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Hi guys,
So I came across another accounting question which has been playing ‘stuck in the mud’ with me since i first started the course. The question asks the following:
Compared to using a capital lease, a lessee that uses an operating lease will most likelyreport higher:A. cash flow from operating activitiesB. cash flow from investing activitiesC. cash flow from financing activitiesWhile i understand that a capital lease treats the two parts of lease payment (i.e. interest and principal) as different categories of cash flows, while operating leases treats the entire lease as operating cash flow. I don’t really understand why the solutions seem to think that the answer is C.
Simply put, what is the reason behind the fact that CFs from financing activities are higher in operating leases (which treats the entire lease payment as operating and none as financing) than capital leases?thanks in advance!
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Hi,
This is a typical CFA trick question.
As you point out for a capital lease the negative cash flow from the lease is split in two (cash flow from operating and cash flow from financing activities), while for an operational lease the negative cash flow from the lease is all classified as cash flow from operating activities.
Because the cash flows are negative the capital lease will result in lower cash flows from financing activities, and the flipside of this argument is the answer that operating leases result in higher cash flows from financing activities (compared to a capital lease).
I hope this makes sense?
All the best, -
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