Financing Cash Flows from Finance Leases: A Comprehensive Guide

Finance leases have become an increasingly popular option for organizations looking to acquire assets without bearing the full burden of ownership. With the implementation of accounting standards such as ASC 842 and IFRS 16, the treatment of finance leases in cash flow statements has undergone significant changes.

In this guide, we will explore everything you need to know about financing cash flows from finance leases, including the impact on your organization's cash flow statement and how to properly classify and present these transactions.

What is the Statement of Cash Flows for ASC 842 and IFRS 16?

The statement of cash flows is a financial statement that provides information about the cash inflows and outflows of an organization during a specific period. It is a crucial tool for assessing an entity's liquidity, solvency, and overall financial performance. With the implementation of ASC 842 and IFRS 16, the statement of cash flows has undergone significant changes in how finance leases are accounted for and presented.

How Do You Present a Finance Lease on a Cash Flow Statement?

Presenting a finance lease on a cash flow statement requires careful consideration of the nature of the lease and the cash flows associated with it. Under ASC 842 and IFRS 16, finance lease payments are divided into two components: principal payments and interest payments.

The principal payments are classified as financing cash flows, while the interest payments are classified as operating cash flows. This classification is important for accurately reflecting the cash flows generated by finance leases and providing users of financial statements with a clear understanding of the organization's financing activities.

How Does the Recognition of an ROU Asset and a Lease Liability Affect a Lessee and Lessor's Cash Flow Statements?

The recognition of a right-of-use (ROU) asset and a lease liability can have a significant impact on both the lessee's and lessor's cash flow statements. For a lessee, the initial recognition of an ROU asset and lease liability results in an increase in financing cash outflows and a decrease in operating cash outflows.

On the other hand, for a lessor, the recognition of a lease liability may result in an increase in financing cash inflows and a decrease in operating cash inflows. It is important for both lessees and lessors to understand the impact of these recognition events on their cash flow statements and to properly classify and present the associated cash flows.

How Do You Classify Lease Cash Incentives and Initial Direct Costs?

Lease cash incentives and initial direct costs can complicate the classification of cash flows from finance leases. Under ASC 842 and IFRS 16, lease cash incentives are generally considered to be financing cash flows for lessees and operating cash flows for lessors.

On the other hand, initial direct costs are typically classified as operating cash flows for both lessees and lessors. It is important for organizations to carefully evaluate the nature of these transactions and properly classify and present the associated cash flows in their cash flow statements.

How Does a Lessee Recognize Lease Payments when the Short-Term Policy Election Applies?

Under ASC 842, lessees have the option to apply a short-term lease policy for leases with a term of 12 months or less. When the short-term policy election applies, lessees are not required to recognize a lease liability or an ROU asset on their balance sheets.

Instead, lease payments associated with short-term leases are recognized as operating cash outflows. This policy simplifies the accounting treatment for short-term leases and provides lessees with greater flexibility in managing their cash flow statements.

How Do You Show Lease Liability on a Cash Flow Statement?

The presentation of lease liability on a cash flow statement depends on the nature of the lease and the classification of cash flows. For finance leases, the lease liability is classified as a financing cash outflow for lessees and a financing cash inflow for lessors.

On the other hand, for operating leases, the lease liability is typically not directly presented on the cash flow statement. Instead, the associated cash flows are classified as operating cash outflows for lessees and operating cash inflows for lessors.

Where Are ROU Assets Recorded on the Cash Flow Statement?

The recording of right-of-use (ROU) assets on the cash flow statement depends on the classification of cash flows. For finance leases, the ROU asset is not directly presented on the cash flow statement.

On the other hand, for operating leases, the ROU asset is typically not directly presented on the cash flow statement either. Instead, the associated cash flows are classified as operating cash outflows for lessees and operating cash inflows for lessors.

Cash Flow Statement Methods for Finance Leases

When preparing cash flow statements for finance leases, organizations have several methods to choose from. The most commonly used methods include the direct method and the indirect method.

The direct method involves the direct presentation of cash inflows and outflows, providing a clear and transparent view of an organization's cash flow activities. On the other hand, the indirect method starts with net income and adjusts for non-cash items to arrive at cash flows from operating activities.

Organize Your Statement of Cash Flows Under ASC 842 with LeaseCrunch

ASC 842 has introduced significant changes to the accounting treatment and presentation of finance leases in cash flow statements. To ensure compliance and streamline the process, organizations can leverage LeaseCrunch, a leading lease accounting software.

LeaseCrunch provides a user-friendly platform that simplifies the organization and preparation of cash flow statements under ASC 842. With LeaseCrunch, organizations can easily classify and present cash flows from finance leases, ensuring accurate and compliant financial reporting.

Eliminate Lease Accounting Errors with LeaseCrunch

Lease accounting errors can have serious implications for an organization's financial statements and overall financial health. With the implementation of ASC 842 and the increased complexity of finance lease accounting, it is essential for organizations to eliminate errors and ensure accurate lease accounting.

LeaseCrunch offers a comprehensive solution to eliminate lease accounting errors. By automating lease calculations, classifications, and presentations, LeaseCrunch minimizes the risk of errors and ensures compliance with ASC 842 and other accounting standards.

Conclusion

Financing cash flows from finance leases require careful consideration and accurate presentation in cash flow statements. With the implementation of ASC 842 and IFRS 16, organizations must understand the impact of these accounting standards on their cash flow statements and ensure compliance with the new requirements.

By properly classifying and presenting cash flows from finance leases, organizations can provide users of financial statements with a clear and transparent view of their financing activities. Leveraging tools like LeaseCrunch can further simplify the process and eliminate the risk of lease accounting errors.