Liabilities

Appendix 3: Leases

Oktay Urcan
Leases
A lease is an agreement between a lessor and a
lessee where the lessee has the right to use an
asset of the lessor for a specific period and a pre-
specified periodic payment.

Starting with December 2018, most of the leases are

capitalized for financial reporting purposes under
U.S. GAAP.
Lease Accounting
Lease accounting at inception:
Calculate present value of future lease payments.
Recognize this amount as an asset and as a liability.

Lease accounting after inception:

Calculate periodic interest expense based on the
amount of liability and the discount rate.
Calculate periodic asset depreciation based on asset
life.
Lease: Example

Firm A leases a truck from Firm B for 5 years. Firm A will

pay $5,000 at the end of every year for the next 5 years.
Assume that discount rate of Firm A is 10%. Also, assume
that the truck has 5 years of life.

Note: The leased asset life is independent of the lease

term.
Lease: Example

Firm A leases a truck from Firm B for 5 years. Firm A will pay $5,000 at
the end of every year for the next 5 years. Assume that discount rate
of Firm A is 10%. Also, assume that the truck has 5 years of life.
Lease accounting at inception:
• Calculate present value of future lease payments.
• Recognize this amount as an asset and as a liability.

Present value of future lease payments = ($5,000)(1-1.1-5)/0.1 = $18,954

 Lease at Inception: Example
Firm A leases a truck from Firm B for 5 years. Firm A will pay $5,000 at the end of every
year for the next 5 years. Assume that discount rate of Firm A is 10%. Also, assume that
the truck has 5 years of life.
Assets = Liabilities + Shareholders’ equity
Cash Lease Asset Lease Payable Income Statement
Lease
$18,954 $18,954
inception
 Lease After Inception: Example
Firm A leases a truck from Firm B for 5 years. Firm A will pay $5,000 at the end of every
year for the next 5 years. Assume that discount rate of Firm A is 10%. Also, assume that
the truck has 5 years of life.
Assets = Liabilities + Shareholders’ equity
Cash Lease Asset Lease Payable Income Statement
Lease
$18,954 $18,954
inception

Year 1 ($3,791) ($3,791)

Depreciation Expense:
$18,954 / 5
 Lease After Inception: Example
Firm A leases a truck from Firm B for 5 years. Firm A will pay $5,000 at the end of every
year for the next 5 years. Assume that discount rate of Firm A is 10%. Also, assume that
the truck has 5 years of life.
Assets = Liabilities + Shareholders’ equity
Cash Lease Asset Lease Payable Income Statement
Lease
$18,954 $18,954
inception

Year 1 ($3,791) ($3,791)

Year 1 ($5,000) ($3,105) ($1,895)

$5,000 - $1,895 Interest Expense:

$18,954 *10%
 Lease After Inception: Example
Firm A leases a truck from Firm B for 5 years. Firm A will pay $5,000 at the end of every
year for the next 5 years. Assume that discount rate of Firm A is 10%. Also, assume that
the truck has 5 years of life.
Assets = Liabilities + Shareholders’ equity
Cash Lease Asset Lease Payable Income Statement
Year 1 Ending
($5,000) $15,163 $15,849 ($5,686)
Balances

Year 2 ($3,791) ($3,791)

Year 2 ($5,000) ($3,415) ($1,585)

$5,000 - $1,585 Interest Expense:

$15,849 *10%
 United Airlines Leases 2018

Present value of future capital lease obligations is $1,283 (in millions).

United Airlines Leases 2018
One can calculate discount rate of United Airlines from the lease
disclosure footnote.
Suppose that lease payments after 2023 will be equally paid over the
next 7 years.

Year 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
Amount -$1,283 $308 $170 $147 $123 $104 $181 $181 $181 $181 $181 $181 $181
IRR 9%

IRR is the internal rate of return which makes present value of future
lease payments to be equal to current present value.

Lease discount rate for United Airlines is 9%