simple question regarding how to view a lease as a debt
 

calculation my net worth and am wondering how i should view the lease on my car. is the total lease one big debt that gets lowered every month? this makes the most sense, yet i wouldn't think to view the lease on a rented home in that manner.

Re: simple question regarding how to view a lease as a debt
 

do you calculate your income as a depreciating asset? i don't think cash flows get calculated in current net worth...since you're also gaining utility every month from the car that hasn't been realized yet, right?

Re: simple question regarding how to view a lease as a debt
 

Hi sublime,

While preparing for my CFA exam in 1 week [img]/images/graemlins/ooo.gif[/img], I am expected to know how to account for leases. Therefore, my advice is mostly tailored to evaluating a firm, however I think for the most part, a lease can be treated the same for personal accounting. You may account for a lease as either an operating lease, or a capital lease. There are more incentives to account for a lease as an operating lease rather than a capital lease. If your lease does not meet any of the following criteria, you may classify it as an operating lease (which I think is most like appropriate).

1) Title to the asset is transfered to the lessee after the lease period.
2) A purchase option exists.
3) The lease period is at least 75% of the asset's economic life.
4) The present value of lease payments is greater than 90% of the fair value of the leased asset.

Most likely your car lease (and probably rented home) does not meet any of these criteria, so you should account for it as an operating lease. Your intuition is correct about your home, and your car is similar.

Think of it simply as a rental, for which you expense the payments in the period they are incurred and do not depreciate any interest/payments made on the lease. When you begin the lease, you would not add the present value of the lease to your assets. These are the primary differences between an operating lease and a capital lease. For a capital lease, you would increase your assets (annd liabilities) at the beginning of the lease, and decrease the value of the lease each period by the payment minus the interest expense. At the end of the period, the value would be zero.

Hope this helps. I can address more specific questions if you have them.

Clark

Re: simple question regarding how to view a lease as a debt
 

Yes, a lease is debt with no asset to offset it.

Jimbo

Re: simple question regarding how to view a lease as a debt
 

Don't most car leases have a purchase option?

Re: simple question regarding how to view a lease as a debt
 

Hi emon87,

I'm not sure if most do or don't. More importantly, I'm not sure about the exact terms of sublime's lease, so I gave information about how to decide which accounting method to use. I hoped to make clear that my recommendation was based on an assumption, and if the particular lease terms were different than I assumed, sublime could still choose the correct accounting method.

Clark

Re: simple question regarding how to view a lease as a debt
 

[ QUOTE ]
Don't most car leases have a purchase option?

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Yes, but that is not relevant to it being a debt with no offsetting asset in a net worth computation. You lease payments do not effect the guaranteed purchase price at the end of the lease.

If you lease a car today and one week from today you want to buy it you will owe the total of all the lease payments plus the buyout price. This is why it has no asset value.

Jimbo

Re: simple question regarding how to view a lease as a debt
 

clark,

36months, xxx amount per month, option to buy which i will most likely decline.

on one hand its a debt, since i am legally obliged to make payments otoh it doesn't 'feel' right to count it as a debt.

Re: simple question regarding how to view a lease as a debt
 

[ QUOTE ]
on one hand its a debt, since i am legally obliged to make payments otoh it doesn't 'feel' right to count it as a debt.


[/ QUOTE ]

This may help. look at it like an office space. Wouldn't you consider that a debt with no asset value? If you went out of business you could still sleep in but that doesn't mean you still don't owe the money. Most leases won't allow you to sublease either so no legal way to recover your value. You can "sell/transfer" a lease to another qualified lessee with approval and then your net worth increases by the amount of debt you released.

Jimbo

Re: simple question regarding how to view a lease as a debt
 

isnt it better to just look at it in a cashflow sense? i mean i am always going to have to pay for electricty, but i dont count that as a 100k liftime debt.

Re: simple question regarding how to view a lease as a debt
 

[ QUOTE ]
isnt it better to just look at it in a cashflow sense? i mean i am always going to have to pay for electricty, but i dont count that as a 100k liftime debt.

[/ QUOTE ]

You can look at it however you like but that doesn't change the accounting guidelines that say a lease obligation is simply a debt with no ofsetting asset.

As for your electricity you didn't sign a contract with the electric company. You can choose to live in a tent if you like, for that matter if you intend on defaulting on your lease don't use it in your net worth calculation either, use the judgement the court will levy.


Jimbo

Re: simple question regarding how to view a lease as a debt
 

Intuitively, it is not a debt. It's more like a service for which he pays periodically. If he croaks, and his estate is liquidated, the lease more than likely does not enter into the picture.

But I'm not an accountant(thank God), nor do I play one on tv.

Re: simple question regarding how to view a lease as a debt
 

[ QUOTE ]
If he croaks, and his estate is liquidated, the lease more than likely does not enter into the picture.


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Just curious as to why you would think that to be true?

Jimbo

Re: simple question regarding how to view a lease as a debt
 

[ QUOTE ]
clark,

36months, xxx amount per month, option to buy which i will most likely decline.

on one hand its a debt, since i am legally obliged to make payments otoh it doesn't 'feel' right to count it as a debt.

[/ QUOTE ]

And your "feel" would be right in a sense. If you're going to consider the lease as debt in calculating net worth, you'd also have to consider the ability to use the car for the remainder of the lease as an asset. In almost any reasonable scenario except one involving high and unanticipated inflation, the latter would not completely offset the former, but it's something to take into account.

Re: simple question regarding how to view a lease as a debt
 

[ QUOTE ]
isnt it better to just look at it in a cashflow sense? i mean i am always going to have to pay for electricty, but i dont count that as a 100k liftime debt.

[/ QUOTE ]

Yeah I kind of see it from this angle. You are obligated to pay your cable bill, energy bill, water, etc... but I certainly wouldn't count it as traditional "debt".

I am renting an apartment right now and my lease runs for 3 more months @ $810/mo. I don't consider this $2,400 of debt when calculating my net worth. I just treat it as money that comes and goes, and is never really mine.

Re: simple question regarding how to view a lease as a debt
 

[ QUOTE ]
And your "feel" would be right in a sense. If you're going to consider the lease as debt in calculating net worth, you'd also have to consider the ability to use the car for the remainder of the lease as an asset. In almost any reasonable scenario except one involving high and unanticipated inflation, the latter would not completely offset the former, but it's something to take into account.


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Completely useless when computing a net worth calculation. The reason is you are paying only for the continuing depreciation of the leased automobile. It is different than being upside down in a regular financed automobile. The difference between what you could sell the car for and your principal balance is your equity minus your debt balance so the auto is an asset, but in the example I gave you still have a negative offset. In a lease you have absolutely no principal equity, future use of the vehicle is not considered an asset on a balance sheet.

Jimbo

Re: simple question regarding how to view a lease as a debt
 

[ QUOTE ]
[ QUOTE ]
And your "feel" would be right in a sense. If you're going to consider the lease as debt in calculating net worth, you'd also have to consider the ability to use the car for the remainder of the lease as an asset. In almost any reasonable scenario except one involving high and unanticipated inflation, the latter would not completely offset the former, but it's something to take into account.


[/ QUOTE ]

Completely useless when computing a net worth calculation. The reason is you are paying only for the continuing depreciation of the leased automobile. It is different than being upside down in a regular financed automobile. The difference between what you could sell the car for and your principal balance is your equity minus your debt balance so the auto is an asset, but in the example I gave you still have a negative offset. In a lease you have absolutely no principal equity, future use of the vehicle is not considered an asset on a balance sheet.

Jimbo

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Huh? Who cares what's considered an asset by some specific set of accounting rules (which btw differ significant from country to country and one time period to another and exist mainly for investor convenience) - does the OP have to file his personal accounting records with the SEC? The question is whether the ability to use the vehicle worth something to the OP or not. Whether he can sell it is irrelevant from an accounting standpoint - it merely affects its valuation (obviously a liquid asset is worth more than an illiquid asset).

Re: simple question regarding how to view a lease as a debt
 

[ QUOTE ]
Huh? Who cares what's considered an asset by some specific set of accounting rules (which btw differ significant from country to country and one time period to another and exist mainly for investor convenience) - does the OP have to file his personal accounting records with the SEC? The question is whether the ability to use the vehicle worth something to the OP or not. Whether he can sell it is irrelevant from an accounting standpoint - it merely affects its valuation (obviously a liquid asset is worth more than an illiquid asset).

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Phone Booth,

You seem like areal smart person and I enjoy your posts but the OP wrote "calculation my net worth and am wondering how i should view the lease on my car." so perhaps my post has everything to do with answering his question and yours is off topic though has value in and of itself, just not in reply to OP's initial question. I assumed he wanted accuracy, not esoteric fantasy.

Jimbo