simple question regarding how to view a lease as a debt

sublime · #1 11-25-2007, 12:19 AM

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.

technologic · #2 11-25-2007, 01:06 AM

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?

Grizwold · #3 11-25-2007, 01:33 AM

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

Jimbo · #4 11-25-2007, 01:36 AM

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

Jimbo

emon87 · #5 11-25-2007, 01:39 AM

Don't most car leases have a purchase option?

Grizwold · #6 11-25-2007, 01:45 AM

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

Jimbo · #7 11-25-2007, 01:45 AM

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

[/ QUOTE ]

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

sublime · #8 11-25-2007, 01:52 AM

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.

Jimbo · #9 11-25-2007, 02:08 AM

[ 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

sublime · #10 11-25-2007, 02:15 AM

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.