Lease Accounting: Operating Leases, Finance Leases, and the Confusing, Changing Rules

For all the files and resources for this video, please go to:

Table of Contents:

0:00 Introduction

4:41 Part 1: Operating Leases vs. Finance Leases (Capital Leases)

6:04 Part 2: Finance Leases and Operating Leases Under IFRS

10:29 Part 3: The U.S. GAAP Treatment of Operating Leases

14:20 Part 4: Leases in Real Life in 3-Statement Models

17:55 Part 5: Valuation Impact, Equity Value, and Enterprise Value

20:59 DCF Impact

24:25 Part 6: What Do You Need to Know for Interviews?

25:38 Recap and Summary

[financialmodeling]

For the files and resources, please see:


No, not every single example is available there, but most of them are. It's a complicated and confusing topic, so we are sharing the most useful bits.

[ankurdhawan]

Thank you so much brother for explaining this topic with example, I was really struggling with this topic but your video really simplified the whole process.

[qwobify]

Germans are notorious for technical interview questions. Had a German PE partner interview me today (I’m based in London) and the first question he asked me was to state the journal entries when creating a deferred tax liability…

[raptokvortex]

Just covered this in my accounting exam

[njabulov.hadebe]

i love these videos so much. i wish youtube can pay you as much as you want for these videos. pure class and excellence! keep going BIWS

this is a confusing topic, how would one get to know what the lease details are for a company in the notes to the financial statements?

[thebluesquid]

bro, best video on asc842 and ifrs16...helped me a ton

[StheSharknl]

Thank you for the video Brian, it’s clear! Appreciate the attention to IFRS treatment ;)

[j]

Not sure if I miss anything, but for the first part (2:32) the Lease Asset and Lease Liability under finance lease and IFRS operating lease seemed to be reduced at different rate each year Lease Asset reduced by depre while Lease Liab reduced by Principal repayment) But under GAAP both are decliend in the same rate as Depre=principal repayment. But under file at 19:38 in Balance sheet, Why under IFRS16, ROU asset=Operating Lease while it is unequal under GAAP (ROU asset=225 while Operating lease=210) where does 225 and 210 comes from? Thank you

[jeffreywen]

great video, just had a question about the dcf impact of all IFRS leases and U.S. GAAP capital leases:

I understand why we need to deduct the full lease expense when calculating UFCF because the lease expense is a true cash outflow, and I understand why we need to deduct the finance lease interest expense.

However, why do we deduct the depreciation of the lease (by not adding it back in the non-cash adjustments)? Isn't depreciation non-cash, and since the true cash impact of the lease is the interest expense + the lease principal repayment, shouldn't we deduct the lease interest expense + the lease principal repayment amount, which equals the lease rental expense, and leave the depreciation untouched (add it back normally)? Otherwise, wouldn't the cash outflows be different than in reality when deducting both the interest expense and depreciation because depreciation is just a constant number (lease asset / lease term), while interest expense is constantly changing, and the two numbers when summed together have no relation to the cash lease expense?

thanks for the help

[sebperez]

To calculate unlevered free cash flow, in the case of capital leases (and all
IFRS), don’t you need to:

a) subtract the lease liab interest expense portion from EBIT
B) subtract the lease liab principal repayment portion

Where A+B = the actual cash outflow related to the lease (ie the rent)

And then C) add back all lease asset depreciation because this is non cash and not adding it back would in some
Way be double counting the expense from the lease

[sadsasadsaf]

If I am doing a comp set that includes companies using IFRS and US GAAP... should i treat operating leases as debt for consistency? and then try to find the rental expense for those US GAAP companies (to effectively calculate EV/EBITDAR)?

[maskedcat]

Great video thanks Brian! A follow up question: to calculate levered FCF under US GAAP a quick way would be to take cash flow from operations and minus capex. Under IFRS with leases, would the equivalent be cashflow from operations - capex - lease repayment (under cash flow from investing activities)?

[Retumn]

great video. is most of this informatoin still up to date (I am europe based) ?

[Cool-yhcz]

Hi - Thank you for the in depth review. I am london based hence work mostly with IFRS/pre IFRS. My question is based around Football field and valuation using DCF vs LBO (using pre IFRS guidelines). Under the LBO, we would mostly deduct the leases principal in the CF statement every year and the interest in the NI which will get a tax-saving effect. When doing a DCf, we would adjust for the leases in the EV but will not account for the tax-saving effect. Should we adjust this in the LBO cash flow statment? I might have misunderstood so please let me know if this is not the correct way to approach this question.

[Ivan-hloy]

I have one question, In DCF valuation (Under IFRS16), If we shouldn't add back all depreciation for calculating Unlevered FCF, what about EBIT? We deduct all depreciation include leases portion from Gross profit in Operating Expense ?

[dbsk]

13:24 still only rental income but split into interest vs depreciation off the statements

[KrishanSingh-gzop]

Question 1 :- why are we applying discount rate on leases?
Question 2:- Can I calculate interest cost on leases, by taking interest paid on leases and dividing it by total lease liabilities?

[ngmingchiat]

For the cash flow statement of (Additions Lease Assets) and (Additions to Lease Liabilities), could you briefly tell me, or just show a screenshot of how the answer suppose to be (for IFRS)? and Thank you for your helpful video.

[kevinblack]

How can the ROU asset and liability not balance? What am I missing here?

[pmr]

Is there an argument to be made, treating leases like CapEx but also deducting it from firm value? If I understand it right we have one leases as a debt-like item in the form of the repayment and interest payment and second the CapEx part of taking on new leases to fill in for the ones that expired. This would mean adding back the full depreciation on leases, decucting the lease repayment charge as a proxy for taking on new leases in CapEx and finally the deduction of the lease liability from the firm value.

In the other treatments my value always goes through the roof, which seems to be the lack of taking into account future leases.