CFAI Mock AM #14 and #15 - Operating lease to finance lease

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Hi guys,
I’d appreciate some help if anyone can explain if problems #14 and #15 .
In problem #15, the question asks for the Interest coverage ratio in 2013 after capitalizing the operating leases… is it referring to the same lease as in #14?
In #14, we adjusted the long-term debt-to-asset ratio by adding the PV of the operating lease to long-term debt and Total assets. I understand that this company, “Aeolus Controls AG”, is the lessor in this scenario because from the lessor’s perspective, the operating lease must be reported in the balance sheets.
However, in problem #15, the question is giving us a scenario of “what if” the operating leases are now finance leases (capitalized lease). As the answer is explained, they adjust EBIT using = EBIT + operating lease payments - depreciation.
Ok…so I understand that we add operating lease payments BACK INTO EBIT to show the reversal effect of “what if” the lease is now capitalized. However, from a lessor’s perspective, do we still add back the operating lease payments?
I’m so d**n confused…
 
If I remember correctly Q14 refers to the year after Q15.
I think the PV figure for Q15 has already been calculated for you in the vignette so it is just case of adjusting the statements to represent a finance lease rather than an operating lease. If the lease is classed as a finance lease, then obviously the leasee won’t be paying operating lease payments anymore so we add them back to EBIT. but they will be paying the interest charge on the lease, so we add that to the interest payments before calculating the interest coverage ratio.
 
I think the problem is that your assumption that this is from a lessor’s perspective is incorrect. The income statement shows there were lease payments so you know right there this is the lessee you’re dealing with.
 
I got this questino right , but i did it slightly differently than the answer key..did i just get lucky?
Computing the PV of interest PMTs to add back …
CF0=0
CF1=126
CF2=130 F=4
CF3= 240 F=1
i.y= 6% NPV>CPT> 713
did i just get lucky here? i don’t really understand what they are doing solving PVA for 3 and 4 Yrs of 80/Year..
Any one else do this?
 
14 I understand now (although got wrong)
One key is the beginning of the year payments. they dont point that out.. you have to notice that the lease payments are due Jan 1st -beginning of the year.
what they are doing is calculating the pv of the lease payments at the end of 2014.that means we are looking at the value of whats left after all activity in 2014. so the 126 i dont think belongs.
from this we look at note 18. we see 4 payments for 130, then we see 1 for 80 and terminal one for 240 (which is 3 80 payments) present value those back and you get the value. (i think you were lucky)

my question is on #15. it says you depreciate the 606 straight line over the remaining life of the lease. (6 years) maybe im adding wrong, but im counting 9- (the 8 from 2015 on and the one from 2014)
also since this is before reducing the lease life from 10 to 8, why isnt it prorated at 11 for 2013?
if someone would clarify this i appreciate it.
 
gad4, really great question. This has me totally stumped. My best guess is that the wording of Note 7 indicates that the useful life assumption has been changed from 10 years to 8 years, but this has nothing to do with the remaining life. So you do 606/8 years to calculate depreciation on newly recognized assets in 2013, since 8 years is the newest, most correct assumption for useful life. That is so confusing
 
Aelus Controls AG is the lessee in this problem.
I have a question related to #15… does anyone know why they use interest EXPENSE instead of interest PAYMENT?? In the front of the FRA book says that interest coverage ratio is based on interest payment (not expense)… i believe the problem gave us both info.
here’s a link to a post i initiated earlier with more details
http://www.analystforum.com/forums/cfa-forums/cfa-level-ii-forum/91343449
 
cebrach–they give you “Interest expense” (which I think is equivalent to “interest payment”) and “Cash interest paid.” For the calculation of interest coverage ratio, you use interest expense/interest payment, not cash interest paid.
 
ks (book 2 pg 36) defines as interst coverage ratio as ebit/income expense.
the thing that sticks out regarding the cash interst paid is its more a cash flow number rather than an accruals based number.
nr2004. thanks for your response. like you im still not sure how they got the 8. hopefully someone with more input can deciper it.
(i cant believe how long i spent ton this one)
 
I thought the cash interest paid would represent the interest payment… thanks for the help guys!
 
hi sorry to bring up 2015 question, can I check for Qn 14, when we adjust from operating lease to finance lease, in this qn, how come we do not omit the ‘current portion’ of the debt, when adding the PV of the operating lease to form the new ‘L-T Debt’?
 
inchvbeam wrote:
hi sorry to bring up 2015 question, can I check for Qn 14, when we adjust from operating lease to finance lease, in this qn, how come we do not omit the ‘current portion’ of the debt, when adding the PV of the operating lease to form the new ‘L-T Debt’?
Click to expand...
Because current-non current debt reclassification doesn’t mater for credit analysis (int.coverage, financial leverage metrics). Current-non current debt makes sense with liquidity ratios only not to solvency ratios.
 
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