IRU Accounting - Financing Lease
Hi all,
I need to model some IRUs for a telco company and wondering if the following accounting would be correct. I think IRUs (20-year fiber leases) should be recognized as follows as they are financing leases, but welcome any opposite views. Obviously this seems a bit messy/complicated, but can't find any good and clear examples online for IRUs paid upfront.
Let's imagine a $80 ROU for 10 years for simplicity, lease payments split as $8 lease and $2 interest
At purchase
Assets
+ 80 ROU
- 80 cash
+80 prepaid expenses
= +80
Liabilities & Equity
+80 financial lease
= +80
Following Years (40% tax rate)
- 8 Depreciation
- 2 interest
= - 6 Net Income
- 6 Net Income
+8 Depreciation
+ 8 prepaid expenses unwind
- 8 lease payments
= + 2 FCF
B/S
Asset
-8 Depreciation
- 8 prepaid expenses
+ 2 FCF
= - 14 Assets
Liabilities & Equity
- 8 Lease Liab
- 6 Equity
= - 14 Liabilities & Equity
Would you do it like that, or rather assume that all liabilities are paid out at IRU purchase, so liabilities = 0 and you just have depreciation flowing through the statements ? In that case, what about the lease interest, how does that flow given this is purely an accounting construct as the IRU are fully prepaid, do you balance it with prepaid expenses?
I don’t know if I’m understanding you correctly but are you calculating depreciation on an ROU or an IRU? Both of these are intangible assets why are you depreciating them? If it is in fact prepaid then it would be a prepaid asset listed on the BS and you expense it when its economic benefit has came and went.
Based on the most helpful WSO content, here's how you can model the IRUs (Indefeasible Rights of Use) for a telco company, assuming they are financing leases:
At Purchase:
Assets: - +$80 ROU (Right of Use) - -$80 Cash - +$80 Prepaid Expenses - Total Assets: +$80
Liabilities & Equity: - +$80 Financial Lease - Total Liabilities & Equity: +$80
Following Years (Assuming a 40% Tax Rate):
Income Statement: - -$8 Depreciation - -$2 Interest - Net Income: -$6
Cash Flow Statement (CFS): - -$6 Net Income - +$8 Depreciation (non-cash expense, added back) - +$8 Prepaid Expenses Unwind - -$8 Lease Payments - Free Cash Flow (FCF): +$2
Balance Sheet (B/S): Assets: - -$8 Depreciation - -$8 Prepaid Expenses - +$2 FCF - Total Assets: -$14
Liabilities & Equity: - -$8 Lease Liability - -$6 Equity - Total Liabilities & Equity: -$14
Alternative Approach:
If you assume all liabilities are paid out at IRU purchase, the liabilities would be $0, and you would only have depreciation flowing through the statements. In this case, the lease interest, which is purely an accounting construct, would be balanced with prepaid expenses.
Income Statement: - -$8 Depreciation - Net Income: -$8
Cash Flow Statement (CFS): - -$8 Net Income - +$8 Depreciation (non-cash expense, added back) - Free Cash Flow (FCF): $0
Balance Sheet (B/S): Assets: - -$8 Depreciation - Total Assets: -$8
Liabilities & Equity: - -$8 Equity - Total Liabilities & Equity: -$8
This approach simplifies the accounting by eliminating the lease liability and focusing on the depreciation expense. The interest component would be accounted for within the prepaid expenses, ensuring the balance sheet remains accurate.
Sources: Difficult Accounting Technical - IBD, DCF Modeling Course ~ Pre-training text.pdf, How do you compute IRR without any negative cash flows?, Beyond the guide: a list of real interview technical questions, Got asked this question in an interview
Is this IRU an expense for your telco company or a revenue source (i.e. you are selling the fiber pair and generating IRU revenue?)
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