Chapter 10: Reporting and Analyzing Leases, Pensions, and Income Taxes Class Homework Solutions

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1 M a. i. 1/3 No entry 12/31 Rent expense (+E, -SE). 12,000 (-A) 12,000 ii. 1/3 d asset (+A).. 57,198 liability (+L) 57,198 $57,198 = $12,000 x /31 Depreciation expense (+E, -SE)... 9,533 Accumulated depreciation (+XA) 9,533 $9,533 = $57,198 / 6 12/31 liability (-L) 7,996 Interest expense (+E, -SE) 4,004 (-A) $4,004 = $57,198 x 0.07; $7,996 = $12,000 - $4,004 12,000 b. + (A) - - (L) + 12,000 12/31 57,198 1/3 12/31 7,996 + d Asset (A) - + Interest (E) - 1/3 57,198 12/31 4,004 - Accumulated Depreciation (XA) + + Depreciation (E) - 9,533 12/31 12/31 9,533 c. Transaction Signed a capital lease. Depreciation on leased asset. Made annual lease payment. Asset + -12,000 Noncash Assets - +57,198 d Asset Balance Sheet Contra Assets = Liabilities + - = +57, ,533 Accum. - = -7,996 Contrib. Capital + = -9,533 Income Statement Earned Capital Revenues - s = -4,004 - = - +9, ,004 Interest Net Income = -9,533 = -4,004 Solutions Manual, Chapter

2 M a. b. 7/1 d asset (+A).. 123,100 liability (+L). 123,100 $123,100 = $4,500 x /30 Depreciation expense (+E, -SE).. 3,078 Accumulated depreciation (+XA, -A). 3,078 $3,078 = $123,100 / (10 x 4) 9/30 liability (-L).. 2,038 Interest expense (+E, -SE) 2,462 (-A) 4,500 $2,462 = $123,100 x (0.08/4); $2,038 = $4,500 - $2,462 12/31 Depreciation expense (+E, -SE).. 3,078 Accumulated depreciation (+XA, -A). 3,078 12/31 liability (-L).. 2,079 Interest expense (+E, -SE) 2,421 (-A) 4,500 $2,421 = ($123,100 - $2,038) x (0.08/4); $2,079 = $4,500 - $2,421 c. + (A) - - (L) + 4,500 9/30 123,100 7/1 4,500 12/31 9/30 2,038 12/31 2,079 + d Asset (A) - + Interest (E) - 7/1 123,100 9/30 2,462 12/31 2,421 - Accumulated Depreciation (XA) + + Depreciation (E) - 3,078 9/30 9/30 3,078 3,078 12/31 12/31 3, Financial Accounting, 5 th Edition

3 d. Balance Sheet Income Statement Transaction Asset + Noncash Assets - Contra Assets = Liabilities + Contrib. Capital + Earned Capital Revenues - s = Net Income 7/1/17 Signed a capital lease. +123,100 d Asset - = +123,100 - = 9/30/17 Depreciation on leased asset. Accum. 9/30/17 Made quarterly lease payment. -4,500 - = -2,038-2, ,462 Interest = -2,462 12/31/17 Depreciation on leased asset. Accum. 12/31/17 Made quarterly lease payment. -4,500 - = -2,079-2, ,421 Interest = -2,421 e. 7/1 No entry 9/30 Rent expense (+E, -SE) 4,500 (-A) 4,500 12/31 Rent expense (+E, -SE) 4,500 (-A) 4,500 The amount of rent expense recognized if the lease is treated as an operating lease is $9,000 ($4,500 + $4,500). However, if the lease is treated as a capital lease, interest and depreciation are recognized. The total expense for 2017 is $11,039 ($2,462 + $2,421 + $3,078 + $3,078). The capital lease method tends to report higher expense in the early periods of the lease. Solutions Manual, Chapter

4 M a. Capital leases require a company to record both the leased asset and the lease liability on the face of the balance sheet. Operating leases, by contrast, do not require a company to record either the leased asset or the lease liability. They are, as a result, a common technique to achieve off-balance-sheet financing. Concerning the income statement, capital leases result in depreciation of the leased asset and interest expense on the lease liability. Operating leases record only rent expense. b. Analysts frequently add the present value of the operating lease payments to both assets and liabilities, thus capitalizing the operating lease. This adjustment improves the interpretation of measures of financial leverage and operating performance. If Yum! s operating lease commitments in total are substantial, they could have a significant impact on the assessment of financial leverage. Yum! indicates no individual lease is material. However, the total commitment could be substantial. M a. Exxon Mobil is reporting $1,378 million in pension expense for b. Expected returns are an offset to service and interest costs and serve to reduce reported pension expense. c. Expected refers to the use of long-term average returns for the investment portfolio. Expected returns are used in the computation of pension expense, rather than actual returns, in order to smooth reported income. M a. A&F maintains a defined contribution plan for the benefit of its employees. b. Contributions are expensed when made. The entry to record expenses for 2014 was ($ millions): Pension expense (+E, -SE) 13.8 (-A) 13.8 c. Only the unpaid contribution, if any, appears on the A&F balance sheet Financial Accounting, 5 th Edition

5 E a. Target maintains only a defined contribution plan for the benefit of its employees. b. Contributions are expensed when made. c. Only the unpaid contribution, if any, appears on Target s balance sheet. d. First, employees who do not meet the unspecified eligibility requirements will not be covered. Second, matching contributions can be reduced or eliminated in bad times. Third, employees covered by defined contribution plans must choose how those funds are invested and, consequently, they bear all of the risks of price volatility. E a. The Home depot reports $684 million as capital lease obligations in its 2014 balance sheet. This amount is reported as $648 million in non-current liabilities and $36 million as a current liability. At the inception of these leases, the leased assets and lease obligations were equal to the present value of the minimum lease payments. Since that point in time, however, the leased assets are depreciated on a straight-line basis and the lease obligations are amortized using the effective interest method. The result is that the net asset value declines faster than the liability. At the end of fiscal 2014, assets totaled $557 million and obligations totaled $684 million. b. Present value = $6,123 million using the NPV function in Excel: c. Home Depot s D/E ratio was 3.29 ([$39,946 million - $9,322 million]/$9,322 million). Adding capitalized operating leases would increase the ratio to 3.94 ([$39,946 million + $6,123 million - $9,322 million]/$9,322 million). Solutions Manual, Chapter

6 E a. According to Verizon s lease footnote, it has both capital and operating leases. Only the capital leases are reported on-balance sheet in the amount of $516 million ($158 million in current liabilities and $358 million as long-term liabilities). This is not the total obligation to its lessors. Verizon also has a significant amount of leases that it has classified as operating. In fact, the minimum lease payments under operating leases are 24 times that for capital leases! These operating leases are not reported onbalance-sheet. b. Although capital leases are reported as an asset and liability on the balance sheet, neither the leased asset nor the lease obligation is reported on the balance sheet for Verizon s operating leases. As a result, total assets and total liabilities are lower than they otherwise would be if these leases were reported as capital leases. Over the life of the lease, total rent expense under operating leases will be equal to the interest and depreciation expense that would have been recorded under capital leases. Profit is unaffected by this classification. During any given year during the life of the lease, however, the two will not be equal. Even if depreciation is computed on a straight-line basis, interest is accrued based on the balance of the lease obligation which is higher in the earlier years of the lease. As a result, depreciation plus interest will exceed rent expense during the early years of the lease life and will be less toward the end of the lease. c. Interest expense will be $23 million. The entry for 2015 is as follows: liability (-L). 158 Interest expense (+E, -SE) 23 (-A) d. The present value of Verizon s operating leases totals $11,832 million. This amount would be added to Verizon s noncurrent assets and to its lease obligations if these operating leases were reported as capital leases Financial Accounting, 5 th Edition

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