CORPORATE FINANCIAL REPORTING 10 - Liabilities II

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CORPORATE FINANCIAL REPORTING

10 - Liabilities II

Long-Lived Assets

Corporate Financial Reporting - Leases

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LEASES: A FINANCIAL REPORTING NIGHTMARE

You fly to San Diego after the course is over.


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LEASES: A FINANCIAL REPORTING NIGHTMARE

Is the car your asset?

http://www.buyagift.co.uk/products/2073.htm


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But if you were a publicly

traded

company would you want to do

that?

LEASES, MAYBE OK FOR YOU


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SIMPLE LEASE EXAMPLEEquipment costs $30,000 new, LESSEE leases the equipment for 3 years, payments at the END of the year. Lessee estimates a residual value of $20,000 at the end of the 3 years and wants to earn 10%/year. The equipment has a 7 year life.

To T1 T2 T3

| | | |

30,000 20,000


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SIMPLE LEASE EXAMPLEHOW MUCH ARE THE ANNUAL LEASE

PAYMENTS?

To T1 T2 T3

| | | |

$ 30,000 20,000

( 15,026) pv

$14,974


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SIMPLE LEASE EXAMPLE

If you were the CEO of a publicly traded company leasing this equipment, would you like to record this equipment as your

asset and liability?


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SIMPLE LEASE EXAMPLE

Suppose you “believed” the equipment was not your asset and so you did not record the asset or liability – in financial reporting terminology you would be saying the lease was an “operating lease.”


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SIMPLE LEASE EXAMPLEif it is an Operating Lease

To T1 T2 T3

| | | | $6,021 $6,021 $6,021

When rent is paid: cash decreases $6,021 and there is rent expense of $6,021 on the income statement.


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SIMPLE LEASE EXAMPLEif it is a Capital Lease

Now, suppose you did believe the equipment was your asset - you would show the equipment as an asset and also a liability – in reporting terminology you would be saying the lease were a “capital (or finance) lease.”


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To T1 T2 T3

| | | |

$ 30,000 20,000

At To: When lease is signed: show an asset and liability for the present value of future payments of ($6,021) which would be $14,974. (Assume for now, the residual value was not guaranteed by the lessee.)


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Lessee is making 3 payments of $6,021- a total of $18,063; the liability is recorded at $14,974. The difference of $3,089 represents what?


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To T1 T2 T3

| | | |

$ 30,000 20,000

At T1 - T3 : When each payment is made, part of the payment is interest and part a payment toward the lease liability.

Also, the asset has been used for a year and should

be depreciated.


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COMPARISON OF INCOME STATEMENTS

OPERATING CAPITAL

YEAR 1 $6,021 1,497 + 4,991 = 6,488

YEAR 2 6,021 1,045 + 4,991 = 6,036

YEAR 3 6,021 547 + 4,992 = 5,539

Total $18,063 $18,063


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LEASES – REPORTING SUMMARYBalance sheet: capital lease increases liabilities (and the “worst ones” at that) and increases non-current assets.

Income statement: capital lease reduces income more in the early years of the lease.

Cash flow statement: Opposite effect! capital lease payments divided between operating activity and financing activity – operating leases are operating activities.


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LEASES – WHICH IS IT?(or what to do to avoid capital leases)

Can the lessee cancel the lease? no

yes

Does title transfer at the lease end? yes BOO !

no CAPITAL

Is there a bargain purchase option? yes LEASE no

Is the lease for ≥ ¾ of the asset’s useful life? yes

no

Is the PVMLP ≥ 90% assets fair value? yesno

HURRAY ! OPERATING LEASE


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LEASESAdditional Considerations

Residual value - unguaranteed or guaranteed

Executory costs

Lessor Accounting


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LEASES – WHAT TO DO WHEN READING FINANCIAL STATEMENTS:

IAS and American GAAP differ in detail, but both do

give you a method to “undo” management

“maneuvers” to avoid capital leases.


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Using Sony Corporation as an example.

•http://www.sony.net/SonyInfo/IR/financial/ar/2006/index.html

http://www.sony.net/SonyInfo/IR/financial/ar/2006/index.html


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Sony CorporationBalance Sheet(in $ million)

{original}

Current assets 3,218 Current liabilities 27,352PP&E 11,868 Long-term liabilities 35,613

Other assets 75,579 Owners’ equity 27,700

Total assets 90,665 Total L. & OE 90,665


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Current assets 3,218 Current liabilities ??PP&E ??

Other assets 75,579 Long-term liabilities ??

Owners’ equity 27,700

Total assets Total L. & OE


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in $ millionYear ending CAPITAL OPERATINGMarch 31: LEASES LEASE

2007 157 4062008 82 2972009 46 2272010 26 1392011 18 98

Later years 40 504Total 369 1,671less interest (42) Present value 327 less current portion (145) Long-term portion 182


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{revised}

Current assets 3,218 Current liabilities ??PP&E ??

Other assets 75,579 Long-term liabilities ??

Owners’ equity 27,700

Total assets Total L. & OE


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In general, if it is a capital lease for the lessee, then the lessor considers the asset to be sold, but not always.

To be considered “sold” the lessor has two additional criteria that must be met.


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LEASES

QUESTIONS?

REPORTING OF INCOME TAXES

Two relevant aspects of income taxes:

Tax loss carryback/carryforward(Net Operating Loss or NOL) and

Deferred income taxes

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NET OPERATING LOSS

Our company reports the following: TAX TAX

YEAR IBT RATE PAID 2004 $10,000 25% $2,500 2005 21,000 20 4,200 2006 12,000 30 3,600 2007 (40,000) 30 ?

2008 13,000 30 ?28Corporate Financial Reporting -

Income Taxes


DEFERRED INCOME TAXES

Example will be handed out in class.

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REPORTING OF PENSIONS

There are thousands of different kinds of pension plans, but in general they can be classified

into two types:defined contribution plans anddefined benefit plans

30Corporate Financial Reporting - Pensions


DEFINED CONTRIBUTION PLANS

Pretty simple, but would you want one?



DEFINED BENEFIT PLANS

How they work and terminology are

what are of interest to us.



DEFINED BENEFIT PLANS TERMINOLOGY

Service cost (SC)Projected benefit obligation (PBO)Plan assets (PA)Settlement rate or discount rateRate of return on plan assetsPrior service costUnamortized gains or lossesAccumulated benefit obligation (ABO)



EXAMPLE FOR DEFINED BENEFIT PLAN

1/1/01: we hire an employee & promise her, after retirement she will receive, for the rest of her life, pension payments equal to:

her highest salary *

the number of years she worked for us *

2%.

And to make Congress happy, we will deposit her pension money in Mutual of Omaha.


QUESTIONS?

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Documents

CORPORATE FINANCIAL REPORTING 10 - Liabilities II