Leases Effects of Lease Accounting Impact of Operating Lease when Capital Lease is Apt: Operating lease understates liabilities--improves solvency ratios such as debt to equity Operating lease understates assets-can im prove return on investment ratios Operating lease delays expense recognition--overstates income in early term of the lease and understates income later in lease term Operating lease understates current liabilities by ignoring current portion of lease principal payment--inflates current ratio other liquidity measures Operating lease includes interest with lease rental (an operating expense)-understates both operating income and interest expense, inflates interest coverage ratios, understates operating cash flow,& overstates financing cash flow l-|=
Leases Effects of Lease Accounting Impact of Operating Lease when Capital Lease is Apt: • Operating lease understates liabilities—improves solvency ratios such as debt to equity • Operating lease understates assets—can improve return on investment ratios • Operating lease delays expense recognition—overstates income in early term of the lease and understates income later in lease term • Operating lease understates current liabilities by ignoring current portion of lease principal payment—inflates current ratio & other liquidity measures • Operating lease includes interest with lease rental (an operating expense)—understates both operating income and interest expense, inflates interest coverage ratios, understates operating cash flow, & overstates financing cash flow
Leases Converting Operating Leases to Capital Leases Panel A: Estimate Average Remaining lease term 1997 1996 Capital Operating Capital Operating (1)MLP-Later years (s) 2,052 6,232 2,508 6,140 2)MLP-Last reported year($ 238 486 304 491 (3) Number of later years [(1)+(2) 9 13 13 (4)Add number of years reported 5 853 5 (5) Remaining lease term (years)[(3)+(4)] 14 Panel B: Estimate Interest Rate on Capital Lease (6)MLP in next year(S 286 367 (7)Less principal component ($) 87 115 (8) Interest($)[(6)-(7)] 199 252 (9)Total MLP (S) 3,355 4,186 (10)Less amount reflecting interest ($) 1,163 (11)Present value of lease($)[(9)-(10)] 2, 192 2.748 (12)Interest rate [(8)+(11)] Panel C: Estimate Average MLP per Year on Operating Lease (13) Total MLP (S) 8.766 8,749 (14)Executory cost($)[27.6%*X(13) 2415 (15)MLP net executory cost($)[(13)-(14)] 6,347 6,334 (16) Average remain ing lease term (years)[5 18 (17) Average MLP per year()[(15)+(16)] 353 352 Panel D: Estimate Present Value of Operating Lease (18)Present value of annuity for 18 years at 9% 8.756 8.756 (19)Present value of operating lease($)[(18)x(17)] 3,091 3,082
Leases Converting Operating Leases to Capital Leases Panel A: Estimate Average Remaining Lease Term 1997 Capital Operating Capital Operating (1) MLP – Later years ($) 2,052 6,232 2,508 6,140 (2) MLP – Last reported year ($) 238 486 304 491 (3) Number of later years [(1) (2)] 9 13 8 13 (4) Add number of years reported 5 5 5 5 (5) Remaining lease term (years) [(3) + (4)] 14 18 13 18 1996 Panel B: Estimate Interest Rate on Capital Lease (6) MLP in next year ($) 286 367 (7) Less principal component ($) 87 115 (8) Interest ($) [(6) – (7)] 199 252 (9) Total MLP ($) 3,355 4,186 (10) Less amount reflecting interest ($) 1,163 1,438 (11) Present value of lease ($) [(9) – (10)] 2,192 2,748 (12) Interest rate [(8) (11)] 9% 9% Panel C: Estimate Average MLP per Year on Operating Lease (13) Total MLP ($) 8,766 8,749 (14) Executory cost($) [27.6%* x (13)] 2,419 2,415 (15) MLP net executory cost ($) [(13) – (14)] 6,347 6,334 (16) Average remaining lease term (years) [5] 18 18 (17) Average MLP per year ($) [(15) (16)] 353 352 Panel D:Estimate Present Value of Operating Lease (18) Present value of annuity for 18 years at 9% 8.756 8.756 (19) Present value of operating lease ($) [(18) x (17)] 3,091 3,082
Leases Converting Operating Leases to Capital Leases--Continued 1998 Panel E: Estimate Interest, Executory Costs, and Depreciation on Operating Lease Conversion (20)Present value of operating lease($)[19] 3091 3082 (21)Interest expense($)[(19)x(12) 278 277 (22)MLP in next year(S) 528 556 (23) Executory cost⑤$)[27.6%*x(22〗 (24)Depreciation expense(S)[(20)+(16) 172 171 Panel F: Estimate Effect of Operating Lease Conversion on Income Statement (25)Increase in executory cost ($)[23 (146) (153) (26)Increase in depreciation expense($)[24] (172) (171) (27)Decrease in lease rental expense(s) 528 556 (28)Effect on operating income($) 210 232 (29 )Increase in interest expense()[21] (278) (277 (30)Effect on income before tax($ 68 45 (31)Decrease in tax provision($)[35%x(30)] 24 16 (32)Effect on Income after tax() 44 Panel G: Principal and Interest Components of Next Year's Operating Lease MLP (33)MLP in next year($)[22] 528 556 (34)Interest($)[21] 278 277 (35)Principal component (S)[(33)-( 34)] Panel H: Decompose Operating Lease Liability into Current and Noncurrent Components (36)Total operating lease liability(s)[19] 3,082 (37)Current liability($)[35] 250 279 (38)Noncurrent liability($)[(36)-(37)] 2841 2803
Leases Converting Operating Leases to Capital Leases--Continued Panel E:Estimate Interest, Executory Costs, and Depreciation on Operating Lease Conversion (20) Present value of operating lease ($)[19] 3091 3082 (21) Interest expense ($) [(19) x (12)] 278 277 (22) MLP in next year ($) 528 556 (23) Executory cost ($) [27.6%* x (22)] 146 153 (24) Depreciation expense ($) [(20) (16)] 172 171 Panel F:Estimate Effect of Operating Lease Conversion on Income Statement (25) Increase in executory cost ($) [23] (146) (153) (26) Increase in depreciation expense ($)[24] (172) (171) (27) Decrease in lease rental expense ($) 528 556 (28) Effect on operating income ($) 210 232 (29) Increase in interest expense ($) [21] (278) (277) (30) Effect on income before tax ($) (68) (45) (31) Decrease in tax provision ($) [35% x (30)] 24 16 (32) Effect on Income after tax ($) (44) (29) Panel G: Principal and Interest Components of Next Year’s Operating Lease MLP (33) MLP in next year ($) [22] 528 556 (34) Interest ($) [21] 278 277 (35) Principal component ($) [(33) – (34)] 250 279 Panel H:Decompose Operating Lease Liability into Current and Noncurrent Components (36) Total operating lease liability ($) [19] 3,091 3,082 (37) Current liability ($) [35] 250 279 (38) Noncurrent liability ($) [(36) – (37)] 2,841 2,803 1998 1997 1997 1996
Leases Restated Financial Statements after Converting Operating Leases to Capital Leases-Kmart ncome statements Before $32,183 $32,183 Operating expenses (31402) (31,170) Operating income before interest taxes $781 $1,013 Interest expense (412) Income taxes 120) (104) Net income 249 S220 Balance sheets Before After Before After Current assets $7,476 $7,476 Current liabilities $3,274 $3524 Leased assets(net) 1,032 4,123 Lease obligations 1,179 4.020 Other assets 5,050 5,050 Other liabilities 3.671 3,671 Shareholders'equity 5434 5434 Total assets $13558 16649 Total liab. and equity 135 16649
Leases Restated Financial Statements after Converting Operating Leases to Capital Leases—Kmart Income Statements Before After Sales $32,183 $32,183 Operating expenses (31,402) (31,170) Operating income before interest & taxes $781 $1,013 Interest expense (412) (689) Income taxes (120) (104) Net income $249 $220 Balance Sheets Before After Before After Current assets $ 7,476 $ 7,476 Current liabilities $ 3,274 $ 3,524 Leased assets (net) 1,032 4,123 Lease obligations 1,179 4,020 Other assets 5,050 5,050 Other liabilities 3,671 3,671 -- -- Shareholders' equity 5,434 5,434 Total assets $13,558 $16,649 Total liab. and equity $13,558 $16,649
Postretirement Benefits Postretirement Benefits Facts Defined - Employer-provided benefit(s) to em ployees after retirement Two kinds of Postretirement Benefits Pension benefits-- Employer-provided monetary pension benefits to em ployees after retirement, e.g., monthly stipend until death Other Postretirement Employee Benefits(OPEB)--Employer provided non-pension (usually nonmonetary)benefits after retirement, e.g., health care and life insurance
Postretirement Benefits Defined -- Employer-provided benefit(s) to employees after retirement Pension benefits -- Employer-provided monetary pension benefits to employees after retirement, e.g., monthly stipend until death Other Postretirement Employee Benefits (OPEB) -- Employerprovided non-pension (usually nonmonetary) benefits after retirement, e.g., health care and life insurance Postretirement Benefits Facts Two kinds of Postretirement Benefits