10 – Liabilities:
Notes, Bonds
& Leases
CORPORATE
FINANCIAL
REPORTING
·1
Long-Lived Assets
UNITED CONTINENTAL HOLDINGS, INC.
CONSOLIDATED BALANCE SHEETS
(In millions)
At December 31,
Long-term debt
Long-term obligations under capital leases
Other liabilities and deferred credits:
Frequent flyer deferred revenue
Postretirement benefit liability
Pension liability
Advanced purchase of miles
Deferred income taxes
Other
2010
11,434
1,036
2009
6,378
1,194
3,491
2,344
1,473
1,159
1,585
2,704
12,756
2,720
1,928
93
1,157
551
1,094
7,450
Liabilities· 2
REMEMBER THE THREE
FINANCIAL REPORTING ISSUES
Recognition
Classification
Valuation
Liabilities· 3
RECOGNITION
A liability is an obligation to give an
asset to, or perform a service for,
another entity in the future.
Remember, liabilities have four
characteristics:
Liabilities· 4
LIABILITY CHARACTERISTICS:
1.
2.
3.
4.
it is a present obligation for which
the future sacrifice is measurable
probable, and
$
is the result of a past transaction.
(economic exchange)
Liabilities · 5
CLASSIFICATION
Some companies do not make a
distinction, but most distinguish
between current and non-current
liabilities.
A current liability is one
management expects will be paid
within the longer of one year or
operating cycle.
Liabilities · 6
WINDOW DRESSING
Current assets
Noncurrent assets
$200
800
$1,000
Current liabilities
$150
Noncurrent liabilities 350
Owners’ equity
500
$1,000
Liabilities · 7
VALUATION
TODAY is October 1, 2011
I promise to pay you $1,000 on Sept. 30, 2013
and to pay you 10% per year, semiannually;
interest will be paid each March 31 and Sept. 30
until Sept. 30, 2013.
Signed tb
But you want to earn 12% interest
compounded semi-annually.
How much money will you loan me?
Liabilities · 8
PRESENT VALUE OF
FUTURE CASH FLOWS
6 mo.
6 mo.
6 mo.
6 mo.
|________|________|________|_______|
50
50
50
50
1,000
Using either Excel PV or NPV function will tell you: $ 965.35
· Liabilities 9
PRESENT VALUE OF
FUTURE CASH FLOWS
You loan me $965 and I repay you a
total of $1,200
What is the difference?
Liabilities· 10
WHAT WILL APPEAR IN MY FINANCIAL STATEMENTS
ON THESE DATES? (on these dates I prepare financial statements)
October 1, 2011
March 31, 2012
September 30, 2012
March 31, 2013
September 30, 2013
Liabilities· 11
FAIR VALUE OPTION
Fairly new accounting rule: companies
have a choice – do what we did when I
borrowed money or show the “fair value”
of the debt on their balance sheet.
For example, suppose on Mar. 31, 2012,
market interest rates are 16%/year for
my company, what is the fair value of my
liability and what would appear in my
financial statements?
Liabilities· 12
REPORTING, IN THE NOTES,
OF FINANCIAL INSTRUMENTS
GAAP requires note disclosure of the fair
value of financial instruments, like notes
payable, bonds payable, etc., even if the
company does not elect to show fair values
on the balance sheet.
{keep this in mind when doing the fsa}
Liabilities · 13
LEASES: A FINANCIAL
REPORTING NIGHTMARE
You fly to San Diego after
the fall term is over.
Liabilities 14
LEASES: A FINANCIAL
REPORTING NIGHTMARE
Is the car your asset?
Week 11/2 · 15
SIMPLE LEASE EXAMPLE
Equipment costs $30,000 new, LESSEE leases the
equipment for 3 years, payments start one year after
signing the lease. 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
Liabilities 16
SIMPLE LEASE EXAMPLE
Equipment costs $30,000 new, LESSEE leases the
equipment for 3 years, payments start one year after
signing the lease. 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
HOW MUCH ARE THE ANNUAL LEASE PAYMENTS?
Liabilities 17
SIMPLE LEASE EXAMPLE
HOW MUCH ARE THE ANNUAL LEASE PAYMENTS?
To
|
$ 30,000
( 15,026)
$14,974
T1
|
T2
|
T3
|
20,000
pv
Liabilities 18
SIMPLE LEASE EXAMPLE
HOW MUCH ARE THE ANNUAL LEASE PAYMENTS?
To
|
$ 30,000
( 15,026)
$14,974
T1
|
T2
|
T3
|
20,000
pv
What future annuity gives a pv of $14,974?
Liabilities 19
SIMPLE LEASE EXAMPLE
HOW MUCH ARE THE ANNUAL LEASE PAYMENTS?
To
|
$ 30,000
( 15,026)
$14,974
T1
|
T2
|
T3
|
20,000
pv
What future annuity gives a pv of $14,974?
Answer: RENT (or payment) = $6,021.
Liabilities 20
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?
Liabilities 21
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.”
Liabilities 22
SIMPLE LEASE EXAMPLE
if it is an Operating Lease
To
|
T1
|
$6,021
T2
|
$6,021
T3
|
$6,021
When rent is paid: cash decreases $6,021 and there is
rent expense of $6,021 on the income statement.
Liabilities 23
SIMPLE LEASE EXAMPLE
if it is a Capital Lease
Now, suppose you believed 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.
Liabilities 24
SIMPLE LEASE EXAMPLE
if it is a Capital Lease
To
|
$ 30,000
T1
|
T2
|
T3
|
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.)
Liabilities 25
SIMPLE LEASE EXAMPLE
if it is a Capital Lease
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?
ses
Liabilities 26
SIMPLE LEASE EXAMPLE
if it is a Capital Lease
To
|
$ 30,000
T1
|
T2
|
T3
|
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.
Liabilities 27
COMPARISON OF INCOME STATEMENTS
Which has more expense over the life of the lease:
OPERATING
CAPITAL
Liabilities 28
LEASES – REPORTING SUMMARY
Balance sheet: a capital lease increases liabilities (and
the “worst ones” at that) and increases non-current
assets.
Income statement: a capital lease reduces income
more in the early years of the lease.
Cash flow statement: Opposite effect! capital lease
payments are divided between operating activity and
financing activity, while operating leases are operating
activities.
Liabilities 29
LEASES – WHICH IS IT?
(OR WHAT TO DO TO AVOID capital LEASES)
Can the lessee cancel the lease?
yes
no
BOO !
CAPITAL
LEASE
HURRAY !
OPERATING
LEASE
Liabilities 30
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
no
BOO !
CAPITAL
LEASE
HURRAY !
OPERATING
LEASE
Liabilities 31
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
no
Is there a bargain purchase option?
yes
no
BOO !
CAPITAL
LEASE
HURRAY !
OPERATING
LEASE
Liabilities 32
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
no
Is there a bargain purchase option?
yes
no
Is the lease for ≥ ¾ of the asset’s useful life? yes
no
BOO !
CAPITAL
LEASE
HURRAY !
OPERATING
LEASE
Liabilities 33
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
no
Is there a bargain purchase option?
yes
no
Is the lease for ≥ ¾ of the asset’s useful life? yes
no
Is the PVMLP ≥ 90% assets fair value? yes
no
BOO !
CAPITAL
LEASE
HURRAY !
OPERATING
LEASE
Liabilities 34
LEASES
INTERNATIONAL VIEW
Risks include:
• possibility of losses from idle capacity or
technological obsolescence
• variations in return because of changing economic
conditions
Rewards are:
• the expectation of profitable operation over the
asset’s life
• gain from appreciation in value of residual value.
· 35
IAS 17 stipulates that if any one of these criteria are met,
substantially all of the risks or rewards of ownership are
deemed to have been transferred:
1. the lease transfers ownership of the asset to the lessee by
the end of the lease term;
2. the lessee has the option to purchase the asset at a price
which is expected to be sufficiently lower than fair value at
the date the option becomes exercisable that, at the inception
of the lease, it is reasonably certain that the option will be
exercised;
3. the lease term is for the major part of the economic life of
the asset, even if title is not transferred;
4. at the inception of the lease, the present value of the
minimum lease payments amounts to at least substantially all of
the fair value of the leased asset; and
5. leased assets are of a specialized nature such that only the
lessee can use them without major modifications being made.
· 36
Further indicators suggesting that a lease might be
properly considered to be a finance lease are:
6. in the lessee can cancel the lease, the lessor’s losses
associated with the lease are to be borne by the lessee,
7. gains or losses resulting from fluctuations in the fair value of
the residual will accrue to the lessee, and
8. the lessee has the ability to continue the lease for a
supplementary term at a rent that is substantially lower than
market rent (i.e., there is a bargain rental option).
· 37
LESSOR
So, lessee must decide if the asset
has been “purchased” or not; and
the lessor must decide if the
asset has been “sold” or not.
Liabilities 38
LESSOR
To treat the lease as a “sale”
At least one of the 4 criteria must be met:
title transfer,
bargain purchase option,
lease ≥ 75% of economic life,
PVMLP ≥ 90% assets fair value
AND
lessor must believe lessee will make payments &
lessor must not have any material uncertain
costs related to the lease.
Liabilities 39
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.
Liabilities 40
LEASES – WHAT TO DO WHEN READING
FINANCIAL STATEMENTS:
Using Sony Corporation as an example.
•http://www.sony.net/SonyInfo/IR/financial/ar/2006/index.html
Liabilities 41
LEASES – WHAT TO DO WHEN READING
FINANCIAL STATEMENTS:
Sony Corporation
Balance Sheet
(in $ million)
{original}
Current assets 3,218
PP&E
11,868
Other assets 75,579
Total assets
90,665
Current liabilities
Long-term liabilities
Owners’ equity
Total L. & OE
27,352
35,613
27,700
90,665
Liabilities 42
LEASES – WHAT TO DO WHEN READING
FINANCIAL STATEMENTS:
Sony Corporation
Balance Sheet
(in $ million)
Current assets 3,218
PP&E
??
Other assets 75,579
Total assets
Current liabilities
??
Long-term liabilities
??
Owners’ equity
27,700
Total L. & OE
es
Liabilities 43
LEASES – WHAT TO DO WHEN READING
FINANCIAL STATEMENTS:
Liabilities 44
LEASES – WHAT TO DO WHEN READING
FINANCIAL STATEMENTS:
Year ending
March 31:
2007
2008
2009
2010
2011
Later years
Total
less interest
Present value
less current portion
Long-term portion
in $ million
CAPITAL
LEASES
157
82
46
26
18
40
369
(42)
327
(145)
182
OPERATING
LEASE
406
297
227
139
98
504
1,671
Liabilities 45 s
LEASES – WHAT TO DO WHEN READING
FINANCIAL STATEMENTS:
Sony Corporation
Balance Sheet
(in $ million)
{revised}
Current assets 3,218
PP&E
??
Other assets 75,579
Total assets
Current liabilities
??
Long-term liabilities
??
Owners’ equity
27,700
Total L. & OE
Liabilities 46
LEASES
QUESTIONS?
Liabilities 47