Analyzing and Capitalizing Operating Lease Payments Disclosed in Footnotes Costc
ID: 2531423 • Letter: A
Question
Analyzing and Capitalizing Operating Lease Payments Disclosed in Footnotes
Costco Wholesale Corporation discloses the following in footnotes to its 10-K report relating to its leasing activities.
At the end of 2016, future minimum payments...under noncancelable leases with terms of at least one year were as follows ($ millions):
2017
$200
2018
195
2019
184
2020
171
2021
166
Thereafter
2,204
Total
$3,120
Operating leases are not reflected on-balance-sheet. In our analysis of a company, we often capitalize these operating leases, that is, add the present value of the future operating lease payments to both the reported assets and liabilities.
(a) Compute the present value of Costco's operating lease payments assuming a 6% discount rate and round the remaining lease term to the nearest whole year. (Use a financial calculator or Excel to compute. Do not round until your final answers. Round each answer to the nearest whole number.)
($ millions)
Present Value
Year 1
$Answer
Year 2
$Answer
Year 3
$Answer
Year 4
$Answer
Year 5
$Answer
After 5
$Answer
Total*
$Answer
* (Use subsequent rounded answers for calculation.)
(b) What effect does capitalization of operating leases have on Costco's total liabilities and total assets (it is reported total liabilities and total assets of $20,831 million and $33,163 million, respectively)?
In its income statement, rent expense is replaced with depreciation and interest expense. There is no effect on the balance sheet.
The company's total assets and total liabilities are increased by the present value of the capitalized leases. In its income statement, rent expense is replaced with depreciation and interest expense.
The company's total assets and total liabilities are increased by the present value of the capitalized leases. In its income statement, rent expense is replaced with interest expense.
The company's total assets and total liabilities are increased by the present value of the capitalized leases. There is no effect on the income statement.
2017
$200
2018
195
2019
184
2020
171
2021
166
Thereafter
2,204
Total
$3,120
Explanation / Answer
(a) Calculation ($ millions) Operating Lease Payment(A) Discount Factor of 6%(B) Present Value (AXB)$ Year 1 200 0.943 188.6 Year 2 195 0.89 173.55 Year 3 184 0.84 154.56 Year 4 171 0.792 135.43 Year 5 166 0.747 124 After 5 2204 8.85 1097.42 ** Total* $3120 1873.56 ** Average life = $2204/166 =13.28periodss we rounded to 13 periods Present value of an annuity of 13 periods @ 6%=8.85 Year 5 lease payment x year 5 discount value x PV annuity of 13 periods @ 6%; $166 x 0.747 x 8.85=1097.42