3/20/2020 Chapter 10 - Homework Assignment

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Question 3 Partially correct Mark 4.80 out of 6.00

Analyzing and Interpreting Footnote on Operating and Capital Leases

Assume Verizon Communications, Inc., provides the following footnote relating to its leasing activities in its 10-K report. The aggregate minimum

rental commitments under noncancelable leases for the periods shown at December 31, 2010, are as follows:

Years (dollars in millions) Capital Leases Operating Leases

2011 $ 83 $ 1,449

2012 71 1,226

2013 67 966

2014 63 796

2015 46 477

Thereafter 143 1,947

Total minimum rental commitments 473 $ 6,861

Less interest and executory costs (122)

Present value of minimum lease payments 351

Less current installments (46)

Long-term obligation at December 31, 2010 $ 305

(a) Conﬁrm that the implicit discount rate for Verizon's capital leases is 8.06%.

N 0 1 2 3 4 5 6 7 8 9

Amount

(351)



IRR

(b) What eﬀect does the failure to capitalize operating leases have on Verizon's balance sheet? Over the life of its leases, what eﬀect does this lease

classiﬁcation have on net income?

Total assets and total liabilities are lower than if the operating lease had been classiﬁed as a capital lease. Over the lease term, total rent expense

under operating leases will be equal to the interest and depreciation expense that the company would record under capital leases.

Total assets and total liabilities are lower than if the operating lease had been classiﬁed as a capital lease. Over the lease term, total rent expense

under operating leases will be greater than the interest and depreciation expense that the company would record under capital leases.

There is no eﬀect on the balance sheet and income statement as a result of the classiﬁcation of leases.

Total assets and total liabilities are higher than if the operating lease had been classiﬁed as a capital lease. Over the lease term, total rent expense

under operating leases will be equal to the interest and depreciation expense that the company would record under capital leases.

(c) Compute the present value of Verizon's operating leases, assuming an 8.06% discount rate and rounding the remaining lease term to 3 decimal

places.(Use a ﬁnancial calculator or Excel to compute. Do not round until your ﬁnal answers. Round each Present Value answer to the nearest whole

number.)

($ millions) Present Value

Year 1

13,241



Year 2

1,050



Year 3

766



Year 4

584



Year 5

350



After 5

1,089



Total*

5,179



* (Use subsequent rounded answers to compute the Total.)

Which of the following statements best describes how we might use this additional information in our analysis of the company?

To assess the company's ﬁnancial condition and performance, we might add the present value of its operating leases to both operating assets and

nonoperating liabilities. No adjustment is necessary for the income statement.

To assess the company's ﬁnancial condition and performance, we might add the present value of its operating leases to both operating assets and

nonoperating liabilities, and we can replace rent expense with the depreciation of the lease assets and the interest on the lease liability.

To assess the company's ﬁnancial condition and performance, we might add the sum of the contractual payments under the operating leases to

both assets and nonoperating liabilities, and we can replace rent expense with the depreciation of the lease assets and the interest on the lease

liability.

Verizon's balance sheet and income statement are prepared in accordance with GAAP. No adjustments are necessary to evaluate the ﬁnancial

condition of the company.

8.06

%

Mark 1.00 out of 1.00

Mark 0.00 out of 1.00