Financial Services Industry
Industry: Email Alert RSS FeedOff-balance-sheet financing & operating leases: impact on lessee financial ratios
RMA Journal, The, Dec, 2006 by Bob G. Kilpatrick, Nancy L. Wilburn
Table 1
Financial Statement Effects from Capital and Operating Leases
Capital Lease Operating Lease
Balance Sheet Income Statement Balance Sheet Income
Statement
Leased Asset Depreciation Expense None Rent Expense
Lease Obligation Interest Expense
Table 2
Lease Comparison
Lease A Lease B
Fair value of asset $700,000 $700,000
Estimated residual value $113,000 $112,500
(unguaranteed)
Lease term (nonrenewable) 5 years 5 years
Interest rate implicit in lease (equals
lessee's incremental borrowing rate) 10% 10%
Annual lease payments (end of year) $166,149 $166,231
Present value of minimum lease $629,836 $630,146
payments
Present value of minimum lease
payments as percentage of fair value 89.98% 90.02%
Table 3
Lease Impacts on Financial Statements
Balance Sheet
Lease A Lease B
Assets:
Leased Assets $0 $630,146
Other Assets $1,750,000 $1,750,000
Total Assets $1,750,000 $2,380,146
Liabilities:
Lease Obligations $0 $630,146
Other Liabilities $1,000,000 $1,000,000
Total Liabilities $1,000,000 $1,630,146
Stockholders'Equity: 750,000 750,000
Total Liabilities and Stockholders' $1,750,000 $2,380,146
Equity
Income Statement
Income before Lease-related Expenses $400,000 $400,000
Lease Rental Expense 166,149 0
Depreciation of Leased Asset (straight line) 0 126,029
Interest on Lease Obligation 0 63,015
Income before Taxes 233,851 210,956
Income Tax Expense (40%) 81,848 73,835
Net Income $152,003 $137,121
Debt-to-Equity Ratio 133.1% 217.4%
Return on Assets 8.7% 5.7%
Table 4
Summary Statistics for Impact of Operating Lease Capitalization 2004
Compared with 1987
Balance Sheet
1987 Averages 2004 Averages
Capitalized Lease Liability
(Discounted, Net of Deferred Tax) $722.6 m $2,649.6 m
Balance Sheet Impact:
% Increase in Total Liabilities 72.8% 87.7%
% Increase in Total Assets 32.4% 36.7%
% Decrease in Equity -21.4% -30.0%
Debt-to-Equity Ratio Impact:
Pre-capitalization 163.4% 130.5%
Post-capitalization 362.9% 323.5%
% change 137.2% 171.6%
Return-on-Assets Impact:
Pre-capitalization 7.5% 3.7%
Post-capitalization 5.7% 2.7%
% change -23.7% -25.0%
Note: In two instances (A&P and Delta), the impact of constructive
capitalization of their operating leases in 2004 was so large that they
resulted in negative equity, thereby making the debt-to-equity ratio
not meaningful. Therefore, these two companies were omitted from the
computations of the impact on the debt-to-equity ratio for both 1987
and 2004.
Table 5
Individual Comparisons of the Impact of Operating Lease Capitalization
2004 Compared with 1987
1987
Reported Revised % Change
Company Debt-to-Equity Debt-to-Equity Debt-to-Equity
American/Albertson 311.9% 400.0% 28.2%
A&P 162.5% 250.0% 53.8%
Delta 175.7% 440.0% 150.4%
Jack-in-the-Box 300.1% 560.0% 86.6%
Limited 117.8% 380.0% 222.6%
Luby's 29.1% 40.0% 37.3%
Pier 1 174.1% 600.0% 244.7%
Walgreen 118.8% 280.0% 135.6%
Winn Dixie 91.7% 280.0% 205.2%
Company Reported ROA Revised ROA % Change
American/Albertson 4.2% 3.9% -7.6%
A&P 4.6% 4.0% -13.0%
Delta 4.9% 3.5% -29.1%
Jack in the Box 3.0% 2.4% -18.8%
Limited 14.8% 9.6% -35.2%
Luby's 14.6% 13.4% -8.3%
Pier 1 6.2% 4.0% -35.9%
Walgreen 7.6% 5.6% -26.3%
Winn-Dixie 7.9% 5.3% -33.1%
2004
Reported Revised % Change
Company Debt-to-Equity Debt-to-Equity Debt-to-Equity
American/Albertson 237.8% 311.9% 31.2%
A&P 1,098.5% NM * NM
Delta NM NM NM
Jack-in-the-Box 132.2% 394.1% 198.1%
Limited 160.8% 285.8% 77.8%
Luby's 79.2% 94.1% 18.7%
Pier 1 53.9% 225.5% 318.4%
Walgreen 63.9% 237.0% 270.8%
Winn Dixie 185.5% 16.3% 286.2%
Company Reported ROA Revised ROA % Change
American/Albertson 2.6% 2.3% -9.6%
A&P -6.6% -4.5% -31.0%
Delta 0.0% 0.0% -15.1%
Jack in the Box 5.8% 3.9% -33.2%
Limited 11.6% 9.3% -19.4%
Luby's 0.8% 0.8% -5.2%
Pier 1 11.2% 7.0% -37.8%
Walgreen 10.1% 6.5% -36.1%
Winn-Dixie -1.9% -1.2% -37.5%
* In instances where equity is negative, the debt-to-equity ratio and
the resulting percentage change are not meaningful (NM).
Lease Discount Present
Fiscal Year Payments Factor 10% Value
2005 $212,699 0.90909 $193,363
2006 202,099 0.82645 167,025
2007 185,215 0.75132 139,156
2008 171,153 0.68301 116,899
2009 153,315 0.62092 95,196
Thereafter (annual for 10 years) 52,543 3.81528 200,466
Total present value $912,105
Assets
Capitalized leased asset (70% x $912,105) $638,473
Liabilities
Capitalized lease Present Value $912,105
obligation
Deferred taxes [40% x ($912,105-$638,473)] ($109,453)
Net effect $802,652
Stockholders'Equity
Retained earnings effect [60% x ($912,105-$638,473)] ($164,179)
$638,473
As Reported
Total Assets $1,052,173
Total Liabilities 368,542
Total Stockholders' Equity 683,631
Net Income 118,001
Debt-to-Equity Ratio $368,542/$683,631=53.9%
ROA $118,001/$1,052,173=11.2%
Adjusted for
Constructive
Capitalization As Adjusted
Total Assets $638,473 1,690,646
Total Liabilities 802,652 1,171,194
Total Stockholders' Equity ($164,179) 519,452
Net Income 0 118,001
Debt-to-Equity Ratio $1,171,194/$519,452=225.5%
ROA $118,001/$1,690,646=7.0%
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