ACCT6003 Fundamental Analysis for Equity Investment Accounting adjustments

Adjusting for operating leases

Airline companies typically do not own their aircrafts. Rather, they lease aircrafts from commercial lessors (e.g. General Electric's finance subsidiary). According to US GAAP, companies are required to disclose their lease information in the footnotes of their financial statements.

Recall that leases can be classified into finance leases (or capital leases) and operating leases (US GAAP and IFRS apply virtually the same rules to leases). Airlines may structure their lease contracts to skilfully avoid the capitalization requirement for capital leases. This removes the need for recognition of these lease liabilities on the balance sheet. The footnote on leases of the 2016 annual report of Delta Air Lines, a major US airline, is provided below:

------------------------------------------2016 ANNUAL REPORT-------------------------------------------------

NOTE 7 . LEASE OBLIGATIONS

We lease aircraft, airport terminals, maintenance facilities, ticket offices and other property and equipment from third parties. Rental expense for operating leases, which is recorded on a straight-line basis over the life of the lease term, totalled $1.3 billion for the year ended December 31, 2016 and $1.2 billion for the years ended December 31, 2015 and 2014 . Amounts due under capital leases are recorded as liabilities, while assets acquired under capital leases are recorded as property and equipment. Amortization of assets recorded under capital leases is included in depreciation and amortization expense. Our airport terminal leases include contingent rents, which vary based upon facility usage, enplanements, aircraft weight and other factors. Many of our aircraft, facility and equipment leases include rental escalation clauses and/or renewal options. Our leases do not include residual value guarantees and we are not the primary beneficiary in or have other forms of variable interest with the lessor of the leased assets. As a result, we have not consolidated any of the entities that lease to us.

The following tables summarize our minimum rental commitments under capital leases and noncancelable operating leases (including certain aircraft flown by regional carriers) with initial or remaining terms in excess of one year for the years succeeding December 31, 2016 :

Capital Leases ( in millions ) Total 2017 5 145 2018 85 2019 2020 2021 24 Thereafter 21 Total minimum lease payments 378 Less : amount of lease payments representing interest ( 54 ) Present value of future minimum capital lease payments 324Less : current obligations under capital leases* ( 122 ) Long-term capital lease obligations 202 Operating Leases Contract Carrier Aircraft ( in millions ) Delta Lease Payments In Lease Payments 121 Total 2017 5 1 , 302 5 270 5 1, 572 2018 1 , 194 249 1, 443 2019 1 , 084 220 1 , 304 2020 962 171 1 , 133 2021 760 96 862 Thereafter 6, 533 248 6, 781 Total minimum lease payments $ 11, 841 5 1, 254 5 13. 095 Includes payments accounted for as construction obligations . 1 21 Represents the minimum lease obligations under our contract carrier agreements with Compass Airlines , LLC , ExpressJet Airlines , Inc . Golet Airlines , LLC , Republic Airline , Inc. ( as successor by merger to Shuttle America Corporation ; and Sky West Airlines , Inc.\f$ 1 20201 Thercaller Total minimum lease payments 462 LOSS: amount of lease PayITICTILS ICPIESETTING interest Present Value of future Minimum capital Lease payments 383 LESS: Current obligations under capital leases |148} LONE- LETIn capital lease obligations 235 Operating Leaves Contract Currier Aircraft (in millions ) Delta Lease Payments in* LEASE PAYMENTS 19\\ Total 2010 1 , 258 $ 375 5 1 , 583 2017 1, 105 1 , 4 40 2018 314 1 , 307 2010 254 1 , 158 20201 $14 270 1 , 0153 Thercaller 5, 8:35 38 1 6, 2 20 Total minimum lease payIncTill 10. 908 $ 1, 853 5 12, 761 i'll Includes payments accounted for as construction obligations .` `` Represents the minimum lease obligations under our contract carrier agreements with Compass Airlines , LLC. Expresslet Airlines , Inc. Linlet Airlines . LLC, Shuttle America Corporation !"Shuttle ATTimes" I and Sky West Airlines , Inc .`