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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

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

Answer

Answer

Answer

Answer

Answer

Answer

Answer

Answer

Answer

Answer

IRR

Answer%











(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 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.)


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 leased 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 leased 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.

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