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In the graphic above, how did they arrive at the 4,356? ANALYST ADJUSTMENTS 10.1 Adjustments for Capitalization of pre-2019 Operating Leases A typical financial statement
In the graphic above, how did they arrive at the 4,356?
ANALYST ADJUSTMENTS 10.1 Adjustments for Capitalization of pre-2019 Operating Leases A typical financial statement analysis includes data for two to three years. Even after firms begin to adopt the new leasing standard, not all years reported will normally include capitalized operating leases because the new standard allows for prospective adoption. For at least the next few years, analysts must adjust balance sheets and income statements for the effects of operating leases to get an apples-to-apples comparison. To illustrate, let's look at Lowe's operating leases. We must obtain the lease footnotes from the form 10-K for each year separately. It would not be accurate to use the latest year's operating lease amounts for prior years. This is because companies routinely change the level of operating leases in response to changes in the business environment. Lowe's lease payment commitments for 2017 through 2019 follow. continued ANALYST ADJUSTMENTS 10.1 Concluded 2019 2017 Lowe's operating lease payment commitments $ millions Year 1.. Year 2. Year 3. Year 4.. Year 5. Thereafter. $ 595 605 564 519 473 2,609 2018 $ 666 626 573 526 476 2,970 $5,837 $ 617 590 550 508 466 3,122 $5,853 Total .. $5,365 The first step in our analysis is to determine the present value of lease payments for each year. A common simplify- ing assumption is to hold constant the interest rate on the leases across the three year analysis period. Unless rates change drastically, this assumption will not introduce significant measurement errors. Using 4% as the discount rate and holding tax rates constant at 22%, we compute the present value for each year and use these amounts to adjust key income statement and balance sheet items, as follows. Balance Sheet Adjustments (S millions) Net operating assets (NOA)... Net nonoperating obligations (NNO) Equity ...... 2019 +4,356 +4,356 0 2018 +4,693 +4,693 0 2017 +4,658 +4,658 0 +146 +145 Income Statements Adjustments ($ millions) 2019 2018 2017 Interest expense (Capitalized amount x 4%).... +174 +188 +186 Net nonoperating expense, NNE (Interest expense x [1 - 22%]) +136 Net operating profit after tax, NOPAT.. +136 +146 +145 Net income... 0 0 0 These adjustments have a large impact on evaluation of Lowe's. The largest impact is to RNOA and FLEV because NOA and NNO both change markedly for all three years. The effect of the adjustment on NOPAT is relatively small, which is common, and thus, NOPM is relatively unaffected. Of course, ROE remains unchanged because neither net income nor equity are impacted in the period we capitalize operating leases. ANALYST ADJUSTMENTS 10.1 Adjustments for Capitalization of pre-2019 Operating Leases A typical financial statement analysis includes data for two to three years. Even after firms begin to adopt the new leasing standard, not all years reported will normally include capitalized operating leases because the new standard allows for prospective adoption. For at least the next few years, analysts must adjust balance sheets and income statements for the effects of operating leases to get an apples-to-apples comparison. To illustrate, let's look at Lowe's operating leases. We must obtain the lease footnotes from the form 10-K for each year separately. It would not be accurate to use the latest year's operating lease amounts for prior years. This is because companies routinely change the level of operating leases in response to changes in the business environment. Lowe's lease payment commitments for 2017 through 2019 follow. continued ANALYST ADJUSTMENTS 10.1 Concluded 2019 2017 Lowe's operating lease payment commitments $ millions Year 1.. Year 2. Year 3. Year 4.. Year 5. Thereafter. $ 595 605 564 519 473 2,609 2018 $ 666 626 573 526 476 2,970 $5,837 $ 617 590 550 508 466 3,122 $5,853 Total .. $5,365 The first step in our analysis is to determine the present value of lease payments for each year. A common simplify- ing assumption is to hold constant the interest rate on the leases across the three year analysis period. Unless rates change drastically, this assumption will not introduce significant measurement errors. Using 4% as the discount rate and holding tax rates constant at 22%, we compute the present value for each year and use these amounts to adjust key income statement and balance sheet items, as follows. Balance Sheet Adjustments (S millions) Net operating assets (NOA)... Net nonoperating obligations (NNO) Equity ...... 2019 +4,356 +4,356 0 2018 +4,693 +4,693 0 2017 +4,658 +4,658 0 +146 +145 Income Statements Adjustments ($ millions) 2019 2018 2017 Interest expense (Capitalized amount x 4%).... +174 +188 +186 Net nonoperating expense, NNE (Interest expense x [1 - 22%]) +136 Net operating profit after tax, NOPAT.. +136 +146 +145 Net income... 0 0 0 These adjustments have a large impact on evaluation of Lowe's. The largest impact is to RNOA and FLEV because NOA and NNO both change markedly for all three years. The effect of the adjustment on NOPAT is relatively small, which is common, and thus, NOPM is relatively unaffected. Of course, ROE remains unchanged because neither net income nor equity are impacted in the period we capitalize operating leasesStep by Step Solution
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