New lease accounting guidance requires companies to record a right of
use asset and a lease liability for all leases, with the exception of short-term leases, at present value. If
Target had used the new lease accounting guidance in its fiscal 2017 (February 3, 2018) financial
statements, what would be the amount reported as a liability for its leases, operating and capital
(finance) combine (rounded to nearest $ million)?
Hint: Assume the payments after 2020 are to be paid evenly over a 16 year period and all payments
are at the end of years indicated. Target indicates elsewhere in its financial statements that 6% is an
appropriate discount rate for its leases.
1.
2.
We lease certain retail locations, warehouses, distribution centers, office space, land, and equipment. Assets held under capital leases are included in Property and Equipment. Operating lease rentals are expensed on a straight-line basis over the life of the lease beginning on the date we take possession of the property. At lease inception, we determine the lease term by assuming the exercise of those renewal options that are reasonably assured. The exercise of lease renewal options is at our sole discretion. The lease term is used to determine whether a lease is capital or operating and is used to calculate straight-line rent expense. Additionally, the depreciable life of leased assets and leasehold improvements is limited by the expected lease term. Rent expense is included in SG&A Expense. Some of our lease agreements include rental payments based on a percentage of retail sales over contractual levels and others include rental payments adjusted periodically for inflation. Certain leases require us to pay real estate taxes, insurance, maintenance, and other operating expenses associated with the leased premises. These expenses are classified in SG&A Expense, consistent with similar costs for owned locations. CVS leases the space in our stores in which they operate CVS branded pharmacies and clinics. Rent income received from tenants who rent properties is recorded as a reduction to SG&A Expense. In February 2016, the FASB issued ASU No. 2016-02, Leases. The new standard requires lessees to record assets and liabilities on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. We plan to adopt the standard as of February 4, 2018, the beginning of fiscal 2018. We will elect the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allows us to carryforward the historical lease classification. We will also elect the practical expedient related to land easements, allowing us to carry forward our current accounting treatment for land easements on existing agreements. In addition, we are electing the hindsight practical expedient to determine the reasonably certain lease term for existing leases. Our election of the hindsight practical expedient will result in the shortening of lease terms for certain existing leases and the useful lives of corresponding leasehold improvements. We will make an accounting policy election to keep leases with an initial term of 12 months or less off of the balance sheet. We will recognize those lease payments in the Consolidated Statements of Operations on a straight-line basis over the lease term. We estimate adoption of the standard will result in recognition of additional net lease assets and lease liabilities of approximately $1.3 billion and $1.4 billion, respectively, as of February 4, 2018. The difference between these amounts will be recorded as an adjustment to retained earnings. We do not believe the standard will materially affect our consolidated net earnings. We do not believe the new standard will have a notable impact on our liquidity. The standard will have no impact on our debt-covenant compliance under our current agreements. 49 2017 $ Rent Expense (millions) Rent expense Rent income (c) Total rent expense Includes rental income from CVS from both ongoing rent payments and amortization of the deferred income liability related to the Pharmacy Transaction. See Note 6 for further discussion. 223 $ (56) 167 $ 2016 202 $ (54) 148 $ 2015 198 (16) 182 $ Total capital lease interest expense was $55 million, $49 million, and $42 million in 2017, 2016, and 2015, respectively, and is included within Net Interest Expense on the Consolidated Statements of Operations. Most leases include one or more options to renew, with renewal terms that can extend the lease term from one to 50 years or more. Certain leases also include options to purchase the leased property. Assets recorded under capital leases as of February 3, 2018 and January 28, 2017 were $1,004 million and $888 million, respectively. These assets are recorded net of accumulated amortization of $295 million and $406 million as of February 3, 2018 and January 28, 2017, respectively. Future Minimum Lease Payments (millions) Operating Leases (8) Capital Leases (6) Rent Income Total 2018 $ 227 $ 92 $ (25) $ 294 2019 234 96 (25) 305 2020 226 97 (24) 299 2021 222 96 (23) 295 2022 217 96 (23) 290 After 2022 3,027 1,524 (307) 4,244 Total future minimum lease payments $ 4,153 $ 2,001 $ (427) $ Less: Interest (c) 849 Present value of future minimum capital lease payments 1,152 Note: Minimum lease payments exclude payments to landlords for real estate taxes and common area maintenance Minimum lease payments also exclude payments to landlords for fixed purchase options which we believe are reasonably assured of being exercised. a) Total contractual lease payments include $1,987 million related to options to extend lease terms that are reasonably assured of being exercised and also includes $386 million of legally binding minimum lease payments for stores that are expected open in 2018 or later. Capital lease payments include $604 million related to options to extend lease terms that are reasonably assured of being exercised and also includes $244 million of legally binding minimum lease payments for stores that are expected to open in 2018 or later. Calculated using the interest rate at inception for each lease. Includes the current portion of $68 million 5,727 (b) We lease certain retail locations, warehouses, distribution centers, office space, land, and equipment. Assets held under capital leases are included in Property and Equipment. Operating lease rentals are expensed on a straight-line basis over the life of the lease beginning on the date we take possession of the property. At lease inception, we determine the lease term by assuming the exercise of those renewal options that are reasonably assured. The exercise of lease renewal options is at our sole discretion. The lease term is used to determine whether a lease is capital or operating and is used to calculate straight-line rent expense. Additionally, the depreciable life of leased assets and leasehold improvements is limited by the expected lease term. Rent expense is included in SG&A Expense. Some of our lease agreements include rental payments based on a percentage of retail sales over contractual levels and others include rental payments adjusted periodically for inflation. Certain leases require us to pay real estate taxes, insurance, maintenance, and other operating expenses associated with the leased premises. These expenses are classified in SG&A Expense, consistent with similar costs for owned locations. CVS leases the space in our stores in which they operate CVS branded pharmacies and clinics. Rent income received from tenants who rent properties is recorded as a reduction to SG&A Expense. In February 2016, the FASB issued ASU No. 2016-02, Leases. The new standard requires lessees to record assets and liabilities on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. We plan to adopt the standard as of February 4, 2018, the beginning of fiscal 2018. We will elect the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allows us to carryforward the historical lease classification. We will also elect the practical expedient related to land easements, allowing us to carry forward our current accounting treatment for land easements on existing agreements. In addition, we are electing the hindsight practical expedient to determine the reasonably certain lease term for existing leases. Our election of the hindsight practical expedient will result in the shortening of lease terms for certain existing leases and the useful lives of corresponding leasehold improvements. We will make an accounting policy election to keep leases with an initial term of 12 months or less off of the balance sheet. We will recognize those lease payments in the Consolidated Statements of Operations on a straight-line basis over the lease term. We estimate adoption of the standard will result in recognition of additional net lease assets and lease liabilities of approximately $1.3 billion and $1.4 billion, respectively, as of February 4, 2018. The difference between these amounts will be recorded as an adjustment to retained earnings. We do not believe the standard will materially affect our consolidated net earnings. We do not believe the new standard will have a notable impact on our liquidity. The standard will have no impact on our debt-covenant compliance under our current agreements. 49 2017 $ Rent Expense (millions) Rent expense Rent income (c) Total rent expense Includes rental income from CVS from both ongoing rent payments and amortization of the deferred income liability related to the Pharmacy Transaction. See Note 6 for further discussion. 223 $ (56) 167 $ 2016 202 $ (54) 148 $ 2015 198 (16) 182 $ Total capital lease interest expense was $55 million, $49 million, and $42 million in 2017, 2016, and 2015, respectively, and is included within Net Interest Expense on the Consolidated Statements of Operations. Most leases include one or more options to renew, with renewal terms that can extend the lease term from one to 50 years or more. Certain leases also include options to purchase the leased property. Assets recorded under capital leases as of February 3, 2018 and January 28, 2017 were $1,004 million and $888 million, respectively. These assets are recorded net of accumulated amortization of $295 million and $406 million as of February 3, 2018 and January 28, 2017, respectively. Future Minimum Lease Payments (millions) Operating Leases (8) Capital Leases (6) Rent Income Total 2018 $ 227 $ 92 $ (25) $ 294 2019 234 96 (25) 305 2020 226 97 (24) 299 2021 222 96 (23) 295 2022 217 96 (23) 290 After 2022 3,027 1,524 (307) 4,244 Total future minimum lease payments $ 4,153 $ 2,001 $ (427) $ Less: Interest (c) 849 Present value of future minimum capital lease payments 1,152 Note: Minimum lease payments exclude payments to landlords for real estate taxes and common area maintenance Minimum lease payments also exclude payments to landlords for fixed purchase options which we believe are reasonably assured of being exercised. a) Total contractual lease payments include $1,987 million related to options to extend lease terms that are reasonably assured of being exercised and also includes $386 million of legally binding minimum lease payments for stores that are expected open in 2018 or later. Capital lease payments include $604 million related to options to extend lease terms that are reasonably assured of being exercised and also includes $244 million of legally binding minimum lease payments for stores that are expected to open in 2018 or later. Calculated using the interest rate at inception for each lease. Includes the current portion of $68 million 5,727 (b)
