Required
Prepare the adjusting journal entries required to capitalize Delta's operating leases, and verbally describe the impact of the recapitalization of operating leases on the 2016 financial statement of Delta Air Line. [For hints, read the notes below.]
ACCT3013 Financial Statement Analysis Workshop Accounting adjustments Tutorial assignment Airline companies typically do not own their aircrafts. Rather, they lease aircrafts from commercial lessors (e.g. General Electric's nance subsidiary). According to US GAAP, companies are required to disclose their lease information in the footnotes of their nancial statements. Recall from ACCT2011 that leases can be classied into nance leases (or capital leases in American English) and operating leases (US GAAP and IFRS apply virtually the same rules to leases) Airlines may structure their [case contracts to skililly avoid the capitalization requirement for capital leases. 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 ofces and other property and equipment 'om third parties. Rental expense for operating leases, which is recorded on a straightline basis over the life of the lease term, totaled $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, aircra 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 beneciary 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 own 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 $ 145 2018 85 2019 60 2020 43 2021 24 Thereafter 21 Total minimum lease payments 378 Less: amount of lease a ents re resentin interest 54 Present value of future minimum capital lease payments 324 Less: current obligations under capital leases (122) Long-term capital lease obligations $ 202 Operating Leases Contract Carrier Aircraft gin millions! gjyltnaniiietz Lea\" Psfzymem Total 2017 $ 1,302 $ 270 $ 1,572 2018 1,194 249 1,443 2019 1,084 220 1,304 2020 962 171 1,133 202 1 766 96 862 Thereafter 6,533 248 6,78 1 Total minimum lease payments $ 11,841 S 1,254 $ 13,095 it) Includes payments accounted for as construction obligations, (2) Represents the minimum lease obligations under our contract carrier agreements with Compass Airlines, LLC, Expressiet Airlines, Inc., GoJet Airlines, LLC, Republic Airline, Inc. (as successor by merger to Shuttle America Corporation) and SkyWest Airlines, Inc. 2015 ANNUAL REPORT ................................................. NOTE 7 . LEASE OBLIGATIONS We lease aircraft, airport terminals, maintenance facilities, ticket ofces 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, totaled $1.2 billion for the years ended December 31, 2015 and 2014 and $1.1 billion for the year ended December 31, 2013 . 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, aircra 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 beneciary 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 own by regional carriers) with initial or remaining terms in excess of one year for the years succeeding December 31, 2015 : Capital Leases (in millions! Total 2016 $ 183 2017 1 14 2018 56 2019 41 2020 29 Thereafter 39 Total minimum lease payments 462 Less: amount of lease payments representing interest (79) Present value of future minimum capital lease payments 383 Less: current obligations under capital leases (148) Long-term capital lease obligations S 235 Operating Leases Contract ' . . Delta Lease E:;:e;}:i::; (in millions) Payments (1) (2) Total 2016 $ 1,258 S 325 $ l,583 2017 1,105 335 1,440 2018 993 314 1,307 2019 899 259 1,158 2020 814 239 1,053 Thereafter 5,839 381 6,220 Total minimum lease payments $ 10,908 S 1,853 $ 12,761 u) Includes payments accounted for as construction obligations. m Represents the minimum lease obligations under our contract carrier agreements with Compass Airlines, LLC, ExpressJet Airlines, Inc., GoJet Airlines, LLC, Shuttle America Corporation (\"Shuttle America\") and SkyWest Airlines, Inc. Suppose you are an analyst following Delta Air Line, and you believe all its operating leases are of the nature of capital leases. Therefore, you decide to capitalize all its operating leases for your analysis. Additional information & assumptions - Recapitalized operating lease asset is 80% of the existing operating lease liability if the operating leases were capitalized. The difference between the lease asset and lease liability reects accumulated depreciation and impairments 'om previous years. 0 New leases initiated in 2016 are assumed to take effect from the end of 2016. o Recapitalized lease assets are depreciated over a useful life of 10 years. 0 Lease obligations due aer 5 years from the reporting date (\"thereaer\") are evenly distributed to the next 8 years. I Ignore any tax effect. Required Prepare the adjusting journal entries required to capitalize Delta's operating leases, and verbally describe the impact of the recapitalization of operating leases on the 2016 nancial statement of Delta Air Line. [For hints, read the notes below] Notes on leases Accounting standards (US GAAP and IFRS-based standards) classify leases into operating leases and capital leases. A capital lease is in fact a nancing transactionin the sense that it is equivalent to borrowing funds from nanciers and then purchase the asset using the borrowed funds. Many rms have incentives to avoid its lease transactions to be classied as capital leases. One key consideration for this preference is that the rm protability appears more \"robust", or of higher \"quality\
