Module 10

1. Module 10 Reporting and Analyzing Off-Balance Sheet Financing

2. Off-Balance Sheet Financing • Off-balance sheet financing means that either assets or liabilities, or both, are kept off of the face of the balance sheet.

3. Leasing • A lease is a contract between the owner of an asset (the lessor) and the party desiring to use that asset (the lessee). • Generally, leases provide for the following terms: • The lessor allows the lessee the unrestricted right to use the asset during the lease term. • The lessee agrees to make periodic payments to the lessor and to maintain the asset. • Title to the asset remains with the lessor, who usually retakes possession of the asset at the conclusion of the lease.

4. Capital vs. Operating Leases GAAP identifies for two different approaches in the reporting of leases by the lessee: • Capital lease method - both the lease asset and the lease liability are reported on the balance sheet. • Operating lease method - neither the lease asset nor the lease liability is on the balance sheet.

5. Capital vs. Operating Leases

6. Operating Leases Benefits for the lessee: • Leased asset is not reported on the balance sheet. • Lease liability is not reported on the balance sheet. • For the early years of the lease term, rent expense reported for an operating lease is less than the depreciation and interest expense reported for a capital lease. • Without analytical adjustments, the portion of ROE derived from operating activities (RNOA) appears higher, and the company’s ROE is perceived of higher quality.

7. Footnote Disclosures of Lessees

8. Capitalizing Operating Leases for Analysis Purposes • Determine the discount rate. • Compute the present value of future operating lease payments. • Adjust the financials to include the present value of the lease asset and lease liability.

9. Pensions • Generally two types of plans: • Defined contribution plan. This plan has the company make periodic contributions to an employee’s account, and many plans require an employee matching contribution. • Defined benefit plan. This plan has the company make periodic payments to an employee after retirement.

10. Accounting for Defined Contribution Plans • From an accounting standpoint, defined contribution plans offer no particular problems. • The contribution is recorded as an expense in the income statement when paid or accrued.

11. Two Accounting Issues Related to Defined Benefit Plans • The appropriate balance sheet presentation of the pension investments and obligation. • The pension standard allows companies to report the net pension liability on their balance sheet. • Underfunded plans are reported on the balance sheet as a long-term liability. • Overfunded plans are reported as a long-term asset. • The treatment of fluctuations in pension investments and obligations in the income statement. • The FASB allows companies to report pension income based on expected long-term returns on pension investments (rather than actual investment returns), and to defer the recognition of unrealized gains and losses on both pension investments and pension obligations

12. Plan Assets and PBO Computations

13. Balance Sheet Presentation

14. American Airlines’ Funded Status