Question

Analyzing, Interpreting and Capitalizing Operating Leases
Assume YUM! Brands, Inc., reports the following footnote relating to its capital and operating leases in its 2010 10-K report ($ millions).

Future minimum commitments under non-cancelable leases are set forth below. At December 25, 2010, and December 26, 2009, the present value of minimum payments under capital leases was $318 million and $228 million, respectively.

Commitments ($ millions)	Capital	Operating
2011	$ 27	$ 428
2012	27	453
2013	65	417
2014	23	390
2015	23	330
Thereafter	276	1,958
	$ 441	$ 3,976

(a) Confirm that the implicit rate on YUM!'s capital leases is 4.30%.

N	Amount	IRR
0	Answer	Answer
1	Answer
2	Answer
3	Answer
4	Answer
5	Answer
6	Answer
7	Answer
8	Answer
9	Answer
10	Answer
11	Answer
12	Answer
13	Answer
14	Answer
15	Answer
16	Answer
17	Answer

Using a 4.30% discount rate and rounding the remaining lease life to three decimal places, compute the present value of YUM!'s operating leases. (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 the adjustments we might consider to YUM!'s balance sheet and income statement from the information in part (a)?

YUM's total assets and total liabilities are increased by the present value of the capitalized leases. In its income statement, rent expense is replaced with depreciation, and interest expense is added to nonoperating expense.

YUM's total assets and total liabilities are increased by the present value of the capitalized leases. There is no effect on the income statement.

Rent expense is replaced with depreciation and interest expense is added to nonoperating expense. There is no effect on the balance sheet.

YUM's total assets and total liabilities are increased by the present value of the capitalized leases. In its income statement, rent expense is replaced with depreciation.

(b) YUM! reported total liabilities of $6,103 million for 2010. Would the adjustment from part (a) make a substantial difference to YUM!'s total liabilities?

Yes, YUM!'s assets and liabilities would be substantially higher following the adjustments suggested.

Yes, YUM!'s liabilities would increase, but there would be no effect on assets.

Yes, YUM!'s assets would increase, but there would be no effect on its liabilities.

No, adjustments are not required. So, there is no effect on YUM!'s balance sheet.

Answer 1

SOLUTION:-

(a) confirming implicit rate at 4.30%

		Capital
	PV Factor	Lease	Discounted
Year	at 4.30 %	Amount	Value
1	0.959	27	25.89
2	0.919	27	24.82
3	0.881	65	57.29
4	0.845	23	19.44
5	0.810	23	18.63
6	0.777	23	17.87
7	0.745	23	17.13
8	0.714	23	16.42
9	0.685	23	15.75
10	0.656	23	15.10
11	0.629	23	14.47
12	0.603	23	13.88
13	0.579	23	13.31
14	0.555	23	12.76
15	0.532	23	12.23
16	0.510	23	11.73
17	0.489	23	11.24
			318 Million

Among statements

statement 1 is correct, there will be increase in both assets and liabilities with present value

and rent expense is replaced by depreciation, interest is non operating expense. Income statement will be affected.

(b) Yes adjustments are required as it will affect both assets and liabilities side to record present value of capitalized lease

Note: With point of calculating present value of operating lease , it has been written round of remaining life of lease to 3 decimals. Statement can't be understood.