Please answer Case 15-72. Deciphering Financial Statements (McDonald’s Corporation)

Please answer Case 15-72. Deciphering Financial Statements (McDonald’s Corporation)

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15
– 66
Part 3
Additional Activities of a Business
EOC
Deciphering Financial Statements (International Lease Finance Corporation)
As mentioned in the chapter,
International Lease Finance Corporation
leases airplanes to
airlines. Disclosure regarding International’s leases is reproduced in Exhibit 15-11 in the text.
1.
By examining the stream of expected future lease payments as of the end
of 2008 and 2009, estimate how much business in new capital leases the
company generated during 2009.
2.
Comment on the relationship between the amount of total lease payments to be
received and the estimated residual values as of the end of 2008 and 2009.
Deciphering Financial Statements (FedEx)
The following summary data are from the May 31, 2009, balance sheet of
FedEx
. All
numbers are in millions.
Total current assets
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
7,116
Property, plant, and equipment (net)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
13,417
Other long-term assets
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
3,711
Total assets
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$24,244
Current liabilities
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
4,524
Long-term debt
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,930
Other long-term liabilities
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4,164
Total liabilities
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$10,618
Stockholders’ equity
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$13,626
Total sales
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$35,497
A summary of future minimum lease payments under capital leases and noncancelable
operating leases with an initial or remaining term in excess of one year at May 31, 2009
is as follows (in millions):
Operating Leases
Capital
Leases
Aircraft and
Related
Equipment
Facilities
and Other
Total
Operating
Leases
2010
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$164
$
512
$1,247
$
1,759
2011
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
20
526
1,086
1,612
2012
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
8
504
947
1,451
2013
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
119
499
817
1,316
2014
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2
472
694
1,166
Thereafter
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
15
2,458
4,894
7,352
Total
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
328
$4,971
$9,685
$14,656
Less amount representing interest
. . . . . . . . . . . . .
34
Present value of net minimum lease payments
. . . .
$294
Instructions:
Compute the following ratio values.
1.
Debt ratio (total liabilities/total assets).
2.
Debt ratio assuming that FedEx’s operating leases are accounted for as capital leases.
3.
Asset turnover (sales/total assets).
4.
Asset turnover assuming that FedEx’s operating leases are accounted for as
capital leases.
Deciphering Financial Statements (McDonald’s Corporation)
The franchise arrangement between
McDonald’s
and its franchisees is summarized in the
following note from McDonald’s 2009 annual report.
Case 15-70
Case 15-71
Case 15-72

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EOC
Leases
15

67
Conventional franchise arrangements generally include a lease and a license and provide for payment of initial
fees, as well as continuing rent and royalties to the Company based upon a percent of sales with minimum rent
payments that parallel the Company’s underlying leases and escalations (on properties that are leased). Under this
arrangement, franchisees are granted the right to operate a restaurant using the McDonald’s System and, in most
cases, the use of a restaurant facility, generally for a period of 20 years. These franchisees pay related occupancy
costs including property taxes, insurance and maintenance. Affiliates and developmental licensees operating under
license agreements pay a royalty to the Company based upon a percent of sales, and may pay initial fees.
The results of operations of restaurant businesses purchased and sold in transactions with franchisees were not
material to the consolidated financial statements for periods prior to purchase and sale. Revenues from franchised
restaurants consisted of:
In millions
2009
2008
2007
Rents
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$4,841.0
$4,612.8
$4,177.2
Royalties
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2,379.8
2,275.7
1,941.1
Initial fees
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
65.4
73.0
57.3
Revenues from franchised restaurants
. . . . . . . . . . . . . . . . . . . . . . . . . .
$7,286.2
$6,961.5
$6,175.6
Future minimum rent payments due to the Company under existing franchise arrangements are:
In millions
Owned
sites
Leased
sites
Total
2010
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
1,218.1
$
1,076.0
$
2,294.1
2011
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,177.3
1,042.9
2,220.2
2012
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,144.5
1,011.5
2,156.0
2013
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,105.1
972.4
2,077.5
2014
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,062.1
924.8
1,986.9
Thereafter
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
8,495.8
6,782.5
15,278.3
Total minimum payments
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$14,202.9
$11,810.1
$26,013.0
At December 31, 2009, net property and equipment under franchise arrangements
totaled $13.1 billion (including land of $3.8 billion) after deducting accumulated
depreciation and amortization of $6.5 billion.
Instructions:
From this information, answer the following questions.
1.
McDonald’s arrangement with its franchisees is that the franchisees agree to
pay a minimum rent plus additional amounts if sales are above a certain level.
Compare the minimum amount to be received from rent payments in 2010 with
the total amount received from franchised and affiliated restaurants in 2009.
How significant are these additional amounts?
2.
As indicated in the franchise note, McDonald’s owns some of its sites and
leases others. An important comparison is the relationship between future
minimum lease payments McDonald’s must make and future minimum payments
to be received from franchisees. The future payments (in millions of dollars)
McDonald’s must make on its leased restaurant sites are summarized as follows.
In millions
Restaurant
2010
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$
1,064.7
2011
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1,002.4
2012
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
928.1
2013
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
859.8
2014
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
783.9
Thereafter
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5,794.5
Total minimum payments
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$10,433.4

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15
– 68
Part 3
Additional Activities of a Business
EOC
Comparing the payments to be made for leased sites and the minimum payments
(plus the additional percentage from royalties) to be collected from franchisees for leased
sites, it looks as if McDonald’s is guaranteed to make money every year on its leased
sites. What would have to happen for McDonald’s to
lose
money on these leased sites?
Writing Assignment (All leases are sales-type leases!)
You are the accountant for Clear Water Bay Company, an equipment manufacturer. In
order to help customers finance their purchases, Clear Water Bay often leases, rather
than sells, the equipment. Clear Water Bay structures the lease agreements so that
most of its equipment leases are classified as operating leases. This is because
customers strongly prefer this treatment in order to keep the lease obligations off
their balance sheets. This treatment does result in a delay in Clear Water Bay’s ability
to report profits from the sales, but this delay has been viewed as part of the cost of
keeping customers happy.
The president of Clear Water Bay just returned from a weeklong accounting and
finance seminar at a prominent university. She is excited about the session she
attended on the accounting for leases. She was told, or thinks she was told, that there
is no need for Clear Water Bay to report its leasing arrangements as operating leases—
according to U.S. GAAP
, lessors can always classify a lease as a sales-type lease even
when the lessee classifies the same lease as an operating lease. The president tells
you to get to work restating Clear Water Bay’s most recent financial statements to
reflect reclassification of all Clear Water Bay’s leases from operating leases to sales-
type leases.
Write a memo to the president clarifying the accounting rules governing sales-type
and operating leases. Carefully explain the circumstances in which the same lease can
be classified as a sales-type lease by the lessor and an operating lease by the lessee.
Ethical Dilemma (Using operating leases to fool the bank)
You are the chief financial officer for RAM Solutions, a small but rapidly growing retail
computer hardware chain. You are trying to figure out how to finance the new buildings
that are scheduled to be purchased this year. The difficulty is that RAM has an existing
loan with Commercial Security Bank (CSB) that requires RAM to maintain an interest
coverage ratio (Operating income/Interest expense) of 2.0 or greater. Forecasts for next
year are as follows:
Forecasted operating income
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
$15,000,000
Forecasted interest expense (assuming no new borrowing)
. . . . . . . . . . . . . . . . . . . . . . . . . . . . .
7,000,000
Cost of purchasing new buildings
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
50,000,000
If you borrow the $50 million needed to finance the new buildings, the increased
interest expense will cause you to be in violation of the interest coverage constraint.
The controller has suggested an accounting solution to this dilemma: lease the
new buildings, carefully constructing the lease agreements so that the leases will be
accounted for as operating leases. The leasing arrangements will be economically
similar to purchase of the buildings with borrowed money, but the annual payments
will be reported as rent expense instead of interest expense. Accordingly, the interest
coverage loan covenant will be completely sidestepped.
You personally negotiated the loan with Commercial Security Bank, and you know that
the intent of the loan covenant was to prevent RAM from incurring large fixed obligations
that might endanger the repayment of the CSB loan. Operating lease payments are fixed
obligations, just like interest payments, and you are uneasy about using this accounting
trick to get around the loan covenant. However, there does not seem to be any other
solution. What should you do?
Case 15-73
Case 15-74

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