Module 10Review Questions

1. This type of lease is considered a form of off-balance-sheet financing.

A) Capital lease
B) Special purpose lease
C) Operating lease
D) Variable interest lease
E) None of the above
2. Failure to appropriately capitalize leased assets and liabilities results in a number of distortions in the ROE
disaggregation analysis. Which of the following is not a distortion?
A) Net operating asset turnover is overstated due to the non-reporting of lease assets.
B) Reported total expense is lower in the early years of a capital lease relative to an operating lease, but is
higher in later years.
C) Financial leverage is understated.
D) Total assets are understated.
E) All of the above are distortions.
3. Cabelas Corp. disclosed the following lease information in its 2011 annual report (in millions). What lease
liability does Cabelas report on its balance sheet?

2012
2013
2014
2015
2016
Thereafter
Total
Amount representing interest
Net present value of leases
A)
B)
C)
D)
E)

Capital
Leases
$ 1,000
1,000
1,000
1,000
1,000
19,500
24,500
(11,578)
$ 12,922

Operating
Leases
$ 10,746
11,022
9,473
8,841
8,579
121,524
$170,185

$ 24,500
$ 12,922
$170,185
$ 11,578
None of the above

4. Which of the following is not a condition requiring the use of the capital lease reporting method?
A) The lease, by its terms, automatically transfers ownership of the leased asset from the lessor to the lessee
at the termination of the lease.
B) The lease term is at least 75% of the economic useful life of the leased asset
C) The lease, by its terms, does not automatically transfer ownership of the leased asset from the lessor to the
lessee at the termination of the lease.
D) The lease provides that the lessee can purchase the leased asset for a nominal amount (bargain purchase
price) at the termination of the lease.
E) None of the above
5. What are the three basic components of pension expense?
A) Service cost, benefits paid, and expected return on plan assets
B) Service cost, benefits paid, and actual return on plan assets
C) Service cost, interest cost, and actual return on plan assets
D) Service cost, interest cost, and expected return on plan assets
E) None of the above

6. Kids Fun Corp. reported the following information in its 2012 annual report (in millions). What were the pension
plan assets at the end of the year?
Plans assets at fair value, January 1, 2012
Actual return on plans assets
Company contributions
Benefits paid
Expected return on plan assets
A)
B)
C)
D)
E)

$13,106
1,362
830
1,140
1,318

$14,114 million
$14,158 million
$12,498 million
$12,454 million
None of the above

7. During 2011, Abbott Laboratories decreased its discount rate used to calculate pension obligation from 5.4% to
5.0%. The effect on the companys pension expense for the year and pension obligation balance at year end is:
A) Increase pension expense, decrease pension obligation
B) Decrease pension expense, decrease pension obligation
C) Decrease pension expense, increase pension obligation
D) Increase pension expense, increase pension obligation
E) No effect on pension expense, decrease pension obligation

Exercise AMR Corp. disclosed the following lease information in its 2011 annual report related to its leasing
activities (in millions).
Capital
Operating
Leases
Leases
2012
$ 167
$ 1,176
2013
149
1,091
2014
129
942
2015
118
779
2016
78
685
Thereafter
477
5,940
Total
1,118
$10,613
Amount representing interest
(439)
Present value of net minimum lease payments
$ 679
a. What did AMR report on its 2011 balance sheet related to leases?

b. The present value of the operating leases at 11% is $5,754.

a. Using a 10.4 average lease life, what would be the impact on depreciation expense of capitalizing
the operating leases?

b. Using the 11% rate, what would be the impact on interest expense of capitalizing the operating
leases?

Exercise General Motors Company reports the following information for its U.S. Pension Plan in its 2011 annual
report (in millions):
Change in benefit obligations
Benefit obligation at January 1, 2011
Service cost
Interest cost
Plan participants contributions
Amendments
Actuarial (gains) losses
Benefits paid
Benefit obligation at December 31, 2011
Change in plan assets
Fair value of plan assets at January 1, 2011
Actual return on plan assets
Employer contributions
Plan participants contributions
Benefits paid
Exchange rate movements
Other
Fair value of plan assets at December 31, 2011

$103,395
494
4,915

(6)
8,494
(8,730)
$108,562

$91,007
10,087
1,962

(8,730)

23
$94,349

a. What is the funded status of the pension plan in 2011?

b. What does the service cost represent?
c.

How does this funded status affect the companys balance sheet?

d. GM paid much more in pensions to its retirees than they contributed in cash to the plan.
a. How is this possible?
b. How long could this situation continue?

SHORT ANSWER

1. There is currently a proposal to capitalize all operating leases in the USA. What would be the impact of this
on corporate balance sheets?