Question

Delta Airlines provides scheduled air transportation for passengers and cargo throughout the United States and globally a fleet of more than 900 aircraft. Information for its 2015 annual report follows.

December 31,

($ in millions)   2015 2014

Asset

            Flight and ground equipment under capital leases                  $1,112             $1,141

                        Less accumulated amortization                                        782                  767

                                                                                                            $   330             $   374

Total Assets                                                                                       $53,134          $54,005

Liabilities

            Current Liabilities                                                                  

                        Current obligation under capital leases                       $    148            $   107

Obligations under capital leases, less current obligations                   $    235            $    291

Total liabilities                                                                                    $42,284          $45,192

NOTE 7. LEASE OBLIGATIONS

We lease aircraft, airport terminals, maintenance facilities, ticket offices and other property and equipment from third parties. Rental expense for operation 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, aircraft 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 beneficiary 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 flown by regional carriers) with initial or remaining terms in excess of one year for the years succeeding December 31, 2015 (in millions):

Year Ending December 31 Capital Leases Operating Leases

2016                                                                            $183                $1,583

2017                                                                            114                1,440

2018                                                                               56                 1,307

2019                                                                               41                 1,158

2020                                                                               29                 1,053

Thereafter                                                                      39                 6,220

                                                                                       A                 $12,761

Less amount representing interest                                  C

Present value of net minimum lease payments              B

Required:

All questions relate to 2015 unless stated otherwise.

1. Solve for the unknowns (A, B, and C)

2. What is the net amount of capital lease assets on the balance sheet?

3. Why is the net amount of capital lease assets on the balance sheet different from the total amount of liabilities recorded on the balance sheet?

4. Compute Delta’s Total debt to Total assets.

5. What entry would Delta make in 2016 to record the effects of capital leases existing at December 31, 2015? You may omit the depreciation entry.

6. What is the amount of operating lease obligation on the balance sheet?

7. What is the present value of operating lease payments? Assume an 11% discount rate.

8. What entry would be made to convert the operating leases to ASU 2016-02 (ASC 842)? Do not make an entry to reclassify long-term liabilities to current liabilities.

9. Recompute the Total debt to Total assets ratio after making the entry in requirement 8. What is the percentage change from the ratio computed in requirement 4?

Answer 1

Post from question 7 onwards seperately.

1. Solve for the unknowns (A, B, and C)

A.The Total Minimum Lease payments is the sum of annual payments of capital lease listed as below:

2016                           $183

2017                           $114

2018                           $ 56

2019                           $ 41

2020                           $ 29

Thereafter                   $ 39

                                  $ 462

C.The present value of net lease payments is $148+$235=$383 .It is the sum of the "Current Obligation " under capital leases of $148 and obligation under capital lease less current obligations of $235 which are shown in the balance sheet.

B.Amount representing interest is equal to A-C=$ 79

2 Capital Lease Net Asset

From Balance Sheet

Cost                              $1112

Accumulated Depre     ($782)

                                    $330

3.Reasons for difference between 1 & 2

A capital lease asset is amortized uisng Delta airlines normal depreciation policies whereas the obligation is reduced using the effective interest method.The lease asset and obligation are equal only at the inception of lease.

4.Total Debt to Total Assets

                 Debt/Total Asset =$42284/$53134=.80

5.Entry to record the capital lease in 2016

Current Obligation under capital leases $ 148 Balance Sheey

Interest Expense                                      $35 Plug

To Cash                                                                     $183

6.Operating lease obligation on the balance sheet

Normally there would be zero on Balance Sheet.However it says that $1.2 billion have been accrued.The entry to record the expense would be a debit to rent expense and credit to accrued liabilities and other liabilities and deferred credits totalling $1.2 billion.This accounting occurs when the rental payments increase over the life of the lease.