Question IV  Lease Accounting

The Financial Accounting Standards Board is considering revising GAAP for leases. One possible revision would change the method of accounting for operating leases by creating a "right-to-use" model.  Under the right-to-use model, companies would determine the present value of all noncancellable lease payments and record an intangible asset ("Right to use buildings and equipment") and corresponding liability ("Lease obligation") when the lease begins.

Consider the following example of how a company currently reports its leases:

At December 31, 2011, the company's minimum rental commitments under capital leases and noncancellable operating leases with initial or remaining terms of more than one year were (in millions):

Assume:

1.    Lease payments for 2012 to 2016 are made annually on December 31 of each year;

2.    No additional leases are created after December 31, 2011;

3.    The interest rate on the leases is 8 percent per year;

4.    The company would amortize the "Right to use buildings and equipment" asset arising from the operating leases using the straight line method over 5 years with no salvage value.

REQUIRED:

1.    Calculate interest expense associated with the capital leases for the fiscal year ended December 31, 2012 under current GAAP.

2.    Calculate the expense on the income statement for the fiscal year ended December 31, 2012 under current GAAP related to the operating leases.

3.    Calculate the present value as of December 31, 2011 of future minimum lease payments arising from noncancellable operating leases under the right-to-use model (labeled A above.)

4.    Compared to current GAAP, how much higher or lower would the company's Earnings Before Taxes be for the year ended December 31, 2012 if the company adopted the right-to-use model of accounting for operating leases?  Indicate if the change to the right-to-use model would increase or reduce Earnings Before Taxes.