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Analysis of Operating Leases
Difficulty: Advanced
An operating lease is treated like a rental contract. Neither the leased asset nor the associated liability is reported on the lessee statement of financial position, but the rights may be very similar to the rights of an owner. The lessee only records the lease payments as a rental expense in income statement.
- Operating Leases Accounting Policy
- Present Value of Future Operating Lease Payments
- Analyst Adjustments for Operating Leases
- Adjusted Ratios for Operating Leases (Summary)
- Adjusted Total Asset Turnover
- Adjusted Debt to Equity
- Adjusted Return on Assets (ROA)
- Adjusted Interest Coverage
- Estimation of Depreciation Expense, Operating Leased Assets
- Estimation of Interest Expense, Operating Lease Obligations
- Present Value of Operating Lease Payments, at Beginning of Year
Operating Leases Accounting Policy
Costco leases land and/or buildings at warehouses and certain other office and distribution facilities, primarily under operating leases. Operating leases expire at various dates through 2064, with the exception of one lease in Costco's U.K. subsidiary, which expires in 2151. These leases generally contain one or more of the following options, which Costco can exercise at the end of the initial lease term: (a) renewal of the lease for a defined number of years at the then-fair market rental rate or rate stipulated in the lease agreement; (b) purchase of the property at the then-fair market value; or (c) right of first refusal in the event of a third-party purchase offer.
Costco accounts for its lease expense with free rent periods and step-rent provisions on a straight-line basis over the original term of the lease and any extension options that Costco more likely than not expects to exercise, from the date Costco has control of the property. Certain leases provide for periodic rental increases based on price indices, or the greater of minimum guaranteed amounts or sales volume.
Costco has capital leases for certain warehouse locations, expiring at various dates through 2054. Capital lease assets are included in land and buildings and improvements in the accompanying consolidated balance sheets. Amortization expense on capital lease assets is recorded as depreciation expense and is included in selling, general and administrative expenses. Capital lease liabilities are recorded at the lesser of the estimated fair market value of the leased property or the net present value of the aggregate future minimum lease payments and are included in other current liabilities and other liabilities in the accompanying consolidated balance sheets. Interest on these obligations is included in interest expense in the consolidated statements of income.
Costco records an asset and related financing obligation for the estimated construction costs under build-to-suit lease arrangements where it is considered the owner for accounting purposes, to the extent Costco is involved in the construction of the building or structural improvements or has construction risk prior to commencement of a lease. Upon occupancy, Costco assesses whether these arrangements qualify for sales recognition under the sale-leaseback accounting guidance. If Costco continues to be the deemed owner, it accounts for the arrangement as a financing lease.
Costco's asset retirement obligations (ARO) primarily relate to leasehold improvements that at the end of a lease must be removed. These obligations are recorded as a liability with an offsetting asset at the inception of the lease term based upon the estimated fair value of the costs to remove the leasehold improvements. These liabilities are accreted over time to the projected future value of the obligation using Costco's incremental borrowing rate. The ARO assets are depreciated using the same depreciation method as the leasehold improvement assets and are included with buildings and improvements. Estimated ARO liabilities associated with these leases were immaterial at the end of 2017 and 2016, respectively, and are included in other liabilities in the accompanying consolidated balance sheets.
Source: Costco Wholesale Corp., Annual Report
Present Value of Future Operating Lease Payments
Costco Wholesale Corp., future operating lease payments
1 Source: Costco Wholesale Corp. Annual Reports
2 Internal rate of return on capital leases
| Year | Future operating lease payments (as reported)1 | Year | Future operating lease payments (estimated) | Present value at % |
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1 Source: Costco Wholesale Corp. Annual Reports
| Year | Future operating lease payments (as reported)1 | Year | Future operating lease payments (estimated) | Present value at % |
|---|---|---|---|---|
| 2017 | |
2017 | |
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1 Source: Costco Wholesale Corp. Annual Reports
| Year | Future operating lease payments (as reported)1 | Year | Future operating lease payments (estimated) | Present value at % |
|---|---|---|---|---|
| 2016 | |
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| 2017 | |
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1 Source: Costco Wholesale Corp. Annual Reports
| Year | Future operating lease payments (as reported)1 | Year | Future operating lease payments (estimated) | Present value at % |
|---|---|---|---|---|
| 2015 | |
2015 | |
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1 Source: Costco Wholesale Corp. Annual Reports
| Year | Future operating lease payments (as reported)1 | Year | Future operating lease payments (estimated) | Present value at % |
|---|---|---|---|---|
| 2014 | |
2014 | |
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| 2015 | |
2015 | |
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| 2016 | |
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| 2017 | |
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1 Source: Costco Wholesale Corp. Annual Reports
| Year | Future operating lease payments (as reported)1 | Year | Future operating lease payments (estimated) | Present value at % |
|---|---|---|---|---|
| 2013 | |
2013 | |
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| 2014 | |
2014 | |
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| 2015 | |
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| 2016 | |
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1 Source: Costco Wholesale Corp. Annual Reports
Analyst Adjustments for Operating Leases
Costco Wholesale Corp., adjustments to financial data
USD $ in millions
1, 2 Equal to total present value of future operating lease payments. See Details »
4 Source: Costco Wholesale Corp. Annual Reports
Adjusted Ratios for Operating Leases (Summary)
Costco Wholesale Corp., adjusted ratios
| Ratio | Description | The company |
|---|---|---|
| Adjusted total asset turnover | An activity ratio calculated as total revenue divided by adjusted total assets. | Costco Wholesale Corp.'s adjusted total asset turnover improved from 2015 to 2016 but then slightly deteriorated from 2016 to 2017. |
| Adjusted debt-to-equity | A solvency ratio calculated as adjusted total debt divided by total shareholders' equity. | Costco Wholesale Corp.'s adjusted debt-to-equity improved from 2015 to 2016 but then deteriorated significantly from 2016 to 2017. |
| Adjusted ROA | A profitability ratio calculated as net income divided by adjusted total assets. | Costco Wholesale Corp.'s adjusted ROA deteriorated from 2015 to 2016 but then improved from 2016 to 2017 exceeding 2015 level. |
| Adjusted interest coverage | A solvency ratio calculated as adjusted EBIT divided by adjusted interest payments. | Costco Wholesale Corp.'s adjusted interest coverage deteriorated from 2015 to 2016 but then improved from 2016 to 2017 exceeding 2015 level. |
Adjusted Total Asset Turnover
2017 Calculations
1 Total asset turnover = Net sales ÷ Total assets
= ÷ =
2 Adjusted total asset turnover = Net sales ÷ Adjusted total assets
= ÷ =
| Ratio | Description | The company |
|---|---|---|
| Adjusted total asset turnover | An activity ratio calculated as total revenue divided by adjusted total assets. | Costco Wholesale Corp.'s adjusted total asset turnover improved from 2015 to 2016 but then slightly deteriorated from 2016 to 2017. |
Adjusted Debt to Equity
2017 Calculations
1 Debt to equity = Total debt ÷ Total Costco stockholders' equity
= ÷ =
2 Adjusted debt to equity = Adjusted total debt ÷ Total Costco stockholders' equity
= ÷ =
| Ratio | Description | The company |
|---|---|---|
| Adjusted debt-to-equity | A solvency ratio calculated as adjusted total debt divided by total shareholders' equity. | Costco Wholesale Corp.'s adjusted debt-to-equity improved from 2015 to 2016 but then deteriorated significantly from 2016 to 2017. |
Adjusted Return on Assets (ROA)
2017 Calculations
1 ROA = 100 × Net income attributable to Costco ÷ Total assets
= 100 × ÷ = %
2 Adjusted ROA = 100 × Net income attributable to Costco ÷ Adjusted total assets
= 100 × ÷ = %
| Ratio | Description | The company |
|---|---|---|
| Adjusted ROA | A profitability ratio calculated as net income divided by adjusted total assets. | Costco Wholesale Corp.'s adjusted ROA deteriorated from 2015 to 2016 but then improved from 2016 to 2017 exceeding 2015 level. |
Adjusted Interest Coverage
2017 Calculations
2 Interest coverage = EBIT ÷ Interest expense
= ÷ =
3 Adjusted interest coverage = Adjusted EBIT ÷ Adjusted interest expense
= ÷ =
| Ratio | Description | The company |
|---|---|---|
| Adjusted interest coverage ratio | A solvency ratio calculated as adjusted EBIT divided by adjusted interest payments. | Costco Wholesale Corp.'s adjusted interest coverage ratio deteriorated from 2015 to 2016 but then improved from 2016 to 2017 exceeding 2015 level. |
Estimation of Depreciation Expense, Operating Leased Assets
USD $ in millions
1 Source: Costco Wholesale Corp., Annual Reports
Estimation of Interest Expense, Operating Lease Obligations
2 Internal rate of return on capital leases
2017 Calculations
3 Estimated interest expense, operating lease obligations = Operating leased assets, at beginning of year × Discount rate
= × =
Present Value of Operating Lease Payments, at Beginning of Year
1 Equal to total present value of future operating lease payments. See Details »
2 Source: Costco Wholesale Corp., Annual Reports
3 Internal rate of return on capital leases
2017 Calculations
4 Total present value of operating lease payments, at beginning of year = (Total present value of future operating lease payments + Aggregate rental expense) ÷ (1 + Discount rate)
= ( + ) ÷ (1 + %) =
