The accounting for operating leases is a controversial issue. Many observers argue that firms that use operating leases are using significantly more assets and are more highly leveraged than their financial statements indicate. As a result, analysts often use footnote disclosures to reconstruct and then capitalize operating lease obligations. One way to do so is to increase a firm's assets and liabilities by the present value of all its future minimum rental payments.
Instructions
Go to the SEDAR website (www.sedar.com) or the websites of the companies and access the financial statements of Canadian National Railway Company (CNR) and Canadian Pacific Railway Limited (CPR) for their years ended December 31, 2011. Refer to the financial statements and notes to the financial statements and answer the following questions.
(a) Identify all lease arrangements that are indicated in each company's financial statements and notes. For each lease arrangement, give the title and balances of the related lease accounts that are included in the financial statements.
(b) Have CNR and CPR provided all the lease disclosures as required by the accounting standards?
(c) What are the terms of these leases?
(d) What amount did each company report as its future minimum annual rental commitments under capital leases? Under operating leases? Are there significant differences between the two companies and the way they provide for their physical operating capacity, or are they basically similar?
(e) Calculate the debt to equity ratio for each company at December 31, 2011.
(f) Assuming that the contract-based approach is adopted by both companies, what would be the impact on the companies' debt-to-total assets ratios? Where necessary estimate the impact on the statement of financial position using 7% as the lessee's implied borrowing rate. What information is missing from the companies' notes to make a more accurate calculation of the impact of adopting the contract-based approach?
(g) Recalculate the ratios in part (e), incorporating the adjustments made in part (f) above. Comment on your results.
(h) What do you believe are the advantages of adopting the contract-based approach when trying to compare companies? Relate your discussion to your analysis above for CNR and CPR.