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Adjusting Enterprise Operations

Adjusting Enterprise Operations. Module 11: Frank Chenxi Huang. Goals of adjustment. Enhance comparability Better distinction between enterprise operating and financing activities Better ability to forecast. Areas to be adjusted. Inventory method Operating leases

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Adjusting Enterprise Operations

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  1. Adjusting Enterprise Operations Module 11: Frank Chenxi Huang

  2. Goals of adjustment • Enhance comparability • Better distinction between enterprise operating and financing activities • Better ability to forecast

  3. Areas to be adjusted • Inventory method • Operating leases • Share-based compensation

  4. Inventory methodFIFO vs. LIFO Assume the cost of inventory keeps going up, • NEA F > L • EPAT F > L • EPM F > L • EATO F < L • RNEA Depends! • Value No change!!

  5. Inventories （from Note A. Significant Accounting Policies) • Raw materials, work in process and finished goods are stated at the lower of average cost or market. Cash flows related to the sale of inventories are reflected in net cash provided by operating activities in the Consolidated Statement of Cash Flows.

  6. Definition of'Lower of Cost and Market Method' • A requirement of GAAP in the United States that inventory be recorded at the lower of either the cost to produce it, the cost to repurchase it or the market value of the inventory • Therefore no adjustment is needed in this area.

  7. Operating Leases • NEA C > O Missing assets due to operating leases • EPAT C > O operating leases lead to rent expense in EPAT, capital leases have associated depreciation (affects EPAT) and interest expense (does not affect EPAT) • EPM C > O • EATO C < O • RNEA Depends! • Value No change!!!

  8. Total contractual obligations are reported in the table excluding the effects of time value and therefore, may not equal the amounts reported in the Consolidated Statement of Financial Position. • The PV of Operating Lease Obligations is not given in the financial statements. I assumed a 10% IRR to discount Operating Lease Payments.

  9. Capitalization of Delta’s Operating Leases on the Balance Sheet

  10. Adjustments to the Income Statement

  11. 3. Share-based compensation • Note R. Stock-based Compensation • Stock options are awards which allow the employee to purchase shares of the company’s stock at a fixed price. Stock options are granted at an exercise price equal to the company’s average high and low stock price on the date of grant. These awards, which generally vest 25 percent per year, are fully vested four years from the date of grant and have a contractual term of 10 years • The company estimates the fair value of stock options at the date of grant using the Black-Scholes valuation model.

  12. Beginning of year share price: 196.35 • End of year share price:187.57

  13. Step 1 • Value of options exercisable at beginning of year • 11,389,721*(196.35-94)=1,165,737,944

  14. Step 2 Value of option exercisable at beginning of year using end of year prices 11,389,721*(187.57-97)=1,031,567,031

  15. Step 3 • Estimated value of exercised options • 5,585,127*(191.96-90)=$569,459,549

  16. Step 4 • Value of options cancelled during the year • 181,643*(191.96-86)=19,246,892

  17. Step 5 • Value of options exercisable at end of year 5,622,951*(187.57-97)=509,270,672

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