Treatment of leases and pensions: ConAgra Foods

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CWID # 50132822

CWID # 50132822

Semester: Summer I

Year: 2014

Course Name: Financial Accounting

  1. Introduction.

Leases and pensions are advanced accounting subjects that have considerable impact on the businesses’ financial statements. Due to the large-scale corporate accounting scandals in recent years, U.S. Congress intervened by passing the Sarbanes-Oxley Act (SOX) of 2002 (Journal of Economic Perspectives, 2007). According to Sarbanes-Oxley Act (2002), publicly traded companies are required to comply by disclosing all of off-balance-sheet transactions. Not only businesses are required to disclose off-balance sheet items, but also they are required to provide an internal control report as well (SOX, 2002). Given these points, both leases and pensions are subjected to strict disclosure regulations, which are due to their significant influence on capital providers and the economy (Chartered Institute of Management Accountants, 2012). This paper provides broad overview of leases and pensions, presents comprehensive analysis of how ConAgra Foods (packaged food company) reports leases and pensions on its financial statements, discusses off-balance-sheet material and explains how leases and pensions affect financial reporting.

  1. Leases.
  1. Capital Lease – Broad Overview.

According to Spiceland (2013), leasing is a preferred method of funding of corporate assets in the United States. We can distinguish two types of leases, capital lease and operational lease, and both of them require different accounting methods (Spiceland, 2013). Capital lease is characterized by asset ownership; the lease title transfers from the lessor to the lessee during or at the end of the lease agreement (Spiceland, 2013). The Financial Accounting Standards Board (FASB) has ruled that a lease is classified as a capital lease when it includes a non-cancellable lease term and at least one criterion outlined below (FASB, 1976):

1. The contract specifies that the title of the asset will transfer from lessor to the lessee (Spiceland, 2013);

2. The contract includes a bargain purchase option (BPO) (Spiceland, 2013);

3. The non-cancellable term of the contract is equal to at least 75% of the estimated economic life of the asset (Spiceland, 2013);

4. The present value (PV) of the minimum amount paid for renting the asset is equal to or greater than 90% of a fair value of the asset (Spiceland, 2013).

For capital leases, lease obligations are recorded in the liabilities section of the balance sheet. Conversely, leased assets are recorded in the assets section of the balance sheet. Capital leases have significant impact on the overall financial picture of the company. As a result, many businesses prefer to structure their contracts in the form of operating leases in order to avoid recording lease obligations on their statement of financial position (The Wall Street Journal, 2004).

  1. Operating Lease €­ Broad Overview.

When it comes to operating leases, lessee has the right to use the asset, but the ownership of asset is retained by the lessor (Spiceland, 2013). Since the title of the asset will not transfer to the lessee, rental payments are recorded as an expense. Under the U.S. GAAP, the lessee is not required to record the cost of the asset and while off-balance-sheet accounting is acceptable under the law, it may hide company’s true financial performance (Investopedia, 2014.). Some companies may use this as a manipulation method in order to keep debt-to-equity ratio low and to appear as if company’s financial performance is better than it actually is (Investopedia, 2014). Even though off-balance-sheet accounting is permissible, this practice may have disastrous effects as it may be misleading to some users of financial statements. To illustrate, ABC Company records their total debt and equity for the amount of $118 million and $355 million respectively, and leases an additional asset under the operating lease agreement for the amount of $710 million. Leased asset does not appear on the company’s balance sheet. If we compute ABC Company’s total debt-to-equity ratio the result will be 0.33. If we adjust the numbers by adding $710 million to $118 million, and compute the ratio again, the result will be 2.33, which shows that ABC Company largely finances their operations with debt.

  1. Types of leases reported in ConAgra’s financial statements.

According to ConAgra’s Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as of May 26, 2013 the company reported debt and capital lease obligations, which amounted to $9.30 billion (ConAgra, 2013). ConAgra also used off-balance-sheet accounting and the amount that was not recorded on company’s statement of the financial position totaled to $1.52 billion (ConAgra, 2013). Furthermore, ConAgra had long-term operating lease obligations as outlined in the table below:

Table 1. ConAgra’s operating leases obligations:

Note: Adapted from ConAgra Foods’ 2013 Annual Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934.

If we calculate ConAgra’s total debt-to-equity ratio as of May 26, 2013, the ratio was 2.8 or 280%. In this case, for every dollar of ConAgra owned by the shareholders, ConAgra owed $2.8 to creditors. If we adjust the numbers by adding $1.52 billion (amount not recorded on ConAgra’s balance sheet) to $15,042.3 million (total liabilities), and compute the ratio again, the result will be higher: 3.09 or 309%. ConAgra’s total debt-to-equity ratio was high and this means that the company was largely financing its growth with debt. However, it is important to mention that debt-to-equity ratio varies from industry to industry and a ratio that high in one industry might be acceptable for another industry (Adkins, 2014).

  1. Pensions – Broad Overview.

Employer-provided pensions play significant function is providing income to individuals during their retirement years (Spiceland, 2013). Generally, we can distinguish two types of pension plans:

  1. Defined contribution pension plans, and;
  2. Defined benefit pension plans.

As stated by Spiceland (2013), defined contribution pension plans (DC plans) offer annual contribution to pension fund and employees can make a decision where they want to invest the funds (Spiceland, 2013). In this case, the pay depends on the amount accumulated at the retirement (Spiceland, 2013).

When it comes to defined benefit pension plans (DB plans), retirement pay is calculated by a predetermined formula and the retirement payment is based on: salary history, tenure of service and on occasion age (Spiceland, 2013). In this case, employer pays pre-established monthly benefit to employee at the retirement (Spiceland, 2013). According to U.S. Social Security Administration (2009), “the percentage of workers covered by a traditional defined benefit (DB) pension plan that pays a lifetime annuity, often based on years of service and final salary, has been steadily declining over the past 25 years.” Furthermore, the numbers of companies that consider eliminating DB plans over time has grown significantly. The slow decline of DB plans is due to the fact that:

  1. DB plans are more costly than DC plans (Workforce Magazine, 2012);
  2. Employers want to shift the investment responsibility to employees (Workforce Magazine, 2012).
  1. Types of pension plans reported in ConAgra’s financial statements.

According to ConAgra’s Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as of May 26, 2013, the company offered defined benefit (DB) retirement plans for qualified hourly and salaried employees (ConAgra, 2013). The benefits offered were based on tenure of service and average remuneration or “stated amounts for each year of service” (ConAgra, 2013). In addition, ConAgra provided funds for postretirement plans, which incorporated dental and medical benefits (ConAgra, 2013). However, effective August 1, 2013, the company decided to close DB plans to new salaried employees and instead, these employees were eligible to participate in ConAgra’s defined contribution plan (ConAgra, 2013).

  1. ConAgra’s pension expense.

According to ConAgra’s consolidated statement of cash flows for the fiscal year ended May 2013, the pension expense recognized on the company’s statement was $23.5 million. Also, the company contributed to pension plans $19.8 million. In this case, the $19.8 million was not included in pension expense and as a result ConAgra’s reported earnings were not reduced by this amount.

When it comes to the expected return on plan assets, ConAgra projected it to be $(216.4). It is important to note that, the expected return on plan assets is controversial in accounting as the companies might use “smoothing techniques” in order to improve their overall financial performance (Flood, 2014).

  1. The Funded Status of the Plan.

As presented in Table 2, the benefit obligations at the end of the year were $3,817.5 billion and the fair value of plan assets at the end of the year was $3,343.3 billion. The fair value of the plan assets subtracted by the benefit obligation resulted in the funded status of $(474.2) million. As we can see, ConAgra’s pension plan at the time was under-funded by $(474.2) million.

Table 2. The changes in benefit obligations and plan assets at May 26, 2013 (in millions).

Note: Adapted from ConAgra Foods’ 2013 Annual Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934.

As reported by Spiceland (2013), “a company’s PBO is not reported separately among liabilities in the balance sheet. Similarly, the plan assets a company sets aside to pay those benefits are not separately reported among assets on the balance sheet.” (Spiceland, 2013, p.1023).

As presented in Table 3, at May 26, 2013, the funded status of the plan ($(474.2)) has not been recognized in ConAgra’s consolidated balance sheet. Instead, the net amount recognized, $(474.2), comprised of other assets, other accrued liabilities and other noncurrent liabilities.

Table 3. Funded status and net amount recognized in ConAgra’s consolidated balance sheet at May 26, 2013.

Note: Adapted from ConAgra Foods’ 2013 Annual Report pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934.

  1. Summary

In summary, when analyzing financial performance of ConAgra Foods, the process of learning accounting for leases and pensions helped me to understand financial statements on a more advanced level. It is crucial to understand off-balance-sheet arrangements as they have a significant impact on a company’s overall financial performance. As I reported above, ConAgra’s used off-balance-sheet accounting and after closer examination it was eminent that the company funded its daily operations largely with debt. Under the FASB regulations, businesses are not required to record certain assets and liabilities on their statement of financial position. However, this aspect may be confusing to the financial statements users as often the company will appear more creditworthy than it actually is.


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