5.2 Classifications
When classifying items as operating or financing in Lufthansa’s balance sheet and income statement, most items can easily be related to the appropriate activity, while other items require further attention and consideration of the item. These items will be discussed and classified below.
5.2.1 Income Taxes and Corporate Tax Rate
Income taxes in Lufthansa’s financial statements cover taxes on both operating and financing activities, which need to be separated. According to Plenborg and Petersen (2012) this can be done by calculating the tax shield from net financial expenses as shown in the following equation:
𝑇𝑎𝑥 𝑆ℎ𝑖𝑒𝑙𝑑 = 𝑁𝑒𝑡 𝐹𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 𝑥 𝐶𝑜𝑟𝑝𝑜𝑟𝑎𝑡𝑒 𝑇𝑎𝑥 𝑅𝑎𝑡𝑒
Several methods can be applied to determine an appropriate tax rate for Lufthansa. The corporate tax rate in Germany increased from 29.6% in 2013 to 29.79% in 2017 (Tradingeconomics, n.d.), however, as the company operates in several countries with varying tax rates, the value of the tax shield is affected when debt is held in foreign entity (Petersen &
Plenborg, 2012). Consequently, it is both theoretically and practically correct to use Lufthansa’s effective corporate tax rate instead of the German corporate tax rate in the analytical financial statements. The varying tax rates in the different countries are mirrored in the effective corporate tax rate as it determines the average tax rate posed on all income as shown in the following equation:
𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐶𝑜𝑟𝑝𝑜𝑟𝑎𝑡𝑒 𝑇𝑎𝑥 𝑅𝑎𝑡𝑒 = 𝐶𝑜𝑟𝑝𝑜𝑟𝑎𝑡𝑒 𝑇𝑎𝑥 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝐵𝑒𝑓𝑜𝑟𝑒 𝑇𝑎𝑥 (𝐸𝐵𝑇)
Appendix 4 shows the calculated effective corporate tax rate for Lufthansa and all peers.
5.2.2 Cash and Cash Equivalents
The item Cash and Cash Equivalents on the balance sheet covers operating cash and excess cash, which can be used to repay debt, buy back shares or paid out as dividends (Petersen &
Plenborg, 2012). It is difficult to properly estimate operating cash as Lufthansa does not distinguish between operating and financing items. In accordance with Petersen and Plenborg (2012) imprecise results are expected when attempting to estimate operating cash, while a stable
cash position can be treated as excess cash as it is done in the analytical income statement for Lufthansa.
5.2.3 Capitalized Operating Leases
The fleet of Lufthansa consist of aircrafts owned by the Lufthansa Group and aircrafts leased on finance contracts or operating contracts. Aircrafts on a finance lease are reported under assets on the balance sheet as Lufthansa has the option to purchase the asset or renew the lease and bears all risks and rewards associated with the lease.
In operating leases, on the other hand, the leased asset is owned by the lessor. Payments associated with operating leases are not disclosed on the balance sheet as an assets with a corresponding liability. This affects operating profits, as an implicit interest expense is included in the rental expense (Koller, et al., 2010), which therefore decreases operating profits.
Moreover, as the assets are not listed in Lufthansa’s balance sheet, capital productivity is boosted. Due to a typically smaller reduction in operating profit than in invested capital, the net effect is an artificial increase in the return on invested capital (Koller, et al., 2010). As airlines have different capital structures, it is essential to adjust for this effect to properly compare Lufthansa to its peers. This adjustment is done by capitalizing the asset value of the operating leases on the analytical balance sheets.
Various methods can be applied in order to capitalize the asset value of the operating leases.
Firstly, rating agencies like S&P compute the present value of the required lease payments, however, (Koller, et al., 2010) argue that this undervalues the asset. Alternatively, the perpetuity method can be used, dividing the rental expense by the cost of debt, which (Koller, et al., 2010) argue overvalues the assets. Lastly, (Koller, et al., 2010) recommends applying the following equation to estimate the asset value;
𝐴𝑠𝑠𝑒𝑡 𝑉𝑎𝑙𝑢𝑒A =𝑅𝑒𝑛𝑡𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑠𝑒ABC 𝑘E+ 1
𝐴𝑠𝑠𝑒𝑡 𝐿𝑖𝑓𝑒
The asset value is calculated from rental expense the following year. Asset life is depicted to be 20 years (Lufthansa Annual Report, 2017), while 𝑘E is the cost of secured debt. According to Koller, et al. (2010) the yield to maturity on AA-rated 10-year bonds can be used to estimate this cost. However, factors such as industry differences causes varying yields to maturity on corporate AA-rated 10-year bonds. Figure 15 shows the yields for US Treasury High Quality
Market Corporate bonds between 2013 and 2018. A steady yield fluctuation between 3% and 4% can be observed.
Figure 15 - US Treasury High Quality Market Corporate 10-Year Bond Yields 2013 - 2018, Own Depiction Based on (treasury.gov, 2018)
Bloomberg additionally reveals yields for 10-year Government Bonds around 3% for the US and 0% to around 4% for EMEA, mainly showing increasing government bond yields.
Consequently, a cost of secured debt of 3.5% will be applied.
Asset value is calculated from rental expenses on operating leases like aircrafts, and is therefore being classified as non-current asset (tangible fixed asset) on the operating side of the invested capital calculations. Consequently, Capitalized Operating Leases are included in Lufthansa’s Total Operating Assets. On the financing side of the invested capital the corresponding liability is classified as non-current liabilities, wherefore it is included in Lufthansa and its peers’ Net Interest-Bearing debt.
In the analytical income statement, a corresponding adjustment is done by separating the implied lease interest expense part and the depreciation part in the leasing expense. Appendix 4 shows the implied lease interest expense and the asset value using the cost of secured debt and asset life. The implied lease interest expense is calculated by the following equation:
𝐼𝑚𝑝𝑙𝑖𝑒𝑑 𝐿𝑒𝑎𝑠𝑒 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 = 𝑘E 𝑥 𝐴𝑠𝑠𝑒𝑡 𝑉𝑎𝑙𝑢𝑒
In the analytical income statement, the implied interest lease expense is added to the EBITDA, therefore increasing the NOPAT.
0,00 1,00 2,00 3,00 4,00 5,00 6,00
Jan 2013 Mar 2013 May 2013 Jul 2013 Sep 2013 Nov 2013 Jan 2014 Mar 2014 May 2014 Jul 2014 Sep 2014 Nov 2014 Jan 2015 Mar 2015 May 2015 Jul 2015 Sep 2015 Nov 2015 Jan 2016 Mar 2016 May 2016 Jul 2016 Sep 2016 Nov 2016 Jan 2017 Mar 2017 May 2017 Jul 2017 Sep 2017 Nov 2017 Jan 2018
US Treasury High Quality Market Corporate 10-Year Bond Yields 2013-2018