Financial Education

As of December 31, 2006 US Cellular Corporation (USM) reported long-term debt of $1.0 billion and total assets of $5.7 billion, resulting in a debt/assets ratio of 17.5%. It also recorded interest expense of $94 million and Earnings Before Interest and Taxes (EBIT) of $407 million, resulting in interest coverage of 4.3x.

In US Cellular’s 10K, the following disclosures are made regarding asset retirement obligations:

U.S. Cellular is subject to asset retirement obligations associated primarily with its cell sites, retail sites and office locations. Asset retirement obligations generally include obligations to remediate leased land on which U.S. Cellular’s cell sites and switching offices are located. Also, U.S. Cellular is generally required to return leased retail store premises and office space to their pre-existing conditions. The asset retirement obligation is included in Deferred Liabilities and Credits in the Consolidated Balance Sheets.

During the third quarter of 2006, U.S. Cellular reviewed the assumptions related to its asset retirement obligations and, as a result of the review, revised certain of those assumptions. Estimated retirement obligations for cell sites were revised to reflect higher estimated costs for removal of radio and power equipment, and estimated retirement obligations for retail stores were revised to reflect a shift to larger stores and slightly higher estimated costs for removal of fixtures. These changes are reflected in “Revision in estimated cash flows” below. The table below also summarizes other changes in asset retirement obligations during the year ended December 31, 2006 and 2005.

We can use this disclosure to adjust the financial statements and treat the ARO as equivalent to financial obligations. Since there are no offsetting trust funds, the process is as follows:

1. Reduce the $128 million ARO as of 12/31/06 by the company’s 38.5% tax rate, to $79 million.
2. Add the $79 million to reported long-term debt of $1 billion.
3. Add the $7 million accretion expense to both EBIT and Interest expense.

As a result of these adjustments we can recalculate the ratios as follows:

Debt/Assets = (1.0 + 0.08)/5.7 = 18.9%
Interest coverage = (407 + 7)/(94 + 7) = 4.1x

The resulting ratios are noticeably different from the unadjusted ratios, but in this instance probably would not significantly impact the evaluator’s opinion.

For more information, see all articles on: Accounting, Adjusting Reported Financial Statements, Case Studies, Financial Statement Analysis, Fundamental Analysis, Ratio Analysis

See also:

Accounting for Asset Retirement Obligations

Analyzing Asset Retirement Obligations

Postretirement Obligations

Hybrid Retirement Plans and Other Employee Benefit Plans

Overconfidence Bias