Advanced Issues  233 short-term debt, long-term debt, and capitalized operating leases. All changes in debt should be included in the reconciliation of total funds invested, not in free cash flow. • Change in debt equivalents. Since accrued pension liabilities and accrued postretirement medical liabilities are considered debt equivalents (see Chapter 23 for more on issues related to pensions and other postretire- ment benefits), their changes should be treated as a financing flow.11 • Dividends. Dividends include all cash dividends on common and pre- ferred shares. Dividends paid in stock have no cash effects and should be ignored. • Share issues and repurchases. When new equity is issued or shares are repurchased, four accounts will be affected: common stock, additional paid-in capital, treasury shares, and retained earnings (for shares that are retired). Although different transactions will have varying effects on the individual accounts, only the aggregate matters, not how the indi- vidual accounts are affected. Exhibit 11.13 refers to the aggregate change as “Repurchases of common stock.” • Outflows to nonconsolidated subsidiaries. Income attributable to noncon- solidated subsidiaries, found at the bottom of the income statement, is a financing flow, similar to dividends. Advanced Issues In this section, we summarize a set of the most common advanced topics in re- organizing a company’s financial statements, including nonoperating charges and restructuring reserves, operating leases, pensions, and capitalized re- search and development (R&D). We provide only a brief summary of these topics here, as each one is discussed in depth in the chapters of Part Three, “Advanced Valuation Techniques.” Nonoperating Charges and Restructuring Reserves  Provisions are noncash expenses that reflect future costs or expected losses. Companies record provi- sions by reducing current income and setting up a corresponding reserve as a liability (or deducting the amount from the relevant asset). For the purpose of analyzing and valuing a company, we categorize provi- sions into one of four types: ongoing operating provisions, long-term operat- ing provisions, nonoperating restructuring provisions, and provisions created for the purpose of smoothing income (transferring income from one period to 11 Pensions will affect many accounts, including the pension expense on the income statement, pension assets, pension liabilities, and deferred taxes. Exhibit 11.16, shown later in this chapter, aggregates each of the pension accounts into a single number for the cash flow statement. 234  Reorganizing the Financial Statements another). Based on the characteristics of each provision, adjust the financial statements to reflect the company’s true operating performance: • Ongoing operating provisions. Operating provisions such as product war- ranties are part of operations. Therefore, deduct the provision from rev- enue to determine NOPAT, and deduct the corresponding reserve from net operating assets to determine invested capital. • Long-term operating provisions. For certain liabilities, such as expected plant decommissioning costs, deduct the operating portion from rev- enue to determine NOPAT, and treat the interest portion as nonoperat- ing. Treat the corresponding reserve as a debt equivalent. • Nonoperating provisions. Unless deemed as ongoing, provisions such as one-time restructuring charges related to severance are nonoperating. Treat the expense as nonoperating and the corresponding reserve as a debt equivalent. • Income-smoothing provisions. Classify any provisions identified for the purpose of income smoothing as nonoperating, and their correspond- ing reserve as an equity equivalent. Since income-smoothing provisions are noncash, they do not affect value. The process for classifying and properly adjusting for provisions is ex- plained in more detail in Chapter 21. Operating Leases Starting in 2019, companies that report under U.S. Generally Accepted Ac- counting Principles (GAAP) or International Financial Reporting Standards (IFRS) are required to capitalize nearly all asset leases, including short-term ones known as operating leases.12 Under both standards, the present value of operating lease payments will be recorded on the balance sheet. On the income statement, IFRS allocates operating lease payments to depreciation and interest expense as appropriate, so no adjustment is necessary. For com- panies using GAAP, the entire lease expense, including embedded interest, is incorporated into other operating expenses like cost of sales. If this is the case, reclassify embedded interest in the lease expense as an interest expense. Since past statements will not be restated, make sure to adjust them for operating leases to create a like-for-like analysis. To estimate the present value of operating leases prior to adoption of the new standard, search the notes for future rental commitments. Costco reports rental commitments in its note on 12 The International Accounting Standards Board (IASB) published IFRS 16, “Leases,” in January 2016, and the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-02, “Leases” (Topic 842), in February 2016.