Note 2. Lease Accounting Policy (Notes)

3 Months Ended

Mar. 31, 2019

Lease Accounting

Starting in February 2016 and continuing into 2019, the Financial Accounting Standards Board ("FASB") issued standards on the recognition and measurement of leases ("Topic 842"). We adopted these standards beginning with the quarter ended March 31, 2019, using a modified retrospective transition approach for leases existing at, or entered into after, the beginning of 2019 and have not recast the comparative periods presented in the Condensed Consolidated Financial Statements. The standards provide a number of optional practical expedients and policy elections in transition. We elected the ‘package of practical expedients’ under which we did not reassess under the standards our prior conclusions about lease identification, lease classification and initial direct costs. We did not elect the use-of-hindsight or the practical expedient pertaining to land easements. Refer to Note 5 for information regarding the adjustments recorded to our Condensed Consolidated Balance Sheet as of the beginning of the quarter ended March 31, 2019 to reflect the adoption of Topic 842. Below is information about the nature of our leases, accounting policies and assumptions subsequent to adopting Topic 842 and other required disclosures.

In certain instances, we lease or sublease certain restaurants to franchisees. Our lessor and sublease portfolio primarily consists of stores that have been leased to franchisees subsequent to refranchising transactions. Our most significant leases with lease and non-lease components are leases with our franchisees that include both the right to use a restaurant as well a license of the intellectual property associated with our Concepts’ brands. For these leases, which are primarily classified as operating leases, we account for the lease and non-lease components separately. Revenues from rental agreements with franchisees are presented within Franchise and property revenues in our Condensed Consolidated Statements of Income and related expenses (e.g. depreciation and rent expense) are presented within Franchise and property expenses. The impact of Topic 842 on the accounting for our lessor and sublease portfolio was not significant.

We lease land, buildings or both for certain of our restaurants and restaurant support centers worldwide. Rental expense for leased restaurants is presented in our Condensed Consolidated Statements of Income as Company restaurant expenses and rental expense for restaurant support centers is presented as General and administrative expenses. The length of our lease terms, which vary by country and often include renewal options, are an important factor in determining the appropriate accounting for leases including the initial classification of the lease as finance (referred to as “capital” leases prior to the adoption of Topic 842) or operating and the timing of recognition of rent expense over the duration of the lease. We include renewal option periods in determining the term of our leases when failure to renew the lease would impose a penalty on the Company in such an amount that a renewal appears to be reasonably certain at the commencement of the lease. The primary penalty to which we are subject is the economic detriment associated with the existence of leasehold improvements that might be impaired if we choose not to continue the use of the leased property. Leasehold improvements are amortized over the shorter of their estimated useful lives or the lease term. We generally do not receive leasehold improvement incentives from the landlord upon opening a store that is subject to a lease. Our leasing activity for other assets, including equipment, is not significant. We determine if an arrangement is a lease at inception.

Prior to the adoption of Topic 842 (“Legacy GAAP”) liabilities for future rental payments under operating leases were not recognized on the balance sheet of the Company except when recognizing a liability was necessary to reflect the impact of recognizing rent expense on a straight-line basis. Upon the adoption of Topic 842, right-of-use assets and liabilities are recognized upon lease commencement for operating leases based on the present value of lease payments over the lease term. Such assets and liabilities have historically been recorded for finance leases. Right-of-use assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Subsequent amortization of the right-of-use asset and accretion of the lease liability for an operating lease is recognized as a single lease cost, on a straight-line basis, over the lease term. For finance leases, the right-of-use asset is depreciated on a straight-line basis over the lesser of the useful life of the leased asset or lease term. Interest on each finance lease liability is determined as the amount that results in a constant periodic discount rate on the remaining balance of the liability. As most of our leases do not provide an implicit discount rate, we use our incremental secured borrowing rate based on the information available at commencement date, including the lease term and currency, in determining the present value of lease payments for both operating and finance leases. Leases with an initial term of 12 months or less are not recorded in the Condensed Consolidated Balance Sheet; we recognize lease expense for these leases on a straight-line basis over the lease term.

Right-of-use assets are assessed for impairment in accordance with our long-lived asset impairment policy, which is performed annually or whenever events or changes in circumstances indicate that the carrying amount of a restaurant may not be recoverable. We reassess lease classification and remeasure right-of-use assets and lease liabilities when a lease is modified and that modification is not accounted for as a separate new lease or upon certain other events that require reassessment in accordance with Topic 842. Operating lease right-of-use assets are included in Other Assets and operating lease liabilities are included in Accounts payable and other current liabilities and Other liabilities and deferred credits in our Condensed Consolidated Balance Sheets. Finance lease right-of-use assets are included in Property, plant and equipment, net, while future rent obligations are included in Short-term borrowings and Long-term debt in our Condensed Consolidated Balance Sheets. The difference between operating lease rental

expense recognized in our Condensed Consolidated Statements of Income and cash payments for operating leases is recognized within Other, net within Net Cash Provided by Operating Activities in our Condensed Consolidated Statements of Cash Flows.

From time-to-time, our lease agreements include rental payments based on a percentage of restaurant sales in excess of stipulated amounts. Such amounts are recognized as variable lease expense when they are incurred. Additionally, certain of our lease agreements include rental payments adjusted periodically for inflation. Liabilities for such leases are not remeasured as a result of changes in the inflation index and, instead, changes in the inflation index are treated as variable lease payments and recognized as lease expense in the period in which the obligation for those payments is incurred. Variable lease payments based on a percentage of restaurant sales or resulting from changes in the inflation index are not significant.



The components of lease expense were as follows:	Quarter Ended 3/31/2019
Operating lease cost	$	29
Finance lease cost
Amortization of right-of-use assets	1
Interest on lease liabilities	1
Total finance lease cost	2
Sublease income	(18		)



Supplemental cash flow information related to leases was as follows:	Quarter Ended 3/31/2019
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases	$	25
Operating cash flows from finance leases	1
Financing cash flows from finance leases	1
Right-of-use assets obtained in exchange for lease obligations
Operating leases	2
Finance leases	3

Supplemental balance sheet information related to leases was as follows:



	3/31/2019			Condensed Consolidated Balance Sheet
Assets
Operating lease right-of-use assets	$	661		Other assets
Finance lease right-of-use assets	36			Property, plant and equipment, net
Total right-of-use assets^(a)	$	697

Liabilities
Current
Operating	$	78		Accounts payable and other current liabilities
Finance	6			Short-term borrowings
Non-current
Operating	643			Other liabilities and deferred credits
Finance	65			Long-term debt
Total lease liabilities^(a)	$	792

Weighted-average Remaining Lease Term (in years)
Operating leases	11.7
Finance leases	11.6

Weighted-average Discount Rate
Operating leases	5.5		%
Finance leases	5.7		%


(a)	U.S. operating lease right-of-use assets and liabilities totaled $281 million and $330 million, respectively, as of March 31, 2019 and primarily related to Taco Bell U.S.

Future minimum lease payments as of March 31, 2019, including rental payments for lease renewal options we are reasonably certain to exercise were as follows:



	Commitments
	Finance			Operating
Less than 1 year	$	10		$	107
1-2 years	10			103
2-3 years	9			95
3-4 years	8			86
4-5 years	8			78
Thereafter	54			546
Total lease payments	99			1,015
Less imputed interest	(28		)	(294		)
Total lease liabilities	$	71		$	721

Future minimum lease payments under the non-cancellable term of leases as of December 31, 2018 as required to be disclosed under Legacy GAAP were as follows:



	Commitments
	Capital		Operating
2019	$	10	$	103
2020	10		89
2021	9		78
2022	8		71
2023	8		61
Thereafter	58		384
Total lease payments	$	103	$	786