Retailers Could Take Big Hit from Lease Accounting Change

Jun 13, 2007

By George Anderson

Proposed changes to how companies account for leases could mean significantly lower earnings for retailers, according to Reuters.

Two groups, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB), are considering rules changes that would mean retailers would now have to account for interest expenses based on a lease’s present value.

The rule change would mean that leases would now be included in balance sheets instead of as a footnote in financial statements.

According to the a study by the accounting boards, if the proposed accounting change were in place in 2006, BJ’s Wholesale Club would have seen earnings per share drop from $1.40 to 28 cents. Saks would have gone from being five cents on the plus side to a down 44 cents a share. On average, earnings from 19 companies studied were reduced by 5.3 percent.

The study’s authors said these figures and others make “clear that excluding operating leases from the balance sheet causes a material distortion of the financial position of the company.”

There are some retailers that benefited under the proposed rule changes as amortization and depreciation of leased properties were less than the costs of rent. Wal-Mart would have earned three cents more per share and J.C. Penney would have increased its earnings by 11 cents.

If the proposed changes are adopted, probably in 2009, companies can expect to see major challenges on balance sheets. Both assets and liabilities are likely to increase, according to the study’s findings.

Questions: Are changes needed to the present accounting rules used by U.S.
retailers? Do current accounting requirements provide a clear picture of a
retailer’s health on its balance sheet? What impact do you think that the proposed
change in accounting for leases would have on retailers’ approach to real estate
and/or other aspects of business?

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3 Comments on "Retailers Could Take Big Hit from Lease Accounting Change"

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David Livingston
14 years 11 months ago

When I was about halfway through Accounting 102 I knew I was in the wrong major. This really should not be a big deal. Bottom line earnings is just a number and does not always represent the true earnings a company is achieving. That’s why accountants came up with Earnings Before Interest, Taxes, Depreciation and Amortization – EBITDA. Now they can just add in another line for leases. Wouldn’t this be good news? Lower earnings means lower taxes, right? Maybe some CPA can correct me on this.

Perhaps this will change the PE ratios on those public companies and scare investors. Numbers lie and liers figure. This further convinces me that companies like Wal-Mart are probably really making more money than they report and companies like Winn-Dixie are probably making a lot less.

Mark Lilien
14 years 11 months ago

Generally when FASB changes are in the air, the discussions go on for years. The businesses who’ll be disadvantaged fight tooth and nail against the businesses who’ll look better. Best example: the fight over expensing stock options. The controversy partially assumes that investors compare one retailer’s financials against other retailers. But many investors do the opposite: they compare a retailer’s financials against itself. Generally, any accounting standard that tends to depress earnings is good for existing retailers, since it discourages new entrants, which reduces competition.

Mike Blackburn
14 years 11 months ago

Boy, the folks at FASB must be really getting bored.

I thought this whole issue was dealt with by classifying the lease as a capital lease or operating lease. Why not just adjust that principal instead of creating a whole new one? Doesn’t seem to make sense to have to add a true operating lease to the balance sheet.

As for the tax implications, since they are prepared with a different set of books, I’m not sure if this will have any impact on actual tax payments.


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