Thursday, August 26, 2010

It's going to be BIG

What will the impact be of capitalizing operating leases, with option periods included? For many retail chains, the tally is literally going to be in the billions of dollars. We've done an analysis for one chain whose liability for capitalized leases will be larger than their entire present current and long-term liabilities (and several times their shareholder equity). The effect of putting an equal amount of assets and liabilities of that magnitude on the balance sheet will be a substantial increase in reported leverage and decrease in important financial ratios. This has important implications for loan covenants and other financial requirements.

It should also be noted that previously reported estimates of the impact of the new standard (such as Georgia Tech's study last year) are likely substantially understated, because they were based on the reported future rent commitments of companies. But those reported commitments exclude most renewal options, which now will have to be included in whole or in part. Many retail store leases have an initial term of 20 years, but then renewal options for as many as 40 more years. Under the new "expected payments" requirement, future rents reported may be double or more what is currently reported, with a commensurate increase in assets & liabilities.

Our EZ13 Lease Accounting software permits you to enter your operating leases for current reporting, but capitalize their remaining rents at a cutover date you specify for pro-forma reports in keeping with the exposure draft of the new lease accounting standard.

No comments:

Post a Comment