There's been a big change that's been occurring in the financial world as it pertains to accounting for leases, and it is and will have a major impact on company balance sheets. Historically, companies have listed capital leases - which cover situations where an asset is essentially treated as owned, as an asset and corresponding liability reported on the balance sheet. Typically the liability for capital leases would be viewed as long-term debt.
Operating leases, however, where an asset was viewed as simply being "rented", and ownership was not transferred, were not included in the balance sheet as an asset or liability. Data on these leases was "off the books", but included in notes to the financial statements. Often analysts would scour the notes, and "capitalize" the operating leases, in order to include them in companies' long-term liabilities as debt.
Financial Accounting Standards Board (FASB) accounting standard ASU 2016-02, which addresses these changes, will be in force for fiscal years beginning after December 15, 2018, although companies were permitted to adopt the change early. The changes impact balance sheets with potentially large changes in both assets and liabilities. McDonald's (MCD) , for instance, reported a huge increase in total assets (from $32.8 billion at year-end 2018 to $46.5 billion at the end of first quarter 2019), and liabilities (from $39 billion to $53 billion) to account for its operating leases.
Microsoft (MSFT) , on the other hand, an early-adopter of the standard, reported just $7.1 billion of operating lease assets for the first quarter, less than 3% of assets.
Investors that are balance sheet junkies (as I am) will need to be careful, and keep these changes in mind when performing calculations or reviewing data. For instance, a metric such as return on assets, may see a major decrease, suggesting a degradation in performance that is not real if the changes are solely due to the inclusion of operating lease assets in the calculation. There will be no major impact on other measures, such as book value, as the operating lease asset and liabilities will mostly offset one another.
Smaller names, especially retailers and restaurants that lease most if not all of their store locations, may be among those showing the greatest effect. Take Big 5 Sporting Goods (BGFV) , for instance. Due to the accounting change for leases, the company reported a 58% increase in total assets (from $420 million to $665 million) for the recently reported first quarter, while liabilities doubled to $490 million.
The impact will be less on those names that own many of their stores, such as Cracker Barrel (CBRL) , which at year-end owned 421 locations and leased 241. As of the first quarter, the company had not yet reported based on the new standards.
So, if you are reviewing company balance sheet data, and notice major changes to assets and liabilities, it may be due to this new standard. Don't panic, just take a closer look.
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