The Effect of the New Lease Accounting Rules on Profitability Analysis in the Retail Industry

• DOI: http://doi.org/10.1002/jcaf.22206
• Date: 01 November 2016
• Author: Dov Fischer,Stephan Fafatas
• Published date: 01 November 2016

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© 2016 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22206

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The Effect of the New Lease

Accounting Rules on Profitability

Analysis in the Retail Industry

Stephan Fafatas and Dov Fischer

INTRODUCTION

On February

25, 2016, the Finan-

cial Accounting

Standards Board

(FASB) completed

its leases project by

issuing Accounting

Standards Update

No. 2016-02, Leases

(Accounting Stan-

dards Codification

Topic 842). For

public compa-

nies and entities

that issuepublicly

tradedsecurities,

the new standard

is effective for peri-

ods beginning after

December 15, 2018.

For calendar-year

companies, the first

year would be the

2019 fiscal year. For

private companies,

the effective date

is one year later

(FASB, 2016a).

The new lease

standards affect

what are currently

known as operating

leases, not the exist-

ing capital leases,

which the standards

refer to as “finance”

leases, and apply to

all assets leased for

a term greater than

12 months. Under

current accounting

standards, operating

leases do not appear

on the balance sheet.

However, under the

new leasing stan-

dards, operating

leases would be capi-

talized and appear as

assets (and liabilities)

on the balance sheet,

much like the current

treatment of capital-

ized (finance) leases.

The new operating

lease rules call for a

single lease expense

to be recorded on

Editorial Review

US accounting principles will soon require com-

panies to capitalize operating leases with terms

longer than 12 months. The new rules will have a

dramatic effect on the reported amounts of assets

and liabilities for companies with significant lease

commitments. These changes will also impact

common profitability measures that use assets as

a base to gauge earnings performance. We explore

the implications of the new lease rules on the

EBIT/Assets ratio, a measure of operating return

on assets. We examine 50 firms with the largest

operating lease commitments and find that 22

retail and restaurant companies are most affected,

as their average ratio declines by over 400 basis

points from 15 percent to 11 percent based on a

hypothetical discount rate of 6% and a lease term

of 10 years. A more comprehensive analysis on a

larger group of retailers and restaurants provides

additional evidence on just how significantly the

new lease rules will impact this ratio. Our findings

highlight the importance of understanding the

implications of the new lease rules on common

methods of financial analysis, particularly when

considering those industries that rely heavily on

fixed assets like restaurants and retailers.

© 2016 Wiley Periodicals, Inc.