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How New Lease Accounting Standard ASC 842 Has Significantly Impacted Corporate Earnings

How new lease accounting standard ASC 842 has significantly impacted corporate earnings

ASC 842 was written to produce very little, if any, impact on corporate P&Ls.  In fact, that is the main difference between FASB’s ASC 842 and IASB’s IFRS 16.  However, there are exceptions that have had significant impact to P&Ls and even earnings per share (EPS), particularly in the restaurant and retail industries.

The exception making a big impact

For years, the Boards worked diligently to converge on one universal set of lease accounting guidelines, but in the end, the FASB wanted to maintain straight-line P&L recognition for operating leases and IASB was determined to have just one (finance) classification of leases.  So, the expense pattern associated with leasing should not change materially under US GAAP, with few exceptions.  However, there is one exception that is making a big impact for some companies.  The big impact is due to sale-leaseback transactions, which are sometimes used to monetize a company’s lease portfolio.  A sale leaseback transaction occurs when a company sells an asset to a buyer and then leases the same asset back.  It is a transaction that can unlock the value of the asset being transferred, while still allowing the company to use the asset to operate the business.  Under previous rules, a sale leaseback transaction may have generated a deferred gain to be recorded as an offset to future rent expense.

Under new lease accounting rules, if a deferred gain due to a sale-leaseback was held on the balance sheet and being recognized over time, companies may need to record that to equity immediately and essentially lose a monthly credit to rent expense going forward.  Because retail and restaurant companies have traditionally been more likely to utilize sale-leaseback transactions, this may impact these industries heavily and it has the potential to be large enough to notice on the P&L.  In some cases this true-up can even move the needle on earnings per share (EPS), a metric widely used by investors and analysts.

Recent examples related to the impact of sale leaseback transactions:

Bloomin’ Brands, owner of several popular restaurant brands including Outback and Carrabba’s, decreased EPS by $0.02 (see more about the impact on Bloomin’ Brands here).

Fiesta Restaurant Group, owner of the Pollo Tropical and Taco Cabana brands, reported ”a significant impact on our results of operations because we had $18.6 million in sale-leaseback gains from which we no longer receive a benefit to rent expense” (see more about the impact on Fiesta Restaurant Group here)

Furniture Retailer Haverty’s reported a $6.8 million adjustment to equity related to adopting the new leasing standard, due in part to derecognizing the gain on previous sale leaseback transactions (see more about the impact to Haverty’s here) .

Brinker International, known for its Chili’s and Maggiano’s Little Italy brands, is expecting “to derecognize the deferred gain from the sale leaseback transactions” in the amount of $269.4 million upon adoption (see more about the impact to Brinker International here) .

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