Monday, November 5, 2018

Calcbench has been hot on the new accounting standard for operating leases lately, since the standard goes into effect on Dec. 15 and could have significant implications for companies that carry large operating lease obligations on their balance sheet.

Now, if you want an example of just how significant those implications can be, look no further than rival shipping giants FedEx and UPS.

We picked them because the two firms are roughly similar in revenue, net income, assets, and liabilities. FedEx, however, pursues a business model where it leases much more space than UPS does. The upshot: FedEx’s obligations for future lease payments are 11 times larger than those for UPS.

Now, recall that the new lease accounting standard requires companies to report those future lease payment obligations as liabilities on the balance sheet; and to add a corresponding “right of use” asset on the asset side of the balance sheet too.

Well, return on assets equals net income divided by total assets. So when you add items to the asset side of the balance sheet, you are expanding the denominator of that formula and your ROA must decline. It’s math.

Take a look at this comparison of FedEx and UPS, all pulled from Calcbench data.

We examined the companies’ current leasing obligations, added them to the liabilities side, and then added an equal amount to the asset side for the offsetting right-of-use asset. Then we recalculated an adjusted ROA according to the new leasing standard.

This is the result: Two companies of similar size, but one (FedEx) experiencing a considerable change in ROA simply because of an accounting change, rather than some fundamental change in business operations.

Financial analysts, therefore, might want to ask FedEx on its next earnings call: do you have any debt covenants that might be triggered when ROA falls below 7.5 or 7 percent? Do any executive compensation agreements tie to ROA? Anything else we should know about involving changes to ROA?

You get the picture. (Like, literally; we supplied the picture three paragraphs above.) Calcbench can dig up the data you need. Whether you feed it into your own Excel models or just fiddle around on the fly, we have it. You can find it.

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