We often talk about the new lease accounting standard on this blog. Today we’re going to explore one specific example of the consequences of the new standard — that is, how a change in accounting rules can lead to changes in a firm’s financial and operating metrics, without any change in actual finances or operations.
Fellow data devotees, we give you Chipotle Mexican Grill ($CMG).
As you might know, the new lease accounting standard requires firms to report the value of operating leases on the balance sheet. The cost of a firm’s operating leases shows up in the liabilities section, while the value of those leases appears in the asset section as a right-of-use (ROU) asset.
For retailers, who lease lots of space, those numbers can be substantial. Since important performance metrics like a firm’s return on assets or its debt-to-equity ratio derive from total assets and liabilities, that means any big shift in total assets or liabilities will also change those metrics.
Chipotle is an excellent example of this. In relative terms, its leasing obligations are substantial. So when it implemented the new standard in Q1 2019, the size of its balance sheet ballooned. Total assets more than doubled from $2.26 billion at the end of 2018 to $4.63 billion in Q1. Total liabilities went from $824.18 million to $3.14 billion — an increase of (gulp) 281 percent.
See Figure 1, below. We zoomed into the liabilities because that’s the bigger shift, but you can also see the shift in total assets near the top.
So what does this mean for Chipotle’s performance metrics? Lots.
We’ll first look at return on assets, calculated as net income divided into total assets. To smooth out any seasonal changes, we’ll compare first-quarter 2018 (before the new lease accounting standard) to first-quarter 2019 (after the standard). See Table 1, below.
|Q1 2018||Q1 2019|
That’s a steep drop in ROA even after a quite respectable jump in net income, all because a new accounting standard changed the location of where Chipotle reported a number.
Chipotle’s debt-to-equity ratio, calculated as total liabilities divided into total shareholder equity, also changes. See Table 2, below.
|Q1 2018||Q1 2019|
|Debt to Equity||0.54||2.12|
In both cases, we have significant changes in performance metrics without any comparable shift in, ya know, actual performance. This sort of thing will happen to all firms as they adopt the new lease accounting standard — although as Chipotle demonstrates, it will happen to some firms much more severely than others. Changes in those metrics can also have real consequences, such as triggering a debt covenant or perhaps influencing the strategy of some automated trading algorithm out there.
Calcbench automatically presents debt-to-equity ratio when you examine a firm’s balance sheet in the Company-in-Detail page. You can also search for ROA and debt-to-equity in our standardized metrics in the Multi-Company page. And don’t forget, we have leasing research galore on our Research page.
* We annualized Net Income to project the total ROA
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