Our latest research report is now available: an in-depth look at how the new accounting standard for leasing costs is affecting the retail sector — and oh boy, it’s affecting that sector in a big way.

You can find the complete report on the Calcbench Research page. Our main finding is that thanks to this new accounting standard, formally known as ASC 842, major retailers are seeing significant spikes in their assets, liabilities, return on assets, and other key performance metrics — all due to a change in accounting rules, rather than any fundamental change in business operations.

ASC 842 requires firms to list the costs of operating leases as liabilities on the balance sheet, along with a corresponding “right-of-use asset” on the asset side. Since retailers generally lease large amounts of commercial space, we wanted to see how the new standard has altered their financial disclosures.

To do that, we compared the financial data reported by 36 retailers as of Q4 2018, just prior to ASC 842 going into effect; against disclosures reported in Q2 2019, after the standard arrived.

The results? See Figure 1, below.

As you can see, the adjustments that firms made, for both ROU assets and operating lease liabilities, exceeded the change in total assets and liabilities for our sample. In other words, all of the change in assets and liabilities — and those numbers jumped 11.8 and 16.6 percent, respectively — was due to implementing ASC 842.

We then did a comparison of assets and liabilities for each of the 36 retailers in our sample — which included firms such as Abercrombie & Fitch ($ANF), Krogers ($KR), Walmart ($WMT), J.C. Penney ($JCP), and Ross Stores ($ROST), among others. Even at the individual level, most firms owed all their fluctuations in assets or liabilities to ASC 842.

And the Performance Metrics

We also studied how those changes affected return on assets and debt-to-equity ratios. ROA is calculated as net income divided by total assets, which means an increase in assets will drive a firm’s ROA down. Debt-to-equity ratio is calculated as total liabilities divided into stockholder equity, so an increase in liabilities will drive that ratio up.

Sure enough, that’s what we found in the retail sector when we ran the numbers.

The ROA calculation is a special case. For all 36 retailers, ROA actually did rise even with the arrival of ASC 842, but that’s because Walmart had a stellar second quarter with gobs of net income, which had an outsized effect on the whole group. Excluding Walmart, the other 35 retailers actually saw ROA fall with the arrival of ASC 842. See Figure 2, below.

Our paper then considers a few specific firms and their changes to ROA and debt-to-equity. Suffice to say, one can find numerous examples of firms with worse return on assets or D/E ratios solely because of ASC 842 and the accounting change. Exclude those operating lease items, and the metrics look better.

Calculating NPV

Liabilities definitely seem to be where the action is with ASC 842. The standard forced a large increase in liabilities than in assets, and higher debt-to-equity ratios can cause headaches like triggering debt covenants with your lenders.

So as Part III of our study, we examined how firms calculated the net present value (NPV) of those liabilities. That number can depend significantly on the discount rate a firm uses, as well as the average remaining term on its leases. We dot-plotted those numbers on a chart.

Figure 3, below, shows the discount rates. See that one outlier, near 12 percent? That’s J.C. Penney.

Anyway, if you’re an analyst who follows the retail sector, download the paper and have a look. Let us know what you think, or what else we should examine in future reports about the leasing standard. We’ll also be publishing more reports on ASC 842’s effect in other sectors, so stay tuned.

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