Improper Accounting for Leases Triggers New Restatements

Changes in how companies account for real estate leases is forcing a wave of corrections in earnings reports.

Accounting for leases came under scrutiny as part of the tough reforms of the 2002 Sarbanes-Oxley Act. It became apparent that the problems were widespread.

Through April 1, 221 companies have either restated their past financial reports, adjusted their accounting or warned that they are assessing their accounting, all because of the lease issue, according to Jack Ciesielski, publisher of the Analyst's Accounting Observer newsletter, reported.

Because the accounting issues are hitting so many companies - especially retailers and eateries with multiple leases - the accounting errors are not expected to have a big impact on companies' operations, said Jamie Cuellar, a retail and restaurant analyst with Brazos Capital Management L.P. in Dallas. However, Cuellar told the Dallas Business Journal that earnings per share may go down slightly.

The newspaper gave an example of how companies have historically accounted for leases: If a retailer put $1 million in improvements into a leased space, it would spread that cost over the longest possible time frame - such as an initial 10-year lease, plus two five-year option periods. At the same time, the company would show only its lease obligations for the initial 10-year lease on the same balance sheet.

Donald Nicolaisen, the Securities and Exchange Commission's chief accountant, in a letter to the AICPA, wrote that under GAAP, the term of the lease and the period over which companies depreciate improvements should be the same.

In addition, companies should show lease expenses even if they are given a "rent holiday” by landlords, or a period of time before they have to start paying rent. Companies should use an average payment of the duration of the lease, according to Nicolaisen. But many companies typically recorded rent expenses only after they started paying rent.

David Hirschmann, a senior vice president at the U.S. Chamber of Commerce, told that Nicolaisen's statement amounted to a new interpretation of the underlying accounting standards.

"The reality is that virtually every company was accounting for leases in the same way,” he said.

But Ciesielski said, “If 1,000 people do a foolish thing, it's still a foolish thing, regardless of whether everyone is doing it or not.”

Charles Mulford, professor of accounting at Georgia Tech's college of management, said the restatements raise the question of whether companies were similarly lax in other areas of their reports.

"They showed us that they had an accounting system in place that allowed a lot of sloppiness to go on. Where else might it lie," he said.

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