FASB Accounting Update: Operating Leases Under ASC 842

In 2019 operating leases will appear on company balance sheets for the first time. Whereas previously the only reporting requirement was a line item on the income statement for related rent expense, moving forward the lease obligation will be listed on the liability side of the balance sheet and the object leased on the asset side. While this changes nothing about the economics of leasing, Jim Grant argues that it will dispel the notion that franchisors are insulated from franchisee failures:

“One reason that QSR, Wendy’s and Dunkin’ trade at fancy multiples … is because they are supposedly insulated from the earnings volatility of restaurant operations. If a franchisee fails, the franchisor is supposedly out only the royalty payment. ASC 842 will make clear that franchisors have significant exposure to lease payments, too.”

In the article Grant cites net rental income (rental income less rental expenses) as a percentage of total operating income for each of the three entities listed above at 28%, 29% and 10%, respectively.

Deloitte released two PDF documents that detail the pending accounting update to reporting leases (ASC 842). The executive summary does an excellent job of summarizing the change in just 8 informative slides. Per the introduction, this revision will have a substantial impact on company balance sheets:

“Practitioners have estimated that $2 trillion of lease liability (with corresponding recognition of leased assets) will be recorded to S&P 500 balance sheets as a result of the application of the new leasing guidance.”

For most I recommend the executive summary over the unabridged 754 page version available at the link below.