Ryder System Inc., Duke Realty Corp., and Darden Restaurants Inc. are among major public companies warning investors that a historic change in accounting will drag down earnings.
Many companies are beginning to adopt changes in lease accounting rules in the first quarter. But lessors like Ryder and Duke—and the diverse industries they represent—stand out for how the overhaul will defer their revenue and accelerate expenses.
The new standard requires companies to bring operating leases for retail space, barges, and warehouses out of the footnotes and onto the balance sheet for the first time. The rules better align accounting for lessors and lessees and also reflect changes in revenue recognition accounting.
Darden, the owner of Olive Garden and LongHorn Steakhouse, among other chains, is still several quarters away from adopting the new standard. But it has already cautioned investors that the accounting change would lower earnings by as much as 5 cents per share.
The company plans to provide more details about changes to the income statement and to the balance sheet in June.
“We expect our balance sheet presentation to be materially impacted upon adoption due to the recognition of right-of-use assets and lease liabilities for operating leases, however, we do not expect adoption to have a material impact on our consolidated statements of earnings,” Darden said in its most recent quarterly report.
Many lessors initially thought the new rules would have a minimal impact, said Bruce Pounder, executive director of GAAP Lab, a technical accounting consultant.
“A lot of companies that I’ve worked with have learned the hard way, it’s just not true,” Pounder said.
The subtle accounting changes resulting from the new rule can ripple across a financial report, altering performance ratios and other metrics used to gauge the health of a company, he said.
Ryder recently told investors that the lease accounting change would reduce its earnings by 20 cents per share annually.
That represents roughly 3 percent of earnings for a company that relies on its leasing business for about half its revenue, said Talon Custer, a Bloomberg Intelligence analyst.
“They are concerned with the income statement aspect of this,” Custer said.
The new rules require companies to separate the leases of tangible assets, like a truck, from non-lease components, like maintenance.
Now, separate revenue for maintenance will be recorded as the service is provided. And that means Ryder will book less revenue initially, resulting in lower earnings per share. Over time, that service revenue will grow as older vehicles require more frequent repairs, said Bill Bosco, an accounting consultant to the Equipment Leasing and Finance Association.
Full-service transportation lessors like Ryder have the most to worry about because of that shift in the timing of revenue, Bosco said.
Expenses & Economics
Real estate investment trusts could also see earnings fall under the new rules because of a shift in the timing of expenses.
Duke, which owns warehouses, told investors that the accounting rule change will drag down earnings 2 to 4 cents per share. The change will require the real estate investment trust to expense up front a significant portion of its internal leasing costs that were previously capitalized, or spread out over time.
Smaller trusts typically use a third-party leasing agent, a type of external cost that will still be capitalized. In comparison, larger companies like Duke with in-house leasing teams will appear a little less profitable on the surface, said Ki Bin Kim, senior REIT analyst and managing director for SunTrust Robinson Humphrey.
“Having more transparency and expensing of these costs is probably the right thing to do longer term because these are real cash out flows,” Kim said.
The Balance Sheet
Any changes to lessors’ balance sheets will be minor in comparison to the trillions of dollars worth of planes, retail stores, and equipment that lessees will record as assets.
Lessors own the assets they rent out so plant, property, and equipment lines will generally remain the same for operating and direct finance leases. And companies will report a lease receivable for payments they expect to receive in the future for sales leases, said Peter Bible, chief risk officer for EisnerAmper LLP.
But the new rules alter the criteria used to sort leases into those three buckets, each with its own accounting treatment.
As companies enter into new agreements, which could total in the thousands for lessors, changes to the type of lease could result in dramatically different accounting, affecting the income statement, balance sheet, and metrics like EBITDA—earnings before interest, taxes, depreciation, and amortization—Pounder said.
Disclosures will serve an important role in helping investors understand that the underlying economics of a business haven’t changed, just the accounting, he said.