The Effect of the New Lease Accounting Rules on Profitability Analysis in the Retail Industry
US accounting principles will soon require companies to capitalize operating leases with terms longer than 12 months. The new rules will have a dramatic effect on the reported amounts of assets and liabilities for companies with significant lease commitments. These changes will also impact common profitability measures that use assets as a base to gauge earnings performance. We explore the implications of the new lease rules on the EBIT/Assets ratio, a measure of operating return on assets. We examine 50 firms with the largest operating lease commitments and find that 22 retail and restaurant companies are most affected, as their average ratio declines by over 400 basis points from 15 percent to 11 percent based on a hypothetical discount rate of 6% and a lease term of 10 years. A more comprehensive analysis on a larger group of retailers and restaurants provides additional evidence on just how significantly the new lease rules will impact this ratio. Our findings highlight the importance of understanding the implications of the new lease rules on common methods of financial analysis, particularly when considering those industries that rely heavily on fixed assets like restaurants and retailers. (c) 2016 Wiley Periodicals, Inc.