Magazine article The CPA Journal

A New Lease on Life

Magazine article The CPA Journal

A New Lease on Life

Article excerpt

Current Issues in Lease Accounting

On April 20, 2005, the Wall Street Journal reported that lease restatements in financial statements were surging. According to the Huron Consulting Group, the three most prevalent accounting issues reported in 2004 restated financial statements were: revenue recognition, equity accounting, and reserves, accruals, and contingencies. Over 250 companies announced restatements for these lease accounting issues and the number keeps increasing. Lease restatements are prevalent for retailers (e.g., Circuit City, Kmart, Linens 'n Things, Office Depot, Sears, Target) and restaurant chains (e.g., Applebee's, Brinker, CKE, Darden, Ruby Tuesday). These troublesome restatements reflect the existence of widespread interpretations of Generally Accepted Accounting Principles (GAAP).

SFAS 13, Accounting for Leases, released in November 1976, is the primary technical literature on lease accounting for GAAP-based financial statements. Other authoritative pronouncements on lease accounting include: SFAS 98, Accounting for Leases (May 1988); FTB 85-3, Accounting for Operating Leases with Scheduled Rent Increases (November 1985); FTB, 88-1, Issues Relating to Accounting for Leases (December 1988); and FSP 13-1, Accounting for Rental Costs Incurred during a Construction Period (October 2005). All cover operating lease accounting issues-the recognition of rent expense and the amortization of leasehold improvements.

Typical Lease: Example

Each lease is unique; however, the following example is meant to illustrate a typical lease in the chain restaurant industry. Casual Dining, Inc. (CDI), is a casual-dining restaurant chain. Attractive Properties, Inc. (API), owns shopping malls and leases space in the malls and associated parking space to tenants. Quality Builders, Inc. (QBI), is a building contractor specializing in restaurants.

API and CDI enter into an operating lease agreement for space in the parking lot of a mall owned by API. API owns the site; CDI pays rent to API. CDI hires QBI to convert the leased site into a restaurant. The base, or primary, lease term is 20 years. Additionally, the lease provides four renewal option periods of five years each, for a total of 40 years. CDI can exit the lease at any five-year interval after 20 years.

The operating lease contains escalating lease payments. During the base lease term, the monthly lease payment is $10,000 for the first 10 years and $12,000 for the next 10 years. During the first renewal option period (years 21-25), the monthly rent payment is $14,000. For each succeeding renewal option period, the rent increases in $2,000 increments. Therefore, the monthly rent payment for the final renewal option period (years 36-40) amounts to $20,000.

Lease Analysis

The chain restaurant industry has three sectors: casual dining (e.g., Applebee's, Ruby Tuesday); fast casual (e.g., Moe's Southwest Grill, Panera Bread); and fast food (e.g., Hardee's, McDonald's). Generally, casual dining restaurants will pick up some renewal options in the leases because the higher cost to build such restaurants means a longer term is necessary to realize a return. On the other hand, fast-food restaurants normally fulfill only the base term of a lease and do not invest as much in their buildings.

Because each lease is unique and different in its provisions, restaurants must evaluate lease agreements carefully. When deciding whether to build a restaurant in a certain location, the nature of the property must be considered. Restaurants in shopping malls may have a lifespan of about 20 years. If the mall deteriorates, the restaurant's profitability may decline significantly. Restaurants in malls fall in and out of favor as tenants come and go. A stand-alone restaurant (e.g., a freestanding structure with its own parking lot) may have a life of 30 to 35 years. Restaurants spend more on stand-alone units as opposed to units in malls. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.