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Lease accounting equals big problems
03/14/05 1:00pm

NEW YORK - Lease accounting, in which companies rent out or "lease" factories, buildings or equipment instead of buying them outright, is rapidly becoming the most troublesome area of accounting

Accounting watchdog Jack Ciesielski, publisher of the Analyst's Accounting Observer in Baltimore, Md., so far counts 145 companies that have been hit with lease-accounting problems. Companies have either restated, or plan to restate, their financials due to improper lease accounting. Other companies have taken a cumulative catch-up charge to fix their lease accounting, or say they are suspicious that they have a problem.

Glass Lewis, a San Francisco investment-research house, has also been tracking the problem and has identified a flurry of restatements due to problematic lease accounting at 36 companies, including Starbucks, Wendy's, Krispy Kreme Doughnuts, Iron Mountain, and Pep Boys.

Former U.S. Securities and Exchange Commission (SEC) chief accountant Lynn Turner, says, "It has been surprising to see the number of companies, with the blessing of their auditors, who got this simple, basic accounting wrong." Turner, now a consultant to Glass Lewis, adds that while at the SEC, he had "audited several companies in the franchising and retailing industry, and certainly this is nothing new."

Eight of ten companies lease all or some of their equipment, as a whole spending $218 billion--or 30% of their capital expenditures last year--in doing so, says the Equipment Leasing Association, an Arlington, Va.-based trade group.

As leases grow in popularity, the auditors can't always figure out what constitutes proper accounting for them. The problems typically involve incorrect amounts booked for depreciation costs, whereby companies wrongfully stretched out their depreciation and amortization costs for buildings and other assets subject to leases.

The bad news comes at a time when companies are struggling with tougher disclosures demanded by the Sarbanes-Oxley legislation, which forces executives to tighten internal controls over their financial reports. The new requirements have prompted an industry-wide review of lease-accounting practices in the retail and restaurant industries, which tend to be heavy users of leases.

An unusual letter sent by current SEC Chief Accountant Donald Nicolaisen to the accounting profession, warns that companies must do a better job disclosing both their capital- and operating-lease obligations in security filings.

Given the choice between leasing and owning real estate or equipment, many companies pick operating leases, which lower reported debt and boost returns on assets. They also typically fatten earnings through, among other items, lower depreciation expenses.

Ciesielski says investors can expect to "see the restatement trend continue until the first-quarter" filings have been completed, adding that, by that time, companies "should have had their audits out of the way, and had the chance to do their evaluations of lease policies."

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