Lesson 7 of 11
The obligation that arrived
Starbucks put $8,910.5 million of lease liabilities on its balance sheet in fiscal 2020. A year earlier the same obligation sat only in a footnote.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Before 2019, an operating lease was a schedule of future rent in a footnote. After it, the same obligation is an asset and a liability on the balance sheet.
- The two figures differ because the balance sheet version is discounted and the footnote version was not.
- Every ratio built on assets or liabilities is not comparable across the transition, and nothing a company owed actually changed.
Until fiscal years beginning after 15 December 2018, a company that rented its stores disclosed the future rent in a note and put nothing on its balance sheet. A company that borrowed to buy the same stores put the debt on.
ASC 842 ended that distinction for most leases. The obligation moved onto the balance sheet, and ten-year histories broke at the line where it happened.
Starbucks: the same obligation, before and after
- Footnote, future minimum rent at 29 September 2019$10,230.9m
- Undiscounted lease payments at 27 September 2020$10,089.6m
- Lease liabilities on the balance sheet at 27 September 2020$8,910.5m
What each number is
Starbucks's fiscal 2019 10-K, filed on 15 November 2019, disclosed future minimum operating lease payments of $10,230.9 million (Starbucks Corporation FY2019 10-K, accession 0000829224-19-000051) at 29 September 2019. That figure was in a note and appeared nowhere on the balance sheet.
The fiscal 2020 10-K, filed on 12 November 2020, shows the same kind of obligation measured under the new standard. Undiscounted lease payments of $10,089.6 million (Starbucks Corporation FY2020 10-K, accession 0000829224-20-000078), less imputed interest of $1,179.1 million (Starbucks Corporation FY2020 10-K, accession 0000829224-20-000078), giving lease liabilities of $8,910.5 million.
That total splits into a current portion of $1,248.8 million and a non-current portion of $7,661.7 million, and the two add exactly to the discounted figure. On the asset side sits an operating lease right-of-use asset of $8,134.1 million (Starbucks Corporation FY2020 10-K, accession 0000829224-20-000078).
Why the asset and the liability differ
They start equal at the moment a lease begins and diverge afterwards. The asset is adjusted for prepaid and accrued rent, lease incentives received, initial direct costs and any impairments; the liability is not.
So a gap between the two is ordinary. At Starbucks the asset was $776.4 million below the liability at the end of fiscal 2020.
What broke, and what did not
Every ratio with assets or liabilities in it moved: asset turnover, return on assets, debt to assets, and any leverage measure that counts lease liabilities. Nothing about the rent Starbucks owed changed on the day of adoption.
The income statement moved far less. An operating lease still produces a single straight-line operating expense, so operating margin is broadly unaffected. That asymmetry is why the transition is easy to miss reading the income statement and impossible to miss reading the balance sheet.
The trap worth naming
Adding the lease liability to debt, to compute a leverage ratio, while leaving rent inside operating costs charges the same obligation twice. The liability already represents the rent, and the rent is already a cost.
Either treat the lease as debt and add the implied rent back to earnings, or leave both alone. Doing one without the other produces a number that is wrong in a direction nobody notices.
Check yourself
Why is the lease liability smaller than the undiscounted future payments?
- Some leases were cancelled
- The balance sheet figure is discounted, and the difference is imputed interest
- Only current liabilities are shown
Show the answer
Answer: B.
At Starbucks the two differed by $1,179.1 million of imputed interest: $10,089.6 million undiscounted became $8,910.5 million on the balance sheet.A company adopts ASC 842 with no new leases and no new borrowing. What happens?
- Nothing changes
- Total assets and total liabilities both rise, while the obligation itself is unchanged
- Only liabilities rise
Show the answer
Answer: B.
A right-of-use asset and a lease liability appear together. Ratios built on either side move, and nothing the company owes has changed.What is wrong with adding the lease liability to debt while leaving rent in operating costs?
- Nothing, it is the standard approach
- The same obligation is counted twice, once as a liability and once as a cost
- Lease liabilities are not real obligations
Show the answer
Answer: B.
Treating the lease as debt requires adding the implied rent back to earnings. Doing one adjustment without the other overstates leverage relative to earnings.Sources
- Starbucks Corporation, FY2019 Form 10-K, filed 15 November 2019, accession 0000829224-19-000051, for future minimum operating lease payments at 29 September 2019.
- Starbucks Corporation, FY2020 Form 10-K, filed 12 November 2020, accession 0000829224-20-000078, for undiscounted lease payments, imputed interest, current and non-current operating lease liabilities, the operating lease right-of-use asset, and total assets at 27 September 2020 and 29 September 2019.
- ASC 842, Leases, effective for public business entities for fiscal years beginning after 15 December 2018.
What this leaves out
- The Starbucks figures are history, read from the filings named. They are not a statement about the company today and not a view on any security.
- Total assets rose in fiscal 2020 for several reasons at once, including debt raised during the pandemic. Only the right-of-use asset is attributed here to the lease standard.
- The 2019 footnote total and the 2020 undiscounted total are measured a year apart and under different rules, so they are not a like-for-like pair.
- Finance leases were already on balance sheets before ASC 842 and are measured differently from the operating leases described here.