A raft of local companies, including Cheesecake Factory Inc., Worldwide Restaurant Concepts Inc. and California Pizza Kitchen Inc., announced that they would have to delay and possibly restate earnings as a result of an SEC clarification on how to account for the financial value of their leases.
A seemingly arcane notation by the Securities and Exchange Commission has created a bit of uncertainty from investors about the financial condition of their companies not helped by the past few years of accounting scandals that have involved restated earnings.
This time, the restatements likely involve not fraud but the more mundane matters of depreciation and amortization. They are generally expected to have only a limited effect on the bottom line.
Basically, the issue involves two practices: companies that hadn't recorded rent payments during periods in which they were receiving either reduced or free leases; and companies that stretched out amortization and depreciation beyond the lease itself.
"(The SEC) wants you to spread it over a period that is realistic and not a pie in the sky," said Robert Boragno, director of accounting and auditing at Shea Labagh Dobberstein, an accounting firm in San Francisco.
As of last week, roughly 150 companies nationwide were facing lease accounting problems of some sort. Most impacted are retail and restaurant businesses that tend to have a lot of leases. Also hit are companies that own considerable amounts of store space, including Santa Monica-based Macerich Co., which announced it was delaying earnings to review its accounting practices.
None of the local companies contacted would comment on the situation.
Interpreting lease rules has been a matter of increased discussion within the accounting community. Finally, SEC Chief Accountant Donald T. Nicolaisen clarified matters in a notification last month to the American Institute of Certified Public Accountants.
The clarification comes as more attention gets paid to financial books in general, particularly with the Sarbanes-Oxley legislation requiring better controls.
"It is like steroids in baseball, everybody is sensitive to it," said Boragno, referring to accounting inaccuracies. "They (the SEC) are looking at these items, and saying these are creating real distortion."
With the economy picking up, Boragno added that the SEC wanted companies to rectify their accounting procedures before company expansions enlarge the problem.
Stores are supposed to include the full cost of rent on their books even during a rent holiday, something they are often given while store improvements are underway. Not all do. They also are supposed to amortize the value of any improvements over the life of the lease. However, stores sometime stretch out that amortization if they anticipate a lease extension.
There is debate on how the sloppy accounting became practice, but some squarely place blame on auditors for overlooking accounting standards.
"This is not a change in the rules, it is a failure to follow the existing rules," said Yaakov Gross, head of the real estate securities practice group at the New York office of Morrison & Foerster LLP. "Because the problem is so widespread in the retail industry it is a failure by the accounting profession."
The big question is how much of a problem this will cause for retailers and restaurants, with some analysts contending that it may be overblown.
"We do not believe this is a big deal," wrote Paul Lejuez, a Credit Suisse First Boston analyst who downplayed the problem in a February industry note. "These changes do not impact overall cash flow, and we believe relate more to form over substance."
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