I’ve web logged a lot about this topic in the last few weeks. This would be a good time to pull together some of the data and some (perhaps) deeper thoughts and prognostications.
Data first. Here’s a list of 37 companies to date who have announced that they have lease accounting dysfunction. Not all of them are restating past financials; some like Target, are simply catching up the errors in the current quarter because they aren’t very significant. I make no claims that this list is all-inclusive. (Yes, I know a table would be much more readable. Unfortunately, I have not advanced my knowledge of Brassica blogging software to the point where I can do this.)
Abercrombie & Fitch
That’s it for the data; thirty-seven companies doesn’t sound like many, but it feels like it’s been in the hundreds because of the Chinese water torture aspect of their arrival. One or two drips a day makes it feel like they’ve been in the news forever.
I suspect that the Chinese water torture may come to an end – and in its place, a dousing with a fire hose. Why? Several reasons. As I mentioned in the prior posting on Cingular, we’re starting to see remedies for dysfunctional lease accounting emerge in an industry other than the restaurant and retail industries. (Don’t forget Siebel Systems, another non-R&R lease restater.) The accounting principles governing leases don’t apply to just real estate so it’s entirely possible that more dysfunctional lease accounting could be uncovered elsewhere. Firms and auditors don’t work in a vacuum. Once an issue has been uncovered, they’d be foolish not to check for exposure in their own house. (Or in their audit client’s house.) This has certainly become a known issue.
I believe that accounting precision has been ratcheted upwards as firms go through their Section 404 reviews, and this may be what got the ball rolling on these issues in the first place. I can’t see any reason for accounting precision to reverse.
There’s another reason we could be awash in more lease accounting revelations. Don Nicolaisen’s lease accounting letter was issued on February 7 – after some firms had already reported their most recent quarter. I think there could be quite a few retailers/restauranteurs alone that issued earnings before the SEC letter was issued, and after the initial lease restatement announcements in late November. They may be waiting until their first quarter earnings to complete their determinations of lease accounting compliance.
Where did it all begin? Impossible to know. The error amounts have certainly not been extreme, but they’re enough to make you wonder if they weren’t part of the “get every penny of EPS” mentality that we’ve observed over the years. Like I said earlier: firms don’t work in a vacuum. If one company adopted any of the improper lease techniques, you can be sure that its competitors would adopt it so as not to lose ground in comparison.
So, I think we can expect more lease accounting foolishness to be revealed. Take it with a grain of salt – rather than smoking gun evidence of financial chicanery, consider them to be a classic example of lowest common denominator accounting, the kind that happens when you try to be too much in touch with the rest of your competitors. It’s like the kid who cheated in grade school by copying the test answers from his neighbor – and copied the answers his neighbor had wrong.
And as auditors sharpen their focus by learning more in their ongoing Section 404 reviews, I wouldn’t be surprised to see more restatement waves for other accounting principles gone sloppy.