Balance Sheet Impacts
With the introduction of the new lease accounting standards, several trillion dollars worth of assets and liabilities will transfer onto corporate balance sheets over the coming years. How will those new assets and liabilities impact the financial metrics that institutional and retail investors use to evaluate the financial performance of publicly traded companies? How will these new accounting rules impact asset turnover, return on assets, and quick ratio?
Income Statement Impacts
Profitability will be impacted by these new lease accounting standards as the way leasing expenses are reported on income statements for IFRS filers will change. In fact, a PwC research study found that the average company will experience a 13% increase in EBITDA. How will other profitability metrics, such as earnings per share, return on equity, and operating cash flow, be impacted?
Cash Flow Statement Impacts
The new lease accounting standards do not cause any differences in total cash flows. However, there are changes within the line items on the cash flow statement. With IFRS 16, companies will need to separate the cash paid into the principal portions of leases from that paid into interest portion. Operating cash outflows will be reduced while financing cash outflows will increase.
How the New Lease Accounting Rules Impact 18 Financial Metrics
Below is a list of how the new lease accounting rules impact financial metrics for 18 commonly used ratios and calculations. The expected changes for both the new FASB (US GAAP) and IFRS lease accounting standards are listed.
Asset turnover decreases under both the new FASB and IFRS lease accounting rules.
Asset turnover is sales divided by total assets.
Interest cover is unchanged under FASB’s new rules. The impact varies under the IFRS rules.
Interest cover is EBITDA divided by interest expense.
EBIT/operating profit is unchanged under FASB’s rules, but increases for IFRS filers.
EBITDA will be unchanged for US GAAP, but will increase under new IFRS lease accounting rules.
EBITDA is earnings before interest, tax, depreciation, and amortization.
EBITDAR will be unchanged for either US GAAP or IFRS.
EBITDAR is earnings before interest, tax, depreciation, amortization, and rent.
Profit or Loss
Profit or loss will be unchanged under FASB’s new rules. The impact varies under the IFRS rules.
Earnings Per Share
Earnings per share will be unchanged for US GAAP. The impact will vary for IFRS filers.
Earnings per share is calculated by dividing a company’s net income by the number of outstanding shares.
Operating Cash Flow
Operating cash flow will be unchanged under FASB’s new rules. It will increase under IFRS.
Return on Capital Employed
Return on capital employed will decrease under US GAAP. The impact will vary for IFRS.
Return on capital employed is typically calculated by dividing EBIT by equity and financial liabilities.
Net Cash Flow
Net cash flow is unchanged under both the new FASB and IFRS lease accounting rules.
Net cash flow is typically calculated by measuring the difference between cash inflows and outflows.
Gross margin is unchanged under both the new FASB and IFRS lease accounting rules.
Gross margin is typically calculated by subtracting the costs of goods sold from a company’s revenues.
Operating Efficiency Ratio
Operating efficiency ratio is unchanged for US GAAP. It increases for IFRS filers.
Operating efficiency ratio is calculated by dividing operating expenses by net sales.
Return on Assets
Return on assets decreases under both the new FASB and IFRS lease accounting rules.
Return on assets is calculated by dividing net income by average total assets.
Return on Equity
Return on equity is unchanged for US GAAP. The impact varies for IFRS filers.
Return on equity is typically calculated by dividing net income by shareholder’s equity.
Quick ratio decreases under both the new FASB and IFRS lease accounting rules.
The quick ratio is calculated by comparing a company’s total cash, marketable securities, and accounts receivable to their current liabilities.
Current ratio is unchanged for US GAAP. It decreases for IFRS filers.
The current ratio measures a company’s ability to pay short-term and long-term obligations.
Leverage ratio is unchanged under US GAAP. It increases for IFRS filers.
Leverage ratio is typically calculated by dividing a company’s total liabilities by its stockholders’ equity.
Net worth decreases under FASB’s new lease accounting rules, but is unchanged under IFRS.