Remember the wave of lease restatements from early 2005? That was when a letter from then-chief accountant Don Nicolaisen triggered re-examinations of lease contracts and accounting far and wide, resulting in over 200 corrections and restatements.
Alaska Airlines (NYSE:ALK) wasn’t one of the companies with a problem, however. Until now. In its 2006 10-K filing, the company performed an SAB 108 adjustment to its beginning of year 2006 retained earnings for $6 million. The adjustment was related to improper amortization of leasehold improvements. How so? Borrowing from the filing, “[o]ur airport lease agreements do not generally carry a renewal right in them, which is a key consideration for SFAS 13 'lease term' definitions.” That key consideration is that a firm shouldn’t depreciate equipment or amortize leasehold improvements for a longer period than it has the right to use the property to which they are attached.
Which is exactly what the airline was doing. Small potatoes, each year, according to the company. To catch up the correction, however, would have been material to earnings in a given period - so the company must have been relying on the balance sheet “iron curtain” approach to determining materiality.
And the same approach must have been used with the “market subsidy” paid to the Horizon commuter lines unit. The company purchased aircraft and received payments from the manufacturer, which the company recognized in income on a cash basis for seven to eight years, depending on the kind of aircraft. It would have been more correct to match the recognition of the credit with the lives of aircraft involved - a 15 to 17 year stretch. That immaterial difference tacked $12.6 million onto earnings for the periods affected - a total of $18.6 million for the two kinds of errors. Curiously - no mention of the periods covered, so investors can see just how material the amounts might have been to discrete periods. It’s not a SAB 108 requirement, but it would have been a braver voluntary disclosure.
ALK 1-yr chart