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David Trainer
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David is CEO of New Constructs (www.newconstructs.com), an independent research that specializes in unearthing key insights from the Financial Footnotes of Annual Reports. Having analyzed over 50,000 annual reports and their Financial Footnotes, New Constructs research regularly produces Hidden... More
My company:
New Constructs
My blog:
Hidden Gems and Red Flags
My book:
The Valuation Handbook
  • Off-Balance Sheet Debt: Bad Enough That FASB Notices, Maybe You Should Too? 1 comment
    Nov 8, 2010 4:49 PM | about stocks: SBUX, WFM, WBA, CVS, TJX, URBN

    After pouring through the Financial Footnotes of over 50,000 annual reports on file with the SEC, we found that over 2,900 companies have off-balance sheet debt. The result is that over $765 billion of corporate liabilities are left off of company balance sheets. The accounting rules allow companies to move debt off their balance sheet by employing operating leases instead of capital leases to account for certain assets. The differences between an operating lease and a capital lease are quite small despite the rather large impact the difference in accounting can have on the balance sheet and economic earnings of the business. For example, there are 10 companies in the S&P 500 whose off-balance sheet debt is greater than 50% of their reported total assets. Details on this group, which includes Whole Foods, Walgreen, Starbucks and others are in our report.

    FASB seems to agree that operating lease accounting rules impair investors’ ability to properly value companies. FASB recently issued a proposed new standard that bans the use of operating lease accounting and requires all leases be capitalized on the balance sheet. The proposed standard, if accepted, is scheduled to be implemented in 2012. I think this new standard is a great step in the right direction by the accounting regulators. However, it does nothing to help investors – in the present – track how much debt is off-balance sheet now or during a company’s history. Even after the new standard is implemented, investors will need to convert operating leases into capital leases for all prior years to perform apples-to-apples historical comparisons.

    I highly recommend that investors understand how much debt companies keep off balance sheet before making an investment. Knowing the true debt of a business may change your mind about making an investment. For example, how do you feel about knowing that Kohl’s kept over $8 billion (61% of total assets and 50% of its market cap) off its balance sheet? Not so good…now maybe you see why FASB is finally getting around to addressing the issue.

    New Constructs includes off-balance sheet debt in all of its reports and adjusts the reported earnings of all companies for this misleading accounting practice.

    Disclosure: no positions
    Stocks: SBUX, WFM, WBA, CVS, TJX, URBN
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  • Gary A
    , contributor
    Comments (3154) | Send Message
    How did SA ignore this instablog and not post it as an article? This is important stuff. Massive manipulation of earnings is going on here.
    2 May 2011, 10:28 PM Reply Like
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