Potential changes in lease accounting could reveal ‘hidden gearing’ in retail chains, exposing them to poor balance-sheet ratios and lower profits, a leading investment bank has warned.
Dresdner Kleinwort Benson also said other sectors, such as pub chains and airlines, could be affected. The prospect has caused consternation among retail finance directors.
The Accounting Standards Board, currently reviewing lease accounting, is considering a requirement for operating leases to be capitalised on the balance sheet. DKB said it expects this to become a major issue over the next three years.
DKB, which prepared a paper – ‘Operating Leases: The Retail House of Cards’ – on the subject, said operating leases represented a huge amount of off-balance sheet debt for retailers.
It warned that capitalising and treating them as debt revealed dangerously high levels of gearing in much of the UK retail sector.
‘Net debt is in excess of 100% of equity market capitalisation in many cases, reducing earnings visibility and exposing shareholders to extremely volatile returns,’ the report warns.
Steve Sargent, FD of jewellery chain Goldsmiths which has 150 retail outlets, said: ‘From a vested interest point of view as FD of a retail operation, this doesn’t help. But from an academic point of view, DKB has a point.’
PricewaterhouseCoopers accounting technical partner Peter Holgate said retailers would be among the sectors most affected by any change.
He also pointed out that operating lease liabilities were already shown in accounting notes. Holgate agreed, however, that if capitalised, they would gain more prominence and affect balance sheet ratios.
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