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Cracker Barrel Announces Lease Re-thinking

If this pace keeps up, there won’t be a single restaurant that hasn’t redone its lease accounting…
Cracker Barrel released an 8-K this morning, announcing that it will re-examine its lease accounting. No numbers, just the promise of restated figures soon.
What’s different in crypto Custodian Barrel’s 8-K, however, is that they sound a bit more defensive of their past accounting than their fellow restaurateur restates (RRs). Below, an excerpt from the 8-K:
“Since 1985, generally accepted accounting principles in the United States (”GAAP”) have required that leases for which there are rent increases over the term of the lease be accounted for at the average rent payment over the applicable term. This typically results in accrued rent expense in the early years being higher than cash rent payments, with the difference being recorded on the balance sheet as deferred rent liability. In later years of the lease, actual cash rent payments typically are higher than the average rent, and the difference is recorded by reducing the deferred rent liability. In effect, rent payments from the later years of the lease are partially accrued in the earlier years of the lease. GAAP generally requires that this average, or straight-line, rent be calculated over the minimum term where the lessee would incur no economic penalty from terminating the lease.”
All true. The reason for the straight-lining of the rent expense over the lease term is that it reflects the way the physical property is being used. If there’s no rent expense in Year 1 because the payment schedule is constructed that way so as to improve earnings, does that mean that the firm didn’t use the property? No. Straight-lining the rent makes the financials reflect what actually happened in the real world.
“The Company indicated that it and apparently many others in the industry have long interpreted this to mean the base term of the lease (i.e., not including option, or renewal, periods) since not renewing a lease generally is an economic advantage because it allows the lessee to cease operations at a poorly performing site or to commence operations at a superior site. “
Accounting rules are pretty specific on what lease term to use. This, from Statement 13: (Paragraph 5f.) “Lease term – The fixed noncancelable term of the lease plus (i) all periods, if any, covered by bargain
renewal options, (ii) all periods, if any, for which failure to renew the lease imposes a penalty on the lessee in an amount such that renewal appears, at the inception of the lease, to be reasonably assured, (iii) all periods, if any, covered by ordinary renewal options during which a guarantee
by the lessee of the less or’s debt related to the leased property is expected to be in effect, (iv) all periods, if any, covered by ordinary renewal options preceding the date as of which a bargain purchase option is exercisable, and (v) all periods, if any, representing renewals or extensions of
the lease at the less or’s option…”
Somehow, the industry either missed this paragraph, or developed a reading disorder. If you’re pretty good at understanding English, it’s hard to interpret the above as just the base term of a lease contract. Sure, there’s an advantage to being able to not renew a lease – if the operation stinks, or demographics turn against you, who wants to stay put at such a location?. All these are events unforeseeable with perfect vision at the outset of a lease. But unless there’s a real financial obstacle embedded in the transaction itself, and you know what you’re doing in the business, you’d be likely to renew.
“The Company indicated that it and apparently many others in the industry, however, also generally have depreciated leasehold improvements over a longer period, the expected life of the property, which may often include optional renewal periods.
The restatement that the Company is recording conforms the period used for straight-line rent calculation with the estimated useful life used for depreciating leasehold improvements. This generally means that rent expense accrued in a given period will include rent that will not actually be paid until an even more remote future period, often more than 20 years hence and for which a lessee has no obligation until an option is exercised at some time in the future. If a lessee determines not to exercise a future renewal option, the rent accrued in the early years of the lease attributable to the later option period would be taken as a credit to income, even though there is no cash transaction. Again, these accrued future rent payments will be accumulated on the balance sheet as a deferred rent liability.”
Well, sure – there’ll be a difference between cash and accrual accounting. And there always is. The accrual accounting would reflect the way the property is used to generate cash returns – and the cash basis reporting wouldn’t. This is why critiques of accrual basis accounting as being inferior to cash basis accounting sometimes fall flat: you can schedule cash payments to fit a pattern you want, and it says nothing about your total obligations or the way you use leased property. Accrual accounting does.
As for any credits due to the reversal of the rental expense for non-renewals would be information about the operations that would be worth sharing with investors. Credits for non-renewal of leases? Why weren’t the properties worth renewing?
Give Cracker Barrel credit for getting with the program. It’ll be interesting to see if other upcoming RRs take the same tone in their announcements.

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