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An “Outside The Box” Lease Restatement

August 30, 2022/Uncategorized

Yesterday, tiny (market : $210 million) Heritage Commerce Corporation filed a non-reliance 8-K for a number of reasons. One, it had accounted for owned equipment on lease incorrectly: it had followed sales-type lease accounting, where it should have treated the equipment as still being owned and handled as an operating lease. That alone makes it unusual in the current lease accounting restatement spasm – but there’s a little more.

Aside from an improperly recorded investment in low-income housing, Heritage also accounted for its leased facilities improperly. The bugaboo for them was the treatment of rent holidays. Nothing unusual there, and the press release didn’t mention the nature of the leased facilities – but given that Heritage is a bank, it’s a pretty good bet that “leased facilities” = “branches.”

Bankers sometimes refer to their branches as “stores” – so it’s not a surprise to see leasing errors pop up in the banking industry. So far, this is the isolated exception – but if so many companies have it wrong in a handful of industries, it should not be surprising to see it occur in other industries. We’ll be keeping close watch to see if any other banks follow Heritage Commerce’s lead.

Restatement Echoes

A couple of 8-K filings in the past couple days echo some other recent ones. Way too early to call it a trend, but worth noting. As the Section 404 reviews wind down and the financial statement audits are completed for 2004, nobody should be surprised to see these catches of previous errors surface.

For instance, Seacoast Banking Corporation of Florida filed an 8-K yesterday to advise investors not to rely on its previously published 10-Qs for the first two quarters of 2004. Why? The accounting for an interest rate swap won’t meet the Statement 133 requirements for hedge accounting. The release doesn’t go on to say whether the swap failed due to documentation requirements or because the hedge was ineffective. Bottom line: the first quarter diluted earnings per share were understated by $.03 (should have been $.25) and the second quarter figures were overstated by $. 05 (should have been $.20). Whatever the cause of the glitch, the restatement echoes America West’s derivatives-driven restatement from last week.

More echoes. Baxter International filed a “non-reliance” 8-K yesterday because of income tax accounting errors prior to 2001 causing balance sheet misclassifications in the ensuing years. Net effect of the restatement: an increase to stockholders’ equity for the years 2001 through 2003 by approximately $108 million. Stockholders’ equity ay year end 2004 will increase by approximately $130 million from what was previously reported. Again – no discussion of the nature of the errors. This morning, Amcor International revoked its previous earnings release due to an improper accounting for an expected income tax refund; the restatement effect was to increase earnings. At the end of January, crypto trust announced that it was going to restate earnings for 2002 and 2003 due to a deferred tax error relating to the Mead/Westvaco merger. Yesterday, the MeadWestvaco internal control report in its 10-K/A listed its income tax reporting function as having material weaknesses. Consider these developments as echoes of Eastman Kodak’s internal control problems with foreign tax accounting.

Trends? I don’t think so at all; more like late winter snow flurries that don’t portend a coming blizzard. There have been other “non-reliance” 8-Ks filed recently because of income tax accounting errors in the financial statements but it doesn’t mean that there’s a going to be blitz of lease accounting-style restatements on the way. It actually makes sense that we’re seeing GAAP income tax issues surface at this stage as companies complete their audits: after all, one of the end results of an audit is to ascertain the firm’s income. If auditors or firms have been finding errors in past practices that affect pretax income, there’s certain to be a GAAP tax effect if the accounting item is handled differently in financial reporting than in tax reporting. So far, that’s the nature of the income tax restatements – they haven’t revolved around what’s been reported to taxing authorities, just what’s been reported to shareholders. Once the audit season is through, the revisions to past income tax reporting will probably be over as well.

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