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The change was scheduled for 2014. Now, it has been delayed to 2015. It goes by the name of "mark-to-market" or "fair value accounting," and the Securities and Exchange Commission will eventually require all publicly-traded companies in the United States to adopt International Financial Reporting Standards (IFRS). These new accounting standards will require assets to be reported at market value instead of book value.
Listing assets at book value has been the standard practice in the past. Book value is the original cost less accumulated depreciation.
Single-store ownership will likely follow the accounting practice of publicly-traded companies. For the 63 percent of operators in the convenience industry today who are single-store owners, the IFRS changes may have a big impact on how their future balance sheets and profitability will look.
Let's take an example. A convenience store property purchased 15 years ago has a book value on the company's financial statements of $350,000. For most single-store owners, real estate is the largest line-item asset on their balance sheet. In this example, we will assume this was the original cost of the land. The store building and fuel service have been fully depreciated. In contrast, a current appraisal of the site, store and fuel service shows a market value of $700,000. In this illustration, market value is twice the book value.
IFRS and the Balance Sheet
In the example above, by registering the assets on the balance sheet under "Property, Plant and Equipment," the new IFRS International Accounting Standard (IAS) 16 will require that $700,000 be reported instead of $350,000. All other things being equal, this increase in the reported value of the assets will increase the net worth, or Owner's Equity, by $350,000. In other words, the real estate will appear on the balance sheet at a higher amount, showing its true market value.
For c-stores that have been in business a few years, market value is usually higher than the book value of the real estate. In these cases, the stated Owner's Equity will increase. This is exactly what happened with Marsh Supermarkets in 2006. Marsh had the option of reporting its assets at book value or market value. When appraisals were made, their real estate holdings were shown to be worth $100 million to $150 million more than the reported book value. As a result, the trading price of Marsh Class A shares more than doubled in a single day.
IFRS and Return on Assets
Market value reporting will also affect business performance measures, such as Return on Assets. Return on Assets is a fundamental economic measure of how well a business is doing. NACS reported the average Return on Assets for the convenience retail industry as 7.87 percent for 2010. The calculation they use is Net Profit Margin x Total Asset Turnover = Return on Assets. Average Net Profit Margin was reported by NACS at 1.93 percent (Net Profit divided by Total Sales Revenue).
Let's use the same example above to calculate Total Asset Turnover and see the effect it has on Return on Assets.
Total Asset Turnover is Annual Sales divided by Total Assets. To keep it simple, let's use only the real estate figures above and assume annual sales of $1.4 million. Using the book value of $350,000, the Total Asset Turnover is four ($1.4 million divided by $350,000). The resulting Return on Assets is 1.93 percent x 4 = 7.72 percent.
However, if market value instead of book value is now reported for the assets, Total Asset Turnover is two ($1.4 million divided by $700,000), and the equation for the Return on Assets becomes 1.93 percent x 2 = 3.86 percent.
The 3.86 percent calculated above reflects the realistic Return on Assets. This economic return is only half that reported under book value and is far below the acceptable economic return for this type of business.
For many single-store owners in the convenience industry, the coming change to fair value financial reporting will mean higher statements of Owner's Equity on the balance sheet, but lower measures of Return on Assets. These changes will create a more realistic financial picture for better management decisions.
Robert E. Bainbridge is an author, instructor and expert witness in the appraisal and valuation of convenience stores and gas stations. He can be reached at [email protected] or (541) 823-0029. Find more valuation information at www.cstorevalue.com.
Editor's Note: The opinions expressed in this column are the author's, and do not necessarily reflect the views of Convenience Store News for the Single Store Owner.