Case Study: Starbucks' Response to New Lease Accounting Standards

This case study examines Starbucks' concerns regarding new lease accounting standards proposed by IASB and FASB, focusing on the impact on their financial statements. Starbucks' worries center around lease terms, expense recognition patterns, and contingent rentals. The report outlines the journal entries required if Starbucks adopts the new standards, explores alternative approaches, and weighs the pros and cons of each. Alternatives discussed include maintaining the current practices, accepting the proposed changes, and adopting Starbucks' own suggestions. Ultimately, the report provides a recommendation based on a thorough analysis of these alternatives, considering the financial implications and operational challenges for Starbucks.

Business Case Study – STARBUCKS: VENTI
LEASES
Group #5
Prepared for:
Professor Ramesh Saxena
ACCT 4000 RLA
Humber college
Prepared by:
Mohit Gadwal(N01332620)
Urvil Pravinbhai Patel (N01332646)
Aliza Tharani(N01349821)
Matthew Johnson(N01268714)
Denvis Tabod (N01250378)

TABLE OF CONTENT
TOC \h \u \z HYPERLINK \l "_l2z9bukj5tw5" \h EXECUTIVE SUMMARY PAGEREF
_l2z9bukj5tw5 \h 3
INTRODUCTION: 4
PROBLEM STATEMENT 4
ANALYSIS OF ISSUES 4
ALTERNATIVES 9
ALTERNATIVES COMPARED 10
RECOMMENDATION 11
APPENDIX 12

EXECUTIVE SUMMARY
The case tells us about the new accounting standards related to leases proposed by IASB and
FASB together and how these new standards will affect Starbucks. Starbucks has also shown
their concern related to the new accounting standards and how these standards can affect their
financial statements. Their major concerns were related to Lease term, Expense recognition
pattern, Contingent rentals. This report provides what journal entries are required if Starbucks
decides to accept the new standards proposed by IASB and FASB. This report also provides
different alternatives and shows the pros and cons of each alternative. After analyzing all the
pros and cons of each alternative we have provided the recommendation.

INTRODUCTION:
The first Starbucks store was opened in Seattle on March 30, 1971 by three partners named Jerry
Baldwin, Gordon Bowker and Zev Siegl. The main product of Starbucks was selling fresh
roasted coffee beans. In 1982, an entrepreneur called Howard Schultz was hired as the director of
retail operation and marketing. After a trip to Italy in 1983, Howard Schultz, urged the Starbucks
owners to adopt their Italian coffee taste, however, they rejected the offer. He thus started his
own business called II Giornale which was his vision for Starbucks. Later in 1987, Starbucks
was then sold to II Giornale which was owned by Schultz which he later named as Starbucks.
Starbucks had 11,000 locations in the USA and 1000 locations in canada. Starbucks now has
32,646 stores worldwide.
PROBLEM STATEMENT
The Vice president and controller of starbuck have concerns about the new accounting standards
proposed by IASB and FASB in regards to lease accounting and how it will affect the companies
financial statements.
ANALYSIS OF ISSUES
Type of Business: The case focuses on a coffee retailing company (Starbucks) which belongs in
the food production industry. Starbucks is noted for their sale of high quality fresh roasted whole
coffee beans in locations where friends can meet for conversations away from their homes and
place of work.
Environment: Starbucks operates in leased identical locations which serves as a third place from
home and work where friends could meet for conservations and enjoy their high quality
products, great service and relax. Their identical environments are community friendly.
Originally, Starbucks operated only as Italian coffee bars in Italy, until the coffee experience in
those bars captured Schultz who adopted the idea in America and then it spread all over the

world.
Stakeholders: Starbucks company has many stakeholders who are interested in the company and
can either affect the business or can be affected by the business. Some of starbuck’s stakeholders
are;
● Customers - they are the key stakeholders in the starbucks company, this is because the
entire business only exists because of them. Starbucks depends on the loyalty of the
customers to survive.
● Investors - they are also very beneficial to the company through their investments, even
though they are liable to lose money through their investments.
● Employees are also stakeholders, as they contribute to the company’s growth by offering
their exceptional services to customers.
● Suppliers - they are important stakeholders because they provide raw material and
supplies for the business to run, for example: Coffee farmers.
According to the case, Starbucks needs to adapt to the new changes in the lease accounting
standards. Before the IASB and FASB jointly issued new accounting standards for all off-
balance sheet leases over 1 year to be reported on a company’s balance sheet as a right to use
assets with a corresponding liability, Starbucks was able to reduce her expenditure and debt by
using off-balance sheet leasing.
So, the new accounting standards are making things difficult for Starbucks, since they have to
stop their off-balance sheet lease practice.
Starbucks is a global retailer with approximately 9,000 company-operated retail locations under
operating leases in the U.S, and across the borders. Accounting standards related to Leases are
important for Starbucks because the stores are the most important asset of the company, and they
lease the stores. Changes in Accounting standards related to the leases would greatly affect the
company. Before August 2010, there were Various classification for leases from both the
International Accounting Standards Board (IASB) and the Financial Accounting Standard Board
(FASB). Both the boards have different approaches, but they established similar categories and
treatment of capital and operating leases.

Operating Leases were shown as an operating expense in the income statement in the period in
which the lease payments were made. The operating leases don't affect the balance sheet of the
company and disclosures were made only in the notes to the financial statements. Capital Leases
were treated differently from the operating Leases. Capital leases were classified as both as an
asset and as a liability on the balance sheet. Sir David Tweedie (Chairman of the IASB) also
commented that the lease accounting standards fell significantly short.
In August 2010, IASB and FASB jointly proposed to standardize the recognition of assets and
liabilities under leases. The proposal was intended to help the financial users of financial
statements to avoid uncertainties that were faced in the existing standards. The new leasing
standards define a lease as a contract that gives the lessee the right to control the use of an asset
for a period in exchange for consideration (lease payments). This will result in that all off-
balance sheet leases must be reported on a company's balance sheet as an asset with a
corresponding liability. IASB and FASB also proposed that assets and liabilities recognized by
lessees and lessors would be measured on basis that-
A. Assumes the longest conceivable rent term that is almost certain to happen, considering
the effects of any other options to extend or end the lease.
B. Uses a normal result procedure to mirror the rent installments, including unexpected
rentals and anticipated installments under term option penalties and residual value
guarantees, indicated by the lease.
C. Is updated when changes in realities or conditions show that there would be a critical
change in those assets or liabilities since the past reporting period.
Starbuck would have been greatly affected by applying these new standards. so they discussed
their concerns about the new standard and they were not following the new standards from IASB
and FASB, The summary of the concerns are as follows-
The lease term
IASB and FASB proposed that the lease term should be determined as the longest term that is
more likely than not to occur, but Starbuck didn't agree with that and argued that the lessee does

not have an unconditional obligation to pay rentals in optional renewal periods until the lessee
has exercised the renewal option. Including not -yet -exercised option period for calculating lease
liability would create inconsistency and would lead to inflated balance. Donna Brooks (Vice
president and controller of Starbucks) also added that it would reduce the reliability and
comparability of financial statements.
Expense Recognition Pattern
IASB and FASB proposed the amortization cost method for the leases. Starbucks argued that the
linked approach would be a better approach for the expense recognition purpose. The company
believed it would accommodate the move away from off-balance-sheet financing and will also
preserve current straight-line rent expense recognition.
Contingent Rentals
Both the boards proposed that Contingent rent should be included in the determination of the
right-of-use asset and related liability. Starbucks stated that the Contingent rent should not be
included unless there is a primary obligation under the lease. Starbucks said the contingent rent
should be considered only when future events occur and trigger liability.
If Starbucks accepts the new standards proposed by IASB and FASB these entries are
required to be done.
If Starbucks accepts the proposal it means that the company needs to classify their lease both as
an asset and as a liability on the balance sheet. The company needs to do journal entry to record
lease as an asset and a corresponding entry for lease liability. We also need to do an entry for
depreciation each year.
To reach the present value of the lease we assumed that the cost of the capital is 6%.
(calculations are shown in the appendix)

Books of Stackbucks corporation
Journal entry
Recognising the future ROU asset lease under new IFRS
Date Particulars Dr. amount Cr. amount
Sep 2010 ROU assets 3511.28
Capital lease Liability 3511.28
(recording for lease under contract which cannot be
cancelled )
For interest expense and payment of lease amount.
Date Particulars Dr. amount Cr. amount
Dec 2010 Interest Expense 40.05
Capital lease liability 667.55
Cash 707.6
And so on for every year till lease matures.
For Depreciation of Non cancelable capital lease
Date Particulars Dr. amount Cr. amount
Dec 2010 Depreciation Expense 234.09
Accumulated Depreciation of ROU asset 234.09
And so on for every year till lease matures.

ALTERNATIVES
Do nothing: The first alternative for Starbucks is to do nothing. They may decide to continue
with their current practices of classifying leases by the contractually obligated term they have
agreed to. This will result in no changes for the business’ current or future operations but leaves
them vulnerable to litigation if the proposed changes take effect. Starbucks was not in a position
to begin listing all of the off-balance sheet leases as assets with a corresponding liability.
Accept the proposed changes: The second alternative for Starbucks is to accept the proposed
changes and begin to reclassify all existing leases they hold to appropriately match the new
standards. This would result in a large shift in their balance sheets as much of the leases are not
recorded as assets, and only the lease payments are recorded under liabilities. This represents a
significant burden to both the accounting and administrative departments as they will need to
make constant adjustments to accurately reflect and change the estimated contingent rental
payments that are made in advance of the actual activities having occurred. The net result of this
alternative should Starbucks choose to adopt this reform is an expensive and time-consuming
procedure that Starbucks sees as entirely unnecessary and too costly to provide any meaningful
changes.
Adopt their own suggestions: The third option for Starbucks is to adopt the recommendations
made in its letter to the Financial Accounting Standards board. In the letter Starbucks recognized
that there is likely a contingent of shareholders who may be interested in the inner workings of
the company’s lease agreements beyond what is already required by the current standards. The
company could choose to add ‘qualitative disclosures’ for these end-users to help explain the
practices and highlight meaningful metrics in the portfolio. Another recommendation for them to
adopt is a linked approach to recognizing expenses. They believe this is a valid method of
recording previously off-balance sheet financing while allowing them to preserve the straight-
line rental expense pattern currently in use. They also argued that in cases where base rent is
either below market rates or nil that contingent rents could be used in its place to effectively
report the lease’s economic substance.

ALTERNATIVES COMPARED
Do nothing
Pro:
· No additional expenses
· No changes made to current internal accounting and reporting procedures
· Consistency in year-to-year reports allows for financial statement users to easily
comprehend and identify trends, should they arise
Cons:
· Leaves the company open to litigation should they fail to adapt to changes
· Possibility of being isolated from other industry leaders should those companies
choose to adopt these rules
Accept Proposed Changes
Pros:
· Stay ahead of changing trends in financial reporting
· Get a head start on changing old lease classifications to reduce reporting delays
Cons:
· Time consuming- beyond a reasonable amount of time would be needed to accurately
account for all contingent rentals
· Constant need for changes to accurately reflect real costs associated with contingent
rent

· The high cost of implementing and carrying proposed changes would diminish the
usefulness of the new reporting standards
· Unnecessary changes could lead to confusion in all stakeholder parties as they adapt to
new reporting standards
Adopt Recommendations
Pros:
· Demonstrate responsible governance on behalf of the company’s board
· Easily understandable rental portfolio could entice future investments
· Demonstrate that proposed changes are unnecessary if recommendations become
industry standard
Cons:
· While not as expensive as a full implementation of the proposed changes this option
still carries high costs
· Adoption of unrequired standards of financial reporting could result in backlash from
shareholders unhappy with any additional unnecessary expenses
RECOMMENDATION
We identified 3 possible solutions in the issues relating to starbucks accounting treatment of
lease accounting and recommend them to go with the second option of accepting the proposed
standard. As it has been developed over time by professionals all over the world with expertise
and sound knowledge. It helps in the true presentation of liabilities and assets of the company
which has already occurred but loopholes are used to hide them. To say by definition Starbucks
already have signed non cancelable contracts of lease and obligation to pay in future have

already occurred, so why not show it today as we already know the value of future cash flows.
By not showing it, stakeholders are not aware of the liabilities which company has taken and the
balance sheet may not show the true state of company affairs. If those standards become
enforceable in future, they cannot escape it and have to change the books and report it in the new
format and in addition pay a penalty for not following it which inturn will increase the cost. IFRS
standards are developed to meet the changing needs of accounting as previous frauds have
teached us loopholes and so should be followed which will also earn stakeholders appreciation
and better representation of company practises and also the ethical side of accounting would be
fulfilled. Although it might be a costly transition, it is worth it in terms of comprehensive
approach to presentation.
Therefore, Starbucks should start transitioning to better represent their leases and liabilities in
accordance with the new changes and avoid being in trouble in terms of non proper presentation
and penalties to avoiding true and fair representation.
APPENDIX
Converting Future Operating Leases into liability
Year Commitment Present Value
2010 707.60 667.55
2011 669.00 595.41
2012 612.30 514.10
2013 551.00 436.44
2014 488.10 364.74
Thereafter 1362.0 933.05
Debt Value of leases = 3,511.28
Present value is converted at 6% pre tax.
Assumed Capital lease average life of 15 years as they vary over time.
IFRS 16 Lease amortization Schedule

Period Cash Interest
expense
liability
reduction liability Depreciatio
n expense
Net Asset
balance
Accumulat
ed
Depreciatio
n
3511.28 3511.28
2010 707.6
40.
05
66
7.55
2,843.7
3 234.09 3277.19 234.09
2011 669.0
73.
59
59
5.41
2,248.3
3 234.09 3043.10 468.18
2012 612.3
98.
20
51
4.10
1,734.2
3 234.09 2809.01 702.27
2013 551.0
114.
56
43
6.44
1,297.7
8 234.09 2574.92 936.36
2014 488.1
123.
36
36
4.74
933.0
5 234.09 2340.83 1170.45
Thereafter till lease
matures