Valuation, 7th Edition

22 Leases

Many companies, especially retailers and airlines, lease their assets from other companies rather than purchasing the assets outright. They do this for many reasons, including greater flexibility and to lower taxes.

In the past, clever use of accounting rules allowed companies to keep assets and debts off balance sheets. These included leased assets and their corresponding debts, securitized assets like receivables, and unfunded retirement obligations. In some cases, this helped companies manage cash flow or take advantage of alternative routes to raise funds. In other instances, off-balance-sheet items were used to artificially boost results such as earnings per share or return on assets.

In response, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) made significant changes to their guidelines. As of 2019, companies are required to capitalize nearly all asset leases, including operating leases, on their balance sheet.¹ This stands in stark contrast to past guidelines, where a company could rent an asset, even for long periods, and recognize only the periodic rental expense.

The new accounting guidelines bring the treatment of operating leases closer to the underlying principles of this book. Implementation of the new guidelines, however, differs across accounting bodies, so incorporating operating leases into your valuation still requires special care.

This chapter begins with a review of the new accounting ...