Valuation: Measuring and Managing the Value of Companies, Fifth Edition

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Leases, Pensions, and Other Obligations

When a company borrows money to purchase an asset, the asset is listed on the company’s balance sheet matched by a corresponding obligation. Over the past 20 years, however, clever use of existing accounting rules has allowed companies to keep many assets and their corresponding debts “off balance sheet.” Instead of recognizing these assets and their corresponding debts, companies may record just the rental and transaction fees on the income statement, disclosing the real nature of these transactions only in the footnotes.

The two most common forms of off-balance-sheet debt are operating leases and securitized receivables. From an economic perspective, operating leases and securitized receivables are no different from traditional asset ownership and debt. When the assets and related borrowings do not appear on the balance sheet, this omission biases nearly every financial ratio, including return on invested capital (ROIC). In fact, because of the distortions caused by operating leases in particular, these leases are now under scrutiny by the Securities and Exchange Commission (SEC), Financial Accounting Standards Board (FASB), and International Accounting Standards Board (IASB). The issue is significant. One SEC study found that 77 percent of U.S. traded public companies have operating leases and these total $1.25 trillion in undiscounted future cash obligations. In response to these staggering numbers, the FASB and IASB formed ...