The Impact of Capitalizing Lease Contingent Payments

Xiaofei Song
(Sobey School of Business, Saint Mary’s University, Halifax, Nova Scotia, Canada)

Abstract: This study empirically examines the impact of capitalizing operating leases and lease contingent payments, a previously unexplored off-balance sheet item, on key reported accounting numbers and financial indicators. The recently published Exposure Draft-Leases by IASB and FASB requires that all leases to be capitalized and lease contingent payments to be included in the estimate of the liabilities associated with the leases. Using a large sample of US companies from 2001 to 2010, this study found that capitalizing operating leases resulted in significant changes in the magnitudes and the relative rankings of total liabilities, total assets, debt ratios, current ratios, and ROAs. Furthermore, capitalizing lease contingent payments resulted in incremental and significant changes in the magnitude and the relative rankings of total liabilities, debt ratios, current ratios and ROAs. The effects of capitalizing off-balance sheet lease obligations on these accounting numbers and ratios were consistent across industries, except for ROAs, which were not significant in all industries. Capitalizing off-balance sheet lease obligations did not significantly affect the magnitude of ROE but did change its rankings. This study contributes to lease research literature by being the first to examine the impact of capitalizing lease contingent payments. This study also provides empirical evidence relevant to IASB and FASB’s ongoing deliberation and revision of their recommendations for accounting for leases.

Key words: capitalization of lease liability; lease contingent payment; operating lease

JEL code: M