Why are Leases Important for Investors?
In January 2019 the US’s Financial Accounting Standards Board’s (FASB) new standard on leases, ASC 842, came into effect, requiring companies to report leasing costs on their balance sheet. But why is lease accounting important for investors and analysis? In a helpful article on Value Walk last week Christine Tan outlined the significance of the changes that have been made to lease accounting.
Before the recent FASB update, lease assets or liabilities classified as ‘operating’ were not required on the balance sheet, whereas those that qualified as ‘capital’ leases were. This gave companies an incentive to structure their lease agreements to keep assets and liabilities off the balance sheet – significantly impacting the accuracy of reporting and key financial ratios like their debt-to-equity ratio and return on asset ratio (ROA). For example, American Airlines was able to keep $9 billion of lease liability off their balance sheet, reducing their reported debt by 40%.
While investors have historically made their own adjustments to compensate for hidden leased assets and liabilities, the new accounting standard requires companies to report leasing costs on the balance sheet, making dramatic differences to a number of financial ratios.
For investors, leases significantly factor into the analysis of a company’s leverage and liquidity, so these additional, key disclosures should increase transparency and comparability amongst companies.
Read more here.