The Relevance of Operating Lease Capitalization to Current and Future Return on Assets

Abstract

Abstract - Operating leases are used to acquire the use of assets, not to acquire legal title to assets. Accordingly, accounting procedures require that firms disclose operating lease obligations at values based on the right to use leased assets rather than the underlying value of the assets. In this study we test for associations between three estimates of operating lease asset values and return on assets. The first capitalized lease value, (1) the present value of disclosed future minimum lease payments, estimates the right-to-use asset value from the firms’ disclosed contractual lease obligations. The second and third capitalized lease values, (2) the present value of an annuity due of the disclosed future operating lease payment and (3) the present value of an annuity due of the projected future operating lease payment extrapolated from past lease cost patterns, estimate the value of the leased assets under firm control. We find that the right-to-use leased asset value is strongly associated with current and future return on assets. However, the two lease asset value measures based on the values of the underlying assets are even more strongly associated with current and future return on assets. In other words, the association between capitalized operating leases and return on assets is strongest when the capitalized value corresponds to the value of the assets being leased.

Keywords: lease accounting

JEL Classification: M41