Capitalisation of Operating Leases and Credit Ratings
Journal of Applied Research in Accounting and Finance (JARAF), Vol. 8, No. 1, 2013
23 Pages Posted: 10 Jun 2013
Date Written: June 9, 2013
The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) will re-expose in the first half of 2013 a revised joint proposal for a new lease accounting standard (FASB 2012). The proposed standard requires lessees to record operating leases as debt, making it more difficult for lessees to avoid liability recognition. We examine whether or not the debt impact of operating leases is reflected in bond ratings. Using the methodology of Damodaran (2009), we compare firms’ actual credit ratings with synthetic ratings calculated using both reported financial statement data and financial statement data that has been adjusted to reflect the debt treatment of operating leases. We find that when operating leases are treated as debt, coverage ratios and synthetic ratings are significantly lower than those created under current accounting rules. In addition, we find that the actual ratings are significantly lower than unadjusted synthetic ratings, while synthetic ratings calculated using adjusted data approximate the actual ratings. This suggests that the debt impact of operating leases is important to ratings agencies and that the agencies incorporate available information into their ratings. However, information available under current accounting rules is incomplete. Given the importance of lease information and the incompleteness of the data available under current accounting rules, we suggest ratings may become more accurate under the proposed standard.
Keywords: financial reporting
JEL Classification: M40, M41
Suggested Citation: Suggested Citation