New Operating Lease Disclosures: the Good, the Bad & the Non-Compliant

Many companies are not complying with the Financial Accounting Standards Board’s (FASB) new standard (ASU 2016-02) for reporting operating lease assets and liabilities on the balance sheet. This standard went into effect in 1Q19 and goes a long way towards closing the loophole that allowed companies to hide trillions of dollars in capital off the balance sheet.

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This report provides specific examples of compliant and non-compliant disclosures as well as a general overview of how many companies fall into each category. Please contact us if you would like more details on which companies are and are not complying with this new rule.

What Investors Need to Know

For operating lease disclosures to be useful for investors, at a bare minimum, companies must disclose:

  • Future annual payments for operating leases
  • Rate used to discount the future annual payments into a net present value (NPV) obligation reported on the balance sheet as an asset and liability
  • NPV of Operating Lease/right-of-use (ROU) assets and liabilities

Since implementation of ASU 2016-02, many companies have not consistently disclosed all three. While companies are better about disclosing the NPV obligation, the two worst areas of disclosure and compliance are future annual payment tables and discount rates. Without the discount rate and future annual payments data, investors cannot assess the reasonableness of the NPV obligation because companies can manipulate that value with their choice of discount rate, see “How Operating Lease Discount Rates Can Mislead Investors.”

Why Disclosure Matters – Required for Accurate Earnings Models

Without compliant disclosures, investors cannot measure the real value of operating lease/ROU asset & liabilities. Since 1998, and long before ASU 2016-02, our models have leveraged detailed footnotes analysis to capture the impact of off-balance sheet debt from operating leases on NOPAT/income statementsinvested capital/balance sheets and the weighted-average cost of capital (WACC).

Though ASU 2016-02 aims to relieve investors of at least some of the rigorous footnotes analysis required to assess operating lease liabilities, plenty of footnotes work remains to ensure we get the right value across 5,000+ companies for our clients and partners. Figure 1 shows just how different our measure of the NPV of operating leases compared to what companies disclose.

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