Operating and synthetic leases: Exploiting financial benefits in the post-Enron era

Abstract

Abstract Applying constructive lease capitalization to operating leases of firms in the 2003 S&P 500 index, we demonstrate that currently companies can hide billions of liabilities, enhance retained earnings, income, and ratios by reporting leases as operating. With the rekindled interests of the International Accounting Standards Board and Financial Accounting Standards Board on lease reporting, our study provides valuable and timely information for their decisions. Results indicate that by reporting operating leases, firms avoided on average $582 million of liabilities (11% of total liabilities) and $450 million of assets (4% of total assets) for our 366 sample firms. Partitioning sample into negative and positive income impact subgroups provides additional insight into firm's motivation for using operating leases. Under lease capitalization the top quartile positive subgroup experienced an 18% increase in income while the top quartile negative subgroup had an 11% decline in income. There was also a significant negative impact on liquidity, leverage and performance ratios.