Operating Lease Accounting and the Market's Assessment of Equity Risk

Abstract

In this paper I examine whether investors view operating leases as property rights. The user's perspective toward a lease is instrumental in determining its accounting treatment, i.e., balance sheet recognition or footnote disclosure. The operating lease accounting practice of footnote disclosure assumes that users focus on who bears the risk of ownership, with lessees of operating leases bearing insufficient risk to treat the leasehold as an asset or the obligation as a liability.' However, Dieter [1979] shows that under the control of property rights perspective underlying the Financial Accounting Standard Board's asset and liability definitions (Statement of Financial Accounting Concepts No. 3) operating leases would give rise to both an asset and a liability. To distinguish these two perspectives, I first evaluate whether the property rights perspective is relevant to users by testing whether one class of user, investors, treats operating leases as property rights when assessing equity risk. Second, I test whether investors evaluate operating leases using methods consistent with the concepts underlying current generally accepted accounting principles (GAAP) by comparing two likely valuation methods, only one of which is consistent with these concepts.