The impact of ASC 842’s new leasing standards on default likelihood by industry

Abstract

PurposeThis paper aims to examine the impact on firm financial distress by industry of one of the most recent accounting changes in the treatment of operating leases, Financial Accounting Standard Board (FASB) Accounting Standards Update (ASU) No. 2016–02, Leases released February 25, 2016. ASU 2016–02, also known as ASC 842, considerably changed how firms account for operating leases.Design/methodology/approachThe authors use the Black–Scholes–Merton (BSM) option pricing methodology to estimate the change in default likelihood (DL) of nine different industries surrounding the adoption of ASC 842. In addition, the authors use univariate and multivariate analysis to test the statistical significance of firm-related factors.FindingsThe authors provide evidence that numerous industry’s DL increased following the FASB’s announcement of the new standard (ASC 842) regarding increased transparency in lease recognition. The effect is especially significant within the energy industry, although it is also shown in the consumer durables, manufacturing, hi-tech equipment, telecom, retail and wholesale and transportation industries. In addition, the authors find the effect is more pronounced for firms with high leverage, low financial slack, low operating return on assets, small market value and accounting for non-balance sheet recorded leases.Practical implicationsBy investigating different industries, this study’s findings provide crucial insight to managers seeking lease financing as an operational strategy in a post-implementation environment and help them understand the impact of this new standard on their firm. Furthermore, this study answers the call of policy makers and academics to provide insight into the impact of updated leasing standards.Originality/valueThis is the only empirical study that examines the impact of ASC 842 on the DL of publicly traded firms by industry.