Capitalizing Non‐cancelable Operating Leases

Abstract

Abstract There have been recent international moves to require the capitalization of non‐cancelable operating leases. Most prior research on the constructive capitalization of leases has been undertaken on US data. The results from US studies may not apply to international firms because non‐US operating lease contracts may differ in lease term, discount rates, and renewal options. This study presents the financial statement impact of constructive capitalization for 38 firms listed on the New Zealand Stock Exchange. New Zealand is an appropriate institutional setting because the required footnote disclosures for operating leases are similar to the International Accounting Standard. The method of constructive capitalization follows the general approach developed by Imhoff, et al. (1991) . The results show that constructive capitalization has a material impact on reported liabilities and financial ratios. The results suggest that, relative to present value procedures of constructive lease capitalization, heuristics used by analysts lead to the overstatement of lease liabilities and lease assets. However, the use of single cross‐sectional parameters (e.g., discount rates, lease life) results in constructed lease assets and liabilities that are similar to more elaborate firm‐specific procedures.

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