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Subject Code and Title ACCT6007 Financial Accounting Theory & Practice Learning Outcomes: 1. Identify the social and corporate imperatives that underlie the accounting conceptual framework 2. Explain the relationship between accounting theory, the accounting conceptual framework and accounting standards 4. Work individually and in groups to identify and apply appropriate accounting standards to a range of authentic accounting scenarios Context: Accounting for leases has been subject to discussion and amendments by the International Accounting Standard Board (IASB). As a result, the new accounting standard AASB 16 Leases will replace AASB 117 Leases from the annual reporting periods beginning on or after 1 January 2019. Prior to the issue of AASB 16 Leases, there was a number of consultation documents and publications discussing different aspects of lease accounting. Among these resources, Spencer and Webb (2015) conducted an extensive review of academic literature on accounting for operating leases. Question: Provide a critique on the extent to which Spencer and Webb (2015) discussed the fundamental characteristics of financial information in the disclosures for operating leases. You are expected to refer to the fundamental characteristics of financial information as set out in the Australian Accounting Standard Board's (AASB) Framework for Preparation and Presentation of Financial Statements. Required sources of reference Article by Spencer and Webb (2015) This article can be searched in the Torrens University library using the following citation: Spencer, A. W. and Webb, T. Z. (2015), Leases: A Review of Contemporary Academic Literature Relating to Lessees, American Accounting Association, Vol. 29, No. 4, pp.997-1023 The AASB's Framework for Preparation and Presentation of Financial Statements (the Framework) The IASB's Framework can be downloaded from the AASB's website: http://www.aasb.gov.au/admin/file/content105/c9/Framework_07-04_COMPjun14_0714.pdf AABS 117 Leases, and AASB 16 Leases These accounting standards can be downloaded from AASB's website: http://www.aasb.gov.au/Pronouncements/Current-standards.aspx Recommended sources of references The International Accounting Standard Board's web site http://www.ifrs.org/Pages/default.aspx The AASB's Statement of Accounting Concepts (SAC 1) SAC 1 can be downloaded from the AASB's website: http://www.aasb.gov.au/Pronouncements/Statements-of-accounting-concepts.aspx AASB 16 Leases (Appendix D), Interpretations 4 Determining whether an Arrangement contains a Lease, and Interpretations 115 Operating Leases - Incentives These accounting standards can be downloaded from AASB's website: http://www.aasb.gov.au/Pronouncements/Interpretations.aspx Accounting Horizons Vol. 29, No. 4 2015 pp. 997-1023 American Accounting Association DOI: 10.2308/acch-51239 Leases: A Review of Contemporary Academic Literature Relating to Lessees Angela Wheeler Spencer and Thomas Z. Webb SYNOPSIS: Accounting for corporate leasing activities has been examined and debated for more than 30 years. Currently both the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) are developing standards to modify financial reporting for operating leases, which are currently reported off-balance sheet. In light of these proposals, we examine existing literature to better anticipate possible effects of any changes. Namely, we review existing studies to understand why firms engage in operating leases and how information about these arrangements impacts users. First, we review studies directly examining leases. As that review reports, some studies show that companies engage in off-balance sheet leasing at least in part to manage financial statement presentation. Other studies, however, suggest that firms utilize operating leases to manage costs and preserve capital. In general, the research reports that lenders, credit rating agencies, and other capital market participants sufficiently understand off-balance sheet leases and consider them in their decision making. Second, we provide commentary on one of the current proposals' more debated areas and a current point of FASB and IASB divergence: classification of expenses associated with operating leases. While the IASB proposes disaggregating interest and amortization elements, the FASB proposes reporting a single, combined lease expense. However, very little research explicitly addresses expenses associated with operating leases. Existing studies do, however, suggest that information disaggregation, particularly with regard to operating and financing activities, is important. Our review may be useful to regulators as the reporting standards for operating leases are debated. Keywords: leases; operating leases; off-balance sheet nancing. Angela Wheeler Spencer is an Assistant Professor at Oklahoma State University and Thomas Z. Webb is an Assistant Professor at Mississippi State University. We thank two anonymous reviewers and the editors for helpful comments on this manuscript. Submitted: July 2013 Accepted: July 2015 Published Online: July 2015 Corresponding author: Angela Wheeler Spencer Email: angela.spencer@okstate.edu 997 Spencer and Webb 998 INTRODUCTION I n May 2013, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) jointly issued a long-awaited Exposure Draft on accounting for leases. If enacted, this proposed standard will fundamentally alter accounting for operating leases, most notably, by eliminating current off-balance sheet treatment for long-term leases and by requiring lessees to recognize a right-of-use (ROU) asset and associated liability. Subsequent decisions, however, reflect divergence between the IASB and FASB regarding income statement reporting related to leases. While the IASB proposes treating all leases in a similar manner and requiring segregation of interest and amortization components, the FASB proposes to continue allowing the reporting of a single operating lease (rent) expense on the income statement. Proponents of the 2013 Exposure Draft maintain that these changes will increase faithful representation, aligned with Concept Statement No. 8 (FASB 2010a), thus improving the usefulness of financial reporting. Detractors charge that these changes will distort the underlying economics of some leases, obscure valuable information, and fail to increase the quality and reliability of financial statements (e.g., Rapoport 2013; Equipment Lease and Finance Association [ELFA] 2013). In light of this ongoing debate, we review evidence relevant to the issue of lease accounting, as it may prove informative in the continuing discussion and research on this issue. We focus on recent findings related to why firms lease, broadly speaking, and how information related to these structures may be applied by users of the financial statements. Long-standing concerns about accounting for leases focus largely on the fact that a substantial portion of these structures are kept off-balance sheet. Under U.S. GAAP, this treatment is made possible through the application of bright-line tests prescribed by Statement of Financial Accounting Standards (SFAS) No. 13, Accounting for Leases (FASB 1976) codified as ASC Topic 840, Leases. Currently, leases are classified into two groups: (1) capital leases, which are effectively treated like purchases, with required recognition of an associated asset and liability, and (2) operating leases, for which only rent (lease) expense is recognized. Because of the bright-line tests associated with this classification, economically similar transactions sometimes receive dramatically different accounting treatment, in some cases due to deliberate structuring of the underlying arrangements (e.g., Weil 2004). Criticism of this standard began almost immediately after SFAS No. 13 was adopted. In fact, in a March 1979 meeting a majority of the FASB agreed that if SFAS No. 13 were to be reevaluated, then they would instead support ''a property right approach in which all leases are included as 'rights to use property' and as 'lease obligations' in the lessee's balance sheet'' (Dieter 1979, 19). Concern about proper accounting for operating leases is understandable, as their economic significance is large. For instance, the Securities and Exchange Commission (SEC) in 2005 estimated that while 22 percent of issuers report capital leases totaling approximately $45 billion (undiscounted), 63 percent of issuers report off-balance sheet operating leases totaling approximately $1.25 trillion (undiscounted) (SEC 2005, 64). Cornaggia, Franzen, and Simin (2013) further detail a dramatic 745 percent relative increase in the use of operating leases since 1980. Despite concerns about off-balance sheet treatment, a substantial body of evidence indicates that users generally see through the accounting associated with these structures and price the underlying economics. Given this apparent market efficiency relating to lease obligations, one might argue there is no need for regulators to act. However, as the Group of Four Plus One (G41)1 1 The G41 consists of standard setters from Australia, Canada, New Zealand, the United Kingdom, the United States, and the International Accounting Standards Committee. Accounting Horizons December 2015 Leases: A Review of Contemporary Academic Literature Relating to Lessees 999 proposal noted in 2000, ''The present accounting treatment of operating leases is not the most relevant of the choices available'' (Nailor and Lennard 2000, 5) and, as Lipe (2001, 302) discusses: This argument ignores the costs and inaccuracies that result from numerous analysts performing their own computations. It also ignores the fact that some contracts or regulations depend solely on recognized amounts. The representational faithfulness of a coverage ratio that ignores material amounts of operating leases is questionable given the empirical results today. Lipe (2001) summarizes key findings of the literature related to leasing; however, the last decade has seen a number of studies, which also examine the leasing question, providing greater insight into why firms utilize leases as a financing mechanism and how users interpret the information about these structures. As the FASB and IASB revise the leasing model to a right-ofuse framework, and thus require recognition of nearly all leases, and as the boards consider the possible economic consequences of this change in regulation, analysis of existing evidence is vital. Consequently, this paper extends the work of Lipe (2001) by summarizing certain studies he includes and discussing in greater detail key work completed since publication of his paper. Specifically, after summarizing the institutional background relating to leases, we synthesize existing work to address questions likely to be of concern to regulators and researchers as they anticipate the possible economic consequences associated with a change in financial reporting for these structures. Specifically, we seek to address the following two questions: (1) Why do firms engage in off-book lease arrangements? (2) How do users assess information related to these offbook structures? Long-standing criticisms of operating leases charge that the bright-line rules associated with these structures enable many lessees to enter into these arrangements simply to achieve off-book reporting. While some recent evidence does suggest that firms use certain types of leases opportunistically (e.g., Zechman 2010; Collins, Pasewark, and Riley 2012), other work indicates that firms use leases as a means of efficient contracting and not simply to achieve off-book treatment (e.g., Beatty, Liao, and Weber 2010).2 Even if operating leases are entered into for the purpose of minimizing costs rather than simply to achieve financial reporting objectives, recognition of these structures may have substantial contracting implications for affected firms. For example, while evidence suggests that operating leases may be indirectly included in contract terms (e.g., through the inclusion of debt ratings), the results of Ball, Bushman, and Vasvari (2008) suggest that few debt covenant provisions appear to directly constructively capitalize operating leases, and a Deloitte (2011) survey reports that 44 percent of firms anticipate that recognition of operating leases will affect existing debt covenants. Further, while the bulk of the evidence supports the conclusion that off-balance sheet leases are generally well understood by users, some work suggests that less reliable and less transparent disclosures may receive different treatment (e.g., Bratten, Choudhary, and Schipper 2013). Consequently, recognition of these structures may in fact result in observable shifts in market behavior (e.g., Callahan, Smith, and Spencer 2013). Additionally, contrary to the proposed change requiring uniform capitalization of most leases, other evidence suggests that users do not necessarily consider all leases to have the same economic implications (e.g., Altamuro, Johnston, Pandit, and Zhang 2014). Finally, although scant work regarding the income statement reporting for operating leases exists, this is perhaps the most controversial of the proposal's unsettled issues. Users have mixed 2 Holthausen (1990, 207) describes efficient contracting as follows: ''The efficient contracting perspective with respect to accounting choice implies that accounting methods, like the form of organization chosen or the form of contracts written, will be selected to minimize agency costs amongst the various parties to the firm. This optimization will result in maximizing the value of the firm.'' Accounting Horizons December 2015 Spencer and Webb 1000 views (FASB 2013) and this issue is currently a point of divergence between the FASB and IASB.3 To better understand the potential implications of reporting the financing and operating components separately (the IASB's proposal) and of reporting lease costs as a single combined amount (the FASB's proposal), we extend our review to include literature on income statement disaggregation. While some evidence suggests limited information content associated with disaggregated earnings (e.g., Callen and Segal 2005), other work suggests information about disaggregated earnings is useful to users (e.g., Lipe 1986), particularly with regard to information concerning operating and financing activities (e.g., Lim 2014). From our review we conclude that while some negative contracting effects may be associated with recognition of operating leases, given what appears to be a sophisticated understanding of these structures, balance sheet recognition of these leases should have minimal implications from a user perspective. If anything, recognition would appear to aid users in understanding the value of the more opaque aspects of these arrangements. However, considering that users appear to value these arrangements differently in certain contexts, it seems imperative that complete disclosures be provided about recognized amounts. Finally, although users express different opinions on the proper income statement treatment for operating lease arrangements (e.g., Financial Accounting Standards Board [FASB] and International Financial Reporting Standards [IFRS] Foundation 2013), based on evidence to date, information on the operating and financing components of these structures appears important. We proceed by first examining the institutional background of leases. Second, we review literature on why firms enter into leases (broadly speaking) and operating leases (specifically). Finally, we review literature on how users apply information about operating leases, including potential use of operating and financing expense components. Table 1 summarizes a selection of the accounting studies cited. INSTITUTIONAL BACKGROUND Although leases have been used since at least 2010 BC (Nevitt and Fabozzi 1985), standardized accounting for leases did not exist until relatively recently. The Accounting Principles Board (APB 1964) Opinion No. 5, Reporting of Leases in Financial Statements of Lessees, issued in 1964, mandated that lessees capitalize leases that were in-substance purchases. Due in part to inconsistent application, however, APB Opinion 31, Disclosure of Lease Transactions by Lessees (APB 1973), and the SEC's Accounting Standards Release (ASR) No. 147 (SEC 1973) both followed in 1973. In addition to the requirement to capitalize certain leases, together these standards required disclosure of the present value of future minimum lease payments and unrecognized income statement effects relating leases receiving off-balance sheet treatment. To rectify deficiencies of APB Opinion 31 and ASR No. 147, Statement of Financial Accounting Standard (SFAS No. 13, FASB 1976), Accounting for Leases, was issued in 1976 and instituted the current framework. Under this standard (codified as part of Accounting Standards Codification [ASC] Topic 840, Leases) these arrangements are recognized in the financial statements as ''capital'' leases if they are in substance purchases of the underlying asset as evidenced by meeting one or more of four criteria.4 All other leases are considered ''operating'' with rent expense reported on the income 3 4 Since the release of the Exposure Draft in 2013, the FASB and IASB have continued to meet to discuss aspects of the Exposure Draft: for example, feedback received on Exposure Draft (November 20, 2013 meeting); lessee accounting model (January 23, 2014 and March 18-19 meetings); definition of a lease (May 22, 2014, October 22, 2014, and December 16, 2014 meetings); and lessee disclosure requirements (January 21, 2015 meeting). The current status of the projects can found at: http://www.fasb.org/jsp/FASB/FASBContent_C/ProjectUpdatePage&cid900000011123 and http://www.ifrs.org/Current-Projects/IASB-Projects/Leases/Pages/Leases.aspx The capital lease criteria are as follows: (1) Transfer of property ownership to the lessee, (2) bargain purchase option, (3) lease term is 75 percent or more of the estimated economic life of the leased property, or (4) the present value of the minimum lease payments is 90 percent or greater of the leased asset's fair value at the beginning of the lease term (ASC 840-10-25-1). Accounting Horizons December 2015 Time Period Experimental 1995-2006 1982-1993 Article Agoglia, Doupnik, and Tsakumis (2011) Beatty, Liao, and Weber (2010) Accounting Horizons December 2015 Billings and Hamilton (2002) Purchase sample (e.g. capital lease) (n 3,068) and operating lease sample (n 2,292). Manufacturing firms (n 3,033); data from LPC and SDC datasets. Experiment 1: 96 experienced financial statement preparers. Experiment 2: 92 experienced financial statement preparers. Sample Findings Related to Leases (continued on next page) Preparers are more likely to capitalize lease arrangements when applying more principles-based criteria, and application across preparers is less variable under this type of regulatory regime. Less precision in such a regime leads to greater concern about regulation and litigation, generating an increased desire to reflect the underlying economics of transactions, resulting in less aggressive reporting. Under a rules-based framework, a strong audit committee mitigates preparer aggressiveness. Low accounting quality is a significant determinant in the decision to lease. However, the association is reduced when banks have greater monitoring incentives or use more restrictive loan provisions, suggesting that the decision is not solely due to a desire for off-balance sheet financing. Also confirm determinants related to financial distress and information asymmetry identified by prior studies (e.g. rate of dividend payment, credit rating, size, loss). The Tax Reform Act of 1986 affected firm investment behavior by altering the regular tax and creating an alternative minimum tax (AMT). The regular tax discouraged purchasing and operating leasing. The AMT encouraged purchases, but the AMT was statistically insignificant in regard to operating leases (or in regard to leasing). Panel A: Summary of Selected Accounting Literature Relating to the Decision to Lease Summary of Selected Accounting Literature Related to Leasesa TABLE 1 Leases: A Review of Contemporary Academic Literature Relating to Lessees 1001 Matched sample of 2009 Fortune Global 500, excluding diversified financials, trading companies, managed care providers, and banks (n 64 firms, 186 firm-year observations). Firms with common stock, more than $1 million in total assets, positive sales, and debt. Exclude financial firms and utilities (maximum n 103,582). Data from Compustat, CRSP, I/B/E/S, John Graham, and SEC/Department of Justice (DOJ) enforcement actions. 2007-2009 1980-2007 Collins, Pasewark, and Riley (2012) Cornaggia, Franzen, and Simin (2013) Experiment: 97 Big 4 auditors. Experimental Cohen, Krishnamoorthy, Peytcheva, and Wright (2013) Sample TABLE 1 (continued) Time Period Article (continued on next page) Auditors are more likely to constrain aggressive reporting (e.g. operating leasing) when applying more principlesbased standards than under rules-based standards. This occurs in both strong and weak regulatory regimes. Find no difference in propensity to lease across U.S. GAAP (rule-based) and IFRS (principles-based) reporting regimes. Find firms using the bright-line tests under U.S. GAAP are more likely to classify leases as operating (off-book) compared to firms applying IFRS, which lacks bright-line tests. Document that application of principles-based standards under IFRS leads to lower dispersion in application. Document a significant increase in leasing over the sample period and that off-balance sheet treatment of leases distorts a number of financial metrics. Find that the increase in leasing is not explained by theoretical determinants and the greatest increase in ''excess'' leasing (that not explained by theoretical determinants) is in the least financially distressed firms and firms with high growth options and intangible assets. Conclude that although conventional debt ratios fall as excess offbalance sheet leasing increases, leasing does not appear to strictly replace conventional debt. Use of leasing appears to be mitigated by scrutiny of equity analysts, credit ratings, and institutional ownership. SEC/DOJinvestigated firms have high levels of excess leasing. Findings Related to Leases 1002 Spencer and Webb Accounting Horizons December 2015 Accounting Horizons December 2015 1992 Experimental 2002 Eisfeldt and Rampini (2009) Jamal and Tan (2010) Zechman (2010) DealScan database and firms reporting impact of FIN 46 (n 120 firms). 90 financial managers in Canada. Firms listed in 1992 Census of Manufactures (n 1,649). Sample Time Period 2000-2009 Article Altamuro, Johnston, Pandit, and Zhang (2014) Firms included in DealScan and Compustat, excluding financial firms (SIC 6000-6999); (n 5,812 loan deals). Sample Findings Related to Leases (continued on next page) Lease-adjusted ratios, whether included as a direct adjustment or through credit ratings, better explain loan spreads than unadjusted measures. However, absent credit ratings, direct adjustments are concentrated in loans from large lenders and are more common when bankruptcy risk is high. Conversely, retailer leases are less relevant for credit risk assessments. Findings Related to Leases Document financially constrained firms value increased debt capacity. These financially constrained firms will lease a larger proportion of capital than non-financially constrained firms. The financially constrained firms are smaller, pay lower dividends, and have lower cash flows. The smallest decile of firms leases almost half of the capital. In the presence of rules-based standards, auditor type (rules- or principles-based) does not influence likelihood of reporting a lease off-balance sheet. In the presence of a principles-based standard, auditor type does matter, as the propensity to report the arrangement off-balance sheet is lowest when the auditor is principles-oriented. Firms with cash constraints are more likely to use synthetic leases and firms with incentives to use offbalance sheet financing fail to provide transparent disclosure about those structures. Panel B: Summary of Selected Accounting Literature Related to User Assessment of Leases Time Period Article TABLE 1 (continued) Leases: A Review of Contemporary Academic Literature Relating to Lessees 1003 (1) 1980-2008 Bratten, Choudhary, and Schipper (2013) 2002-2003 1988-2005 1984-2006 Callahan, Smith, and Spencer (2013) Chu, Levesque, Mathieu, and Zhang (2008) Dhaliwal, Lee, and Neamtiu (2011) (2) 1994-2008 Stylized Example Time Period Boatsman and Dong (2011) Article (1) Firms with SDC and Compustat data; (n 1,750 firm-year observations for 709 firms). (2) Firms with SDC and Compustat data and available operating lease disclosures in EDGAR (n 565 firm-year observations for 268 firms). 125 firms with synthetic lease arrangements adopting FIN 46 with data in Compustat and CRSP. Firms in SIC codes 2000-5999 receiving a private loan (identified through LPC DealScan database) and with data available in Compustat (n 8,508 loans for 1,577 firms). NYSE, AMEX, and NASDAQ firms with Compustat and I/B/E/S data, excluding utilities and financial institutions (n 13,301 firm-year observations). NA Sample TABLE 1 (continued) (continued on next page) Find a positive association between ex ante cost of capital estimates and financial leverage (risk) and operating leverage (risk) adjusted for operating leases. However, this effect is weaker for operating leases (compared to capital leases), and the effect of operating leases is reduced after the 2005 regulatory guidance on accounting for leases. Find that banks increase loan spread as a function of operating leases. Further, the impact is lower than predicted under perfect information and attributable to banks' estimates of operating lease obligations being lower than the true operating lease obligation. Document increases in reliability and value relevance of synthetic lease amounts following adoption of FIN 46. Mechanical errors associated with the accounting for operating leases cancel one another out. Assuming a consistent (and correct) exogenous cost of equity capital, equity is not mispriced when leases are reported off-balance sheet. Both capital and operating lease amounts are impounded in a similar manner into proxies for costs of debt and equity. However, there is a difference between recognized and off-book amounts when the disclosures are less reliable (i.e. those amounts due after five years). Findings Related to Leases 1004 Spencer and Webb Accounting Horizons December 2015 Accounting Horizons December 2015 1998-2008 2002-2008 1995-2011 Experimental 1999-2001 Jennings and Marques (2013) Kraft (2015) Lim, Mann, and Mihov (2014) Nelson and Tayler (2007) Sengupta and Wang (2011) Experiment 1: 108 students enrolled in an M.B.A.-level intermediate accounting course; Experiment 2: 104 students enrolled in an M.B.A.level intermediate accounting course. Research Insight (Compustat) and CRSP firms that have defined benefit pension plans and bond ratings at or above BA (n 1,712). Firms carried in Moody's Financial Metrics dataset (n 1,729 firmyears for 849 issuers). SIC codes 2000-5999; Compustat, SDC database, Dealscan database, and FRED database (n 31,339 firm-years for 5,378 firms). Firms with available Compustat data (41,753 firm-year observations). Quebec loan officers (n 65). Sample Find that bond-rating agencies include operating leases when assessing debt obligations and do so in a manner similar to that of recognized capital leases. For financially constrained firms or those with lower marginal tax rates, operating leases have less impact on borrowing costs and credit ratings than does debt financing, providing evidence of theoretical predictions. Firms lease more as they approach ratings borderlines (especially the investment grade borderline). When users expend the effort to constructively capitalize operating leases, these amounts have a greater effect on user judgment. Operating leases are less relevant in lending decisions than are capital leases. Survey evidence also reveals that bankers generally believe that recognition of operating leases would improve their ability to analyze lessees. Demonstrate that present value amortization is superior to straight-line amortization in the case of zero net present value leased assets. Empirical analysis reveals, however, that only lower profitability firms have leased assets priced at zero net present value. Regardless, present value amortization does appear to improve comparability. Documents significant rating agency adjustments for offbalance-sheet items such as operating leases. Findings Related to Leases This table presents summaries of more recent works cited within. In this table we only include papers after 2001 that deal directly with leases. Survey Durocher and Fortin (2009) a Time Period Article TABLE 1 (continued) Leases: A Review of Contemporary Academic Literature Relating to Lessees 1005 1006 Spencer and Webb statement, supplemented by disclosure of the required future minimum lease payments. Adopted in 1997, International Accounting Standard (IAS) 17 (IASC 1997) lacks the bright-line tests associated with SFAS No. 13 but is similar in spirit to that standard and likewise follows an ''ownership approach,'' as described by Biondi et al. (2011). Although neither assets nor liabilities related to operating lease arrangements are recognized in the balance sheet, disclosure of future minimum lease payments is required within the operating lessee's notes to the financial statements (ASC 840-20-50). As a result, users can constructively capitalize these arrangements. For example, by using present value techniques similar to those applied in the recognition of capital leases or by using a factor method, multiplying current rent expense by a fixed multiplier.5 Constructive capitalization of off-balance sheet leases has long been advocated;6 in actual application, however, it can be a cumbersome exercise fraught with potential error. For instance, assuming a present value approach is employed, users must, at a minimum, estimate the appropriate discount rate. Further, firms are required to disclose the specific timing of only the next five years' worth of lease payments. As a result, amounts due after five years are typically aggregated into one lump sum, leading to information loss. Thus, constructive capitalization of amounts due after five years requires additional estimation. As the example in Appendix A demonstrates, the amounts due after five years can be substantial: while Chipotle, Inc. reports nearly $2.5 billion in future lease obligations, over 67 percent of that amount is due after five years (the ''thereafter'' portion) and users of these financial statements must estimate the timing of those payments in order to constructively capitalize these arrangements. Further, considering that Chipotle reports assets on the corresponding balance sheet of less than $1.7 billion, this estimation problem is not inconsequential. The relative opacity in these disclosures likewise impacts the precision available to academic researchers and is evident in the variety of methodologies used to capture firm leasing activity. For example, while some studies employ a factor method to capture leasing activity (e.g., Beatty et al. 2010) others use a present value technique (e.g., Bratten et al. 2013). Further, the choice of factors differs, and among those using present value techniques, choices of discount rates and treatment of payments due after five years often vary. As a result, it is possible that much of the work to date may be affected by measurement error in estimating these obligations. Although the SFAS No. 13 framework remains in effect, it has been modified with two regulatory actions. First, Financial Interpretation Number (FIN) 46/46 (R) (FASB 2003a, 2003b), Consolidation of Variable Interest EntitiesAn Interpretation of ARB 517 (effective beginning in 2003), modified accounting for a certain class of off-balance sheet leases known as synthetic leases. Under FIN 46, many of the special purpose entities (SPEs) holding the leased asset were consolidated by the lessee, effectively requiring capital lease treatment for those structures. Second, in 2005, guidance issued by the FASB and SEC further clarified proper lease accounting, resulting in multiple lessee restatements, most often due to improperly amortized amounts (e.g., Fornaro and Buttermilch 2006). 5 6 7 Berman (2007) discusses various methods of constructive capitalization used by rating agencies, which highlights divergence in practice. For example, while Moody's applies various industry-specific factors of five times, six times, or eight times rent expense, Standard & Poor's applies a present value approach. For instance, even in the earliest editions of Security Analysis Graham and Dodd advocated constructive capitalization of leases, noting that ''the question of liability under long-term leases received very little attention from the financial world until its significance was brought home rudely in 1931 and 1932, when the high levels of rentals assumed in the preceding boom years proved intolerably burdensome to many merchandising companies'' (Graham and Dodd 2009, 223). Collectively referred to hereafter as ''FIN 46.'' Accounting Horizons December 2015 Leases: A Review of Contemporary Academic Literature Relating to Lessees 1007 In 1996 and 1999, the G41 proposed that the same recognition criteria be applied to all leases with the fair value of the rights and obligations conveyed in the lease recognized at the beginning of the lease term (Nailor and Lennard 2000). Similar in spirit to the G41 recommendation, the FASB and IASB have proposed changes in accounting for operating leases, issuing joint Exposure Drafts in both 2010 and 2013. These proposed changes would require recognition, under the ROU model, of nearly all but short-term (less than one year) operating leases. That is, lessees would recognize an associated asset and liability on the balance sheet. The 2013 Exposure Draft (FASB 2013) establishes two types of leases: (1) a Type A lease, and (2) a Type B lease, basing the classification on the nature and use of the underlying asset. Under the framework proposed by the Exposure Draft, Type A leases are generally those arrangements involving items other than property (e.g., equipment). However, if the lease term is an insignificant part of the economic life or if the present value of lease payments is insignificant relative to the underlying asset's fair value, then the lease is instead classified as a Type B lease. Type B leases generally involve leases for property (e.g., buildings). However, if the lease term is a significant part of the economic life or if the present value of lease payments is substantially all of the underlying asset's fair value, then the lease will instead be classified as Type A. For leases with a maximum possible term of more than 12 months, the lessee will recognize a right-of-use asset and lease liability (present value of lease payments) on the statement of financial position under both Type A and Type B leases. For Type A leases, interest expense and amortization expense for the right-of-use asset will be presented separately on the income statement. For Type B leases, amortization expense for the right-of-use asset and interest expense related to unwinding of the discount will be presented together as a single cost on the income statement.8 Although the present value computations proposed for recognition are similar to some current methods for constructive capitalization of operating leases, the Exposure Draft (reaffirmed during the April 23, 2014 joint FASB/IASB board meeting) proposes that elements of leases such as in substance-fixed payments (i.e., contingent rentals likely to be enforced) will also be included. Because such payments are not necessarily part of currently reported minimum lease payments, the estimated magnitude of the effect of recognition may be understated. While the 2013 staff summary of comments received on the Exposure Draft (FASB and IFRS Foundation 2013) suggests that many constituents support recognition of the ROU asset and liability for all leases longer than 12 months, it also reports that many respondents to the exposure draft disagree with the lessee accounting model and prefer IAS 17's and ASC 840's existing lessee accounting model. Divergence of opinion also exists on the lessee income statement presentation. Some respondents preferred aggregating amortization and interest expense in a single lease expense, whereas other respondents prefer disaggregation by disclosing amortization expense and interest expense separately. In addition, some respondents would prefer to recognize the expense on a straight-line basis for Type A leases and disagreed with the proposed requirement to front-load expenses on such leases. Since issuance of the 2013 Exposure Draft and analysis of public feedback, the boards have modified and diverged in their proposed changes to accounting for operating leases. Based on a joint FASB/IASB meeting held March 18 and 19, 2014, the FASB prefers a dual recognition approach and proposes classifying leases as follows: Type A leases include most of those currently reported as capital/finance leases, and Type B leases include most of those currently reported as operating leases. For Type A leases, both amortization expense and interest expense 8 Although our focus is on lessees, it should be noted that for a Type A lease, the lessor will derecognize the underlying asset and recognize a lease receivable, a residual asset, and any lease income at the commencement of the lease; whereas for a Type B lease, the lessor will recognize the underlying asset and recognize lease income on a straightline basis. Accounting Horizons December 2015 Spencer and Webb 1008 will be recognized separately. For Type B leases, a single total lease expense will be recognized.9 Thus, under the FASB's approach, income statement presentation would not be affected for operating leases. In contrast, the IASB proposes choosing a single recognition approach for lessee accounting. Under IFRS, all leases will be considered Type A leases and, as with the FASB's Type A lease, the lessee would recognize amortization expense and interest expense separately. In light of the current proposal and related controversies, we next summarize related accounting literature. First, we examine why firms lease in order to better understand how a change in standards might affect them. Second, we examine user interpretation of these structures and facets of their presentation, both to inform about the possible consequences of recognition and to better understand how users fundamentally view these arrangements and the information set they need for decision making. REVIEW OF ACADEMIC RESEARCH Methodology Our goal is to better understand how firms' motivation to enter into these structures might change if operating leases are recognized in the balance sheet and how the proposed reporting may impact users. To find studies relevant to these issues, we utilized Google Scholar and academic databases Business Source Complete and ScienceDirect. We searched for literature examining why firms engage in lease arrangements and how users interpret information provided about those arrangements. We searched scholarly working papers and accounting journals including the following: Accounting & Finance, Accounting Horizons, The Accounting Review, Advances in Accounting, Contemporary Accounting Research, Journal of Accounting & Economics, Journal of Accounting and Public Policy, Journal of Accounting Research, Journal of Business Finance & Accounting, Journal of Corporate Finance, The Journal of Finance, Review of Accounting Studies, The Review of Financial Studies, and Journal of Accounting, Auditing & Finance. In particular, we searched for subject terms including the word ''lease'' after 1990. We do not include all papers returned by that search. Instead, we focus on those papers not covered by Lipe (2001) and those that we believe best provide insight into the primary questions we examine:10 (1) Why do firms lease? (2) How do users interpret available information about leases?11 While this methodology returned a large number of results, the vast majority of those studies pertain to the balance sheet aspects of leasing arrangements. Because the income statement implications are the points currently most subject to debate, we extended our search to include studies that relate to the income statement elements related to lease arrangements. Specifically, we searched for papers including terms such as ''interest expense,'' ''amortization,'' ''depreciation,'' ''income statement,'' and ''disaggregation.'' Papers returned from that search and included here are those that we believe provide the best insight into the presentation of lease-related items within the income statement. 9 10 11 For lessors, the lease would be classified as Type A or Type B based on whether the lease is financing or a sale. For context, we do briefly discuss some papers covered by Lipe (2001) as well as other, older papers not directly identified through our search process. We excluded papers related to leasing if the papers did not address our questions: (1) Why do firms lease? and (2) How do users interpret information about leases? Accounting Horizons December 2015 Leases: A Review of Contemporary Academic Literature Relating to Lessees 1009 Why Do Firms Engage in Lease Arrangements? A large body of literature, particularly in the finance area, examines why firms choose to obtain productive capital through leases (whether reported as capital or operating arrangements) rather than purchase. This work provides substantial evidence of a variety of economic incentives to lease, many of which likely exist regardless of the required accounting for these structures. For example, leasing is often an attractive option for firms in financial distress. In part because of legal protections afforded to lessors, Sharpe and Nguyen (1995) document that firms facing high costs for external funds can lower overall financing costs through leasing, and Realdon (2006) shows that financial leasing fair credit spreads may decrease as the lessee's probability of default increases. Further, Eisfeldt and Rampini (2009, 1621) suggest that, considering bankruptcy implications, features of leases such as the ability to repossess may allow lessors to ''implicitly extend more credit than a lender whose claim is secured by the same asset.'' Even if lessees do not face high costs for external funds because of financial constraints, cost savings can also be realized through the effective transfer of capital asset tax benefits to lessors paying taxes at a higher rate than the lessee (Graham, Lemmon, and Schallheim 1998). Consequently, tax implications can likewise lead firms to use leases as a complement to, rather than substitute for, debt (Lewis and Schallheim 1992).12 Conversely, other work finds that leases are used to replace debt (e.g., Marston and Harris 1988; Krishnan and Moyer 1994). Although discussion of whether leases are used to expand debt capacity (i.e., complement to debt) or to replace debt (i.e., substitute for debt) continues, recent work has identified firm characteristics that help to explain the differential results to date. For example, Yan (2006) finds that substitutability is greater for firms that pay no dividends and have more growth options, while Schallheim, Wells, and Whitby (2013) find that firms using leases as a complement to debt are smaller and less financially distressed compared to firms using leases as a substitute for debt. While these studies focus on the use of leases, broadly speaking, other work examines the use of operating leases specifically. In the accounting literature and consistent with the results cited above, Beatty et al. (2010) find that firms that are financially distressed and/or suffering from information asymmetry (firms not paying dividends, not rated, smaller in size, and reporting losses), and firms with lower marginal tax rates are more likely to engage in operating leasing activities. Further, they provide evidence that low accounting quality provides an incentive for firms to engage in these off-book arrangements. However, Beatty et al. (2010) also show that other governing mechanisms (e.g., bank incentives to monitor and restrictive loan provisions) reduce the relationship between low accounting quality and leasing activity, suggesting that operating leases are not entered into strictly to achieve off-balance sheet presentation and may enable more efficient contracting. With regard to pending financial reporting changes related to operating leases, this last point might prove particularly important, as it suggests the choice to engage in operating leases is not predicated on the ability of the firm to report the arrangement off-balance sheet. From these results one might infer minimal response from lessee firms if recognition is ultimately required. Utilizing data from bond markets and private lending agreements, Lim, Mann, and Mihov (2014) likewise provide evidence that operating leases provide additional financial flexibility to firms by preserving and/or expanding debt capacity, particularly for firms with low marginal tax rates and existing financial constraints. Further, they find that firms enter into operating leases at greater rates when they approach ratings thresholds, particularly the investment grade ''borderline.'' 12 Billings and Hamilton (2002) evaluate a related effect of taxes, examining the impact of alternative minimum tax (AMT) and the Tax Reform Act of 1986 on the decision to lease assets. While they find that both have significant explanatory power in general, the relationship between AMT and operating leases is insignificant. Accounting Horizons December 2015 1010 Spencer and Webb As they note, their results provide empirical support for theoretical work that suggests that leases can be used as a means to expand debt capacity (e.g., Eisfeldt and Rampini 2009; Lewis and Schallheim 1992). Thus, although evidence indicates that operating leases are included in credit ratings (discussed in more detail in the next section), the work of Lim et al. (2014) suggests that firms may enter into operating leases in order to influence credit ratings, consistent with the work of Alissa, Bonsall, Koharki, and Penn (2013). Other evidence further suggests that the required accounting for operating leases does influence managers' incentives to enter into these arrangements. For example, Imhoff and Thomas (1988) find that managers appear to have substituted operating leases for capital leases upon adoption of SFAS No. 13, and El-Gazzar, Lilien, and Pastena (1986) document a positive association between the use of operating leases and management compensation based on reported income. Examining synthetic leases,13 Zechman (2010) provides further insight into firms' incentives to enter into off-balance sheet leases, specifically considering the accounting for those structures. Prior to adoption of FIN 46, disclosure about these structures was not mandatory. Consequently, it was possible for firms to take advantage of the cash savings synthetic leases offered, as well as the related opaque reporting. Alternatively, firms could choose to voluntarily report additional information about these transactions. Focusing on firms with synthetic leases subject to FIN 46, Zechman (2010) provides evidence that firms with incentives to defer payments (i.e., cash constrained firms) are more likely to employ these structures to finance fixed assets. Further, she also demonstrates that firms that use these structures and have incentives to report opaquely (measured as a function of relationships with long-term stakeholders and leverage and bankruptcy risk) fail to provide transparent disclosures related to these transactions. Thus, it does appear that some firms use off-book leases opportunistically. Further, one of the most frequently cited concerns about operating leases is that the ''brightline'' tests prescribed by U.S. GAAP allow firms to structure leasing arrangements with the explicit intent of narrowly avoiding requirements for capitalization. As a result, detractors charge that transactions that should be reported on-book (considering their underlying substance and the intent of SFAS No. 13) are reported off-book solely because of the structured form of the arrangement. Collins et al. (2012) examine this issue by investigating whether the bright-line tests required under U.S. GAAP lead to different reporting results compared to the more principles-based analysis required under IFRS. Using a matched sample of Fortune Global 500 firms, they find that the difference in reporting regimes is not associated with differences in the decision to lease rather than purchase assets. However, they find that classification of these leases as either capital or operating differs significantly across firms applying IFRS or U.S. GAAP. Specifically, they find that firms reporting under U.S. GAAP are more likely to classify leases as operating, rather than capital. Further, consistent with the experimental work of Agoglia, Doupnik, and Tsakumis (2011), they do not find evidence that principles-based reporting leads to greater dispersion in financial reporting outcomes. The results of Collins et al. (2012) may suggest that adoption of principles-based standards leads to application more consistent with the underlying economics of these transactions. That is, arrangements that are in substance purchases may be more frequently capitalized under a principles-based regime. Such a change would result in a more conceptually appealing result: 13 Although more complex than traditional lease arrangements, these structures were formerly treated as operating leases for financial reporting purposes and thus provide a relevant comparison. Synthetic leases utilize special purpose entities (SPEs) to acquire an asset and obtain necessary financing. The asset is then leased through a contract that qualifies as a capital lease for tax purposes and, prior to adoption of FIN 46, as an operating lease for financial reporting purposes. These arrangements provided a number of economic benefits to sponsor lessee firms, including cash savings. Zechman (2010) and Callahan et al. (2013) provide a more in-depth discussion of the details and benefits of these arrangements. Accounting Horizons December 2015 Leases: A Review of Contemporary Academic Literature Relating to Lessees 1011 operating leases allow a firm to obtain use of an asset by assuming a related liability. Recognition of these arrangements would thus be in accordance with Concept Statement No. 6 (FASB 1985). Similarly, in an experimental setting using Canadian financial managers, Jamal and Tan (2010) investigate the impact of both rules-based accounting and rules-based auditing standards. They find that when standards are rules based (e.g., current accounting for leases), auditor type does not impact the likelihood of reporting the transaction off-balance sheet. However, when accounting standards are principles based, auditor type does matter. Specifically, the propensity to report the arrangement off-balance sheet is lowest when the auditor is also principles oriented. In line with these results, Cohen, Krishnamoorthy, Peytcheva, and Wright (2013) find the propensity of auditors to constrain aggressive reporting of leases is lower under a principles-based auditing regime, regardless of the strength of the regulatory regime. Taken together, it seems that a shift to principles-based reporting may improve alignment between financial reporting and underlying economics. However, it is possible that such a change may only remediate the lower accounting quality associated with operating leases if auditing standards are similarly modified. While the 2013 Exposure Draft largely requires recognition of all long-term leases, certain aspects of the proposal, in particular those requiring extensive judgment, are arguably principles based.14 The results cited within this section suggest that while the off-balance sheet treatment of operating leases is used opportunistically by some firms, these structures also provide substantial benefits to others, particularly those with financial constraints. While recognition of these structures will not negate the inherent economic benefits of these arrangements, the possible impact of recognition of these structures on existing debt covenants and the ability of firms to obtain future financing is not a trivial matter. In particular, given that financially constrained firms may be those with the tightest covenant slack, this point may prove particularly important. Further, it is important to recognize that if unaccompanied by corresponding changes in auditing standards, any principles-based changes to recognition requirements may fail to accomplish their underlying objectives. How Do Users Assess Off-Book Lease Arrangements? According to Concept Statement No. 8 (FASB 2010a), the ultimate goal of financial reporting is to provide information useful in decisions involving resource allocation. As part of achieving this objective, firms report assets and liabilities. According to Concept Statement No. 6 (FASB 1985, }25), assets are ''probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events,'' while liabilities are ''probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events'' (FASB 1985, }35). Given that non-cancellable lease obligations both require a lessee to make a future sacrifice and provide the lessee with a future benefit, conceptually, it seems without question that these arrangements contain both assets and liabilities, similar to items otherwise reported on the balance sheet.15 Thus, operating leases appear important as users make decisions about providing resources to the firm, as these structures have important implications for firm value and risk. Perhaps unsurprisingly, the bulk of the evidence to date does suggest that most users generally price operating leases according to their underlying economics rather than their accounting 14 15 For example, in calculating the lease term, lessees must determine whether they have a ''significant economic incentive'' to exercise any options to extend or terminate the lease. While the Exposure Draft specifies that the lessee should consider contract-based, asset-based, entity-based, and market-based factors in making this assessment (ASC 842-10-55-4), no bright-line or threshold tests are provided. Monson (2001) discusses the evolution of the standard-setting view of this issue, as well as alternate views of leased assets: the financial components approach and the whole asset approach. Accounting Horizons December 2015 1012 Spencer and Webb presentation. Nonetheless, contrasting findings raise substantial questions about the relative importance of all operating lease obligations. We explore each of these issues within the next section. Operating Leases, Lending, and Contractual Evaluation Although not formally recognized on the balance sheet, given that they require future cash flows, information about operating leases may prove helpful in evaluating the riskiness of lessee firms. Although Elam (1975) finds that inclusion of off-balance sheet leases does not generally improve prediction of financial distress, Altman, Haldeman, and Narayanan (1977) find that inclusion of these structures does improve predictive abilities. Wilkins and Zimmer (1983) provide consistent experimental evidence that loan officers evaluate all leases as debt equivalents. However, using a sample of private Canadian lenders, Durocher and Fortin (2009) document that while operating leases are considered in the lending process, they do not receive as much attention as do capital leases or other forms of on-book debt. Similarly, Chu, Levesque, Mathieu, and Zhang (2008) develop a model to establish the expectations of the impact of operating leases on loan spreads. Their model anticipates that the impact should be at least as great as that of debt reported on the balance sheet. However, while their empirical analysis demonstrates that operating leases do impact interest rates on private loans, the observed effect is less than expected and is below that of long-term debt and recognized capital lease obligations. Altamuro et al. (2014) further find that not all operating leases are priced in the same manner. Utilizing a sample of loans obtained from DealScan, they find that leases are relevant in explaining loan spreads and credit ratings, although the explanatory power for loan spreads is greatest for large lenders and when the borrower's bankruptcy risk is high. Further, they find that leases in the retailing industry, which they surmise most resemble ''true'' leases, are less relevant in credit risk assessments. In other words, it can be inferred that lenders appear to view these true leases to be rentals rather than liabilities. In contrast, Altamuro et al. (2014) find that lenders treat operating leases with residual value guarantees or with related parties as liabilities. As a result, they conclude that capitalizing all leases, regardless of economic characteristics, may prove problematic. In addition to having a smaller effect on loan pricing (relative to on-book debt), operating leases do not appear, in general, to be directly included in many contracts governing debt. For instance, although their focus is not on leasing arrangements, Ball et al. (2008) examine performance pricing provisions in loan contracts and find that only a small portion of their sample (3.3 percent) use ''tailored'' accounting measures, such as the inclusion of off-balance sheet leases, when computing debt levels. Additionally, El-Gazzar, Lilien, and Pastena (1989) conclude that offbalance sheet leases are an effective method for avoiding covenant restrictions. However, Demerjian (2011) documents a decline in balance-sheet-based covenants in debt contracts and notes that firms with fewer operating leases are more likely to have covenants based on the balance sheet. As he notes, ''High levels of operating leases may diminish the contracting value of the balance sheet, as assets under the borrower's control are not recognized on the balance sheet'' (Demerjian 2011, 188). Together, this evidence suggests that many debt covenants may be impacted if operating leases are capitalized. However, the real significance of that effect is debatable. Although it may be in the best interest of lenders to modify covenants for any mechanical change induced by recognition of operating lease arrangements, it is unclear whether such modifications will be universally enacted. Indeed, a Deloitte (2011) survey found that 44 percent of respondents expect recognition of operating leases to affect existing debt covenants. Further, other observers have expressed concern about the effect of recognition on debt covenants and regulatory capital requirements (Leone 2010). Accounting Horizons December 2015 Leases: A Review of Contemporary Academic Literature Relating to Lessees 1013 Conversely, Ball et al. (2008) document that 44.8 percent of their sample utilizes credit ratings as a means of performance pricing in debt covenants, and Altamuro et al. (2014), Kraft (2015), and Sengupta and Wang (2011) all document the constructive capitalization of off-book leases in credit ratings. Thus, it appears that for rated firms, creditors may indirectly impound these leases, which Altamuro et al. (2014) and Kraft (2015) suggest. However, not all firms are rated, and evidence suggests that unrated firms are more likely to engage in operating leases (e.g., Beatty et al. 2010). Thus the impact of lease recognition on future borrowing costs is debatable. In fact, the Deloitte (2011) survey reports that 37 percent of respondents did not know how recognition of these leases would impact their ability to obtain future financing, and 25 percent believed that financial analysts had not already accounted for the effects of recognition in evaluating their firm. Finally, related to managerial performance evaluation, Dutta and Reichelstein (2005) demonstrate that compared to leases reported off-book, recognized capital leases allow residual income to better reflect the value added by a lease contract, thus providing better goal congruence between managers and long-term firm value. However, Imhoff, Lipe, and Wright (1993) find no significant evidence of incorporation of operating leases in computations related to executive compensation. Accordingly, some have expressed concerns that recognition of operating leases will impact compensation plans (Leone 2010). However, as Imhoff et al. (1993) note, it is possible that compensation committees deliberately disregard operating leases in deriving cash payments because other elements of compensation may be tied to stock performance, which does appear to efficiently price the economic substance of these structures. In summary, although lease obligations appear to have important implications regarding lessees, and although creditors appear to have a generally sophisticated understanding of the implications of operating leases, these arrangements do not appear to be directly included in many contractual provisions. Although these structures may be indirectly incorporated into contractual measures, it is unclear why this is the chosen manner of incorporation. Further, if these arrangements are ultimately recognized, then ramifications of this indirect inclusion are also unknown. Future research could provide insight into this issue. Operating Leases and Markets Although constructive capitalization of operating leases is in theory a straightforward exercise, given the relatively aggregated nature of the information provided in operating lease disclosures and the fact that some inputs must be estimated, the possibility of error exists. In fact, Chu et al. (2008) surmise that their results, which suggest that operating leases may be underweighted by banks in pricing loans, may be due to the failure of even sophisticated users to accurately price disclosed lease obligations. Altamuro et al. (2014) find adjustments for operating leases more concentrated in loans from larger lenders, which are ostensibly more sophisticated users. Because market participants generally have less available information than do users such as banks, any errors in adjusting for these structures may be even more pronounced in a market setting. Boatsman and Dong (2011), however, mechanically demonstrate that such errors should have little impact on the pricing of equity. Boatsman and Dong (2011) observe operating return, nonoperating return, and return on equity are misstated when operating lease expenditures are treated as payments to an operating supplier rather than payments to a capital provider. However, this accounting error may result in no direct mispricing of equity value. Assuming an exogenously determined and constant cost of equity capital, and applying three different valuation models (discounted free cash flow, residual net income, and residual operating income models), they demonstrate by stylized example that failure to capitalize operating leases does not result in material differences in estimated firm value. As the Accounting Horizons December 2015 1014 Spencer and Webb authors acknowledge, however, their results depend upon a cost of equity capital that properly includes the risk of off-book operating leases. A substantial body of evidence suggests this is generally the case, at least for publicly traded firms. For instance, Bowman (1980) demonstrates that uncapitalized financing lease liabilities disclosed under ASR No. 147 are positively associated with market beta, Imhoff et al. (1993) find that lease liabilities estimated based on SFAS No. 13 disclosures are positively associated with total shareholder risk (standard deviation of returns), and Ely (1995) finds that these estimated lease liabilities are likewise associated with t