Capitalization versus Disclosure: The Balance Sheet Effects of Capitalization on Operating Lease Activity

Abstract

Beginning in 2019, U.S. public companies are required to capitalize operating leases under the new accounting lease standard, ASC 842. While the standard changes the accounting for operating leases on balance sheets, it maintains the accounting in income statements. Using this unique feature of the standard, I identify the balance sheet effects of the capitalization of operating leases and study how they affect managerial decisions. I find a significant decrease in operating lease activity upon the adoption of ASC 842. The decline is driven by the firms that benefited the most from the off-balance-sheet treatment of operating leases in the pre-ASC 842 periods and by short- and mid-term leases (i.e., remaining lease term less than or equal to three years). I also document a significant increase in capital expenditures around the adoption, suggesting that ASC 842 affects firms' lease-versus-buy decisions.