Managing the Balance Sheet with Operating Leases

Capitalization of Operating Lease and Its Impact on Firm's Financial Ratios

“…Model 1 is a multiple linear regression model to test factors that affect activity of company's operating lease. Consistent to study by Cornaggia et al (2012), the following formula is used to measure activity of operating lease of a company: where cash flow is the ratio of operating income and depreciation to book value of total asset at the beginning of year. Leverage is the ratio of book value of long-term debt to book value of total asset in current year.…”

“…Based on these reasons it is predictable that a firm in need of specific asset will acquire it via lease, which transfer the problem of reselling the asset to lessor (Berk & DeMarzo, 2007). Studies by Cornaggia et al (2012) and Kim and Kung (2011) find that lease is increasingly favored by companies acquiring specific assets although there are ongoing theories suggest otherwise, namely lease is more often used as a method to acquire generic or non-specific asset rather than specific asset.…”

“…Research performed by several previous researchers in economic determinants that can explain the use of operating lease (Slotty, 2009;Eisfeldt & Rampini, 2009;Kim & Kung, 2011;Cornaggia et al, 2012) yield mixed results. Other researchers (Imhoff, Lipe, & Wright, 1991;Beattie, Edwards, & Goodacre, 1998;Bennet & Bradburry, 2003;Lückerath & Bos, 2009) performed test to prove whether capitalization of operating lease can significantly alter financial figures.…”

“…Accounting standards that require capitalization of lease is expected to reduce the possibility of managers' manipulation of operating lease policy, which is categorized as off-balance sheet debt. Cornaggia, Franzen, and Simin (2012) have tried to prove that operating lease activity can be explained by theoretical determinants. If operating lease activity cannot be explained by theoretical determinants, then there is a great probability that managers have the incentive to use operating lease as off-balance sheet item to hide company debts.…”

“…Referring to studies by Cornaggia et al (2012) and Lückerath and Bos (2009), this study aims to test whether theoretical determinants can explain the choice of operating lease and whether capitalization of operating lease affects comprehensive financial performance. If financial ratios before and after capitalization of operating lease differ significantly, the information of operating lease is meaningful and useful in decision making.…”