Canadian Evidence on the Constructive Capitalization of Operating Leases

One type of relevant ex ante research supporting the accounting standard‐setting process is the study of a proposed standard's impact on reported figures. The International Accounting Standards Board recently decided to review the lease accounting standard, which will naturally involve consideration of the G4 + 1 recommendation to capitalize all noncancellable lease contracts, including operating leases. National evidence of the impact of the G4 + 1 proposals provides feedback for the international standard‐setter. This study developed and used a refined constructive capitalization method, in which company‐specific assumptions — interest rate, total/expired/remaining lives of leased assets, and tax rate — were used to compute the impact of operating‐lease capitalization on key financial indicators for a sample of Canadian public companies. The results indicate that capitalizing operating leases would lead to the recognition of important additional assets and liabilities on the balance sheet. It would therefore significantly increase the debt‐to‐asset ratio and significantly decrease the current ratio. These results were noted across all industry segments in the sample. Income statement effects were generally less material. Significant impacts on return on assets, return on equity, and / or earnings per share were noted in only three industry segments: merchandising and lodging, oil and gas, and financial services. Intercompany comparability would not be affected overall nor within industries, because of similar rankings for each financial indicator before and after operating‐lease capitalization.