Operating Leases and ratios adjustments


Currently, new accounting standards force companies to include both a lease asset and liability on the balance sheet for operating leases.

To adjust leverage ratios and EV, would you present value the lease payments and add the sum to debt or just use the stipulated balance sheet figure?

I would say that there is no need to PV the lease payments like the old days and add it to the BS since it is already there. Just adjust EBIT by adding back the least pmt and subtracting the depreciation portion.

For example, Facebook has operating lease payments that flow as an expense and the PV of the lease on both sides of the balance sheet. What are the correct adjustments to the ratios?

Please let me know if this makes sense?

I’m not a fan of using the lease liabilities from the balance sheet because they may not reflect the true economic liability. For example, if a company has 1 year left on its lease the liability is going to be lower than a company with 10 years left on its lease. However, both companies will have the same lease expense on the income statement. In order to do this accurately, you would need to arrive at your own estimate of lease liability based on lease payments.

Hi Chad!

Meta (aKa Facebook) has an operating liability, of $13,873 and an operating asset of $12,155. I’ve taken a look at the contractual lease payments on their 2021-10k and calculated a present value of lease payments of $14,282. I took the current year (2021) lease payment of $2,171 and added back to EBIT and subtracted the depreciation portion of $1,099 ($14,282/13).

How would I go about adjusting the balance sheet?
Would I swap the lease asset and liability and equity adjustment an add my calculated debt amount as and asset and liability?

Are these all operating lease liabilities? If the lease payment is $2.1b and the PV is $14.3b, that is about a 14% cap rate which seems really high. That is the issue with this exercise. It is very difficult to true up the balance sheet because the average lease term could be only 5 years so the PV is underestimating the future cost of maintaining these operating leases. As a data point, single-tenant cap rates are in the lower single digits right now.

Thank for noticing. I did not add leases commencing in between 2022 - 2028 worth $ 8.34B and $1.62B. This would make the PV of the lease $24,282 and the cap rate 6% if I average the next 5 lease payments or 9% If I use the lease payment in 2021.

Would I swap the $13.8B lease for the $24b? How would I adjust the bs?

Thank you!

Ps. For some reason I can’t send a snap shot of the 10k.

The purpose of this analysis is to put every company on a debt-free “as owned” basis so we need to figure out what it would cost to buy every asset that is being leased by the company. I think your 6 cap sounds like a much more reasonable figure given the current market.

To adjust the balance sheet you would remove these lease liabilities (and right-of-use assets) by adding them as fixed assets through an equity issuance. So, add the $24b to PPE and to additional paid-in capital.

Shouldn’t lease obligations be considered debt and be accounted for on the bs and leverage ratios? We could use EV/EBITDA to put all companies with leases on the same basis?

The purpose of EV/EBITDA is to remove the impact of the capital structure when comparing companies so treating the operating leases as debt will not impact that analysis.

You will need to add the lease expense to operating income since that expense would go away if the company owned the leased assets.

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Thank you for taking the time to explain the treatment of operating leases. Much appreciated.