The Financial Statement Effects of Capitalizing Operating Leases

Assessing the Impact of the Right-of-Use Model

Stephen H. Bryan, PhD, and Steven Lilien, PhD, CPA, and Dale R. Martin, DBA

Under both U.S. GAAP and International Financial Reporting Standards (IFRS), there are two main classes of leases: operating and capital (referred to as a “financing” lease in IFRS). Both types of leases are executory contracts, meaning that they represent signed contracts that obligate the parties (lessor and lessee) to future performance (execution) under the terms of the contract. Generally, executory contracts do not trigger a journal entry when they are signed; only upon performance under the terms of the contract is it recognized in the financial statements. Capital leases represent an exception, however, because they are booked at inception of the lease.