Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionVIII. Topics in Corporate
Finance(^900) 26. Leasing © The McGraw−Hill
Companies, 2002
disclose the existence of the lease contract on the balance sheet. Lessees had to report in-
formation on leasing activity only in the footnotes to their financial statements.
In November 1976, the Financial Accounting Standards Board (FASB) issued its
Statement of Financial Accounting Standards No. 13 (FASB 13), “Accounting for
Leases.” The basic idea of FASB 13 is that certain financial leases must be “capital-
ized.” Essentially, this requirement means that the present value of the lease payments
must be calculated and reported along with debt and other liabilities on the right-hand
side of the lessee’s balance sheet. The same amount must be shown as the capitalized
value of leased assets on the left-hand side of the balance sheet. Operating leases are not
disclosed on the balance sheet. Exactly what constitutes a financial or operating lease
for accounting purposes will be discussed in just a moment.
The accounting implications of FASB 13 are illustrated in Table 26.1. Imagine a firm
that has $100,000 in assets and no debt, which implies that the equity is also $100,000.
The firm needs a truck costing $100,000 (it’s a big truck) that it can lease or buy. The
top of the table shows the balance sheet assuming that the firm borrows the money and
buys the truck.
If the firm leases the truck, then one of two things will happen. If the lease is an op-
erating lease, then the balance sheet will look like the one in Part B of the table. In this
case, neither the asset (the truck) nor the liability (the present value of the lease pay-
ments) appears. If the lease is a capital lease, then the balance sheet will look more like
the one in Part C of the table, where the truck is shown as an asset and the present value
of the lease payments is shown as a liability.^4
CHAPTER 26 Leasing 877
TABLE 26.1
Leasing and the
Balance SheetA. Balance Sheet with Purchase
(the company finances a $100,000 truck with debt)
Truck $100,000 Debt $100,000
Other assets 100,000 Equity 100,000
Total assets $200,000 Total debt plus equity $200,000B. Balance Sheet with Operating Lease
(the company finances the truck with an operating lease)
Truck $ 0 Debt $ 0
Other assets 100,000 Equity 100,000
Total assets $100,000 Total debt plus equity $100,000C. Balance Sheet with Capital Lease
(the company finances the truck with a capital lease)
Assets under $100,000 Obligations under $100,000
capital lease capital lease
Other assets 100,000 Equity 100,000
Total assets $200,000 Total debt plus equity $200,000In the first case, a $100,000 truck is purchased with debt. In the second case, an operating lease
is used; no balance sheet entries are created. In the third case, a capital (financial) lease is used;
the lease payments are capitalized as a liability, and the leased truck appears as an asset.(^4) In Part C, we have made the simplifying assumption that the present value of the lease payments under the
capital lease is equal to the cost of the truck. In general, the lessee must report the lesser of the present value
of the lease payment stream or the cost of the equipment under lease.