Are Leases Capital Expenditures?

Unless you’ve been under a rock for the last three years, you should know by now that the FASB (and IASB) are proposing significant changes to the accounting standards on leasing that will require virtually all leases to be included on the balance sheet.  I have seen many discussions on whether leases actually belong on the balance sheet as well as discussions on the proper income statement presentation of leases.  I’ve also seen several write-ups on how the standard would result in leasing cash payments being place all over the statement of cash flows rather than being neatly tucked away in operating cash flow as it is today. I do not intend to get into those topics here.

What I want to bring up is how the new leasing standard may impact the reporting of a significant non-GAAP disclosure for many companies – Capital Expenditures.  Capital Expenditures (or Cap Ex) is a significant metric that many investors take a high interest in when companies report their quarterly and annual numbers.  It’s an indicator of internal investment opportunities and management’s intent to grow the business organically rather than through acquisitions among many other things.

Today, most companies already include a significant intangible asset in their Cap Ex number – software acquisitions.  But also today, most companies do not include another intangible asset – the right to use (RTU) of leased items – because that right to use is not recorded on the balance sheet (unlike software).  I know capital leases are included on the balance sheet, buts let’s face it, a vast majority of leases are not capital leases and many companies work very hard to make their lease terms result in the lease being considered an operating lease to ensure they don’t have to recognize the lease on the balance sheet. As a result many companies report Cap Ex as the amount of cash paid for PP&E and software in the investing section of the statement of cash flows.

That brings us to the new leasing standard.  The standard is very clear that the initial recording of the RTU asset is a non-cash transaction (debt RTU, credit lease liability).  In fact the standard requires disclosure of the amount of RTU initially recognized during the reporting period as a supplemental non-cash item.  So that brings me to my question – will companies redefine Cap Ex – remember this is a non-GAAP term so the FASB doesn’t really have any say over it – to include the noncash RTU asset or not?  I don’t know the answer, but it will be interesting to watch because I see it as a referendum of sorts on the FASB position that all leases are really just a form of financing.  If preparers and investors agree with the FASB, then the Cap Ex numbers will be adjusted to include the RTU amount acquired during the year.  If preparers do not agree, and investors implicitly support the preparers by not adjusting the Cap Ex results for the clearly disclosed non-cash item, then maybe they are saying the FASB is wrong and leasing is something more or different from just another form of financing.

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