Impact of ASC 842 on Key Financial Ratios and Value Relevance

Abstract

In 2016, the Financial Accounting Standard Board (FASB) issued Accounting standard Codification (ASC) Topic: 842 Leases, replacing the previously criticized ASC 840. After a long transitioning period, ASC 842 became effective for public companies on January 1st, 2019. The new lease accounting standard enforced the capitalization of the majority of lease agreements. We collected data from the CRISP/Compustat merged database, resulting in a final sample of 13 100 observations and 1 310 companies spanning from the period 2014 to 2023. Following the methodological approach of Morales-Díaz & Zamora-Ramírez (2018), we analyzed the transition from ASC 840 to ASC 842 for US public companies. We examined the impact on key financial ratios such as balance sheet/leverage, profitability, and interest coverage. We also investigated whether these changes vary by sector. By extending the Ohlson Model (Ohlson, 1995) we aimed to determine the value relevance of ASC 842 in contrast to ASC 840. This was done to further investigate the association between accounting information and share price, where the latter served as a proxy for value relevance. Our finding aligns with those of Morales-Díaz & Zamora-Ramírez (2018), revealing that capitalizing operating leases significantly affects financial ratios for US-quoted companies, varying by sector and within sectors. Differences between IFRS 16 and ASC 842 were noted, particularly in profitability and coverage ratios. Post-ASC 842 implementation, most sectors see increased assets and liabilities, decreased lease expense explained by an increase in liabilities, increased leverage, and varying effects on profitability, with lease-intensive sectors being the most affected. Utilizing the modified Ohlson model, we found no evidence that post-ASC 842 accounting information is more value-relevant than ASC 840. Instead, the results suggest a decrease in value relevance of operating lease expense post the adoption of the new lease accounting standard, ASC 842. A potential explanation for this puzzling finding is that the value relevant information has been moved from the income statement to the balance sheet.