Variable Leases Under ASC 842: First Evidence on Properties and Consequences

The new lease standard (ASC 842) allows firms to keep variable leases off-balance-sheet, on the assumption that future expenses cannot be estimated reliably. We show that variable-lease expenses are common and significant; they are as persistent and predictable as operating-lease expenses, and not very responsive to changes in revenues. After adopting ASC 842, firms report 3.5% lower minimum operating lease commitments on average. This decline reflects firms' compliance with ASC 842 rather than a shift of operating leases off-balance-sheet. After adopting ASC 842, firms' leverage increases substantially; equity betas increase modestly and credit ratings decrease modestly, but neither of them reflect potential variable-lease liabilities. Conservative estimates show that recognition of variable-lease liabilities would increase debt by 8% on average. Our findings challenge the assumptions underlying ASC 842's differential treatment of variable leases, and thus call into question the current practice of keeping variable-lease liabilities off-balance-sheet.