What Is an Operating Lease?
An operating lease is essentially a long-term rental. The lessee pays for the use of an asset over a set term while the lessor retains ownership and takes back the asset at the end. Retailers leasing stores, airlines leasing aircraft, and companies leasing office space are classic examples. Because the arrangement does not transfer ownership or consume most of the asset's economic life, it is treated differently from a finance lease.
For decades, operating leases lived entirely off the balance sheet, appearing only as rent expense and a footnote disclosure of future commitments. ASC 842, effective for public companies in 2019, ended that treatment by requiring lessees to recognize the lease on the balance sheet, closing one of the most widely used forms of off-balance-sheet financing.
How the Accounting Works Under ASC 842
At lease commencement, the lessee records a right-of-use (ROU) asset and a corresponding lease liability, both measured as the present value of the remaining lease payments discounted at the rate implicit in the lease or the lessee's incremental borrowing rate. A company signing a 10-year office lease at $1 million per year with a 6% discount rate would book an ROU asset and liability of roughly $7.4 million.
On the income statement, an operating lease produces a single straight-line lease expense recorded within operating costs, which keeps EBITDA lower than it would be under finance lease treatment. This is a key difference from IFRS 16, which treats all leases like finance leases and splits the cost into amortization and interest, boosting EBITDA for IFRS reporters relative to otherwise identical US GAAP companies.
Why Operating Leases Matter in Analysis
Bringing operating leases onto the balance sheet added hundreds of billions of dollars of recognized liabilities across the market and materially changed metrics for lease-heavy sectors. Debt-to-equity ratios, returns on assets, and EV multiples all shifted, so analysts comparing companies across the 2019 adoption boundary or across GAAP and IFRS must adjust carefully to keep multiples apples to apples.
In practice, analysts decide whether to treat operating lease liabilities as debt in enterprise value. If lease liabilities are included in EV, the corresponding lease expense should be excluded from the earnings metric, which is why some practitioners use EBITDAR for retailers and airlines. Interviewers use lease questions to test whether candidates understand the link between capital structure choices and comparability of multiples.
