Operating leases are generally considered debt for financial analysis purposes, and since ASC 842 and IFRS 16 took effect they sit on the balance sheet as lease liabilities alongside traditional borrowings. The obligation behaves like debt in the ways that matter to lenders and investors: fixed payments, contractual default risk, and a claim on future cash flows. How fully you treat that liability as debt depends on what you are trying to measure. Credit rating agencies, lenders, and equity analysts each handle it differently, and none of them ignore it.
Why Lease Liabilities Look Like Debt
Under the old rules (ASC 840), operating leases could stay entirely off the balance sheet. A retailer could sign billion-dollar lease commitments and disclose them only in footnotes, while a competitor that borrowed money to buy the same buildings carried all that debt front and center. ASC 842, issued by FASB, and IFRS 16, issued by the IASB, closed that gap. Both require lessees to recognize a right-of-use (ROU) asset and a corresponding lease liability for virtually all leases with terms longer than 12 months.1Deloitte Accounting Research Tool. Appendix B – Differences Between U.S. GAAP and IFRS Accounting Standards
The lease liability is the present value of future non-cancelable lease payments. In economic terms, that is the same construct as a loan balance: a fixed schedule of payments discounted back to today. If a company stops making those payments, it loses access to assets it needs to run the business. Defaulting on rent for a distribution center disrupts operations the same way missing a bank loan payment would. Any credit or valuation model that ignores that obligation understates risk.
One framework difference worth flagging. ASC 842 keeps two lease categories on the income statement, finance and operating, while IFRS 16 uses a single model that effectively treats every lease like a finance lease. The balance sheet liabilities look similar, but expense timing on the income statement will differ between two otherwise identical companies reporting under different standards.
Where the Debt Analogy Breaks Down
Lease liabilities are not identical to bank debt, and the differences matter for some analytical questions.
Traditional secured debt is backed by specific collateral the lender can seize. A lease liability’s “collateral” runs the other direction: if the lessee stops paying, it loses the right to use the leased asset, but the lessor doesn’t gain a general claim against the lessee’s other property in the way a secured lender does. Lease default is operationally devastating but structurally simpler.
Cash flow classification is another wrinkle. Finance lease principal payments appear in financing activities on the cash flow statement, mirroring a loan repayment. Operating lease payments, however, flow entirely through operating activities.2Deloitte Accounting Research Tool. 7.6 Leases – Statement of Cash Flows A company with heavy operating leases will report lower cash flow from operations and higher cash flow from financing activities than it would if those same obligations were structured as loans. Two companies with identical total obligations can report very different operating cash flow numbers based solely on lease classification.
There is also the question of substance. Some leases are short, cancelable in practice, or tied to assets a company could readily replace. Others cover core operating infrastructure over decades. Treating both as debt in the same way ignores real differences in the underlying obligation.
How Credit Rating Agencies Treat Operating Leases
There is no single industry consensus. The three major rating agencies each developed distinct approaches, and the divergence is itself instructive: if there were a clean, universally correct answer, they would have converged long ago.
Moody’s
Moody’s has long treated operating leases as debt-equivalent obligations. Its methodology capitalizes leases by multiplying annual rent expense by a factor of 5x, 6x, 8x, or 10x depending on the sector, reflecting different asset useful lives and interest rate assumptions. If the present value of minimum lease payments exceeds that multiple-based estimate, Moody’s uses the higher figure. On the income statement, Moody’s reclassifies roughly one-third of rent expense to interest and the remaining two-thirds to depreciation, and moves the principal portion of lease payments from operating cash flow to financing activities.3Moody’s Investors Service. Analytical Adjustments: Approach to Global Standard Adjustments in the Analysis of Financial Statements
S&P Global Ratings
S&P focuses on the present value of future lease payments. For operating leases not already reported on the balance sheet, S&P discounts future payments at a 7% rate. When the disclosed payment schedule extends beyond five years (typically a “thereafter” lump sum), S&P assumes annual payments equal the fifth-year amount, capped at a total payment profile of 30 years.4S&P Global Ratings. Credit Rating Model: S&P Global Ratings Arrow Basic
Fitch Ratings
Fitch’s position has shifted. In 2020, Fitch excluded leases from debt for most corporate sectors and used a multiple approach only for lease-intensive industries like retail, while using the reported lease liability directly in transportation.5Fitch Ratings. What Investors Want to Know: Lease Accounting More recently, Fitch has moved toward using reported ASC 842 and IFRS 16 lease liabilities as a proxy for lease debt across sectors, replacing its previous multiple-based methodology.6Fitch Ratings. Lower Leverage Under Lease Criteria Balanced by Coverage and Other Factors
What Happens to Your Ratios When You Include Leases
Adding lease liabilities to debt changes several widely used metrics, sometimes sharply. The effects are largest in asset-intensive industries like retail, airlines, and restaurants, where operating leases historically represented enormous off-balance-sheet commitments.
Leverage Ratios
Debt-to-equity rises because reported liabilities go up while equity stays the same. Debt-to-assets also increases, though less dramatically, because the ROU asset partially offsets the liability on the other side. Both numerator and denominator grow, so the proportional impact is smaller than with debt-to-equity.
EBITDA and Valuation Multiples
This is where the accounting change creates the most confusion. Under the old rules, operating lease payments were rent expense, deducted before EBITDA. Under ASC 842, for finance leases and under IFRS 16 for all leases, that same cash outflow gets split into amortization and interest, both of which sit below the EBITDA line. Reported EBITDA rises mechanically, with zero change in actual business performance.
If a company had $100 million in annual rent expense that moved below the EBITDA line, reported EBITDA jumps by $100 million. That inflated figure flows straight into valuation multiples like EV/EBITDA if the analyst isn’t careful. Match numerator and denominator: if enterprise value includes lease debt, use EBITDAR (EBITDA before rent) so both sides consistently reflect the lease obligation. If enterprise value excludes lease debt, traditional EBITDA works. Mixing an enterprise value that includes lease liabilities with a lease-inflated EBITDA produces a misleading multiple.
Net Debt-to-EBITDA
The leverage ratio most commonly used in credit analysis gets hit from both sides. Net debt goes up (new lease liabilities in the numerator) and EBITDA goes up (rent reclassified below the line in the denominator). The combined effect can make the ratio look deceptively stable when both components have shifted materially. Comparing this ratio across the pre- and post-ASC 842 divide without adjustment is meaningless.
Choosing a Treatment for Your Analysis
Most sophisticated analysis falls between full inclusion and full exclusion. Some models include only the current portion of the lease liability in adjusted debt. Others apply a haircut to the full liability, reflecting the view that lease obligations carry lower default risk than secured bank debt. Others follow one of the rating agency methods above.
The choice depends on what you are measuring. Credit analysis of a heavy lessee should include the full lease liability, because the fixed payment claim is real regardless of how it’s labeled. Screening for financial flexibility might weight leases lower than bank debt, since the operational consequences of default differ. Peer comparisons within an industry can use whichever treatment is consistent across the peer set.
The important thing is internal consistency. Whatever treatment you pick for the balance sheet should carry through to the income statement and cash flow adjustments as well. Counting the liability as debt while leaving rent expense in EBITDA double-counts the obligation. Excluding the liability while adjusting EBITDA upward understates it. Pick a framework and apply it end to end.
Loan Covenants Are a Separate Question
When ASC 842 took effect, many companies faced the prospect of mechanical covenant breaches. A borrower whose loan agreement capped debt-to-equity at 3:1 could suddenly breach that threshold just by recognizing existing lease obligations, without actually borrowing another dollar.
Companies that anticipated this negotiated with lenders before adoption. A common solution was “freezing” GAAP at the pre-842 standard for covenant purposes, so lease liabilities appeared on GAAP statements but were excluded from covenant compliance calculations for the life of the existing loan. New credit agreements written after ASC 842’s effective date incorporate the updated accounting treatment into their covenant thresholds from the start. If you are analyzing covenant headroom, check the agreement’s definitions rather than assuming reported GAAP debt is what the covenant measures.
Watch Out for Historical Comparisons
A leverage ratio from 2024 under ASC 842 is not directly comparable to the same ratio from 2018 under ASC 840. FASB offered two transition paths, and most companies chose the simpler option of not restating prior periods. Investors building multi-year trend analyses need to either locate voluntary restatements or manually estimate what the historical lease liability would have been. Without that normalization, leverage appears to jump sharply at the adoption date. Misreading that accounting artifact as genuine deterioration in financial health is one of the more common errors in post-842 analysis.