Modeling operating leases as debt
Hello! I’m an investment banking analyst in a small firm. I’ve always thought that I had a pretty good understanding of accounting, but I have realized that I have a major blank space regarding operating leases under GAAP.
Ok, so I understand that the present value of the future payments on the lease are recorded as an operating lease liability, and an equivalent increment in the ROU. Then, you record the operating lease expense on the income statement as an operating expense (both the principal and interest component).
The thing is, you are supposed to treat the operating lease liability as equivalent to debt. But, at the same time, you are expending the cash payments on the lease as an operating expense. Thus, if I calculate the Enterprise Value with this cash flows, and then I subtract operating lease liabilities as a part of debt, I would be double counting the operating lease (one in the from of an operating expense and one when I subtract the liability to the EV).
What am I missing?
You can think of the lease liability as a financial liability just like bank debt to finance PP&E, and the ongoing future cash payments as "capex" which are needed to sustain cashflows, i.e. these are operating in nature. These should be exclusive any interest, which are non-operating in nature and therefore need to be subtracted out.
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