Understanding the Impact of ASC 842 on Key Performance Indicators
Under the ASC 842 lease accounting standard, companies must report most leases as assets and liabilities on the balance sheet (ASC 842-20-25-1). That shifts both operating and financial strategy. The change affects critical performance indicators. It changes how companies report financial health.
It does not change how leases are taxed. It changes the book numbers, and so the deferred taxes you track. See Deloitte’s Roadmap: Leases, section 13.3, Income Taxes.
For companies working through these requirements, one thing is essential: know how leasing structures, such as finance leases and operating leases, affect each metric.
In this post, we look at the key performance indicators ASC 842 affects. We give examples of how these changes might play out in real-world cases. And we offer action steps for the various roles within a company.
Key Performance Indicators Affected by ASC 842
ASC 842 requires companies to recognize Right-of-Use (ROU) assets and lease liabilities on the balance sheet. In plain words, the right to use the leased item goes on the books as an asset, and what you still owe goes on as a liability. The liability is the present value of the payments not yet made, not their face total (ASC 842-20-30-1). That affects many financial metrics.
Below we break down the performance indicators most affected. For each one, we show how the two leasing structures, finance leases and operating leases, move the measure.
Return on Assets (ROA)
ROA measures how well a company uses its assets. It divides net income by total assets.
Impact: ASC 842 requires both finance and operating leases to add ROU assets to the balance sheet (ASC 842-20-25-1). Total assets rise, and ROA may fall.
Example: A company holds high-value, long-term equipment leases. Under ASC 842 its assets rise sharply, so ROA falls even though income is stable. In this case, a shorter lease term is the lever that limits asset growth. A shorter term means a smaller present value, so a smaller ROU asset (ASC 842-10-30-1, ASC 842-20-30-5).
Strategic Actions: CFOs should weigh whether to lease or buy based on ROA goals. Classification is not the lever. ASC 842-20-30-5 measures the ROU asset the same way for a finance lease and an operating lease. In later years the operating lease ROU asset is usually the larger of the two, as the side-by-side examples in KPMG’s Handbook: Leases show.
Classification is not an election either. ASC 842-10-25-2 settles it at commencement from the lease’s own terms. The only lever is how the lease is written: its term, purchase option, and residual guarantee.
Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)
EBITDA is a profitability metric often used in debt covenants. It is operating income plus depreciation and amortization. You get the same figure by adding interest, taxes, depreciation, and amortization back to net income.
Impact: Under ASC 842, operating leases reduce EBITDA. Their cost is a single straight-line lease cost in operating expense (ASC 842-20-25-6(a), 842-20-45-4(b)). Finance leases generally do not reduce EBITDA. Their cost shows up as interest and amortization, which EBITDA adds back (ASC 842-20-45-4).
Example: A retail chain uses finance leases for its store locations. It can keep lease costs outside of EBITDA. That presents stronger profitability to potential investors.
Strategic Actions: Companies that want to keep a strong EBITDA may prefer finance leases. Finance leases keep lease expense out of operating costs. That helps companies with EBITDA-based debt covenants.
Debt-to-Equity Ratio
The debt-to-equity ratio measures financial leverage. It compares total liabilities to shareholder equity.
Impact: Finance lease liabilities behave like debt. Operating lease liabilities do not. ASC 842-20-45-1 keeps them separate from finance lease liabilities and from other liabilities, on the balance sheet or in the notes. The FASB characterized them as operating liabilities rather than debt (ASU 2016-02, BC264).
Both still raise total liabilities, so a ratio built on total liabilities rises either way. Check how your credit agreement defines debt.
Example: An asset-heavy company adds lease liabilities under ASC 842. That raises its debt-to-equity ratio and affects how lenders see it.
Strategic Actions: CFOs might negotiate shorter lease terms to manage the size of the liability. A short stated term only helps if it is genuinely short. Under ASC 842-10-30-1, renewal periods the company is reasonably certain to take count in the lease term.
Companies can also explain the change to stakeholders: the higher liabilities come from recognition ASC 842 requires, not from new borrowing.
Net Income and Earnings Per Share (EPS)
Net income is the company’s total profit. EPS divides net income by outstanding shares.
Impact: ASC 842 affects these measures differently for finance and operating leases. Finance leases may reduce net income early on, because their expense is front-loaded. That affects EPS.
Example: A company with large finance leases sees lower EPS in the early years of adoption. That affects how investors see it.
Strategic Actions: Financial analysts and investor relations teams should be ready to explain the short-term swings in EPS due to ASC 842. They should also explain the shape of the expense.
A finance lease’s annual charge falls over the term as interest shrinks with the liability (ASC 842-20-35-1). The total cost over the lease is the same as under an operating lease. An operating lease’s single lease cost is the total lease payments plus initial direct costs, spread straight line over the term (ASC 842-20-25-6(a), 842-20-25-8). Only the timing differs.
Free Cash Flow (FCF)
FCF is the cash a company generates after capital expenditures. It is essential for financial health and investment analysis.
Impact: A finance lease splits its payments. Principal is a financing outflow. Interest follows Topic 230 and usually lands in operating (ASC 842-20-45-5(a), (b)).
Operating lease payments are operating outflows. The exception is a payment that is a cost to bring another asset into service. That payment goes to investing (ASC 842-20-45-5(c)).
The cash leaving the company is identical. Only the line it sits on changes, so any FCF improvement is presentation, not cash.
Example: A technology firm with finance leases reports higher FCF. That makes it more attractive to investors who focus on cash flow.
Strategic Actions: Finance leases can lift reported FCF, because principal payments sit in financing. CFOs should present that as a change in where the cash is reported, not as a stronger cash position. That matters most in capital-intensive industries.
Navigating ASC 842: Actions and Mitigation Strategies by Role
For CFOs and Finance Teams
- Optimize Lease Structure: Assess with care whether finance or operating leases fit your strategic goals better. Classification is not a choice. It follows from how the lease is written (ASC 842-10-25-2). Focus on metrics like ROA, EBITDA, and FCF.
- Communicate with Stakeholders: Explain the changes in the financial statements clearly. Point out that the higher liabilities come from ASC 842 transparency, not new debt.
For Accounting Teams
- Ensure Accurate Reporting: Stay in compliance with ASC 842. Remeasure the ROU asset and lease liability when a modification is not accounted for as a separate contract (ASC 842-10-35-4(a)). A modification that adds a right of use at its standalone price is a separate contract. It leaves the original lease alone (ASC 842-10-25-8).
- Prepare for Audit Scrutiny: Document all assumptions, above all discount rates and lease classifications. That speeds up audits and meets regulatory requirements.
For Investor Relations Teams
- Manage Investor Expectations: Raise the possible EPS and debt-to-equity ratio impacts with investors before they ask. Make clear that these changes stem from accounting adjustments, not operational risks.
- Highlight Strategic Advantages: Explain the shape of finance lease expense and where lease cash flows are reported. That helps investors who focus on cash flow read the numbers.
For Tax Advisors
- Analyze Tax Implications: Review the tax treatment of lease payments under finance and operating leases. Tax reporting may differ from financial reporting. A lease’s accounting classification does not set its tax classification (Deloitte Roadmap: Leases, section 13.3).
- Advise on Lease Terms: Guide lease negotiations with tax benefits in mind. That includes shaping lease terms so they fit both tax and accounting goals.
In Summary
ASC 842 brought major changes to lease accounting. It affects a range of performance indicators. When companies know how finance and operating leases affect key metrics, they can structure leases to balance financial transparency with profit goals.
For CFOs, accountants, investor relations teams, and tax advisors, that takes three things: planning ahead, clear communication, and ongoing adjustments to stay aligned with company goals. Handling ASC 842 well does more than improve compliance. It also strengthens the company’s overall financial resilience and its strategic position in the market.
Sources and further reading
KPMG, Handbook: Leases, Examples 6.4.10 and 6.4.20 (the same lease payments accounted for as a finance lease and as an operating lease). Section 6.9.60 (operating lease liabilities are not presented as debt).
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