Electronic Arts develops, markets, publishes, and distributes interactive software games. The “lease commitments” section of the Commitments and Contingencies note from the company’s annual report for the year ended March 31, 2012, includes the following:
As of March 31, 2012, we leased certain of our current facilities, furniture and equipment under non-cancelable operating lease agreements. We were required to pay property taxes, insurance and normal maintenance costs for certain of these facilities and any increases over the base year of these expenses on the remainder of our facilities.
Operating leases are “off-balance sheet” obligations, meaning that under GAAP the lease obligations are not recognized in a company’s balance sheet. Operating lease obligations are only disclosed in the financial statement notes. In contrast, capital leases are recognized in the balance sheet, resulting in the recording of both an asset (representing “economic ownership” of the asset, even though the company does not have legal ownership) and a liability (representing the obligation to make the promised payments). (Chapter12 provides the details.)

1. Suppose Electronic Arts had accounted for the leases described in the note as capital leases rather than operating leases. Describe qualitatively the effect this change would have had on Electronic Arts’ long-term debt-to-assets ratio.
2. Should credit analysts consider operating leases when they evaluate a firm’s creditworthiness?

  • CreatedSeptember 10, 2014
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