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What the interviewer is testing
Whether you know the current lease rules, can contrast operating and finance leases and IFRS 16, and apply the consistency rule for EV and EBITDA.
Answer framework
- Balance sheet: a right-of-use (ROU) asset and a lease liability equal to the present value of lease payments.
- Income statement (US GAAP operating lease): a single straight-line lease cost within operating expenses, so it reduces EBITDA.
- Cash flow: operating lease payments are in cash from operations.
- Finance leases and IFRS 16: depreciation plus interest expense, so EBITDA excludes the lease cost; principal payments are financing cash flows.
- Valuation: under US GAAP operating leases, usually do not add lease liabilities to EV; with IFRS 16 EBITDA, add them for consistency.
Sample answer
Since ASC 842 took effect, US companies put almost all leases longer than 12 months on the balance sheet. For an operating lease, the company records a right-of-use asset and a lease liability, both based on the present value of future lease payments.
The income statement still looks like old rent expense: one straight-line lease cost inside operating expenses, so it reduces EBITDA. The payments are in cash from operations. A finance lease is different: the company records amortization of the asset and interest on the liability, so the cost sits below EBITDA, and principal repayments are financing cash flows. IFRS 16 treats almost all leases like finance leases.
For valuation, the rule is consistency between EV and the metric. If I use US GAAP EBITDA for a company with operating leases, the lease cost has already reduced EBITDA, so I normally do not add operating lease liabilities to enterprise value; adding them would count the leases twice. If I am using IFRS EBITDA, which excludes lease costs, I add lease liabilities to EV. When comparing US and IFRS peers, I adjust them to the same basis first.
Likely follow-ups
Common mistakes
- Saying operating leases are still off balance sheet.
- Adding operating lease liabilities to EV while using US GAAP EBITDA.
- Confusing operating and finance lease income statement treatment.
- Comparing US GAAP and IFRS companies' EBITDA without adjustment.
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Related questions
Based on question #23 in the full question bank.