A retailer that owns its 500 stores shows the buildings in PP&E and their funding in debt. You can see the capital, and the ROIC is fair. In the pre-2019 world, a retailer that rented the identical 500 stores showed no asset and no liability, just rent inside EBIT. Same economics, and a dramatically higher measured ROIC. Analysts capitalized leases by hand for decades. Then the standards converged on putting leases on the balance sheet. They did it unevenly, and what's left over is a live comparability trap. You flagged it when you studied leases:
- IFRS 16 / Ind AS 116 (India, FY2019-20 onward): all significant leases are capitalized. The ROU asset goes on the sheet and the lease liability into financing. The P&L shows ROU depreciation inside EBIT and lease interest below EBIT, so EBIT already looks like ownership. All you do is include ROU assets in operating IC and lease liabilities in financing IC, as you did for Kaveri. Both sides then tie automatically.
- US GAAP ASC 842: operating leases go on the balance sheet as an ROU asset and a liability. But the income statement keeps a single straight-line rent expense inside EBIT, with no split. So for a US company you still have to adjust the numerator by adding back the interest embedded in rent.
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How do you capitalize an operating lease?
Run the mechanics once on Trellis Retail Inc. (synthetic; US GAAP). Revenue is $10,000m and EBIT is $800m after rent expense of $500m. Invested capital ignoring leases is $3,000m, and tax is 25%. Naïve ROIC = 600 ÷ 3,000 = 20.0%. Now capitalize. The lease liability is the present value of remaining payments. Post-842 it's printed on the balance sheet, and pre-2019 you'd discount the commitments note yourself. Here it's $4,000m at a 5% implicit rate. In a steady state rent ≈ depreciation + interest. So imputed interest = 5% × 4,000 = $200m, and implied ROU depreciation = 500 − 200 = $300m.
Adjusted EBIT = EBIT + rent − ROU depreciation = 800 + 500 − 300 = 1,000
(shortcut: EBIT + imputed interest = 800 + 200 = 1,000)
Adjusted NOPAT = 1,000 × 0.75 = 750
Adjusted IC = 3,000 + 4,000 = 7,000
Adjusted ROIC = 750 ÷ 7,000 = 10.7%The "capital-light 20% compounder" is really a 10.7% business renting its capital. Against a 9% US hurdle that's a thin spread and no moat at all. Now the twin trap. An IFRS/Ind AS company with identical economics already reports EBIT ≈ 1,000, so putting raw US GAAP EBIT (800) next to IFRS EBIT (1,000) compares apples with rent-flavored oranges.
Which businesses are most affected by operating leases?
It bites hardest wherever the stores, the aircraft or the machines are rented: retail, airlines, hotels, QSR, diagnostics. IndiGo (InterGlobe Aviation) is the Indian case in point. Its fleet is largely leased and its lease liabilities dwarf its borrowings, so any returns math that ignores them is fiction. It barely matters for an asset-heavy owner like a steelmaker, or for a software firm whose leases are a rounding error. Either way, check the lease note. Adjust when it is material, and say that you did.