Leasing Agreements and Their Impact on Financial Ratios of Small Companies
Notice bibliographique
Résumé
ABSTRACT Current accounting standards specify two ways of reporting leased assets. Operating leases are viewed as true leasing agreements. Owners simply report the cost of the lease payments made in the current period as rental expense. If, on the other hand, the owner enters into a noncancelable lease agreement that extends through most of the asset's useful life, the lease agreement must be capitalized. These reporting requirements have resulted in operating lease agreements being the contract of choice for small businesses. The classification rules of leasing agreements currently depend on arbitrarily-established limits set by the Financial Accounting Standards Board in 1976. This approach has been highly criticized because it focuses on the contract rather than the way in which the underlying asset is being used The Financial Accounting Standards Board periodically reexamines this issue and, at one point, issued a special report supporting a position that leases should be viewed in terms of property rights, rather than ownership rights. Under this approach, many lease contracts that are currently reported as operating leases would be capitalized. To show the potential impact of this approach, I use a set of 273 privately-held companies in the trucking industry. Descriptive analyses show the potential impact of leases. These results are applicable to industries where leased equipment comprise sizable portions of companies'fixed assets and illustrate the economic impact of leasing on the profitability and liquidity of the business. INTRODUCTION The Financial Accounting Standards Board (FASB), in conjunction with the International Accounting Standards Committee (IASC) and the accounting standards boards of Australia, Canada, New Zealand, and the United Kingdom, issued in 1996 a report entitled Accounting for Leases: A New Approach. The report discusses the perceived deficiencies in existing lease accounting standards in the US, especially with respect to the recording of operating leases by the lessee. The report points out that current reporting rules require the capitalization of lease contracts based on the benefits and risks of ownership, raising concerns that the economic substance of the leasing transaction is often lost through the writing of contracts to suit the self-interests of the parties involved. The report suggests a new approach for the recognition of leases by lessees that focuses on the property rights and obligations created under lease contracts. This new approach would be more consistent with the FASB and IASC conceptual frameworks. Under the properly rights approach, the focus is on whether the entity controls the future economic benefits generated by the leased asset, rather than whether the entity owns the leased asset. The decision to capitalize is based on qualitative, rather than quantitative criteria that are difficult to manipulate through contracting. This would require many long-term leases that currently fit the definition of operating leases to be capitalized on the lessee's balance sheet. This issue is relevant to entrepreneurial research because (1) the ratios used in this study are often used by creditors in evaluating potential borrowers and in debt covenants, (2) accounting numbers are used in valuation and performance measurement by investors and (3) market evidence is consistent with investors viewing leases as properly rights (Beattie, Goodacre and Thompson, 2000(a) and 2000(b)). Several studies provide empirical evidence suggesting that following the lease disclosure rule change requiring capitalization of certain leases (FASB 1976), firms substituted operating leases for capital leases to avoid the effects of capitalization. Imhoff, Lipe and Wright (1993) present evidence consistent with the assertion that adjustments for operating leases are not made to financial ratios in determining management bonuses. This implies that the accounting method choice for leased assets and the resulting impact on important financial ratios have the potential to materially influence at least some financial statement users. …
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|---|---|---|
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