Critique on the extent to which Spencer and Webb (2015) discussed the fundamental characteristics of financial information in the disclosures for operating leases
The current assignment aims to deal with the accounting for leases, which has developed as the subject matter and amendments made on the part of International Accounting Standard Board (IASB). Due to this, the new standard of accounting AASB 16 leases would replace AASB 117 leases from the yearly reporting periods beginning on or after 1st January 2019. Before the issue related to AASB 16 leases, different documents of consultation and publications have discussed various aspects of lease accounting. One of these resources Spencer and Webb (2015) have carried out a considerable review of academic literature on accounting related to operating leases. Hence, this assignment sheds light on providing a critique to the extent that discussed the fundamental features of financial information in the disclosures for operating leases.
Critique on the extent to which Spencer and Webb (2015) discussed the fundamental characteristics of financial information in the disclosures for operating leases:
The corporate leasing activities associated with accounting have been examined as well as debated in the past 30 years. In the current condition, “International Accounting Standards Board (IASB)” and “Financial Accounting Standards Board (FASB)” are involved to enforce the standards in order to modify financial reporting in relation to operating leases. These leases are treated as off-balance sheet item with respect to the literature conducted on the part of Spencer and Webb for anticipating the effect of any modification (AASB, 2015). These researchers have conducted the entire study to gain an insight of the reasons behind the engagement of firms in operating leases and the impact of information related to them on the users.
In addition, the researchers have conducted reviews on the various previously conducted articles associated directly with leasing. According to the review reports, the organisations involve themselves in the activities of off-balance sheet to lease in portions in order to manage financial statement preparation (Xu et al., 2017). However, in accordance with the other researches, it is recommended that the organisations often make utilisation of operating leases to manage cost along with saving the overall capital. In particular, these researches reveal that the agencies of credit rating, lenders and other capital market participants have greater knowledge of the off-balance sheet leases and they consider these for making effective decisions (Annan, 2014).
In addition, Spencer and Webb have provided information about the existing proposals and the present standing of the divergence of FASB and IASB including the distribution of expenditures associated with operating leases. It has been observed that FASB has recommended reporting as the only combined leasing expenditures, while IASB recommended non-distribution of the constituents of interest and amortisation. Despite these recommendations, adequate significance has not been provided to the operating lease expenditures, even though the non-distribution of information in relation to operating and financing activities is necessary. The review of the researchers is crucial for the regulators, since reporting standards associated with operating leases are contradictory (Carey, Potter & Tanewski, 2014).
Operating lease treatment in accordance with AASB 16
The payments of leasing associated with operating leases need to be realised on any systematic basis or straight-line basis. Hence, it is necessary for the lessor to apply other systematic basis, if deemed appropriate. In addition, the costs including depreciation need to be identified in order to earn lease income as expenditure. The opening direct costs incurred to obtain the operating lease at the asset’s carrying value need to be added and the costs need to be realised as an expenditure over lease term on identical basis like that of the income. The depreciation method for the depreciable asset, which is subject to operating leases, need to be inconsistent with the method of depreciation of the lessor for identical kind of asset. Therefore, it is necessary for the lessor to compute depreciation in accordance with AASB 116 and AASB 138. Moreover, the lessor needs to apply AASB 136 to ascertain whether operating lease could be subject to operating lease and accounting for impairment loss. The manufacturer could not track the profit from the sale of asset at the time of operating lease, since it is non-identical to sales (Wong & Joshi, 2015).
The lessor needs to consider the changes in relation to operating lease as new lease from effective modification date associated with accrued lease payment of the actual lease as the portion of lease payments for new lease. The lessor’s objective of disclosure forms the basis for the financial statement users to evaluate the effect of leases on the overall financial performance, financial condition and cash flow of the lessor. The objective intends to reveal the information through notes along with information in balance sheet, income statement and cash flow statement (Wong, Wong & Jeter, 2016).
The objective of disclosure for the lessor to disclose the information under notes and provided information in balance sheet statement, cash flow statement and income statement provides an insight about the evaluation of effect on the financial position because of leases (Council, 2014). It is crucial for the lessor to reveal the amounts for reporting year in relation to profit or loss from sale, financial income related to net lease investment and income in relation to variable lease payments are excluded to gauge the net lease investment. For operating leases, there is separate disclosure of information and the lease income in relation to variable payments of lease does not rely on the index (Loyeung & Matolcsy, 2015).
Operating lease disclosure
Moreover, the lessor needs to reveal the additional qualitative as well as quantitative information about leasing activities needed to accomplish the objective of disclosure. The excessive information takes into account the features related to leasing activities of the lessor and the method through which the lessor reveals the strategy for risk management and it takes into account the ways through which the lessor minimises the risk (Dakis, 2016). These ways might consider the guarantees of residual value, repurchase agreements and variable lease payments for use of above limits.
The operating leases have been related closely with credit ratings and consistency of accounting information along with its effect on risk related to operating leases. According to the research work of Spencer and Webb, credit rating has been classified into seven categories starting from AAA (1) to CCC or smaller (2). The researchers have found that there is relevancy in operating lease along with relevance risk as financial lease at the time of reliability in the disclosures of operating lease (Gas, 2016).
In addition, consistency pertaining to accounting information has an effect on the pertinence of risk of the operating leases in order to describe the credit risk. For anticipating the amount of obligations related to operating lease, the method of present value takes into account that the amount incurred for lease payments is fixed over the term of lease, while there is constructive capitalisation of operating lease (Holland, 2016). However, at the time the organisation has different contracts of lease entered at different periods, the lease payment amount minimises gradually due to the expiry date of each contract. Moreover, despite the re-categorisation of the capitalisation constructive method and credit rating, the rating does not differ from the findings.
Conclusion:
From the above discussion, it could be inferred that there is strong association between operating leases and credit rating. Along with this, the operating leases as well as financial leases are processed in an identical fashion while ascertaining the credit rating. However, there is considerable variation of the financial lease with the operating lease risk approach. Furthermore, the capital market denotes that the off-balance sheet operating lease is taken into account at the time of assessment of the credit risk of the organisation for revealing more reliably. The study has found out the influence of operating lease capitalisation on credit rating regardless of the understanding of the operating lease disclosures due to their various limitations.
For instance, it has been found that the consistency of accounting information has severe effects on the risk approach in relation to operating lease through utilisation of the leftover lease contract with the proxy for consistent information. Both IASB and FASB have initiated new standard of accounting for lease requiring the lessees to realise all assets. This includes financial leases and operating leases under the statement of financial position. In case, this consideration of circumstances is made, the accounting information consistency has an effect on the pertinence of risk related to the operating lease. Such evaluation has helped in giving information in relation to the capitalisation of operating leases.
References:
AASB, C. A. S. (2015). Investment Property.
Annan, M. (2014). The Case of Lease Accounting (Doctoral dissertation, University of Amsterdam).
Carey, P., Potter, B., & Tanewski, G. (2014). AASB Research Report No.
Council, K. I. (2014). Annual Report 2015-2016.
Dakis, G. S. (2016). Upcoming changes to contributions and leasing standards. Governance Directions, 68(2), 99.
Gas, N. (2016). Significant Developments.
Holland, D. (2016). Simplifying income recognition for not-for-profit entities. Governance Directions, 68(11), 666.
Loyeung, A., & Matolcsy, Z. (2015). CFO’s accounting talent, compensation and turnover. Accounting & Finance, 55(4), 1105-1134.
Spencer, A.W. & Webb, T.Z. (2015). Leases: A Review of Contemporary Academic Literature Relating to Lessees. Accounting Horizons, 29(4), 997-1023.
Wong, J., Wong, N., & Jeter, D. C. (2016). The Economics of Accounting for Property Leases. Accounting Horizons, 30(2), 239-254.
Wong, K., & Joshi, M. (2015). The impact of lease capitalisation on financial statements and key ratios: Evidence from Australia. Australasian Accounting Business & Finance Journal, 9(3), 27.
Xu, W., Xu, W., Davidson, R.A., Davidson, R.A., Cheong, C.S. & Cheong, C.S. (2017). Converting financial statements: operating to capitalised leases. Pacific Accounting Review, 29(1), 34-54.
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