The main objective of this study is to analyse how and whether the participants from the capital market utilise the operating lease from off-balance sheet while evaluating the credit risks of the firms. This study will elaborate the risk associated with the operating lease utilizing the credit ratings as the proxy for debt cost. Moreover, the study will evaluate the impact of reliability of the accounting information on the associated risks of the operating lease. The FASB (Financial Accounting Standard Board) and IASB (International Accounting Standard Board) suggested a new accounting model for lease that required the lessees to identify all the leases on the balance sheet (IASB 2009, 2010 and 2013). At present, the lease accounting model as per IFRS, IAS – 17 and GAAP, ASC -840 segregated the leses as operating lease or finance lease and account tem differently (International Accounting Standards Board (IASB) 2016). The account standard setters consider the the operating leases are same as that of the finance lease from the economic aspect. However, it does not require the lessees to identify the operating leases on the balance sheet. As the existing AS creates inaccuracy and asymmetry of the information under the market, the FASB and IASB criticized those and finally released the new AS for lease that required the lessees to identify both the leases in the balance sheet.
Analysis of Spence and Webb’s literature
Accounting for the exercises of corporate leasing are argued about and analysed for more than past 30 years. Therefore, FASB (Financial Accounting Standard Board) and IASB (International Accounting Standard Board) together are actualizing the norms for adjusting the money related revealing concerning the operating leases that are at display announced as shaky sheet thing. With respect to the proposition of Spencer and Webb (2015) broke down the existed writing to gauge the normal effect of any modification. They contemplated the existed thinks about for understanding the way that why the firma draw in them in the working leases and how the data identified with these have its effect on the clients. They additionally looked into the reports specifically identified with the leases (Fitó, Moya and Orgaz 2013). According to the survey reports, the organizations draw in themselves in the shaky sheet exercises for renting in parts for dealing with the introduction of money related articulation. Nonetheless, according to the next investigation it is proposed that the associations utilize the working leases for dealing with the cost and to protect the capital (Financial Accounting Standards Board (FASB) 2016). Further, Spencer and Webb gave the insights in regards to current recommendations and the present purpose of the IASB and FASB uniqueness that incorporates the isolation of the costs related with the operating leases. Normally, the examination recommends those lenders, credit rating agencies and different members of the capital markets comprehend the off balance sheet leases effectively and consider them during the time spent for decision making (Spencer and Webb 2015). Where IASB recommends disaggregating the amortization components and interest, FASB proposed reporting the single and joined costs for leases. Be that as it may, the current examinations recommend that the disaggregation of data with respect to the operating activities and financing is important. In any case, very little significance has been given as to the costs that are related with the working leases (International Accounting Standards Board (IASB) 2013).
Treatment of operating lease under AASB 16
The payments under the operating lease are recognized on straight line method or any other suitable method. Therefore, as per the experience, knowledge and suitability, the lessor shall recognize the lease appropriately. He shall recognize the expenses of initial costs incurred for getting the income from lease as at carrying amount of the underlying asset and it identifies that the costs as expenses over the lease term similarly as of the income. Further, the cost shall be identified taking into consideration the depreciation that is required to earn the lease income as the expenditure. The depreciation policy applicable for the underlying asset with regard to the operating lease shall be consistent with the normal depreciation policy of the lessor for similar asset. Moreover, the depreciation shall be calculated as per AASB 116 and AASB 138. Further, AASB 136 shall be applied for determining the fact that whether the asset under consideration is subjected to impairment and needs the accounting of impairment loss, if any. The dealers or the manufacturers do not recognize the profit recognized from sale of the asset when they are entering into operating lease and the amount is not same as the amount of sale. Further, the lessor shall account for the modification of operating lease as new lease term from medication date with regard to prepaid or accrual lease payments for the original lease is the part of lease payments for the new lease. The lessor’s disclosure objective for lessor in disclosing the information in notes along with the delivered information in the cash flows statement, financial position statement, profit or loss statement and it offers the approach for users of financial statement for evaluating the effect of lease that is expect to have on the cash flow statement, financial position and financial performance of the lessor (Müller, Riedl and Sellhorn 2015).
Disclosing operating lease
The lessor shall disclose the amount related to profit or loss from sales, income from the lease investment in the reporting period and the income concerning the variable payments from lease are not accounted for while calculating the net investment with regard to lease. With regard to the operating leases, the separately disclosed income and the various lease payments from operating lease do not depend on the index rate. Additional information including the features of the lease states the approaches in which the lessor discloses the risk management strategies and it further involves the way in which the lessor minimizes the associated risk. Moreover, the lease shall disclose extra information regarding qualitative and quantitative data of leasing required for meeting the disclosure objectives (Arrozio, Gonzales and da Silva 2016). Further, for forecasting the obligation amount of operating lease under the present value approach, it assumes that the payment over the lease term is constant; however, in real the payments are constructively capitalized. However, if the company has more than one lease contracts that have different expiry time the amount of payments shall get reduced progressively.
Further, the lessee shall disclose the following for the operating lease –
- Total amount of minimum future lease payments under the non-cancellable operating leases for each following periods –
- Later than the period of 5 years
- Not later than the period of 1 year
- Later than the period of 1 year but not Not later than the period of 5 year
- Payment from lease that are recognized in profit and loss statement under the period along with the separate amount of contingent rents and minimum lease payments
- Total amount of minimum future sublease payments that are forecasted for receipt under the non-cancellable sublease as on the date of balance sheet.
- Payments receivable or received from sub-lease are accounted for in profit and loss statement for the current period (Barone, Birt and Moya 2014).
- The general description for the considerable leasing arrangement by the lessee including the following –
- Restrictions that are imposed by the arrangement of lease for instance, the details regarding dividends, further leasing and additional debts.
- Method on which the contingent payments of rent are determined
- Te terms and existence of purchase or renewal options and the clauses of escalation
- The lessor shall include the asset under operating lease in the fixed asset under balance sheet (Bohušová 2015).
- The lease income arising from the operating leases shall be accounted for under the profit and loss statement on straight line method for the lease term unless any other method is more appropriate for the lease payment
- The lessor shall, apart from the requirements of AS 6 and AS 10, and government statute, must disclose the following things for the operating leases for each class of assets –
- Reversal of the impairment losses in profit and loss statement
- Recognition of impairment loss in profit and loss statement
- Recognition of depreciation in the profit and loss statement (Chambers, Dooley and Finger 2015).
From the above discussion, it is concluded that through the finance lease and the operating leases are treated similarly, the risk approach of both the leases are different. The risk of use approach is replaced by the risks and rewards model. Leases shall be recognized as the liability or asset at the inception of the lease. Further, the liabilities with regard to the lease shall be accounted for in association with the optional lease terms when the organization is sure to exercise the option of extending the term of lease. Finally, the lessees shall re-assess the term of lease if only any significant event takes place that are under the control of lessee.
Arrozio, M.M., Gonzales, A. and da Silva, F.L., 2016. Changes in the financial ratios of the wholesale and retail sector companies arising from the new accounting of the operating lease. Revista Eniac Pesquisa, 5(2), pp.139-159.
Barone, E., Birt, J. and Moya, S., 2014. Lease accounting: a review of recent literature. Accounting in Europe, 11(1), pp.35-54.
Bohušová, H., 2015. Is Capitalization of Operating Lease Way to Increase of Comparability of Financial Statements Prepared in Accordance with IFRS and US GAAP?. Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, 63(2), pp.507-514.
Chambers, D., Dooley, J. and Finger, C.A., 2015. Preparing for the Looming Changes in Lease Accounting. The CPA Journal, 85(1), p.38.
Financial Accounting Standards Board (FASB). 2016. Accounting Standards Codification (ASC) Topic 842, Leases. FASB
Fitó, M.À., Moya, S. and Orgaz, N., 2013. Considering the effects of operating lease capitalization on key financial ratios. Spanish Journal of Finance and Accounting/Revista Española de Financiación y Contabilidad, 42(159), pp.341-369.
International Accounting Standards Board (IASB) 2013. Exposure Draft, Leases. IASB.
International Accounting Standards Board (IASB) 2016. International Financial Reporting Standards (IFRS) No. 16, Leases. IASB.
Müller, M.A., Riedl, E.J. and Sellhorn, T., 2015. Recognition versus disclosure of fair values. The Accounting Review, 90(6), pp.2411-2447.
Spencer, A. W., and Webb, T. Z. 2015. Leases: A review of contemporary academic literature relating to lessees. Accounting Horizons, 29(4), 997–1023.
Wong, K. and Joshi, M., 2015. The impact of lease capitalisation on financial statements and key ratios: Evidence from Australia. Australasian Accounting Business & Finance Journal, 9(3), p.27.