AASB 117 Leases requires lessees to classify leases as either finance leases or operating leases. The accounting treatment required under each approach is very different and this has raised concerns by investors and other financial statement users regarding the usefulness of the information provided. This essay will critically discuss and the criticisms and usefulness of lease accounting treatment. It will also examine lessee firm’s responses to Australian Standard 117 Accounting for Leases.
Definition of capital and operating lease
AASB 117 provides the current rules for leases. In general terms, the lessee classifies leasing transactions under one of two categories. The current state of practice requires the capitalisation of certain lease contract that meet specific criteria related to the transfer of substantially all the benefits and risks of ownership from the lessor to the lessee. If sufficient risks and rewards of ownership are transferred to the lessee, the lessee records the transaction as a purchase (i.e., a capital lease); absent the transfer of sufficient risks and rewards of ownership, the lessee records the transaction as a rental (i.e., an operating lease).
The existing accounting model for leases has been criticized for failing to meet the needs of users of financial statements. IASB and FASB noted a number of criticisms of the existing accounting requirements, including the following
The existence of two very different accounting models for leases means that similar transactions can be accounted for very differently. This reduces comparability for users. Preparers and auditors have criticised the existing model for its complexity. In particular, it has proved difficult to define the dividing line between finance leases and operating leases in a principled way. Consequently, the standards use a mixture of subjective judgments and ‘bright-line’ tests that can be difficult apply
The dominant issue is there...