Exposure Draft 242 Lease Essay

Topics: Balance sheet, International Financial Reporting Standards, Asset Pages: 9 (2063 words) Published: April 15, 2015
Exposure Draft 242: Leases
The Exposure Draft (ED) on leases is dissected to prove its ability to provide useful information to the user. This essay will firstly describe the objectives and the three key issues, which are lessee accounting, presentation of statements and disclosure. Secondly, it will analyse how the changes in new ED affect users and provides useful information in terms of those three issues. Lastly, a conclusion will be drawn to summarise and restate the topics.

Objectives and key issue of ED-242
The revised ED is aimed to improve the quality and comparability of financial reporting by providing a greater transparency about the leverage, the asset that an entity used in its operations, and the risk to which it is exposed from entering into lease transactions (AASB ED-242, 2013). Lessee Accounting

The ED wants all leases to be recognised as right-of-use assets and lease liabilities, except short-term leases. AASB 117 only requires finance leases to be recognised on statements. This essay will focus on lessees and recognising operating leases on financial statements as the ED affects them the most. Presentation of Statements

Financial statements will include more lines of items as a result of capitalising operating leases. Items include right-of-use-asset, lease liability, interest expense and amortisation. This ensures quantitative information is provided to decision makers. Disclosures

Additional qualitative information such as descriptions of leases is to be included on statements due to the overwhelming complexity for users to understand elements such as how variable lease payments are determined. Enhanced disclosures will assist users to understand the additional information to be presented on statements.

Effects of ED-242
Recognising operating leases
Current situation
Operating leases are a way to avoid on-balance sheet debt to make financial statements look more appealing (Fülbier, Silva & Pferdehirt, 2006, p. 1). Beattie, Goodacre and Thomson (2000) estimated that operating leases were approximately thirteen times larger than finance leases. The attraction to classify leases as operating is the ability to manipulate ratios and thereby increase finance opportunities (Leo, Hoggett & Sweeting, 2012, p. 343) (Hartman & Sami, 1989) such as low-interest loans. Duke, Hsieh and Su (2009) released a study on capitalisation of operating leases and found that companies hid billions of dollars of liabilities, enhanced retained earnings, income and ratios by reporting leases as operating.

Effects of capitalising operating leases
The effects of the ED are researched to gauge the impact of the changes and the usefulness of the new information provided to the user. Canadian studies resulted in the recognition of additional assets and liabilities on the balance sheet, increasing the debt-asset ratio and decreasing current ratio (Durocher, 2010, pp. 227-256). New Zealand studies on materiality indicated impacts on reported liabilities, therefore affecting leverage. It also showed decreases in liquidity and profitability (Bennett & Bradbury, 2003, p. 112). US studies were done and reported back to the FASB comparing various lease capitalisation techniques on five US corporations. The study summarises that because of the necessary assumptions to capitalise leases, the capitalisation can only be deemed an estimate, so as long as companies are not required to disclose the actual parameters (Bostwick, Fahnestock & O’Keefe, 2013, p. 98).

The ED will remove estimation uncertainties and provide users with an accurate picture of the company’s assets and liability obligations. It will also provide analysts with information that will enable informed decisions on the company’s worth. However, capitalising operating leases causes changes in equity which will affect investor and creditor decisions as to whether or not to finance a firm because of the increased risk being assessed (Beattie et al.,...

References: Australian Accounting Standards Board (2013) 'AASB Exposure Draft 242 Leases ' (viewed 29 September 2013)
Beattie, V., Goodacre, A
Beattie, V., Goodacre, A. & Thomson, S. (2006) 'International lease-accounting reform and economic consequences: The views of U.K. users and preparers ', The International Journal of Accounting, Vol. 41, Issue 1, p. 82 (viewed 25 October 2013)
Bennett, B.K
Bostwick, E.D., Fahnestock, R.T. & O’Keefe, W.T. (2013) ‘Effects of lease capitalization techniques on key measures of financial performance’, Journal of Finance and Accountancy, Vol. 12, pp. 91-102 (viewed 10 October 2013)
DeVilliers, R
Duke, J.C., Hsieh, S.& Su, Y. (2009) 'Operating and synthetic leases: Exploiting financial benefits in the post-Enron era ', Advances in Accounting, Vol. 25, Issue 1, pp. 28-39 (viewed October 2013)
Durocher, S
Fülbier, R.U., Silva, J.L. & Pherdehirt, M.H. (2006) ‘Impact of lease capitalization on financial ratios of listed German companies’, Working paper, pp. 1-29 (viewed 10 October 2013)
ImhoffJr, E., Lipe, R
Tai, B.Y. (2013) 'Constructive Capitalization of Operating Leases in the Hong Kong Fast-Food Industry ', International Journal of Accounting & Financial Reporting, Vol. 3, Issue 1, pp. 128-140 (viewed 21 October 2013)
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