Barents Report:
Potential Impacts of Asset/Liability Framework in Accounting
Table of Contents:
- Preface
- Executive Summary
- Introduction
- Interviews with Accounting and Finance Professionals
- Financial Accounting Standards Board
- U.S. Securities and Exchange Commission
- Association for Investment Management and Research
- Standard and Poor’s Rating Service
- Financial Accounting Standards Board
- Qualitative Discussion of Potential Economic Impacts
- Impacts Suggested by Economic Theory of Leasing Decisions
- Impacts Suggested by Informational Inefficiencies in the Market
- Changes in Lessee Behavior Suggested by Empirical Evidence
- Potential Impacts Arising from Changes in Lessee Behavior
- Impacts Suggested by Economic Theory of Leasing Decisions
- Summary and Conclusions
- APPENDIX 1: Detailed Interview Questions and Responses
- Financial Accounting Standards Board
- Association for Investment Management and Research
- Financial Accounting Standards Board
Summary and Conclusions
The people interviewed for this study expressed a strongly held belief among accounting standards-setters, regulators, and financial accounting professionals that the current accounting standards for leases have not worked as intended. According to some of those interviewed, the intention of SFAS 13 was to put more financing transactions on lessees’ balance sheets, and they believe that this has not occurred. All of the parties interviewed believe that the current lease accounting standards are too complex, and all are concerned that the standards are not being applied uniformly in practice. However, the format of the interviews did not permit a more detailed discussion of specific cases or examples that would illustrate the asserted lack of uniform application of the current standards. It also should be noted that many of those interviewed were not specialists in lease accounting, though they had given lease accounting issues considerable thought. So, it is not clear to what extent their concerns regarding the complexity of current standards reflect a lack of familiarity with the leasing industry. Different views on the issue of complexity can be expected from lessors and lessees who deal with lease accounting on a daily basis.
Without exception, the interviewees expressed the view that additional information is required by investors and creditors in order for them to make more reliable evaluations of the performance and creditworthiness of companies that engage in operating leases. Many of those interviewed further believed that the current standard provides too many opportunities for abuses, and leads to a great deal of economically unproductive financial activity designed solely to gain off-balance-sheet treatment for leases. However, some of those interviewed acknowledged that the leasing cases that they hear about most tend to be the extreme cases. And, it is unclear from the interviews how large a fraction of actual lease cases involve the sorts of problems about which they are concerned. An empirical investigation would be required to show what fraction of actual leasing transactions are of the type that regulators and standard-setters consider to be "abusive."
Most of the people interviewed believe that an asset/liability framework, under which substantially all leases would be capitalized as assets and liabilities on lessees’ balance sheets, would go a long way toward remedying the perceived problems with the current standard. Increased disclosure of the characteristics of lease contracts was also considered to be desirable. However, only a few of those interviewed appeared to appreciate the fact that the McGregor approach would not automatically achieve the improvement in comparability asserted by that author.
The fact that the comparability issue appears to be poorly understood by many financial accounting and financial analysis professionals suggests that this issue should studied in greater depth. The results of such a study would be a useful contribution to discussions regarding the future of lease accounting. The Equipment Leasing Association and other parties could play a role in educating interested parties about the complexity and nuances of the comparability issue. Without such efforts, standards-setters, regulators, and financial market professionals may remain focused on the apparent simplicity of application of the McGregor approach compared to the current standard.
The analysis in this report of potential economic impacts of a change in the lease accounting framework is intended as a preliminary and qualitative analysis to identify the various channels through which impacts may occur. The result is a list of issues and questions that may be subjected to more rigorous quantitative analysis in the future.
Other things held constant, the principal financial-statement impacts of the change in accounting framework on lessees with operating leases would be (a) an increase in reported financial leverage, (b) a decrease in reported asset-based measures of performance (such as return on invested assets), and (c) a decrease in reported interest coverage. In other words, reported financial statements would appear to show a decline in the profitability and creditworthiness of affected lessees when, in fact, nothing of economic substance has changed. If markets were perfectly efficient in processing information, such cosmetic changes would be expected to have no economic consequences. However, if investors or analysts reach less favorable conclusions about lessee performance and creditworthiness when operating leases are capitalized -- or if lessee managers believe that they do -- then the apparently cosmetic change in accounting standards can have real effects on lessee financing decisions. These effects may or may not entail significant costs to lessees, but a resulting decline in demand for leases is expected to cause wealth and job losses in the leasing industry.
Empirical evidence on the effects of the adoption of SFAS 13 suggests that the adoption of an asset/liability accounting framework for lessees would lead to considerable rearranging of the capital structures of companies that currently engage in operating leases. These changes would include reductions in outstanding debt, increases in equity, and/or substitution from leases to nonlease financing. Such shifts in financing policy would entail temporary transitional costs for lessees, and the general decline in demand for leasing products would result in permanent losses to some segments of the leasing industry. However, the existing empirical evidence is insufficient for drawing conclusions about the size and economic significance of such potential impacts.
Several areas are suggested for future research to quantify the potential economic impacts. These include
- further investigation of the extent to which markets efficiently process information about firms’ leasing activities;
- an empirical investigation of the economic impacts of past accounting standards changes that have led to increased reported leverage;
- an empirical investigation of the potential for distributional impacts across lessees in different industries, and across lessors and lessees engaging in different kinds of lease transactions and involving different kinds of assets;
- a quantitative analysis of the likely changes in lessee financing decisions when off-balance-sheet financing is no longer available; and
- a study of the extent to which economic impacts of a change in standards could be reduced through the use of appropriate transition rules.
APPENDIX 1: Detailed Interview Questions and Responses
In this appendix, we provide the detailed questions and responses from our interviews with representatives of FASB and AIMR.
Financial Accounting Standards Board
Representatives of FASB were interviewed at their offices in Norwalk, Connecticut, on March 10, 1998. Representing FASB at the interview were James Leisenring, Deputy Chairman; Timothy Lucas, Director, Research and Technical Activities; Leslie Seidman, Deputy Director, Research and Technical Activities; and Neel Foster, FASB Board Member. Both Leisenring and Lucas represented FASB in the International Accounting Standards Committee (IASC) working group discussions that resulted in the McGregor Report.
In the following, we state each of the general topics of discussion and questions that were posed to FASB representatives, followed by a summary of the interviewees’ specific responses.
Initial remarks on the topic of economic impacts as the underlying purpose of the study.
Introduction of the notion of an economic impact study elicited the question, "Why should we care about economic impacts?" from more than one