Question

What are the accounting issues observed in the lease capitalization on Financial statement and what are the findings made as per the Journal by Wong and Mahesh Joshi on the impact of lease capitalisation on financial statement and ket ratios:evidence from Australia?

Answer 1

The IASB/FASB exposure draft ED 2013 on lease accounting, if introduced as a standard, will fundamentally change the way that leases are accounted for and reported in financial statements. This paper seeks to provide information on the proposed new lease accounting rules and to illustrate their impact on financial statements and financial ratios of leading Australian companies. The study follows the method of constructive capitalisation developed by Imhoff et al. (1991) to demonstrate the potential impact of the new rules on financial ratios and financial statements. The results show that financial statements will change significantly
when all lease assets and liabilities are capitalised. The study finds that lease capitalisation will have a material impact on the reported numbers in the balance sheet and income statement and result in significant changes to return and leverage ratios. A comparison between positive and negative income subgroups also shows significant changes in the financial ratios of both these sub- groups. This is the first Australian study that serves to provide computations of the effects on financial reporting changes in lease accounting standard. The results have practical implications for corporate managers and accounting practitioners in planning and formulating
strategies to lessen the impact of this important change in lease accounting.

These existing lease standards required classification of operating leases or finance
leases. Operating leases are permitted to be off balance sheet. However, operating leases are
controlled by entities due to past transaction in order to produce future economic benefit or
future obligation. These criteria meet the definition of assets and liabilities.the impact of lease capitalisation on their financial statements.
Their study adopted the constructive lease capitalisation method suggested in Imhoff et al.
(1991) and recorded an increase in both unrecorded lease assets and unrecorded lease liabilities of approximately 6% and 39% to the total assets and long-term liabilities respectively

Impact on the Finacial Ratio

1.Leverage (Gearing) ratios

2.Profitability ratios

Leverage ratios such as D/E, D/A ratios are the common measurements used to evaluate
the liquidity of the companies and to understand the financing method of the companies
(Investopedia, 2011). Most of the prior studies have focused on the lease capitalisation effect on leverage ratios and have documented the significance of the changes in the selected ratios.

Profitability ratios such as return on assets (ROA) and return on equity (ROE) are two important performance measurement tools used to assess the companies’ ability to generate income when compared to the expenses or other financing instruments, such as assets and equities .