Canadian Evidence on the Constructive Capitalization of Operating Leases*

Abstract

One type of relevant ex ante research supporting the accounting standard-setting process is the study of a proposed standard's impact on reported figures. The International Accounting Standards Board recently decided to review the lease accounting standard, which will naturally involve consideration of the G4 ϩ 1 recommendation to capitalize all noncancellable lease contracts, including operating leases. National evidence of the impact of the G4 ϩ 1 proposals provides feedback for the international standard-setter. This study developed and used a refined constructive capitalization method, in which company-specific assumptions -interest rate, total/expired/remaining lives of leased assets, and tax ratewere used to compute the impact of operating-lease capitalization on key financial indicators for a sample of Canadian public companies. The results indicate that capitalizing operating leases would lead to the recognition of important additional assets and liabilities on the balance sheet. It would therefore significantly increase the debt-to-asset ratio and significantly decrease the current ratio. These results were noted across all industry segments in the sample. Income statement effects were generally less material. Significant impacts on return on assets, return on equity, and / or earnings per share were noted in only three industry segments: merchandising and lodging, oil and gas, and financial services. Intercompany comparability would not be affected overall nor within industries, because of similar rankings for each financial indicator before and after operating-lease capitalization.

Impact of New Standard "IFRS 16 Leases" on Statement of Financial Position and Key Ratios: A Case Study on an Airline Company in Turkey

“…In addition; it has been determined that the unrecorded lease liabilities are as much as 89.5% of the reported liabilities on average and the unrecorded assets are as much as 39.4% of the reported assets. Durocher (2008) has examined the impact of the reflection of the operating leases belonging to 100 companies having the highest revenue in 2002 and 2003 and whose securities have been traded in Canadian stock market on the balance sheet on the financial indicators under certain assumptions (interest rate, total life cycle of the lease/consumed life cycle/remaining life cycle and tax rate). The results have shown that the reflection of the operating leases on the balance sheet has caused to significant increases in the liabilities and assets and for this reason, there shall be a significant increase in the ratio of liability/asset and a significant decrease in the current ratio and the impacts of the operating leases on the income statement are less important.…”

The Effects on Financial Leverage and Performance: The IFRS 16

“…The results of this study indicated that capitalizing operating leases could increase the debt-to-asset ratio and decrease the current ratio significantly. These results were noted across all industry segments in the sample, whereas significant impacts on return on assets, return on equity and/or earnings per share were noted in only three industry segments: merchandising and lodging, oil and gas, and financial services (Durocher, 2008). Another study in 2008 in Germany (Fulbier, Pferdehirt, & Silva, 2008) analysed the impact of operating lease capitalization for a sample of 90 companies belonging to the three major indices (DAX 30, MDAX and SDAX) for the years 2003 and 2004.…”

“…Many scholars have studied leases (Barone et al, 2014); while some of them have focused on the effect on stock market prices (Ro, 1978, Bowman, 1980, most of them have focused on the analysis of the impact of capitalization of operating leasing on key financial ratios (Ashton, 1985, Imhoff, Lipe, & Wright 1991, Beattie V. et al, 1998, Goodacre, 2003, Durocher, 2008, Jesswein, 2009, Grossman & Grossman 2010, Singh, 2010, Fitò, Morgan & Orgaz, 2013, Nuriani, Hengb, & Jeliesta, 2015.…”

Is Capitalization of Operating Lease Way to Increase of Comparability of Financial Statements Prepared in Accordance with IFRS and US GAAP?

“…The remaining rental expense is considered as depreciation of leased assets. To provide results comparable to prior researches - Imhoff , Lipe Wright (1991, 1993, 1997, Opperman (2013), Durocher (2008), Beatie (2006), Bennett, Bradbury (2003), Mulford, Gram (2007), the research is focused on non-fi nancial companies reporting under IFRS indexed on BCPP. There were 25 companies with securities listed on BCPP in December 2013.…”