Information inductance and its significance for accounting

Journal of Property Research

2003

SummaryAccounting standard-setters have proposed that the right to use assets (including land and buildings) acquired under operating lease contracts should be recognised on the balance sheet of lessee companies. In recent years, several empirical research studies have investigated the potential impact of the proposed changes in accounting for leases. The current paper reviews this work and presents some new evidence, for a property audience.The paper summarises evidence that operating leases represent a major source of finance for many companies generally, and more specifically for companies in the retail sector. Recognition of operating leases on the lessee's balance sheet would have a significant impact on performance measures, especially gearing. If markets are informationally 'efficient' such changes should have little impact. However, research evidence on efficiency with respect to lease accounting information is mixed. What's more, company managers do not believe that the market is efficient so are likely to behave as if the markets are 'inefficient'. Possible reactions include reduced use of leasing, shorter lease contract terms, more break clauses, or increased use of contingent rental agreements. It seems likely that lessors will be under pressure to bear greater risks.

Section: Does It Really Matter?mentioning

confidence: 99%

Assessing the potential impact of lease accounting reform: a review of the empirical evidence*

Journal of Property Research

2003

“…First, there may be changes in either the behavior of users or the behavior of managers. The latter includes actions to mitigate the expected impact on users, a situation known as 'information inductance' (Prakash and Rappaport, 1977). Second, the company's formal or informal contracts may be affected.…”

Section: Economic Consequencesmentioning

confidence: 99%

International lease-accounting reform and economic consequences: The views of U.K. users and preparers

Beattie

The International Journal of Accounting

Thomson

2006

In response to perceived difficulties with extant lease accounting standards in operation worldwide, the G4+1 issued a discussion paper which proposes that all leases should be recognized on the balance sheet (ASB, 1999). Leasing is now on the active agenda of the IASB. A major difficulty faced by standard setters lies in overcoming the preparer/user lobbying imbalance and obtaining ex ante evidence on the likely impact of regulatory reform. This paper contributes to the ongoing international debate by conducting a questionnaire survey of UK users and preparers to assess their views on proposals for lease accounting reform and on the potential economic consequences of their adoption. The results, based on 132 responses, indicate that both groups accept that there are deficiencies in the current rules, but they do not agree on the way forward and believe that the proposals would lead to significant economic consequences for key parties. The impact on respondents' views of familiarity with the proposals, level of lease usage, and company size, is also examined.

“…They found that only a minority of managers believed that internal financing or investment decisions would be significantly affected by the proposed accounting standard. However, managers believed that users' decisions, including risk assessment, were likely to be affected, suggesting that managers' behaviour could be influenced by information inductance ( Prakash & Rappaport, 1977). Managers also anticipated that future lease contracts would be structured as operating leases to avoid capitalisation; a similar response was reported by Drury & Braund (1990) in their (post-SSAP21) general survey of the leasing decision.…”

Section: Literaturementioning

confidence: 63%

The Potential Impact of Enforced Lease Capitalisation in the UK Retail Sector

2001

SSRN Journal

The main objective of the paper is to assess the potential economic consequences of the G4+1 proposed changes to lease accounting by examining companies in the UK retail sector over the 1994-99 period. The magnitude of the impact of lease capitalisation is assessed by examining the effect on nine key accounting ratios that are used in decision-making and in financial contracts. A 'constructive capitalisation' procedure is used to estimate the unrecorded lease liability and asset.Operating lease finance is shown to be very important in the retail sector, with a long-term liability approximately 3.3 times higher than on-balance sheet long-term debt; by contrast, finance leases are immaterial. Operating leased assets, the major part of which is 'land and buildings' (98%), represent a significant proportion (28%) of reported total assets. Capitalisation of operating leases would have a major impact on all nine ratios. Further, the ranking of companies changes markedly for asset turnover, interest cover and the three capital-based gearing measures, and especially for general retailers.Using credit-risk adjusted discount rates would lessen slightly the impact of capitalisation, but would have little impact on intra-sector ranking of company performance. Anticipation of future lease rental increases would have a significant impact on the level of operating lease assets/liabilities and on profit after tax. While the use of renewable short lease contracts (or break clauses) would reduce the level of operating lease assets and liabilities, substantial amounts would remain to be reported on-balance sheet.These findings contribute to the assessment of the economic consequences of a policy change requiring operating lease capitalisation. Prior research suggests that individual users of financial statements are not efficient information processors, and also that company managers do not believe that users, even in aggregate (e.g. the stock market) are efficient processors. Consequently, the significant changes in the magnitude of key accounting ratios and the major shift in company performance rankings suggest that interested parties' economic decisions are likely to be affected.