The Effect of Capitalising Operating Leases On Charities

Abstract

This paper examines the effect of capitalising operating leases on the total liabilities to total assets and surplus to total asset ratios for a sample of New Zealand charities. It finds that both ratios have significantly increased post-capitalisation and that expenditures change. This extends the constructive lease capitalisation literature to the not-for-profit sector. This paper also discusses the characteristics of charities' operating leases and how they differ from the for-profit sector. Overall, this paper provides timely evidence to standard setters, especially considering the current exposure draft converging International Public Sector Accounting Standard lease accounting with International Financial Reporting Standard 16 Leases.

The Impact of Lessee and Lessor Accounting in Local Councils

“…This is much smaller than documented in prior research, and highlights the different financial structures of councils, with a large amount of infrastructure assets and high expenditure from service provision. There is a material increase in the return on assets (ROA) from −0.4% to 4.5%, which, although in contrast with the for-profit literature, is consistent with research in the charity sector (Fahad and Scott 2021). We draw the same inference that the change in the surplus, from the decrease in total expenditure, is more impactful than the increase in the total assets in public sector entities with a breakeven aim.…”

“…This is much smaller than documented in prior literature. For example, Bradbury and Bennett (2003) document 22.9% (14.8%) in a sample of NZ companies, whilst Fahad and Scott (2021) find 59.1% (14.8%) in a sample of NZ charities. Many councils have very large asset bases from infrastructure assets such as roads.…”

“…However, would we expect the same results from capitalising leases outside the for‐profit sector? Fahad and Scott (2021) consider the effect of capitalising leases in charities and find evidence that the leverage ratios worsen by more than in the for‐profit sector, but that ROA increases. They argue that this is caused by the different financial structures of charities with low or no liabilities and that they typically aim to make no or a modest surplus.…”

Resilience in Vulnerable Small and New Social Enterprises

“…We estimate financial surplus by normalizing net income by total revenues. As described earlier, evidence suggests that social enterprises accumulate surpluses, though the implications of such are under debate [57,86].…”

“…Aside from market pricing for assets and liabilities, social enterprises (especially those with an asset lock) are not always readily able to estimate the market capitalization of their business. Concepts of earnings per share do not apply to nonprofit organizations, and while EBIT (earnings before interest and taxes) estimates and retained earnings are possible to calculate, they do not mirror the context of the corporate sector [57]. Second, though corollaries exist in the social sector for these missing estimators, the social sector has unique financial concerns such as fundraising expenses and revenue type diversification that need to be accounted for when measuring financial health.…”