Evaluation of the Lease Accounting Proposed in G4+1 Special Report

Abstract

AAA Financial Accounting Standards Committee CHARACTERISTICS OF A CONCEPTUALLY SOUND LEASING STANDARD The Committee supports development of a single, conceptually sound approach to accounting for all types of leases and believes that such an approach should have the following characteristics: 1. The approach should recognize that all leases, regardless of their specific terms and conditions, convey rights and obligations, and so create assets and liabilities. The nature of the property under lease should not affect the accounting, nor should the length of the lease. 2. The approach should recognize that accounting for leases is a special case of accounting for contracts. Accounting for all contracts should be placed on a sound conceptual footing, and the principles developed for leases should be both internally consistent and generalizable, in the sense that the principles governing accounting for leases should be suitable for application to accounting for contracts generally. 3. The approach should be robust to shifts in the contractual details of lease contracts when such shifts do not materially alter the economic substance of the arrangements. In particular, the approach should require that substantially similar lease contracts be accounted for similarly and substantially dissimilar lease contracts not be forced into a misleading appearance of comparability. 4. The approach should take account of practical realities of the leasing market that make measuring lease assets and liabilities difficult. Because lease contracts are frequently tailored to the desires of the parties to the lease, it can be difficult or even infeasible to identify similar lease contracts. [1] Moreover, public information about the specifics of lease contracts is often unavailable. [2] For these reasons, the markets for trading lease assets and liabilities are relatively undeveloped. In addition, the existence of transaction costs associated with relocating and releasing assets under lease may yield incentives that affect the contractual lease provisions. While the measurement difficulties discussed in point 4 above must be considered carefully, the Committee believes that the principles governing accounting for lease receivables and liabilities should conform to the accounting for other financial instruments. In this regard, we note that in previous comment letters to the FASB (most recently, to its December 1999 Preliminary Views Reporting Financial Instruments and Certain Related Assets and Liabilities at Fair Value), the Committee stated its support for fair value accounting for financial instruments once the conceptual and measurement issues are resolved. REVIEW AND DISCUSSION OF EMPIRICAL RESEARCH This section contains three parts. Part 1 surveys empirical research and related practice on the use of financial report disclosures of minimum operating lease payments (hereafter operating lease disclosures) by investors for equity valuation and equity risk assessment purposes. This research generally finds that estimates of the lease obligation derived from operating lease disclosures are associated with the market value of equity and market-based measures of equity risk similar to recognized capital leases and debt. Likewise, evidence indicates that practitioners treat operating leases like debt. Part 2 summarizes empirical research bearing on whether balance sheet recognition of operating leases would be more useful for decision-making purposes than the current disclosures of minimum lease payments. The research findings are mixed but suggest that the usefulness of lease information to decision makers would not be reduced and might be improved by recognition rather than disclosure of all leases. Part 3 s urveys empirical research that describes how leasing behavior has changed over time in response to changes in accounting rules. 1. Existing research indicates that operating leases are similar to capital leases and debt for valuation and risk assessment purposes. …