Lessee Reactions to Regulation of Accounting for Leases

Abstract

This study examines lessee firms’ responses to Australian Accounting Standard 17, Accounting for Leases (AAS 17, 1987) and Approved Accounting Standard ASRB 1008, Accounting for Leases (ASRB 1008, 1987). Both Standards required that lessees capitalize finance leases, thus bringing the finance leases of many firms‘on balance sheet’ and increasing reported leverage. If the capitalization requirement altered firms’ equilibrium contracting cost distributions sufficiently, firms would take actions to mitigate its effect, possibly by altering their capital structures. The study examines whether the capital structures of these firms did change in response to the requirement, and if so, how. The results indicate that firms responded to the Standards by reducing their reliance upon finance leasing and increasing their reliance upon non‐lease debt and shareholders’ funds. Firms do not appear to have used definitional interpretations to classify leases as operating rather than finance leases. As expected, the firms previously disclosing finance leases in footnotes experienced increases in non‐lease debt reliance while the control sample (firms that previously capitalized the lease obligations) experienced decreases.Differences between control firms’ and footnote disclosure firms’ reactions to the Standard are generally consistent with contracting theory predictions. Control firms reacted to the loss of the potential to off balance sheet finance. Footnote‐disclosure firms reacted to the loss of an already utilized off balance sheet financing technique.