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The impact of constructive operating lease capitalisation on key accounting ratios

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  • Vivien Beattie
  • Keith Edwards
  • Alan Goodacre

Abstract

Current UK lease accounting regulation does not require operating leases to be capitalised in the accounts of lessees, although this is likely to change with the publication of FRS 5. This study conducts a prospective analysis of the effects of such a change. The potential magnitude of the impact of lease capitalisation upon individual users' decisions, market valuations, company cash flows, and managers' behaviour can be indicated by the effect on key accounting ratios, which are employed in decision-making and in financial contracts. The capitalised value of operating leases is estimated using a method similar to that suggested by Imhoff, Lipe and Wright (1991), adapted for the UK accounting and tax environment, and developed to incorporate company-specific assumptions. Results for 1994 for a random sample of 300 listed UK companies show that, on average, the unrecorded long-term liability represented 39% of reported long-term debt, while the unrecorded asset represented 6% of total assets. Capitalisation had a significant impact (at the 1% level) on six of the nine selected ratios (profit margin, return on assets, asset turnover, and three measures of gearing). Moreover, the Spearman rank correlation between each ratio before and after capitalisation revealed that the ranking of companies changed markedly for gearing measures in particular. There were significant inter-industry variations, with the services sector experiencing the greatest impact. An analysis of the impact of capitalisation over the five-year period from 1990 to 1994 showed that capitalisation had the greatest impact during the trough of the recession. Results were shown to be robust with respect to key assumptions of the capitalisation method. These findings contribute to the assessment of the economic consequences of a policy change requiring operating lease capitalisation. Significant changes in the magnitude of key accounting ratios and a major shift in company performance rankings suggest that interested parties' decisions and company cash flows are likely to be affected.

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  • Vivien Beattie & Keith Edwards & Alan Goodacre, 1998. "The impact of constructive operating lease capitalisation on key accounting ratios," Accounting and Business Research, Taylor & Francis Journals, vol. 28(4), pages 233-254.
    • Handle: RePEc:taf:acctbr:v:28:y:1998:i:4:p:233-254
    DOI: 10.1080/00014788.1998.9728913
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    References listed on IDEAS

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    1. Brown, Stephen J, et al, 1992. "Survivorship Bias in Performance Studies," Review of Financial Studies, Society for Financial Studies, vol. 5(4), pages 553-580.
    2. Bouwman, Marinus J. & Frishkoff, Patricia A. & Frishkoff, Paul, 1987. "How do financial analysts make decisions? A process model of the investment screening decision," Accounting, Organizations and Society, Elsevier, vol. 12(1), pages 1-29, January.
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    Cited by:

    1. Białek-Jaworska Anna & Dobroszek Justyna & Szatkowska Paulina, 2022. "Does the IFRS 16 affect the key ratios of listed companies? Evidence from Poland," International Journal of Management and Economics, Warsaw School of Economics, Collegium of World Economy, vol. 58(3), pages 299-315, September.
    2. Beattie, Vivien, 2005. "Moving the financial accounting research front forward: the UK contribution," The British Accounting Review, Elsevier, vol. 37(1), pages 85-114.
    3. Marco Sorrentino & Margherita Smarra & Massimiliano Farina Briamonte, 2021. "Lease Accounting: Back into the Past—A General Review of Different Theoretical Approaches," International Journal of Business and Management, Canadian Center of Science and Education, vol. 15(2), pages 136-136, July.
    4. Beattie, Vivien & Goodacre, Alan & Thomson, Sarah, 2000. "Operating leases and the assessment of lease-debt substitutability," Journal of Banking & Finance, Elsevier, vol. 24(3), pages 427-470, March.
    5. José Morales-Díaz & Constancio Zamora-Ramírez, 2018. "The Impact of IFRS 16 on Key Financial Ratios: A New Methodological Approach," Accounting in Europe, Taylor & Francis Journals, vol. 15(1), pages 105-133, January.
    6. Beattie, Vivien & Goodacre, Alan & Thomson, Sarah Jane, 2006. "International lease-accounting reform and economic consequences: The views of U.K. users and preparers," The International Journal of Accounting, Elsevier, vol. 41(1), pages 75-103.
    7. Kusano, Masaki & Sakuma, Yoshihiro & Tsunogaya, Noriyuki, 2016. "Economic consequences of changes in the lease accounting standard: Evidence from Japan," Journal of Contemporary Accounting and Economics, Elsevier, vol. 12(1), pages 73-88.
    8. Diamant, Olga, 2010. "Leasing und bilanzpolitische Motive," Leasing - Wissenschaft & Praxis, Universität zu Köln, Forschungsinstitut für Leasing, vol. 8(2), pages 7-32.
    9. Vivien Beattie & Alan Goodacre & Sarah Jane Thomson, 2006. "Corporate Financing Decisions: UK Survey Evidence," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 33(9‐10), pages 1402-1434, November.
    10. Nafiz Fahad & Tom Scott, 2022. "The Impact of Lessee and Lessor Accounting in Local Councils," Australian Accounting Review, CPA Australia, vol. 32(3), pages 388-395, September.
    11. Stefania Cosci & Roberto Guida & Valentina Meliciani, 2015. "Leasing Decisions and Credit Constraints: Empirical Analysis on a Sample of Italian Firms," European Financial Management, European Financial Management Association, vol. 21(2), pages 377-398, March.
    12. Rey, Andrea & Maglio, Roberto & Rapone, Valerio, 2020. "Lobbying during IASB and FASB convergence due processes: Evidence from the IFRS 16 project on leases," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 41(C).
    13. Jennergren, L. Peter, 2011. "Firm Valuation with Operating Leases," SSE/EFI Working Paper Series in Business Administration 2011:3, Stockholm School of Economics, revised 30 May 2011.
    14. Begoña Giner & Francisca Pardo, 2018. "The Value Relevance of Operating Lease Liabilities: Economic Effects of IFRS 16," Australian Accounting Review, CPA Australia, vol. 28(4), pages 496-511, December.
    15. Jennergren, L. Peter, 2009. "On the forecasting of lease expense in firm valuation," SSE/EFI Working Paper Series in Business Administration 2009:12, Stockholm School of Economics, revised 22 Feb 2010.
    16. Jennergren L. Peter, 2011. "Approximate Firm Valuation with Operating Leases," Journal of Business Valuation and Economic Loss Analysis, De Gruyter, vol. 6(1), pages 1-22, September.
    17. Nafiz Fahad & Tom Scott, 2022. "The Effect of Capitalising Operating Leases On Charities," Australian Accounting Review, CPA Australia, vol. 32(1), pages 141-148, March.
    18. Sylvain Durocher & Anne Fortin, 2009. "Proposed Changes in Lease Accounting and Private Business Bankers' Credit Decisions," Accounting Perspectives, John Wiley & Sons, vol. 8(1), pages 9-42, February.
    19. Barral Rivada, Antonio & Cordobés Madueño, Magdalena & Ramírez Sobrino, Jesús N., 2014. "Los arrendamientos operativos: impacto de su reconocimiento en los estados financieros y en la política de financiación de las compañías españolas y del Reino Unido," Revista de Contabilidad - Spanish Accounting Review, Elsevier, vol. 17(2), pages 212-223.
    20. Anne Beatty, 2007. "How does changing measurement change management behaviour? A review of the evidence," Accounting and Business Research, Taylor & Francis Journals, vol. 37(S1), pages 63-71.
    21. Alžběta Veverková, 2019. "IFRS 16 and its Impacts on Aviation Industry," Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, Mendel University Press, vol. 67(5), pages 1369-1377.
    22. Sylvain Durocher, 2008. "Canadian Evidence on the Constructive Capitalization of Operating Leases," Accounting Perspectives, John Wiley & Sons, vol. 7(3), pages 227-256, August.
    23. Hana Bohušová, 2015. "Is Capitalization of Operating Lease Way to Increase of Comparability of Financial Statements Prepared in Accordance with IFRS and US GAAP?," Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, Mendel University Press, vol. 63(2), pages 507-514.

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