NOTES ON THE IMPACT OF LEASE CAPITALISATION ON FINANCIAL STATEMENTS

AND KEY RATIOS: EVIDENCE FROM AUSTRALIA.

1. Introduction
1.1 IFRS “Lease as a contract, that conveys the right to use an asset for a period of time in
exchange for consideration.”
Lessor - One who leases out the asset & the one who uses - lessee.
1.2 AASB 17
“Lessee should recognize the asset and its corresponding lease liability” (p.468).
principle - a contract that possesses the right to use an asset with the purchase
price paid in installments.

1.3 Importance Kerin (2007) - “About 90% of Australian leases are off balance sheet and most
companies have some” (p.28).
Leasing financial products amounts for 40% of the total equipment capital
expenditure in Australia.

2. IFRS17
2.1 ED 2010/9 Issued in 2010, became effective only in 2012 but was implemented in 2015-16 (p.29).
2.2 IFRS 17 ‘Risk and rewards concept’, classifying leases according to specified criteria.
2.2.1 Fin. Leases in balance sheet & Operating leases in Income stat.
Advantages
Acc. treatment of operating leases is less complex than the treatment of fin.
leases (Hendrie 2016).
Opportunity for companies to enter into lease contracts & avoid potential lease
2.2.2 assets and liabilities to be recorded in the BS. (p.29).
Drawbacks Financial statement users are exposed to higher risk in their investment.
Inconsistent & difficulty in comparability of financial statements.
3. Impacts
3.1 Financial Imhoff et al. (1991) recorded an increase in both unrecorded LA and unrecorded
statements LL of approx. 6% and 39% respectively (p.31).
Similar findings by Bennett and Bradbury (2003) with increase of unrecorded
LL by 22.9% and 8.8% for LA (p. 31).
Kilpatrick and Wilburn (2006)’s findings confirmed that lease capitalization has
a crucial impact on TA., TL. & moreover, on TE. in BS. by a significant
decrease (i.e. it observed a decrease of equity of 21.4% in 1987 & 30% in 2004.)
Lease capitalization also has far more significant impact on TL. Than TA.
Primary study conducted in 107 companies on ASE calculated an average of $
679.67 million, equal to 3.63% of TA and 4.48% of TL (p.33)
Altering the accounting method will cause a considerable inflation in the BS of
companies (p.33).
Mean TA will increase by 3.47% and the mean TL will increase by $4.34% due
to lease capitalization (p.33).
Average on 0.27 % will decrease in TE (p.33).

3.2 Key ratios

3.2.1 Leverage Assesses the ability of the company to meet its financial obligations (Hayes
ratios 2018)
NOTES ON THE IMPACT OF LEASE CAPITALISATION ON FINANCIAL STATEMENTS
AND KEY RATIOS: EVIDENCE FROM AUSTRALIA.
Increase in D/E ratio of companies with both high and low operating leases.
Increase in LTD/ Cap. Employed ratio when comparing two years (1874 &
2004).
Significant increase in D/E ratio (260%) than LTD/ Cap. Employed (92.8%)
(p.32)
Imhoff et al. (1993) found that the lease capitalization will increase the D/A
ratio.
First hand study concluded that D/E ratio & D/A ratio will significantly increase
by 31.69 % and 10.11% respectively.
3.2.2
Profitability Assesses business's ability to generate earnings relative to its associated
expenses (Investopedia 2018)
ratios
Concluded with findings that decrease in ROA by Beattie et al. (1998) was
similar to other studies such as Bennett and Bradbury (2003), Kilpatrick and
Wilburn (2006), Duke et al. (2009) and Branswijck et al. (2011) (p.33)
Increase in ROE was studied in Beattie et al. (1998), supported by the study in
Fülbier et al. (2008).
ROA decrease drastically by 15.35% & ROE by 1.23% in the primary study
(p.38).
3.2.3 Positive &
Duke et al. (2009) divided their sample of companies into positive and negative
Negative income groups, reporting a increase in the D/E and D/A ratios for both income
Income groups (p.38).
companies ROA decreased by 0.47% for the negative income group but increased by 0.11
for the positive income group (p.38)
Primary study confirmed with similar findings of Duke et al (2009).
4. Conclusion Lease capitalization will have an impact on the financial statements and financial
ratios as concluded from other researches and also primary study.
IFRS 16 which promotes the ‘right of use’ model will face technical
discrepancies before being implemented (p.40).
The new standard may affect lessors’ business system and controls , as lease
needs and behaviors of lessees change (PWC 2016).
5. References Hayes, A 2018, Leverage Ratio, in , Investopedia, viewed 8 December 2018,
https://www.investopedia.com/terms/l/leverageratio.asp .
Hendrie, R 2016, The difference between IAS 17 and IFRS 16: How lease accounting is
changing, in , Innervision, viewed 7 December 2018,
http://blog.innervision.co.uk/blog/the-difference-between-ias-17-and-ifrs-16-how-lease-
accounting-is-changing .
PWC 2016,IFRS 16- Lease Standard Is Changing. Are You Ready?, viewed 7
December 2018, https://www.pwc.com/gx/en/services/audit-assurance/assets/ifrs-16-
new-leases.pdf .
Wong, K & Joshi, M 2015, ‘The Impact of Lease Capitalization on Financial Statements
and Key Ratios: Evidence from Australia’, Australasian Accounting Business &
Finance Journal, vol. 9, no. 3, pp. 27–44.

6. Abbreviations D/E- Debt to Equity D/A- Debt to Asset ROA- Return on Asset ROE- Return on Equity
LTD- Long Term Debt Cap.- Capital TA-Total Asset TL- Total Liability TE- Total Equity
%-Percent &-And BS- Balance Sheet Fin.- Financing Acc.- Accounting
NOTES ON THE IMPACT OF LEASE CAPITALISATION ON FINANCIAL STATEMENTS
AND KEY RATIOS: EVIDENCE FROM AUSTRALIA.
NOTES ON THE IMPACT OF LEASE CAPITALISATION ON FINANCIAL STATEMENTS
AND KEY RATIOS: EVIDENCE FROM AUSTRALIA.