Accounting For Leases And New Proposed Models - Essay Example

Introduction: Lease is the periodic payment, usually paid per month, by the lessor to the lessee for use of property rented. There have been many opinions, counter opinions regarding better ways to record these lease contracts. The many controversial issues regarding the consideration of the whole asset approach, the asset and liability approach and other approaches will unfold in the next paragraphs. Its conclusion is very convincing. Accounting For Leases And New Proposed Models. The Conceptual Framework And Accounting For Leases By Dennis W. Monson his article was written in the year 2001 yet. For many years, the users of the financial statements, academics and others have given various comments on the present lease accounting procedures. The International Accounting Standards Board calls for a new lease accounting principle that relates to assets and liabilities. This write up proposes criteria to be set for deciding between two interpretations of whether the lease increases or decreases both assets and / or liabilities. SFAS no. 13, which was issued by FASB, was at that time, 2001, showing improvement on the setting of accounting standards for leases. Many write ups on leases followed suit such as 9 FASB amendments, 12 FASB technical bulletins, EITF consensus, 6 FASB interpretations and others. The FASB is continually working to come up with an adjustment to the Statement of Financial Accounting Standards no. 13 (lease) because it has failed to address many questions by many sectors of the accounting, school, business and other companies on the accounting procedures and interpretation of leases. SFAS no 13 states that an asset can be considered a capital lease, where the value of the leased property is included in the balance sheet of the lessee, If the four conditions listed a are met: a) The lease conveys ownership to the lessee at the end of the lease term. b) The lessee has an option to purchase the asset at a bargain price at the end of the lease term. c) The lease term covers 75% or more of the economic life of the asset. d) The present value of the rental payments when using the lessee's incremental borrowing rate is ninety percent or more of the fair market value of the asset. TWO ALTERNATIVE CONCEPTS OF LEASE ACCOUNTING One of the main points of SFAS 13 is that all lease contracts generate obligations that should be presented in the balance sheet, contrary to what the Financial Accounting Standards Board believes. In fact, SFAS no. 13 states that "a lease that transfers substantially the entire benefits and risks incident to the ownership of property should be accounted for as the acquisition of an asset and the incurrence of an obligation by the lessee and as a sale or financing by the lessor. All other leases should be accounted for as operating leases. (FASB 1976, para. 60)" FASB differs this by saying that not all lease contracts create both a new asset and a new liability. The FASB and G4+1 group have been implementing the FASB standard on lease recording. Companies in Canada, Australia, United Kingdom and New Zealand have also been following the FASB standards. THE CONCEPTUAL FRAMEWORK AND ACCOUNTING FOR LEASES When assessing the generally accepted accounting principles states that accounting information that should be included in the financial statements are those that are submitted on time to the decision makers. These financial statements must also be relevant to the decision making process. Further, the financial statement items should stated in such a way as to permit comparability between two accounting periods or two or more financial entity who are subsidiaries, branches or competitors. Therefore, when rights and obligations are recorded in a lease contract, intangible assets are created. An airline company comes into "existence" when it buys an airplane. According to monsoon, There is a possibility that lessees may record the lease asset in the balance sheet will be boundless because intangible assets cannot be easily estimated. When a bank request a company to submit a balance sheet as one of the requirements of a bank loan, the asset item lease may include goodwill which the bank could not quantify easily. How can a person compute the goodwill or intangible asset amount if those assets have not been bought physically but only estimated How will you record an airplane that has been leased and to be returned at the end of ten years Can it then be recorded as an asset and a liability Well since accounting is an art, each person has his or her own interpretation of what an asset or likewise is. But people will have to follow generally accepted principles accounting principles which were suggested, voted and approved by the The G4+1 report states that the committee will develop a conceptual, single approach to accounting for leases and believes an approach will have the following characteristics. a) All leases shall create assets and liabilities b) Lease accounting is a specialized law contract between 2 or more parties c) There must be healthy change in the lease contract that do not alter economic substance of the original contract. The leasing market is so unique. Unique in the sense that no two lease contract are exactly the same. In this environment, there is difficulty to compare the lease contract among other lease contracts. The committee favors fair market value of reporting when the measurement and conceptual measurement issues are agreed upon. REVIEW AND DISCUSSION OF EMPIRICAL RESEARCH. Existing research indicates that operating leases are similar to capital leases and debt for valuation and risk assessment purposes. The first research shows that operating leases are generally the same as capital leases. They are both considered for valuation and risk assessment. According to Bowman (1980) he said " that estimated lease liabilities based on ASR No. 147 disclosures are positively associated with market-based measures of equity risk." Also, Ely (1995) and later Imhoff et al. (1993, 1995) discovered that the estimated operating lease liabilities based on SFAS No. 13 disclosures are positively associated with measures of equity risk. Whisenant (1998) even finds that the fair market value of equity reflects estimated operating lease liabilities based on SFAS No. 13 disclosures." Finance research shows another interpretation of leases. Leases focus on the attributes that differentiates lease from debt financing. The theory goes like a dollar of economic lease liability replaces a debt dollar. The big difference between the lease and the debt is that in the lease situation, the lessor owner pays for the taxes on the asset leased. In a debt situation, the borrower of money pays for the asset (maybe a house) Therefore the buyer now has to pay estate or other related taxes. Bowman(1980) and Ang and Peterson (1984) indicated that when companies have more debts, then most of these debts are used to pay for property investments. Therefore debts complement leases. In the second research, Wilkins and Zimmer(1193) discovered that acceptance and recognition of leases can help much in the presentation of financial statements. Bank loans always list leases as debt equivalents. This is due to the increase of basic commodities. Imhoff ET all (1993, 1995) said that market based equity risk measures reflect simple estimates of operating lease liabilities. 3. Empirical research finds that leasing behavior changes when lease Accounting rules change. This 3rd The G4+1 feel that leases are similar to contracts and are therefore binding. The committee knows that the committee knows that the main purpose of lease accounting is to get the value of the obligations and rights of the lesser and lessee. The committee also believes that treatment of a transaction as to lease or capital depends on the personal judgment of all gathered facts. CURRENT LEASE ACCOUNTING MODEL. According to International Accounting Standards no. 17, there are ONLY two kinds of leases acceptable. The first, operating lease is just the simple renting by lessor of his or her private property to the lessee for a sum of money. The property during the entire rent situation remains the property or asset of the lesser. The payments are recorded as rent expense by the lessee. The second lease situation is the capital lease. The equipment, building and other assets, although the lessor and lessee agreed that the will follow the usual rent situation, can be recognized as a capital asset. The criteria for such an asset to be capitalized that the lease agreement can not b cancelled. Another requirement is that one of the following situations occurs: a) the lease contract will transfer ownership of the property from the lessor to the lessee after the lease contract expires b) there is a lease bargain option. This means that the lessor is granted the option to buy the property at a price lower than the fair market value of the asset leased c) Lease period exceeds a major (more than seventy five percent) of the asset's economic life. And lastly d) the present value of the minimum lease payments is equal to substantially 90% of the fair value of the leased asset or assets at the inception date of the lease contract. Discuss and contrast the current lease accounting model with the two proposed alternative concepts of lease accounting financial accounting approach and the whole asset approach, G4 PROPOSAL. The lease agreement here is considered as contract. Therefore the lease contract is enforceable upon agreement. This proposal states that all lease contracts, no matter what the conditions are, can give and receive rights and properties. But this does not affect the accounting or length of the lease. The new approach sees to it that the approach should be robust to shifts in the contractual details of lease contracts then 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. The whole asset approach is a better choice. This is the reason why the later version of International Accounting Standards no. 17 (followed by most countries) states that there are presently two ways to record a lease called the rent expense method and the capitalized asset method. The rent method simply states that there is a landlord - tenant relationship. No assets are recorded in the balance sheet by the lessee. Payments by the lessor is recorded as rent expense. After the end of the lease contract, the lessee has the liability to return to the lessor the leased property. The second method under the present lease set up is the capital lease method. For a lease contract to be capitalized where the asset leased is included as part of the assets and a liabilities of the lessee company. The whole asset approach is a good alternative because the leased asset is recorded as asset when used and recorded as a liability because at the end of the lease contract term, the assets have to be returned to the lessor for disposal. CONCLUSION: Therefore, when the FASB eventually undertakes a project to reconsider the accounting for leases, the FASB as of the two report date, 2001 was still searching for the best solution to break the impasse. Their research to choose between these two approaches started. Finally, In the year 2003, International Accounting Standard 17 was born. The International Accounting Standards board (IAS) an organizations of Certified Public Accountants from many countries, issued the international Accountant Standards no. 17. This was crafted and implemented in most countries in Europe and Asia and the United States. This International Accounting Standard no 17 puts the icing on the cake, as the final decision as to which of the two approaches to implement. So the issue as to which of the two former alternatives is better is now obsolete or irrelevant. BIBLIOGRAPHY: A AA "Evaluation of the Lease Accounting Proposed in G4+1 Special Report." Accounting Horizons Vol 15 No. 3 Sept (2001) p 289 -298 Dennis Monson, AAA "The Conceptual Framework and Accounting for Leases." Accounting Horizons Vol 15 No.3 Sept (2001) p 275-287 Sannella, A., The Impact of GAAP on Financial Analysis: Interpretations and Applications for Commercial and Investment Banking. New York, Quorum Books, 1991 Van Riper, R., Setting Standards for Financial Reporting: FASB and the Struggle for Control of a Critical Process, Westport, CT,1994. IAS Plus, "Standards: IAS 17.", 20,Mar. 2006 Read More