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The impact of constructive operating lease capitalisation on key accounting ratios

Beattie, V., Edwards, K., and Goodacre, A. (1998) The impact of constructive operating lease capitalisation on key accounting ratios. Accounting and Business Research, 28 (4). pp. 233-254. ISSN 0001-4788

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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.

Item Type:Article
Status:Published
Refereed:Yes
Glasgow Author(s) Enlighten ID:Beattie, Prof Vivien
Authors: Beattie, V., Edwards, K., and Goodacre, A.
Subjects:H Social Sciences > HF Commerce > HF5601 Accounting
College/School:College of Social Sciences > Adam Smith Business School > Accounting and Finance
Journal Name:Accounting and Business Research
Publisher:Institute of Chartered Accountants in England and Wales
ISSN:0001-4788
Copyright Holders:Copyright © 1998 Institute of Chartered Accountants in England and Wales
First Published:First published in Accounting and Business Research 28(4):233-254
Publisher Policy:Reproduced with the permission of the publisher

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