FINANCIAL ACCOUNTING IN THE REAL WORLD - Accounting Assignment

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Internal Code: MAS3351 Questions: In 2008, following spectacular corporate collapses like that of Enron, the International Accounting Standards Board (IASB) outlined a proposal that operating leases should be included on a company’s balance sheets in the interest of transparency for creditors and investors around corporate debt. The IASB was forced into a rethink after a backlash from major retailers including Woolworths and Wesfarmers, denouncing the original proposals as complex and costly. Under the latest changes to lease accounting rules put forward by the IASB, retailers such as Woolworths, Wesfarmers, Myer, David Jones, JB Hi-Fi, Harvey Norman, Specialty Fashion and Premier Investments will have to calculate the net present value of future lease commitments and recognise them as debt on their balance sheets. Instead of recognising rent payments as costs incurred, retailers will have to expense theoretical amortisation and financing costs. This will boost earnings before interest, tax, depreciation and amortisation but will reduce pre-tax and net profits, as the amortisation and financing costs will exceed rental payments, especially for faster growing retailers with relatively new leases. According to a report by Morgan Stanley, the impact on retailers will be ‘considerable’, blowing out gearing levels and reducing return on capital employed, but will vary from retailer to retailer. Reactions to the proposed rules include a report by Morgan Stanley predicting a considerable but varied impact on retailers including reduced capital return and a blow out of gearing levels. The report says Myer, Specialty Fashion and The Reject Shop will be more affected than Kathmandu and Fantastic Furniture as the former have significant and long-term lease liabilities. Also new retailers like Lovisa, who are early into lease terms will probably be impacted more than established leaseholder retailers. Read the brief extract from an article by Sue Mitchell entitled ‘Rules hit retailers with rolled- up leases’ and answer the following FOUR questions:   1.Why would companies have preferred to treat the leases as operating leases (if there is an operating lease then the assets and liabilities associated with leased asset are not shown on the statement of financial position) rather than finance leases (if the lease were a finance lease then the liabilities and assets associated with the lease would be shown on the statement of financial position)? 2. Explain why the change in the accounting standard for leasing might cause organisations to breach covenants included within debt contracts. 3. What is the difference between debt covenants that rely upon ‘floating GAAP’ and those relying on ‘fixed GAAP’, and which provide less risk to the borrower? 4. Which organisations would be more likely to lobby against the accounting standard?