Journal of International Accounting, Auditing and Taxation - Accounting Assignment Help

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The purpose of this study is to examine the effects of constructively capitalizing operating leases on credit ratings in Japan. In particular, this study investigates whether and how a credit rating agency considers operating lease information when determining credit ratings. First, this study shows that constructively capitalized operating leases are associated with credit ratings. Second, this study finds that the associations between operating leases versus finance leases and credit ratings are not substantially different. However, when operating lease disclosures are less reliable, this study finds that operating leases are not associated with credit ratings and that the risk relevance of operating leases is substantially different from that of finance leases. This study reports that the reliability of accounting information has significant effects on the risk relevance of operating leases. These results indicate that a credit rating agency considers operating lease information in determining credit ratings to the extent that this information is reliable. This study contributes to the literature on the usefulness of operating lease disclosures and to the discussions on the global convergence of accounting standards.

1. Introduction

The purpose of this study is to examine whether and how capital market participants use off-balance sheet operating leases when assessing firms’ credit risk in Japan. In particular, using credit ratings as a proxy for firms’ credit risk, this study investigates the associations between operating leases and credit ratings. Furthermore, this study analyzes the effects of the reliability of accounting information on the risk relevance of operating leases. The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) proposed a new lease accounting model that required lessees to recognize almost all leases on their balance sheet (IASB, 2009, 2010, 2013). The current lease accounting models under International Financial Reporting Standards (IFRS) (IAS 17) (IASC, 1982) and U.S. Generally Accepted Accounting Principles (GAAP) (ASC 840/SFAS 13) (FASB, 1976) classify leases as either finance (capital) leases or operating leases and account for them differently. Both accounting standard setters assume that operating leases are similar to finance leases from an economic perspective; however, current accounting standards do not require lessees to recognize operating leases on their balance sheet. Because existing accounting standards create asymmetry and inaccuracy of information in the market, the IASB and the FASB criticized them and finally issued new lease accounting standards that required lessees to recognize both types of leases on their balance sheet (FASB, 2016; IASB, 2016). Capitalization of operating leases has been proposed for a long time (e.g., Lorensen, 1992; McGregor, 1996; Myers, 1962; Nailor & Lennard, 2000). Prior literature examines whether capital market participants sufficiently understand disclosed operating leases and https://doi.org/10.1016/j.intaccaudtax.2017.12.008 ? This paper was originally accepted for publication in Advances in Accounting. E-mail address: kusano@econ.kyoto-u.ac.jp. Journal of International Accounting, Auditing and Taxation 30 (2018) 45–56 Available online 20 December 2017 1061-9518/ © 2017 Elsevier Inc. All rights reserved. T consider them in their decision making (Barone, Birt, & Moya, 2014; Lipe, 2001; Spencer & Webb, 2015). In particular, previous studies investigate the associations between operating leases and equity or credit risk and find the risk relevance of operating leases (Altamuro, Johnston, Pandit, & Zhang, 2014; Andrade, Henry, & Nanda, 2014; Beattie, Goodacre, & Thomson, 2000; Bratten, Choudhary, & Schipper, 2013; Chu, Levesque, Mathieu, & Zhang, 2008; Dhaliwal, Lee, & Neamtiu, 2011; Ely, 1995; Ge, Imhoff, & Lee, 2008; Imhoff, Lipe, & Wright, 1993; Lim, Mann, & Mihov, 2017; Sengupta & Wang, 2011).

These studies show that constructively capitalized operating leases are risk relevant mainly using a sample of firms in the U.S. However, operating lease disclosures under Japanese GAAP are less informative than those under U.S. GAAP and IFRS. In Japan, regarding operating leases, future minimum lease payments divided between within one year and more than one year out are only disclosed in the notes to financial statements. Compared with recognized items in financial statements, capital market participants face higher information processing costs for disclosed information in the notes (Barth, Clinch, & Shibano, 2003; Schipper, 2007). The risk relevance of operating leases depends on the extent to which disclosed information has been processed by various capital market participants. In fact, previous studies report that sophisticated investors lower information processing costs, thereby resulting in a complete understanding of disclosed items (Michels, 2017; Müller, Riedl, & Sellhorn, 2015; Yu, 2013). In particular, prior literature shows that one of the sophisticated capital market participants, namely a credit rating agency, considers operating lease disclosures when assessing firms’ credit risk (Kraft, 2015; Lim et al., 2017; Sengupta & Wang, 2011). However, in Japan, because operating lease information is not sufficiently disclosed, even sophisticated capital market participants might face higher information processing costs to understand disclosed operating lease information. Thus, disclosed operating leases may not provide useful information to capital market participants. Accordingly, using a sample of Japanese firms, it is necessary to empirically investigate whether and how a credit rating agency considers operating lease disclosures when determining credit ratings. Employing this unique setting, this study analyzes the effects of constructively capitalized operating leases on credit ratings. The first objective of this study is to examine whether a credit rating agency understands disclosed operating leases and uses them when assessing firms’ credit risk. When operating lease information is not sufficiently disclosed in the notes to financial statements, capital market participants may have difficulty understanding operating lease disclosures. Credit rating agencies are more sophisticated at processing financial information to evaluate firms’ credit risk. Thus, this study investigates whether a credit rating agency considers disclosed operating lease information when determining credit ratings and shows that constructively capitalized operating leases are associated with credit ratings. Even though operating leases are risk relevant, examining whether they have the same risk relevance as finance leases for explaining credit risk is necessary because the possibility exists that the reliability of accounting information differs between finance leases and operating leases. The amounts of finance lease obligations are reported in financial statements, including the notes; however, the value of operating leases is estimated using a constructive capitalization method with footnote information. Accordingly, the second objective of this study is to investigate whether a credit rating agency processes operating leases and finance leases similarly when determining credit ratings. This study reports that the risk relevance of operating leases is not substantially different from the risk relevance of finance leases

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