CH 3 (1 Nilai Maks 100)
Theory in action 3.1 Companies should come clean on the value of leases in their books (50% - 50 poin)
1. Describe current accounting practices for leases as outlined in this article.
Accountants distinguish between capital and operating leases. Capital leases go on the balance sheet while operating leases do not. Australian standards require that lease classification is based on the ‘substance’ of a transaction. However, the guidance criteria for what constitutes a capital lease (e.g. the requirements relating to the lease term covering a major part of an asset’s economic life) leave openings for companies to exercise discretion in classifying leases. US GAAP includes criteria such as the present value of minimum lease payments exceeding 90% of asset’s value.

2. Why does the author call leasing standards ‘silly accounting rules’?
The author says the rules mean that companies exclude real assets and liabilities from their balance sheets. The effect of ‘off-balance’ sheet items is that a company’s assets and liabilities are understated and performance ratios such as return on investment are overstated. In addition, financial risk measures are not accurate and useful (‘bear no relation to reality’).

Off-balance sheet items attracted attention at the time of the collapse of Enron in the USA in 2001. A report by the SEC in 2005 estimated that US companies were committed to US$1.25 trillion in lease payments relating to leases which did not appear on balance sheet. The author estimates that 90% of Australian leases are off-balance sheet.

3. Standard setters propose revising leasing standards to require capitalisation of all leases. Explain the financial impact for Coles and Woolworths in 2007-08 of having ‘off-balance sheet’ leases.
In the 2006-07 year, Woolworths had AUD $11.8 billion and Coles AUD $10.8 billion of off-balance