1.1 Introduction
The purpose of this thesis is to investigate the possible effects of the proposed changes in the International Accounting Standard (IAS) 17 'Leases' in Germany and in France. The rapid growth of leasing during the 1970's motivated standard setters in several countries to develop lease accounting standards to overcome the deficiencies of accounting in regards to leasing. Current lease accounting standards are based on the view of economic ownership. Leases are currently classified as either financial or operating leases, the latter is not reported by the lessee on his balance sheet and therefore can have major implications on investors and other user of financial statements. McGregor (1996) notes that the current standards fail to recognize the assets/liabilities on the lessee's balance sheet that arises from operational leases.
The popularity of leasing as a means to acquire access to benefits associated with property, equipment and other assets has to managers becoming more opportunistic. IAS 17 requires lease transactions to be categorized based on their substance rather than their form, managers may sometimes structure leases in ways advantageous to them. For example, in order to receive large tax benefits by keeping these transactions off- balance or to structure these transactions in a certain manner that they are categorized as operating leases.
Regulators/standard setters and other interested parties have complained that the current state of lease accounting does not provide financial statement users with transparent information regarding the lease transactions. This situation has created the amendment of the lease accounting standards during their history. Accounting scandals such as Enron and WorldCom has led to several accounting regulating bodies to act and implement new laws and legislation such as SOX. The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) in July 2006 started a joint project in response to the SEC's 2005 Report and Recommendations Pursuant to Section 401(c) of the Sarbanes-Oxley Act of 2002 on Arrangements with Off-Balance Sheet Implications, Special Purpose Entities, and Transparency of Filings by Issuers . The objective of standard setters was to revise and to evaluate the areas of concern and proposed several changes that would better reflect the current state of lease accounting. Standard setters, regulators and others believe that to improve the quality of lease accounting a thorough reexamination in the current standard is needed. McGregor (1996) expressed concern about the information presented in financial statements in regards to leases, and more specifically about operational leases. Beattie et al. (2000) expressed this same concern in his study by noting that operational leases are thirteen times larger than financial leases. McGregor (1996, p.1) states 'Lease finance in modern economies continues to provide a significant source of funds to business for the acquisition of property, plant, equipment and other assets'. Similar findings have been found by (Imhoff, 1993; Graham, 1998) . According to the White Clarke Global Leasing Report 2014, the total volume of leasing transactions of the top 50 countries in 2012 amounted to 868 billion dollars.
The new approach to lease accounting that is being studied/ evaluated would treat the majority of leases as financial leases therefore all assets an obligations that may arise from lease transactions would be recognized on the balance sheet . The main reasons for this possible new lease accounting approach is to improve:
(i) transparency and comparability between firms
(ii) to provide investors more reliable decision-making information
(iii) improve the quality of published financial information
This new lease accounting approach has been heavily criticized by lease organizations and auditing firms worldwide do to its complexity, costs and the negative effects that capitalization of operational leases would have on a firm's financial health.
Prior studies have investigated the effects of operational lease capitalization, they have to some extend found that capitalization has a negative effect on a firm's solvency, gearing and profitability (Sharpe, 1995). Capitalization also affects a firm's ability to attract investors and other types of funding. Capitalization of leases remains a focal point of researchers, standard setters (FASB, IASB) and other stakeholders, especially because an increasing demand exists for more adequate financial reporting. As signaled previously the purpose of this thesis is to investigate the potential effects of the proposed changes to IAS 17 in Germany and in France. In order to investigate this accordingly the next research question and sub-questions have been formulated:
Does capitalization of operational leases in Germany and in France have a negative economic effect on listed firms?
1. What are the characteristics of financial accounting?
2. What characteristics influence the operational lease intensity of listed firms?
3. How are key financial performance measures affected by the capitalization of operational leases?
4. Will the economic effects of the proposed changes caused by the intended adoption of IAS 17 differ from one another for Germany and for France
1.2 Motivation and contribution
The main motivation for this thesis is the ongoing debate between regulators, standard setters and other stakeholders regarding whether operational leases should be capitalized and appear on balance sheet/ financial statements of lessees. Secondly the capitalization of operational leases has not been studied in a German and in a French setting. Germany is the largest European leasing market while France is the third largest; this creates an interesting setting because it is not sure if the expected negative effect will be statistically significant. Finally the country effect will be investigated, even though both Germany and France are categorized macro-uniform based countries (Nobes, 1983). Germany is more law based and France more tax-based, a possibility exists that other factors can influence the lease transactions within these countries. According to Branswijck et al. (2011) after the implementation of IFRS in 2005 all listed firms in the Europe Union used the same standard to account for leases, however firms first prepare their statements according to their local standards (GAAP), this can affect the way that IAS (IFRS) is interpreted and applied.
Prior research was mostly focused on the UK and on the US but little research has been performed for other European countries especially large European leasing markets. This thesis will contribute to prior research by first investigating the effects of the proposed changes to IAS 17 in two of the largest European leasing markets. Secondly provides further evidence which industries are most affected by the capitalization of leases and what determinants of the operational leasing have the most influence on the operational lease intensity of listed firms.
1.3 Objectives
The main objective of this thesis is to investigate whether the proposed amendments to IAS 17 will affect listed firms in Germany and France in negative manner. Previous research suggests that capitalization of operational leases has a negative effect on: key financial ratios, firm's solvability and can lead to violation of the debt covenants. However firms many firms do not agree with the proposed changes to IAS 17 because eliminating the distinction between financial and operating leases would mean all leases would be classified as financial leases and would have to appear on all balance sheets. This would affect a firm's profit margin, key ratios, and their ability to attract funding/ investors and would increase the cost of capital. Other objective is to investigate the drivers of lease intensity for listed firms. Previous research suggests that for example the industry where a firm operates or tax rates can heavily influences a firm's operational lease intensity. In order to investigate the possible negative effects of the capitalization this thesis will focus on the key ratios that are most affect by the capitalization of operational leases. In addition, in order to determine the most important factors that drive the operational lease intensity this thesis will use various variables used by previous studies in to one model.
1.4 Methodology
This paragraph briefly discusses the method of this paper. Data regarding the operational leases will be retrieved from annual reports, as this information is mostly unavailable in databases do to the reporting nature of operational leases at the moment. Secondary data needed for the model will be retrieved from Compustat, Orbis and other bibliographic databases. For the purpose of this thesis only firms who have active operational lease contracts in 2013/2014 will be used. The reason for this is that firms in order to perform this thesis it is essential that the firms that are investigated have active operational lease contracts the objective of this thesis is to investigate the effects of the capitalization of those contracts. Secondly the year 2013/2014 is chosen as sample period in this study because its 5/6 years after the financial crisis of 2007-2008 and 8/9 years after the mandatory adoption of IFRS. Prior research was mostly focused prior or during the financial crisis where regulation was less prevalent and where firms were more likely to have engaged in the use of operational leases as sources of debt financing or other.
To perform comparisons between all the different industries, the firms in the final sample will be categorized according to their industry. Secondly the lease liability will be calculated according to the method used by (Imhoff, 1991). The impact on the key financial ratios will be investigated by computing before and after capitalization computations of the ratios most affected by the capitalization of operational leases. Finally the relation between PVOL (dependent variable) and de independent variables in this thesis will be test by performing a univariate analysis using the established regression model. This process will be further explained in detail in the chapter research design method and sample.
1.5 Demarcations and limitations
As signaled before, this study will use a slightly modified version of the constructive capitalization method developed by Imhoff, 1991. This method is based on certain assumptions such as: 10% interest rate, straight-line depreciation, and combined tax rate of 40% etc. Other possible limitations maybe that the assumptions used in this thesis may/ or may not agree with the contemporary understanding of accounting theory or the application of this theory for example the assumptions signaled previously. The unavailability of information or misleading information found regarding operational leases has the ability to influence the results of this thesis, and is qualified as a major limitation of this thesis. For example if operational leases are structured in a certain manner so that they are not considered operational leases, these will not be part of this thesis, but will affect the quality of the findings in this thesis.
This paragraph focuses on the potential limitations of this thesis even before the empirical part of this thesis is carried out. Some factors have been found that are able to for example influence (a) the quality of the findings (b) the ability effectively answer to the main thesis question and / or hypotheses. As the constructive capitalization method has been found to have more explanatory power than other existing capitalization methods even though it is based on several assumptions concerning future research it would be difficult to completely eliminate/ mitigate these factors.
1.6 Thesis structure
In order to answer the research question and the subsequent sub questions in a proper manner this thesis has been structured in the following manner. The first chapter presents an introduction about the subject of this thesis, its main research question/ sub questions, motivation, objectives and methodology. The second chapter will focus on the history of leasing. In addition this chapter will discuss the current standards and the changes that are being proposed by standard setters. Finally the chapter also focuses on leasing in general in both Germany and France. The third chapter focuses theories related to leasing and how these theories may affect the lease intensity of firms. In addition this chapter also discusses certain incentives that may lead firms to engage in leasing rather than using other methods of finance. The fourth chapter discusses prior research in relation to leasing, more specifically what are the determinants that influence the operational lease intensity and the impact of capitalization on the key financial ratios. The fifth chapter will explain the research method, the variables of the model and the sample of this thesis. Chapter six will present and analyze all results pertaining to this thesis and chapter seven will focus on answering the research question/ sub questions and conclusions. This chapter in addition will highlight the limitations and the need for further research regarding this or close related topics.