Determining the impact of capitalising long-term operating leases on the financial ratios of the top 40 JSE-listed companies

Abstract

Operating leases form a great part of companies’ financing structures in today’s economic environment. Some accounting standard-setters and other users of financial statements are of the opinion that the current standard on accounting for operating leases, IAS 17, does not provide sufficient guidelines on the disclosure of a company’s leasing activities. The current accounting standard on leases provides companies with the opportunity to classify lease contracts into different classes which leads to off-balance-sheet financing. This problem is currently being addressed by the IASB as they are in the process of developing an improved standard on leases. The main focus of this paper is to determine the impact of the improved accounting standard on the financial statements and the resulting financial ratios of the JSE Top 40 companies when operating leases are accounted for as on-balance-sheet debt. The differences between the current IAS 17 and the Exposure draft (ED/2010/9) are identified and the comparison indicates significant differences between these two approaches on accounting for operating lease activities. The focus of the IASB in developing this exposure draft was to provide the users of financial statements with a universal picture of the leasing activities that the company is engaged in. The findings include that this objective is achieved as users are not left uninformed about any of the financing activities that stakeholders are exposed to if indeed a company is engaged in operating lease activities. The study also revealed that the capitalising of long-term operating leases will have a significant effect on the key financial ratios that stakeholders use to interpret a company’s financial performance.