Assignment attached below Essay Example

Off-Balance Sheet Financing3

ACCOUNTING STANDARDS APPLICATION TO OFF-BALANCE SHEET FINANCING

Off-balance sheet depicts distinctive ways for comprehending the degree of a company’s liabilities in published financial statements. It is far much, a result of managerial behaviours , which is directly influenced by the certainty on whether a company has borrowed under terms and conditions that necessitate it to sustain a specific level of liquidity , debt-to equity ratios or even within a given set of external borrowings (Miller & Bahnson, 2010). It is important to understand that off-balance sheet financing activities encompasses a significant number of items that might include; specific loan commitments and letters of credit. It is executed in order to allow for the generation of an improved earnings ratio given that it will always utilise assets as its immediate component (Miller & Bahnson, 2010). Given the fact that earnings that are produced from these specific activities are involved in a firm’s immediate income level, while still making sure that the total asset balances are not in any way affected results to the aforementioned earnings ratio appearing to be higher than they would in case that income was generated from an on-balance sheet activities (Henry& Holzmann, 2011). Most notably, the regulatory concern with off-balance sheet financing activities emanates from the mere fact that it subjects a firm to given level of risks that in most cases, involve credit risks.

In essence, Henry and Holzmann (2011, p.66) notes that off-balance sheet financing revolves around managerial behaviours aimed at overlooking debt covenants set forward. For instance, in the early 1980s most of the Australia-based firms engaged in raising of capital funds mainly through borrowings hence they were directly affected by intensive restrictions called for by lenders in relation to negative pledge or other forms of borrowing covenants (Dechow & Skinner, 2000). It thus goes without saying that these levels of debt contracts might have played a critical role in influencing these firms commercial and accounting policies and practices (Lambert & Lambert, 2010). A perfect example of how these companies engaged in window-dressing their balance sheets is indeed simple in nature; these corporations would allow for the payment of its current liabilities shortly before the balance period, which interestingly improved on their immediate reported relationship between current assets and liabilities falling within the reporting dates (Lambert & Lambert, 2010).

A rather more sophisticated example of a similar practice by Australian corporations in window-dressing their balance sheets can be perceived from the 1987 accounts of Bond Corporations Holdings Limited;

The firm’s 1987 balance sheet indicated that $456M that was raised from the direct issue of convertible bonds were recorded as accounts receivables at the end of 30th June despite the fact that the entire proceeds of these issues were not received till 9th July of the same period. Notwithstanding, about $299.9 M of the issues that were anticipated were posted as having been released in order to repay a given degree of term advances, which resulted to the reduction of the amounts posted as owing to the company’s creditors. Subsequently, another significant material misrepresentation made to the firm’s immediate accounts was depicted from an alteration in the accounting treatment of both the provision for taxation and asset items, future income tax benefits that were decreased by at least $156M in the course of the financial year 1986-1987. The two forms of material adjustments helped, in a great way, to improve the reported financial position of Bonds Corporation Holdings Limited since it portrayed a current ratio of 2:1 while without those adjustments, it could only attain a less-impressive ratio of 1:1.

It is noted that most of the current leading Australian-based entrepreneurial premises opted to indicate convertible notes as being shareholders’ level equity hence improving the underling reported debt-to-equity ratios (Coulton, Taylor, & Taylor, 2005). A recent noted amendment made to the existing statutory requirements calling for immediate financial disclosures was directly aimed the practice of intentional material adjustments; especially with the alterations that took effect thereby affecting the requirements for a standard-format balance sheet and it stated that under Schedule 7 of the Companies Regulations is to be amended by way of omitting from the sub-clause 6(1) total shareholders’ equity (Coulton, Taylor, & Taylor, 2005). However, it is quite noticeable that even though terms and conditions related to firms’ engagement to borrowing of funds depicts to influencing commercial and accounting practices, they fail to expound on these practices (Coulton, Taylor, & Taylor, 2005). There are other significant facets that describe the application of these commercial and accounting practices for example a firm’s directors and company officers might at some period aspire to illustrate aspects related to financial prudence and managerial success. Significant increases in the degree of debt in relation to the overall shareholders’ funds might portray that the managers have employed risky financial models to execute business operations.

Markedly, despite the different forms of inferences drawn from the outcomes of empirical studies into reactions to notable accounting disclosures, it still remains inevitable these studies are mainly attributed to the overall market behaviours as opposed to the manner for which individual users execute decisions while solely focusing on the already prepared and published financial statements (Coulton, Taylor, & Taylor, 2005). In consequence, despite the fact that the introduction of legal requirements for the disclosure of accounting practices and policies has ensured that published financial reporting is more transparent than before, still even the most knowledgeable and experienced analysts cannot perceive through the full influence of most techniques employed in the placement of debt off-balance sheet (Coulton, Taylor, & Taylor, 2005).

Leasing is, in itself, one of the oldest and simplest ways through which most leading Australian corporations have continued to use for purposes of off-balance sheet financing activities. AASB 177 calls for corporations that engage in the acquisition of equipment through mere purchase transactions on credit terms should at all times be recorded as an asset and liability in its financial accounts within a given year of operations (Coulton, Taylor, & Taylor, 2005). On the contrary, firms that engage in lease-based transactions might avoid this rather tedious recording of the entries involved by only portraying these lease payments as simple expenses in the exact operational periods for which the payments were made or fall (Coulton, Taylor, & Taylor, 2005). For this situation, the commitment to ensure that the payments for leases are not portrayed in a company’s balance sheet is fairly expounded in Schedule 5 of the Corporations Regulations, which necessitates the disclosure of convertible notes to the overall accounts of the amount and timing of the commitments made within the period at hand.

For a substantial period, the entire accounting professions have continued to seek ways for presenting the accounting treatment of leases. Currently, there exists a concept emanating from the international consent amongst the many profession-sponsored standard setting frameworks calling for the immediate differentiation of finance and operating leases. In regards to the standards generated by the accounting profession, operating leases cannot be recorded as giving rise to both assets and liabilities but not any overdue lease instalments (Coulton, Taylor, & Taylor, 2005). On the contrary, finance leases should be treated in relation to their respective substance as opposed to their form meaning that the transaction is perceived as being the acquisition of an asset on credit terms and conditions. For this case, the firm that enters into a given finance lease would be required to record it as both as an asset and a liability within its balance sheet. In the course of interpreting these accounting standards, the concern on whether a given contract would result to either an operating or finance lease lies solely on professional levels of judgments (Coulton, Taylor, & Taylor, 2005).

A significant perspective note in relation to accounting profession AAS 17; Accounting for Leases provides that it might not be necessary for a similar classification to be employed by both the lesser and lessee. Subsequently, an editorial commentary in the accounting standard AASB1008; Accounting for Leases that is mainly employed and applied by the numerous Australian-based firms provides that the standard will usually lead to in a specific lease being similarly identified and described by the lessee and lesser that are involved within a given lease transaction (Coulton, Taylor, & Taylor, 2005). In practical terms, it can be fairly seen that there exists different form of viewpoints in regards to the classification of leases that can be held by both the lesser and lease with the lessees portraying an infinite level of tendency to depict leases as operating in nature (Dechow & Skinner, 2000).

In the late 1980s, the annual surveys by the Australian Bureau of Statistics in relation to specifically finance firms indicated the fact that lesser engaged in the classification of their respective leases receivables as being finance leases in an enormous ratio of 950:1.

A most recent Australian development rests with the immediate release of the Statement of Accounting Concepts, SAC 4 that involves numerous fundamental descriptions of assets and liabilities involved within a lease-based transaction (Bouvier, 2011). A careful look at the SAC 4 postulates that the treatment of all operating leases as an attribute form of off-balance sheet financing is in itself indeed questionable since they should also be regarded as liabilities, which in effect further put up questions in regards to the desirability of posting it as an asset in order to access future services.

In the meanwhile, and in the milieu of existing regulatory stipulations, managers that are perceived to be very anxious to position debt off-balance sheet will vehemently carry on to ensure that they enter into lease agreements that could be classified as operating in nature (Bouvier, 2011). On the contrary, lease brokers will carry on to market the leases that they assume are structured in order to overlook the possibility of adhering to numerous accounting standards set forward to oversee the exercise since this will ensure the effectiveness and reliability of published financial position as well as their respective rates of return within given period (Bouvier, 2011).

On a global perspective, it has been found that specific companies as well as their respective managerial workforce have continued to utilise individualistic motives in relation to the classification of leases as operating capital and as a result, preventing the much needed integrity and transparency needed in publish a firm’s financial information within a given period (Burkholder, 2011). As a result of this persistent misrepresentation and unfaithfulness on the part of companies, such accounting bodies as FASB and IASB have resorted to formulation of a sole initiative aimed at establishing a newer framework to lease-based accounting treatments that could promote a credible and faithful perception of all leasing transactions. The efforts made by these accounting bodies can be seen through the 2010 Exposure Draft: “Proposed Accounting Standards Update: Leases (Burkholder, 2011). For the lessee, the draft eliminates any possible distinction between operating and capital leases while for the lesser, the draft ensures to postulate on whether to employ a performance obligation model or the de-recognition technique.

To sum up the discussion above, it can be noted that numerous accounting bodies and professions worldwide have ensured to comprehend the fact that lease accounting is indeed crucial for all users of financial reports. On the contrary, it has also been unmistakeably clear that the concept of accounting for leases is hindered with intensive loopholes that act to trigger possibility of immoral managerial behaviours in a way that posits a challenge to overall spirit and purpose of the standard of lease accounting treatment. Numerous accounting standards and bodies have come up to ensure that the loopholes identified are covered and efforts made to steer this important accounting aspect into the right direction. Recent exposure drafts have ensured to provide both the lesser and lessee with important guidelines on how to ensure that they conduct lease accounting treatment.

References List

Bouvier, S. 2011 IASB, FASB hear concerns about hybrid approach to lessor accounting. Accounting Policy and Practice Report, vol.7, no.1, pp. 29-30

Burkholder, S. 2011, FASB members indicate lease accounting proposal ‘not a done deal’ at rules forums. Accounting Policy & Practice Report, vol.7, no.2, pp.62-63

Coulton, J, Taylor, S & Taylor, S 2005 “Is benchmark beating by Australian firm’s evidence of earnings management? Accounting & Finance Journal, vol.45.pp.553-576

Dechow, P. M & Skinner, DM 2000 Earnings management: reconciling the views of accounting academics, practitioners and regulators, Accounting Horizons vol.14, pp. 235–250.

Henry, E & Holzmann, O. J.2011 Lease accounting project reaches exposure draft stage. Journal of Corporate Accounting & Finance, Vol.22, pp.65–70

Lambert, C & Lambert, C.2010 “An investigation of earnings management through investments in associated companies: An Australian perspective, Journal of Business & Economics Research, vol.1, no.7, pp. 13-23

Miller, P., & Bahnson, P. 2010. Off-balance-sheet financing: Holy Grail or holey pail? Accounting Today, vol.24, no. 13, pp. 16-17.