Discuss the effectiveness of SFAS No. 13 in addressing the lease capitalization problem.

Question

What will be an ideal response?

Answer 1

ANSWER:
The problem that many leases are not being capitalized but should be continues to be true under SFAS No. 13. An inherent weakness of the finite uniformity approach is that management may prefer some accounting methods over others. In these instances, companies will be motivated to manipulate the relevant circumstances in order to get the desired accounting result. With leases, lessees continue to believe that there are advantages to off-balance-sheet financing through leases. This will always motivate companies to try to defeat the capitalization tests of lease accounting standards.

It is not very difficult to structure a lease contract to defeat the four tests of SFAS No. 13 because the four tests are not stringent. A more challenging task, though, is to defeat lease capitalization tests for the lessee while satisfying them for the lessor. Lessors normally desire to capitalize leases and recognize sales revenue, but lessees prefer the effects of off-balance-sheet financing. One innovative method to accomplish both objectives is the use of third parties to guarantee residual values to the lessor, reducing the lessee’s obligation under test (4) of SFAS No. 13 and, if significant enough, could lead to non-capitalization. However, there is no effect on the lessor because the lessor’s accounting deals with the estimated residual value in total. No distinction is made between guaranteed and unguaranteed residual value.