Current accounting for leases requires that certain leases becapitalized. For capital leases, an asset and the associatedliability are recorded. Whether or not the lease is capitalized,the cash flows are the same. The rental payments are set bycontract and are paid over time at equally spaced intervals.Required:a.If one of the objectives of financial reporting is toenable investors, creditors and other users to project future cashflows, what difference does it make whether we report the lease asa liability or simply describe its terms in foot-notes?b.Theefficient market hypothesis states that all available informationis impounded in security prices. In an efficient capital market,would it make a difference whether the lease is reported as aliability or simply described in foot-notes? Explain.c. When thereare debt covenants that restrict a company`s debt-to-equity ratioand when debt levels rise relatively to equity, management may bemotivated to structure leasing agreements so that they are notrecorded as capital capital leases. Discuss this motivation interms of agency theory.
Current accounting for leases requires that certain leases becapitalized. For capital leases, an asset and the associatedliability are recorded. Whether or not the lease is capitalized,the cash flows are the same. The rental payments are set bycontract and are paid over time at equally spaced intervals.Required:a.If one of the objectives of financial reporting is toenable investors, creditors and other users to project future cashflows, what difference does it make whether we report the lease asa liability or simply describe its terms in foot-notes?b.Theefficient market hypothesis states that all available informationis impounded in security prices. In an efficient capital market,would it make a difference whether the lease is reported as aliability or simply described in foot-notes? Explain.c. When thereare debt covenants that restrict a company`s debt-to-equity ratioand when debt levels rise relatively to equity, management may bemotivated to structure leasing agreements so that they are notrecorded as capital capital leases. Discuss this motivation interms of agency theory.
