ACCT352 Research Case-Fall 2020
The Lease Line
To understand the differences between lease classification under ASC840 and ASC842.
To expose you to the fundamental arguments for and against each approach.
To think critically about the relevance and appropriateness of “bright line” accounting policies.
To provide you an opportunity to demonstrate and improve upon your communication skills.
To develop an opinion and articulate it.
Leasing transactions represent a very significant portion of the capital investments of many companies.
The accounting classification of these leases can have a dramatic impact on the financial position and
earnings reported by a company. The AICPA Accounting Trends and Technique – 2010 disclosed that 488
of the 500 companies surveyed (98%) had leases. During the early 2000s, a resurgence of interest in offbalance sheet financing took place in the economic environment, which placed a premium on asset return
and return-on-equity ratios. This same interest continues today as companies contemplating financing often
view the benefits of off-balance sheet accounting as a major factor in deciding whether to consummate a
For many years, there have been concerns raised stating that the ASC840 lease accounting model is
inadequate, the leasing standard has often been criticized as being too reliant on bright lines and subjective
judgments. Many believe that such reliance has led entities to account for economically similar transactions
differently and has presented opportunities for entities to structure transactions to achieve a desired
accounting effect. Such criticism prompted the SEC — in its 2005 report on off-balance-sheet arrangements
— to recommend that the FASB undertake a project on lease accounting.
The FASB issued the ASU 2016-021 (codified in ASC 842) on February 25, 2016, and focused on
implementation efforts related to the adoption of ASC842.The primary objective of the leases project was
to address off-balance-sheet financing concerns related to lessees’ operating leases. ASC842 will require
lessees to recognize most leases on their balance sheets as leased liabilities with corresponding right-ofuse assets. This change will affect a large number of companies, with the U.S. Securities and Exchange
Commission (SEC) estimating that companies have approximately $2.3 trillion in operating lease
There are basic differences in determining the classification of a lease as either an operating lease or a
capital/finance lease when comparing ASC840 and ASC842. ASC840 uses a bright line approach whereas
ASC842 uses a conceptual, principles-based approach. Consequently, it is quite possible to achieve a
different accounting result for a lease classified as operating or capital/finance, depending on which
accounting standard is being used.
One industry that relies heavily on off-balance sheet financing through leasing is the airline industry. A
significant proportion of aircraft utilized by major airline carriers is financed under operating leases. This
practice is not just in the US but also abroad. Below is an overview of some of these airlines and the
percentage of their aircraft that is classified as off balance sheet via operating leases as obtained from 2013
as a percentage of
as a percentage
of total aircraft
(excludes fleet operated
by regional carriers)
Review Subtopics 10 through 30 of ASC 840 and ASC842, Leases.
Obtain Delta Airlines, Inc.’s, Form10-K for the fiscal year ended December 31, 2013. Review the
financial statements and the footnotes pertaining to leases. Use the following link:
Collins, D.L., W. R. Pasewark, and M. E. Riley. 2012. Financial Reporting Outcomes under RulesBased and Principles-Based Accounting Standards. Accounting Horizons 26 (4), 681-705.
Based on the reference material mentioned above, answer the following questions:
1) What are the advantages and disadvantages of the ASC840 bright-line approach versus the
ASC842 conceptual approach in determining the classification of a lease?
2) With regard to the potential change to account for most leases on the balance sheet under
ASC842, provide the following:
What would be the impact on the financial statements of Delta Airlines, Inc. if all its leases
were required to be recorded on the balance sheet as recently adopted ASC842 (assume
that Delta consumes more than an insignificant portion of its leased airplanes) ? Would this
be an improvement in transparency?
Analyze the above and prepare a 1-2 page report (font 12 of Times New Roman; short answers
with bullet points are encouraged) addressing the above questions.
Vol. 26, No. 4
American Accounting Association
Financial Reporting Outcomes under
Rules-Based and Principles-Based
Denton L. Collins, William R. Pasewark, and Mark E. Riley
SYNOPSIS: This archival study addresses whether the presence or absence of ‘‘bright
lines’’ in a lease accounting standard influences the classification of leases as capital or
operating. To the best of our knowledge, our study is the first archival research to
address the association between lease classification decisions and the use of U.S.
GAAP and IFRS lease accounting standards. We examine firms’ lease classification
decisions using 2007–2009 data from a matched sample of members of the Fortune
Global 500 that report under U.S. GAAP and IFRS. Consistent with experimental work by
Agoglia et al. (2011), we find strong evidence that U.S. GAAP firms using a lease
standard containing bright-line guidance (i.e., ASC 840) are more likely to classify leases
as operating than IFRS firms adhering to a lease accounting standard that lacks the
bright lines of the U.S. standard (i.e., IAS 17). Also consistent with Agoglia et al. (2011),
we find little evidence of increased dispersion accompanying financial reporting under
IFRS. In fact, we find some evidence suggesting the use of IFRS may actually lead to
lower dispersion in reporting outcomes.
Keywords: ﬁnancial reporting; IFRS; leasing; principles-based standards; rules-based
rinciples-based accounting standards are typically characterized as containing clear
statements of intent but lacking detailed implementation guidance, while rules-based
standards are generally characterized as providing greater detail regarding implementation
and compliance (SEC 2003). Taken together, these characterizations imply that, for a given
financial reporting scenario, principles-based standards require the accounting professional to
Denton L. Collins is an Associate Professor and William R. Pasewark is a Professor, both at Texas Tech
University, and Mark E. Riley is an Assistant Professor at Northern Illinois University.
Submitted: December 2010
Accepted: April 2012
Published Online: July 2012
Corresponding author: William R. Pasewark
Collins, Pasewark, and Riley
exercise judgment, while rules-based standards require professional expertise in researching the
Most accounting standards, whether U.S. GAAP or IFRS, are to some extent rules based in that
they contain rules for entities to follow when accounting for specific transactions. However,
accounting standards vary in their degree of specificity, or ‘‘bright lines,’’ such that the more
specific standards tend to be classified as rules based while the less specific standards are classified
as principles based. The U.S. GAAP lease accounting standard (ASC 840) contains a significant
amount of bright-line guidance. Meanwhile, the IFRS lease accounting standard (IAS 17) contains
far less bright-line guidance, requiring accountants to exercise professional judgment in making
reporting decisions. Given the SEC’s (2003) categorization of accounting standards described
above, it seems reasonable to characterize the U.S. standard as rules based and the IFRS standard as
Recent experimental research by Agoglia et al. (2011) finds that different approaches (‘‘less
precise’’ versus ‘‘more precise’’) to accounting standard setting lead to different conclusions in
classification of leasing transactions. To determine if the Agoglia et al. (2011) experimental result
obtains in leasing transactions occurring during the normal course of business, we use archival data
to investigate whether corporations subject to rules-based standards (U.S. GAAP) report leases
differently than corporations that utilize principles-based standards (IFRS). We examine this issue
from the perspective of the lessee, rather than the lessor.
Those favoring rules-based standards argue that the detailed guidance contained in such
standards reduces diversity in application of the standards, thereby enhancing financial statements’
consistency and comparability. However, critics of rules-based standards argue that such standards
encourage firms to structure transactions in such a way that they comply with a strict reading of the
rules while avoiding the intent of such rules. Proponents of principles-based standards, while
acknowledging the potential for diversity in application, assert that the likelihood of varied
interpretation decreases when well-trained professionals apply good judgment. The proponents also
suggest the increased disclosure required under principles-based guidance mitigates diversity in
judgment. Both the Financial Accounting Standards Board (FASB) and the SEC suggest that
standards without bright lines may force preparers to look beyond the form of the transaction to
concentrate on its economic substance (FASB 2002; SEC 2003). However, critics of a
principles-based approach to standard setting argue that, because principles-based standards
require extensive professional judgment, such standards lead to more diverse financial reporting
outcomes (Niemeier 2008).
In light of these competing views, we also investigate whether reporting regime type is
associated with the dispersion in reporting outcomes. As motivation, the experimental results
reported by Agoglia et al. (2011) suggest that principles-based standards are associated with lower
variability in lease classification when compared to rules-based standards. But this result has not
been confirmed in an archival setting. Thus, we conduct our study to determine whether the lack of
quantitative specificity (bright lines) in the IFRS lease accounting standard (IAS 17) promotes more
or less dispersion in lease classification when compared to the high degree of quantitative
specificity present in the U.S. GAAP lease accounting standard (ASC 840).
Before investigating differences in reporting outcomes under rules-based versus principlesbased standards, we first determine whether differences in standards are associated with differences
in lease utilization. That is, do the different standards create different incentives to lease versus
purchase productive capacity? We perform this analysis first since differing incentives to lease
versus purchase arising from different standards could suggest our subsequent lease classification
analyses are also influenced by these differing incentives. We measure lease utilization in two ways:
(1) the lease obligation as a percent of total assets, and (2) lease payments as a percent of total
Financial Reporting Outcomes under Rules-Based and Principles-Based Accounting Standards
revenue. We find no evidence that a difference in accounting standards is associated with a
difference in the degree to which firms use leasing to acquire productive capacity.
Turning our attention to our main research questions, we find strong evidence that the
classification of leases as operating versus capital differs with reporting regime. Specifically, we
measure lease classification by (1) expressing the capital lease obligation as a percent of the total
lease obligation, and (2) expressing capital lease payments as a percent of total lease payments. Our
sample consists of 64 large corporations, 32 that utilize U.S. GAAP and 32 that utilize IFRS,
matched in pairs based on the industry in which they participate. Our analyses reveal that U.S.
GAAP firms are more likely to classify leases as operating leases compared to IFRS firms, which
confirms in an archival setting the experimental findings of Agoglia et al. (2011). Note that this
result also supports the SEC’s concerns that reporting regime will influence reporting choices.
However, the finding is at odds with Tweedie’s (2008) assertion that IFRS results ‘‘are not far away
from what you have.’’ Also consistent with Agoglia et al. (2011), but inconsistent with the SEC’s
concerns, we find no evidence that the use of IFRS guidance in lease reporting is associated with
greater dispersion of our lease classification metrics. This latter result suggests that the concerns
expressed by the SEC (2003) and Sunder (2009), that application of principles-based standards
could lead to greater dispersion in financial reporting outcomes, may be unwarranted.
Our paper contributes to the accounting literature in at least four important ways. First, we
examine recent financial recognition, reporting, and disclosure data on firms’ leasing activities from
2007 to 2009, thus reporting fresh evidence regarding leasing behavior since the earlier work of
Imhoff and Thomas (1988). Second, we update the literature on how companies account for leases
in the period immediately prior to the issuance of the FASB’s exposure draft on a new leasing
standard. Such evidence can be useful in assessing the impact of changing accounting standards.
Third, we explicitly compare lease-reporting practices for firms following U.S. GAAP (ASC 840)
and IFRS (IAS 17). To our knowledge, the accounting literature reports no evidence on actual lease
reporting behavior of firms currently operating under U.S. GAAP versus IFRS. Clearly, as the
FASB and IASB move toward the development of joint standards, and as the SEC considers
adoption of IFRS, it is useful to understand how these different accounting standards might lead to
different reporting outcomes. Finally, and most importantly, we offer archival evidence that
complements the experimental results reported by Agoglia et al. (2011). To summarize, our archival
results suggest that reporting under IFRS is associated with a greater tendency to adopt capital/
finance lease classification when compared to reporting under U.S. GAAP, and that the use of IFRS
does not appear to give rise to greater dispersion in classification.
The remainder of our paper is structured as follows. In the next section, we review the literature
regarding rules- and principles-based standards, and compare U.S. GAAP and IFRS lease
accounting standards. We then present a brief review of the literature associated with lease
disclosures and firm behavior. Next, we develop our hypotheses, describe our sample and
methodology, and present our results. Our final section discusses the implications of our results.
The Rules- versus Principles-Based Argument
Several authors have argued that both U.S. GAAP and IFRS are principles based. Schipper
(2003, 62) contends that U.S. GAAP is based on ‘‘a recognizable set of principles derived from the
FASB’s Conceptual Framework.’’ Nelson (2003, 91) states that ‘‘[b]ecause U.S. accounting
standards typically are written to operationalize the FASB’s underlying conceptual framework, they
are based on principles.’’ However, he also notes that U.S. GAAP utilizes an ‘‘incremental
perspective’’ in which rules added to a standard increase the standard’s precision, but also its
complexity. Nelson (2003, 91) defines ‘‘rules’’ as ‘‘specific criteria, ‘bright-line’ thresholds,
Collins, Pasewark, and Riley
examples, scope restrictions, exceptions, subsequent precedents, implementation guidance, etc.’’
While both regimes may be principles based, U.S. GAAP typically incorporates many more rules
The argument over rules-based versus principles-based standards is potentially moot unless it
can be shown that the regimes result in different reporting/disclosure outcomes. Indeed, much of the
debate and criticism about IFRS adoption in the United States revolves around the lack of
specificity associated with principles-based standards, with opponents arguing that less guidance
and greater judgment will likely result in more diverse interpretations, treatments, and practices.
Sunder (2009, 104) makes the point succinctly:
High-quality standards based on principles instead of rules are supposed to help generate
financial reports that are more useful by reason of being more comparable across firms,
industries, and countries . . . A general principle is concise and calls for judgment in its
application, which must necessarily vary across individuals and situations, giving rise to
greater variability in applications than a more detailed rule—presumably calling for less
Schipper (2003) speculates that lack of specificity in standards could give rise to volatility in
reported accounting numbers. Similarly, the SEC (2003), in its study on the adoption of principlesbased accounting standards, acknowledges and discusses the consistency and comparability
problems inherent with both principles-only standards and rules-based standards. The SEC’s
concerns with principles-only and rules-based accounting standards are expressed as follows (SEC
2003; italics added):
Principles-only standards may present enforcement difficulties because they provide little
guidance or structure for exercising professional judgment by preparers and auditors.
Rules-based standards often provide a vehicle for circumventing the intention of the
The expressed concern of the SEC is that either too much guidance in the form of bright-line tests or
too little guidance can reduce the usefulness of financial statements to users. In essence, the SEC is
saying that rules-based standards tend to emphasize form over substance, leading to poor reporting
quality. In contrast, principles-only standards hurt comparability and consistency as interpretations
of the principles vary across time and companies. Niemeier (2008) believes that the lack of
specificity makes principles-based standards ‘‘not appropriate for use in a regulatory context. By
design, they are of limited enforceability.’’
The arguments presented above suggest that different accounting regimes will likely give rise
to different accounting outcomes.1 On the other hand, at least one prominent participant in the
debate suggests there will be little difference in accounting outcomes. Specifically, Sir David
Tweedie, former chairman of the International Accounting Standards Board (IASB), speaking as
chairman in 2008 to an audience in the United States, asserted:
What you have that the rest of the world frankly does not want is a volume of guidance.
U.S. GAAP is [over] 25,000 pages. [IFRS are] just over 2,500, yet the results are not far
away from what you have.
The interesting (and explicit) aspect of this statement is the notion that significantly different
approaches to standard setting (i.e., principles-based versus rules-based) yield outcom …
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