The Value Relevance Of Straight-Lining Lease Expenses

Abstract

The International Accounting Standards Board envisions the global acceptance of International Financial Reporting Standards (IFRS). Despite attempting convergence with IFRS, some national accounting standard setters, such as in India allow for certain carve-outs in their own accounting standards so as to meet country-specific requirements for fair presentation. Indian Accounting Standards allow for operating leases with fixed inflationary linked escalations to be accounted for on an as-incurred basis in contrast to the existing requirement in IFRS to straight-line such leases. This study explores whether operating lease expenses with fixed inflationary linked escalations and accounted for on a straight-line basis provide incremental value relevance beyond the as-incurred basis.

This study exploits an occurrence in South Africa, where listed companies that previously accounted for operating leases with fixed inflationary-linked escalation clauses on an as-incurred basis, were required to straight-line those leases. Using the Ohlson (1995) valuation model this empirical study investigates the incremental value relevance of the straight-line basis over the as-incurred basis.

Results show a significant change in the association between property-related operating lease expenses and market value indicators after the effect of straight-lining is introduced. This suggests that the straight-line basis provide investors with more value relevant information than when accounting for the expense as-incurred.

Findings from this study prompt national accounting setters that allow for operating leases with fixed inflationary linked escalations to be accounted for on an as-incurred basis to consider first whether the straight-line basis do not provide more relevant information. Limiting the choice of accounting treatment may enhance comparability of financial statements.