Accounting for Lease Renewal Options: The Informational Effects of Unit of Account Choices
51 Pages Posted: 29 Jul 2011
Date Written: July 27, 2011
This study examines the informational effects of unit of account choices in the context of a proposed standard on lease accounting. Standard setters have tentatively decided that leases in excess of one year should be recognized on a lessee’s balance sheet, including optional lease periods, even though the lessee can choose not to renew the lease. We argue that this approach lacks representational faithfulness and creates an informational problem for users. Using an experiment, we show that the proposed treatment of renewal options has a negative effect on lenders’ willingness to lend to a firm with renewal options. However, we also show that disaggregating the capitalized optional renewal periods from the fixed-term lease obligation mitigates some of the negative effects of the proposed approach, particularly when disaggregation occurs on the face of the financial statements. These results should be of interest to standard setters as they deliberate changes to lease accounting and when considering the tradeoffs that can arise with expansive unit of account choices.
Keywords: functional fixation, leasing, lending, presentation effects, unit of account
JEL Classification: C91, M41
Suggested Citation: Suggested Citation