Journal of Applied Research in Accounting and Finance
Vol 8 (1) June 2013
Capitalisation of Operating Leases and Credit Ratings by Brett D Cotten, Douglas K Schneider and Mark G McCarthy
The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) will re-expose in the first half of 2013 a revised joint proposal for a new lease accounting standard (FASB 2012). The proposed standard requires lessees to record operating leases as debt, making it more difficult for lessees to avoid liability recognition. We examine whether or not the debt impact of operating leases is reflected in bond ratings. Using the methodology of Damodaran (2009), we compare firms' actual credit ratings with synthetic ratings calculated using both reported financial statement data and financial statement data that has been adjusted to reflect the debt treatment of operating leases. We find that when operating leases are treated as debt, coverage ratios and synthetic ratings are significantly lower than those created under current accounting rules. In addition, we find that the actual ratings are significantly lower than unadjusted synthetic ratings, while synthetic ratings calculated using adjusted data approximate the actual ratings. This suggests that the debt impact of operating leases is important to ratings agencies and that the agencies incorporate available information into their ratings. However, information available under current accounting rules is incomplete. Given the importance of lease information and the incompleteness of the data available under current accounting rules, we suggest ratings may become more accurate under the proposed standard.
Separating Winners from Losers Among Value and Growth Stocks in Canada: Another Step in the Value Investing Process by George Athanassakos
The paper investigates two questions (a) whether there is value premium in a sample of Canadian non-interlisted stocks for the period May 1, 1985-April 30, 2009, and (b) whether an additional step to screening for possibly undervalued stocks can be employed to separate the good stocks from the bad ones, as not all low P/E stocks are worth investing in. The paper extends this analysis to both value and growth stocks. We document a consistently strong value premium over the May 1, 1985-April 30, 2009 sample period, which persists in both bull and bear markets, as well as in recessions and recoveries. We show that the value premium is not driven by a few outliers, but it is pervasive. Our results are consistent with, but, in general, stronger than, those of other Canadian and US studies. We were able to construct a composite score indicator (SCORE), combining various fundamental and market metrics, which enabled us to predict future stock returns and separate the winners from the losers among value and growth stocks. A strategy which would involve shorting the high SCORE value stocks and buying the low SCORE value stocks would have beaten the low P/E portfolio by about 30% over the May 1, 1985-April 30, 2009 period. On the other hand, shorting the high SCORE growth stocks and buying the low SCORE growth stocks would have beaten the high P/E portfolio by about 40% over the same period. We also find that the return of a portfolio strategy that buys (sells) stocks that rank low (high) in the composite score indicator has significant explanatory power in an asset pricing model framework. Results remain robust out of sample.
Two Steps Backward and One Step Forward: The IASB's Response to Off-Balance Sheet Financing Through Investments in Other Entities by Mark D Hughes and Simon J Hoy
In the wake of the Global Financial Crisis, a number of influential stakeholders called on the International Accounting Standards Board (IASB) to improve the quality of accounting rules relating to investments in other entities. This paper argues that rather than heeding these calls, the IASB's response has led to an increase in opportunities for entities to engage in off-balance sheet financing through the use of potential voting rights and supermajorities. This paper demonstrates how the rules on potential voting rights have been relaxed and shows that under the comparatively more restrictive IAS 27, the use of supermajorities is already used by approximately 28 per cent of the top 100 Australian- listed companies, as these entities do not consolidate majority-held investees. Evidence is presented which indicates these entities tend to be larger, have less favourable leverage and have better efficiency ratios, compared to entities which do not disclose these structures. The paper also uses a case study to demonstrate the impact this variant of off-balance sheet financing can have on the general- purpose financial reports of investing companies.