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"It is time for a second overhaul of lease-accounting rules," says Peter Holgate. In 1981, when the current lease rules were developed, there was a reasonably clear distinction between leases that were equivalent to purchasing an asset (capital leases) and others that were in the nature of short-term hire (operating leases). Though unpopular, the new rule was well accepted. Gradually, though, the leasing industry became more sophisticated: The capital/operating distinction became blurred through innovation as financial engineers sought to keep debt off the balance sheet. This was particularly prevalent in the United States. A result of this innovation is that it is now time for another lease-accounting revolution. The basic idea is to abolish the distinction between capital leases and operating leases and require lessees to show all leases on the balance sheet as a liability and an asset.
REQUIRED:
a. What is the difference between a lease that is "equivalent to purchasing an asset" and "others that were in the nature of short-term hire"?
b. Why was the lease-accounting rule passed in 1981 unpopular with industry?
c. How have financial engineers sought to keep debt off the balance sheet?
d. Do you agree with Mr. Holgate's proposal? Why or why not?
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