OVERVIEW OF LEASE ACCOUNTING
The evolution of lease activities and lease accounting
1.1.1 The evolution of lease activities
A lease is a contractual agreement that outlines the conditions under which a property owner (lessor) rents their asset to a tenant (lessee) This contract ensures that the tenant has the right to use the property while the owner receives regular payments for a designated timeframe Failure to adhere to the lease terms by either party can result in penalties.
The practice of leasing property dates back to around 2000 BC, with early rentals involving agricultural tools, draft animals, and land use rights Aristotle (384-322 BC) emphasized that renting was essential for social production, stating that the essence of property lies in its use rather than ownership, as the utilization of property generates wealth This early recognition of rental agreements facilitated production and business activities, allowing freelance farmers and craftsmen to hire idle resources such as tools, land, and livestock The significance of these lease transactions grew so substantial that by 1700 BC, King Hammurabi of the Babylonian dynasty established laws to regulate them.
By the early 19th century, advancements in science and technology led to a flourishing commodity economy, resulting in a wide variety of products As society progressed, human needs and demands continued to grow, reflecting the dynamic interplay between innovation and consumer expectations.
In situations where individuals or organizations cannot or do not need to invest in sufficient equipment for production and consumption, rental transactions have emerged as a viable solution, leading to significant growth in quantity, type, and value As society evolves, traditional asset leasing has struggled to meet the new demands of participants in these transactions, paving the way for financial leasing to complement operating leases Businesses lacking capital often opt for financial leasing to acquire machinery or production lines, while even financially stable companies may prefer leasing to avoid costs associated with asset depreciation.
1.1.2 The evolution of lease accounting
The rapid growth and popularity of leasing globally necessitate robust accounting standards to accurately reflect these activities in financial statements In response, research and regulations regarding rental property accounting have evolved significantly over time These standards focus on the point at which a lease transfers most risks and benefits to the lessee, enhancing the quality of information on lease transactions and providing users with a clearer understanding of a company's financial health.
In 1949, lease accounting was officially introduced to address the rapid growth of leasing activities, leading to the development of progressive accounting standards that accurately reflect the leasing market and company operations Originating in the United States, leasing accounting gained prominence there before other countries adopted their own asset rental accounting standards tailored to their unique characteristics Consequently, various leasing accounting models emerged worldwide, each with different recognition systems To unify these approaches, the International Accounting Standards Committee (IASC) was established, tasked with consolidating the diverse accounting models into a common standard for accurately reporting leasing activities in companies' financial statements.
1.1.3 Introduction of IAS 17 and its drawbacks
The International Accounting Standard IAS 17, effective from January 1, 1984, and reissued in December 1997, is the leading standard for lease accounting It establishes the accounting policies and disclosure requirements for lessees and lessors, classifying leases into finance leases, where risks and rewards of ownership are transferred, and operating leases, where the asset remains on the lessor's balance sheet The classification of leases is crucial, as it significantly impacts financial statements; a lease is deemed a finance lease if it transfers substantially all ownership risks and rewards, while all other leases are classified as operating leases IAS 17 emphasizes that the classification depends on the substance of the transaction rather than its form and provides specific scenarios for identifying finance leases, along with detailed accounting guidance for both lessors and lessees, including treatment for sales and leaseback transactions.
IAS 17 requires firms to classify leases into two types, leading to drawbacks that prompted reform A significant loophole is off-balance-sheet financing, allowing companies to manipulate financial statements to avoid reporting liabilities The criteria for lease classification are subjective and vague, particularly regarding the term “substantially transferred,” making it difficult for companies to determine the appropriate lease type Some companies exploit this ambiguity by adjusting lease contracts to qualify as operating leases, thereby concealing debt obligations from the balance sheet Although these adjustments can be revealed in the notes, most users, aside from auditors, often overlook them By modifying contract terms—such as ensuring no transfer of ownership, no bargain-purchase option, a shorter lease term than the asset's economic life, and keeping the present value of minimum payments below 90% of the asset's fair value—companies can classify leases as operating, resulting in no recorded assets or liabilities This manipulation impacts the company's total assets and liabilities, significantly affecting financial ratios like the debt-to-equity ratio.
In a comparison of two firms, A and B, both hire identical machines with a capacity, size, and value that allow for an economic life of 10 to 12 years Firm A enters into a financial lease with a contract term of 8 years, utilizing 80% of the asset's economic life, while Firm B opts for a lease term of 7 years, covering 70% of the machine's lifespan.
An asset with an operational lease is recognized over its 11-year useful life, resulting in minimal differences in benefits between 7 and 8 years However, company A records a lease liability, while company B simply accounts for rental expenses annually in their profit and loss statement This discrepancy leads to a higher debt-to-equity (D/E) ratio for company A compared to company B, making A appear riskier despite both firms being in similar financial situations.
Off-balance sheet financing under IAS 17 diminishes the comparability of financial statements, as analysts often adjust publicly available data to account for operating lease obligations These adjustments impact key financial metrics such as total liabilities, debt-to-equity ratios, and profit-to-total-assets ratios However, the lack of uniform guidance in accounting standards leads to varied adjustment methods and assumptions, resulting in inconsistent interpretations of the same transactions The G4 + 1 (1996) report recommended that replacing current accounting rules on operating and financial leases with a uniform method would enhance comparability and usefulness Additionally, the disparity between IAS 17 and other standards, such as IAS 39/IFRS 9, creates conflicts in lease accounting, further complicating the financial landscape for users, particularly shareholders, investors, and lenders, who may be misled about a company's financial position and face challenges in comparing companies that lease versus those that purchase assets.
The reform of lease accounting and IFRS 16
1.2.1 Overview of the reform of lease accounting
In response to the transparency issues and potential manipulation associated with IAS 17, the Group of Four Plus One (G4 + 1) collaborated with the IASB in 1996 to propose a converged standard that aimed to eliminate operating leases This initiative laid the groundwork for a new lease accounting standard In 2010, the IASB published the first Exposure Draft, which suggested that all leases be reported on the balance sheet as both assets and liabilities, though this model faced significant criticism After extensive discussions and revisions with stakeholders, the second Exposure Draft was released, reinforcing the requirement to include all leases, except short-term leases, on the balance sheet Ultimately, the IASB issued IFRS 16 in January 2016, which became effective on January 1, 2019.
The proposal to eliminate operating leases sparked both support and opposition, particularly following the G4+1 initiative launched in 1996 Notable research, such as the detailed questionnaire survey by Goodacre, Beattie, and Thomson (2005), aimed to gauge the perspectives of users and preparers regarding the new lease standard that mandates all leases be recognized on the balance sheet Their findings indicated that finance directors and investment analysts shared concerns about the current standard's susceptibility to manipulation, lack of uniformity, and failure to accurately represent the substance of transactions While investment analysts largely supported the principles outlined in the G4+1 proposals, finance directors were less enthusiastic Nonetheless, both groups acknowledged that many operating leases would result in increased assets and liabilities on the balance sheet, consequently raising reported gearing measures.
After the implementation of IFRS 16, which replaced IAS 17, Bunea (2017) analyzed feedback from 641 individuals, including auditors and entities reliant on leased assets The general consensus indicated that preparers are open to accepting conceptually unsubstantiated solutions if they result in cost savings However, both auditors and the European Financial Reporting Advisory Group emphasized the importance of a unified model for both lessors and lessees.
Qualitative research on lease accounting reform indicates that users are generally open to the transition; however, preparers exhibit reluctance due to the perceived benefits of the old standard, leading to hesitation in fully embracing the new guidelines.
IFRS 16 aims to define the principles for the recording, measurement, and presentation of lease assets, ensuring that both lessees and lessors deliver relevant and transparent information during transactions.
Under IFRS 16, a unified accounting model mandates lessees to recognize assets and liabilities for all leases, except those with a term of 12 months or less or involving low-value assets In contrast, lessor accounting remains largely unchanged from IAS 17, allowing for continued classification of leases as operating or finance Additionally, IFRS 16 introduces a revised definition of a lease, closely resembling the previous definition under IAS.
17 However, when it comes to services contract, companies need to be very careful IFRS 16 provides a detailed guidance to determine whether the contract is a lease contract or a service contract (non-lease contract) The 3 main questions company needs to make clear to identify whether the contract can be classified as a lease (adjusted by IAS 16) or a non-lease contract (mostly adjusted by IFRS 15) are: (1) Whether an underlying asset can be identified? (2) Does lessee have the right to gain most of the economic benefits of using leased asset during the lease term? (3) Does lessee have the right to direct the use of asset?
Under IFRS 16, companies must differentiate between lease and non-lease components of rental or lease payments The lease component is accounted for under IFRS 16 if it meets specific criteria, while the service component is typically treated as an expense in profit or loss Following this standard's reform, lessees are required to recognize a right-of-use asset and a corresponding liability on their statement of financial position Additionally, the asset must be depreciated and the liability amortized over the lease term, resembling the accounting treatment for finance leases under IAS 17.
Table 1 below illustrates the key differences between IAS 17 and IFRS 16, emphasizing the updates introduced by IFRS 16 aimed at enhancing the transparency of lease accounting and improving comparability across financial statements.
Table 1: The difference between IAS 17 and IFRS 16
Operating leases off-balance sheet as a single expense Finance leases on balance sheet
Operating leases recognize assets and liabilities on balance sheet Operating leases to report depreciation and interest separately
Focus on whether lessee or lessor carries the risk and reward Both lease and non-lease components accounted off balance sheet
More focus on who controls the ROU asset, linking with IFRS 15 Non-lease components still excluded, but lease components will need to be reported on
Focus on lease type from an operational perspective Many lessees used operating leases to avoid balance sheet recognition
Others prefer the reduced risk and reward, as well as the competitive pricing that operating leases offer
Lease type has a lower impact from an accounting standpoint, however, a greater focus is placed upon on the deal types that can be negotiated
Operating leases are generally simpler to account for than finance leases, resulting in a higher volume of operating leases compared to finance leases Consequently, accounting departments face fewer complex calculations in managing these leases.
Under the new standard, however, as all leases will be treated under the same accounting treatment, accounting departments will have a higher volume of complex amortization calculations to perform
Finance leased assets and liabilities are measured at the fair value of the
Measures the lease liabilities at the
PV of the lease payments that are not leased property or, if lower the PV of the minimum lease payments
The discount rate for calculating the present value (PV) of minimal lease payments should be the implicit rate if known; otherwise, it defaults to the lessee's borrowing rate Initial direct costs incurred by the lessee are included in the asset's value, discounted using the implicit rate if available, or the incremental borrowing rate if not Notably, the measurement does not consider fair value and is unrelated to minimal lease payments, focusing instead on unpaid lease payments.
Disclosures Disclosures cover the specific requirement of finance leases separate from operating leases
Disclosures eliminate the need for separate reporting of finance and operating leases for lessees, mandating instead the disclosure of right-of-use assets and liabilities Additionally, lessees must provide specific disclosures indicating whether they have chosen not to apply IFRS.
Disclosures are mandatory for short-term and low-value leases, particularly when elections are made regarding these lease types Additionally, variable lease payments are excluded from the calculation of lease liabilities.
The reassessment of liabilities under IFRS 16 represents a significant shift from the previous IAS 17 lease accounting standards Unlike IAS 17, which allowed companies to establish a fixed allocation schedule for lease accounting, IFRS 16 requires firms to reassess critical lease components, such as the lease term, at each reporting period This ongoing evaluation ensures that financial statements reflect the most current market conditions, enhancing the accuracy and relevance of lease-related financial information.
IFRS 16 is anticipated to enhance capital allocation by improving credit and investment decision-making for both investors and companies, as noted by the IASB in 2016 This standard is expected to impact the reported figures of nearly 50% of listed companies, particularly in North America, where 62% of IFRS and US GAAP companies disclose off-balance-sheet leases due to a well-developed leasing market.
Table 2: The use of off balance sheet leases by listed companies throughout the world
Percentage of IFRS / US GAAP companies who disclose off balance sheet leases
Total future minimum payments for off balance sheet leases (undiscounted)
PV of future minimum payments for off balance sheet leases (estimate)
LITERATURE REVIEW ON LEASE ACCOUNTING AND
The empirical researches on lease accounting
Lease accounting has been a contentious issue since the 1990s and remains a significant topic today Research indicates that IAS 17 and similar lease accounting standards have loopholes that facilitate off-balance sheet financing Numerous studies have explored the impact of lease capitalization on financial ratios, assessing the quantitative effects before and after capitalization Additionally, while not directly addressed, the relationship between accounting quality and lease propensity has also emerged as a pertinent consideration.
2.1.1 Loophole of lease accounting under IAS 17
The G4+1 (1999) in their Special Report "Leases: Implementation of a New Approach" highlighted that under the International Accounting Standards (IAS 17), leases are classified as either financial or operating based on the transfer of risks and benefits from the lessor to the lessee This classification allows leasing companies to exploit regulatory loopholes, often misclassifying lease assets as operating leases to avoid recognizing liabilities on financial statements This practice is motivated by the desire to prevent an increase in the debt ratio and other financial metrics that could negatively impact the company's financial position.
Bohušová, Svoboda, and Blašková (2014) highlight the ambiguity and subjectivity in classifying lease terms after initial recognition in lessees' financial statements They argue that lease terms based solely on the primary lease duration are heavily influenced by the reporting entity's perspective The IASB and FASB's joint Leases project aimed to eliminate this subjectivity in lease recognition and measurement, a goal that would be compromised if entities could choose from multiple classification options Additionally, fluctuations in both external and internal conditions could necessitate frequent remeasurement of lease-related items on the lessee's side, underscoring the need for established rules governing the periodic review of estimates.
Also agree that IAS 17 contains loopholes that result in off-balance sheet financing, Dechow, Sloan and Sweeney (1995), Duke et al (2002), Goodacre (2003),
Ge (2006), Beatty, Liao and Weber (2010), Franzen, Cornaggia and Simin (2011) carried out researches to examine the impact of this problem
Research on off-balance sheet financing explores various aspects, primarily focusing on two key approaches: the relationship between accounting quality and leasing, and the connection between financial ratios and leasing While the body of research examining the relationship between accounting quality and leasing is relatively scarce, a significant amount of literature has concentrated on the relationship between financial ratios and leasing.
Operating leases are a crucial financing source for numerous companies, as highlighted by Goodacre (2003) The inclusion of operating leases on the lessee's balance sheet could notably affect key performance metrics, particularly gearing ratios.
Franzen, Cornaggia, and Simin (2011) discovered a dramatic 745% increase in off-balance sheet leases as a percentage of total debt from 1980 to 2007, while capital leases relative to total debt declined This off-balance sheet accounting treatment for lease financing plays a crucial role in shaping corporate capital structure, as rising off-balance sheet leasing leads to a decrease in conventional debt ratios.
Contributing to the motivation of off-balance sheet financing, Duke et al
Research from 2002 indicates a strong connection between leasing behavior and the degree of ownership in closely held firms Restrictive financial policy covenants tend to drive an increase in operating leases Additionally, there is a negative correlation between tax rates and operating leases, while a significant positive relationship exists between the debt-to-equity ratio and operating leases.
Research indicates that financial ratios, particularly the debt ratio, are significantly influenced by off-balance sheet financing Various studies, including those by Imhoff, Lipe, and Wright (1991), Goodacre (2003), Fülbier, Silva, and Pferdehirt (2008), Bohušová (2015), Wong and Joshi (2015), and Trifts and Porter (2017), have employed the construction capitalization method to analyze the quantitative effects across diverse data samples.
2.1.3 The capitalization of operating lease and impact on financial ratios
Constructive capitalization is the most widely used method for calculating balance sheet figures and financial ratios as if lease assets were capitalized, allowing for a deeper analysis of their impact Developed by Imhoff, Lipe, and Wright in 1991, this method highlights the significant effects of capitalizing operating leases on risk and return measures, including accounting ratios Their research indicated that in fiscal 1987, capitalizing operating lease commitments for 14 U.S companies would have led to an average 34% decrease in return-on-assets for high lessees and 10% for low lessees, alongside a 191% increase in the debt-to-equity ratio for high lessees and 47% for low lessees In a subsequent study in 1997, the same authors estimated the present value of operating leases for 29 airlines and 51 grocery stores from fiscal years 1984-89, revealing a mean percentage increase in the debt-to-assets ratio of 16.2% for airlines and 15.9% for grocery stores.
After that, using the same method, Goodacre (2003), Fülbier, Silva and Pferdehirt (2008), Bohušová (2015), Wong and Joshi (2015), and Trifts and Porter
In 2017, a study examined the effects of operating lease capitalization on financial statements and analysis ratios across various sectors and economies, utilizing a substantial sample size The findings revealed that capitalizing operating leases leads to an increase in both total assets and total liabilities, while total equity experiences a decline Additionally, the debt-to-equity (D/E) and debt-to-assets (D/A) ratios both rise post-capitalization Conversely, profitability ratios, specifically return on assets (ROA) and return on equity (ROE), show a significant decrease.
Trifts and Porter (2017) discovered that specific industries, particularly Retail, experienced a significantly aggressive increase in financial metrics While the median change in total assets for 1,000 firms was only 2.6% and the average was 7.3%, the Food Retail industry saw an impressive average change of 63.3% Additionally, the average change in debt ratio across sectors was 3.9% with a median of 1.6%, but the Retail Trade–Miscellaneous Retail segment, represented by Michaels Company, reported a remarkable 17.2% change in debt ratio Supporting this trend, Goodacre (2003), Singh (2011), and Y Tai (2013) found that capitalizing lease assets in the Food Retail sector led to more dramatic changes in financial statement figures and ratios compared to broader sector samples.
Financial reporting quality and lease propensity
The existing research on off-balance sheet financing is limited compared to the extensive studies on financial ratios This thesis aims to address the gap in lease accounting quality by focusing on this underexplored area Key contributions to this field include the works of Beatty, Liao, and Weber (2010), Ge (2011), and Balakrishnan, Core, and Verdi (2014).
Beatty, Liao, and Weber (2010) conducted a study on 3,030 manufacturing firms from 1995 to 2006, revealing that companies with lower accounting quality are more likely to lease assets Their research indicates that the relationship between accounting quality and leasing diminishes when banks have stronger monitoring incentives or when loans include capital expenditure provisions To evaluate minimum lease payments, they assumed a cost of capital of 10% and treated lease payments as a perpetuity The study utilized accruals-based metrics to assess accounting quality, focusing on the estimation of abnormal accruals through regression analysis with fundamental accounting variables such as revenue, accounts receivable, and fixed assets.
Schipper and Vincent (2003) consider the residuals of regression as indicators of abnormal or unexplained cumulative values They employed three established measures of accounting quality, adapting the deflator to address variations in accounting for operating leases compared to asset purchases, drawing from the research of Teoh, Welch, and Wong (1998), Dechow, Sloan, and Sweeney (1995), and Dechow and Dichev (2002) Additionally, factors such as dividend payments, firm size, occurrence of loss years, and marginal tax rates are also linked to a company's propensity to lease.
Ge (2011) found that off-balance sheet operating lease activities negatively impact future earnings and stock returns, suggesting that information from operating lease footnotes can predict these financial outcomes The study utilized data from the statement of cash flows to calculate total accruals, representing the difference between earnings and free cash flows In this context, accounting quality is defined as predictability, reflecting the ability to forecast future profitability based on current profits, highlighting the overall usefulness of financial information for making predictions Additionally, Schipper and Vincent (2003) reviewed the quality of accounting information research and categorized it based on the time-series properties of earnings.
Balakrishnan, Core, and Verdi (2014) investigate the impact of changes in a firm's real estate asset values on its financing capacity, focusing on the relationship between reporting quality and investment decisions Their study reveals that firms with higher reporting quality experience less fluctuation in financing and investment due to changes in leased asset values compared to those with lower reporting quality Additionally, firms tend to enhance their reporting quality when faced with reduced financing capacity This research, encompassing 25,839 firm-year observations, employs the accruals quality measurement developed by Dechow and Dichev (2002) and refined by Francis et al (2005), which calculates accruals quality based on the standard deviation of residuals from a regression analysis involving total current accruals and various cash flow metrics.
Research on the relationship between accounting quality and leasing propensity remains limited, particularly in developed markets like the United States, where companies have leveraged the loopholes in IAS 17 to manipulate financial statements Evidence suggests that firms opting for leases over purchases prioritize their public financial image over actual accounting quality While some findings exist in developed countries, the applicability of these insights to developing nations, such as Vietnam, remains uncertain In Vietnam's emerging market, where leasing is still gaining traction, it is crucial to explore whether companies exploit existing accounting standards to influence the relationship between leasing tendencies and accounting quality, as well as the impact of improved debt ratios on asset leasing decisions This thesis aims to investigate the interplay between accounting quality and various factors influencing leasing propensity.
Research hypothesis development
In recent years, leasing activities have experienced significant growth, yet the sector remains underdeveloped due to its status as a relatively new field Despite the limited popularity and scale of lease transactions among market participants and guiding regulations, leasing is beginning to permeate various sectors and businesses of all sizes However, it has not garnered adequate attention from regulators and stakeholders involved in leasing, as existing regulations are often simplistic and can even conflict with one another.
The current lease accounting standard, VAS 06, closely mirrors IAS 17 by classifying leases into operating and financing categories, resulting in distinct treatment for each Financial leases are recognized as assets and liabilities on the balance sheet, while operating leases are recorded solely in the income statement as rental payments This similarity perpetuates existing loopholes, allowing firms to manipulate financial statements Additionally, there is a notable lack of research on lease-related regulations and standards Future research should focus on the relationship between accounting quality and leasing propensity, building on the findings of Beatty, Liao, and Weber.
Current accounting regulations in Vietnam present potential loopholes for creative accounting, particularly in leasing activities, which are often overlooked by many enterprises Consequently, the flaws in lease accounting are not viewed as critical or urgent issues To address this, empirical evidence is needed to establish a suitable approach and necessary preparations for the adoption of IFRS and IAS in the near future.
This research highlights the impact of lease accounting on accounting quality, revealing that firms with lower accounting quality often exploit loopholes in existing lease accounting regulations to manipulate their financial statements.
H1: A firm’s tendency to lease instead of buying declines in its accounting quality
This is the main hypothesis of the research Similar to the research of Beatty, Liao and Weber (2010), this thesis is looking for the acceptance on this hypothesis
Besides, come to the question of whether other factors like tax rate, gearing, ROA, size, growth have correlations with leasing propensity, there will be the following 5 hypothesis:
H2.1: The lease propensity of firm is decrease when tax rate increase
H2.2: The lease propensity of firm is increase when gearing increase
H2.3: The lease propensity of firm is increase when ROA increase
H2.4: The lease propensity of firm is increase when size increase
H2.5: The lease propensity of firm is increase when growth increase
These hypothesis shall be solve within a single model
Chapter 2 reviews empirical research on lease contract classification, highlighting its main directions, purposes, methods, and results It identifies significant loopholes in the criteria for classifying leases as operating or financing, leading to off-balance sheet financing, a topic of considerable interest among researchers The two primary approaches discussed are lease capitalization and its impact on financial ratios, and the factors influencing lease propensity over purchasing, with accounting quality being a crucial element While the majority of research focuses on lease capitalization, there is a notable lack of attention on lease propensity, particularly in developed countries This research aims to bridge that gap by exploring the relationship between accounting quality and factors such as tax rate, gearing, ROA, firm size, and growth in the context of lease propensity, with hypotheses developed based on the current landscape of lease activities and accounting practices in Vietnam.
RESEARCH BACKGROUND AND METHODOLOGY
Lease activities and lease accounting in Vietnam
Leasing is gaining popularity in Vietnam as an effective and convenient financing method, enhancing the diversity of credit options, particularly for mid and long-term needs This approach alleviates capital challenges for businesses, facilitating the modernization of machinery, equipment, and technology.
Leasing activities in Vietnam have emerged relatively recently compared to global standards, resulting in a limited scope and popularity of lease transactions This delay has led to fewer market participants and a lack of comprehensive guiding regulations in the sector.
The leasing market in Vietnam is rapidly expanding across various sectors and business sizes, despite the lack of comprehensive statistics In the airline industry, for instance, Vietjet Air leases 95% of its fixed assets, primarily aircraft, through sale and leaseback arrangements, while Vietnam Airlines finances over 75% of its fleet through leasing since 2015 The retail sector, encompassing groceries, fashion, jewelry, and electronics, also heavily relies on leasing; Vincommerce has acquired all 2,880 VinMart+ stores through leasing, and Elise leases all 106 of its stores In manufacturing, companies often lease expensive equipment that cannot be produced domestically, such as aircraft and large ships Financial institutions and tech companies lease spaces for their branches and offices, and even small businesses benefit from leasing as a low-risk, efficient financing option for property use.
Leasing presents a significant opportunity for lessors in Vietnam, where, as of December 31, 2019, there are 10 financial leasing companies with a combined charter capital exceeding 4,500 billion VND These companies primarily serve small and medium enterprises, newly established businesses, and private firms, demonstrating that leasing effectively addresses the limitations of traditional money lending This financing method provides a vital capital channel for businesses that may not qualify for bank loans.
Leasing has significantly enhanced efficiency for businesses by alleviating capital investment challenges and providing access to modern technology and equipment This approach is particularly beneficial for companies undergoing restructuring and technological upgrades However, as leasing activities continue to expand in Vietnam, businesses must navigate various emerging challenges.
The financial services sector in Vietnam, while promising and beneficial to the economy, is constrained by a limited operational network consisting of only 10 companies, predominantly based in major cities—6 in Ho Chi Minh City and 4 in Hanoi This narrow network pales in comparison to the extensive reach of commercial banks There is a significant demand for medium and long-term capital, as many businesses seek to expand and innovate but struggle to secure bank loans, particularly in areas where leasing services are unavailable Consequently, a disconnect exists between suppliers and demanders in the leasing market Overall, leasing as a financing method remains underutilized in Vietnam, presenting challenges for both consumers and providers due to its relative novelty.
The legal regulations on leasing activities
Despite existing regulations aimed at safeguarding the leasing company's ownership of leased assets, these rights lack robust legal guarantees and effective enforcement measures Consequently, lessees can still dispose of or mortgage these assets Additionally, the legal framework for resolving disputes related to rental contracts remains ambiguous, leaving the question of which agency will handle arbitration in such cases unresolved.
The choice between leasing and buying an asset
When companies consider how to access the rights to use assets, they face the choice between buying or leasing While leasing is often seen as a simpler financing option since it doesn't require mortgages, many banks are now providing appealing interest rates and relaxed loan conditions to compete with leasing companies For instance, state-owned enterprises can borrow without needing to mortgage their assets Consequently, leasing companies must engage in intense competition upon entering the market.
Leasing activities in Vietnam are experiencing growth and gaining popularity; however, challenges remain, including inadequate legal regulations and an undervalued demand for leasing as a financing option.
To accurately represent lease contracts in companies' financial statements, the Government and the Ministry of Finance have released numerous legal documents and Circulars to guide the accounting treatment of asset leasing activities.
In Vietnam, lease accounting is governed by VAS 6 – Leases, established by the Minister of Finance in Decision No 165/2002/QD-BTC on December 31, 2002 This standard outlines the accounting principles and methods for both lessees and lessors, covering financial and operating leases in a coherent manner, serving as the foundation for financial statement preparation VAS 6 is based on IAS 17, maintaining the core principles despite minor differences.
Table 5: Comparison between IAS 17 and VAS 06
IAS 17 Leases prescribes the accounting policies and disclosures applicable to leases, both for lessees and lessors Leases are required to be classified as either finance leases (which transfer substantially all the risks and rewards incidental to ownership, and give rise to asset and liability recognition by the lessee and a lease receivable by the lessor) and operating leases (which result in expense recognition by the lessee, with the asset remaining recognized by the lessor) IAS 17 was reissued in December 2003 and applies to annual periods beginning on or after 1 January 2005 IAS 17 is to be replaced by IFRS 16 - Leases from 1 January 2019
VAS 6 is fairly similar to IAS 17 There are areas in IAS 17 which are silent in VAS
IAS 17 requires that manufacturers or dealer lessors shall recognize selling profit or loss in the period, in accordance with the policy followed by the entity for outright sales If artificially low rates of interest are quoted, selling profit shall be restricted to that which would apply if a market rate of interest were charged
Manufacturers or dealer lessors incur costs related to negotiating and arranging leases, which are recognized as expenses when the selling profit is acknowledged Although IAS 17 does not provide a specific definition for manufacturers or dealer lessors, a general understanding of these terms is widely accepted in the industry.
VAS 6 is silent on this manufacturer/dealer lessor as a lessor that either manufactures the leased asset or acquires the leased asset as part of its dealing activities The difference as compared to a ‘normal’ lessor is the cost at which the lessor acquires an asset for lease The manufacturer/dealer obtains the asset at its cost of manufacture or at a wholesale price, so its cost will be below a normal selling price to other customers
Research methodology
After gathering the essential data, I will conduct an analysis of the variables and perform calculations The statistical software STATA will be utilized to execute regression analysis and other statistical evaluations Below are the specifics regarding the empirical model, definitions of variables, measurements, and data collection methods.
This research builds upon the model developed by Beatty, Liao, and Weber (2010) while acknowledging the limitations in data availability in Vietnam Due to the lack of information transparency, certain variables from the original model were modified and adjusted to better fit the accessible database This adaptation aims to enhance the model's predictive accuracy in alignment with the unique characteristics of Vietnam's market dynamics.
This model highlights the limitations of the previous lease standard, where companies relied on operating leases to manage performance, leading to the exclusion of operating leases from the balance sheet and only disclosing them in financial statement notes Following the original method proposed by Imhoff, Eugene A, Lipe, and Wright (1991), the study introduces a constructive capitalization approach for long-term operating lease commitments, ensuring that both assets and liabilities are recorded on lessees' balance sheets To capitalize total minimum lease payments, the research applies specific assumptions: the discount rate is based on the estimated average interest rate for mid to long-term loans over five years (2014-2018), with detailed calculations provided in Appendix D; payments due within one year are discounted at t=0, those from one to five years at t=3, and payments over five years at t=5 The variable Lease is calculated as the present value (PV) of total minimum payments divided by the sum of property, plant, and equipment (PPE) and the PV of total minimum payments.
Tax is considered to be a factor to why firms prefer leasing over buying
According to Duke et al (2002), tax rate and operating lease have negative relation
In Vietnam, rental expenses are deductible for enterprises leasing assets from individuals, as outlined in Clause 2, Article 4 of Circular 96/2015/TT-BTC To determine these deductible expenses, businesses must maintain the property lease contract and documentation of rental payments.
The lease equation can be expressed as Lease = β0 + β1*AccQual + β2*Tax + β3*Gearing + β4*ROA + β5*Growth + β6*Size + ε By opting for leasing instead of making substantial investments to acquire assets, companies can benefit from tax-deductible period payments Tax is calculated as the current tax expenses divided by net income before tax for the period, excluding deferred tax since rental expenses are deductible in both tax and accounting bases Consequently, it is anticipated that tax will have a negative correlation with leasing activities.
Off-balance sheet leasing allows companies to keep liabilities off their financial statements, effectively lowering their debt ratios According to Franzen, Cornaggia, and Simin (2011), increasing the use of operating leases can be a strategic choice for firms with high debt ratios By opting for operating leases instead of purchasing assets, companies can utilize the necessary resources without exacerbating their debt levels.
This study investigates the relationship between gearing and lease increases, with gearing defined as the ratio of average total assets to average total equity.
The profitability of firms can be shown through ROA ratio According to
Wong and Joshi (2015) found that capitalizing operating leases significantly reduces the mean Return on Assets (ROA) Off-balance sheet financing not only adds to liabilities but also keeps certain assets off the balance sheet, resulting in a lower denominator for ROA calculations This suggests that maintaining a high ROA could incentivize firms to opt for leasing rather than purchasing assets ROA is calculated as net income divided by average total assets.
Size and growth serve as key control variables influencing firms' leasing decisions Companies may prefer leasing over purchasing when expanding, especially if they have lower financial burdens associated with larger size and better growth Research indicates that the relationship between size, growth, and leasing can vary, depending on the prevailing circumstances In Vietnam, where many firms rely on borrowed capital, the tendency to lease is more pronounced Here, size is measured by total assets, while growth is calculated as the change in net revenue divided by initial total equity.
The measurement of accounting quality in this study utilizes a model adapted from Teoh, Welch, and Wong (1998) and modified by Beatty, Liao, and Weber (2010), focusing on accrual quality This approach evaluates profit quality by analyzing the interplay between profit, accruals, and cash flow Abnormal accruals are estimated using fundamental accounting parameters, with the cumulative sum regressed against basic variables such as revenue and accounts receivable The residuals from this regression serve as indicators of abnormal or unexplained cumulative values.
Beatty, Liao, and Weber (2010) modified the original model by substituting total assets with the combined value of property, plant, and equipment (PPE) and capitalized minimum lease payments This adjustment was made to address the impact of off-balance sheet accounting practices related to operating leases on the denominator.
AccQual is determined as the negative of the absolute value of current discretionary accruals, following the methodology of Teoh, Welch, and Wong (1998) Essentially, it represents the residuals from both the general and sample models of current accruals A higher absolute value indicates a lower level of explicability for the accruals The negative sign is introduced to highlight the inverse relationship between AccQual and Lease The initial step involves estimating a regression to obtain the necessary coefficients.
After that, the minus absolute value of discretionary accruals - AccQual is then calculated as:
–|Current_Acc/Total_Inv – α^0*(1/Total_Inv)
Current_Acc = Net income before tax – Cash flow from operating activities +
Total_Inv = The sum of PPE and capitalized lease expenditure; ΔRev = Change in sales; ΔAR = Change in accounts receivables
To sum up, the detail calculation of each variables is described in table 7:
Lease PV of total minimum payments divided by the sum of PPE and the PV of total minimum payments
Tax Current tax expenses divided by net income before tax in the period
Gearing Averaged total asset divided by averaged total equity
ROA Net income divided by averaged total assets
Growth Change in net revenue divided by the beginning total equity
After reviewing the financial statements of publicly listed firms in the Cafef database, it was found that only companies audited by Big Four firms and Baker Tilly extensively disclose lease commitments in their notes Consequently, this study focuses on firms audited by these five audit firms Initially, the thesis aimed to concentrate on the Retail and Airline sectors, as they are the most impacted by lease capitalization according to IASB (2016) and PwC (2016) However, due to the limited number of companies in these sectors that publicly disclose their financial statements, the scope has been expanded to include seven sectors, as detailed in Table 8, with the exception of the Airline industry, which has a notably smaller representation.
Out of four firms, two disclosed their financial statements, with the initial focus on the retail industry before evenly distributing the analysis across five additional sectors A random observation of approximately 40 companies in the retail sector and 25-30 companies in the remaining sectors was conducted over a five-year period from 2014 to 2018 Due to many companies not releasing reports for 2019 because of COVID-19 delays, that year’s data was excluded from the sample Companies that did not disclose operating leases in their financial statements for the entire five-year period were eliminated, resulting in a final sample of 45 firms and a total of 225 observations Detailed distribution can be found in Table 8.
Sector Number of company In %
(Calculated and summarized by author)
The sample encompasses various sectors, with Retail being the most concentrated due to its susceptibility to lease capitalization, as noted by the IASB in 2016 Other sectors represented include Manufacturing, Service, Medical, Information Technology, Energy, and Airline Although the Airline sector is significantly impacted by lease agreements, Vietnam has only four airline companies, with just two publicly disclosing their financial statements, resulting in the Airline sector comprising only 4% of the total sample In contrast, the Retail sector accounts for 27%, while the remaining sectors contribute between 9% and 20%.
EMPIRICAL RESULTS, DISCUSSION AND IMPLICATION
Empirical results
Using the data described above, descriptive statistic, regression and test were carried out The detail results are as follow:
Table 9: Summarize of lease model variables
Variable Obs Mean Std Dev Min Max
(Calculated by author using STATA software)
Lease : The PV of total minimum lease payments divided by (PPE plus PV of total minimum lease payments)
AccQual : the negative of absolute value of current discretionary accruals based on Teoh, Welch and Wong, (1998)
Tax : The current tax expense divided by net income before tax
Gearing : The averaged total assets over averaged total equity
ROA : The net income divided by averaged total assets
Growth : The change in net revenue divided by the beginning total equity
Table 9 summarizes the variables, revealing that the lease has a mean of 25.8%, with a significant gap between the minimum and maximum values Additionally, the primary variable, AccQual, also exhibits a substantial disparity.
The average lease percentage varies significantly by sector, with the Airline industry at 89% and the Medical sector at just 5% The Retail sector aligns with expectations at an average of 42% According to IASB (2016), Airlines and Retail are the two sectors most influenced by leases However, comparisons across the remaining sectors are limited due to differing classifications in various countries Notably, Information Technology, Energy, and Medical/Healthcare are among the top ten sectors impacted by lease capitalization, while Service and Manufacturing are not, likely due to varying sector definitions Overall, lease rates in Vietnam are considerably higher than those reported by IASB (2016), with the Airline sector being 3.92 times higher and Information Technology 6.33 times higher.
In Figure 2, the trend of Lease and AccQual through the 5 years period is visualized Noted that all the figures represent for the year ended (period), not at a
During the sampled period, lease propensity and accounting quality (AccQual) generally exhibit opposing trends, with the exception of 2016 when both variables declined simultaneously Notably, more significant fluctuations in lease propensity correspond with dramatic shifts in AccQual Throughout the first half of the period, leasing propensity decreased but began to recover in 2017 Over five years, lease propensity experienced a slight decline of 0.4%, while accounting quality saw a modest increase of 0.03.
Figure 2: The trend of Lease and AccQual for the 5 years period
The financial situation of the sample over the years, as illustrated in Figure 3, reveals a gradual increase in the sample size, reflecting a growing trend in total assets with an average rise of 3,000 billion While both gearing and return on assets (ROA) show fluctuations, the average leverage increases by 2%, and average ROA decreases by 1.1% This indicates that as firms expand, they rely more on debt to finance their assets, and despite the growth in total assets, the increase in income may not keep pace with the expansion in size.
Figure 3: Financial situation of companies for the 5 years period
(Summarized by author) The pairwise correlations of variables presented in Table 10
Table 10: Pearson correlation coefficients for lease model variables
Lease AccQual Tax Gearing ROA Size Growth Lease 1.0000
*indicates strong evidence with p-value less than 5%
(Calculated by author using STATA software)
AccQual is negatively related with Lease, which is consist with the prediction
The analysis reveals that Gearing, Size, and Growth exhibit a strong correlation with Lease, all with p-values below 1% Among these, Gearing shows the most significant relationship with Lease, boasting a coefficient of 30% This suggests a higher likelihood of the initial scenario occurring in Vietnam In contrast, Tax and ROA demonstrate minimal correlation with Lease, as indicated by their larger p-values Notably, Tax retains a negative sign, while ROA maintains a positive sign, aligning with expectations Furthermore, the findings indicate a strong relationship between Tax, ROA, and Size, while ROA and Gearing negatively impact each other.
The coefficients from regression of the empirical model (*) is presented below
Table 11: Coefficients from OLS estimations
(Calculated by author using STATA software)
The R-squared value of 27.05% indicates that the independent variables explain 27.05% of the variance in Lease, which is below the typical benchmark of 50% However, given the nature of the financial model, this level of explanation is acceptable Supporting this, research by Beatty, Liao, and Weber (2010) found an R-squared of 33% using reliable Compustat data Additionally, all variables in the model have p-values below 5%, with variables such as AccQual, Gearing, and Size showing p-values close to 0, signifying significant correlations.
Before analyzing the results presented in Table 11, three essential tests were conducted to identify potential regression errors, specifically focusing on multicollinearity, heteroskedasticity, and autocorrelation, as detailed in Tables 12 to 14 The analysis utilized widely recognized tests, including the Variance Inflation Factor (VIF) for multicollinearity, the Breusch-Pagan/Cook-Weisberg test for heteroskedasticity, and the Breusch-Godfrey LM test for autocorrelation.
(Calculated by author using STATA software)
In the test for multicollinearity, each and the mean variance inflation factor is 1.37 which is less than 2, indicate that there is no multicollinearity phenomenon between independent variables
Table 13: Breusch-Pagan / Cook-Weisberg test for Heteroskedasticity
Variables: fitted values of Lease chi2(1) = 12.60
(Calculated by author using STATA software)
The Breusch-Pagan test was used to detect heteroskedasticity The Prob value is equal to 0.3%, so H0 is reject Therefore, have to accept the hypothesis H1: The variance is not homogenous
Table 14: Breusch-Godfrey LM test for Autocorrelation
H0: no serial correlation lags(p) chi2 df Prob > chi2
(Calculated by author using STATA software)
The Breusch-Godfrey test indicates that with a probability value below 5%, we reject the null hypothesis (H0) of no serial correlation, confirming the presence of an autocorrelation phenomenon.
Heteroskedasticity and autocorrelation were identified across the three tests conducted To address this, Robust Standard Errors, as proposed by White (1980), were utilized to provide coefficient estimates without relying on the assumption of constant variance The findings are presented in Table 15 below.
The coefficients remain unchanged when compared to the initial results in Table 11; however, variations in standard errors lead to different p-values Despite these changes, all p-values are below 5%, confirming that the coefficients retain their statistical significance.
Table 15: Coefficients from regression using Robust Standard errors
(Calculated by author using STATA software)
The study reveals that AccQual and Tax have a negative relationship with leasing, while four other factors show a positive correlation Specifically, changes in accounting quality account for a 2% variance in leasing behavior Conversely, a decrease in the tax rate leads to a 19.8% increase in leasing propensity Additionally, a 1% rise in Gearing and ROA results in increases of 5.3% and 49.2% in leasing tendencies, respectively Furthermore, as Size and Growth expand, their inclination towards leasing activities also rises, indicating a positive association between these factors and leasing.
The discussion and possible reasons for these results are detailed in the following part.
Discussion on the results
With the above results, the status of all hypothesis is presented in table 16:
Table 16: The results of Hypothesis
H1: A firm’s tendency to lease instead of buying declines in its accounting quality
H2.1: The lease propensity of firm is decrease when tax rate increase
H2.2: The lease propensity of firm is increase when gearing increase
H2.3: The lease propensity of firm is increase when
H2.4: The lease propensity of firm is increase when size increase
H2.5: The lease propensity of firm is increase when growth increase
The study reveals a negative relationship between accounting quality (AccQual) and leasing practices, indicating that lower accounting quality correlates with a higher likelihood of firms opting for leasing, particularly operating leases, instead of purchasing assets This finding aligns with the initial hypothesis, suggesting that firms exploit existing loopholes in lease accounting standards to manipulate their financial reporting Furthermore, these results corroborate the conclusions drawn by Beatty, Liao, and Weber (2010).
The negative coefficient of Tax aligns with previous predictions, indicating that in multivariate regression, lower Tax correlates with higher Lease Unlike the Pearson model, which shows no association between Tax and Lease, leasing assets allows firms to fully deduct rental payments from their taxes This means that, depending on the tax rate, the cost of acquiring asset usage rights decreases proportionately with the tax rate on total payments Consequently, leasing is driven by tax incentives, as higher tax rates enable firms to gain more from leasing assets Research by El-Gazzar, Lilien and Pastena (1986), Duke et al (2002), and Beatty, Liao and Weber (2010) supports this relationship between tax rates and leasing propensity.
Gearing positively influences leasing, serving as a tool for adjusting debt and profitability ratios Off-balance sheet financing allows firms to conceal debt, resulting in a lower perceived liability on the balance sheet This manipulation affects the return on equity (ROE), as companies can control ROE by managing their reported debt levels However, investors may discern the reasons behind a high ROE, making increased leverage a risky strategy By engaging in off-balance sheet financing, firms can limit liability growth and decrease debt relative to capital employed Research by Franzen, Cornaggia, and Simin (2009), Bohušová, Svoboda, and Blašková (2014), Tai (2013), Wong and Joshi (2015), and IASB (2016) indicates that capitalization leads to increased debt ratios Additionally, a high debt ratio, as indicated by gearing, encourages firms to lease assets to maintain control over their debt levels.
Return on Equity (ROE) is influenced by Gearing, but Return on Assets (ROA) plays a more crucial role in explaining the increase in ROE for both companies and investors According to Wong and Joshi (2015), after capitalization, ROA can decrease significantly by 15.35%, while the mean ROE declines by 1.23% This decline occurs because leases are not only hidden from liabilities but also from assets, which affect the ROA denominator By utilizing leased assets, firms can maintain a higher ROA, leading to improved ROE Consequently, companies can enhance their profitability ratios through operating leases, suggesting that when ROA is at risk of falling, firms may opt to manage their asset levels by leasing to present a favorable ROA to stakeholders.
In Vietnam, the relationship between firm size and growth indicates a trend towards leasing as a financing option for fixed assets, contrary to the findings of Beatty, Liao, and Weber (2010), which suggested that larger firms face fewer financial constraints As firms expand their operations, they increasingly opt for leasing, highlighting the unique dynamics of the Vietnamese capital market, which remains heavily reliant on bank financing In this context, bank credit serves as the primary means of capital mobilization within the economy.
In Vietnam, the size of firms often does not align with financial constraints, as larger companies may face increased risks due to the need for borrowed capital to fund expansion Consequently, leasing emerges as a more cost-effective and efficient solution for gaining access to necessary assets.
The findings align with initial predictions, indicating that lower accounting quality leads firms to exploit standard loopholes for tax benefits and financial result manipulation, as reflected in solvency and profitability ratios Additionally, the size and growth of firms in Vietnam correlate with their leasing tendencies These results provide quantitative evidence of the shortcomings of IAS 17 and VAS 06 Consequently, the anticipated adoption of IAS and IFRS, especially IFRS 16, is expected to enhance the quality of accounting information in Vietnam.
Limitation of the research
In the scope of this topic and within my ability, this thesis contains some limitation that can be the direction of future researches
The thesis is limited by a small sample size due to restricted access to public data and the time constraints involved in manual data collection Additionally, not all companies disclose their operating lease commitments in their financial statement notes, which further constrains the sample Greater access to data could have expanded the sample size, providing a more comprehensive representation of the overall landscape.
Second, this thesis only use the one simple model of Teoh, Welch and Wong,
Since 1998, various methodologies have been developed to calculate accounting quality Key contributions from researchers such as Francis et al (2004), Francis, Olsson, and Schipper (2008), Schipper and Vincent (2003), and Dechow, Ge, and Schrand (2010) have summarized the criteria for assessing reporting quality These criteria provide a foundation for measuring accounting quality in future research efforts.
The variables and measurements utilized in this thesis model account for only a portion of the variance in leasing propensity compared to buying Consequently, the calculations are based on assumptions Future research should consider incorporating additional factors and measurements into the model, allowing assumptions to be substituted with actual data for more accurate results.
Despite utilizing robust standard errors, the regression model's results still exhibit some inaccuracies Future research could enhance these results by expanding the sample size, altering variable combinations and their measurements, or employing alternative modeling approaches.
Implication and recommendation for adoption of IFRS 16 – Leases 50
The findings indicate that in Vietnam, companies' propensity to lease is linked to low accounting quality The sample firms have engaged in leasing for over five years, suggesting a deliberate choice to utilize leased assets Whether these firms are fully aware of the loopholes in current accounting standards or are inadvertently benefiting from leased assets, their use of such assets undeniably affects debt ratios and profitability metrics This situation leads to misconceptions among users regarding the financial statements of these companies, diminishing comparability With the impending adoption of IFRS in Vietnam, lease accounting should be a primary focus, especially given the rapid growth of leasing trends.
The transition from the current accounting system in Vietnam to IFRS represents a significant shift, marked by substantial differences and advancements Understanding the ethical framework and methodologies of IFRS is crucial for interpreting the implications of financial statements within the Vietnamese financial market The key distinctions between Vietnamese Accounting Standards (VAS) and IFRS highlight the core aspects of Vietnamese financial statements.
The primary ethical principle of IFRS is to ensure that financial statements are disclosed transparently in the financial market, thereby preventing misleading information that does not accurately represent a company's financial status and business performance.
The new lease standard IFRS 16, effective January 1, 2019, is set to be implemented in Vietnam following the Ministry of Finance's "Decision No.345/QD-BTC," which establishes a voluntary application starting in 2022 and mandatory adoption by 2025 This standard mandates that all leased assets be recorded on the balance sheet, aligning with loan presentations, thus eliminating the previous practice of off-balance sheet reporting that distorted financial representations Although current regulations do not allow for off-balance sheet recording of long-term leased assets like aircraft, previous standards created loopholes that companies exploited The enforcement of IFRS 16 aims to close these gaps, enhancing the integrity of financial statements, including the Statement of Financial Position, Income Statement, and Cash Flow Statement Consequently, the implementation of IFRS 16 is expected to enhance transparency and accountability in the financial reporting of both lessors and lessees, ultimately benefiting users of financial information through improved statement quality.
So in the preparation state of the upcoming adoption of IAS and IFRS, some issues that lawmakers, regulators and the Ministry of Finance need to consider are:
- Definitions and regulations should be revised to match IFRS in general and that related to lease of assets and IFRS 16 in particular to avoid confusion for implementers;
- Encourage businesses to gradually apply new standards to reduce workload and costs when the application becomes mandatory;
- Quickly complete and publish the Vietnamese version of the standards, so that businesses can widely soon understand the new direction as well as for educational purposes
For Vietnamese enterprises, it is necessary to be prepared for change by starting to take actions:
- Understand the financial impact of IFRS 16 on the financial statements and the main measures of the company;
Effectively evaluate the implications of capital structure and the impact on stakeholders due to fluctuating financial indicators Implement strategies that enable businesses to proactively address these changes and engage in negotiations with relevant parties as needed.
- Examine whether IFRS 16 will impact their future financial structure to avoid disadvantages and difficulties in negotiations with lenders;
- Assess whether the current system and process is fit for IFRS 16 and gradually makes changes if necessary;
- Start sorting the current leased asset portfolio and identifying gaps in the data need to be fulfilled
Accountants, auditors, analysts, and investors must swiftly enhance their understanding of new standards Continuous education and training are crucial, as these professionals will directly implement IFRS in the preparation and utilization of accounting information.
IFRS 16 introduces significant changes for various industries and businesses, making it essential for all entities to prepare for its mandatory implementation by 2025 Enterprises, particularly those with numerous lease contracts, will be most affected, facing complex and time-consuming adjustments Consequently, Vietnamese businesses must gain a comprehensive understanding of IFRS 16 to effectively account for leased assets in the near future.
The weaknesses in IAS 17 have prompted significant reforms in lease accounting, leading to the issuance of IFRS 16, which became effective in early 2019 This new standard eliminates operating leases, significantly affecting the financial reporting of numerous firms Research consistently indicates that this change will enhance transparency and improve overall accounting quality, making the mandatory adoption of IFRS 16 a pivotal development in financial reporting practices.
IFRS and IAS in Vietnam from 2025 will accompany with this new lease standard
And same other IFRS adopter in the world, it is believed that accounting quality in
Vietnam after application of new standard will be improved, including accounting for lease, as VAS 06 was built on IAS 17
Research analyzing data from 45 listed companies between 2014 and 2018 indicates that firms with poor accounting quality, as measured by accrual quality, are more likely to prefer leasing over purchasing Additionally, a lower tax rate correlates with a higher propensity for leasing In contrast, factors such as solvency, profitability ratios, company size, and growth exhibit a positive relationship with leasing practices.
Firms in Vietnam may exploit existing loopholes in the current lease standards to manipulate their reporting information This raises concerns about the deficiencies of these standards, suggesting that the forthcoming adoption of IFRS and IAS will enhance the quality of reported information.
Vietnam is actively preparing for the adoption of IFRS, necessitating significant changes and preparations It is essential for regulators, businesses, users, and preparers to take prompt action Gradual updates should be implemented as soon as possible to minimize workload and costs when the application becomes mandatory.
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APPENDIX Appendix A: IAS 17 Leases – Guidance of IAS Overview
IAS 17 Leases prescribes the accounting policies and disclosures applicable to leases, both for lessees and lessors Leases are required to be classified as either finance leases (which transfer substantially all the risks and rewards of ownership, and give rise to asset and liability recognition by the lessee and a receivable by the lessor) and operating leases (which result in expense recognition by the lessee, with the asset remaining recognized by the lessor)
IAS 17 was reissued in December 2003 and applies to annual periods beginning on or after 1 January 2005 IAS 17 will be superseded by IFRS 16 Leases as of 1 January 2019
The objective of IAS 17 (1997) is to prescribe, for lessees and lessors, the appropriate accounting policies and disclosures to apply in relation to finance and operating leases
IAS 17 applies to all leases other than lease agreements for minerals, oil, natural gas, and similar regenerative resources and licensing agreements for films, videos, plays, manuscripts, patents, copyrights, and similar items [IAS 17.2]
However, IAS 17 does not apply as the basis of measurement for the following leased assets: [IAS 17.2]
Property held by lessees that is accounted for as investment property for which the lessee uses the fair value model set out in IAS 40;
Investment property provided by lessors under operating leases (see IAS 40);
Biological assets held by lessees under finance leases (see IAS 41); and
Biological assets provided by lessors under operating leases (see IAS 41)
A lease is designated as a finance lease when it significantly transfers the risks and rewards associated with ownership, while all other leases fall under the category of operating leases This classification occurs at the lease's inception, in accordance with IAS 17.4.
Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form
Situations that would normally lead to a lease being classified as a finance lease include the following: [IAS 17.10]
The lease transfers ownership of the asset to the lessee by the end of the lease term;
The lessee can buy the asset at a price anticipated to be significantly lower than its fair value when the purchase option becomes available, making it reasonably certain that the option will be exercised at the start of the lease.
The lease term is for the major part of the economic life of the asset, even if title is not transferred;
At the inception of the lease, the PV of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset;
The lease assets are of a specialized nature such that only the lessee can use them without major modifications being made
Other situations that might also lead to classification as a finance lease are: [IAS 17.11]
If the lessee is entitled to cancel the lease, the lessor's losses associated with the cancellation are borne by the lessee;
Gains or losses from fluctuations in the fair value of the residual fall to the lessee (for example, by means of a rebate of lease payments);
The lessee has the ability to continue to lease for a secondary period at a rent that is substantially lower than market rent