Read the article by Kate Burgess entitled 'Leasing rules new liability for top 20' in Financial Accounting in the News 3.7 and answer the following questions: (a) Why would companies have preferred to treat the leases as operating leases (if there is an operating lease then the assets and liabilities associated with leased asset are not shown on the statement of financial position) rather than finance leases (if the lease were a finance lease then the liabilities and assets associated with the lease would be shown on the statement of financial position)? (b) Explain why the change in the accounting standard for leasing might cause organisations to breach covenants included within debt contracts. (c) What is the difference between debt covenants that rely upon 'floating GAAP' and those relying on 'fixed GAAP', and which provides less risk to the borrower? (d) Which organisations would be more likely to lobby against the accounting standard? Leasing rules new liability for top 20 Kate Burgess The Australian Financial Review, 19 August, 2010 The rules, issued by the London-based International Accounting Standards Board yesterday, will require airlines, retailers and other companies to recognise billions of dollars of leased assets now held off balance sheet. The changes will increase debt levels, putting some companies in breach of debt covenants, making it harder for businesses trying to secure finance in the next two years. When the changes are adopted, Woolworths will have to increase liabilities on its balance sheet by $4.96 billion, Wesfarmers by $4.73 billion and Qantas by $3.96 billion, based on their most recent accounts. The accounting rulemakers hope the changes will stop companies window dressing their accounts by under-reporting liabilities. This will end one of the big rorts in accounting. The lease standard is not precise and companies have been able to leave major assets off their balance sheets,' Grant Thornton partner Keith Reilly said. The new rules will also hit banks that own branches through sale and leaseback agreements and any company that leases its head office premises. Woolworths chief financial officer Tom Pockett described any comment that companies were under-reporting liabilities as 'sensationalist' and said the changes would add complexity with few benefits. 'The initial significant negative impact is, for those companies that have long-term debt in place, their debt covenants could be breached. Many of these covenants may be difficult to change because of the long-term nature of the debt,' he said. Virgin Blue chief financial officer Keith Neate said gearing levels would increase but that operating leases, which stood at $655 million in the 2009 financial year, were counted as a liability when reporting to the board. 'We don't have covenants tied to our aircraft financing or on any other debt financing. We have no corporate debt. It's a disclosure issue more for us,' he said. A Qantas spokesman said long-term commitments were considered in gearing calculations but did not specify if this included leases. Companies that had debt covenants would need to meet with their lenders to renegotiate these terms, Mr Neate added. The changes affect only operating leases, where typically the asset is not purchased and is not maintained by the owner of the asset. Finance leases, where the risks are transferred to the lessee, are already reported as balance sheet liabilities. The new rules will apply globally from around 2013. Stamping out the use of leases to window dress company accounts is a long-held ambition of IASB chairman David Tweedie. He has said on several occasions that he hopes one day to fly on an aircraft that is held on a company balance sheet. Mr Tweedie's Australian counterpart, the chairman of the Australian Accounting Standards Board, Kevin Stevenson, said the changes were a response to calls for more consistent accounting rules to paint a clearer picture of the financial situation. Accounting experts are calling for an extension on the typical time given to companies to get used to new accounting rules due to the expected cost of compliance. 'Companies need to ensure a good transitional period because there will be significant system changes to be analysed,' KPMG partner Kris Pearch said, adding that more than 12 months was needed. All companies face a stack of paperwork to prepare for the changes, as they must trawl through records of lease agreements, identify and classify each one and transfer it to the new accounting method. Credit ratings are unlikely to be affected as ratings agencies already factor in off-balance-sheet arrangements but security arrangements over assets may be affected when leases are recognised on balance sheets. Bankers said companies would need to discuss higher gearing levels with their banks but said most S&P/ASX 200 companies would not risk breaching covenants if operating leases were recognised. 'There are standard clauses in documents that deal with changes in accounting standards. Most large corporates should have additional headroom to accommodate a bit of extra leasing,' Westpac head of loans and syndications for NSW Gavin Chappell said. Aircraft leases typically carry a charge over the aircraft itself, but syndicated loans on corporate balance sheets can be unsecured or have general charges over the company's assets or cash flows, said Deutsche Bank analyst Cameron McDonald. Retailers would have to estimate the present value of rents based on turnover of inflation for each year of a lease, which can run up to 20 years, for each store leased   10.28 Paddy Manning's article in Financial Accounting in the News 10.7, 'Hardie asbestos costs soar—New report puts liabilities $500m above estimates', discusses how James Hardie Industries set up a trust to provide funds to claimants who had taken action against companies in the James Hardie Group for the effects of exposure to asbestos. On the basis of the allegations that the trust has been underfunded, do you think James Hardie should have made any reference to the alleged shortfall within its annual report of the time and, if so, what form should such a disclosure take? FINANCIAL ACCOUNTING IN THE NEWS10.7 Hardie asbestos costs soar—new report puts liabilities $500m above estimates Paddy Manning The Australian, 8 June 2004, p. 19 Asbestos liabilities at two former James Hardie subsidiaries are $500 million higher than earlier estimates, according to a report commissioned and released by the building materials group. James Hardie chief executive Peter Macdonald said last night that the new findings were 'extremely concerning to the directors of the company', which stands accused of underfunding a foundation set up to deal with future asbestos-related legal claims. Actuaries at accounting group KPMG found the future liabilities of the two subsidiaries, housed within the Medical Research and Compensation Fund set up by James Hardie in 2001, were now $1.57 billion. Previously both James Hardie and the MRCF had relied on actuarial estimates by Trowbridge Consulting, which put the liabilities at June 30, 2003 at $1.089 billion. The foundation relied on this figure in October, when it announced a funding shortfall of almost $800 million. In addition, KPMG has produced a new estimate of the asbestos liabilities as at February 2001, when James Hardie set up the foundation with the $293 million in funding it claimed would be enough to meet future liabilities. Using the same data, KPMG estimates liabilities when the foundation was established at $694.2 million—$372 million higher than the Trowbridge estimate of $322.6 million. KPMG said the Trowbridge assessment at the time fell 'outside the bounds of what would be regarded as reasonable actuarial advice'. The NSW Government is inquiring into the transfer of assets to the foundation by James Hardie, and whether liabilities can be met. James Hardie, which has moved its headquarters to The Netherlands, has denied it is liable for any shortfall. 'The different figures are extremely concerning to the directors of the company, who believed that the funding set aside at the time the foundation was created would meet the most likely estimate of future anticipated claims,' Mr Macdonald said. 'Directors are considering the implications of the KPMG report.' The new KPMG report claims Trowbridge underestimated the number of future mesothelioma claims, the rate of 'superimposed inflation' on compensation payments, and the rate of future nil (no payout) settlements. Superimposed inflation is the rate of increase in compensation payments awarded by courts. In the report, KPMG Actuaries director Richard Wilkinson said it was unreasonable for Trowbridge in 2000–01 to say the number of reported mesothelioma claims had already peaked. 'This was not so at a national level, nor would it have been reasonable in respect of James Hardie,' he writes. One building materials analyst said last night the 'worst case just got worse' for James Hardie. He said the present value of the increased liabilities could wipe another $1 off its share price, compounding recent heavy falls. But leading analyst David Leitch of JPMorgan, who downgraded James Hardie last week, said he would not cut his rating or valuation further. James Hardie shares have tumbled more than 10 per cent in the past month. They closed 2c higher at $6.22 yesterday, with KPMG's report released after the close of trading.