Abstract
The issue of the formal recognition of financial events versus off-balance sheet disclosure has become more prominent in the accounting research literature ever since the United States Financial Accounting Standards Board’s request in 1992 for more research into this matter. As the current lease accounting standards adopted in many countries prescribe disclosure requirements that enable the users of financial statements to re-cast financial statements as if non-cancellable operating leases had been capitalised at their inception. the main focus of this research has centred on the treatment of these off-balance sheet commitments. The purpose of this study is to contribute to the literature in this area by examining whether the New Zealand capital market efficiently incorporates non-cancellable operating lease information into its equity risk assessments. To examine this issue, ordinary least squares regression is performed on models relating a market-based measure of total equity risk to accounting measures of asset and financial risk. Two approaches are used to capitalise the non-cancellable operating leases. The first method, the capitalisation method development by Imhoff, Lipe and Wright (1991), capitalises the off-balance sheet commitments in a manner consistent with the current treatment of finance leases. The second method, known as the factor method, is an inaccurate method believed to be frequently used by market participants. The results suggest that the New Zealand capital market does not incorporate non-cancellable operating lease information into its equity risk assessments. No association is found between total equity risk and the non-cancellable operating lease information under the two capitalisation approaches. Accordingly, it appears that in a New Zealand environment and with respect to non-cancellable operating lease information. off-balance sheet disclosure is not an adequate alternative to formal recognition.