Ethical Issues in Financial Reporting: Is Intentional Structuring of Lease Contracts to Avoid Capitalization Unethical?

Journal of Business Ethics (2008) 80:4559 Springer 2007 DOI 10.1007/s10551-007-9436-y

Ethical Issues in Financial Reporting: Is Intentional Structuring of Lease Contracts to Avoid CapitalizationUnethical? Thomas J. Frecka

ABSTRACT. Under present accounting rules, lessees frequently structure contracts for leased assets, in situations where they enjoy benefits similar to outright ownership, in a way that keeps both the leased assets and related liabilities off their books. This method of accounting creates off-balance sheet financing and is called operating lease accounting. The paper debates the ethicality of intentionally structuring lease contracts to avoid disclosing leased asset and liability amounts and describes the slippery slope of rule-based accounting for synthetic leases and special purpose entities, that, in the authors opinion, led to the accounting debacles at Enron and other companies. The ethical intent that is implicit in the Securities and Exchange Commission and Financial Accounting Standards Board regulations is discussed and suggestions for improving the ethicality of financial reporting are provided.

KEY WORDS: accounting, accounting ethics, ethics and lease accounting, ethics of nancial reporting, rule-based accounting, rule-based ethics

Introduction

This paper discusses lease accounting as an example of how one can structure a discussion of ethical issues related to nancial reporting choices. The importance of this topic relates to the complexity of

issues surrounding lease accounting, the slippery slope that violating the intent of lease accounting rules leads to, and the generally gray conclusions that result from attempting to answer the question, Is intentional structuring of lease contracts to avoid capitalization unethical? A second intention of the paper is to illustrate how the question of ethics can be used to help students understand and appreciate the effects of technical nancial reporting rules. After an introduction that provides background concerning how one accounts for leases, the rest of the paper is organized as follows. Part II discusses the ethical ideals of nancial reporting as summarized by terms such fair and full disclosure and transparency. The accounting conceptual framework that is consistent with these ideals and alternative structures (principles-based versus rule-based) for specifying nancial reporting and disclosure standards are also discussed in this section as background for debating, in Part III, the ethicality of intentionally structuring lease contracts to avoid reporting assets and liabilities on the nancial statements of lessees....