What is the impact of the new information location of leases under the IAS 17 proposed lease standard on the materiality thresholds of auditors?

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NIVERSITY OF

A

MSTERDAM

What is the impact of the new information location of leases under the IAS 17 proposed

lease standard on the materiality thresholds of auditors?

Heleen Becht 10564373

17-06-2015

Word count: 19.194

MSc Accountancy & Control: both specialization tracks

Amsterdam Business School

Faculty Economics and Business, University of Amsterdam

Supervisor: Prof. dr.V.S. Maas

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Statement of Originality

This document is written by Heleen Becht who declares to take full responsibility for the

contents of this document.

I declare that the text and the work presented in this document is original and that no sources

other than those mentioned in the text and its references have been used in creating it.

The Faculty of Economics and Business is responsible solely for the supervision of completion

of the work, not for the contents.

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MSc Thesis

Narrative report on research into effects of the IAS 17 proposed lease accounting

standard on auditors materiality threshold decisions

Master Thesis

Student:

Heleen Becht

Student number:

10564373

Date:

17-06-2015

Program:

MSc Accountancy & Control: both specialization

tracks

University of Amsterdam:

Amsterdam Business School,

Faculty of Economics and Business

Supervisors:

Prof. dr. V.S. (Victor) Maas

University of Amsterdam, Faculty of Economics and Business, Head ABS

Accounting section.

M. (Martijn) Schoolderman

KPMG, Audit (Leisure, Tourism, Media and Entertainment), senior auditor.

University of Amsterdam

KPMG

Amsterdam Business School

Laan van Langerhuize 1

Plantage Muidergracht 12

Postbus 74500

1018 TV Amsterdam

1186 DS, Amstelveen

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4 ABSTRACT

TYPE OF THESIS Degree Project in Economics and Business for Master of Science in Accountancy & Control, 15 credits

UNIVERSITY University of Amsterdam, Amsterdam Business School, Faculty of Economics and Business

SEMESTER Spring 2015 AUTHOR Heleen Becht

SUPERVISOR Prof. dr.V.S. Maas

TITLE What is the impact of the new information location of leases under the IAS 17 proposed lease accounting standard on the materiality thresholds of auditors?

BACKGROUND AND PROBLEM DISCUSSION Many companies take the decision to lease rather than purchase assets. However, under the current lease accounting regulation many lease commitments fail to appear on balance sheet of lessees, and economically similar transactions can be accounted for differently because of the distinction between operating and finance lease. Therefore IASB and FASB jointly introduced an exposure draft that would eliminate the off-balance sheet treatment of operating leases. The proposal would have a major effect on lessees that have a large number of operating leases, like the global aviation industry, as these would now be accounted for in the same way as finance leases. The proposed IAS 17 lease accounting standard could affect the materiality decisions of auditors. PURPOSE The purpose of this thesis was to investigate what the impact was of the new information location of lease obligations (on balance sheet treatment of all lease liabilities) on materiality thresholds and audit misstatement posting thresholds of auditors. There was explored if auditors decisions change for recognizing operating leases on balance sheet under the proposed IAS 17 lease standard in their

materiality decisions.

RESEARCH DESIGN AND METHOD The research question and hypotheses were investigated by creating an experimental environment in which materiality decisions of auditors under current and proposed lease accounting setting are explored. In the proposed lease accounting setting the recognition of lease obligations on balance sheet was also divided in an experimental setting with aggregated and disaggregated information on renewal options, since renewal options are another important changed aspect of the proposed lease accounting standard. An ANOVA was conducted to test the hypotheses. RESULT AND CONCLUSION Auditors judgements on materiality thresholds and maximum amount of understatement that is recognized or disclosed are affected by the IAS 17 proposed lease accounting standard. Under the proposed lease accounting standards lower materiality thresholds and significantly lower errors in financial statements are allowed by auditors. There is no main effect for the level of aggregation of renewal options on materiality thresholds in general, nor from the AMPT that is recognized or disclosed in the different aggregation conditions.

SUGGESTION AND FURTHER RESEARCH Future research could examine if and how

disaggregation of cancellable and non-cancellable lease obligations can be used for structuring lease obligations and how this affects auditors materiality threshold decisions.

KEY WORDS Lease transaction structuring, proposed lease accounting standard, recognition vs. footnote disclosure, disaggregation, judgement and decision making, materiality thresholds

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ABBREVIATIONS

AMPT = Audit Misstatement Posting Threshold. The maximum amount of understatement

(errors) in financial statements which are allowed by auditors

DP = Discussion Paper. A document that is released by the Financial Accounting Standards

Board (FASB) which is designed to obtain initial views and comments on important issues that

the IASB will consider as it develops an Exposure Draft of a revised accounting standard

ED = Exposure Draft. A document released by the Financial Accounting Standards Board

(FASB) for public commentary on proposed new accounting standards

FASB = Financial Accounting Standards Board. Provides standards for GAAP-based financial

reports, both within and outside the United States

IFA = International Federation of Accountants

IAS = International Accounting Standards

IASB = the International Accounting Standards Board. Provides standards for IFRS-based

financial reports, global set of accounting standards.

MLP = Minimum Lease Payments

PBT = Profit Before Tax

PPE= Property Plant and Equipment

ROU asset and lease liability= Right-of-use asset and lease liability

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Table of Tables

Table 1: Demographics of participating auditors specified per experimental condition………....….25

Table 2: Experimental design………....…..26

Table 3: Correlation Matrix………....….33

Table 4.1: Z-values and skewness different panels Materiality Thresholds………...36

Table 4.2: Z-values and kurtosis different panels Materiality Thresholds……….…...36

Table 5.1: Z-values and skewness different panels AMPT……….……....37

Table 5.2: Z-values and kurtosis different panels AMPT………..……….……….37

Table 6: Kolmogorov-Smirnov test………..…….…...…...38

Table 7: Homogenity of variance (Levene’s Test)……….. ……….……...39

Table 8: Descriptive Statistics and Planned Comparisons for Hypotheses Testing……….………...42

Table 9: Results Independent-Samples Kruskal-Wallis Test………...….….47

Table 10: Descriptive Statistics and Statistical Tests for Materiality-related Measures From Exit Questionnaire……….…………..49

Table 11: Coding Scheme and Descriptive Statistics for Written Responses……….…….………52

Table 12: Descriptive Statistics for Written responses……….…...…52

Table of Figures

Figure 1: Libby’s predictive validity framework……….…………..…..…....12

Figure 2: IASB conceptual framework: Fundamental qualitative and enhanced characteristics……..…...13

Figure 3: Standard setting process by IASB………...….14

Figure 4: Finance lease versus Operating Lease………..14

Figure 5: Proposed IAS 17 standard recognition of leases (Snapshot Leases May 2013, IASB)……..….16

Figure 6: Recording lease agreements………..………..……….………...….16

Figure 7: Cause-effect relationship proposed IAS 17 lease accounting standard and materiality decisions……….…..27

Figure 8: Primary task: experiment……….………..…...29

Figure 9.1: Normality distribution materiality threshold voluntary disclosure (current IAS 17) or recognition (dis)aggregated (proposed IAS 17)………..……….…36

Figure 9.2: Normality distribution maximum amount of understatement that is recognized or disclosed under voluntary disclosure (current IAS 17) or recognition (dis)aggregated (proposed IAS 17)……...…37

Figure 10: Box plot materiality thresholds required by auditors under voluntary disclosure (current IAS 17 standard) or recognized (dis)aggregated (proposed IAS 17 standard)………40

Figure 11: Box plot maximum amount of understatement that is recognized or disclosed (AMPT) required by auditors under voluntary disclosure (current IAS 17 standard) or recognized (dis)aggregated (proposed IAS 17 standard)………..………41

Figure 12: Materiality thresholds under current versus proposed IAS 17 lease accounting standard….…44 Figure 13: Audit Misstatement Posting Threshold under current versus proposed IAS 17 lease accounting standard……….………...44

Figure 14: Materiality threshold and Audit Misstatement Posting Threshold under current versus proposed IAS 17 lease accounting standard………....………45

Figure 15: Materiality threshold required in different aggregation conditions………...46

Figure 16: Maximum amount of understatement that is recognized or disclosed in different aggregation conditions………...…..46

Figure 17: Kruskal-Wallis test results Audit Misstatement Posting Threshold under current versus proposed IAS 17 lease accounting standard……….…..….48

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1 Introduction

In this paragraph firstly the research question of the thesis is addressed. Hereafter the importance of the question is described from academic and societal point of view, following the current state of knowledge with regard to the lease accounting and materiality decisions of auditors is defined. Next the experimental design and the main findings are outlined. Finally the overall contribution of the study is pointed out.

The aim of this thesis is to investigate the effects of the proposed IAS 17 lease accounting standard on materiality thresholds and audit misstatement posting thresholds of auditors. Current leasing standards are perfectly harmonized world-wide. However as the current IAS 17 does not require lessees for an operating lease to recognize any assets or liabilities identified as arising in a lease contract on the balance sheet, consequentially hardly any leased assets appear on balance sheet. Chairman David Tweedie sketched the problem with accounting for leases under the current IAS 17 lease standard in a speech during an IASB dinner hosted by the Financial Reporting Council in Australia.

“I can guarantee almost all of you here have never flown in a plane that has appeared in the airline's balance sheet. And the reason is they tend not to buy them, they lease them.”

- Sir David Tweedie, Chairman of IASB, 2002

To decrease the limitations of the current lease regulation, IASB and FASB have jointly developed a new lease accounting model in which all lease obligations will be recorded in financial statements. In the global aviation industry, where firms heavily depend on operating leases for growth and expansion, changes in lease accounting rules will likely have a material and significant effect on financial statements. Liability recognition under the initial 2010 exposure draft was deemed likely to lead to a three-fold increase in the debt levels in the global aviation industry. Thus, impact of liability recognition in financial statements on auditors’ materiality thresholds could be extensive, since important factors in materiality judgements are net income, total and type of assets (e.g. net PPE), debt-to-equity ratio, net income-to-equity ratio, the earnings trend (Nichols, 1988), all items which are strongly influenced by the lease classification.

§1.1 Research question

If an auditor determines materiality thresholds for a company in the global aviation industry, would he set lower materiality thresholds under the current IAS 17 lease standard, than under the proposed IAS 17 lease accounting standard? And why is it that auditors (only) set lower materiality thresholds when information is recognized in financial statements than when only disclosed? When lease liabilities are recognized in financial statements, another question arises: is there a difference between aggregation and disaggregation of renewal options? And what factors could predict materiality thresholds under the proposed IAS 17 proposed lease standard?

Based on these questions this thesis is guided by the following explorative research question: “What is the impact of the new information location of leases under the IAS 17 proposed lease standard on the materiality thresholds of auditors?”. The proposed IAS 17 lease accounting standard provides a unique opportunity to study the relationship between information location, disaggregation of information (i.e. renewal options of lease obligations) and auditors’ decisions regarding materiality thresholds.

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§1.2 Relevance research question

This thesis is motivated by the forthcoming changes in the IAS 17 lease accounting standard that require that all lease arrangements, of an IFRS applying entity, must be recognized as a right-of-use asset and equivalent lease liability in the financial statements. The motives for structuring lease obligations or determining materiality thresholds are described in many articles. However, the IAS 17 proposed new lease standard provides a unique opportunity to do further research regarding effects of recognizing lease arrangements in financial statements on materiality thresholds judgements by auditors. This is important because research regarding expected impact of the proposed rules could give information about implementation planning to prevent additional financing costs and provide more reliable financial statements.

§1.3 Current state of knowledge and literature gap

Although the fields of materiality threshold decisions and lease accounting are extensively researched already, there’s no study that researched the effect of the proposed IAS 17 lease accounting standard on materiality thresholds of auditors. There is no evidence yet on auditors materiality threshold decisions with both operational and finance lease recognized on-balance, as with the proposed IAS 17 for lease accounting. Nevertheless, the effects of both information location of leases and (dis)aggregation of information on auditors materiality decisions are made clear in some articles. Research of Libby, Nelson and Hunton (2005) and Chewning et al. (1989) shows audit partners require greater correction of misstatements in recognized amounts than in the equivalent disclosed amount. Previous research also shows that publicly available financial measures explain a significant portion of the variability in auditors materiality judgments (Morris and Nichols, 1988). Variables that influence materiality decisions are most often net income, type of asset, debt-to-equity ratio, net income-to-equity ratio and the earnings trend (Blokdijk, Drieenhuizen, Simunic and Stein, 2003). Thereby, disaggregation decisions can influence auditors’ tolerance for misstatements. Research of Libby and Brown (2012) suggests that disaggregating expense items can reduce the allowable error in the disaggregated amounts, increasing the reliability of the disaggregated amounts as well as the resulting financial statement subtotals and totals.

Since IAS 17s proposed lease standard has an enormous impact on both information location and key financial ratios (Singh, 2012), there are implications of a great impact of the proposed changes on the materiality assessment decisions of auditors. By comparing various information location and disaggregation conditions, the effect of the (proposed) IAS 17 lease standard on materiality or audit misstatement posting threshold decisions of auditors is explored.

§1.4 Experimental study

To answer the research question, data is collected using an experimental research. 60 KPMG Auditors from ‘senior level’ and above determined the materiality thresholds of financial statements under the current IAS 17 with voluntary lease disclosure, or for the proposed IAS 17 standard adjusted financial statements (with aggregated or disaggregated numbers). Since the final implementation of the proposed IAS 17 standard is expected in 2017, by which it is not possible to examine the ex-post (actual) impact, doing an ex-ante research is an appropriate option. The focus will be on the perceived impact of information location under the IAS 17 lease standard on the materiality thresholds auditors instead of the actual/ex post impact.

§1.5 Main empirical findings

Auditor’s judgements on materiality thresholds and maximum amount of understatement that is recognized or disclosed are affected by the IAS 17 proposed lease accounting standard; lower materiality thresholds are allowed under the proposed lease accounting standard. A more pronounced effect is found for the maximum amount of misstatement that should be recognized or disclosed (AMPT). Under the IAS 17

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proposed lease accounting standards significantly lower errors in financial statements are allowed by auditors. However, in contrast expectations, there is no main effect for the level of aggregation of non-cancellable lease information under IAS 17 proposed lease accounting standard on materiality thresholds in general, nor for the maximum amount of understatement that is recognized or disclosed in the different aggregation conditions.

§1.6 Overall contribution of the study

The research offers unique contributions to knowledge in the auditing field. By showing if auditors do adjust when both operational and finance lease recognized on-balance, and disaggregation effects of lease renewal options in their assessment of materiality this thesis could contribute to a wider understanding of the possible effects a new lease standard could have on the materiality decisions of auditors. Research regarding impact of the proposed lease accounting standards on materiality thresholds could give information about the reliability of financial statements to prevent additional financing costs, and is interesting from both academic and societal point of view. Financial statement users, investors, creditors, regulators, and academics could find the information useful and relevant in assessing and evaluating the potential changes and corporate actions of firms who treat all of their lease arrangements on-balance. Hereby reliability effects of the recognition versus disclosure decisions for standard setters and auditors' responsibilities for providing correct materiality thresholds can be determined. By answering the research question evidence of the impact of the new form of lease accounting on materiality thresholds is established. Previous research about the proposed IAS 17 lease standard will be extended with the focus on the effect of materiality thresholds of auditors.

§1.7 Thesis structure

This thesis is structured as follows:

Chapter 2. Literature review – In this chapter the concepts and variables that are investigated in this thesis are introduced, also the theoretical perspectives that are used to develop hypothesis are presented following by the current state of our knowledge regarding possible answers to the research question Chapter 3. Hypothesis development – In this chapter testable statements that summarizes the answer to (parts of) the research question, based on what is learned from the literature review, are described. Predictions of cause-effect relationships are presented in two unambiguous hypotheses.

Chapter 4. Research Method – The participants, experimental design, procedures, experiment task, manipulations for each variables are presented and motivated.

Chapter 5. Results – In this chapter the results are discussed and compared to the theories presented in the literature review.

Chapter 6. Discussion/conclusion – The final chapter provides a summary of the thesis and a final answer to the research question. Also the contribution to academic literature is discussed, as well as the contribution to practice as this thesis will provide the reader with extensive knowledge on the

(dis)advantages of the proposed IAS 17 lease accounting standard on both materiality thresholds and audit misstatement posting thresholds, and enables auditors to link their materiality decisions to financial statement reliability. At last the most important limitations and interesting directions for future research that emerge from the study are described.

In the next paragraph a literature review on the professional accounting and auditing standards, research on recognition versus disclosure of leasing, materiality and disaggregation, and judgement and decision making as a basis for developing the research question and hypotheses is provided. The research method is then presented followed by the results and a discussion/conclusion section.

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2 Literature review

This chapter contains the literature review and is based on Libby’s predictive framework to explain the underlying mechanism that relates the theoretical constructs. First an explanation of the conceptual accounting framework of IASB is outlined. Hereafter the current and the proposed IAS 17 lease accounting standard are described following with literature about materiality. Next the theoretical perspectives that are used to develop hypothesis are described. Finally the current state of our knowledge is described by providing empirical evidence regarding similar lease accounting issues.

To determine the structure and content for this second chapter, Libby’s validity framework is used as basis (figure 1). In this framework the relevant theories, and literature become clear. As there is limited theory that already explains the research question, my research question is broken down in two phenomena and these are explained with existing theories.

Theory level

Empirics

Figure 1: Libby’s predictive validity framework The relation between materiality thresholds, audit misstatement posting thresholds, information location and level of aggregation under the current and proposed IAS 17 lease standard is further explored in this research.

§2.1 Professional accounting and auditing standards (IFRS and FASB)

The International Accounting Standards Board (IASB) is the independent standard-setting body of the IFRS foundation. The IASB is a private international standard setter, and differs from national accounting standard practices which traditionally have different objectives about the provision of decision relevant information and specific domestic rules. The mission of IASB is to develop International Financial Reporting Standards (IFRS) that bring transparency, accountability and efficiency to financial markets around the world. IFRS standards facilitate the harmonization of accounting standards around the globe

Operational Definition B Materiality judgements:

• How are materiality thresholds determined

• How are Audit Misstatement Posting Thresholds determined 1 Moderating Variables • Information location • Materiality and aggregation • Effect on pre-tax earnings Operationalization Operationalization Operational Definition A • Voluntary disclosure (Current IAS 17) -Recognition of lease arrangements (Proposed IAS 17) • (Dis)aggregation of renewal options Concept A Accounting Change Concept B Materiality Thresholds

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and furthers IASB’s ‘single market’ idea. The IFRS standards are used in 138 jurisdictions, including the G20 (IASB, 2015). IASB’s work serves the public interest by fostering trust, growth and long-term financial stability in the global economy and is based on the conceptual framework. Benefits from IFRS include that they provide an existing set of high quality standards, and that the IASB is an international, independent and autonomous standard setter. A disadvantage is it only has access to US markets in the long run. US companies mostly use FASB’s standards. FASB is a private US standard setter which is voluntary adopted by many companies and required for SEC registration. Disadvantages are FASB is hardly acceptable, and it is not possible to participate in standard setting. Currently the US is considering IFRS adoption for domestic firms, and FASB undertakes initiatives to align US GAAP and IFRS, the convergence project. In 2002 IASB and FASB agreed to work together in consultation with other national and regional bodies, the convergence project. Accounting regulations determine the market’s performance assessment and impact on the actual value of firms, even if customers do not change their behavior and even if the operating costs do not change.

Accounting standards are based on the conceptual framework (see figure 2) which is the foundation of IASB when developing and revising IFRS standards. The conceptual framework sets out the concepts that underlie the preparation and presentation of financial statements and addresses matters that are fundamental to the accounting process (IASB, 2015).

Figure 2: IASB conceptual framework: Fundamental qualitative and enhanced characteristics

The general revision process by IASB and FASB of the current IAS 17 lease standard is now described. In July 2006, after setting out the concepts that underlie the preparation and presentation of financial statements, IASB’s due process Leases started with research in which IASB considers the issues that should be added to the agenda. Hereafter the Lease project was planned and IASB decided to conduct the project together with another standard-setter (FASB) and had set up a project team. This resulted in a Discussion Paper (DP) on 19 March 2009, which provided a comprehensive overview of the Lease issues, possible approaches in addressing it, preliminary views and an invitation to comment. Following, on 17 August 2010, an Exposure Draft (ED) was issued, which was used as the main vehicle for consulting the public. An ED sets out a specific proposal already in the form of a proposed/amended standard. Its development is build on several groups. The draft was consulted by the IASB and (again) published for public comments on 21 July 2011. Comments led to publication of a revised Exposure Draft on 16 May 2013. When the

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IASB is satisfied that is has reached a conclusion on the issues arising from the exposure draft, it instructs the staff to draft an IFRS. The Boards expect to complete redeliberations in the third quarter of 2015, and a finalized IFRS is expected during 2017. The standard setting process of the IASB is summarized in figure 3 graphically below.

Figure 3: Standard setting process by IASB

§2.1.1 IAS 17 current lease accounting standard

The current accounting standard for leases (IAS 17) was introduced in 1982 and defined a lease as an agreement that conveys to the lessee a right to use an asset for a period of time (IAS 17.4, definitions). IAS 17 leases prescribes the accounting policies and disclosures applicable to leases, both for lessees and lessors. IAS 17 recognized two types of leases (figure 4): 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). Accounting treatment and disclosures required differ substantially for finance and operating leases.

Figure 4 Finance lease versus Operating lease

A finance lease is viewed similar as a debt-finance sale of an asset from the lessor to the lessee (Libby et al., 2005). Lease arrangements are capitalized and (accumulated) depreciation expense on the lease, the lease obligation based on the present value of future lease payments and reduction in lease obligation are recognized in the balance sheet (IAS 17.20). Thus the balance sheet shows an asset (the lease arrangement) and a lease liability (the lease obligation) for the lease. The result is financial statement information that stakeholders can use for their decisions.

Under operating lease a periodic rental expense to income is recognized (IAS 17.56). Operating leases are viewed as an ongoing service relationship between the lessor and the lessee, and the lessee only recognizes rental expenses in the income statement. The amount of rental expenses under operating lease differ from the amounts of depreciation and lease obligation by finance lease which is expected to lead to

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a different net income. So economically similar transactions can be accounted for differently because of the distinction between operating and finance leases. This results in a financial statement for which stakeholders should make adjustments that are arbitrary or based on estimates.

IFRS and FASB based their lease standards on different models. IAS 17 is principle based, with a distinction between finance and operating lease by having a lease term for the major part of the economic life of the leased asset where the present value of the lease payments is at least equal to substantially all of the fair value of the leased asset. Principles based lease accounting is based on use of professional judgement which leads to more diverse reporting outcomes. This reduces the consistency and comparability qualities of the conceptual framework. On the other hand US GAAP uses bright-line tests regarding lease obligations, with a distinction between finance and operating lease by having a lease term that is equal to 75 percent or more of the estimated economic life of the leased property. The present value of the minimum lease payments to be paid by the lessor equals or exceeds 90 percent of the fair value of the leased asset. However, this rules-based reporting regime could provide opportunities of structuring transactions in such a way to comply with a strict reading of the rules while avoiding the intent of such rules. Nonetheless, research of Collins, Pasewark, and Riley (2012) shows that IFRS and US GAAP regimes did not create significantly different incentives to use leasing as a means of acquiring capacity (but US GAAP firms are more likely to classify leases as operating leases).

IASB criticized the current standard for not representing the fundamental qualitative characteristics within the conceptual framework according to IASB (IASB, IAS 17, 2010). IASB/FABS concerns are that many lease commitments fail to appear on the balance sheet of lessees and similar transactions can be accounted for very differently because of the distinction between operating and finance leases. This leads to a more difficult comparability and it provides opportunities to structure transactions around desired accounting outcomes. Also operating lease accounting understates the assets and liabilities of lessees. It is difficult for investors to compare different entities and the implications of different leases.

§2.1.2 IAS 17 proposed lease accounting standard

The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) jointly introduced a discussion paper proposing changes to the existing lease accounting rules that would eliminate the off-balance sheet treatment of operating leases on March 19, 2009 (FASB, 2009). The following new exposure draft of the lease standard should overcome the criticism by increasing the decision usefulness, a more faithful representation and greater transparency about the lessee’s leverage. To improve the quality and comparability of financial reporting under IAS 17 proposed lease accounting standard, all lease arrangements are on-balance as Type A (similar to operational lease) or Type B (similar to financial lease) lease. This means bright lines will be gone. A right-of-use (ROU) asset and lease liability are recognized in the balance sheet for all lease arrangements of a firm. Figure 5 shows the effects of type A and Type B leasing on the income statement and cash flow statement.

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Figure 5: Proposed IAS 17 standard recognition of leases (Snapshot Leases May 2013, IASB)

The recognition of lease agreement under current and proposed standard are as follows:

Figure 6: recording lease agreements

In contrast to the current IAS 17 lease standard the proposed IAS 17 lease standard is straightforward regarding renewal options: if a lessee has a significant economic incentive to exercise a renewal option, the substance of the arrangement dictates that the lease term should include the additional periods contemplated in the renewal provision. The transparency increases by including all (cancellable and non-cancellable) lease obligations on the balance sheet. It gives a better view of the leverage position of a company. If lessees recorded the assets and liabilities that arise from all lease contracts, it is argued that investors would better understand leasing activity (understandability). For example Nelson (1963) showed that inter-firm comparisons were inaccurate without lease capitalization. However, one could argue that the reliability decreases since increased use of fair value. Remaining Biondi et al. (2011) conclude that the joint IASB/FASB exposure draft on accounting for leases contains some big loopholes (i.e. in the scope, spe and intragroup operations and definition of the lease term) that need to be closed off.

§2.2 Materiality

Before approaching the variables of the research, the concepts of materiality and materiality threshold decisions of auditors are described in this paragraph. The materiality threshold is the boundary between the important and the trivial. Both IAS 1 and IAS 8 define materiality as follows: information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements (IAS 1 paragraph 30 and IAS 8). The size or nature of the item, or a combination of both could be the determining factor [IAS 1.7, IAS 8.5]. Materiality is a key concept in both the theory and practice of accounting and auditing, and can be divided in planning materiality (audit materiality) and evaluation

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materiality (financial statement materiality) (Messier, Martinov-Bennie, and Eilifsen, 2005). The concepts of planning and evaluation materiality are now outlined.

Generally, auditors ‘‘allocate’’ a portion of the planning materiality to account balances or classes of transactions. This allocated amount represents the amount by which the account or class of transactions can be misstated and not be considered material. (Messier et al., 2005). Planning materiality judgements involve two separate sub-decisions: (1) the choice of an appropriate base for calculating materiality and (2) selection of a percentage for multiplying base. The base was shown to depend on the information about the perceived needs of the financial statement users and objective characteristics of the client. The percentage rate depended on information about intended use of the clients financial statements and the nature of the audit engagement (Steinbart, 1987).

At the completion of the audit, detected misstatements are compared to tolerable misstatement in order to determine if these misstatements are material enough to require adjustment of the client’s books. This is called the evaluation materiality (financial statement materiality). Robinson and Fertuck (1985) find that objectively verifiable misstatements are more likely to be material. This part of the process is typically referred to as ‘‘evaluation’’ materiality. Auditing standards indicate that, theoretically, planning materiality should be similar to evaluation materiality if it was based on the same information available at the planning stage (Messier et al., 2005). The determination of materiality thresholds is an important judgement made by the auditor when designing an audit program, since the extent of the “auditor effort” in performing the examination will vary inversely with the level of materiality thresholds. However, professional guidelines for setting the level of materiality thresholds are purposefully non-prescriptive. Messier et al. (2005), Nelson (2004), Nelson and Tan (2005), and Libby and Seybert (2009) provide relevant recent views of literature examining quantitative and qualitative benchmarks used in practice for judging reporting materiality. Most recent studies show net income before tax is the most important materiality qualitative benchmark (with a benchmark of 5% to be material).

Research of Holstrum and Messier (1982) that summarized four important areas in the materiality concept; (1) the nature of the item, (2) the structural form of the decision model, (3) the relative importance of factors used to determine materiality, and (4) materiality thresholds. As mentioned before there are no qualitative and quantitative standards of materiality judgments. Friedberg et al. (1989) show that the relationship of a misstatement to net income and the effect of a misstatement on earnings trends were consistently mentioned as affecting quantitative and qualitative materiality. For example, a commonly used rule-of-thumb is that misstatements less than 5% of profit before taxes are likely immaterial, misstatements greater than 10 percent of profit before taxes are likely material, while the materiality amounts in the intermediate range depends on the specific circumstances (Holstrum and Messier, 1982). Research of Morris and Nichols (1988) illustrates that net income dominated the auditors’ materiality decision, and other important materiality-related measures are total assets, the type of assets (e.g. net PPE), debt-to-equity ratio, net income-to-equity ratio and the earnings trend. All items which are strongly influenced by the lease classification. Drawing further on the goal of this report, companies with high debt-ratios such as at companies with considerable lease arrangements are more likely to have misstatements declared material.

§2.3 Information location, accounting principle changes and judgment and decision making

In this paragraph the current state of our knowledge and the interplay between (regulatory) changes and determining materiality thresholds described. Empirical evidence regarding similar issues are outlined by first describing research of auditors materiality thresholds decisions in recognition versus disclosure situations, hereafter auditors’ tolerance for misstatement with disaggregation of financial statement or

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reporting changes are described and finally the psychological environment of general judgement and decision making questions is outlined.

§2.3.1 Recognition and disclosure

Voluntary disclosure theories generally conclude that managers disclose information when the benefits exceed the costs (e.g., Verecchia, 1983, 2001). Research regarding voluntary disclosure and materiality considerations provides evidence on how materiality decisions vary across different types of disclosures (Heitzman, Wasley and Zimmerman, 2009). The study of Chewning, Pany, and Wheeler (1989) find that auditors allow more misstatement of disclosed amounts than recognized amounts regarding materiality thresholds because they believe those amounts tend to be more subjective or less reliable. Libby et al. (2005) show differences between recognition versus disclosure and auditor tolerance for misstatements and the reliability of stock compensation and lease information. Audit partners require greater correction of misstatements in recognized amounts than in the equivalent disclosed amounts. Research of Morris and Nichols (1988) shows the relationship between publicly available financial information and auditors materiality judgements as signaled by consistency exception opinions. Major findings were that publicly available financial information measures explained a significant portion of the variability in auditor materiality judgement. These results have implications for the proposed IAS 17 standard where a conversion of operational lease with footnote disclosures into recognition of lease arrangements is required.

§2.3.2 Disaggregation of financial statements and auditors tolerance for misstatement

Research of Libby and Brown (2012) shows that voluntary disaggregation of income statement numbers increases the reliability of income statement subtotals because auditors permit less misstatement in disaggregated numbers. This because disaggregated amounts will affect the judgment of a reasonable investor, which is the overall basis for judging reporting materiality. Furthermore, experienced auditors require correction of smaller errors in disaggregated numbers. These findings support the idea that disaggregated items affect auditors, and could be considered when assessing materiality. However, the effects are substantially reduced if the disaggregated numbers are presented in the notes. The result also suggest a positive consequence of the disaggregation of non-cancellable and cancellable lease obligations under the proposed IAS 17 lease standard. Possible effects of auditor behavior and required disaggregation resulting from adoption of the IAS 17 exposure draft are investigated in this thesis. The main focus will be examining if disaggregation by greater regulatory attention to lease obligations (cancellable and non-cancellable lease obligations) that contain errors will lead more likely to a required correction of a discovered error.

§2.3.3 Auditor decisions involving accounting principle changes

Chewning, Pany and Wheeler (1989) found evidence that auditors interpret the materiality concept different for companies that have changed accounting principles. The two most important variables considered by auditors in making accounting change opinion modification judgments were income effect of an accounting change (this appears to be the primary factor ) and the size (book value of net assets). A paper of Farmer et al. (1987), where they present 75 auditors with a description of a client that is taking a novel accounting approach (without stating the accounting issue or related evidence), shows that more experienced auditors are more likely to require change. This result could also affect the outcomes of this thesis in determining materiality thresholds in the proposed IAS 17 lease accounting circumstances.

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§2.3.4 Judgement and decision making

Behavioral research regarding auditing judgement and decision making (JDM) of Nelson and Tan (2005) provides evidence that various types of knowledge (world knowledge, sub-speciality knowledge, etc.) contribute to expert performance. Krogstad et al. (1984) suggests that task complexity and knowledge differences required for different tasks explain the judgement decisions of auditors. Also some aspect of individual characteristics (e.g. knowledge, ability and personality) affect audit tasks in various ways (Nelson and Tan, 2005). Fundamental to the audit function are auditors’ decisions about whether to require a client to correct a detected misstatement. Much of this decision depends on the auditor’s assessment of the materiality of the misstatement. Jiambalvo and Waller (1984) perform an experiment in which some auditors made an overall evaluation test of details risk (an element of detection risk), while others used a decomposition approach to make assessments of different components in the audit risk model along with the same overall evaluation. They find that the overall test is different from the that obtained by an algorithmic combination of the separate risk components made in the decomposition approach. This study provides a good illustration of an approach that can be used to examine the (dis)aggregation issue in determining materiality thresholds.

§2.4 Summary literature review

IASB and FASB jointly introduced an Exposure Draft for the IAS 17 lease standard, to improve quality and comparability of financial reporting by recognizing all lease arrangements on-balance as Type A (similar to operational lease) or Type B (similar to finance lease). By including all leases on the balance sheet, a better view of the leverage position of a company is provided. Hereafter research in the field of materiality is outlined. The materiality concept defines the threshold between the important and the trivial. Research relied on materiality has identified a number of significant findings. First, there appear to be differences in the way firms establish planning materiality and evaluation materiality (Martinov and Roebuck 1998) with judgement playing a significant role. Second, Nichols (1988) found that net income, total and type of assets (e.g. net PPE), debt-to-equity ratio, net income-to-equity ratio, the earnings trend and audit experience are important factors in materiality threshold decisions. Besides, decisions to book or waive detected misstatements entails multiple factors in addition to the size of the misstatement, i.e. it’s effect on net income (Holstrum and Messier, 1982). Finally, to draw further on the goal of this thesis, objectively verifiable misstatements are more likely to be material. The current state of our knowledge regarding misstatements is that audit partners require greater correction of misstatements that are recognized than the equivalent of disclosed amounts (Libby et al. 2005) and publicly available information explain a significant portion of the variability in auditors materiality judgement (Morris and Nichols, 1988). When amounts are recognized in financial statements the level of aggregation is likely to have an effect on auditors judgements too. Libby and Brown (2012) show that voluntary disaggregation of income statement numbers increase the reliability of income statement subtotals because auditors permit less misstatement in disaggregated numbers. Chewning, Pany and Wheeler (1989) found evidence that auditors interpret the materiality concept different for companies that have changed accounting principles. Finally behavioral research regarding auditing judgement and decision making (JDM) of Nelson and Tan (2005) provides evidence that various types of knowledge (world knowledge, sub-speciality knowledge, etc.) contribute to expert performance, which is important to take into account analyzing auditors’ assessment of the materiality judgements.

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3 Hypotheses development

In this chapter testable statements that summarizes the answer to (parts of) my research question, based on what is learned from literature on materiality thresholds, recognition of information in financial statements, disaggregation of information, auditors decisions after accounting changes and judgement and decision making research are described. Predictions of cause-effect relationships between the lease accounting standard an materiality judgements of auditors are presented in two unambiguous hypotheses.

This thesis is set up to determine how, when and (ultimately) why important features of lease accounting standards (information location and (dis)aggregation of renewal options) influence auditors’ behavior. The current literature provides limited guidance about theoretical answers to my

Research question

: “What is the impact of the new information location of leases under the IAS 17 proposed lease standard on the materiality thresholds of auditors?”.

The IAS 17 lease accounting standard offers three key features that make it well suited for an investigation of effects of information location of leases on materiality threshold judgements of auditors. First, in contrast to the proposed IAS 17 standard, the current IAS 17 standard provides guidelines for finance and operational leases which provides companies the flexibility to choose between off- and on-balance accounting treatment (Imhoff, Lipe and Wright 1991). Previous research of Nelson et al. (2002) shows companies are more likely to attempt structure transactions around precise accounting standards as is possible under the current IAS 17. Since the opportunities to structure lease obligations off-balance are eliminated under the proposed IAS 17 lease standard this could affect auditors’ materiality decisions. Second, there is a clear divide between companies and regulators preferences. Companies generally have incentives to prefer off-balance sheet disclosure of lease obligations, whereas regulators (FASB 2010; IASB 2010; SEC 2005) and auditors (e.g. Libby and Brown 2012) generally prefer recognition of lease obligations for more reliable financial statements. The regulatory requirements regarding recognition of all lease obligations could impact auditors’ materiality thresholds as Chewning, Pany, and Wheeler (1989) find that auditors allow more misstatement of disclosed amounts than recognized amounts because they believe those amounts tend to be more subjective or less reliable. Greater regulatory attention to lease obligations could lead to a higher required correction of a discovered error and a lower materiality threshold. Third, because lease obligations are essentially debt, auditor’s perceptions of the risks in determining materiality thresholds should increase with the amount of its lease obligations (FASB and IASB 2011).

Theories on the effect of recognizing both operational and finance lease in financial statements and disaggregation of renewal options in lease accounting on materiality decisions of auditors are scarce. While some research suggest that auditors tolerance for misstatement are at least partially adjusted for operating leases (e.g., De Franco et al. 2010; Lee et al. 2010), other research provides evidence that recognized debts have a stronger influence on auditors’ judgements than does disclosed debt information. The literature examining auditors’ materiality decisions suggest stronger responses to recognized than disclosed information. For example, Libby et al. (2006) provide evidence that auditors are willing to allow greater misstatements in stock-compensation and lease-liabilities that are recognized than to those that are only disclosed; additionally information in footnotes might lack reliability because auditors permit more misstatement in disclosed, as opposed to recognized, amounts. In part because auditors view misstatements in disclosed amounts to be less material. Experimental studies provide converging evidence, demonstrating that information location affects the extent to which auditors respond to information (Krische, Sanders and Smith, 2014; Libby and Brown, 2005; Libby and Brown, 2012).

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§3.1 Auditors responses to recognition (proposed IAS 17) versus disclosure (current IAS 17) of lease obligations

First, auditor’s judgements of materiality thresholds across conditions of recognition (proposed IAS 17) and disclosure (current IAS 17) of lease obligations are examined. This makes it possible to assess the impact of the proposed lease accounting standard on auditors’ materiality threshold decisions. The overall question posed here is what is the effect of recognizing all lease obligations in financial statements on auditors materiality thresholds?

While Messier et al. (2005), Nelson and Tan (2005) and Libby and Seybert (2009), provide most relevant recent literature examining quantitative and qualitative benchmarks used in practice for materiality thresholds, with profit before tax as the most important quantitative benchmark as being defined as 5 percent of current period profit before tax1. Messier, Martinov-Bennie and Eilifsen (2005) showed that net income, total assets and type of assets (e.g. leased PPE) are also variables that dominate auditor’s materiality decisions. Neither researches directly assesses whether auditors materiality thresholds would differ depending upon different information locations of lease obligations in financial statements. However, this research does provide indirect support for setting higher materiality thresholds for disclosed lease numbers since these materiality variables are strongly influenced by lease classification under current IAS 17 versus proposed IAS 17. Thereby is recognition of information in financial statements playing a remarkable role in auditors judgements of materiality threshold, as research of Libby et al. (2005) implies that the more information is recognized in financial statements, the lower the materiality thresholds of auditors. They show that when information is recognized it represents liabilities better and the importance of correct materiality thresholds increases. Overall, the literature on materiality thresholds and information location suggest that auditors attend somewhat to disclosed information (as under the current IAS 17), but less so than to recognized information (as under the proposed IAS 17). This leads to an expectation of lower materiality thresholds under the proposed IAS 17 lease standard where information about lease obligations is recognized in financial statements. Therefore the first hypothesis is focused on the inverse association between the proposed lease standard and materiality decisions and is formulated as follows:

H1 Auditors have lower materiality thresholds under the proposed IAS 17 lease standard than under the current IAS 17 lease standard.

Thus, recognizing all lease obligations in financial statements under the proposed lease accounting conditions is expected to lead to lower materiality thresholds. Due to the higher reported level of liabilities when lease obligations are recognized, auditors will judge risks of material misstatements to be higher under the proposed IAS 17 than under the current IAS 17.

1_{In unusual periods, such as those where net income before taxes is very small or negative, other benchmarks such} as sales and assets are used.

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§3.2 Auditors responses to (dis)aggregation of information of renewal option

Next, the effects of disaggregation of lease information that recognizes non-cancellable and cancellable lease obligations (renewal options) on materiality thresholds of auditors is investigated. The second hypothesis is thus focused on the effects of the proposed lease regulation regarding information of renewal options in lease obligations on financial statements. Current research has little to say directly about the effects of disaggregation of renewal options of lease obligations on the materiality thresholds of auditors. However, as discussed, prior research shows auditors tolerance for misstatement is lower under disaggregated information in financial statements (Libby and Brown, 2012; Krische, Sanders and Smith, 2014). The effect of disaggregation of information is examined by a number of recent papers which have recognized that disaggregation issues like the assignment of a financial disclosure to a particular financial statement, to a specific subsection within a statement, or to the notes, affects auditors interpretation of its relevance and meaning (Libby, Bloomfield and Nelson, 2002; Libby and Brown, 2005; Heitzman, Wasley, and Zimmerman, 2010). Under the proposed IAS 17 lease accounting standard companies are required to disclose information on cancellable and non-cancellable renewal options of lease obligations. Disaggregation of renewal options in lease obligations can help auditors understand the financial statement effects of structuring lease renewal options to achieve cancellable lease treatment, and should be sufficient for auditors to perceive different levels of material risks in financial statements compared to aggregated disclosed information alone. Therefore materiality decisions are presumably more strictly when cancellable and non-cancellable renewal options are disaggregated than when information regarding renewal options of lease obligations is aggregated. Given that other forms of financial statement disaggregation appear to have the potential to affect auditors judgements, to the degree that auditors believe that broad income statement disaggregation is aimed at improving auditors’ ability to predict the entity’s future cash flows, it could be assumed that disaggregated items are also important benchmarks for judging materiality thresholds. In accordance with this thesis first hypothesis is expected that materiality thresholds are lower under the proposed IAS 17 lease standard than under the current IAS 17 lease standard. Therefore the following hypothesis is formulated:

H2 Auditors have lower materiality thresholds for disaggregated information of renewal options under the proposed IAS 17 lease standard than under aggregated information of renewal options under the proposed IAS 17 lease standard.

Thus, there is predicted that auditors materiality judgements will be influenced by the level of disaggregation, in this case, specifically via the effect of cancellable and non-cancellable lease renewal options. The main focus will be if disaggregation by greater regulatory attention to lease obligations (cancellable and non-cancellable lease obligations) that contain errors will lead more likely to a required correction of a discovered error. A nested design is used in the experiment to separately evaluate the effects of auditor’s understanding of the financial statement impact of the treatment of renewal options in lease accounting. The presence of disaggregated lease information will likely influence auditor’s judgements by clarifying the financial statement effects of lease renewal options.

Overall there will be investigated how lease accounting methods and disclosure alternatives affect auditors materiality interpretations of financial statements. The effects of the proposed IAS 17 standard on materiality thresholds are tested in a between subject (H1 and H2) setting, as Libby et al. (2002) note, “The subjects design provides a clean test of the subject’s natural reasoning process. The between-subjects test is a better indicator of what they believe or know. This means afterwards “superior” disclosure methods for auditors judgment or decision making during their materiality assessments can be defined.

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§3.3 Summary hypotheses development

Based on theory and deductive argumentation a research question and two hypotheses are formulated. First of all it is expected that the proposed IAS 17 lease accounting conditions (recognizing all lease obligations in financial statements) will lead to lower materiality thresholds than the current IAS 17 lease accounting conditions. This expectation implies that auditors under the proposed lease accounting condition have less tolerance for audit misstatement posting thresholds than auditors under the current lease accounting condition.

For complementary effects of the proposed standard the consequences of the disaggregation of renewal options under the proposed lease standard is expected to lead to a greater difference between the materiality thresholds under different conditions of the current and proposed lease accounting standard. Results are expected to show that there is a more pronounced effect of materiality threshold decisions of auditors under the current lease standard (voluntary disclosed) versus the proposed lease standard (aggregated recognition) criteria, than for the differences in the proposed lease standard (aggregated recognition versus disaggregated recognition criteria).

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4 Research design experiment

In this section the research design is described. First the participants, their selection and demographics are outlined. Hereafter the experimental design is defined, following by the experimental procedures.

An experiment was conducted in a lease-liability setting, in which misstatements primarily affect the balance sheet (proposed IAS 17) or the voluntary lease disclosures (current IAS 17). The materiality threshold decision of an auditor after a lease misstatement is compared to both current, and proposed lease accounting standard.

Under the current IAS 17 Lease accounting standard, a finance lease is viewed as a lease used to finance equipment for the major part of its useful life where substantially all of the risks and rewards (control) of the asset are transferred to the lessee, and therefore, the lessee will use an on-balance sheet treatment even though he is not the owner. Operating leases are viewed as leases used to finance equipment for less than its useful life, where risk and rewards (control) of the asset are NOT transferred, and therefore, the lessee will use an off-balance sheet treatment. Accounting in this area is controversial, with IASB advocating for capitalization of all lease contracts (IASB, March 2009). The proposed IAS 17 lease accounting standard requires recognition of all lease liabilities. When the primary hypothesis is applied to this context, it predicts that auditors tolerate more misstatement in disclosed lease liabilities (current IAS 17) than they do in recognized lease liabilities (proposed IAS 17). Because amounts of lease obligations are contractually defined the risk of measurement uncertainty for disclosed amount is ruled out.

§4.1 Participants

A total of 60 experienced auditors from KPMG participated in the study. Auditors were selected on job level (‘senior level’ and above) due required experience in determining materiality thresholds and contacted directly by asking to participate in the study during April and May 2015. Of the 60, 3 identify their current position as audit partner, 22 as audit manager, 9 as assistant manager and 26 as supervisor. 75% of the respondents is male (M=0.75; SD=.44). The average finished education level of the auditors is Post-Master: Theoretical (M=7.00; SD=1.33), with a mean of 8.40 years of relevant auditing experience (M=8.40; SD=7.70). The auditors are on average 31.50 years old (M=31.48; SD=7.84) and completed a pencil-and paper version of the task. Most of the participant’s experience is with public, commercial, or corporate companies. See table 1 below for descriptive statistics regarding demographics and a specification per experimental condition. The participants are assigned randomly to the experimental conditions.

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Table 1: Demographics of participating auditors specified per experimental condition

Total Voluntary Disclosure Recognition aggregated Recognition disaggregated

Number of participants N=60 (N=20) (N=20) (N=20) Gender Male N (%) Female N (%) 45 (75.00%) 15 (25.00%) 13 (65.00%) 7 (35.00%) 15 (75.00%) 5 (25.00%) 17 (85.00%) 3 (15.00%) Age M (SD) 31.48 (7.85) 31.35 (6.80) 28.60 (3.36) 34.50 (10.74) Job Title Supervisor N(%) Assistant Manager N(%) Manager N(%) Partner N(%) 26 (43.30%) 9 (15.00%) 22 (36.70) 3 (5.00%) 10 (50.00%) 2 (10.00%) 7 (35.00%) 1 (5.00%) 8 (40.00%) 7 (35.00%) 5 (25.00%) 8 (40.00%) 10 (50.00%) 2 (10.00%) Finished Education BSc Accounting N(%) BSc Other N(%) MSc Accounting N(%) MSc Other N(%) Post-Master: TheoreticalN(%) Post-Master: Executive N(%) 1 (1.70%) 1 (1.70%) 11 (18.30%) 3 (5.00%) 13 (21.70%) 31 (51.70%) 3 (15.00%) 2 (10.00%) 3 (15.00%) 12 (60.00%) 1 (5.00%) 1 (5.00%) 4 (20.00%) 1 (5.00%) 4 (20.00%) 9 (45.00%) 4 (20.00%) 6 (30.00%) 10 (50.00%) Number of years relevant auditing

experience M (SD) 8.40 (7.78) 8.23 (6.50) 5.45 (2.85) 11.52 (10.88)

Prior experience lease accounting Yes N(%) No N(%) 17 (28.30%) 43 (71.70%) 6 (30.00%) 14 (70.00%) 6 (30.00%) 14 (70.00%) 5 (25.00%) 15 (75.00%) Auditing experience in global

aviation industry Yes N(%) No N(%) 4 (6.70%) 56 (93.30%) 1 (5.00%) 19 (95.00%) 20 (100.00%) 3 (15.00%) 17(85.00%)

What is the impact of the new information location of leases under the IAS 17 proposed lease standard on the materiality thresholds of auditors?

U

NIVERSITY OF

A

MSTERDAM

What is the impact of the new information location of leases under the IAS 17 proposed

lease standard on the materiality thresholds of auditors?

Heleen Becht 10564373

17-06-2015

Word count: 19.194

MSc Accountancy & Control: both specialization tracks

Amsterdam Business School

Faculty Economics and Business, University of Amsterdam

Supervisor: Prof. dr.V.S. Maas

Statement of Originality

This document is written by Heleen Becht who declares to take full responsibility for the

contents of this document.

I declare that the text and the work presented in this document is original and that no sources

other than those mentioned in the text and its references have been used in creating it.

The Faculty of Economics and Business is responsible solely for the supervision of completion

of the work, not for the contents.

MSc Thesis

Narrative report on research into effects of the IAS 17 proposed lease accounting

standard on auditors materiality threshold decisions

Master Thesis

Student:

Heleen Becht

Student number:

10564373

Date:

17-06-2015

Program:

MSc Accountancy & Control: both specialization

tracks

University of Amsterdam:

Amsterdam Business School,

Faculty of Economics and Business

Supervisors:

Prof. dr. V.S. (Victor) Maas

University of Amsterdam, Faculty of Economics and Business, Head ABS

Accounting section.

M. (Martijn) Schoolderman

KPMG, Audit (Leisure, Tourism, Media and Entertainment), senior auditor.

University of Amsterdam

KPMG

Amsterdam Business School

Laan van Langerhuize 1

Plantage Muidergracht 12

Postbus 74500

1018 TV Amsterdam

1186 DS, Amstelveen

ABBREVIATIONS

AMPT = Audit Misstatement Posting Threshold. The maximum amount of understatement

(errors) in financial statements which are allowed by auditors

DP = Discussion Paper. A document that is released by the Financial Accounting Standards

Board (FASB) which is designed to obtain initial views and comments on important issues that

the IASB will consider as it develops an Exposure Draft of a revised accounting standard

ED = Exposure Draft. A document released by the Financial Accounting Standards Board

(FASB) for public commentary on proposed new accounting standards

FASB = Financial Accounting Standards Board. Provides standards for GAAP-based financial

reports, both within and outside the United States

IFA = International Federation of Accountants

IAS = International Accounting Standards

IASB = the International Accounting Standards Board. Provides standards for IFRS-based

financial reports, global set of accounting standards.

MLP = Minimum Lease Payments

PBT = Profit Before Tax

PPE= Property Plant and Equipment

ROU asset and lease liability= Right-of-use asset and lease liability

Table of Contents

Table of Tables

Table of Figures

1 Introduction

2 Literature review

Theory level

Empirics

Figure 6: recording lease agreements

3 Hypotheses development

Research question

4 Research design experiment