Client versus public interest : an analysis of auditors’ lobbying behavior

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Client versus public interest

An analysis of auditors’ lobbying behavior

Name: Siena Sparrius Student number: 11109947

Thesis supervisor: Dr. S.W. Bissessur Date: June 26, 2017

Word count: 15.344

MSc Accountancy & Control, specialization Accountancy Faculty of Economics and Business, University of Amsterdam

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Statement of Originality

This document is written by student Siena Sparrius 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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Abstract

This study examines to what extent auditors represent their clients’ interest when they lobby for new accounting regulation. The lobbying behavior of auditors is analyzed through a lens of legitimacy theory, as auditors face tension in serving either the interests of their audit clients or the public interest, and auditors need to serve both in order to create legitimacy. The research is conducted by performing an analysis of the comment letters that auditors sent in response to the revised leasing exposure draft of 2013. By means of this analysis, five emerging themes were identified, which were used to interpret auditors’ lobbying behavior. The findings suggest that auditors lobby for their clients’ interest in order to create pragmatic legitimacy, and that auditors lobby for the public interest in order to create moral legitimacy. In addition, smaller accounting firms seem to act more in their clients’ interest, whereas the Big Four appear to act more in the public interest. The findings of this study provide an insight into auditors’ incentives for lobbying and can be interpreted in the broader context of how auditors define their role with respect to the tension they face in serving either the public interest, or the interest of their clients.

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1 1 Introduction

‘‘Auditors are still asked to do that, to treat the public as master, though engaged and paid by another master – the audited corporation’’ (Shapiro, 2004). This quote reflects the tension that auditors face in serving either the public interest, or the interest of their clients. It seems that clients and the public at large both expect auditors to assume a different role. In the view of the public at large, auditors should limit their services to the provision of an independent audit opinion on the truthfulness of the financial statements of organizations (Chye Koh & Woo, 1998; Hayes et al., 2014), whereas audit clients expect that auditors deliver additional audit services beyond the scope of a financial statement audit, in exchange for their audit fee (Fontaine et al., 2013). Moreover, it is unclear whether auditors perceive their role more in terms of the public interest, or their clients’ interest.

One way in which auditors can provide additional audit services from which clients can benefit, is by lobbying the standard-setter on behalf of their clients (McLeay, 2000). Lobbying is defined as a way of exercising political influence over standard setters, with the purpose of affecting the outcome of the standard-setting process (Gipper et al., 2013). Clients benefit from an auditor that lobbies on their behalf, as they can exercise more influence over the standard-setter when auditors lobby for the same issues (McLeay, 2000). There is however only a limited amount of literature that examines the incentives auditors have to lobby the standard-setter, and the evidence is inconclusive. Whereas Watts & Zimmerman (1982) and Puro (1984) find that auditors lobby both to defend their own self-interest and their clients’ interest, the study by Allen et al. (2014) indicates that auditors lobby to improve financial reporting. Moreover, it is unclear to what extent auditors lobby in order to fulfill clients’ expectations of additional services. Therefore, this paper studies to what extent auditors consider their clients’ interest when they lobby for new accounting regulation.

The lobbying behavior of auditors is analyzed through a lens of legitimacy theory, as auditors face tension in serving either the interests of their audit clients or the public interest, and auditors need to be perceived as legitimate by both parties, in order to exercise their audit function. On the one hand, auditors need moral legitimacy from society, as they cannot lend credibility to financial statements if they are not perceived as credible themselves (Shapiro, 2004). On the other hand, auditors need pragmatic legitimacy in order to gain and regain clientele (Shapiro, 2004). Whereas auditors’ quest for moral legitimacy motivates auditors to act in the public interest, auditors’ quest for pragmatic legitimacy motivates auditors to act in their clients’ interest (Suchman, 1995). Moreover, legitimacy theory can be used to analyze auditors lobbying behavior.

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6 A common way in which auditors lobby standard-setters, is by means of comment letters (Allen et al., 2014). Therefore, the lobbying behavior of auditors will be examined by means of an analysis of the comment letters that auditors sent in response to the revised leasing exposure draft of 2013. As part of the development of a new leasing standard, the Boards issued a revised exposure draft in 2013, and invited stakeholders to comment by means of a comment letter. In total, auditors sent 63 comment letters in response to the exposure draft. These comment letters will be analyzed by applying the inductive analysis of Gioia et al. (2013). As such, the concerns that auditors have with the proposed standard, will first be classified as an issue, reason, effect, or solution. Subsequently, these categories will be coded in order to identify emerging themes in the comment letters. These themes will be used to analyze the lobbying behavior of auditors. Finally, auditors’ lobbying behavior will be interpreted through a legitimacy research lens to explain the behavior that we observe.

The findings of the comment letter analysis indicate that auditors consider both the public interest and their clients’ interest when they lobby for new accounting regulation. On the one hand, auditors lobby for their clients’ interest by lobbying for a standard that would be less complex to apply and would have fewer adverse effects for their clients. On the other hand, auditors lobby for the public interest by lobbying for a standard that would improve the quality of financial reporting and lower structuring opportunities. Although the viewpoints of all audit firms are generally influenced by the specific types of clients they audit, smaller accounting firms seem to consider their clients’ interest more than the Big Four.

These findings are of societal relevance, as the findings can be interpreted in the broader context of the tension that auditors face in creating legitimacy, as a result of diverging interests between audit clients and the public. As the purpose of the research is to advance knowledge on the extent to which auditors define their role in terms of their clients, or the public, the issue that is indirectly examined is the extent to which auditors promote the welfare of their clients, at the expense of societal welfare.

The academic contribution of this study if twofold. Firstly, the study contributes to the stream of literature on auditor lobbying. Although several studies have examined the participation of stakeholders in the standard-setting process, these studies focus almost exclusively on the lobbying behavior of financial statement preparers (e.g. Francis, 1987; Dechow et al., 1996; Kosi & Reither, 2014). The few studies that do examine auditor lobbying, were either conducted in the 1980s (Watts & Zimmerman, 1982; Puro, 1984), when statistical power was significantly lower and there were only few audit comment letters (Gipper et al., 2013), or do not examine auditors’

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7 lobbying behavior in relation to the underlying auditor-client relationship (Allen et al., 2012). To the best of my knowledge, the study by Burnett et al. (2014) is the only recent study that focuses on auditor lobbying on behalf of clients. However, this study quantitatively examines the severity of an auditor that lobbies on behalf of his client and therefore takes the assumption that auditors lobby on behalf of clients as a starting point. Moreover, this study responds directly to the call of Gipper et al. (2013) for a study that examines whether auditors lobby on behalf of their clients. As such, this is the first contemporary study that addresses to what extent auditors lobby on behalf of their clients. In addition, this is also the first study to apply legitimacy theory to explain auditors’ lobbying behavior.

To this end, this paper is structured as follows. In the next chapter, the theoretical framework will be established. It starts with a section on the institutional background of the leasing standard, followed by a section that discusses existing literature on stakeholder lobbying. In the next section, the auditor-client relationship and legitimacy theory are discussed, which are applied to the specific research setting of this study. The subsequent chapter gives an overview of the methodology that will be used to identify the emerging themes in the comment letters. This overview is followed by an elaboration of the emerging themes, which will be used in order to identify patterns in auditors’ lobbying behavior. Next, auditors’ lobbying behavior will be interpreted through the lens of legitimacy theory. The final section answers the research question by drawing a conclusion on the overall findings, and additionally discusses the limitations of this study.

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2 2 Theory

This chapter is structured as follows. It starts with a discussion of the institutional background of leasing, followed by an examination of auditors’ incentives for lobbying. Next, the auditor-client relationship is outlined, followed by a discussion of legitimacy theory. Lastly, legitimacy theory is applied to the specific research setting that is under study.

2.1 Institutional background

In 2002, the IASB and the FASB decided to initiate a convergence project, of which the purpose was to harmonize IFRS and US GAAP. As part of this project, in 2006 it was decided that the IASB and the FASB would initiate a joint project to develop a new leasing standard that would replace the current leasing standards IAS 17 and SFAS 13. The main reason for developing a new leasing standard was to improve the quality of financial reporting by addressing the criticism on the current standards.

The current standard IAS 17 allows organizations to classify a lease as either a finance lease or an operating lease, which both have different accounting treatments. Whereas finance leases require the recognition of a lease asset and liability on the balance sheet, operating leases remain off-balance sheet and should be expensed periodically in the income statement. A lease qualifies as a finance lease, when it transfers substantially all risks and rewards of ownership to the lessee (Discussion paper Leases, 2009). However, it appears that organizations have an incentive to structure finance leases as operating leases, because that allows them to keep the liability off-balance sheet (Lückerath-Rovers, 2007). Consequently, the main criticism on IAS 17 is that the standard provides structuring opportunities (Revised Exposure Draft, 2013), which has two implications for the quality of financial reporting. That is, the balance sheet does not faithfully represent the underlying economic situation of an organization, and economically similar transactions are accounted for differently, which reduces comparability (Conceptual Framework IFRS, 2010).

IFRS standards are developed according to the standard-setting process of IFRS, the ‘due process’. As such, the Boards issued a discussion paper in 2009 that addressed the issues with the current standards and set out an initial idea of how the current standard could be improved. Stakeholders are involved in the due process, by inviting them comment on proposals created in the due process (Due Process Handbook, 2016). Moreover, stakeholders of the Boards were asked to comment on the discussion paper of 2009 and the exposure draft of 2010. The exposure draft

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9 proposed a single lease model, which required all leases to be capitalized in the same manner. Due to the wide resistance of stakeholders against the proposal, the Boards had to create a revised exposure draft, which was issued in 2013. The comment letters that stakeholders sent to argue whether they supported the proposed standard, are under examination in this study. Therefore, it is informative to examine the accounting requirements of the revised exposure draft more closely.

Whereas the exposure draft of 2010 proposes a single lease model in which all leases are recorded in the same manner, the revised exposure draft of 2013 proposes a dual lease model. Under the dual lease model, it is still the case that all leases, with a term longer than one year, are capitalized on the balance sheet. However, the dual lease model distinguishes between a Type A lease and a Type B lease. Although both types of leases require the recognition of a lease asset and liability, amortization and interest are treated differently under both models. Whereas for Type A leases it is required to recognize amortization and interest expenses separately, Type B leases require the recording of a single lease expense, which is a combination of the amortization and interest expense (Revised Exposure Draft Leases, 2013).

Moreover, this section briefly summarized the institutional background of the development of the new leasing standard. Chapter 4 will give a more extensive overview of the accounting requirements of the proposed leasing standard and the differences with the current models, as that chapter elaborates on the emerging themes that were identified in the audit comment letters. The next section examines what motivates stakeholders, and auditors in particular, to participate in the due process by writing a comment letter to the IASB and FASB.

2.2 Lobbying

As was already briefly mentioned in the previous section, comment letters form a crucial part of the standard-setting process of the IASB. By inviting stakeholders to participate the due process, the IASB and the FASB gain an understanding of the effects the standard will have on the various types of stakeholders (Due Process Handbook, 2010). Stakeholders also benefit from the opportunity to participate in the due process, as stakeholders can use comment letters to lobby the standard-setter (Sutton, 1984). Lobbying is defined as a way of exercising political influence over standard setters, with the intention of affecting the outcome of the standard-setting process (Gipper et al., 2013). As such, stakeholders use comment letters to influence the final version of an accounting standard.

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10 In order to examine the lobbying behavior of auditors, and specifically the extent to which auditors consider their clients’ interest when they lobby for new accounting regulation, it is informative to examine what incentivizes auditors to lobby. Additionally, it is informative to examine the lobbying behavior of preparers, as this helps the understanding of the type of accounting standards that auditors’ clients might prefer.

Starting with a general motivation for parties to lobby the standard-setter, Sutton (1984) argues that only the parties for whom the potential benefits of lobbying outweigh the costs of lobbying, participate in the standard-setting process. Moreover, the parties that have an incentive to lobby, are those parties that are most severely affected by the proposed changes in a particular accounting standard (Sutton, 1984). Francis (1987) builds on the finding of Sutton (1984) to explain the lobbying behavior of preparers. The study of Francis (1987) defines the benefit of lobbying as the higher likelihood to avoid adverse economic effects that arise from the proposed standard. Therefore, the decision of a preparer to lobby may be explained by the wish to avoid the negative economic consequences that the preparer expects from the proposed standard. Moreover, there is a consensus in literature that preparer’ lobbying is driven by self-interest (Dechow et al., 1996; Kosi & Reither, 2014).

Prior literature is, however, inconclusive about the incentives that auditors have to participate in the standard-setting process. The early study of Watt & Zimmerman (1982) indicates that auditors lobby to defend their own self-interest, and additionally, to defend the interest of their clients. This finding was confirmed by Puro (1984), who argues that auditors’ lobbying behavior is on the one hand driven by achieving accounting regulation that is beneficial to the auditors themselves, and on the other hand by achieving accounting regulation that minimizes adverse effects for their clients. The only other study that examines auditors’ lobbying behavior, is the study by Allen et al. (2014). This study examines whether auditors’ lobbying behavior has changed in response to a higher risk of litigation. They find that it has indeed changed, and that auditors lobby for accounting standards that would improve the quality of financial reporting, in the face of higher litigation. Moreover, there is no consensus in literature on the incentives that auditors have to lobby the standard-setter. It could either be to defend their own self-interest, to defend their clients’ interest, or to defend the public interest.

2.3 Auditor-client relationship

Auditors face tension in serving either their clients’ interest, or the public interest (Dellaportas & Davenport, 2008). The issue is of how auditors define their role is of great importance, as it determines what type of behavior auditors consider as legitimate (Cooper, 2006). In order to

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11 understand the implications of the role that auditors assume, this section examines how clients’ expectations from auditors differ from society’s expectations. These findings are used to describe the trade-off that auditors face in serving the public interest versus their clients’ interest.

It is clear wat type of role society expect auditors to assume. From the perspective of society, the role of an auditor is to act in the public interest by lending credibility to organizations’ financial statements (Hayes et al., 2014). In society’s perspective, auditors can only fulfill this role when they express an independent audit opinion on the fairness of the financial statements of their clients (Hayes et al., 2014). Moreover, for society it is crucial that auditors assume an independent attitude and that auditors limit their services to the provision of an independent audit opinion. Clients also acknowledge the value of auditor independence. That is, Free (2009) argues that clients perceive an audit as a way to create legitimacy. The independent opinion of an auditor on the fairness of an organization’s financial statements lends credibility to the information that is incorporated in the financial statements. The benefit of this credibility does not only accrue to users of the financial statements, but also to the organization that publishes the audited financial statements. Therefore, clients can create legitimacy if they publish financial statements that were verified by an independent auditor (Free, 2009; Power, 2003). The study of Fontaine et al. (2013) however indicates that while clients acknowledge the value of an independent auditor, clients define the role of an auditor beyond the provision of an independent audit opinion. Based on interviews with 20 financial managers, Fontaine et al. (2013) conclude that an audit has a ‘core value’ and an ‘added value’ for clients. Whereas the core value relates to the benefit of credibility as described by Free (2009) and Power (2003), the added value relates to the additional services that auditors deliver beyond the scope of the financial statement audit.

This finding has implications for the role that clients expect their auditors to assume. In fact, the study by Fontaine et al. (2013) indicates that clients perceive auditors’ additional services as more valuable than auditors’ core audit service. This finding was based on the interviews with financial managers, in which clients were asked to indicate what they expected from their auditor-client relationship. It is most important for auditor-clients that auditors deliver give additional services, from which they can benefit. Clients argue that auditors have a lot of experience and connections in various industries and that they would like to benefit from this expertise and network (Fontaine et al., 2013). The quality of the auditor-client relationship is the second most important aspect for clients. As an interviewee describes, ‘‘the actual audit service is a commodity and the differentiating factor is the relationship with the people delivering the audit service’’ (Fontaine et al., 2013). Moreover, clients find it important to build a good relationship with their auditor. In fact, clients consider it the responsibility of the auditor to build and maintain the auditor-client relationship (McCracken et

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12 al., 2008). Clients expect that the auditor ‘keeps the client happy’ (McCracken et al., 2008). Thirdly, clients expect that an audit validates the efforts of financial directors. Lastly, clients expect an auditor to be independent. That is, they want the relationship with their auditor to be ‘‘close, but not too close’’ (Fontaine et al., 2013). Interestingly, the financial managers consider auditor independence as the least important aspect of the auditor-client relationship. These findings imply that clients and society have different expectations from auditors, and that they both define the role of an auditor differently. This raises the question of how auditors define their own responsibility and what trade-off they face in acting either in the public interest, or in the interest of their clients.

In the study of McCracken et al. (2008), auditors indicate that their role consists of two parts. On the one hand, auditors perceive it as their responsibility to express an independent opinion on the fairness of the financial statements of their clients. They perceive it as their task to achieve the highest quality of financial reporting (McCracken et al., 2008). On the other hand, auditors argue that it is part of their responsibility to gain an understanding of the needs of their clients, such that they can properly serve their clients and maintain a good auditor-client relationship (McCracken et al.,, 2008). As such, auditors define their responsibility both in terms of serving society, and in terms of serving their client.

Given that auditors perceive it as part of their responsibility to serve the public interest, and part of their responsibility to serve clients’ interest, what is the trade-off that auditors face? It seems that both society and clients can exercise some influence over auditors. On the one hand, the most important asset of an auditor is his perceived independence (Hayes et al., 2014), which may motivate auditors to act in society’s interest. In addition, the risk of litigation may motivate auditors to behave in a manner that promotes societal welfare (Weber, 2008). On the other hand, clients can position auditors by threatening to fire them (Shapiro, 2004). In addition, whereas auditors do not ‘work for’ their client, they do generate their income from their clients, which may motivate auditors to serve clients’ needs (Shapiro, 2004). Therefore, it is argued that auditors face a trade-off between creating a reputation for integrity and the need to gain and regain business, as ‘‘the reality is that reputation means precious little if a firm has no clients’’ (Shapiro, 2004).Relating this observation to the previous findings that clients expect that auditors serve their needs, leads to the implication that auditors face a trade-off between delivering additional audit services to ‘keep the client happy’, and the creation of a reputation for independence. Moreover, auditors face a trade-off in serving clients’ and society’s needs.

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13 2.4 Legitimacy

Suchman (1995) defines organizational legitimacy as ‘‘a generalized perception or assumption that the actions of an entity are desirable, proper or appropriate within some socially constructed system of norms, values, beliefs and definitions’’. Noteworthy here is that the creation of legitimacy depends on others’ perception of legitimacy. This means that legitimacy is the result of others’ interpretation of an entity’s behavior. Moreover, the ability to create legitimacy depends on the extent to which an entity’s actions correspond with the beliefs of a particular social group. Lindblom (1994) also defines legitimacy in terms of the correspondence between the value system of the entity and of the larger social system. By implication, there is a ‘‘threat to the entity’s legitimacy’’ (Lindblom, 1994) when the two value systems do (perceivably) not correspond. The disparity between the expected organization’s behavior (ex-ante) and the perceived (ex-post) behavior creates a legitimacy gap (Lindblom, 1994). In figure 3.1, areas Y and Z depict a legitimacy gap as here the value systems of the organization and society do not overlap. On the contrary, area X depicts a situation where the value systems do overlap and organizations may be perceived as legitimate. Consequently, organizations strive for a position reflected by area X, where they are perceived as legitimate (O’Donovan, 2002).

Figure 2.1 Legitimacy gap (O’Donovan, 2002)

Why is it that organizations strive for legitimacy? Deegan (2006) argues that legitimacy is essential for the survival of an organization, since a legitimate organization is more capable of attracting funds, employees and customers. Similarly, Suchman (1995) argues that legitimacy fosters organizations’ continuity, because it is easier for an organization to attract capital if that organization is perceived as legitimate. In addition, Suchman (1995) argues that legitimacy lends organizations credibility, thereby increasing their trustworthiness and reliability.

Next, the different types of organizational legitimacy are discussed. The fundamental idea of legitimacy theory is that there is a social contract between the organization and society (Deegan, 2006). Suchman (1995) refers to society as a ‘collective audience’ and distinguishes three types of

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14 organizational legitimacy that all relate to a different layer in the collective audience. The three types of legitimacy are defined as pragmatic legitimacy, moral legitimacy and cognitive legitimacy. Pragmatic legitimacy is centered on the fulfilment of the needs and interests of the organization’s most immediate audiences (Suchman, 1995). The immediate audiences consider whether they can benefit from the actions the organization undertakes and, if so, they support the organization in exchange (Suchman, 1995). As Bamber & McMeeking (2016) put it, pragmatic legitimacy is about making the right decisions for the organization’s most immediate audience. Consequently, the discourse between the organization and the audience is characterized by self-interest Bamber & McMeeking (2016). On the contrary, moral legitimacy is acquired when the organization makes the right decisions for society as a whole and not only for its most immediate audience (Suchman, 1995). Therefore, moral legitimacy is about promoting societal welfare and considers a broader context than pragmatic legitimacy.

There are four types of moral legitimacy: consequential, procedural, structural and personal legitimacy. Consequential legitimacy judges an organization based on the consequences of the actions it undertakes, or put differently, on whether a certain action results in a socially valued outcome (Suchman, 1995). Procedural legitimacy focuses more on whether the action itself is socially valued, that is, on the ‘rightness’ of the procedure itself. Bamber & McMeeking (2016) argue that procedural legitimacy is determined by the perception of the independence and impartiality of the organization. Structural legitimacy indicates whether an organization’s socially constructed capacity enables it to perform certain practices and personal legitimacy depends on the reputation and charisma of organizational leaders (Suchman, 1995). Finally, the ultimate form of legitimacy that an organization can acquire is cognitive legitimacy. Cognitive legitimacy is acquired when ‘‘an organization, process or procedure is considered unchallengeable or when there is thought to be no alternative’’ (Bamber & McMeeking, 2016). This implies that an organization, process or procedure is not questioned at all, but taken for granted instead.

2.5 Legitimacy theory applied to the audit setting

This section discusses in what way auditors create legitimacy by applying the aforementioned legitimacy theory to the specific setting that is under examination, the audit field. Following the logic of Suchman (1995), auditors are able to create legitimacy if their behavior is perceived to fulfill the expectations and beliefs of a group in the wider social environment. The relevant social group from which auditors seek legitimacy varies with the specific type of legitimacy that the auditor seeks to establish.

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15 Applying the theory of Suchman (1995), auditors’ pragmatic legitimacy depends on their ability to fulfil the needs and interests of their most immediate audiences. In order to understand how auditors create pragmatic legitimacy, it is critical to define the most immediate audience of auditors. Suchman (1995) argues that the relationship between an organization and its most immediate audience is often characterized by a direct exchange between the two parties. In addition, Soobaroyen & Devi Mahadeo (2008) argue there exists a ‘‘critical resource (financial) dependence’’ between the organization and its immediate audience. Moreover, the most immediate audience is the group that provides resources, mostly financial, to the organization, in exchange for the service of that organization. Interpreting this in terms of the audit field implies that the auditee, or put differently, the client, is the most immediate audience of an auditor. After all, the task of auditors is to audit the financial statements of the auditee, in exchange for an audit fee. This means that the relationship between auditors and their clients involves a direct exchange. Moreover, the audit clients are considered as the most immediate audience of auditors in this study. Consequently, an auditor’s ability to achieve pragmatic legitimacy depends on auditors’ ability to fulfill the needs and interest of their audit clients.

The second aspect that needs to be defined in order to understand how auditors create pragmatic legitimacy, is what it means to ‘make the right decisions’ for clients in the audit field. Therefore, it has to be established what the interests of clients are in the specific aspect of the audit field that is under study – accounting regulation – and what this means for their expectations from auditors. Based on the finding of Francis (1987) that preparers lobby for accounting standards that have the best overall economic consequences for their company, it is assumed that the needs of clients can be summarized as achieving accounting standards that have the best overall economic consequences for their company. One way in which clients can achieve desirable accounting standards is by lobbying the standard-setter. However, the study of McLeay (2000) indicates that preparers can exercise substantially more influence over the standard-setter if auditors lobby for the same issues. What does this mean for the role they expect auditors to assume?

On the one hand, it could be expected that it is not in clients’ interest when auditors lobby on their behalf, as this could pose an advocacy threat to auditors’ independence (Burnett et al., 2014). After all, clients’ legitimacy depends on the independence of the auditor (Free, 2009). On the other hand, it could be expected that it is in clients’ interest when auditors lobby on their behalf, as the finding of McLeay (2000) implies that this would increase the likelihood that clients achieve a desirable accounting standard. Given that clients perceive they benefit more from an auditor that delivers additional services than an auditor that limits his services to independent core audit services (Fontaine et al., 2013), it is assumed that it is in clients’ interest if auditors lobby on

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16 their behalf. As clients additionally expect that auditors ‘keep the client happy’ (McCracken et al., 2008), it is assumed that auditors fulfill the needs of their clients when they lobby on their behalf.

On the contrary, moral legitimacy depends on an organization’s ability to fulfill the needs of a larger social group, that is, of society as a whole. A critical condition for attaining moral legitimacy is behaving in a manner that promotes societal welfare. How should this be interpreted in the audit field? In auditing, ‘doing what is right’ is defined by the Code of Ethics for Professional Accountants, developed by the IESBA, the International Ethics Standards Board of Accountants. The Code of Ethics prescribes that it is an auditor’s responsibility to act in the public interest. That is, instead of simply serving their clients’ interest, auditors should consider the public interest when exercising their profession.

The function of auditing is to serve the public interest by lending credibility to financial statements prepared by managers (Hayes et al., 2014). The importance of lending credibility can be explained by the information asymmetry problem that exists between managers and users. Managers have discretion in determining what information is disclosed in the financial statements and have an incentive to overstate the financial situation of the company (Healy & Palepu, 2001), while investors, creditors and other stakeholders have no choice but to rely on the information disclosed in the financial statements (Hayes et al., 2014). Without the external verification of an auditor that the financial statements truthfully depict the financial situation of an organization, investors will not be assured of the reliability of the financial statements, which impairs the efficient functioning of capital markets (Hayes et al., 2014). Moreover, auditors’ societal responsibility is to give an external verification of the reliability of the financial statements, thereby lending credibility to the financial statements.

However, the IESBA prescribes that an auditor can only fulfill his responsibility to act in the public interest when the auditor is (perceived as) independent. After all, the entire value of the profession rests on the external verification of the reliability of the financial statements. By implication, once the auditor is (perceived as) being too sympathetic to clients’ needs, the audit function loses its value. The IESBA distinguishes between two types of independence: independence of mind and independence in appearance. Independence of mind refers to auditors’ actual independence throughout the audit and independence in appearance refers to others’ interpretation of this independence (Hayes et al., 2014). That is, the actions of an auditor should signal his impartiality, such that the public also perceives him as independent. Moreover, auditors should serve the public interest by lending credibility to financial statements. In order to realize this, it is critical that auditors are independent in mind and in appearance.

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17 Relating this back to the description of moral legitimacy that was developed by Suchman (1995), auditors can create moral legitimacy if they are able to promote societal welfare. Societal welfare is promoted when auditors fulfill the needs of society at large. As was just established, society expects that auditors act in the public interest by assuming an independent attitude towards clients. Therefore, it is assumed that auditors fulfill society’s needs when they lobby for societal welfare, rather than for the interest of their clients.

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3 Analysis comment letters

3.1 Research methodology

In order to examine to what extent auditors lobby on behalf of their audit clients, a documentary analysis is performed of a set of comment letters that were written in response to the revised leasing exposure draft of the IASB and the FASB. The draft was issued on May 16, 2013 and stakeholders were invited to respond to the proposed new leasing standard by means of a comment letter and to express whether they supported the proposed changes, or not. The consultation period was open till September 13, 2013. In total, 641 comment letters were written in response to the exposure draft, of which 3 letters were submitted after the closing of the consultation period. All comment letters are publicly available on the website of the FASB.

Firstly, all letters were retrieved from the website of the FASB and were analyzed in order to determine the sample size. As such, each respondent was categorized in terms of its stakeholder role and the country in which the respondent is established. In categorizing each respondent as a certain type of stakeholder, the 5 constituent categories of the IASB and the FASB were used: users, regulators, standard setters, auditors and preparers (Staff paper leases, 2013). The analysis shows that 63 letters were submitted by auditors or audit associations, 381 letters by preparers and 197 letters by regulators and standard setters. Moreover, the total sample of this research consists of 65 comment letters, ranging from 1 to 36 pages and in total amounting to 524 pages of comments.

The research approach that will be used in this study is the systematic inductive research analysis developed by Gioia et al. (2013). This particular analysis is useful to identify the issues that auditors have regarding the new leasing standard and to gain insight into the lobbying behavior of auditors. Moreover, the research approach is ‘meaning-oriented’ and enables an understanding of why we observe what we observe. The inductive approach of Gioia et al. (2013) is designed to structure large amounts of qualitative data, which is accomplished by an analysis that consists of two parts, a first-order analysis and a second-order analysis. The first-order analysis implies that data is firstly organized into broadly defined categories. Within these categories, data are labeled such that the data can be narrowed down further to second-order categories. Subsequently, these categories are coded such that key themes can be identified. These themes represent the recurring issues that were most prevalent in the audit comment letters.

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19 3.2 Data analysis

Starting with the first-order analysis of Gioia et al. (2013), all audit comment letters were read and the concerns raised in each letter were classified into one of the categories of table 3.1. Moreover, each argument in the comment letters was marked as either an issue, reason, effect or solution. An issue represents a constituent’s viewpoint on a specific topic, either agreeing or disagreeing with one of the proposed concepts. Reasons represent the motivation as to why the constituent has that particular viewpoint, effects are the consequences the constituent expects the proposed new standard to have and solutions are the recommendations that the constituent makes that in his view would be a better accounting treatment.

Classification Observations Keywords

Issue 702 We are concerned about…

We (dis)agree with…

Reason 493 For this reason…

We believe…

Effect 200 That would result in…

That leads to…

Solution 343 The IASB should…

We recommend…

Total 1538

Table 3.1: First-order categories

In total, 702 issues were encountered, which equals approximately 11 issues per letter on average. As can be derived from the table, not all issues were motivated by a reason, effect or were backed up by a solution. Besides this categorization, another part of the analysis was to evaluate whether constituents overall supported the proposed changes, or not. It appears that out of 63 auditors, only three supported the exposure draft (CL21, CL231, CL522). This equals a percentage of 4.76%. These three constituents were still concerned about a couple of aspects of the exposure draft, but they supported the overall proposal and were of the opinion that the proposal should be implemented. Furthermore, some constituents were labelled as neutral, meaning that they are ‘‘less opposed than those coded against, but less supportive than those coded in favor’’ (Puro, 1984). In total, there were 17 neutral constituents, or a percentage of 26.98%. Lastly, 43 constituents were unilaterally against the implementation of the proposed standard, which equals a percentage of 68.25%.

Next, all comment letters were reread and all issues, reasons, effects and solutions were entered in Excel. The purpose of this step was to turn the first-order categories into first-order concepts. Or in other words, to specify the various types of issues, reasons, effects and solutions

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20 that were mentioned. After this process was completed and all issues, reasons, effects and solutions were turned into first-order concepts, the concepts were coded. As the purpose of the coding process was to transform the first-order concepts into second-order concepts, the first step was to look for differences and similarities in the first-order concepts. Similar concepts received the same code. For example, some constituents mentioned that the amortization pattern under type B does not reflect the underlying economic reality, while others mentioned that the amortization pattern under type B is no faithful representation. These concepts received the same code such that they would be captured under the same second-order concept. This process resulted in 40 second-order issues, 41 reasons, 6 effects and 32 solutions. Subsequently, the common themes were identified. To accomplish this, firstly the second-order concepts were grouped based on the question ‘What is the common factor here?’. Secondly, once the second-order concepts were grouped, the frequency of the individual second-order concepts was assessed. Moreover, it was determined how often a particular concept was mentioned by respondents. It was concluded that concepts that were mentioned most frequently and that related to each other formed an overarching theme. This process led to the identification of five overarching themes, which are displayed in table 3.2.

Overarching themes

1. Quality of financial reporting decreases due to ambiguity in proposal

2. Structuring opportunities because classification criteria require subjective judgement

3. Dual approach is unnecessarily complex 4. The proposal is burdensome on preparers

5. Additional costs outweigh additional decision usefulness Table 3.2: Themes comment letters

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4 Themes audit comment letters

This section presents the emerging themes that were identified in the audit comment letters. The purpose is to gain an insight in auditors’ views on the proposed leasing standard, which will be informative for analyzing auditors’ lobbying behavior. It should however be noted that there is subjectivity involved in the identification of the emerging themes. As there is only one researcher, the emerging themes depend fully on the analysis of that one researcher. In addition, it will become clear that the themes are interrelated, so they cannot be seen as completely separate from one another.

4.1 Lower quality of financial reporting

One of the most prevalent criticisms throughout the comment letters was the effect the proposed new leasing standard would have on the quality of financial reporting. Most firms did not explicitly mention they were concerned about the quality of financial reporting, but rather raised the concern that the proposal would be detrimental to (one of) the qualitative characteristics of accounting information. Therefore, concerns about the effect the proposed changes would have on the qualitative characteristics were grouped together under the common denominator of lower quality of financial reporting. This process led to the identification of two subcategories that together form the reduction in the quality of financial reporting: a reduction in comparability and lower faithful representation.

The reduction in the quality of financial reporting would mostly conceptualize in terms of lower comparability. Auditors are worried that various aspects of the proposed standard would lead to inconsistent classifications, divergence in practice and to economically similar transactions being accounted for differently. Interestingly, due to the lack of comparability of lease accounting under IAS 17, the objective of the new leasing standard was to improve the quality of financial reporting, and comparability in particular (Revised Exposure Draft, 2013). Nevertheless, auditors are concerned that the overall ambiguity in the proposal will still lead to economically similar transactions being accounted for differently, leading to a reduction in comparability.

Several audit firms attribute the expected decrease in comparability to the use of unclear concepts throughout the proposal (CL183, CL199, CL214, CL226, CL236, CL378, CL397A, CL489, CL491, CL494, CL497, CL546, CL629). It is argued that the concepts of ‘‘more than an insignificant portion’’, ‘‘significant economic incentive’’ and ‘‘in-substance fixed payments’’ are unclearly defined and may lower comparability. Auditors argue that these ambiguous benchmarks require judgement in application, resulting in economically similar transactions being accounted

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22 for differently. More specifically, they are concerned about inconsistencies in the classification of leases as type A or type B:

‘‘Also, paragraph 31 notes that a lease is classified as a Type A lease if the lessee has a significant economic incentive to exercise a purchase option. Interpretation of the term significant economic incentive could result in incomparability between financial statements based on the interpretation of individual preparers (CL494, PKF International)’’.

‘‘Despite our support for the Type A and Type B classifications, the consumption-based principle is based upon a very ambiguous benchmark. Without further explanation, illustration, and definition, we believe that this benchmark will be interpreted differently amongst preparers’’ (CL236, NJCPA).

In addition, auditors are worried about comparability because the classification criteria is not consistent with the classification criteria in the revenue recognition standard:

‘‘(…) not consistent with the criteria in the forthcoming revenue recognition standard for transfer of the significant risks and rewards of ownership of the asset. The proposed model poses a potential risk of different accounting treatments for economically similar transactions’’ (ICPAK, CL630).

Besides the reduction in comparability, auditors are also concerned with the lack of faithful representation that results from the proposal. Ironically, one of the main criticisms on IAS 17 was that it challenged the qualitative characteristic of faithful representation because the standard allowed an off-balance sheet treatment for lease liabilities. Moreover, a transaction that would economically result in a liability, would be expensed instead of capitalized. However, auditors are also concerned that certain accounting requirements in the proposed new standard would not be reflective of the underlying economic reality. Firstly, some audit firms argue that the amortization for type B leases would not faithfully represent the underlying economic situation (CL65, CL359, CL487, CL489, CL641):

‘‘As the standard currently reads, a right to use the asset under a type B lease would be amortized at a rate that is less in the early years and increases over the life of the lease in order for the straight-line (or single line) lease expense to be achieved. We do not feel this ‘decelerated amortization’ reflects the economics of the transaction’’ (Cherry Bekaert, CL359).

‘‘In our opinion, the amortization charge may not reflect the pattern in which the right of use asset is expected to be consumed by the lessee’’ (Mazars, CL641).

Secondly, some auditors are of the opinion that basing type A leases on the total economic life instead of on the remaining economic life is conceptually not justified (CL183, CL199, CL236, CL262, CL536, CL629, CL641):

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23 ‘‘Furthermore, we do not believe there is adequate justification for using a different economic life to test whether a lease is type A or type B – i.e. for non-property it is the total economic life, while for property it is the remaining economic life (…). We believe the remaining life should be used in both cases, as this reflects the underlying asset that is being leased’’ (ICAS, CL629).

4.2 Structuring opportunities

As was already briefly mentioned previously in the paragraph on faithful representation, IAS 17 enabled lessees to keep leases that would actually give rise to liabilities, off-balance sheet. This is due to the structure of IAS 17, because it gave lessees the option to record a lease as either a finance lease, or an operating lease. It appears that lessees had an incentive to record operating leases instead of finance leases, because operating leases would exclude the lease liability from the balance sheet, lowering debt ratios (Lückerart-Rovers, 2007). Moreover, IAS 17 enabled lessees to structure their leases as operating lease and obtain the accounting result they wanted to achieve. With the development of IFRS 16, the IASB intended to eliminate the opportunity to record operating leases and rather let all leases (over 12 months) be recorded on the balance sheet. Although it is indeed no longer possible to record operating leases, auditors expect that new structuring opportunities will arise. The concern that the proposed new standard would still provide structuring opportunities for lessees was prevalent throughout many audit comment letters, and therefore forms the second overarching theme. Auditors identified the following types of structuring opportunities: recording a service contract instead of a lease, recording a type A lease that should have been a type B lease or reverse.

Firstly, auditors are worried about the incentive lessees may have to structure leases as a service contract instead of as a lease. This incentive because service contracts are not within the scope of the proposed leasing standard. Hence, structuring a lease transaction as a service contract would enable an off-balance sheet accounting treatment.

‘‘We believe the proposed guidance does not achieve its initial goal to reduce structuring opportunities: the area for structuring will no longer be driven by the distinction between finance and operating leases. Instead, entities will strategize with the distinction between service and lease contracts’’ (Mazars, CL641). ‘‘However (…) the proposals as drafted might lead to structuring opportunities, which could lead to some contracts being treated as service contracts when they are in substance leases’’ (Kingston Smith, CL143). Of course, if the standard would be constructed such that structuring opportunities are eliminated, lessees would not be able to execute this structuring behavior. However, auditors identify two weaknesses in the proposed standard which allow lessees to structure their leases as a service

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24 contract. Firstly, the definition of a lease is unclear and requires judgement, and secondly, there is no clear description of a service contract in the proposal. It is argued that the proposal does not provide guidance on the distinction between the two, and hence, structuring opportunities are created.

‘‘We believe that the ED does not provide sufficient guidance to distinguish between leases and service contracts. We expect this would be a key issue when implementing the proposals, because of the significantly different accounting outcomes for leases and executory contracts as the latter would remain off-balance sheet (…)’’ (TFRSC, CL65).

Secondly, auditors are worried about structuring opportunities due to the two-model approach. The proposed standard allows leases to be classified as either type A or type B, and both types have a different accounting treatment. While both types require the recording of a right-of-use asset and a lease liability, there is a difference in the treatment of amortization and interest. For type A leases, it is required to recognize the amortization of the right-of-use asset and interest on the lease liability separately, whereas for type B leases it is required to recognize a single lease expense that represents both amortization and interest. Moreover, the dual model in the proposed standard still provides lessees with the opportunity to structure their leases such that they can create a desirable accounting result.

‘‘As proposed, we are concerned that the ED’s distinction between Type A and Type B leases will give rise to structuring of lease contracts in order to achieve a desirable accounting result’’ (BDO, CL536). Depending on the desired accounting outcome, it appears auditors are concerned lessees have an incentive to structure leases as either type A or type B:

‘‘Type A lease classification may cause the entity to pass a debt covenant based on EBITDA. Similarly, an entity that is leasing a machine with a debt covenant based on net income may wish to minimize the frontloading impact of a Type A lease, and may therefore assert the total economic life is greater than it actually is in order to achieve Type B classification’’ (Crowe Horwath, CL397).

Besides the fact that the dual model provides structuring opportunities by offering a choice between two different accounting treatments, it is important to note that the proposal facilitates these structuring opportunities with the ambiguous classification criteria of consuming more or less than ‘an insignificant part’ of the economic benefits.

‘‘Although both Type A and Type B models require the entity to recognize the underlying assets and liabilities (…) the separation of lease contracts based on whether the lessee is expected to consume more

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25 than an insignificant portion of the economic benefits of the leased asset inherently creates an opportunity for entities to structure lease contracts’’ (Crowe Horwath, CL397).

Thirdly, some auditors are concerned that the proposal will enhance the likelihood of structuring opportunities in general. They argue that these opportunities are created because the proposal has made lease accounting more rules-based:

‘‘The ED, despite alluding to principles, sets a series of requirements and rules in order to regulate lease accounting. We consider this approach is unhelpful and will lead to structuring opportunities with bright lines and rules that can be worked around’’ (Baker Tilly, CL183).

‘‘As one of the major criticisms of the current lease accounting model is the bright line between operating and finance leases, we are concerned that another dual approach will not deliver the desired improvements in financial reporting’’ (ICAS, CL629).

Auditors give several solutions to eliminate the structuring opportunities. They suggest that the distinction between a lease and a service contract as well as the classification criteria of type A and B should be clarified, that a single lease model should be implemented instead of a dual model and finally that the IASB should introduce a more principle-based standard.

4.3 Complexity dual model

The new leasing standard was initially developed with the aim of addressing the criticism on the current leasing standards. As was established in previous sections, the main criticism on the current standards was the lack of comparability and faithful representation and the structuring opportunities that arose because of the ability to record leases in two different ways, each with an entirely different accounting result. Therefore, the initial objective of the IASB was to develop a single lease model with one accounting treatment that would apply to all leases (Discussion paper leases, 2009). This would limit structuring opportunities, result in consistent accounting for leases and enhance faithful representation. However, the exposure draft of 2013 proposes a dual lease model instead of a single lease model.

The idea behind the dual model was that it would better reflect the economic differences between different leases (Exposure draft leases, 2013). However, as it appears from the audit comment letters, auditors largely reject the two-model approach. The argument is that while the dual approach does not address the shortcomings of the current standards, it does introduce additional complexity:

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26 ‘‘Proposing two approaches is not only inconsistent with the Board’s initial objective of introducing a single lease accounting model, it also impairs the comparability of financial statements, offers structuring opportunities and makes accounting for leases complex and costly’’ (IDW, CL487).

Two audit firms supported the idea of a dual model, indeed for the reason that different types of leases deserve different accounting treatments (CL331, CL491). However, even these firms could eventually not support the particular proposed dual model approach, due to the complexity of type B leases:

‘‘We agree with the two model approach for lessees (…) but without the complexity of the proposed Type B model’’ (Illinois CPA Society, CL331).

‘‘The economics of lease transactions vary (…) Thus we believe it reasonable to develop a different accounting approach to be applied to such lease transactions. However, we have some concerns related to the proposal as it pertains to the lessee accounting and the presentation of leases classified as Type B’’ (The Japanese Institute of CPAs, CL491).

It appears that the complexity of the dual model was even prevalent in the comment letters of the audit firms that do expect the dual model to improve lease accounting. Moreover, the additional complexity introduced by the dual model forms the third theme.

Auditors attribute the additional complexity to various aspects of the dual model. The main source of the complexity introduced by the dual model relates to its general accounting requirements. Firstly, it complex for preparers to classify a lease as either one of the types, as it requires testing of the lease characteristics against the (ambiguously defined) conditions:

‘‘The model includes new concepts and judgmental thresholds that are not defined or thoroughly explained in the proposals, which will add greater complexity for users, preparers and auditors’’ (KPMG, CL199). ‘‘The two-model approach would require lessees to perform additional analysis to classify and bifurcate all

of its lease contracts’’ (Crowe Horwath, CL397).

Secondly, it is complicated and resource-intensive for preparers to separately measure and re-measure the different types of leases. On top of that, the dual model is also difficult to understand for users, leading to the conclusion that the dual model is ‘unnecessarily complex’.

‘‘Separating the accounting for the right-of-use asset and the lease liability in a manner that involves divergent treatments, each with their own accounting complexities (…) and then further complicating the accounting with different treatments of some of those components depending on whether the lease is classified as a Type A or Type B lease, results in a level of complexity which we believe is unnecessary and which we

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27 believe will make the financial reporting more difficult for users to understand and analyze’’ (Cohn Reznick, CL337).

Furthermore, auditors argue that the dual model, specifically type A, introduces additional complexity for lessors. The dual model requires lessors to estimate the fair value of the asset and of the residual value when the lease is initiated. The complexity of the dual model for lessors is particularly due to the estimation of the fair value of the residual value at commencement date. It requires substantial judgement and is rather complex when the asset is leased multiple times:

‘‘The suggested accounting model for Type A leases for lessors are by far the most technically complex accounting solution in the proposed standard and would need the lessor to assess the fair value for the asset (…) For assets that during their economic life are repeatedly leased, the application of the receivables and residual model is likely to be very complex in practice’’ (FAR, CL489).

In addition, auditors are worried that the dual model leads to asymmetrical accounting between lessors and lessees. That is, lessees are required to record a right-of-use asset and lease liability, while lessors are not required to record a corresponding lease receivable for type B leases. This complicates the understanding of the dual model approach:

‘‘We believe that the introduction of a dual measurement approach and asymmetrical accounting treatments for lessors and lessees (mainly for Type B leases) has increased the complexity of the proposals as well as the likely costs associated with their implementation, which does not help to understand the right of use model’’ (RSM, CL497).

Due to the complexity of the dual model, many audit firms argue that it would be more appropriate to replace the dual model by a single model with one approach that would apply to all leases. Besides, a single lease model is more consistent with the objectives of the Boards:

‘‘A single lessee accounting model would provide comparability between leases for lessees, would facilitate the accounting and record keeping requirements of entities, and reduce the inherent complexity of applying multiple lessee accounting approaches’’ (Cohn Reznick, CL337).

4.4 Burden on preparers

Another issue that materializes in the audit comment letters is the concern the proposal is particularly onerous for preparers. Although the complexity of the dual model is definitely also one of the factors that contribute to the implementation burden for preparers, this theme focuses on situations where auditors explicitly mention the onerousness for preparers. This issue is prevalent throughout the comment letters, and auditors discuss it in several ways. On the one

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28 hand, they discuss the source of the onerousness, which are specific accounting requirements in the proposal, and on the other hand, they discuss the onerousness itself. That is, they discuss the additional costs and adverse effects the proposal has on preparers.

Starting with the source of the onerousness of the proposal, auditors argue that the reassessment requirements for the lease term and variable lease payments are particularly demanding. The proposal requires that the lease term is re-assessed when there is a change in relevant factors (Exposure draft leases, 2013). Auditors argue this is costly for preparers, as it requires them to continuously monitor potential assessment triggers and to continuously re-measure the lease term, as re-re-measurement is also required when there is only a minor change in relevant factors:

‘‘Reassessment will be required more frequently than ideal, which could be onerous to apply in practice (…) as currently drafted paragraph 27 appears to require reassessment if there is any change in relevant factors.’’

(Kingston Smith, CL143).

Similarly, the proposal requires reassessment of variable lease payments when there is a change in an index or a rate that was previously used to determine the lease payments (Exposure draft leases, 2013). Auditors perceive this requirement to be even more demanding than the reassessment of the lease term, as indices and rates fluctuate constantly. The reassessment gives rise to high implementation costs for preparers, as it requires the development of a system to monitor changes and re-measure the liability. Besides, they argue that the impact from the re-measurement is only marginal.

‘‘The requirement for lessees to reassess and remeasure lease liabilities on an ongoing basis would give rise to significant costs (e.g., information systems costs, costs of implementing and maintaining internal controls over financial reporting) that are not present today’’ (EY, CL297).

‘‘By requiring preparers of financial statements to remeasure the lease liability for changes in the index or rate, the standard is placing additional burden on entities to create processes and procedures to remeasure all lease agreements (…) As many entities have numerous lease agreements, this could be an extensive process resulting in potentially only minor changes’’ (Moss Adams, CL555).

In order to reduce the implementation burden, auditors suggest that reassessments should be required periodically instead of continuously, and that re-measurement should only be required when there is a significant change in relevant factors and ratios.

Secondly, auditors argue that disclosure requirements are burdensome on preparers. They argue that disclosure requirements are excessive and that it is costly to collect all necessary information:

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29 ‘‘In our view, the proposed disclosures are excessive and would pose a significant burden on preparers’’ (IDW, CL487).

‘‘AC notes that the ED requires very significant disclosures which could be voluminous and time consuming to prepare’’ (Chartered accountants Ireland, CL608).

In auditors’ view, the disclosure requirements are mainly excessive because leases are already capitalized under the proposed standard. The idea of capitalizing leases was that the financial statements would provide more transparency and give more useful information, thereby reducing the need for additional disclosure requirements. Ironically, the disclosure requirements in the proposal are higher than under the current standard.

‘‘FAR would not have expected that a proposal that attempts to provide more useful financial information regarding leases by recognizing the assets and liabilities in the statement of financial position that arise in leases should require significantly more disclosures than under current standards’’ (FAR, CL489). Taking it a step further, it is even suggested that the excessive disclosure requirements in the proposal reflect the failure of the Boards to develop an improved standard:

‘‘We believe the proposed disclosure requirements are symptomatic of the complexity of the Boards’ recognition and measurement proposals, and the failure to develop an accounting model that increases transparency and comparability of lease accounting and otherwise achieve the Boards’ objective of a single simplified accounting model for lease accounting. (KPMG, CL199).

Moreover, auditors perceive the new disclosure requirements as excessive, resulting in high costs to collect the necessary information, thereby causing an increase in overall implementation costs. Besides the implementation costs, auditors expect the proposed standard will give rise to other additional costs and adverse effects for preparers. Firstly, auditors expect that the lease capitalization will affect the key financial metrics of preparers that are currently using operating leases. Due to the lease capitalization, a liability is added to the balance sheet that did not exist before. As this creates a different leverage position, preparers’ key financial metrics are adversely affected and preparers may no longer be able to meet their debt covenants. Therefore, preparers will be required to recalculate and renegotiate their debt covenants.

‘‘It blows loan and other financial covenants (…) by adding liabilities that had not existed before. Lenders will have to re-write loan covenants as entities they loaned to under restricted limits no longer will meet specific ratios or dollar limits of debt’’. (Morton Alan Haas & Co, CL104).

‘‘Further, the potential impact to loan covenants due to altered ratios such as current ratios for bank loans could be extremely costly to renegotiate and detrimental to my client’s operations’’ (D. Supkis Cheek, CL238).

Client versus public interest : an analysis of auditors’ lobbying behavior