Leese, a public limited company and a subsidiary of an American holding company operates its business in the services sector. It currently uses operating leases to partly finance its usage of land and buildings and motor vehicles. The following abbreviated financial information was produced as at 30 November 2000:

The company is concerned about the potential impact of bringing operating leases onto the balance sheet on its profitability and its key financial ratios. The directors have heard that the Accounting Standards Board (ASB) is moving towards this stance and wishes to seek advice on the implications for the company.
For the purpose of determining the impact of the ASB’s proposal, the directors have decided to value current year and future operating lease rentals at their present value.
The appropriate interest rate for discounting cash flows to present value is 5% and the current average remaining lease life for operating lease rentals after 30 November 2003 is deemed to be 10 years.
Depreciation on land and buildings is 5% per annum and on motor vehicles is 25% per annum with a full year’s charge in the year of acquisition. The rate of corporation tax is 30%
and depreciation rates equate to those of capital allowances. Assume that the operating lease agreements commenced on 30 November 2000.
Required

(a) Discuss the reasons why accounting standard setters are proposing to bring operating leases onto the balance sheets of companies. (7 marks)

(b) (i) Show the effect on the Profit and Loss Account for the year ending 30 November 2000 and the Balance Sheet as at 30 November 2000 of Leese capitalising its operating leases; (10 marks)
(ii) Discuss the specific impact on key performance ratios as well as the general business impact of Leese capitalising its operating leases. (8 marks)
ACCA, Financial Reporting Environment (UK Stream), December 2000 (25 marks)

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Profit and Loss Account for the year ending 30 November 2000 m Turnover Profit on ordinary activities before taxation Taxation on profit on ordinary activities Profit on ordinary activities after taxation 580 88 (30) 58