Question 1

There is a need to report the lease obligation as a liability in financial statements. This is prompted by the idea that recording lease obligation as part of footnotes might not provide investors, creditors and other relevant stakeholders with the appropriate information on the actual liabilities. As the lease payments are made, they tend to be recorded as a reduction of the lease liability.

Question 2

In an efficient capital market, it would not make a difference whether a lease is simply described in footnotes or is reported as a liability. This is because by the time financial statements are being issued, the shares market price already reflects the information that is contained. As a result, accounting information is not relevant in this case. Efficient Market Hypothesis asserts that stocks will always be traded at fair value in stock exchanges hence making it impossible for investors to either sell stocks at inflated prices or purchase undervalued stocks.

Question 3

According to agency theory, the link between the management pay and the stock price changes through stock option plans or any other stock-based compensation forms ought to align the management’s goals with those of the stockholders. In addition, if the stock options are measured at the fair value, an expense will be recorded making any portion of the management’s bonus, which is based on accounting earnings to be affected negatively. This gives the management the motivation to work in favor of stockholders to help boost their own prospects in the process. The same thing applies to the aspect of structuring lease agreements so that they are not recorded as capital leases.

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