Capitalized customer acquisition costs and earnings quality: A case study of PhotoWorks,Inc

This case examines issues related to accounting method choice, earnings management, and earnings quality. Specifically, the case examines a company (PhotoWorks, Inc.) that chose the less conservative approach of capitalizing and then amortizing a certain type of advertising expenditure rather than expensing the costs as incurred. The primary purpose of this case is to illustrate the role of judgment in accounting method choice and how it provides potential opportunities for earnings management. The case also allows students to explore the multi-dimensional nature of financial reporting decisions and to develop a greater appreciation for how their accounting coursework relates to important “real-world” issues. After completing this case, students should be able to do the following: (1) describe factors that are involved in accounting method choice and support the appropriateness of an accounting method choice based on a search of the accounting standards; (2) understand and evaluate the effects of accounting method choice on the financial statements; (3) describe the conflicting motivations managers face when deciding on financial accounting methods versus tax accounting methods; (4) explain what is meant by earnings management, factors that motivate managers to manage earnings, methods they can use to manage earnings, and how earnings management affects earnings quality; and (5) describe the role of auditors in analyzing a company’s accounting method choices and in assessing the quality of a company’s earnings.     

The economics of external reporting: Three frameworks for the classroom

In this paper three frameworks are presented that can be used by accounting instructors to explain some of the economic issues surrounding the external reporting process. The first framework explains accounting numbers in terms of the relationships among capital providers, managers, and auditors. The second framework explains external reporting in terms of its role in determining capital market allocations. The third framework focuses on the policymaking process and the notion of “economic consequences.” In each case the framework is first described and then some suggestions are provided on how it might be used in the classroom. The frameworks have been developed for use in introductory, intermediate, and advanced accounting courses at both the undergraduate and graduate level.     

A Comparative Analysis of Auditor, Manager and Financial Analyst Interpretations of SFAS 5 Disclosure Guidelines

This study examines empirically whether financial analysts (users), as well as managers (preparers) and external auditors ascribe different interpretations to the SFAS 5 disclosure criteria. We find: (1) financial analysts are, on average, more conservative than managers and auditors in their numerical interpretations of both the 'remote' and 'probable' verbal phrases; (2) managers and auditors share very similar numerical interpretations of these verbal phrases; (3) audit partners' numerical interpretations of the 'remote' region are between those of managers and users, whereas audit managers align their numerical interpretations with those of managers. One danger is that preparers of financial statements may omit loss contingency information that users consider valuable.     

Earnings quality at initial public offerings

We show that, contrary to popular belief, initial public offering (IPO) firms report more conservatively. We attribute this to the higher quality reporting demanded of public firms by financial statement users and consequentially higher monitoring by auditors, boards, analysts, rating agencies, press, and litigants, and to greater regulatory scrutiny [Ball, R., Shivakumar, L., 2005. Earnings quality in UK private firms: comparative loss recognition timeliness. Journal of Accounting and Economics 39, 83–128]. We also question the evidence of Teoh et al. [1998b. Earnings management and the subsequent market performance of initial public offerings. Journal of Finance 53, 1935–1974] supporting the alternative hypothesis that managers opportunistically inflate earnings to influence IPO pricing. We conjecture that upward-biased estimates of “discretionary” accruals occur in a broad genre of studies on earnings management around similar large transactions and events.     

Index investors and the return of stewardship accounting

Passive asset managers, seeking to deliver investment returns that mirror market indices, now control and vote about 30% of all managed U.S. shares. When bad news surfaces, index investors do not sell a company's shares. Instead, these beneficial owners protect the value of equity investments by influencing governance practices to restore long-term value creation. Interviews with stewardship offices at leading index investment firms suggest that passive investors do not use financial accounting information to value securities. The implication of this study is that the current focus of accounting standard setting – predicated on the idea that the purpose of financial reporting is to permit prediction of future cash flows – does not meet the needs of a particular group of financial statement users who have considerable influence over the governance of leading listed companies around the world.     

The development of an expert system for managerial evaluation of internal controls

Both practitioners and researchers have devoted signi?cant effort to the study of decision aids, especially expert systems, to assist auditors in internal control evaluations. In addition to being used as a decision aid, researchers have long contended that expert systems could be used to train non‐expert users. Even though the professional accounting literature makes it clear that responsibility for maintaining an effective internal control system rests with management rather than auditors, the focus to date has been on expert systems aimed at assisting/training auditors, not an organization's management. In contrast, this study focuses on management as users of an expert system for internal control evaluation. We describe the development process, explain how the resulting system was evaluated, and discuss results of that evaluation. These results suggest that such a system gives a new way to help managers increase effectiveness and ef?ciency of a critical organizational process: the evaluation of internal controls. Copyright © 2004 John Wiley & Sons, Ltd.     

Examining the differences between United States Generally Accepted Accounting Principles (U.S. GAAP) and International Accounting Standards (IAS): implications for the harmonization of accounting standards

Current trends indicate continued movement towards the harmonization of accounting standards, but not without difficulty and concern. At times, the political and financial market pressure, push the movement in opposite directions. The paper discusses the conceptual framework used in establishing Global Generally Accepted Accounting Principles (GAAP) (International Accounting Standards, IAS) and U.S. GAAP. Numerous transactional examples are illustrated under both Global GAAP and U.S. GAAP treatment. Several country specific references are presented demonstrating the difficulty in achieving harmonization. Implications for harmonization of accounting standards include arguments “for” and “against” Global GAAP.     

To Fair Value or Not to Fair Value: A Broader Perspective

Fair value is considered here with respect to the two primary objectives of financial statements proposed in the joint conceptual framework that is under development by the FASB and the IASB, namely (a) informativeness—to assist providers of capital in predicting, evaluating, and comparing the amounts, timing and uncertainty of future cash flows, and (b) stewardship—to assist in evaluating how efficient and effective managers have been in enhancing shareholders' value. More specifically, a comprehensive set of accounting measures and a set of corporate governance reforms intended to align corporate insiders' and auditors' behaviour and decisions with the interests of investors is outlined. Suggested reforms show how to present a mix of effectively historical quantifications, exit values, and the discounted values of future cash flows expected from the particularized use of combinations of assets within the firm. Additionally, the article describes how markets can be reformed in order to align the interests of the officers who prepare such accounts, and the auditors who certify them, with those of investors. These market-based reforms would require auditors to insure misrepresentations, and managers to take equity to induce truthful reporting. Also included is a radical extension to earlier proposals by the author, requiring an officer of the company to make the market in shares in a way that would place limits upon the value of the insider's private information.     

The Impact of Recognition Versus Disclosure on Financial Information: A Preparer's Perspective

We investigate whether recognition on the face of the financial statements versus disclosure in the footnotes influences the amount that financial managers report for a contingent liability. Using an experiment with corporate controllers and chief financial officers, we find that financial managers in public companies expend more cognitive effort and exhibit less strategic bias under recognition than disclosure. This difference appears to be associated with capital market pressures experienced by public company managers as we find that both the cognitive effort and bias exhibited by private company managers are unaffected by placement. As a result, public company managers make higher liability estimates for recognized versus disclosed liabilities. Their liability estimates are similar to those of private company managers for recognition but lower than private company managers’ estimates for disclosure. Our results have implications for auditors and financial statement users in evaluating recognized versus disclosed information for public and private companies.     

Strategy and accounting in a U.K. conglomerate

This paper sets out to explore various aspects of the relationship between the use of accounting information for performance reporting and control and the formulation and implementation of business and corporate strategy. It does this by means of a case study of the acquisition and subsequent management of “ELB Ltd” by “Conglom Inc.” The case gives an account of the structuring of relationships both between the Corporate centre and ELB senior management, and within ELB itself. A very complex picture of the relationship between strategy and accounting emerges. Although accounting results are often taken as a proxy for the relative success of strategy, the case suggests that in this respect accounts typically conceal as much as they reveal. Especially with a conglomerate structure it is quite possible for corporate financial “success” to be realized at the expense of the long term strategic positioning of individual unit companies. The paper illustrates how the sharing and integration of market knowledge required for the successful formulation and implementation of strategy can conflict with the conformity and distorted communication encouraged by the hierarchical use of accounting controls. It also describes some of the positive effects that can be realized from deliberate attempts to integrate strategic decision making with routine accountability.     

Internal auditors’ use of interpersonal likability,arguments, and accounting information in a corporate governance setting

Internal auditors play an important role in influencing managers’ judgments. Yet, the practitioner literature indicates that, because internal audit lacks the client services incentives of external audit, internal auditors often adopt a “policeman approach” that can lead to negative interpersonal relationships with managers. We investigate three variables fundamental to internal auditors’ ability to influence managers: (1) internal auditors’ interpersonal likability, (2) the information used to support their positions, and (3) whether they present that information in a thematically organized argument. We find that managers agree more with an internal auditor who is both likable and uses a thematically organized argument. We find further that this joint effect occurs regardless of whether the internal auditor’s information is relatively supportive or unsupportive of his position. Overall, our theory and findings suggest that an internal auditor can achieve agreement from managers on important corporate governance issues with this fairly straightforward presentation tactic, even when the underlying information is relatively unsupportive and managers otherwise tend not to agree with the internal auditor’s position. Our study contributes to accounting, psychology, and writing and discourse theories with new evidence of the effects of an argument structure (holding the underlying information constant) on users’ judgments, and how those effects depend on the likability of the source of information. Our findings have important implications for internal auditors, managers, external auditors, and others interested in corporate governance.     

Determinants of going concern opinions and audit fees for development stage enterprises

Startup entities have been the focus of much political and academic interest recently. Development stage enterprises (DSEs), as defined by SFAS 7, are startup entities for which some publicly available information exists. New accounting standards have removed the DSE designation and related extra reporting requirements, and placed more responsibility on owners and managers to assess the ability of entities to continue as a going concern. We examined information from financial statements and audit reports of companies previously reporting as DSEs to investigate what increases the likelihood of receiving a going concern modification in auditors' opinions (GCO) and what affects audit fees. Our overall analyses indicate that the asset size of DSEs, negative working capital, and prior-year going concern modifications consistently influence going concern modifications to auditors' opinions. Managers should clearly consider these conditions when making their assessment of their companies' future going concern status. Our results indicate that the size of the audit firm did not influence the going concern modification decision, but Big4 auditors charge significantly higher fees than other auditors. Thus, managers/owners of DSEs should weigh the benefits of having a Big4 firm audit on their financial statements against the higher fees charged by those firms.     

Auditors’ decision-making under going-concern uncertainties in low litigation-risk environments: Evidence from Hong Kong

This study examines the audit opinions issued by auditors in a low litigation-risk environment at a time of high economic uncertainty – that of Hong Kong in the period immediately after the Asian financial crisis of 1997. Empirical research using United States data has shown that, contrary to professional guidance which restricts the issue of “disclaimer of opinion” only to situations where existing uncertainties prevent the auditor from forming an opinion, auditors tend to use the “disclaimer” report (in the going concern context) to signal more extreme client firm’s distress. In the high litigation-risk environment of the US, researchers have attributed this tendency to the idea that “disclaimer of opinion” reports are used by auditors to provide some protection against potential legal liability. The results of this study provide evidence that, even in the low litigation-risk environment of Hong Kong, auditors still use “disclaimer” reports to signal more extreme client firm financial distress. Thus, the maintenance of a high litigation-risk environment does not appear to be a necessary pre-requisite for high quality audits.     

Lease transaction structuring,earnings management,and management credibility

Despite recent regulatory concerns regarding off-balance sheet financing, and concerns about lease accounting in particular, relatively little is known about how financial statement users view lease transaction structuring compared to other forms of earnings management. We examine sell-side financial statement analysts’ views on lease transaction structuring and its impact on their assessments of management credibility. Although operating leases often act as the prototypical example of transaction structuring, survey responses suggest that lease structuring and related voluntary reconciliations do not raise the same concerns for analysts as do other earnings management activities (which lower analysts’ perceptions of management credibility). Our findings are consistent with prior research demonstrating that, with precise accounting standards, managers are more likely to attempt earnings management by structuring transactions, but auditors are also less likely to adjust such attempts, and suggest that financial statement users may also be less concerned with transaction structuring than with other forms of earnings management.     

Auditors and base rates revisited

In their 1981 study “Are Auditors' Judgments Sufficiently Regressive?” [Journal of Accounting Research (Autumn 1981) pp. 323–349] Joyce & Biddle found that auditors underweighted base rates relative to a normative standard (Bayes' theorem), but appeared to be more sensitive to base rates than other subject groups. This study extends their results by addressing three questions raised by their findings: (1) Do auditors generally possess greater ability to recognize and utilize base rates than other decision makers? (2) Did the auditing context of the Joyce & Biddle experimental problems influence the results? and (3) Is it the framing of the experimental problems that influenced the apparent integration of base rates?Using students and auditors as subjects, the following five experiments replicate selected Joyce & Biddle experimental problems. The results suggest that it is the framing of the Joyce & Biddle experimental problem that drive their results rather than attributes of auditors or auditing context.     

The persuasiveness of audit evidence: The case of accounting policy decisions

This study examines how auditors respond to precedents in accounting situations where authoritative guidance does not exist. Three experiments were conducted with practicing audit managers and partners from a Canadian Big Six accounting firm. The results show that auditors rely to a greater extent on precedents that are similar (versus not similar) to the problem situation. When the client's position on the accounting matter was known to the auditor and all available precedents pointed to the same treatment of the accounting issue in question, auditors did not heed the client's position. Rather, they used the available precedents to judge the appropriate accounting. In contrast, when the client's position was known and the available precedents were mixed in their implications for the appropriate accounting treatment, auditors tended to follow the client's position. These results are considered in light of issues of auditor independence and the accounting regulatory environment.     

Monitoring Compliance with IFRS: Some Insights from the French Regulatory System

European Union Regulation 1606/2002 is aimed at improving the quality of financial reporting and developing a single capital market in Europe. Nevertheless, these goals cannot necessarily be achieved solely by making a requirement for EU companies to use International Financial Reporting Standards (IFRS), and the EU has sought to create a mechanism to oversee the appropriate application of these standards. In this paper, we describe and comment on the methods used by the French stock exchange regulator, the Autorité des Marchés Financiers (AMF), for monitoring compliance with the national reporting rules as this bears upon the issue of enforcement of IFRS in Europe as from 2005. The AMF has been chosen in our study because of its extensive experience with the review of financial statements of listed companies. Our paper draws on qualitative interviews with people involved directly in scrutinizing financial information at the AMF as well as on the experience gained from attachment to the AMF's Accounting Division. While there is recent research that addresses the issues on enforcement of accounting standards, there is still a lack of studies which discuss the relevance and effectiveness of the methods used to monitor compliance with accounting standards. Our paper may be of interest to different groups of participants including regulatory oversight bodies, auditors, producers and users of financial information in the capital markets.     

审计质量保障的权利配置研究视角

现行审计质量问题是审计委托权配置失范的外部性表现.提高审计质量的有效措施是对现行会计流程控制权配置范式进行变迁,改变目前企业管理当局集会计政策选择权、会计人员聘任权及审计委托权于一身的状况,使会计信息供应脱离管理当局的直接控制而由财务报告委员会及其所属的独立会计机构全程负责,此时高质量审计服务成为信息生产者、信息使用者、企业管理当局及注册会计师的共同需求,审计质量有了保障.     

Accounting information and managerial work

Despite calls to link management accounting more closely to management (Jonsson, 1998), much is still to be learned about the role of accounting information in managerial work. This lack of progress stems partly from a failure to incorporate in research efforts the findings regarding the nature of managerial work, as well as inadequate attention devoted to the detailed practices through which accounting information is actually used by managers in their work. In this paper I draw on prior research to develop a series of propositions focused on three primary insights into how and why managers use accounting information in their work. First, managers primarily use accounting information to develop knowledge of their work environment rather than as an input into specific decision-making scenarios. In this role, accounting information can help managers to develop knowledge to prepare for unknown future decisions and activities. Second, as accounting information is just one part of the wider information set that managers use to perform their work, it is imperative to consider its strengths and weaknesses not in isolation but relative to other sources of information at a manager’s disposal. Third, as managers interact with information and other managers utilising primarily verbal forms of communication, it is through talk rather than through written reports that accounting information becomes implicated in managerial work. These insights have important implications for how managers use accounting information, and, in particular, require reconsideration of the types accounting information that managers find, or could find, helpful. The paper also considers how existing experimental and field-based methods could fruitfully be adapted to focus on the detailed activities through which managers engage with accounting information.     

“Informing” technologies and the World Bank

The current study examines how the World Bank uses an assemblage of information generation and reporting practices, bounded by accounting/financial expertises, to attempt to influence the practices associated with administering education in Latin America. Starting from the premise that these “informing” technologies make the objects of governance knowable in terms of accounting and financial expertises, we consider how accounting practices embedded within lending agreements enable, translate and regulate behaviour. Focusing on the institutional field(s) of basic education, the study offers an in-depth analysis of 15 World Bank loan agreements from across the region, plus 25 interviews with field participants from a single Latin American country. We examine how the World Bank lending agreements install a variety of informing technologies across a network of agents in Latin America. We propose that such agreements can be viewed as technologies of governance in that they diffuse financial technologies to distant fields, re-structure the habitus of these fields, and serve to reaffirm the expertise of the Bank within these fields. In this way, the World Bank increases its legitimacy with other potential borrower countries and ensures its continuing influence.