Functional fixation: Experimental evidence on the presentation of financial information through different digital formats

This study examines whether, in the presentation of financial information, digital formats address the concern over users’ functional fixation. The accounting literature indicates that the presentation of financial information either within the financial statements or in the notes to the financial statements often creates functional fixation where users of financial statements fail to adjust for differences in accounting policy. This leads users to judge what would otherwise be identical financial situations as being different due to the different accounting policies and methods adopted. It has been suggested that the use of digital formats in presenting financial reports may overcome functional fixation. Using an experimental design involving accountants in public practice, the results indicate that the use of digital formats to present financial reports does not fully overcome the issue of functional fixation in the processing of financial information. Although the participants were able to identify and extract relevant information, irrespective of whether or not the information was presented within the financial statements or in the notes to the accounts, the evidence indicates that functional fixation remained when the participants made final decisions based on available information. This suggests that functional fixation may not be caused by access to or extraction of information but by the level of perceived significance based on where the information is reported in the financial statements. In general, the results indicate that current technology may not be able to fully reduce functional fixation in the evaluation of financial information prepared in accordance with different accounting policies and methods.     

THE REPORTING OF INVESTMENTS IN ASSOCIATED COMPANIES AND CREDIT EVALUATIONS: AN EXPERIMENTAL STUDY

Policymakers have been concerned with the problem of accounting for investments in associated companies. A field experiment was conducted to investigate the effects of alternative methods of recognising revenue from investments in associated companies on creditors' evaluations and decisions. Results indicate that most creditors do not adjust financial statements based on alternative methods of accounting and that different methods of accounting affect credit assessments and decisions. The implications of these findings for policymakers and creditors are discussed.     

Are IFRS value-relevant for separate financial statements? Evidence from the Italian stock market

Using a sample of Italian firms, this paper investigates whether separate financial statements are useful to capital market investors, and whether International Financial Reporting Standards (IFRS) are more value-relevant than domestic generally accepted accounting principles (GAAP). These issues are key in evaluating the decision made by some states in the European Union to extend the use of IFRS to separate financial statements. The study provides evidence that separate financial statements are value-relevant, regardless of the accounting standard set. However, contrary to expectations, separate financial statements under IFRS do not have incremental information content beyond domestic GAAP. There is even some evidence that domestic GAAP financial statements are more value-relevant than IFRS. Finally, this paper documents the important role of model specification in value-relevance studies.     

Financial statement recasting and credit risk assessment

This article examines the importance of adjustments to corporate financial statements for credit risk assessment. Prior research has tended to examine individual adjustments one at a time. As correlations among adjustments and control variables may bias inferences when researchers examine a single adjustment and ignore other adjustments, our results provide important new information about previous research by documenting whether or not such bias exists. We find that financial statement recasting adjustments – which aim to better reflect firms' indebtedness, financing costs and recurring earnings than reported financial numbers – are reflected in bond yield spreads and have an economically significant impact on credit pricing and loss forecasting. Among individual adjustment categories, we find that those for off‐balance‐sheet leases, defined benefit pensions and securitized debt have an economically significant impact on credit pricing and loss forecasting.     

财务会计的本质、特点及其边界

为了指明财务会计的本质特点 ,我认为财务报表是财务报告的中心部分 ,而报表附注、其他财务报告等传送财务信息方法仅是次要的手段。在财务报表上确认的任何项目 ,都必须符合可定义性、可计量性、相关性与可靠性的特征。会计程序包括计量、记录和报告都必须以确认为基础。因此 ,财务报表的信息可以按真实和公允的要求来描述财务业绩和现金流量。财务会计的基本职能既不试图提供可能的未来的信息 ,又不产生非财务信息。财务会计的主要目的是通过它的报表反映一个企业经济活动及其结果的真实图像。结论 :财务会计作为一门学科是历史科学 ;作为一项实务是一个信息系统 ,它的任务是为企业提供历史的财务信息。     

Accounting aggregation: User preferences and decision making

This experiment tests the effects of alternative aggregations of accounting data in a simulated portfolio task. Certain entropy-based aggregation criteria were used to prepare differentially aggregated financial statements for use in the task. Subjects made allocations of initial edowments between hypothetical firms, disclosed confidence in their allocation decisions and reported on specific characteristics of the financial statements. Differences in reported usefulness of statement sets furnished were found to be associated strongly with measured information content. The results also provide limited evidence that decisions and judgments of subjects were affected by the information content of the accounting aggregations provided.     

The Effect of Analysts' Adjustments in the Context of Loan Assessment

This paper demonstrates that improvements in the classification of loan default can arise through making simple accounting adjustments to the financial statements of small firms prior to calculation of ratios. However, the improvement in loan default classification exists only on a univariate basis. The adjustments do not increase default classification when a multivariate linear discriminant model is employed. The data base comprises commonly used financial ratios extracted from the financial statements of 40 small New Zealand businesses with manufacturing or distribution activities.     

Cash flows and leverage adjustments

Recent research has emphasized the impact of transaction costs on firm leverage adjustments. We recognize that cashflow realizations can provide opportunities to adjust leverage at relatively low marginal cost. We find that a firm's cashflow features affect not only the leverage target, but also the speed of adjustment toward that target. Heterogeneity in adjustment speeds is driven by an economically meaningful concept: adjustment costs. Accounting for this fact produces adjustment speeds that are significantly faster than previously estimated in the literature. We also analyze how both financial constraints and market timing variables affect adjustments toward a leverage target.     

The Disciplinary Role of Financial Statements: Evidence from Mergers and Acquisitions of Privately Held Targets

This study examines whether requiring the disclosure of audited financial statements disciplines managers’ mergers and acquisitions (M&As) decisions. When an M&A transaction meets certain disclosure thresholds, the Securities and Exchange Commission (SEC) requires the public acquirer to disclose the target's audited financial statements after the merger is completed. Using hand‐collected data, I find that the disclosure of private targets’ financial statements is associated with better acquisition decisions. Furthermore, I find that this disciplining effect of disclosure is more pronounced when monitoring by outside capital providers is more difficult and costly, and when other disciplining mechanisms are weaker. Finally, these findings are robust to several alternative explanations, such as monitoring from blockholders and voluntary disclosures. In sum, the evidence suggests that the ex post mandatory disclosure of private targets’ accounting information disciplines managers’ acquisition decisions and improves acquisition efficiency.     

Macroeconomic conditions and capital structure adjustment speed

Using two dynamic partial adjustment capital structure models to estimate the impact of several macroeconomic factors on the speed of capital structure adjustment toward target leverage, we find evidence that firms adjust their leverage toward target faster in good macroeconomic states relative to bad states. This evidence holds whether or not firms are subject to financial constraints. Our results are robust to an alternative method of calculating states and to omitting zero-debt boundary firms and are not driven by firm size, deviation from target, or leverage definitions.     

Recognition versus Disclosure: An Investigation of the Impact on Equity Risk Using UK Operating Lease Disclosures

This study examines the equivalency of accounting recognition versus disclosure. OLS regression analysis is used to determine whether there is an association between equity risk and an adjustment to financial risk for off-balance sheet operating leases. Two methods of adjustment are considered: constructive capitalisation and a simple factor method. The observation of a reliably positive association suggests that UK investors/analysts view operating leases from a property rights perspective rather than an ownership perspective. This supports the argument for recognition of all lease rights and obligations 'on-balance sheet', as proposed in the recent G4+1 discussion paper ASB (1999).     

The Effects of Uncertainty and Disclosure on Auditors' Fair Value Materiality Decisions

Financial accounting standards increasingly require fair value measurements. I experimentally examine how uncertainty affects auditors’ adjustment decisions when evaluating fair values. I manipulate two types of uncertainty, input subjectivity and outcome imprecision, and one reporting choice, supplemental disclosure. I find that auditors are most likely to require adjustments when fair values contain both more input subjectivity and more outcome imprecision, but that this likelihood diminishes when clients supplement recognized fair values with additional disclosure. Thus, consistent with moral licensing, I find that auditors tolerate greater potential misstatement in the financial statements when clients provide disclosure, suggesting that the SEC's preference for supplemental disclosure may have the unintended consequence of affecting fair values recognized in the body of the financial statements. I also provide evidence that auditors determine adjustment size by comparing recorded fair value to the nearest bound, rather than the midpoint, of the auditors’ own range estimate, consistent with strict application of auditing standards.     

建立中国财务会计概念框架的总体设想

本文围绕在我国建立财务会计概念框架的基本问题,系统探讨了财务会计目标、财务报告信息的质量特征、财务报表的要素、要素的确认与计量、财务报告的列报等问题。本文在借鉴国外既有研究成果的基础上着重探讨了资产要素的定义,结合收入要素探讨了确认问题,在财务报告列报部分还具体探讨了财务报表确认、财务报表附注及其它财务报告的披露问题。     

Information Quality of Interim Financial Statements

Expressing concern about the Canadian capital market environment, Boritz (2006) suggested that the accounting and auditing profession may be paying limited attention to quarterly reports. This study investigates whether fourth‐quarter adjustments are significantly different from the previous three, thereby limiting the reliability or faithful representation of the firms' results for each quarter. This study includes four years (2003–2006) of quarterly financial information of 353 Canadian public companies. Our results indicate that the volatility of net income in each of the first three quarters is considerably lower than in the final quarter. While lower volatility can improve predictability, the resulting relevance may be limited. The low volatility of reported earnings in the first three quarters suggests that either earnings management is taking place or that management may not be exercising sufficient care at the end of each of the first three quarters on the measurements that generally accepted accounting principles call for and readers of financial statements expect. This could result in quarterly financial statements that do not faithfully represent the underlying resources and obligations of the reporting firms at the end of the quarter, or the firm's performance during the quarter. Our findings support Boritz's proposition for increased audit requirements for interim reports and changes in the approach to the annual audit to integrate it more closely with interim financial reporting.     

How audit effort affects audit quality: An audit process and audit output perspective

Using a unique dataset of audit days in China from 2006 to 2011, this paper examines the relationship between audit effort and audit quality from the perspective of audit process and audit output. The results show that audit effort significantly increases the probability of audit adjustments, which inhibits positive earnings management and improves the quality of audited financial statements. We also find that audit effort does not have a significant effect on the issuance of modified audit opinions overall, but that a modified audit opinion is more likely to be issued in the absence of an audit adjustment. Furthermore, we find that the impact of audit effort on audit quality is attenuated when clients are more complex and when audit firms are larger. Collectively, our evidence suggests that audit effort plays an important role in improving audit quality by influencing audit process and audit output. Our study extends the literature on the impact of audit effort on audit quality in emerging markets, and the conclusions have important implications for the improvement of China’s audit market efficiency.     

The value-relevance of adopting IFRS: Evidence from 145 NGAAP restatements

Firms listed on stock exchanges within the European Economic Area are required to report consolidated financial statements according to International Financial Reporting Standards (IFRS) since 2005. The firms that adopted IFRS in 2005 were also required to restate their 2004 financial statements from national GAAP to provide comparable accounting figures. These two sets of financial statements for 2004 are thus based on identical underlying economic activities and are fully specified according to two different reporting regimes. Our sample consists of 145 restatements from Norwegian Generally Accepted Accounting Principles (NGAAP) to IFRS for firms listed on the Oslo Stock Exchange in Norway. We test whether the IFRS accounting figures correlate more strongly with stock market values than the corresponding NGAAP figures. We find little evidence of increased value-relevance after adopting IFRS when comparing and evaluating the two regimes unconditionally. On the other hand, when evaluating the change in the accounting figures from NGAAP to IFRS, we find evidence that the reconcilement adjustments to IFRS are marginally value-relevant due to increased relevance of the balance sheet and the normalized net operating income. By weighting our sample by firm size, intangible asset intensity and profitability, we learn that the increased value-relevance of the net operating income stems from different reporting of intangible assets. Since more intangible assets are capitalized according to IFRS than NGAAP, our finding is consistent with the view that capitalizing intangible assets is more value-relevant than expensing them as incurred or through goodwill amortization.     

Client Characteristics and the Negotiation Tactics of Auditors: Implications for Financial Reporting

Although the financial statements of an organization are considered a product of management, prior research suggests that a company's financial statements may be affected by the negotiation strategy employed by the auditor when resolving audit differences with management. However, little subsequent research discusses the potential strategies that auditors may employ during the negotiation process. Our study extends the literature by investigating, in a post–Sarbanes‐Oxley environment, whether auditors will employ a reciprocity‐based strategy for the resolution of audit differences and what client characteristics (client management's negotiating style and client retention risk) increase the extent to which it is utilized. Further, we explore the potential effect of a reciprocity‐based strategy on the quality of the financial statements. Such a strategy involves bringing inconsequential items to management and subsequently waiving these items in an effort to encourage management to be more cooperative in the posting of significant income‐decreasing adjustments. The results of experiment 1 indicate that client management's negotiating style and retention risk have an interactive effect on auditors' use of a reciprocity‐based strategy. Specifically, auditors are more likely to utilize a reciprocity‐based strategy when management's negotiating style is competitive and client retention risk is high. Experiment 2 findings suggest that the auditor's use of reciprocity during negotiation can actually result in more conservative financial statements by helping the auditor manage perceived client pressures to waive or reduce proposed adjustments.     

Examining dual accounting systems in Europe

After adoption of International Financial Reporting Standards (IFRS) for consolidated financial statements by European-listed companies, a number of European countries still require the use of local standards in the preparation of legal entity financial statements. This study investigates whether this requirement can be explained by a low demand for high-quality financial reporting and an orientation of accounting toward the fulfilment of regulatory needs in these countries. Specifically, using accounting quality as an indicator of the focus of accounting on capital providers' needs, we compare accounting quality between countries permitting and prohibiting the use of IFRS in individual financial statements. Consistent with our expectations, we find that countries requiring the use of local standards in the preparation of legal entity financial statements exhibit a significantly lower level of accounting quality, both prior to and after IFRS adoption. We interpret these results as evidence that these countries have local standards more oriented toward the satisfaction of regulatory needs, rather than investors' needs. Furthermore, since differences in accounting quality persist after the implementation of IFRS, results suggest that firms in these countries face a lower demand for high-quality financial reporting.     

A case against the consolidation of foreign subsidiaries’ and a United States parent’s financial statements

Generally accepted accounting principles in the United States usually require that companies which own more than 50% of the voting stock of foreign corporations prepare consolidated financial statements. The foreign financial statements must be recast into US GAAP and the foreign currency financial statements must be translated into US dollars. Alternative methods of translating foreign currency have major impacts on consolidated financial statements and on the behavior of management. Further, foreign subsidiary financial statements which are recast into US GAAP are less useful than the originals, and US users cannot analyze them without reference to the foreign environment. The interests of financial statement users are better served by alternative presentations of foreign currency denominated accounts rather than by consolidation.     

The effect of government industrial policies on corporate accounting conservatism

This study examines whether and how firms adjust their accounting conservatism in response to government support through industrial policies, which reduce firms’ dependence on external financing from the capital market. Based on China’s unique economic programme called ‘Five-Year Plan’ from 1991 to 2015, we observe a decline in accounting conservatism among firms covered by government industrial policies. The decline is more pronounced in covered firms, which face higher ex-ante financial constraints, and in the subsample of firms which receive higher government support. These findings are robust to alternative specifications of accounting conservatism and policy timing. Our evidence implies that government industrial policies can have unintended consequences for corporate financial reporting.