Evidence on the effect of bond covenants and management compensation contracts on the choice of accounting techniques: The case of the depreciation switch-back

Provisions of bond indenture agreements and management compensation contracts are examined to derive testable implications concerning management's incentives to choose among alternative accounting techniques. The hypotheses are subjected to empirical examination by investigating the voluntary change from accelerated to straight-line depreciation for financial reporting purposes only. The methodology utilized incorporates an expectations model of accounting earnings in an attempt to separate out of the effects of earnings announcements from accounting change announcements which are often concurrent. The evidence from both price and non-price data is not consistent with the general hypothesis that bond covenants and management compensation contracts are important determinants of the decision to change depreciation techniques. Five potential explanations for the results are offered.     

Economic consequences of firms’ depreciation method choice: Evidence from capital investments

This study identifies several interrelated reasons why firms’ depreciation method choice is likely to influence managers’ capital investment decisions. We find that firms that use accelerated depreciation make significantly larger capital investments than firms that use straight-line depreciation. Further, we find that there has been a migration away from accelerated depreciation to straight-line depreciation over the past two decades. Firms that make such accounting changes make smaller capital investments in the post-change periods than in the pre-change periods. These results suggest that a choice made for external financial reporting purposes influences managers’ capital investment decisions.     

Articulation in cash flow statements: a resource for financial accounting courses

Recent accounting research (Bahnson, P., Miller, P., & Budge, B. (1996). Nonarticulation in cash flow statements and implications for education, research and practice. Accounting Horizons, 10, 1–15 has shown that firms implementing the indirect method for reporting cash flows under SFAS 95 rarely produce financial statements that articulate cleanly. The purposes of this paper are (1) to provide financial accounting educators with a list of companies for which articulation does exist, (2) to describe the process by which educators can update the list in the future, or modify it to suit their own preferences, and (3) to present an analysis of firms’ reporting practices on the cash flow statement, which may be of interest to more advanced students studying the complexities of the statement of cash flows. This analysis of reporting practices involves an assessment of the articulation of individual COMPUSTAT line items (e.g. inventory) and subsets of line items (e.g. inventory, receivables, deferred taxes, and depreciation) for the 1998 data year. The findings indicate that relatively few firms report consistent values for single line items and that very few firms report consistent values across subsets of line items. Although the rate of articulation decreases as firm size, and hence reporting complexity, increases, 74 large, publicly-traded firms for which clean articulation does exist were identified. This list of firms should prove useful to introductory accounting educators who use real-world examples for classroom purposes.     

Voluntary IAS 1 accounting disclosures prior to official IAS adoption: An empirical investigation of UK firms

This paper focuses on firms’ voluntary compliance with the reporting requirements of the International Accounting Standard (IAS) 1 before the official adoption of IASs. The paper seeks to identify the motives for the voluntary adoption of IAS 1 and investigates the relation to the provision of voluntary accounting disclosures, the increase in equity capital, managers’ remuneration and firms’ stock returns. The study shows that the decision-making process of firms is significantly influenced by the intention to improve key financial measures, such as leverage, profitability and growth. Firms would tend to adopt an accounting policy or regulation when they feel that adoption would favourably impact on their financial situation. For example, the study indicates that firms voluntarily adopted IAS 1 before the official IAS adoption date in order to provide evidence of superior managerial ability and high quality reported accounting information. It is found that firms that perform well are more motivated to voluntarily abide by IAS 1. The study also reports that firms that provide voluntary accounting disclosures and perform increases in their equity capital appear to voluntarily adopt IAS 1. Similar findings are obtained for firms that display higher management remuneration and stock returns.     

The effects of governmental accounting methods on asset-acquisition decisions: A theoretical model and three case studies

This study explores possible effects of municipal accounting practices on asset-acquisition decisions. Theoretical decision models are developed using expenditure and depreciation accounting for reporting performance. The models suggest that expenditure accounting may lead to uneconomical leasing. Case studies of three cities focused on comparing present values of their leases to purchase alternatives and on interviewing department administrators. Significant uneconomical leases were found. The case studies suggest that a complete model of municipal administrators' acquisition decisions include consideration of accounting methods used to report performance; perceived risk of obsolescence; restrictions of grantors, third-party reimbursers and higher management; and administrators' background and training.     

On the Optimal Relation between the Properties of Managerial and Financial Reporting Systems

We develop a theoretical model of the firm that links properties (stewardship vs. valuation focus) of financial reporting regimes with the informational properties of optimal managerial accounting systems. We show that, contrary to the standard textbook proposition, properties of management and financial accounting systems are not independent. Significantly, we provide an explicit connection between exogenous and observable properties of a firm's financial reporting system and the quality of the managerial accounting system on which manager(s) base real economic decisions. As the quality of those economic decisions can also be inferred from publicly available data, our theory generates new opportunities for empirical managerial accounting research on large nonproprietary samples. Further, by being able to identify enhanced performance due to improved managerial accounting information, our theory provides opportunities to gain a better understanding of the link between particular managerial accounting practices and the quality of the information produced.     

Understanding accounting discretion in China: An analysis of fair value reporting for investment property

This study sheds light on the discretionary accounting practices in China, the largest emerging market in the world. In particular, we focus on whether Chinese firms use discretion in investment property fair values to manage reported performance. We examine whether firms’ ex ante needs for accounting discretion affect their decisions to adopt fair value reporting for investment property and the ex post performance management by these fair value adopters. Our findings show that the voluntary adoption of fair value reporting for investment property in China remains low. However, the fair value option for investment property is significantly more likely to be chosen by firms with greater needs for accounting discretion. Consistent with the conjecture that firms choose the fair value model to manipulate reported earnings, we show that fair value adopters use the unrealized gains and losses associated with investment properties to smooth earnings and that these firms are also more likely to meet or beat earnings benchmarks after adoption. Overall, our findings indicate that the use of fair value reporting for investment property in the emerging Chinese market is driven by managerial opportunism.     

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 adoption of international accounting standards by small and closely held companies: evidence from Bahrain

This study examines the accounting practices and the degree of adoption of international accounting standards (IASs) by small and closely held companies in Bahrain. It finds that 86% (31) of the 36 companies responding to the questionnaire applied IASs and they considered IASs to be very relevant for them. All firms prepare balance sheets, and the majority prepares income statements and cash flow statements. They also duly audit these statements. The data collected also revealed that the quotient influence on whether or not a firm adopted IAS was exerted by their external auditors. External auditors exerted the greatest influence on getting firms to adopt IASs. Banks and company partners were the primary users of company financial statements; inventories, depreciation, disclosure on financial statements, and the presentation of current assets and liabilities. The main IASs followed by a majority of firms are those pertaining so. Some of the standards were considered totally irrelevant, contrary to the prevailing idea that adoption of IASs creates an information overload for small and closely held companies. The results of this study indicate that a majority of our respondents did not find that it was costly to adopt or interpret IASs. Those few firms that experienced some difficulties sought clarification from their external auditors. About 84% of those who adopted IASs strongly agreed that using IASs improves their organization's ability to financial assistance from the banking sector. Also, about 90% of the respondents fully agreed that IASs help to achieve the objectives and improve the effectiveness of financial reporting.     

Accounting Conservatism and the Relation Between Returns and Accounting Data

This study adds change in cash investments and change in lagged operating assets to the regression of returns on earnings levels and earnings changes examined in Easton and Harris (1991). We argue that a positive coefficient on change in cash investments captures conservatism associated with investments in positive net present value projects the effects of which will not flow into the accounting statements until the expected future benefits are realized. A positive coefficient on change in lagged operating assets implies accounting conservatism associated with the application of accounting rules to operating assets in place. Our empirical results are, in general, consistent with these arguments. We examine differences in conservatism across samples with different market to book ratios, we compare firms with non-negative returns with firms with negative returns, we compare firms reporting losses with firms reporting profits, and we examine firms in different industries, firms with different levels of research and development expenditure, different amounts of depreciation, different amounts of advertising expense, and firms that adopt LIFO inventory valuation compared with those that adopt an alternative to LIFO.JEL Classification: M41     

Anticipating the Impact of IFRS on the Management of German Manufacturing Companies: Some Observations from a British Perspective

The introduction of International Financial Reporting Standards (IFRS) in 2005 marked a significant departure from Germany's traditional financial accounting practices. This paper questions whether this change may have consequential effects on the distinctive traditional management accounting practices in the field of Controlling. We examine the possible impact on manufacturing companies drawing upon perceptions and expectations of managers in three Bavarian companies and two management consultancy firms. We consider whether financial accounting will assume an increased importance within firms, and whether this may lead to abandonment of some traditional management accounting practices and the adoption of different techniques in internal reporting compatible with the new IFRS regime for external reporting. This prompts consideration of whether such changes would lead to financial accounting domination of management accounting in Germany analogous to that argued by Johnson and Kaplan in 1987 in their ‘Relevance Lost’ thesis. We conclude that, at this juncture in the development of their information systems, German managers face an important choice between integrating external and internal reporting in ways that might fundamentally change established Controlling practices, or of continuing to operate dual accounting systems in much the same way as in the past so that adoption of IFRS is restricted to external reporting.     

International Accounting Standards and Accounting Quality

We examine whether application of International Accounting Standards (IAS) is associated with higher accounting quality. The application of IAS reflects combined effects of features of the financial reporting system, including standards, their interpretation, enforcement, and litigation. We find that firms applying IAS from 21 countries generally evidence less earnings management, more timely loss recognition, and more value relevance of accounting amounts than do matched sample firms applying non‐U.S. domestic standards. Differences in accounting quality between the two groups of firms in the period before the IAS firms adopt IAS do not account for the postadoption differences. Firms applying IAS generally evidence an improvement in accounting quality between the pre‐ and postadoption periods. Although we cannot be sure our findings are attributable to the change in the financial reporting system rather than to changes in firms' incentives and the economic environment, we include research design features to mitigate effects of both.     

Determinants of Actuarial Valuation Method Changes for Pension Funding and Reporting: Evidence from the UK

This study examines various factors that potentially explain cross‐sectional variations in UK corporate managerial discretion to switch towards a market‐based actuarial pension valuation method for pension funding and reporting purposes. Evidence is based on accounting, actuarial and share market data for an industry‐matched pair sample of 90 UK firms. Consistent with our hypotheses we find that companies have a greater propensity to switch actuarial methods if they use lower discount rates, lower flow funding ratios and sponsor larger pension plans in the pre‐switch valuation year. These findings are consistent with the traditional perspective, which implies that UK corporate switching decisions are explained by characteristics of their defined benefit pension funds. The results run contrary to the findings of earlier US based studies that find that such choices can be explained from an alternative corporate financial perspective.     

HOW DO SMALL FIRMS MAKE INVENTORY ACCOUNTING CHOICES?

In the past, the attention of studies on inventory method choices has invariably been focused on large firms' motivations to use LIFO. Small firms' inventory accounting decisions are different from those of large firms due to the fact that there are differences in financial reporting considerations. This study examines small firms' inventory accounting choices from the perspective of three major factors (firm size, risk, and managerial ownership). It was found that firm size, financial risk, and the interaction effect between financial risk and business risk are significantly correlated with the LIFO choice for small firms.     

Can we trust the accounting discretion of firms with political money contributions? Evidence from U.S. IPOs

Using hand-collected data from the U.S., we examine the influence of political money contributions (PMC) on IPO financial reporting. Unraveling the conflicting managerial incentives, we develop and test three distinct hypotheses whereby accounting discretion is utilized to downplay, embellish, or truthfully impart the PMC firm’s prospects. Consistent with the last two hypotheses, we document income-increasing reporting. The effects are strongest for firms sensitive to policy outcomes, and least affected by contemporaneous political events. Post-issue analysis shows that at-issue discretionary accruals systematically predict future accounting performance but are unrelated to stock returns. Survival analysis indicates a lower probability of IPO failure. Robust to a battery of checks, our results support the value-relevance of financial information and a novel use of accounting discretion as a means of signaling expected political gains.     

The mitigation of high-growth-related accounting distortions after sarbanes-oxley

This study examines the effect of the Sarbanes-Oxley Act of 2002 (SOX) on accounting distortions in the context of the earnings quality of high-growth firms relative to lower-growth firms. High-growth creates unique management and reporting challenges that can contribute to accounting-related distortions. SOX, with its emphasis on financial reporting, control systems and management responsibility, could have been particularly relevant for high-growth firms with such challenges. Test results indicate a stronger reduction (weaker increase) in accounting distortions related to total accruals and book-tax differences (performance-matched modified Jones discretionary accruals) for high-growth firms from the pre- to the post-SOX period relative to lower-growth firms. Other tests indicate that the relation between accounting returns and market returns strengthened for high-growth firms in the period after SOX, but not for lower-growth firms. These results suggest greater reductions in accounting distortions and related improvements in reporting quality for high-growth firms relative to other firms coinciding with the post-SOX period.     

Minimum tax legislation and its effect on corporate financial reporting: A comparative analysis between US and India: a discussion

In this study, the authors investigate imposing a minimum alternative tax (MAT) on Indian corporations during the 1996–1997 budget years. The authors have two objectives: to assess the new legislation's impact on tax revenue, and to determine how corporations responded to its imposition because of its explicit link to financial reporting. They first assess whether, on average, firms with low estimated tax rates before the imposition paid higher taxes after imposition and find, overall, that corporations paid, in total, a greater amount of their income in taxes. They also find that the largest firms in their sample experienced a smaller increase in their effective tax rates than smaller firms did. Next, they assess whether MAT-affected firms altered their financial statement reporting to reduce exposure to the MAT. Specifically, they assess whether a greater portion of MAT-affected firms changed their financial statement depreciation policies than non-MAT-affected firms. They report that, for their sample, a significant number of MAT-affected firms increased their depreciation rate after MAT imposition. The proportion of non-MAT-affected firms changing depreciation rates after imposition was not significant. They also partition MAT- and non-MAT-affected firms on increasing or decreasing book profit and find that MAT-affected firms made proportionally more changes. The authors conclude that the MAT appeared to have increased horizontal equity among taxpayers in India, but its tax revenue enhancement potential is limited by its scope, limited applicability, and avoidance behavior by affected corporations. My comments are directed at what I perceive to be motivational and methodological issues in the paper and the conclusions we can draw from the current representation.     

Financial reporting quality and outsourcing of accounting tasks: Evidence from small private firms

This study explores whether the financial reporting quality of small firms differs between firms that outsource accounting tasks and firms that perform these tasks internally. Using accruals quality as a measure for the financial reporting quality and a sample of small Finnish limited liability firms, we find that the quality among the firms is positively related to the decision of purchasing accounting services from an external service provider. This result is also economically significant. The evidence shows that outsourcing of accounting tasks such as the preparation of the statutory financial statements and longer outsourcing relationships increases reporting quality. However, outsourcing of additional tasks, such as payroll processing, does not result in higher quality. These findings are consistent with previous studies showing that small firms in general lack the resources and expertise to prepare high quality financial reports. We provide evidence of an important yet under-researched area of financial reporting quality among small firms.     

Domestic Accounting Standards, International Accounting Standards, and the Predictability of Earnings

We investigate (1) whether the variation in accounting standards across national boundaries relative to International Accounting Standards (IAS) has an impact on the ability of financial analysts to forecast non-U.S. firms' earnings accurately, and (2) whether analyst forecast accuracy changes after firms adopt IAS. IAS are a set of financial reporting policies that typically require increased disclosure and restrict management's choices of measurement methods relative to the accounting standards of our sample firms' countries of domicile. We develop indexes of differences in countries' accounting disclosure and measurement policies relative to IAS, and document that greater differences in accounting standards relative to IAS are significantly and positively associated with the absolute value of analyst earnings forecast errors. Further, we show that analyst forecast accuracy improves after firms adopt IAS. More specifically, after controlling for changes in the market value of equity, changes in analyst following, and changes in the number of news reports, we find that the convergence in firms' accounting policies brought about by adopting IAS is positively associated with the reduction in analyst forecast errors.