Market Valuation of Research and Development Spending under Canadian GAAP*

Section 3450 of the Canadian Institute of Chartered Accountants (CICA) Handbook requires Canadian firms to capitalize development costs that meet certain criteria and to expense those that relate to research. International Accounting Standard (IAS) No. 38 favours a similar approach. In the United States, Statement of Financial Accounting Standard (SFAS) No. 2 recommends the immediate expensing of all research and development (R&D) spending. The only exception is SFAS No. 86, which requires software development costs to be capitalized when a product successfully passes a technological feasibility test. Consequently, the Canadian financial disclosure regime provides a rich setting for testing the market valuation of capitalized R&D. Our primary research question asks whether capitalized R&D provides useful information to market participants investing in Canadian firms. We use price‐level and return models to assess the value relevance of capitalized R&D disclosed in the financial statements under Canadian GAAP. In line with expectations, using a price‐level model, we find that capitalized R&D and R&D expense as disclosed in the financial statements provide information that is value relevant to market participants. However, we find that R&D capitalized during the year helps explain returns while R&D expense does not. Thus we conclude that the application of section 3450 of the CICA Handbook produces value‐relevant information.     

R&D资本化选择动机与影响因素——来自高新技术行业的经验证据

随着企业R&D投入的不断增长,R&D支出会计选择的经济后果变得重要。我国新会计准则由R&D费用化政策转为可选择的有条件资本化政策,面对会计政策的变迁,研究上市公司管理层R&D资本化选择的动机与影响因素成为首要问题。选取2007～2010年高新技术行业公司为样本,研究发现,大规模企业、国有控股公司、机构投资者持股比例越高的公司管理层倾向于选择资本化R&D政策,"四大"审计并未抑制R&D资本化,而债务融资约束不能解释R&D资本化选择动机。我国上市公司管理层选择资本化R&D会计政策既有提高和平滑利润的盈余管理动机,亦有向市场传递研发信号的动机。     

Standards for risk assessment of standards: how the international community is starting to address the risk of the wrong standards

Technical standards pervade commerce and society and allow the complexity of modern life to operate at all levels, global included. They also provide protection against many risks, whether from food, from dangerous products or from fraud. They are so self-evidently worthy that they are rarely challenged, yet anything as powerful and pervasive as the web of standards needs some element of oversight and quality assurance. There is a danger of over-regulating and the placing of unnecessary constraints on the market and, cumulatively, a constraint on liberties. Technical standards are derived from many sources and for many reasons. The oversight function may need to relate to these reasons, such as the World Trade Organisation controls on damage to trade through protectionist standards. A very common reason for standards is safety, which tends to be treated as an absolute, as an objective technical matter, and there is less oversight or quality assurance of standards set for safety reasons. But safety is a relative term and increases in safety will usually have costs. Judgement needs to be applied in a risk assessment but that raises institutional issues as to who is qualified to apply that judgement. There are also issues of the accountability of those who increase the safety ratchet, which are also related to the institutional issue. This paper explores a case study of one draft standard as an illustration of the need for oversight and then goes on to consider methods of managing the risks inherent in standardisation and technical regulation. It looks in particular at two recent initiatives from within the standards community itself. One is a broad-based proposal for the community to focus on risk management and the other is an instance where a technical regulator has commissioned and designed an impact assessment system in order to provide that quality assurance and accountability.     

Organizational controls and discretionary program decision making: A field study

This paper reports the results of a field study aimed at exploring how one important class of decisions— discretionary program decisions—are controlled in decentralized films. Data were collected from profit centre managers using unstructured interviews and a questionnaire survey. The data show that decisions are affected by many devices that can be called controls, including net income targets, expense targets, headcount constraints, requirements for approvals, and directives given by higher management. They also show that the effects of the controls can vary with certain characteristics of the profit centers' situation (e.g. strategy, recent performance), the management style of the company chairman, and the accounting treatment for the expenditure (i.e. whether capitalized or expensed).     

The coming commoditization of processes

Despite the much-ballyhooed increase in outsourcing, most companies are in do-it-yourself mode for the bulk of their processes, in large part because there's no way to compare outside organizations' capabilities with those of internal functions. Given the lack of comparability, it's almost surprising that anyone outsources today. But it's not surprising that cost is by far companies' primary criterion for evaluating outsourcers or that many companies are dissatisfied with their outsourcing relationships. A new world is coming, says the author, and it will lead to dramatic changes in the shape and structure of corporations. A broad set of process standards will soon make it easy to determine whether a business capability can be improved by outsourcing it. Such standards will also help businesses compare service providers and evaluate the costs versus the benefits of outsourcing. Eventually these costs and benefits will be so visible to buyers that outsourced processes will become a commodity, and prices will drop significantly. The low costs and low risk of outsourcing will accelerate the flow of jobs offshore, force companies to reassess their strategies, and change the basis of competition. The speed with which some businesses have already adopted process standards suggests that many previously unscrutinized areas are ripe for change. In the field of technology, for instance, the Carnegie Mellon Software Engineering Institute has developed a global standard for software development processes, called the Capability Maturity Model (CMM). For companies that don't have process standards in place, it makes sense for them to create standards by working with customers, competitors, software providers, businesses that processes may be outsourced to, and objective researchers and standard-setters. Setting standards is likely to lead to the improvement of both internal and outsourced processes.     

The value-relevance of R&D and advertising expenditures: Evidence from Korea

This study examines the value-relevance of R&D and advertising expenditures of Korean firms, using a regression model based on the Ohlson [Contemp. Account. Res. (1995) 661] equity-valuation framework. Results indicate that R&D expenditures are positively associated with stock price, suggesting that capitalizing R&D expenditures is appropriate. The association is stronger for the portion of R&D expenditures that is capitalized, rather than expensed, suggesting that investors agree with management that the capitalized expenditures represent greater future economic benefits. Investors also appear to interpret fully expensed R&D expenditures as positive net present-value investments, however, suggesting that these expenditure should also be capitalized. Additional results indicate that advertising expenditures are negatively associated with stock price, and the magnitude of this negative association is similar to the association between other expenses and stock price. These findings suggest that investors believe the economic benefits of advertising expenditures expire in the current period, similar to other expenses.     

A POLITICAL ECONOMY OF SSAP22: ACCOUNTING FOR GOODWILL

In late 19th century Britain it was widely accepted by leading authorities that «goodwill» was simply the purchase of sufficient expected «surplus profits» to persuade the owners of a business to part with its net assets and control, and that this expenditure should be capitalized and amortized against those surplus profits as they are realized. Although this method remains the conventional wisdom, and dominates current international regulation and practice, its conceptual foundation appears lost to modern scholars, for whom the «problem» of accounting for goodwill is «insoluble». In the first part of the paper the concepts of Marx's political economy are employed to elaborate the conventional method, which is argued to be necessary to allow the capital markets to observe the generation and realization of profit and the rate of return on capital. From this perspective, the heavily criticized decision of the UK authorities in SSAP22 to encourage the write-off of goodwill against capital is an anomaly requiring explanation. It is usually explained as either the ASC's acceptance of economic income accounting as the ideal for financial reporting, or its acquiescence to powerful managerial interests. In the second part, these explanations are criticized, and an alternative hypothesis advanced which is consistent with the limited evidence available. That, although the capital markets usually want purchased goodwill to be capitalized and amortized, in the peculiar circumstances of the UK, where unusually large portions of its manufacturing industry were closed or run down in the acquisitions and merger boom of the 1980's, writing-off purchased goodwill against capital was in the collective interest of investors because it helped to hide from public view the fact that dividends were being paid from capital.     

Asian Corporate Governance—and the Case of Dual‐Class Shares: CARE Conference | Hong Kong Polytechnic University | June 9, 2014

The case of the Alibaba IPO illustrates the divergence of corporate governance standards between the United States and many other markets, and reopens the debate on the one‐share one‐vote principle. Since corporate governance standards develop in ways that reflect the history and legal and political environments of different countries, we should not expect to see a global convergence of these standards—nor is it generally desirable to transplant policies from one market to another without understanding their historical backgrounds. Nevertheless, the U.S. approach to regulation raises the concern that competition among exchanges will cause issuers to “shop around” and tempt the exchanges to relax their standards in a race to the bottom. While market participants and regulators outside of the U.S. debate whether and how to modify the one‐share, one‐vote rule, they face challenges in coming up with new rules that strike the right balance between effective corporate governance and market development.     

Multiple Dimensions of Accounting in the Development of GAAP

The phrase 'accepted accounting principles' underlying financial statements is a forerunner of today's accounting standards. Here, it is argued that history shows that the term 'principles' is often most vague in debates on the development of those standards. The reasons for and consequences of that vague use are varied and complex. This article provides insights not highlighted in earlier analyses of the periods reviewed. While debates like the rule- versus principle-based standards are set up as two-dimensional, the many dimensions of accounting often allow argument to be easily diverted. The debate/argument thus remains unresolved. For progress to be achieved in the establishment of accounting standards the many dimensions of accounting must be acknowledged and attempts to divert debate minimized. Those with a stake in the development of accounting standards need to consider the total scene of the related accounting. In a particular debate, dimensions under scrutiny must be stated, with any others in that total scene being acknowledged even if kept constant.     

Financing Gaps of Public Pension Schemes and Market Potential for the Private Retirement Market

Abstract

Increasing longevity, declining birth rates, and high unemployment severely threaten the financial basis of many public pension plans. These problems are most pronounced in continental Europe, where public pension plans tend to be relatively generous and are usually funded on a pay-as-you-go basis. Given the demographic development, future pension payments exceed the expected contribution payments. The resulting financing gaps can be seen as implicit public debts (net pension liabilities), which often exceed the value of GDP figures and are in many cases higher than the explicit public debt figures. If people would decide to cover these financing gaps via life insurance, life insurance premiums would triple in Germany, more than double in Italy, and double in Canada and France. The increase would be only moderate in the U.S. and particularly small in the U.K.     

What Do FAS 157 “Fair Values” Really Measure: Value Or Risk?

FAS 157, the U.S. accounting standard that prescribes how fair values of assets and liabilities are to be measured when other U.S. GAAP standards require fair valuation, stipulates that fair values be measured as the exit values of assets and liabilities—the proceeds for assets hypothetically sold on the date of the financial report, and, correspondingly, the amount required to settle liabilities on the date of the financial report. This conceptual article argues that exit values do not reflect the value of the net assets of the firm to shareholders, which is best reflected by discounted cash flows to maturity. Moreover, exit values—biasing fair values downward when markets are illiquid—have a pernicious, systemic risk effect; specifically, they give rise to write‐downs that in turn cause contagion: prices of equities and other financial instruments of peers react negatively, leading to further write‐downs by those peers. This may have aggravated the recent financial crisis. However, while exit values are not proper measures of value to shareholders, they are useful measures of downside risk when prospects turn sour for a firm. Thus, both exit values and discounted cash flows should be presented in financial statements.     

The influence of process accountability and accounting standard type on auditor usage of a status quo heuristic

There has been considerable discussion about the U.S. reporting standards becoming less rules based, similar to International Financial Reporting Standards (IFRS). One proposed advantage of a change to IFRS is increased comparability across multinational and non-U.S. companies. Additionally, some believe that IFRS afford greater flexibility in its principles, thereby enabling firms’ accounting choices to better reflect the true economic nature of any given transaction (FASB, 2002; SEC, 2003). With fewer rules, both financial statement preparers and auditors would be expected to adjust to having more options with regards to financial reporting. However, some proposed changes leave the option open to implement IFRS (or other principles-based standards) in ways that still follow rules in U.S. GAAP. This paper investigates whether prior year accounting treatments influence the judgment for current year treatments when one way to implement the standard is to follow the prior year treatment. We find that some auditors fixate on prior year scenarios and judgments, even if the current year scenario and applicable accounting standards are different. We find that holding auditors accountable for their decision making process reduces the likelihood of sticking with the prior year treatment most notably when the prior year standards were U.S. GAAP.     

Revenue Sharing versus Expenditure Sharing in a Federal System

Problems of intergovernmental policy coordination can take many forms and are becoming increasingly important with continuing economic integration. In this paper we focus on the fiscal competition problem where the non-cooperative choice of taxes and transfers among governments typically leads to a suboptimal outcome. We look at the effect of two widely used corrective policies: revenue sharing and expenditure sharing (or intergovernmental matching grants). Our main result is that these two corrective policies have opposite effects depending on the form of competition between governments, namely whether governments compete in taxes or expenditures. More precisely, for any form of competition, revenue sharing is desirable exactly when expenditure sharing is not and vice versa. The implication is that the choice of the optimal corrective policy requires a complete understanding of the underlying non-cooperative behavior among governments. Our second main result is that neither revenue sharing or expenditure sharing can be sustained as a Nash equilibrium among governments, although all governments would benefit from one of these two corrective policies. Central intervention is therefore inevitable unless governments can pre-commit to the optimal corrective policy before setting their fiscal policies.     

Enforced Standards Versus Evolution by General Acceptance: A Comparative Study of E-Commerce Privacy Disclosure and Practice in the United States and the United Kingdom

We present data on privacy practices in e‐commerce under the European Union's formal regulatory regime prevailing in the United Kingdom and compare it with the data from a previous study of U.S. practices that evolved in the absence of government laws or enforcement. The codification by the E.U. law, and the enforcement by the U.K. government, improves neither the disclosure nor the practice of e‐commerce privacy relative to the United States. Regulation in the United Kingdom also appears to stifle development of a market for Web assurance services. Both U.S. and U.K. consumers continue to be vulnerable to a small number of e‐commerce Web sites that spam their customers, ignoring the latter's expressed or implied preferences. These results raise important questions about finding a balance between enforced standards and conventions in financial reporting. In the second half of the 20th century, financial reporting has been characterized by both a preference for legislated standards and a lack of faith in its evolution as a body of social conventions. Evidence on whether this faith in standards over conventions is justified remains to be marshaled.     

LARGE BANK STOCKHOLDERS IN GERMANY: SAVIORS OR SUBSTITUTES?

This article challenges Mark Roe's suggestion that the prevalence of the widely held public corporation in the U.S. may not have been inevitable because U.S. laws prevented financial institutions from playing the monitoring role assumed by large German banks. The differences between Germany and the U.S. in the importance of trading markets and the role of banks as monitors can be explained in large part by actions of German banks that blocked the development of German capital markets and provided big banks with informational advantages over other traders.
Markets are likely to be more effective monitors than large banks because of the banks' conflicts of interest as creditors as well as underwriters and market-makers for German firms. Moreover, there is more diversity in the ownership structure of U.S. corporations than the current governance debate would suggest. In the U.S. there are many publicly owned companies that are either closely held or have reverted to private ownership through LBOs. This in turn suggests that U.S. capital markets have devised means for bringing about concentrated stock ownership in those cases where large stockholder monitoring is likely to be more efficient.
Thus, to the question what is likely to happen to U.S. corporate ownership structure if remaining legal constraints on stock ownership by U.S. banks are relaxed, the answer this article offers is "not much." Indeed, if one considers increasing U.S. institutional ownership together with recent SEC attempts to liberalize shareholder communications, there appears to be a striking trend toward a new concentration of voting power–one that may ultimately rival that of the German banks.     

The positive externalities of IFRS R&D capitalization: enhanced voluntary disclosure

Studies comparing IFRS with U.S. GAAP generally focus on differences in the attributes and consequences of the recognized financial items. We, in contrast, focus on voluntary disclosure resulting from arguably the most significant difference between IFRS and GAAP: the capitalization of development costs—the “D” of R&D—required by IFRS but prohibited by GAAP. Using a sample of Israeli high-technology and science-based firms, some using IFRS and others U.S. GAAP, we document a significant externality of IFRS development cost capitalization in the form of extensive voluntary disclosure of forward?looking information on product pipeline development and its expected consequences. We show that this disclosure is value-relevant over and above the mandated financial information, including the capitalized R&D asset. We also show that the capitalized development costs (an asset) is highly significant in relation to stock prices, and enhances the relevance of the voluntary disclosures.     

The Nature and Rationale of a Conceptual Framework for Financial Reporting by Islamic Banks

Islamic banks have to abide by the revealed doctrines in Islam in conducting their business and financial transactions. They employ in-house religious advisers—often referred to as Shari'a Supervisory Board (SSB)—who issue a special report to inform users of financial statements whether or not the bank has adhered to the Islamic principles. Recently, a private standard-setting body—the Financial Accounting Organization for Islamic Banks and Financial Institutions (FAOIBFI)—has been set up to externally regulate the financial reporting by Islamic banks. The FAOIBFI has published two statements on the objectives and concepts of financial reporting to act as a framework in setting accounting standards for Islamic banks. This paper examines the FAOIBFI's approach for developing objectives and concepts of financial accounting and investigates its need for such a theoretical framework. It is argued that the FAOIBFI's objectives and concepts would not be useful in mandating accounting standards on issues that are affected by religious ruling. This does not necessarily mean that such a framework may not be useful in legitimating the FAOIBFI's role and in setting accounting standards for issues that are not governed by revealed moral doctrines although it will be subject to similar limitations to those found by other standard-setting bodies in utilising and applying their framework. However, it implies that the more the FAOIBFI sets accounting standards that incorporate religious ruling, the less it would tend to find its own objectives and concepts useful. The ambiguities that may arise from different interpretations of the religious rules will require resolutions primarily by reference to religious rather than accounting authority.     

Presidential Address: The Cost of Active Investing

I compare the fees, expenses, and trading costs society pays to invest in the U.S. stock market with an estimate of what would be paid if everyone invested passively. Averaging over 1980–2006, I find investors spend 0.67% of the aggregate value of the market each year searching for superior returns. Society's capitalized cost of price discovery is at least 10% of the current market cap. Under reasonable assumptions, the typical investor would increase his average annual return by 67 basis points over the 1980–2006 period if he switched to a passive market portfolio.     

Reporting on software development projects to senior managers and the board

It is contended that the scale of some in-house software projects (and the potential impact of project failure on an organization's operating capabilities and reputation) is such that the progress of those projects warrants the concentrated attention of senior managers (and possibly, the Board). The article utilizes a case study to illustrate how the adoption of key proposals outlined in the business information systems and software engineering literatures for the management of these projects may not necessarily be effective. This work augments Walker and Oliver (2005 ), which examined the options when accounting for software expenditure and recommended expensing for consistent treatment. This article then reviews the 'information needs' of senior managers, and presents a set of six reporting templates to facilitate the effective monitoring of progress of software projects (including post-migration expenditure on system enhancements and maintenance, and efforts to capture planned benefits). In some circumstances, the scale and risks associated with software development projects warrant oversight of these projects by the Board, possibly through the establishment of specialist 'IT governance' subcommittees. Accordingly, a model charter for an IT governance committee is presented in an appendix.     

Do analysts follow emerging economy firms with higher intangible assets? Empirical evidence from Egypt

This paper tests whether analyst coverage and effort are related to the level of intangible assets reported by Egyptian listed firms. Intangible assets represent increasingly important investments for many firms, but most of these assets are not capitalized under prevailing accounting standards. Analysts reduce the information asymmetry by examining both financial reports and other information. Many Egyptian firms today seek access to foreign capital. I hypothesize that the larger the potential intangible assets of firms the more analysts will cover these firms and pursue private information about these firms. Sample consists of 435 firm-year observations over the period 1999–2007, and intangible assets are measured using eight different firm- and industry-level proxies. Consistent with prior research, results suggest that coverage is significantly associated with firm R&D, industry advertising expenses, firm size, and trading volume. Results also suggest that analyst effort is a function of firm and industry-level R&D expenses and firm size.