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Volume 11

The Policy Implications of Legislating Accounting Change: The Case of S&L Goodwill and Tax NOLs

Anthony Catanach

The Supreme Court recently ruled that the U.S. government breached its contracts with several acquirers of insolvent savings and loans (S&Ls, thrifts) when it mandated goodwill write-offs in 1989. This study shows that investors recorded tax attributes (net operating losses and built-in losses) received in these regulatory-assisted mergers as goodwill. Consequently, goodwill write-offs were overstated by the value of tax attributes and regulatory enforcement actions against many S&Ls may have been premature. This study's results will interest regulators, thrift owners, and lawyers who currently are litigating "breach of contract" suits. The study also provides insights into the interaction of legislative policy with accounting, the regulatory process, and the general conduct of business. Volume 11, 1997, pgs. 3-23.

An Investigation of Auditor Resignations

Mark DeFond, Michael Ettredge and David B. Smith

The business press reports a recent increase in resignations motivated by auditors' desires to shed risky clients. Client companies whose auditors resign must specifically mention the resignations in their Form 8-K filings. This Securities and Exchange Commission (SEC) requirement, imposed in Financial Reporting Release (FRR) No. 31 of 1988, implies that resignations differ from dismissals, and that the existence of an auditor resignation is useful information for investors. We examine these claims by comparing characteristics of companies whose auditors resign with those of companies that dismiss their auditors. We also compare stock market reaction to resignations versus dismissals.

We argue that resignations are driven by litigation risk and hypothesize that the clients involved are predictably different from companies that dismiss their auditors. We test these hypotheses by comparing 62 companies reporting auditor resignations to a randomly chosen control sample of 61 companies disclosing an auditor change without a reported resignation. Our sample is drawn from the pre-FRR No. 31 era, 1982-1987, so that this study provides evidence useful for concluding whether the SEC's implied assertions about auditor resignations are consistent with data available to the SEC at the time FRR No. 31 was promulgated. A logit analysis indicates that auditor resignations are more likely to be associated with auditor-client disagreements and with declines in client firm cash flows. These results are somewhat consistent with a scenario in which resignations are triggered by auditor distrust of client management coupled with declining client financial health. Volume 11, 1997, pgs. 25 -45.

Regulating Research: Relevance versus Elegance?

Michael Maher

This paper examines the effect of the Ford Foundation's business school reform efforts on managerial accounting research. During the 1950s, a group of academics initiated a self-regulated reform of business schools using the resources and influence of the Ford Foundation to further their cause. This paper hypothesizes that those reformers had a significant impact on managerial accounting research. In particular, the reformers affected research methods used, reliance on outside disciplines such as economics and mathematics, and authorship by practitioners. In addition, the paper examines the influence of the Journal of Accounting Research in the reform effort.

The results support the hypotheses, and indicate that the reformers created a shift in the literature unparalleled in the history of managerial accounting research. These results provide insights into reasons for recent criticisms of managerial accounting research which argue that researchers focus on narrow, tractable problems instead of issues relevant to the practice of accounting. Volume 11, 1997, pgs. 47-72.

The Effect of SEC Enforcement on Auditor IPO Market Share

Keith A. Moreland

One objective of the enforcement activities of the Securities and Exchange Commission (SEC) is to maintain the credibility of the financial disclosure system in the United States, in which auditors play a key role. One direct effect for auditors found by the SEC to have performed substandard audits is that the audit firm is subject to disciplinary action by the SEC. During recent years auditing firms also have faced rapidly increasing costs associated with litigation for alleged substandard audit work. This study examines whether auditors also experience an indirect effect in the form of decreased market share of initial public offering (IPO) audits following the SEC's reports of enforcement actions issued from 1978 to 1991.

The IPO market is a rich setting to examine the market for audit services because of the significance that client firms attach to auditor selection in order to enhance the attractiveness of the securities offering. Reports of SEC enforcement actions (or sanctions) and litigation cases against auditors are modeled as information that negatively affects assessed auditor quality. It is hypothesized that some IPO firms will avoid auditors reported in such information.

Post-sanction changes IPO market shares of criticized auditors and a control group were examined using regression analysis. The regression models also controlled for differences in market shares and levels of litigation across audit firms.

The results suggest that reports of SEC enforcement actions, negatively affect auditor IPO market shares during the period from one to three years after the sanction. No market share effects related to litigation were observed. The sanction-related market share decrease suggests that client firm managers use information from the regulatory organization in assessing auditor quality and in auditor selection decisions. These results may have implications for regulators and audit firm executives who are concerned with assessing the impact that disciplinary actions against auditors have in the market for audit services. Volume 11, 1997, pgs. 73 -98.

The Effects of Financial Reporting Disputes with the SEC on the Informativeness of Earnings

Obeua S. Persons

This study provides evidence concerning the impact of regulatory enforcement actions on the return/earnings relationship. In particular, it examines the effect of financial reporting disputes with the SEC on the perceived informativeness of earnings. Financial-reporting-dispute firms are defined as those that were investigated by the SEC for possible violations related to accounting practices and these investigations were reported in the Wall Street Journal. Because reporting disputes are likely to increase the perceived uncertainty or noise in present and future earnings, this study hypothesizes that market and analyst reactions to earnings following dispute disclosures will be less pronounced than those before the disclosures. An earnings response coefficient model (a return model) and an analyst earnings revision model are used to test this hypothesis. This study controls for information environment, management change, growth/persistence, systematic risk and risk-free interest rate. Results, which are robust against several diagnostic tests including the use of matched nondispute firms, strongly support the hypothesis. The evidence here suggests that a regulatory enforcement action, such as the SEC's financial reporting investigation, is an important mechanism in maintaining public confidence in the reported earnings numbers. Volume 11, 1997, pgs. 99 -123.

Comment Letters as Indicators of Overall Corporate Manager Preferences: Employers' Accounting for Pensions

Georgia Saemann

The underlying objective of this study was to determine if comment letters filed in the FASB's due process are indicative of overall corporate opinions or just a select interest group, and to offer explanations for the relationship between filing choice and accounting preferences. The study examines models of corporate positions (support or oppose) on seven controversial requirements of SFAS 87 with four explanatory variables including filing choice, firms size, and pension plan size and status. The analyses are unique in that prior studies of the lobbying process have examined differences between filers and non-filers (using filing choice as a proxy for accounting preference), or have investigated the positions stated by a relatively homogenous group -- comment filers. The results confirm prior researchers' assumptions that filing choice relates inversely to positions taken on certain issues and, more importantly, the findings suggest that filers and nonfilers have differing accounting concerns. Large companies, who tend to be more active filers than their smaller peers, were more likely to oppose and comment on measurement issues that led to increases in reported income level and volatility. Volume 11, 1997, pgs. 125 -142.

The SEC's Audit Requirements for Companies Acquired and Equity Investees

Jerry L. Arnold and William W. Holder

 In some circumstances the Securities and Exchange Commission (SEC) requires acquiring businesses to file audited financial statements of businesses to file audited financial statements of businesses or portions of businesses acquired. This article addresses the nature and content of the applicable SEC rules, difficulties in compliance and recommendations for entities, auditors and policy-setters. The article initially discusses the underlying framework and content for the SEC’s Regulation S-X, the accounting regulation. It then examines the nature of significant acquisitions under Regulation S-X and focuses on the specific requirements for audited financial statements. Those requirements apply at both the time of acquisition and on a continuing basis for entities accounted for under the equity method. Difficulties in compliance with such rules are discussed as are recommendations to overcome such problems as well as implications for standard-setters and regulators. Volume 11, 1997, pgs. 145 -157.

The Auditor Expectation and Performance Gaps: Views from Auditors and their Clients

Dale E. Marxen

In 1988 the AICPA's Auditing Standards Board issued nine new auditing standards meant to reduce the audit "expectation gap">the gap between what the public expects to receive from an audit and what auditors feel obligated to deliver. Since then, two published studies have indicated that important public sectors>judges and investors> still appear to hold unrealistic expectations for auditors. This study of 56 auditors and 65 of their clients, however, found that the auditors' clients did not hold unreasonable expectations for their auditors, nor did they tend to judge the auditors' actual performances excessively negatively. The clients' most evident concern was the potential conflict of interest caused by accounting firms providing both audit and management advisory services. Volume 11, 1997, pgs. 159-176.

The Impact of Central Bank of Denver: Some Empirical Evidence

Ross D. Fuerman

Until the April 19, 1994 Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A. decision by the United States Supreme Court, auditors could be charged with aiding and abetting a violation of Section 10(b) of the Securities Exchange Act of 1934. Almost immediately after the announcement of the decision, Congress began holding hearings on the question of amending the Securities Exchange Act of 1934 to legislatively overturn the Supreme Court's controversial holding. This is a study of securities disclosure lawsuits commenced from April 20, 1992 through April 19, 1995. The results of the study indicate that Central Bank is associated with a significant short-term reduction of auditor litigation risk. However, Central Bank is not associated with a reduction of intermediate-term auditor litigation risk. Indeed, Central Bank is associated, albeit insignificantly, with an increase in intermediate-term auditor litigation risk. Volume 11, 1997, pgs. 177-190.

Deceptive Trade Practices Legislation: More Litigation Ahead for Accounting Firms?

Philip Little and Debra Burke

This article addresses the potential for Deceptive Trade Practices Acts (DTPAs) to add to the already substantial litigation burden caused primarily by relaxed privity standards, class action lawsuits, and joint and several liability. Although accounting firms in many states may be able to argue that the provisions of DTPAs do not apply to accounting services, the risk of additional liability exposure looms.

Accounting firms and their lawyers should become familiar with the DTPA in the state in which they practice in order to develop sound defenses against any lawsuits which might develop under the provisions of the legislation. The provisions for treble damages, attorneys' fees, and court costs make DTPA lawsuits appealing for potential claimants and quite costly for those unfortunate accounting firms that unsuccessfully defend such lawsuits. Volume 11, 1997, pgs. 191-201.

Address to the December 1996 AICPA Conference on SEC Regulations

Dennis R. Beresford

Our four strategic directions are:

-                 To build broader acceptance of our process and its results among our constituents.

-                  To make standard setting more timely and efficient.

-                  To enhance the financial reporting model as a tool for decision making in a rapidly changing economic and technological environment.

                             -              To promote the development and acceptance of superior international accounting standards.              Volume 11, 1997, pgs. 205-213.

The Misappropriation Theory: An Emblem of Change

Mark A. Segal 

Over the past three years substantial change has occurred in the legislation and approach taken by courts concerning accounting related securities litigation. Supreme Court decsions in 1994 indicated that strict statutory construction should govern the application of securities law (Reves and Central Bank). In December 1995 the Private Securities Litigation Reform Act was enacted into law in an express effort to deter and sanction abusive and frivolous securities class action lawsuits. Still questions remained as to the extent and SEC enforcement and rule making authority, particularly those grounded upon judicial doctrines.

Utilization of a strict statutory approach would remove the courts from the ability to create a form of judicial legislation, and would instill stability, predictability, and great uniformity into the application of the securities laws. Implicit in this is the belief that these objectives are favored over the desirability and inherent risk of giving the judiciary flexibility to apply doctrines and implement expansive statutory interpretation further to the stated objectives of the securities law. Insight into how courts have put these recent developments into practice is evident in recent cases handed down by the Eighth and Fourth Circuits concerning what has come to be known as the misappropriation theory. The theory had been a commonly accepted basis for applying Rule 10(b)(5) liability to non-insiders. In this paper the misappropriation is explained, and these recent cases and their significance examined.   Volume 11, 1997, pgs. 215-221.

A Perplexed Accounting Student's Guide through the SEC Maze

Barbara Clemenson

…After obtaining a basic understanding of the SEC, its purpose, and its requirements for public companies through secondary sources, it is helpful before conducting research to learn about the SEC’s publications. Paul B. W. Miller and Jack Robertson’s “A Guide to SEC Regulations and Publications: Mastering the Maze” will provide you with the basic structure you need.

All of the SEC’s codes are in “Title 17,” which you will see on the spine of several of the Code’s volumes. You may look in these volumes for SEC information. Fortunately, each volume has a table of contents which will help you locate what you need. The “Titles” are divided into sections known as “Parts,” which are numbered. When you are researching the SEC in other sources, you will find references such as 17 CFR Part 210. This refers to the specific portion of the SEC official code found in Title17, Part 210 of the Code of Federal Regulations. The Parts are further divided into Subparts… Volume 11, 1997, pgs. 223-230.