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Volume 13

Industry and Auditor Effects in the Timing of Adoption of Mandated Accounting Standards:
A Study of SFAS NO. 87

Kumar Sivakumar

This paper studies the timing of adoption of Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 87, "Employers' Accounting for Pensions." The study extends existing research on the timing of adoption of mandated accounting standards by combining economic variables, which have been the primary focus of accounting researchers, with institutional variables, specifically the effects of competitors and auditors. An empirical analysis of the timing decisions of 657 firms from 1985 to 1988 shows that firms with a positive income effect on their reported income and large firms adopt early and firms with a high debt-equity ratio delay adoption. The results also reveal that as the proportion of firms within an industry that have adopted the standard increases, the probability that other firms in the industry will adopt the standard also increases. The findings also indicate that clients of large auditors appear to adopt early, especially, if they have a positive income effect. Taken together, these results suggest that institutional and economic factors influence the decision of timing of adoption of mandated accounting standards. Volume 13, 1999, pgs. 1- 20.

The Effects of Selected Engagement Characteristics on Auditors' Judgments

Alan T. Lord

Prior research has reported the effects of client (or engagement) characteristics on auditors' perceived judgments (Shockley 1981; Knapp 1985; Gul 1989; Lindsay 1989), but has not investigated the effects of client characteristics on actual judgments made by auditors. This study investigates the effects of four of these characteristics on auditors' judgments about financial reporting alternatives. Experienced audit managers (CPAs) employed by an international public accounting firm examined a set of sixteen cases that were created by combining an auditor-client conflict scenario about an audit opinion with all possible sets of "strong" and "weak" treatment levels for each of four client characteristics. The conflict scenario for this study was designed so that uncertainty existed about accepting the client's position, and provided an optimal opportunity to test whether engagement characteristics influence auditors' judgments. The results of this research document judgments that may be undesirable, despite a fairly transparent manipulation of the treatment levels of the engagement characteristics. The client's historical financial condition (which had the most significant effect), an auditor's competitive environment, and a client's relative revenue contribution to an auditor's firm were each found to have a statistically significant effect upon auditors' judgments about financial reporting alternatives. In contrast, the auditor's provision of non-attest services to a client was not a significant factor in the judgment process. Volume 13, 1999, pgs. 21-42.

Preliminary Support for the FASB's Revised Segment Reporting Requirement

Jenice Prather-Kinsey

The debate continues about the usefulness of the geographic segment disclosures required by accounting regulatory bodies, including the Financial Accounting Standards Board (FASB), the International Accounting Standards Committee (IASC) and the Accounting Standards Board (AcSB) of the Canadian Institute of Chartered Accountants (CICA). The AcSB, FASB and IASC revised their accounting regulation regarding segment reporting in 1997 from an external to an internal perspective. Specifically, the FASB went from an external to a "management approach" but continued to use the ten percent materiality threshold in its newly revised segment reporting requirement: Statement of Financial Accounting Standard (SFAS)131. Extant accounting literature and financial analysts support that geographic disaggregations reported using the ten percent materiality threshold are not useful to market participants in assessing the varying risks and returns of an enterprise. This article addresses the usefulness of geographic segment reporting from an external perspective using the ten percent materiality threshold in explaining cross-border listing activities of multinational corporations (MNCs). The empirical results show that SFAS 14 disclosures provide significant explanatory power about firm's cross-border listing activities. These results may partially explain why the ten percent materiality threshold is consistent between the internal approach, SFAS No 14, and the "management approach", SFAS No. 131, of the FASB's geographic segment reporting regulation. Volume 13, 1999, pgs. 43-54.

Certified Public Accountants' Self-Regulation in Socio-Legal Perspective

Jack C. Robertson and Keith Hawkins

The regulation of Certified Public Accountants' (CPA) activities has been described by CPAs for CPAs in numerous sources, generally in the spirit of praising and promoting CPAs' efforts to keep their own house in order. Except for periodic Congressional critiques of CPAs' practices, very few efforts to evaluate CPA self-regulation in a more critical spirit have been made. However, the field of socio-legal studies, which explores the institutions, practices, and professions of law from a social-scientific standpoint, contains an emerging literature--indeed a set of generic theoretical ideas--of regulatory law enforcement, which can be recruited to help us look more closely at CPAs' regulatory practices. Most of this socio-legal literature deals with the theory and practice of social regulation and was developed from the established literature on police activities. As a result, socio-legal scholars have not to any significant extent turned their theoretical attention toward self-regulation as a form of social control, nor to the enforcement of standards in the learned professions. Quite recently, the accounting profession embarked on an extensive visioning project--looking to the prospects for accountancy in a rapidly changing business world. The CPA Vision--2011 and Beyond report paints a challenging futuristic picture for CPAs. The picture combines the business of accounting practice (especially public practice) with the forces of professionalism. A judicious combination of business and professionalism deserves continual debate and discussion, and we bring to bear the socio-legal perspective to point out the need for attention to traditional self-regulation institutions and processes. The socio-legal theoretical perspective applied herein introduces some of the language and concepts of law and social science and applies them to CPA self-regulation. The main thesis is that effective self-regulation depends upon (1) designing an effective system, (2) establishing the system in institutions and processes and providing sufficient resources, and (3) operating the system to the satisfaction of both the regulated persons and outside observers. Hence, our general hypothesis is that CPA self-regulation meets these criteria, and now we seek observational evidence to negate the hypothesis. Our analysis shows some little-acknowledged deficiencies in the ways CPAs conduct their self-regulation, and we suggest that CPA self-regulation can benefit from certain changes.

Volume 13, 1999, pgs. 55-80.

Regulation of Accountants: A Test of the Stigler-Peltzman Theory

George D. Sanders

In 1969 a committee of the American Institute of Certified Public Accountants recommended that the education requirements for licensure for public accounting in the United States be increased from the equivalent of four years to the equivalent of five years of university education. This report represents the beginning of a lobbying effort by the Institute to persuade state legislators to change the licensing requirement in the various states. Through 1997, 37 states had adopted the new requirement. This study uses logistic regression and event history analysis of the adoption of the new educational requirements to test the economic theories of regulation developed by Stigler (1975) and Peltzman (1984). The results suggest that these theories have significant explanatory power with respect to the pattern of adoption, both cross-sectionally and over time. The number of AICPA members in a state relative to population is the most significant predictor of adoption. The relative number of business proprietors is negatively associated with adoption and the relative number of local governments is positively associated with adoption. Volume 13, 1999, pgs. 81-96.

The Impact of Scholarly Research on the Regulation of Governmental Accounting and Auditing

Richard E. Brown

For several years the business media and business community have been critical of schools of management for a number of perceived ills, including what is often viewed as irrelevant research by university faculty members. More recently a number of scholars have voiced similar concerns. This paper, prepared by an author with a background in both the practice and academic worlds, focuses on governmental accounting and auditing to examine the relevance of scholarly research to a series of fundamental accounting and auditing issues presently either under study or in use in public financial management. All relevant papers from The Accounting Review and the Journal of Accounting Research, two of the profession's premier academic journals, were reviewed to determine the relevance and contribution of these papers to the current debate surrounding generally accepted accounting principles and generally accepted auditing standards for government. Findings suggest that, at least since the late 1960s or early 1970s, relatively few scholarly papers have advanced insights or information which would appear useful or relevant to the current debate. Moreover, when cited in other journals, the published papers overwhelmingly tend to appear only in other academic journals. This paper explores some of the possible reasons for this development, and its costs, and also offers suggestions to reverse the trend. Volume 13, 1999, pgs. 97-110.

The Impact of Accounting Information on Contributions to Charitable Organizations

Janet S. Greenlee and Karen L. Brown

Although numerous studies have examined the impact of accounting information on investments in publicly traded corporations, few have addressed the ways in which accounting information affects contributions to nonprofit organizations. The two types of organizations are similar in at least one important respect: both rely on external sources of scarce capital. Only a limited amount of funds are available to nonprofit organizations, and each organization must somehow convince resource providers that it deserves financial support. This paper explores the relationship between selected information and contributions to charitable organizations. Specifically, cross-sectional regression analysis is used to see if any relationships exist between administrative cost ratios, fundraising cost ratios and contributions to charitable organizations registered in the Commonwealth of Pennsylvania between 1991 and 1994. The results indicate that an inverse relationship exists between administrative cost ratios and contributions; more contributions were received by those charities with smaller administrative cost ratios. A positive relationship was found between fund raising ratios and contributions; more contributions were received by those charities with larger fundraising cost ratios. Volume 13, 1999, pgs. 111-126.

Political Cost Incentives for Earnings Management in the Pharmaceutical Industry During 1993 Campaign for Health Care Reform

Obeua S. Persons

This study investigates political cost incentives for earnings management among pharmaceutical companies during President Clinton's health care reform campaign in 1993. Two hypotheses are examined. First, pharmaceutical firms are hypothesized to engage in income-decreasing management in order to alleviate the political costs associated with health care reform. Second, pharmaceutical firms with higher political visibility (larger and more profitable) are hypothesized to engage in more income-decreasing management than those with lower political visibility (smaller and less profitable). Earnings management is measured by discretionary (unexpected) accruals (Dechow et al. 1995). Results indicate that pharmaceutical firms engaged in income-decreasing management in 1993. Regression results also suggest that pharmaceutical firms with higher political visibility have more income-decreasing discretionary accruals than those with lower political visibility. Further analysis reveals that pharmaceutical firms also used discretionary noncash write-offs to manage earnings downward. This study has three major contributions. First, it contributes to the literature of earnings management by providing additional evidence in support of the political cost hypothesis. Second, it contributes to the law and economics literature by documenting the effects of regulation on the financial reporting strategies of the pharmaceutical industry. Third, it provides an evidence of earnings management consistent with the SEC's concerns. Two implications for the SEC, other regulators, and investors are: (1) they should look out for any potential income-decreasing schemes among those companies facing political pressure, and (2) they should focus their scrutiny on larger and more profitable firms. Volume 13, 1999, pgs. 127-150.

Assessing Auditor Independence: Audit Fees and Enforcement Patterns

John A. Pendley and Joseph Legoria

In this report, we examine the effect that fees earned from a client have on auditor independence. Recent comments by the Securities and Exchange Commission (SEC) and members and staff of the Independence Standards Board (ISB) continue to raise questions about the potentially adverse effects of auditor economic dependence on specific clients. We address this question by examining whether the chance of a poor quality audit increases if an auditor earns a greater proportion of fee revenue from a given client. For this study, poor quality audits are identified from the SEC's Accounting and Auditing Enforcement Releases (AAERs). We compare the audits identified in AAERs with audits with similar characteristics but not cited in AAERs. Our findings show that even after controlling for other audit quality attributes (such as expertise), level of fee dependence is significantly related to the probability of being cited in an SEC enforcement action. Thus, our research findings lend support to concerns about the economic dependence of auditors as bearing an adverse influence on auditor independence and the perception of the quality of an audit. Volume 13, 1999, pgs. 151-168.

Why Do Bankrupt Companies Receive Unmodified Audit Opinions?

Jeffrey R. Casterella, Barry L. Lewis, and Paul L. Walker

Regulators and the financial press often appear perplexed with the audit opinions issued to failing firms. The purpose of this paper is to offer some rather straightforward explanations for these opinions. The underlying argument of this study and the proposed model is that the auditor did not (or could not) anticipate the bankruptcy filing because there were not enough warning signs present to raise the auditor's suspicion. The approach taken in the paper is to build a model of the audit opinion that is simple, has face validity, and is consistent with both practitioners' explanation of their decision and with professional standards. Additionally, the paper explores the predictive accuracy of such opinions given various signs of trouble for each company. The results indicate that although auditors fail to modify the reports of many soon-to-be bankrupt companies, they are reasonably good at identifying and modifying the audit reports of companies with multiple signs of financial distress. Implications for future research, the profession, and regulators are discussed. Volume 13, 1999, pgs. 169-178.

Update: The Stock Index and Market Seasonals (SIMS 2.0) Database

Anthony J. Cataldo, II

A detailed description and descriptive statistics from the first version of the Stock Index and Market Seasonals (SIMS) database was published in the preceding issue of this journal (Cataldo 1998). This article also contained a statistical test of the validity of Fosback's (1976) proposed three-day window for holiday effects, which was supported. A second version of SIMS is nearing completion. Volume 13, 1999, pgs. 179-180.

State Accountant Privity Laws: Narrowing the Scope of Accountant Liability to Third Parties

Carl Pacini, David Sinason, and William Hillison

In the previous two decades, the accounting profession has confronted a litigation explosion. One response of the accounting profession to the litigation crisis has been to mount a campaign aimed at legislative reform. A key issue for state tort reform legislation is the extent to which someone other than the client is owed a professional duty and can sue an accountant for negligence. This article assesses the current status of accountant privity law reform. It also examines court decisions made under various state accountant privity statutes. Policy implications of state accountant privity laws, including diminished litigation risk and reduced litigation costs, are also outlined. Several reasons are offered why more states have not enacted an accountant privity statute. A continuation of enactment of accountant privity laws may signal a change in state public policy toward limitations on the liability of accountants to non-clients. Volume 13, 1999, pgs. 181-200.

A Survey of Audit Service Pricing in South Korea

Mark H. Taylor, Daniel T. Simon, and F. Greg Burton

This paper studies the audit services market in South Korea. Compared to the audit services market in other countries, the market for audit services in South Korea is unique because it is heavily regulated. The findings indicate significant differences in the market for audit services in South Korea and countries previously studied. For example, the results suggest that the large audit-firm fee premium observed in many countries does not exist in South Korea as well, variables other than firm size that are typically related to client characteristics, such as complexity and risk, are not significant. The difference in the results for Korea and for other countries is likely due to the very different regulatory environment in Korea, especially regulation of the fee setting process. Volume 13, 1999, pgs. 201-210.

Claiming the Right to Know: 

An Information Perspective for Business Reporting

Robert James Bricker and Gary John Previts

Traditionally, business reporting has been oriented towards investors and creditors. This paper studies business reporting from a property rights perspective. This broadens the orientation of business reporting to incorporate the information rights of claimholders in addition to those of investors and creditors. Our paper begins by developing historical and philosophical links between property rights, rights of use, information rights, and reporting. We argue that contemporary reporting tends not to fully reflect the changes in information rights because of technological limitations, transaction costs of changing, and habit. Consequently, reporting remains traditionally oriented towards investors and creditors. We introduce a broader perspective of accountability that addresses the information rights of all business organization claimholders. The resulting model theoretically describes the relationship between a company's resources, claims, and related information rights, but does not address how the information rights of claimholders are to be met. While the traditional reporting model is adequate to meet some information rights, alternate reporting methods may be necessary where accounting technologies are inadequate. The paper concludes by asserting a need to reexamine business reporting and expressions of the traditional reporting model as it is currently understood and taught. We argue for research to reorient business reporting to bring them more into consonance with the global operations of current capital markets institutions and the property rights-information rights of a broader community of user constituencies. Volume 13, 1999, pgs. 211-230.

Improving Audit Committee Effectiveness

Gregory J. Jonas and Stephen J. Young

Concepts such as board accountability and audit committee effectiveness are increasingly topics of discussion and the subject of corporate governance studies and surveys. In 1998, Arthur Andersen commissioned a study of audit committee best practices. In this paper, we share the results of that study by identifying the ten key areas of audit committee responsibility and the best practices associated with each. Volume 13, 1999, pgs. 231-240.

Regulation of Hedge Funds: The Bailout 

The Long-Term Capital Management

Roman M. Fatkhiyev and Kyle M. Hannaford

The expanding presence of hedge funds in the global capital markets has raised concerns over the virtually unregulated condition of these funds. This has become even more apparent after the near-collapse and subsequent rescue of one of the most successful hedge funds, Long-Term Capital Management, in September 1998. However, as a result of the government-initiated bailout, American investors are left with unanswered questions regarding the government's role in the marketplace and the future direction of federal regulatory authority. While some market participants, especially lenders, have already begun to voluntarily impose restrictions on the activities of hedge funds in the wake of the LTCM crisis, greater government involvement in this area is still likely.Volume 13, 1999, pgs. 241-248.