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Volume 15

Segment Disclosures Under SFAS 131:  Impact on the Banking Industry

 Nancy B. Nichols, Ashton C. Bishop and Donna Street

 This research reviews the 1997 and 1998 annual reports of the US's largest banks to determine whether SFAS 131 adequately addressed user concerns about segment disclosures and the extent to which the anticipated benefits set forth in SFAS 131 materialized.  The findings reveal that segment reporting in the banking industry has improved.  For example, the number of segments reported and the consistency of segment information with the introductory annual report material and MD&A increased significantly in 1998 as compared to 1997. The findings also reveal that 28 of the nation's largest banks provided reportable operating segment disclosures in 1998 although the same banks previously provided no segmental data in the footnotes of their financial statements.  Thus, the SEC's recent focus on segmental reporting combined with the release of SFAS 131 have all but ended many banks' tendency to provide no segmental data in the notes to their financial statements.



Delay in Accounting Harmonization: Evidence on Auditor Selection and Cost-of-Capital Effects, 1986-1990

Wanda A. Wallace

As entities compete for capital, they can choose a variety of bonding and monitoring mechanisms that improve the quality of information and hence are expected to lower the cost of capital, one component of which is effective interest cost. Lending contracts have long included language requiring audited financial statements, at times being specific as to the auditing firm. The Big 5 auditors are world firms, which represent that their use of world-wide auditing standards enhance the consistency of audit quality around the globe. In 1991, the Financial Accounting Standards Board (FASB) changed its mission to incorporate international harmonization. Arguably, until such date, debate was active as to whether this was even a preferred course of action. This study focuses on the time frame from 1986 to 1990, to assess whether use of the Big 5 was a temporary solution to disparate national accounting practices across borders. Although the Big 5 are not the largest of firms in many countries, they do have trademark recognition in global markets. Banking markets are increasingly global, and the Big 5 have been viewed as "deep pockets," creating insurance or stewardship incentives for their selection. This research poses the question of whether Big 5 auditor association, as well as the event of a change toward one of these Big 5 CPA firms, is associated with the five-year average effective interest rate incurred, once leverage, size, profitability, and effective tax rate are controlled. Evidence is consistent with lower interest cost being incurred by those entities in six countries--Italy, Spain, Australia, Germany, France, and the United Kingdom (as well as a hold-out sample from Canada)--that have selected Big 5 auditors. Preliminary evidence is also provided that differences in countries even for the brief time frame analyzed have declined over time, consistent with the evolution toward more unity of information reporting and/or increased globalization of markets. An interpretation is that delay in accounting harmonization created an apparent reward to those selecting global auditors. The latter provided a substitute for the evolving international accounting regulatory infrastructure.



 Voluntary Disclosure of Value Driver Information: A Content Analysis of Global M&A and Other Cross-Boundary Disclosures of the Ford Motor Company 1995-2000

 Orhan Celik

 The interest of financial executives, regulators and standard setters to provide investors with  ‘key performance indicators’ may be served by articulating “value drivers” as a step in the process toward such indicators. Value Drivers serve as a collecting focus, identifying content items from which patterns of information are observed.  Such patterns improve understanding of useful non-financial as well as financial performance measures. Universal and particular value drivers are developed as orientation guides to determine whether information reported is relevant to important management objectives. In this study particular value drivers are established for automotive [OEM] and merger and acquisition activity. These are developed in a global, cross boundary, context that represents the geographic, social and political environment of management.

 The authors employ content analysis methods to identify information in mandated [SEC 10-K] and GAAP [Corporate Annual Report] disclosures, which relate to value drivers.



 Financial Statement Fraud:  Capital Market Effects and Management Actions

 Albert L. Nagy

 The purpose of this research is to examine the effects that financial statement fraud announcements and certain strategic actions have on the perceived validity of financial disclosures.  This study posits that:  (1) Financial statement fraud announcements damage the perceived validity of financial disclosures, and (2) certain strategic actions performed subsequent to a fraud announcement improve the perceived validity of financial disclosures.  The hypotheses are based upon prior literature that uses the earnings response coefficient (ERC) to measure earnings quality.  The OLS regression results provide evidence that a financial statement fraud announcement is associated with a decrease in the ERC, and that the strategic actions of changing external auditor and increasing the percentage of outsiders comprising the board of directors following a fraud announcement improve the ERC.  These results suggest that financial statement frauds reduce the perceived validity of financial disclosures, and that the strategic actions of changing external auditor and increasing the percentage of outside directors help mitigate this reduction.



 Evidence of Earnings Management with the Selection of the Discount Rate for Pension Accounting: The Impact of an SEC Letter

 David R. Vruwink

 In September 1993,the Securities Exchange Commission (SEC) sent the Financial Accounting Standards Board (FASB) a letter, which made the charge that many companies were not following current accounting standards in the selection of the discount rate for computing pension liabilities and pension expense. This study compares the discount rates, before and after the SEC letter, of firms with rapid earnings growth to those firms that had declining earnings from the previous year for the 1991 to 1995 time period. The results provide some evidence that prior to the SEC letter, firms with positive earnings were influenced by past operating performance in selecting the discount rate. After the SEC letter, no significant difference was found between the discount rates for the two groups of firms. This outcome supports the view that the SEC letter appears to have been successful in influencing more companies to follow current accounting standards in selecting the discount rate.



 SEC Audit Requirements and Audit Fees: A Research Note

 Charles P. Cullinan

 The SEC has active regulatory oversight of the accounting and disclosure practices of mutual funds (e.g., SEC 2001; Brown 2000). Such oversight requires the SEC to consider the costs and benefits of regulatory requirements. There is limited research, however, on the costs of accounting and disclosure regulations in the mutual fund area. The objective of this study is to examine the effects of two SEC mutual fund audit requirements on audit costs. The two requirements are that auditors of mutual funds audit the valuation of every security held by a fund, and that the auditor provide an opinion on the funds internal control system.  Results suggest that auditing the valuation of every security held results in a small incremental audit cost, even for funds of similar size. The study also indicates that the internal control requirement may be less costly for funds in large fund families due to potential economies of scale.



AUDIT COMMITTEE Characteristics and Auditor Switches

 Lawrence J. Abbott and Susan Parker

 The role of the audit committee in corporate governance is the subject of increasing public and regulatory interest. We focus on the role of the audit committee in auditor selection at the time of an auditor switch. We argue that independent and active audit committee members demand a high level of audit quality because of concerns about monetary or reputational losses which may result from financial misstatements. We find that audit committees which meet certain recommendations of the Blue Ribbon Committee with respect to composition and are at least minimally active are more likely to increase auditor quality at the time of an auditor switch. This study contributes to our understanding of audit committee functions and provides evidence that industry specialization is an important element of auditor selection.



 Staff Accounting Bulleting 101: Testing Students’ Knowledge of Revenue Recognition Principles          

 Jimmy W. Martin

Throughout the twentieth century, revenue transactions have presented challenges for accountants and auditors.  Although the profession has devoted considerable efforts in defining the requisites for revenue recognition, the problems seem to proliferate.  One plausible explanation for revenue recognition problems is that students are graduating with incorrect or incomplete concepts of revenue.  To test this hypothesis, the author has utilized case situations developed by the Securities and Exchange Commission in Staff Accounting Bulletin No. 101 and structured responses to each case.  These cases and possible responses were given to both undergraduate and graduate accounting students for the purpose of determining how they would make revenue decisions.  The objective is to develop a test instrument that will identify revenue misconceptions and thereby allow instructors to modify their instruction techniques.          



 The Legality of the SEC's Authority to Regulate the Scope of Services for CPA Firms

Mark A. Segal and Frank R. Urbancic

On June 27, 2000 the SEC proposed a rule to address auditor independence requirements and impose restrictions on the scope of non-audit services offered by CPA firms.  The restrictions, as initially proposed by the SEC, had the potential to greatly impact the public accounting profession, especially the Big-Five CPA firms.  However, following an extensive public hearing process, the SEC reached a compromise agreement with the accounting profession on November 15, 2000 and approved a modified version of its original proposal.

            The purpose of this study is to assess whether the SEC has the legal authority to regulate the scope of services offered by CPA firms.  The assessment considers whether there is either a clear set of directives or prior court case(s) that empowers the SEC to establish regulations in the area of services offered by CPAs.  An understanding of the parameters of the SEC’s authority is important as the Commission may revisit the issue of independence in the foreseeable future.




Julia Grant and Larry Parker

 The authors present a definition and explanation of a popular non –GAAP alternative performance measure EBITDA.   In their consideration and review of several instances where the measure has been employed in the past six years they identify several issues and concerns, especially as related to use by individual investors. They conclude by identifying the importance of relating EBITDA to GAAP-derived cash flow measures. 



Disclosure and Accounting in a Global Market: Looking to the Future

 Lynn E. Turner

In today’s global economy, many businesses of all sizes operate and conduct business on an international basis.  World trade has grown as businesses have extended their operations beyond their own national borders, aided by technological advances in communication and data transmission, and the reduction of national barriers to commerce, trade and travel.  Companies have learned that to be successful, they must be able to compete in international markets for both customers and capital.  

Quality financial reporting is critical to the efficient operations of the world’s capital markets.  With the increasing expansion of all market participants beyond their national borders, the challenges of continuing to maintain quality and transparency in financial reporting has increased.   Those challenges include protecting investors and international capital markets in an environment of exploding technology and fierce global competition. 

These challenges require the coordinated effort of public companies, auditors, standard setters, regulators and governments.  They cannot be met by just one or two of these groups. They cannot be met by a rush to “short-term convergence” just for the sake of getting a “quick fix” that ultimately could cause incredible damage to the markets.  Instead, it is critically important that everyone closely coordinate their efforts and devise and execute the changes needed for future success.  These are changes that need to be made in a timely fashion, with input from the public, and with appropriate due process.  With such an approach, it is hopeful that a quality product will be developed that ensures the continued success of the world’s capital markets.  That success in turn should result in companies having access to capital that is so important to the global economy.



The Development of Financial Reporting, the Stock Exchange and Corporate Disclosure in Thailand

Aim-orn Jaikengkit

After enjoying a decade economic growth, Thailand was suddenly hit by the crisis of 1997. This crisis brought with it not only a reformation in monetary and fiscal policies, but also a fundamental change in the Thai financial structure. The Thai financial structure switched from depending on funds from banks or financial institutions, to using money markets, both in Thailand and overseas. The new era, the era of appreciation for better disclosure by Thai firms, was ushered in. This study discusses the development of financial reporting, the stock exchange and corporate disclosure in Thailand from the period before 1974 to 2000.


Mandatory Auditor Rotation: A Critique of the Panel on Audit Effectiveness

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

The Public Oversight Board appointed the Panel on Audit Effectiveness to perform a comprehensive review of how audits are performed and the environment in which audits take place.  The purpose of this paper is to provide both a brief summary of the work and recommendations of the Panel and a critique of the approach it employed to evaluate audit effectiveness.  We argue that the Panel did not use a coherent framework of auditing that would allow them to identify relevant issues, examine existing evidence related to those issues, or propose additional research.  As a result, the Panel apparently ignored the issue of mandatory auditor rotation, despite the fact that both Congress and the SEC have expressed concern about long term auditor-client relationships.