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Volume 20

Revised Pension Rules and the Cost of Debt

Kenneth W. Shaw, University of Missouri

Statement of Financial Accounting Standards No. 158 significantly changes how firms report the financial position of their defined-benefit pension plans.  Under this new standard, firms must report the funded status, equal to the net of the projected benefit obligation and the fair value of their pension plan assets, on the balance sheet.  As a result, prior service costs and gains or losses, previously unrecognized but disclosed in footnotes to the financial statements, are included on the balance sheet.  Using a sample of firms with defined-benefit pension plans over 1999-2005, this study examines the relation between yield spreads on new debt issues and recognized or disclosed pension information.  The results show that both recognized and disclosed pension information are related to yield spreads.  Further, there is no significant difference in the relation between pension information and yield spreads depending on the location of pension information in the financial statements. Overall, the results suggest that bond investors utilize both recognized and disclosed pension information in their pricing decisions, suggesting little potential impact of SFAS No. 158 on the cost of debt.


An Examination of Comment Letters to the IASC: Special Purpose Entities

Robert K. Larson, University of Dayton

While major strides toward the convergence of accounting standards have occurred, concern exists that self-interested political pressures, if effective, may create international accounting standards that are not always in the best interest of investors and others.  This case study examines comment letters generated by an important accounting topic, Special Purpose Entities (SPEs), in order to gain further insight into whether concerns of political pressure in the development of international accounting standards have merit.  Famous since Enron, SPEs are used in off-balance sheet financing vehicles that now involve trillions of dollars annually.  During the period when the International Accounting Standards Committee (IASC) was trying to earn the support of the International Organization of Securities Commissions (IOSCO), the IASC’s Standing Interpretations Committee (SIC) issued Draft Interpretation 12 (DI-12), Consolidation of Special Purpose Entities.  DI-12 required SPEs to be consolidated more frequently than under US GAAP. 

Although most respondents, including IOSCO, supported DI-12, about 25 percent adamantly opposed it.  Opposition came from those in countries with more flexible rules on the consolidation of SPEs, including the staff of the Financial Accounting Standards Board and all other US letter writers.  It is also possible that political considerations may have influenced some as Arthur Andersen and all banking interests opposed to DI-12 were heavily involved with SPEs.  However, with the support of IOSCO and many others, the SIC’s final SPE standard was even stricter than originally proposed.  

Demographic Challenges Facing the CPA Profession

Julia Grant, Case Western Reserve University

Prior research (Young, 1995) using AICPA and census data illustrated a level of maturity in the accountancy profession, with numbers of CPAs increasing dramatically within the population from the early 20th Century. This work also illustrated strong growth in AICPA membership, and reported a shift in the activities of the AICPA members. Corporate practice was growing more quickly and public practice growing only very slowly, sometimes shrinking. The current paper examines ten additional years of AICPA data and gathers further economic and demographic U. S. Census data to explore these patterns and related issues. The professional membership of the AICPA continues to have relatively flat growth overall, and public practice has continued to decline relative to other pursuits of AICPA members. When the data are split into gender and age cohorts, different patterns are detected and challenges identified for continued involvement in the profession as defined by AICPA membership.

The Effect of Tax Refunds on Taxpayers’ Willingness to Pay Higher Tax Return Preparation Fees

Scott B. Jackson, University of South Carolina, Richard A. White, University of South Carolina

This study examines the historical profile of tax refunds and reports the results of an experiment which helps to explain the economic consequence that tax refunds may engender.  Analysis of historical tax refund data reveals that the incidence and magnitude of tax refunds have increased significantly over the past half-century, which suggests that legislative efforts aimed at reducing tax refunds have been largely ineffective.  The results of the experiment reveal that taxpayers who receive tax refunds from the IRS tend to frame tax return preparation fees as a cost, while taxpayers who owe the IRS additional taxes tend to frame tax return preparation fees as a loss.  In turn, the manner in which taxpayers frame tax return preparation fees influences the perceived benefits that taxpayers ascribe to the tax return preparation service, which, in turn, influences taxpayers’ willingness to pay higher tax return preparation fees.  Importantly, when the results of this study are considered in conjunction with the results of extant research, which reveals that tax professionals bill taxpayers for larger fractions of billable fees when taxpayers receive tax refunds than when taxpayers owe additional taxes (Hatfield et al. 2007), it seems reasonable to conclude that higher equilibrium tax return preparation fees are likely to evolve when taxpayers receive tax refunds than when they owe additional taxes. 

Deregulation and Voluntary Disclosure by the Airlines: A Case Study

David S. Gelb, Seton Hall University, Theresa F. Henry, Seton Hall University, Mark P. Holtzman, Seton Hall University

This study examines airlines’ voluntary disclosure behavior before and after deregulation.   Before deregulation, did airlines avoid voluntary disclosures in order to reduce political costs?  After deregulation, did airlines reporting higher earnings provide more voluntary disclosures in order to reduce their cost of capital?  How do firms tradeoff between political costs and cost of capital? Airline deregulation offers a unique setting for this quasi-experiment because it is one of the largest deregulation events in the history of the United States, and because of the availability of a unique database of disclosure ratings during this time period.  Prior to deregulation, we find little or no association between earnings and voluntary disclosures, suggesting that political costs subverted incentives for the most profitable airlines to make voluntary disclosures.  After deregulation, we find a direct and positive relationship between airlines’ earnings and the volume of their voluntary disclosures.

Audit Pricing and Internal Control Disclosures among Non-Accelerated Filers

Jean C. Bedard, Bentley College, Udi Hoitash, Rutgers University, Rani Hoitash, Bentley College

In this paper we examine the association of audit fees with disclosures regarding internal control effectiveness under Section 302 of the Sarbanes Oxley Act of 2002 (SOX).  In contrast to previous studies, we focus on non-accelerated filers, whose eventual compliance with the costly provisions of SOX Section 404 internal control reporting has become a contentious issue.  While auditors are not required to test controls under Section 302, we find that companies disclosing Section 302 problems pay higher audit fees, suggesting greater engagement effort and/or a risk premium.  Further, our results indicate that fees are adjusted for risk associated with problem severity, but relative risk adjustment does not change between 2003 and 2004. We also find a significant fee increase for “clean” companies in 2004, although there was no change in regulation for non-accelerated filers in that year.  Further examining fee changes from 2003 to 2004, we find that companies remediating internal control problems disclosed in 2003 continue to pay higher fees in 2004, and fees of first-time disclosers in 2004 are significantly higher.  Additionally, audit fees are higher for both continuing and new clients of the Big 4, lower for companies switching away from Big 4 firms and unchanged for companies switching to another Big 4 firm.  


Impact of Environmental Regulation on Financial Reporting of Pollution Activity: A Comparative Study of U.S. and Canadian Firms

Paul Ashcroft, East Central University, L. Murphy Smith*, Texas A&M University, Lmsmith@tamu.edu
  *Contact author

Business firms are under scrutiny to provide accurate environmental reporting, including capital costs and operating expenses concerning pollution. Environmental reporting is incorporated into annual financial reports as well as specialized environmental reports. The extent or value of such information is an appropriate subject for accounting research. This study investigates environmental reporting in audited financial statements of U.S. and Canadian firms prior to SOP 96-1, to determine whether environmental regulation starting with SOP 96-1 was needed. One would expect that environmental information would be useful to shareholders and others in assessing the environmental risk exposure of a firm. The key question addressed by this study is whether a firm’s reported environmental information (environmental capital costs and environmental operating costs) actually reflects the firm’s pollution. The findings suggest that many firms were failing either to record or to fund necessary environmental expenditures, and therefore may have significant amounts of unrecorded future environmental obligations. As a result, the accounting guidance provided by FASB, starting with SOP 96-1, were appropriate for enhancing financial reporting regarding environmental matters.


An Examination of Supplemental Disclosure Requirements for Development Stage Enterprises

Mark P. Bauman, University of Northern Iowa, Rick Francis, University of Northern Iowa, Rick.

Under U.S. GAAP, development stage enterprises are required to report cumulative (i.e., inception-to-date) totals for each line item in the statements of income, cash flow, and stockholders’ equity.  The purpose of this study is to investigate whether additional income statement disclosures provide value-relevant information to investors.  Based on an empirical analysis of a sample of publicly-traded development stage enterprises, we find that historical income statement components do not exhibit a significant association with equity values after controlling for the effects of non-financial information and current accounting data.  In terms of current accounting data, book value of equity (primarily contributed capital), cash holdings, and R&D expense appear to be most useful for valuation purposes.  These results imply that supplemental disclosure requirements geared toward providing qualitative information about development stage firms may prove more informative than providing cumulative financial statement data.


Provision of Non-Audit Services and Individuals’ Investment
Decisions: Experimental Evidence

Lucy F. Ackert, Michael J. Coles College of Business,Federal Reserve Bank of Atlanta, Bryan K. Church, Georgia Institute of Technology,  Arnold Schneider, Georgia Institute of Technology

We conduct an experiment to investigate whether concerns about an auditor’s independence and reputation affect individuals’ investment decisions.  We examine whether the disclosure of audit and non-audit fees affects participants’ investment decisions.  We find that investment in clients of a less reputable auditor is reduced relative to that in other companies when non-audit fees exceed audit fees.  Participants’ investment in companies audited by a reputable auditor, however, is not affected by fee disclosures. 


Financial Reporting after the Sarbanes-Oxley Act: Conservative or Less Earnings Management?

Jian Zhou, SUNY at Binghamton

One of the goals of the Sarbanes-Oxley Act (hereafter SOX) was to restore confidence in financial reporting by providing incentive for firms to report financial results that reflect the underlying economic performance.  Early findings are inconclusive on the success of the Act.  Cohen, Dey and Lys (2005) show that firms engage in less earnings management post-SOX, but Lobo and Zhou (2006) find that firms report earnings more conservatively.  Reporting more conservatively could be consistent with greater earnings management.  We simultaneously examine conservatism using discretionary accruals and earnings management using the absolute value of discretionary accruals  Our findings suggest that firms are reporting more conservatively (i.e., reporting lower discretionary accruals), but also engaging in less overall earnings management (i.e., reporting lower absolute value of discretionary accruals).  Our paper contributes to the literature by investigating the impact of SOX on financial reporting and reconciling potentially conflicting findings in other studies.


Regulatory Change and the Quality of Compliance to Mandatory Disclosure Requirements: Evidence from Bangladesh

Tanweer Hasan, Roosevelt University, A.K.M. Waresul Karim, Victoria University of Wellington, Shakil Quayes, (contact author), Arizona State University, quayes@asu.edu
This study investigates the effectiveness of changes in the regulatory environment on the quality of compliance to mandatory disclosure requirements in Bangladesh.  Statistical analysis of the Mandatory Disclosure Index, as developed in this paper using annual reports of the exchange-listed firms pre and post changes in the regulatory environment, shows a significant improvement in the quality of compliance during the more regulated time period.  The size of the firm, the qualification of its accounting staff that prepares financial statements and the reputation of its auditing firm have significant positive impact on the quality of compliance.  The analysis points to two additional important findings: lack of a firm’s profitability does not seem to affect the quality of its compliance, and the performance of domestic firms is at par with foreign affiliated firms as far as the quality of the compliance is concerned.  The findings reported in the present study lend support to the conventional notion that well packaged and timed regulations can foster sustainable development in the overall reporting environment of a country.


The Impact of Sarbanes-Oxley Act on Cosmetic Earnings Management

June Y Aono*, University of Hawaii at West Oahu, Liming Guan, University of Hawaii at Manoa* Contact author

This study examines the mitigating effect of Sarbanes-Oxley Act on cosmetic earnings management, referred by Kinnunen and Koskela (2003) as earnings manipulative behavior to round earnings such that they result in an upward bias.  This behavior reports income numbers to achieve key cognitive reference points represented by N x 10k.  Using Benford’s law, our analysis compares the distribution of second digits in reported annual earnings for publicly listed U.S. companies between a two-year periods before and after the year 2002 when Sarbanes-Oxley Act went into effect.  Our empirical results suggest that, in the two-year period prior to the Act, there was evidence of cosmetic earnings management.  However, such behavior in manipulating earnings has noticeably decreased in the period after the Act.  This finding is consistent with the notion that Sarbanes-Oxley Act has a deterring impact on corporate America’s manipulative behavior to report earnings that achieve certain key reference points.


International Financial Reporting Standards (IFRS) and the Development of
Financial Reporting Standards in Turkey

Yüksel Koç Yalkin, Ankara University, Voklan Demir, Galatasaray University, Defne Demir, CPA, Turkey

The European Union decided that IFRS would be effective as of the beginning of 2005. Consequently, the IMF, the World Bank, IOSCO as well as other similar organizations have established policies to support the adoption of IFRS. Similarly, since January 1, 2005, banks and firms in Turkey registered on the Istanbul Stock Exchange have prepared their financial statements in accordance with principles set out in IFRS. Moreover, the Turkish Accounting Standards Board (TASB) which oversees Turkish Accounting Standards has accepted harmonization with the principles of IFRS in order to get international acceptance.

The TASB is the sole authority charged with the development and application of accounting standards in Turkey. Therefore, future acceptance and application of these standards by other regulatory organizations is inevitable.


The Independence Concept Revisited

John L. Carey (1904-1987)

John L. Carey retired as executive director and administrative vice president of the AICPA in l970.  He had been associated with the AICPA since 1925.  The first non-CPA to receive the AICPA Gold Medal Award, and one of the few non-CPAs to be elected to the Accounting Hall of Fame, Carey authored numerous articles for professional journals and books.  In 1969-70 he authored a two volume history of the AICPA entitled The Rise of the Accounting Profession.  The original version of this paper, previously unpublished, was delivered to an accounting seminar at the University of Illinois in 1970.  Carey’s first major book length work on CPA ethics was published by the American Institute in 1946.  A specialist in CPA ethics, Carey continued to follow the developments of the CPA profession from his retirement home in Taconic, Connecticut until he passed away. This paper was first published in 1987 and is reproduced from Catalyst magazine with permission from The Ohio Society of CPAs


Developments in Accounting Regulation:  A Synthesis and Annotated Bibliography of Evidence and Commentary in the Academic Literature (2005-2006)

Stephen R. Moehrle*, University of Missouri – St. Louis,  Jennifer A. Reynolds-Moehrle, University of Missouri – St. Louis,  Pamela Stuerke, University of Missouri – St. Louis, * Contact author

In this article, we synthesize, in annotated bibliography form, recent regulation-related findings and commentaries in the academic literature.  This annotated bibliography is the third in a series of bibliographies that will summarize regulation-related academic research for at least the period from 1990 forward.  We reviewed academic outlets such as The Accounting Review, The Journal of Accounting Research, The Journal of Accounting and Economics, Accounting Horizons, The Journal of Accounting, Auditing & Finance, The Journal of Accounting and Public Policy, The Journal of Business, Finance & Accounting, Auditing:  A Journal of Practice and Theory, and Research in Accounting Regulation.  We annotate results of regulation-related research studies and key points from regulation-related commentaries.