Discretionary Allocation of Corporate Income to Segments
Qian Wang, Iowa State University; Michael Ettredge, University of Kansas
The SEC continues to view companies’ segment disclosures, including segment earnings, as needing improvement. Under a controversial provision of FAS 131, the sum of a company’s segment earnings need not equal corporate net income. We refer to the difference between summed segment earnings and corporate-level income, when it exists, as the Gap. This study examines why Gaps exist. We find that the existence and direction of Gaps appear to reflect both reporting decisions intended to better reflect segment operating results and reporting incentives to obscure differences in profitability across segments. Gaps created for the former reason are shown to provide useful information to investors. We also find that summed segment earnings are, on average, more useful than corporate earnings (i.e. more persistent, predictable and informative) when there are negative Gaps (aggregated segment earnings exceed comparable corporate earnings), but less useful, on average, when positive Gaps are observed. On balance the evidence suggests that the FASB’s decision in FAS 131 to allow segment-related income Gaps was justified.
JEL Codes: M41
Keywords: Segments, FAS 131, proprietary costs, agency costs, mandatory disclosure, earnings response coefficient.
Bank Loan Officers’ Perceptions Concerning Independence, Objectivity, and Reliability When External Auditors also Perform Tax Compliance Activities for Nonpublic Clients
Dave Thompson, Jr., Alabama State University; Quinton Booker, Jackson State University
This study examines bank loan officers’ perceptions of auditor independence, objectivity and the reliability of the report on the financial statement when the attest auditors also provide (1) tax compliance services to the nonpublic entity that they audit, and (2) tax compliance services to executives of said entities. The primary issues addressed are (1) whether performing the external audit and providing tax compliance services for the same entity affects the aforementioned perceptions, and (2) whether adding tax compliance work for the executives of the entity affects these perceptions. We used a between-subject design and bank loan officers as participants. Findings based on 181 participants indicate that bank loan officers generally perceive a significant difference in independence and objectivity when the auditor also performs tax compliance work for the audited entity. On the other hand, loan officers do not perceive a significant difference concerning the reliability of the report on the financial statements. Similar results hold when tax compliance services for entity executives are added to the services performed with the exception that perceptions regarding the reliability of the report on the financial statements are also reduced significantly. Implications and limitation of these findings are discussed.
Keywords: auditor independence, objectivity and reliability, tax compliance services
Developments in Accounting Regulation: A Synthesis and Annotated Bibliography of Evidence and Commentary in the 2012 Academic Literature
Laurel Franzen, Loyola Marymount University; Michele Meckfessel, University of Missouri – St. Louis; Stephen R. Moehrle, University of Missouri – St. Louis; Jennifer A. Reynolds-Moehrle, University of Missouri – St. Louis
In this article, we synthesize in annotated bibliography form, recent regulation-related findings and commentaries in the academic literature. This annotated bibliography is one in a series of bibliographies that summarizes regulation-related academic research. We reviewed academic outlets such as The Accounting Review, Journal of Accounting Research, Journal of Accounting and Economics, Contemporary Accounting Research, Accounting Horizons, The Journal of Accounting, Auditing & Finance, Journal of Accounting and Public Policy, 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. The literature featured some strong regulation-related threads in 2012 including the foundations of financial reporting, the role of financial reporting in the financial crisis, accounting disclosure, financial reporting choices, international financial reporting standards, and Sarbanes-Oxley and its impact on accounting and auditing quality.
Keywords: Sarbanes-Oxley, disclosure, standards
Does Information About Auditor Switches Affect Investing Decisions?
Arnold Schneider, Georgia Institute of Technology
This study examines the impact of auditor dismissals and resignations on investing decisions. The study also aims to ascertain whether these decisions differ due to a reason given for the dismissal or resignation. Participants were given a scenario involving an investing decision and were first asked to assess the level of risk associated with investing in the company. Next, they were asked to allocate $10,000 between investing in the company versus a money market account. Five different questionnaires were created by varying information about an auditor switch and the reason for the switch. Results indicated that auditor switches produce higher investment risk assessments and marginally lower amounts invested than no auditor switches. Furthermore, the effects of resignations were not significantly different from the effects of dismissals. Also, disclosure of a disagreement as a reason for an auditor switch had no impact.
Keywords: Auditor switches, auditor changes, resignations, dismissals, investing
Principles-Based vs. Rules-Based Accounting Standards: The Effects of Auditee Proposed Accounting Treatment and Regulatory Enforcement on Auditor Judgments and Confidence
Gary P. Braun, University of Texas at El Paso; Christine M. Haynes, University of West Georgia; Tom D. Lewis, Creighton University; Mark H. Taylor, Case Western Reserve University
Using an interest capitalization context, this paper examines the impact of accounting standard type (rules-based vs. principles-based) on the auditor’s agreement with an auditee’s proposed accounting treatment. Contrary to prior studies that have investigated lease classification contexts, results indicate that auditors are more likely to agree with the auditee’s accounting treatment under a principles-based than a rules-based standard. The possibility of a Securities and Exchange Commission (SEC) investigation does not affect auditors’ agreement with their auditee’s accounting treatment. However, auditors are more confident in the rules-based scenario when they have no knowledge of a possible SEC investigation. Thus, the lack of precision inherent in a principles-based, interest capitalization standard may initially persuade auditors to agree with auditee judgments, but this perception may be moderated by a reduced level of confidence. Those interested in the standard setting process should look beyond the traditional lease structuring scenario and consider the possible effects of other principles-based standards on auditors’ judgments and confidence.
Keywords: principles-based standards; rules-based standards; enforcement; auditor judgment
The effect of In-Process Research and Development Capitalization on M&A and purchase price allocations
Thomas D. Dowdell, Jr., North Dakota State University; Steve C. Lim, Texas Christian University
We investigate whether the change in accounting treatment of in-process research and devel-opment cost (IPRD) from expensing to capitalization affects the frequency of acquiring target firms with IPRD and the purchase price allocated to IPRD. We examine 1,490 acquisitions in high-technology industries using a unique data set of purchase price allocations. For our sample as a whole, we find that the accounting rule change does not reduce the number of acquisitions with IPRD or the purchase price allocated to IPRD, but our results vary by industry. We provide some evidence that the frequency of acquisitions with IPRD decreased for two of the four in-dustry groups and IPRD intensity (IPRD/Assets Acquired) decreased for two industry groups. Our study contributes to research that examines whether mandatory accounting changes affect company economic decisions and research on managing earnings using IPRD.
Keywords: in-proces research and development cost, mandatory accounting changes, earnings management
Corporate Ethics and Auditor Choice – International Evidence
Muhammad Nurul Houqe, Victorian University of Wellington; Tony van Zijl, Victoria University of Wellington; Keitha Dunstan, Bond University Gold Coast, Australia; AKM Wares Karim, Eastern Illinois University and Victoria University of Wellington
This paper examines whether firms’ auditor choice reflects the strength of corporate ethics. Based on a sample of 132,853 firm year observations from forty-six countries around the globe during the period between 1999-2007 and controlling for a number of firm-and country-level factors, we find that firms in countries where “high corporate ethical values” prevail are more likely to hire a Big 4 auditor. We also find that the positive effect of home country corporate ethical values on the likelihood of hiring a high-quality auditor is reinforced by the extent of the firm’s board size. These results establish an indirect link between corporate ethics and financial reporting quality through the firms’ choice of auditor.
JEL Codes: F23, G15, M41
Keywords: Corporate ethics, auditor quality, board size.
Do Risk Management Activities Impact Earnings Volatility?
Christopher T. Edmonds, University of Alabama at Birmingham; Jennifer E. Edmonds, University of Alabama at Birmingham; Ryan D. Leece, University of Alabama at Birmingham; Thomas E. Vermeer, University of Delaware
This study investigates whether changes in the quality of risk management are associated with changes in earnings volatility. Our findings are consistent with firms achieving lower earnings volatility by implementing higher quality risk management systems. These results are robust across profit and loss firms, although the economic impact of risk management quality is more pronounced for loss firms. Our results provide evidence as to how companies accomplish market performance through a quality risk management framework, and offer a reason why companies should allocate resources towards risk oversight. In addition, our results also suggest that recent public policy initiatives to improve risk management practices have tangible rather than superficial benefits to external stakeholders.
Keywords: Risk Management; Earnings Volatility; COSO Guidance.
The JOBS Act Disclosure Exemptions: Some Early Evidence
Aleksandra Zimmerman, Case Western Reserve University
This paper examines early evidence of IPO registrants’ disclosure exemption choices in response to the optional disclosure relief provided by the recently enacted Jumpstart Our Business Startups Act (JOBS Act) of 2012. The JOBS Act provides firms going public classified as “emerging growth companies” (EGCs) with certain accounting and financial reporting and disclosure exemptions not available to other issuers. The study’s results for EGC firms filing prospectuses through August, 2013, indicate that for the earliest companies affected by the JOBS Act, greater board independence and audit committee accounting expertise are associated with greater likelihood of foregoing financial reporting exemptions. Moreover, the study finds that scaled executive compensation disclosure exemptions had widespread acceptance while the private company accounting standards and reduced audited financial statements exemption provisions were initially less utilized. Finally, the study finds that even though the JOBS Act raised the threshold for disclosure relief up to $1 billion in revenues, those firms that already classified as smaller reporting companies, who already have less extensive disclosure demands under SRC Rule #33-8876, were those most likely to initially take these exemptions. The paper discusses the practical implications of the study’s findings for accounting standard-setters, watchdogs, and policy makers.
Keywords: JOBS Act, voluntary disclosure, corporate governance, initial public offering, accounting regulation.
Compliance costs and disclosure requirement mandate: Some Evidence
Kathy Fogel, Zinoplex, Inc.; Rwan El-Khatib, Zayed University, Dubai, UA; Nancy Chun Feng, Suffolk University; Ciara Torres-Spelliscy, Stetson University
This note contributes to the discussion on the compliance costs of disclosure requirements for publicly traded companies. Prior research tends to focus on audit cost increases when disclosure requirements are stricter. We add some evidence from the point of views of shareholders. Particularly, we contrast stock market reaction to the 2002 Sarbanes-Oxley (SOX) Act which significantly enhanced public company disclosure requirements, with the 2012 Jumpstart Our Business Startups (JOBS) Act which alleviated disclosure requirements for small firms. Contrary to popular belief that more disclosure rules impose regulatory burdens on firms and are costly to implement, we find that the stock market reacted positively toward rules that require more disclosure; whereas, it reacted negatively toward rules that require less disclosure, even though those disclosure rules were initially designed to reduce the costs of compliance.
Keywords: Sarbanes-Oxley Act; Jumpstart Our Business Startups Act; Disclosure rules; Costs of compliance; Market reactions
FASB and Private Company Financial Reporting: a Story of Institutional Change
Judith H, O’Dell
This presentation reviews the history of the Financial Accounting Standard Board (FASB) and the biases it has developed in its history. As certain thought patterns developed while being the standard setting body for public companies, there were thus numerous challenges to overcome as the FASB changed course and began focusing on private companies. Three factors were reviewed including the fact that the Securities and Exchange Commission (SEC) designated the FASB as the standard setter for public companies and the American Institute of CPAs (AICPA) recognized their standards as authoritative for private companies and non-profits. The Financial Accounting Foundation oversees FASB by appointing board members and setting the budget but not the agenda. It also evident that standard setting is not done in a vacuum, but rather world events and political pressures influence the agenda. The presentation summarizes the developments that have occurred to allow the organization to change its course toward private standard-setting, outlining the Private Company Council’s (PCC) role in the changes. The first PCC meeting was held in December 2012, and since then, the PCC has worked to issue four ASUs addressing various private company issues. The Financial Accounting Foundation developed a Private Company Review Committee, who will convene in 2015 to review the operation of the PCC. While some of the issues of GAAP for private companies have already been addressed, the PCC is also working on ideas to improve accounting for share-based payments and uncertain tax positions.
Keywords: Financial Accounting Foundation, Financial Accounting Standard Board, Private Company Council,
The Reckoning: Financial Accountability and the Making and Breaking of Nations by Jacob Soll, 2014, (276 pp.) New York: Basic Books, $29.
ISBN13:978-0-465-03152-8
Stephen P. Walker, University of Edinburgh
This review describes how Jacob Soll’s The Reckoning has the potential to illustrate the importance of the role of accounting while also inspiring the discipline. This book describes the role of accounting in cultural and political formations while identifying “cycles of destruction” where accounting was not present or was practiced deficiently. Strong and stable governments were reviewed in which accounting and financial accountability were practiced sufficiently and were a key ingredient in the foundation of policy. It is shown that effective accounting practices are fundamental to achieving success in nation building. A transparent and accountabile government is key to avoiding the cycle of destruction. The recent financial crisis was reviewed and illustrated to show the limited extent to which financial shortcomings have simulated rethinking of the importance of financial accountability. The conclusion of the book states that accounting is failing and unable to keep pace with vast technological changes. To flourish as a society, accounting and accountability must be “culturally and socially embedded”. The publicity surrounding this book suggests numerous challenges for the profession including an overall minimal understanding of the history of accounting, which must be an issue that is addressed.
Keywords: financial crisis, financial accountability, governmental accountability, historian, state building