The Impact of Fair Value Accounting on Earnings Quality in Eastern European Countries

Abstract

This research investigates whether the extent to which fair values are used in financial reports is related to the earnings quality measures in Eastern European countries over 2002-2011 periods. It is expected that companies (banks) in Eastern Europe will more often estimate fair values by using valuation techniques (i.e. mark-to-model) than companies (banks) in market developed countries, due to lack of market data. This gives opportunity to managers to manipulate with estimation values and therefore could lead to lower quality of reported earnings. Six earnings quality approximations are examined: persistence, predictability, smoothness, accruals quality, value relevance and conservatism. Furthermore, an aggregate earnings quality measure is formed based on six earnings attributes. Exposure to fair value accounting is measured by income statement approach. First, for both banks and companies in the selected sample, two alternative measures of reported income are compared: net income and comprehensive income, because other comprehensive income consists mainly of fair value adjustments. Second, reported net gains (losses) on assets at fair value through income statement are used to capture the extent to which fair values are used in banks’ income statements. Preliminary empirical findings suggest that both firms and banks with increased exposure to fair value accounting in financial reporting have lower level of aggregate earnings quality.