Accounting Policy Choice Research Articles

Achieving International Harmonisation through Accounting Policy Choice

The impact of international harmonisation pressures on accounting policy choice is investigated in this study by examining the extent to which firms make policy choices that align with US GAAP or use International Accounting Standards (IAS) options that are not acceptable under US GAAP. Five policy areas (tangible assets, available-for-sale marketable securities, identifiable intangible assets, research and development expenditure and goodwill amortisation period) are considered. The firms are domiciled in the United Kingdom, France, Germany, Japan and Australia. In a composite measure of alignment, and in individual policies, there is more use of US GAAP-consistent policies, and little use of options allowed under IAS. US GAAP alignment is greatest among firms domiciled in Germany, France and Japan. There is some use of IAS options in the United Kingdom, and most use in Australia. Foreign listing and leverage are significant factors for policy choice. Foreign firms traded in the United States (US) are more likely to align with US GAAP than other firms. The listing effect is observed in the regulated and less-regulated US markets, indicating voluntary alignment of policy choices with US GAAP and demonstrating that the US regulator's requirements influence not only the use of non-national standards and the provision of additional information, but also the choices made within a firm's accounting policies.

The financial numbers game: detecting creative accounting practices

1 Financial Numbers Game. Rewards of the Game. Classifying Creative Accounting Practices. Plan of This Book. Summary. Glossary. Notes. 2 How the Game Is Played. Accounting Policy Choice and Application. Fraudulent Financial Reporting. Cleaning Up after the Game. Clarifying Terminology. Summary. Glossary. Notes. 3 Earnings Management: A Closer Look. What Is Earnings Management? Incentives and Conditions for Earnings Management. Earnings Management Techniques. Evidence of Earnings Management. Effectiveness of Earnings Management. Is Earnings Management Good or Bad? Summary. Glossary. Notes. 4 The SEC Responds. The Chairman's Speech. The Action Plan. Subsequent Developments. Enforcing the Securities Laws. Summary. Glossary. Notes. 5 Financial Professionals Speak Out. Survey of Financial Professionals. Survey Results. Summary. Glossary. Notes. 6 Recognizing Premature or Fictitious Revenue. Is It Premature or Fictitious Revenue? When Should Revenue Be Recognized? Detecting Premature or Fictitious Revenue. Checklist to Detect Premature or Fictitious Revenue. Summary. Glossary. Notes. 7 Aggressive Capitalization and Extended Amortization Policies. Cost Capitalization. Detecting Aggressive Cost Capitalization Policies. Amortizing Capitalized Costs. Detecting Extended Amortization Periods. Checklist to Detect Aggressive Capitalization and Extended Amortization Policies. Summary. Glossary. Notes. 8 Misreported Assets and Liabilities. Link with Reported Earnings. Boosting Shareholders' Equity. Overvalued Assets. Undervalued Liabilities. Checklist to Detect Misreported Assets and Liabilities. Summary. Glossary. Notes. 9 Getting Creative with the Income Statement: Classification and Disclosure. Current Income Statement Requirements and Practices. Reporting Comprehensive Income. Creative Income Statement Classifications. Creativity with Other Aspects of the Income Statement. Summary. Glossary. Notes. 10 Getting Creative with the Income Statement: Pro-Forma Measures of Earnings. Recasting the Bottom Line: Pro-Forma Earnings Measures. Summary. Glossary. Notes. 11 Problems with Cash Flow Reporting. Reporting Cash Flow. Problems with Reported Operating Cash Flow. Using Operating Cash Flow to Detect Creative Accounting Practices. Checklist for Using Operating Cash Flow to Detect Creative Accounting Practices. Summary. Glossary. Notes. Subject Index. Company Index.

Empires of the sky: determinants of global airlines' accounting-policy choices

This study quantifies the current level of diversity observed in airline accounting and examines possible determinants that explain accounting-policy choices by the global airline industry. Airlines' accounting-measurement policy for unrealized foreign-exchange differences and their disclosure of frequent-flyer information remains diverse. Inferential statistics shows that larger airlines tend to take unrealized foreign-exchange differences directly to equity and tend to disclose frequent-flyer accounting policy, while airlines with lower leverage tend to disclose frequent-flyer accounting.

An Empirical Study of Bank Loan Officers’ Functional Fixation on Agricultural Co‐operatives and their Reported Earnings

There has been a long held perception of bias against Australian agricultural co‐operatives in the debt capital market. This perception may be attributable to the possibility that bank loan officers are functionally fixated on the reported earnings of co‐operatives and on an entity type in forming their loan decisions. The independent variable in this study is comprised of the manipulated information content of financial variables which incorporate entity type choice and accounting policy choice, and is measured at four treatment levels of reporting. The dependent variables are comprised of the three loan officer decisions: interest rate above prime, need for extra information, and importance of financial variables. The results obtained do not support the hypothesis of functional fixation on reported earnings and on an entity title.

Economic Recession, Corporate Distress and Income Increasing Accounting Policy Choice

In late 1997 much of the Asian region experienced a major economic downturn. Such economic conditions can give rise to external pressure on corporate managers, so that they react to this pressure by changing accounting policy choice.The present paper is set in a time period in Australian corporate history when there was also a substantial economic downturn. In that context, the present study examines the use of income increasing policy choice by stock exchange listed companies. In particular, we look at whether companies experiencing financial distress are more inclined to use income increasing policy choice than ‘healthy’ companies. Prior research supports the view that managers of ‘financially troubled’ firms try to lift reported income, thereby disclosing more favourable performance measurements and avoiding default of loan agreements and/or enhancing their own wealth.The results show the use of income increasing policy choice does not increase monotonically with the level of financial distress. In particular, we show that firms classified as ‘distressed’ which do not subsequently fail in the short term, show a significant tendency to increase reported income using changes in accounting policy. However, firms which subsequently fail within the short term do not select income increasing techniques more frequently than ‘healthy’ firms.One reason why firms that fail in the short term may not engage in income increasing policy choice is the clear prospect of imminent ex post settling up (including litigation against former directors, auditors and others) which can occur following corporate failure. Such costs are not widely recognized in the tests of accounting policy choice which rely on indicators of financial health such as leverage or interest coverage.

An investigation of goodwill accounting policy choice within a specific knowledge framework

This study, using Singapore data, investigates the relationship between Chief Executive Officers' (“CEOs”) specific knowledge and the accounting method choice on capitalisation of goodwill. International Accounting Standard 22 (1987), applicable in Singapore in 1996, the year of the study, permits a choice between capitalisation with subsequent amortisation and immediate write-off of goodwill to reserves. This study proposes a positive relationship between human capital specificity of CEOs and the recognition of purchased goodwill on the balance sheet. Specific knowledge is unique to firms and is acquired through experience. Given that specialised assets arise from firm-specific circumstances, firm-specific knowledge potentially explains the recognition policies pertaining to specialised assets. Overall, the evidence in this study supports a positive relationship between CEOs' firm-specific knowledge and the capitalisation of goodwill. © City University of Hong Kong.

Incentives Facing Life Insurance Firms to Manage Actuarial Earnings: Evidence from Australia and the UK

The propensity of proprietary life insurance firm managers to voluntarily report supplementary information concerning the present value of actuarially-calculated earnings (earnings expected to emerge from their existing business in the future) is predicted to be related to their desire to provide information to capital market participants about their future profit expectations. By contrast the existence of complex residual claims in mutual firms suggests that equivalent incentives facing managers of mutual firms is expected to be motivated by earnings management behaviour. These predictions are tested on a random sample of 67 Australian and UK proprietary and mutual firms. Even after controlling for other variables posited to affect accounting policy choice, Australian and UK proprietary firms reporting the present value of actuarial earnings tend to have higher future profit expectations. However, results for mutual firms are more equivocal and do not support an earnings management hypothesis. Key words: Actuarial earnings; Present value; Earnings management

Disclosure Interactions: Accounting Policy Choice and Voluntary Disclosure Effects on the Cost of Capital

In this research we consider how disclosure of accounting policy interacts with subsequent choice over voluntary disclosure of a non-financial performance metric. We compare and contrast regimes. In the first, firms are free to choose between a conservative or an aggressive accounting policy before they decide whether to make additional voluntary disclosures. In the other regime, all firms either voluntarily or via mandation use the same accounting policy. We then investigate the cost of capital for firms under the two regimes. We show that communication via voluntary disclosure need not be a simple substitute for communication via accounting policy choice. Key Words: Voluntary disclosure; Accounting policy choice; Cost of capital

The Ethics of Creative Accounting: Some Spanish Evidence

'Creative accounting' involves accountants in making accounting policy choices or manipulating transactions in such a way as to give the impression in the accounts that they prefer. While regarded as unethical by most observers, a defence of creative accounting can be based on the ability of the users of accounts to identify bias in accounting policy choices and make appropriate adjustments. In this paper we take the example of the Barcelona Football Club where the club management made three key accounting policy choices that presented a favourable position, and a supporters' club presented an alternative report choosing three alternative accounting policies that presented an unfavourable position. We presented each of these financial reports to one of two groups of Spanish bank loan offices, with supporting notes making the impact of the accounting policy choices clear. We found that the more favourable set of accounts was significantly more likely to attract a positive response to a loan request. This result undermines the defence for creative accounting, based on the ability of users to identify manipulation.

The ethics of creative accounting some Spanish evidence

Creative accounting involves accountants in making accounting policy choices or manipulating transactions in such a way as to convey a preferred and deliberately chosen impression in the accounts. Although it is regarded as unethical by most observers, a defense of creative accounting can be based on the assumption that users of accounts can identify bias in accounting policy choices and make appropriate adjustments. In this paper we take the example of the Barcelona Football Club where the club management made three key accounting policy choices that resulted in the presentation of a favourable position, and a supporters club presented an alternative report choosing three alternative accounting policies that presented an unfavourable position. We presented each of these financial reports to one of two groups of Spanish bank loan officers: we found that the more favourable set of accounts was significantly more likely to attract a positive response to a loan request. This result undermines the validity of defending creative accounting based on the argument that accounts users can identify manipulation.

Economic Recession, Corporate Distress and Income Increasing Accounting Policy Choice

In late 1997 much of the Asian region experienced a major economic downturn. Such 'hostile' economic conditions can give rise to external pressure on corporate managers. Managers may react to this pressure by changing accounting policy choice. In the context of high external pressure what might the implications be for accounting policy choice? The present paper is set in a time period in Australian corporate history when there was also a substantial economic downturn. In that context, the present study examines the use of income increasing policy choice by stock exchange listed companies. In particular, we look at whether companies experiencing financial distress are more inclined to use income increasing policy choice than healthy companies. Prior research supports the view that managers of financially troubled firms try to lift reported income, thereby disclosing more favourable performance measurements and avoiding default of loan agreements and/or enhancing their own wealth. The results show the use of income increasing policy choice does not increase monotonically with the level of financial distress. In particular, we show that firms classified as distressed which do not subsequently fail in the short term, show a significant tendency to increase reported income using changes in accounting policy. However, firms which subsequently fail within the short term do not select income increasing techniques more frequently than healthy firms. One reason why firms that fail in the short term may not engage in income increasing policy choice is the clear prospect of imminent ex post settling up (including litigation against former directors, auditors and others) which can occur following corporate failure. Such costs are not widely recognized in the tests of accounting policy choice which rely on indicators of financial health such as leverage or interest coverage. Key Words: Economic recession; Corporate failure; Accounting income; Policy change

Structure versus judgement in the audit process: a test of Kinney’s classification

Sullivan suggests that the alternative audit approaches adopted by accounting firms be expressed in terms of “structure” and “judgement”, with a division provided by the degree to which auditor judgement is replaced by structured quantitative algorithms. Cushing and Loebbecke attempt to operationalise this division by examining the guidance provided to practising auditors by their firms. Kinne extends this study by classifying accounting firms as “structured”, “intermediate” or “unstructured” in terms of their audit methodologies. Provides a test of Kinney’s classification by examining the tolerance of accounting firms to accounting policy choices which have an income effect in their clients’ financial statements. Argues that those firms with a structured audit approach will manage audit risk through a greater reliance on mechanistic procedures, resulting in a greater tolerance of income manipulation. The results are confirmatory for the period under study, but evidence is provided to suggest that audit firms have subsequently become less diversified in their approach.

Determinants and Harmonisation of Asia‐Pacific Manufacturing Companies' Measurement Practices

This paper examines accounting harmonisation and determinants explaining accounting measurement policy choice decisions by Asia‐Pacific listed manufacturing companies. Using Thomas' (1991) theoretical framework, four contingent variables (country of reporting, company size, profitability and debt leverage) are examined as possible determinants of firms' accounting choices concerning non‐current asset valuation measurement base, goodwill and depreciation. 130 listed manufacturing companies' annual reports were examined from Australia, Hong Kong, Indonesia, Malaysia, and Singapore. This study involves two phases. The first phase evaluates accounting harmonisation measurement indices in comparison with the extant literature. An important innovation is the operationalisation of Archer et. al. (1995) between‐country and within‐country C indices. Computed comparability indices indicated variations in the level of harmony across the five countries for all three accounting measurement practices. The second phase employed logistic regression to examine possible determinants of accounting policy choice decisions. Such a combined research approach should lead to a better understanding of de facto accounting harmonisation and practices.

Structure versus Judgement in the Audit Process: A Test of Kinney's Classification

Sullivan (1984) suggests that the alternative audit approaches adopted by accounting firms be expressed in terms of 'structure' and 'judgement', with a division provided by the degree to which auditor judgement is replaced by structured quantitative algorithms. Cushing and Loebbecke (1986) attempt to operationalise this division by examining the guidance provided to practising auditors by their firms. Kinney (1986) extends this study by classifying accounting firms as 'structured', 'intermediate' or 'unstructured' in terms of their audit methodologies. This study provides a test of Kinney's classification by examining the tolerance of accounting firms to accounting policy choices which have an income effect in their clients' financial statements. The paper argues that those firms with a structured audit approach will manage audit risk through a greater reliance on mechanistic procedures, resulting in a greater tolerance of income manipulation. The results are confirmatory for the period under study, but evidence is provided to suggest that audit firms have subsequently become less diversified in their approach.

Accounting for Goodwill on the Acquisition of Corporate Subsidiaries

Despite the existence of regulation, Australian firms retain considerable discretion over the amount of goodwill recorded on the acquisition of corporate subsidiaries. The acquisition of a corporate subsidiary is a significant transaction that represents an incremental change to the investment opportunity set of a firm. This isolation of a subset of the firm's investment opportunity set provides a unique opportunity to address the endogeneity problem encountered by other studies that attempt to isolate the incremental importance of ex ante and ex post explanations for accounting policy choice. The findings support the conclusion that the proportion of the purchase price allocated to goodwill is ex ante related to the investment opportunity set of the target company and ex post determined by the firm wide characteristics, leverage and the investment opportunity set of the acquiring company.

International Trade and Accounting Policy Choice: Theory and Canadian Evidence

The accounting policy choice literature has identified many factors which have been shown to be useful in explaining cross-sectional variation in the accounting methods used by public companies. One relationship which has been relatively unexplored in this literature is the potential effect of international trade on accounting choice. This study proposes that international trading activities may create incentives for firms to choose income increasing accounting policies. This proposition was tested by examining the depreciation choices of a sample of Canadian firms. Results suggest that importers were more likely to choose income increasing accounting methods than non-importers, while exporting was not found to be related to this accounting choice. These diverging results may be caused by the declining value of the Canadian dollar (relative to the US dollar), which tends to benefit exporters, but is of detriment to importers.

The economics of Accounting for Growth

This is a study of the accounting policies of the leading UK companies analysed by Terry Smith in Accounting for Growth (1992). Smith's critical survey achieved a certain notoriety at the time both for the content, which catalogued important ambiguities in UK GAAP, and also because the author was a leading investment analyst whose employers attempted to suppress the publication. The events that led to his dismissal were extensively reported in the financial press. In this paper we revisit the original analysis in the context of recent advances in the economics of accounting policy choice. Agency theory variables are used to predict the individual accounting policy choices and combinations of policies in Terry Smith's analysis. In particular, size, gearing, the presence of an industry regulator and industry classification are good predictors of accounting policy choices. Our results are stronger for the whole set of accounting policies than for each individual policy. This is consistent with accounting policy choice being a strategic and comprehensive selection from interactive policies rather than a series of independent decisions.

Competition Among Pressure Groups for Political Influence Over the Determination of Accounting Standards

This paper integrates prior studies of accounting policy choice and lobbying activities by testing the empirical implications of Becker''s (1983) theory of competition among pressure groups for political influence over the determination of accounting standards. The theory is applied to explain the nature and outcome of conflict among pressure groups representing financial intermediaries (suppliers) and pension fund members (users) over the development of conflicting Australian pension accounting rules in 1991-92. Various pension fund financial characteristics and management incentives (including discretionary accounting policy choice and voluntary financial disclosures in pension plan financial reports) are posited to affect the pressure functions of each group. These functions combine to affect a political influence function that determines the rule development process. Consistent with the predicted relationships, it is found that supplier groups exert the most political pressure and secure political influence over the development of rules affecting defined benefit pension plans, whereas no group influences the development of rules affecting defined contribution pension plans.

Still Searching for Excellence? International Accounting and the World's Most Outstanding Companies

This paper measures the effect of accounting policy choices in the context of Davis, Flanders and Star's (DFS) (1991) league table of the world's most outstanding companies. Our study is an investigation of the robustness of the research underlying Kay (1993). The sensitivity of the rankings to the three major conventions that are used in calculating added value are examined: depreciation policy, the estimation of the cost of capital inputs and consistency of international generally accepted accounting principles. The key finding is that the degree of disruption caused by international accounting differences is likely to be the most material. It is equivalent, in this study, to a 60% increase in the cost of capital or an 80% change in the depreciation lives of fixed assets. After adjusting towards consistent international accounting, we now find that four Japanese companies appear in the top ten. Before adjustment there were none.

Accounting Policy Choice: The Relationship Between Corporate Tax Burdens and Company Size

Whilst there have been a number of papers that test the Watts and Zimmerman positive accounting hypotheses in a UK setting, no similar test has been made of the size effect using corporate tax burdens as a proxy for political costs. Using data for 5,998 year‐ends from 1968 to 1993 this paper finds that: during 1968–79 there is evidence of a size effect; in a number of years a negative association between firm size and tax burden exists; and of the five industry categories examined, the ‘mineral extractive’ industry had the highest tax burden throughout the period 1968–1979.