Foreign Currency Translation Adjustment Research Articles

Subjectivity in fair-value estimates, audit quality, and informativeness of other comprehensive income

This study empirically examines whether difference in audit quality is reflected in the pricing of other comprehensive income (OCI). Specifically, we first investigate whether OCI measures of Big 4 clients are more value-relevant than those of non-Big 4 clients. Considering different degrees of subjective management judgment involved in the OCI reporting process, we then explore whether the differential valuation effect of OCI between Big 4 and non-Big 4 clients is more pronounced for more subjective OCI components (e.g., minimum pension liability and foreign currency-translation adjustment) than a less subjective component (e.g., marketable securities adjustment). We predict that the aggregate OCI of a Big 4 client is more value-relevant than that of a non-Big 4 client. We also hypothesize that the differential valuation effect between Big 4 and non-Big 4 clients can be attributed to the amount of subjective assumption and judgment required in estimating OCI. Consistent with our predictions, we find that aggregate OCI audited by a Big 4 auditor has incremental information content over earnings, compared to OCI audited by a non-Big 4 auditor. More interestingly, our results also show that the differential valuation effect between Big 4 and non-Big 4 clients is stronger for OCI components of a more subjective nature. Our results are robust even after controlling for self-selection bias, the potential effect of the financial crisis, and other related effects.

How Do Malaysian ACE Market Companies Report Comprehensive Income

In Nov 2009, the Malaysian Accounting Standards Board (MASB) released FRS 101, Presentation of Financial Statements, effective for fiscal years beginning on or after 1 January, 2010. This statement established certain standards for reporting and presenting comprehensive income in the general-purpose financial statements. In accordance with the definition provided by FRS 101, total comprehensive income is the change in equity during a period resulting from transactions and other events, other than those changes resulting from transactions with owners in their capacity as owners. Data were collected from 84 non-financial companies of the ACE market listed on the Bursa Malaysia (Malaysian Stock Exchange). The study showed that 82 companies used a first format which combined the statement of net income and comprehensive income (using a single statement of comprehensive income), while only 2 companies used the second format which separated the income statement from the statement of comprehensive income. Only 51 companies reported items that fall under the Other Comprehensive Income (OCI) category. Foreign currency translation adjustment was the most prominent item in the OCI, followed by gains and losses on re-measuring available-for-sale financial assets. Almost half of the companies that reported OCI were negatively affected by the foreign currency translation adjustment. Further, the paper also discusses some ancillary findings pertaining to the presentation of the details of comprehensive income.

The Decision Usefulness of Comprehensive Income Reporting in Canada

In this study, we empirically investigate the decision usefulness of mandatory reporting of comprehensive income in Canada. Drawing upon Ohlson’s (1999) discussion of the attributes of transitory earnings, we used a sample of 324 firms listed on the Toronto Stock Exchange for the study period to test whether OCI and its individual components (namely, unrealized gains and losses on cash flow hedges, unrealized gains and losses on available for sale investments, and foreign currency translation adjustment on foreign subsidiaries) possess forecasting relevance, predictability and value relevance. We found that aggregate OCI and some of its individual components are relevant in forecasting future abnormal earnings. We also found that OCI is predictable, and incrementally value relevant to net income. The results of our study suggest that Ohlson’s description of transitory earnings might not apply to OCI, and that the reporting of comprehensive income in Canada did enhance the decision usefulness of accounting numbers.

Reporting Comprehensive Income: Evidence from Malaysian ACE Market Companies

In Nov 2009, MASB released FRS 101, Presentation of Financial Statements, effective for fiscal years beginning on or after 1 January, 2010. This standard established certain rules for reporting and presenting comprehensive income in the general-purpose financial statements. FRS 101 prescribed two alternative formats for the presentation without mandating any one specific format. FRS 101 also required certain details of comprehensive income to be displayed prominently in the financial statements. The current study examined the presentation of comprehensive income by a sample of companies traded on the ACE market of the Bursa Malaysia (Malaysian Stock Exchange) to determine the predominant method of presentation among these companies, just one year after FRS 101 became effective. Using a sample of 84 non-financial companies an example of each format is provided and the choices of format made by the companies are analyzed. The study showed that 82 (98%) companies used a first format which combined the statement of net income and comprehensive income (using a single statement of comprehensive income), while only 2 (2%) companies used the second format which favored the presentation of comprehensive income in a separate statement. Sixty-three percent of the companies (32 out of 51) were negatively affected by the foreign currency translation adjustment. Further, the paper also discusses some ancillary findings pertaining to the presentation of the details of comprehensive income.

Comprehensive Income Options: A Detriment To Transparency

The Financial Accounting Standards Board (FASB) in 1997 compromised its belief that comprehensive income (CI) should be listed either in a combined statement of net income and CI or in a separate statement of CI and allowed corporations to choose using the statement of changes in stockholders’ equity (SCSE). Of course, the latter option implies just as Jordan and Clark (2002) suggest, that CI is not a measure of financial performance. Studies incorporating professional analysts by Hirst and Hopkins (1998) and a study of nonprofessional investors by Maines and McDaniel (2000) both conclude that format presentation matters and behaviors can be affected. We believe that FASB should revisit the format structure of CI and eliminate the SCSE option, which was their initial intent before they compromised with corporate managers in 1997. In addition, we believe that all items of other comprehensive income (OCI) – foreign currency translation adjustment, pension value adjustments and adjustment to securities-for-sale should be presented on an after-tax basis only in order to prevent investors from being forced to comb through the footnotes.

The relative and incremental explanatory powers of dirty surplus items for debt interest rate

This study investigates the relationship between dirty surplus items on the balance sheet and the cost of debt for Japanese firms. We focus on three dirty surplus items—unrealized gains and losses on available-for-sale securities (SEC), foreign currency translation adjustment (FOC), and land revaluation surplus (LAND). While many previous studies on dirty surplus adopted the value-relevance perspective, we examine the effect of dirty surplus items on the interest rate spread of bonds from the bond market perspective. We use the [Vuong, Q. H. (1989). Likelihood ratio tests for model selection and non-nested hypotheses. Econometrica, 57, 307–333] test to evaluate the relative explanatory power of the equity ratio with and without dirty surplus items for the interest rate spread on bonds issued. We find evidence that the equity ratio with dirty surplus items is more strongly associated with the debt interest rate than that without dirty surplus items. The results suggest that the total amount of dirty surplus items have statistically significant explanatory power for the interest rate spread. However, some dirty surplus items do not have explanatory powers for the bond interest rate spread. While FOC has relative and incremental explanatory powers and SEC has only incremental explanatory power, LAND has neither relative nor incremental explanatory power for the bond interest rate spread. The results mean that FOC and SEC are useful to Japanese bond investors.

Additional Evidence on the Value Relevance of the Foreign Currency Translation Adjustment

Additional Evidence on the Value Relevance of the Foreign Currency Translation Adjustment

An evaluation of SFAS No. 130 comprehensive income disclosures

In this study, we provide evidence on the pricing of other comprehensive income (OCI) that differs from most evidence in prior research. Prior archival research has largely concluded that OCI is not priced by investors. In contrast, we provide evidence in the post-SFAS 130 period that OCI is priced on a dollar-for-dollar basis as is predicted by economic theory for transitory income items. We attribute this finding to our use of post-SFAS 130 as-reported measures of OCI rather than pre-SFAS 130 as-if estimates of OCI measures. Furthermore, we document that two components of OCI, foreign currency translation adjustment and unrealized gains/losses on available-for-sale securities, are priced by investors. In the post-SFAS 130 period, we also find that the type of financial statement in which firms report OCI and its components affects pricing, consistent with the conclusions of prior experimental research. However, our evidence suggests that investors pay greater attention to OCI information reported in the statement of changes in equity, rather than in a statement of financial performance. This could be attributed to investors becoming more familiar in the post-SFAS 130 period with the predominant reporting of OCI and its components in the statement of changes in equity. These findings may be relevant to both the Financial Accounting Standards Board and the International Accounting Standards Board, which jointly are undertaking a new project that, in part, is addressing financial statement presentation of OCI items.

An Evaluation of Sfas No. 130 Comprehensive Income Disclosures

In this study, we provide evidence on the pricing of other comprehensive income (OCI) that differs from most evidence in prior research. Prior archival research has largely concluded that OCI is not priced by investors. In contrast, we provide evidence in the post-SFAS 130 period that OCI is priced on a dollar-for-dollar basis as is predicted by economic theory for transitory income items. We attribute this finding to our use of post-SFAS 130 as-reported measures of OCI rather than pre-SFAS 130 as-if estimates of OCI measures. Furthermore, we document that two components of OCI, foreign currency translation adjustment and unrealized gains/losses on available-for-sale securities, are priced by investors. In the post-SFAS 130 period, we also find that the type of financial statement in which firms report OCI and its components affects pricing, consistent with the conclusions of prior experimental research. However, our evidence suggests that investors pay greater attention to OCI information reported in the statement of changes in equity, rather than in a statement of financial performance. This could be attributed to investors becoming more familiar in the post-SFAS 130 period with the predominant reporting of OCI and its components in the statement of changes in equity. These findings may be relevant to both the Financial Accounting Standards Board and the International Accounting Standards Board, which jointly are undertaking a new project that, in part, is addressing financial statement presentation of OCI items.

The Valuation-Relevance of the Foreign Translation Adjustment: The Impact of Barriers to Entry and Rigidity of Wages

We examine the economic effects of barriers to entry and rigidity of wages signaled by the foreign currency translation adjustment on multinational firms' stock returns. Specifically, based on economic theories an appreciation (depreciation) of the foreign currency exchange rate could signal (a) an increase (decrease) in the foreign country's economic growth leading to potentially higher future cash flows for firms operating in environments with barriers to entry: innovation-intensive companies and asset-intensive companies, and (b) a decrease (increase) in future profits for firms operating in environments with rigidity of wages: labor-intensive companies. Firms that are research and development (R&D) leaders in their industry are our proxy for innovation-intensive companies. Among the R&D followers, firms with large total assets (employees) to sales ratio are classified as asset-intensive (labor-intensive) firms. Innovation- and asset-intensive firms are our proxy for firms likely to be affected by the barriers to entry and labor-intensive firms are our proxy for firms likely to be affected by the rigidity of wages. We find that the foreign currency translation adjustment is positively associated with abnormal stock returns for R&D leaders and asset-intensive, R&D followers. We also find that the foreign currency translation adjustment is negatively associated with abnormal stock returns for labor-intensive, R&D followers. This shows the importance of assessing the valuation-relevance of the foreign currency translation adjustment by considering the economic contexts of foreign currency fluctuations. Overall, the evidence shows that the accounting rules governing foreign currency translations in general produce results consistent with the economic effects of foreign exchange rate changes.

Usefulness of Comprehensive Income Reporting in Canada

In March 2003, the Canadian Accounting Standard Board (AcSB) issued an Exposure Draft (ED) proposing a new Handbook Section 1530, COMPREHENSIVE INCOME(along with two other related new standards on FINANCIAL INSTRUMENTS-RECOGNITION AND MEASUREMENT, and HEDGES). These proposed standards are partly motivated partially by the need to recognize the change in the fair value of certain financial instruments as other comprehensive income and partially to harmonize the accounting standards between the US and Canada. The objective of this paper is to examine the incremental information content of the components of the other comprehensive income over net income and the relative predictive power of comprehensive income vis-a-vis net income, using a sample of crosslisted Canadian firms in the period of 1998 to 2003 (listed in the U.S.), which already report other comprehensive items in accordance with SFAS 130. Since the exposure draft on comprehensive income issued by the AcSB states that it aims to harmonize the accounting standards between the US and Canada, we expand our sample to include the entire sample of US firms to investigate the usefulness of disclosing components of other comprehensive income in the post-adoption periods of the SFAS130 (1998 - 2003) and compare it with the pre adoption period (1994-1997), using the COMPUSTAT database. In addition, we re-examine the association between market returns and the components of other comprehensive income for a sub-sample of firms obtained from the Mergent Online database, to examine the change in the fair value of cash flow hedges for the period from 1999 to 2003. In contrast to the results documented by Dhaliwal et al. (1999) of no significant association between the components other comprehensive income and stock returns, we provide evidence that each of the components of other comprehensive income are associated with market returns. This association is stronger for the post-adoption period of SFAS 130 than for the pre-adoption period. The results also hold for non-financial institutions. We observe, however, that net income is a better predictor of future net income/comprehensive income/cash flows from operations than comprehensive income. The results for the reduced sample using the Mergent database with cash flow hedges indicate that the market reacts positively for firms' cash flow hedges. These results also hold (except for foreign currency translation adjustment) for a sub-sample of Canadian cross-listed firms. Overall, our findings suggest that requiring Canadian firms to disclose other comprehensive income components is likely to improve the usefulness of accounting information. These findings, therefore, are of interest to the accounting standard setters in Canada.

Employee Incentive Stock Options: To Be Expensed or Not to Be, that Is Not the Question

Many companies have granted large numbers of employee incentive stock options, and there is intense debate as to how they should be reported on financial statements. According to the mission statements of the regulatory organizations responsible for financial statements, the primary purpose of financial reporting is to help investors evaluate a company so that capital can be efficiently allocated. I show that to accomplish this purpose, investors need financial statements that: (1) report the estimated aggregate value of all outstanding stock options as a balance sheet line-item separate from common equity accounts, similar to the way preferred stock is reported; (2) update the estimated aggregate value of the stock options (i.e., mark to market the stock options) each reporting period; and (3) reduce stockholders' common equity by the amount that the value of outstanding options increases during the reporting period (or increase stockholders' equity by the amount that the stock options' aggregate value decreases). This change in stockholders' equity could be accomplished either indirectly (via an expense on the income statement that flows through to retained earnings) or directly (without affecting reported net income, in the same way that an unrealized change in value due to a foreign currency translation adjustment is reported). Although either method is satisfactory for purposes of valuation, reporting ISO grants as an operating expense on the income statement actually complicates the analysis for investors, since they must undo this non-cash charge when estimating cash flows. Thus, investors do not need option grants to be reported as an expense, if the estimated aggregate value of option grants is reported as a separate balance sheet line-item and is updated each reporting period.

Building an Awareness of Unrealized Capital Accounts in Stockholders' Equity

Abstract Accounting faculty and students are familiar with the accounts included in a simple stockholders' equity section of a balance sheet. However, in recent years there has been a substantial increase in the number of corporations reporting additional equity accounts that are not as readily recognized or understood. This article explains six of these accounts: cumulative foreign currency translation adjustment, unearned compensation, guaranteed employee stock ownership plan (ESOP) obligations, net unrealized holding gain or loss on available-for-sale securities, stockholders' notes receivable, and unrealized pension cost. An illustration of how these accounts may appear on the balance sheet is provided.

Inflation, Translation and Conflicts in Statements of Financial Accounting Standards*

AbstractThis paper utilizes the concept of aggregative consistency defined in Rubinstein and Fishburn [1986], and the FASB's concept of representational faithfulness to evaluate foreign currency translation and accounting for changing prices as embodied in SFAS 70. The paper shows that SFAS 70 produces measurement errors and creates a foreign currency translation adjustment which does not reflect the effects of exchange rate changes. The conditions defined in the paper also facilitate an evaluation of the relative merits of restate/translate and translate/restate. Restate/translate can conceivably be used if there is no consolidation. In the more usual case where consolidation is required, translate/restate using the relevant shareholders' consumption index will yield aggregatively consistent values under fewer restrictive conditions.