Fundamental Accounting Research Articles

A Comparative International Analysis of the Impact of Accounting Standards on Fundamental Accounting Variables: the USA versus Latin America

Al emplear un modelo Logit de elección múltiple ordenado y modelos de ecuaciones estructurales, se encuentra una clara relación entre educación y pobreza; los estructurales revelan la retroalimentación entre ambas variables. Producto de esta última observación, se plantea que aunque la inversión en capital humano mediante la educación es un factor clave para mejorar el ingreso de las personas, ésta por sí sola no es suficiente para alterar el cambio de condición de pobre a no pobre, pues dado que se requiere un ambiente macroeconómico favorable en el cual individuos pobres educados en el mercado de trabajo incrementen su flujo de ingresos.

Introducing The Accounting Equation With M&Ms

On the first day of Principles of Accounting classes, students learn the fundamental accounting equation from which all financial accounting practice emerge. The accounting equation is the criterion by which companies are valued and by which company performance is measured. This activity simplifies assets, liabilities, and owners equity to the representation of M&Ms in order to focus on overall patterns of company structure and provides further illustration using real public U.S. companies assets, liabilities, and owners equity.

Fair Depreciation: A Shapley Value Approach

We adopt the Shapley value approach to examine the fair allocation of the depreciation charges among the time periods of the asset's useful life. Essentially, the allocation under the Shapley value solution rewards each time period of the asset's useful life with a share of the earnings that corresponds to its "responsibility" in the earnings-generating process. The latter is thus consistent with the developments in accounting standards, which maintain that the depreciation and amortization methods should reflect the pattern in which the asset's economic benefits are consumed by the enterprise. We show that the Shapley solution always conforms to a set of fundamental accounting requirements such as the matching principle and the impairment test. Moreover, unless the asset is associated with constant revenues and/or extremely profitable investments, the Shapley value solution can never coincide with the prevalent straight-line depreciation method. Finally, we identify the family of earnings patterns for which the Shapley solution coincides with the equal surplus and the economic depreciation methods.

Neural network earnings per share forecasting models: A comparison of backward propagation and the genetic algorithm

Zhang, Cao, and Schniederjans [W. Zhang, Q. Cao, M. Schniederjans, Neural Network Earnings Per Share Forecasting Models: A Comparative Analysis of Alternative Methods. Decision Sciences 35(2) (2004), 205–237, hereafter ZCS] examined the relative ability of neural network models to forecast earnings per share. Their results indicate that the univariate NN model significantly outperformed four alternative univariate models examined in prior research. The authors also found that a neural network forecasting model incorporating fundamental accounting signals outperformed two variations of the multivariate forecasting model examined by Abarbanell and Bushee [J.S. Abarbanell, B.J. Bushee, Fundamental Analysis, Future EPS, and Stock Prices. Journal of Accounting Research 35(1) (1997), 1–24]. To estimate the neural network weights of their neural network models, ZCS used backward propagation (BP). In this paper we compare the forecasting accuracy of neural network weights estimated with BP to ones derived from an alternative estimation procedure, the genetic algorithm [R.S. Sexton, R.E. Dorsey, N.A. Sikander, Simultaneous Optimization of Neural Network Function and Architecture Algorithm. Decision Support Systems 36(3) (2004), 283–296]. We find that the genetic algorithm produces models that are significantly more accurate than the models examined by ZCS.

Juggling the books: the use of accounting information in circus in Australia

This article outlines the role of accounting information in circus in Australia in the approximate period 1847—1963. Responding to the call for an increased historical narrative in accounting, we have studied the literature, documentation and personal memoirs concerning circus in Australia. From our examination, we have abstracted and analysed material that expresses, or implies, the use of accounting information. Themes identified include the magnitude and nature of capital investments; ticket pricing and revenues; the nature and composition of operational costs; standards of internal control; insolvencies and liquidations. We have established that, despite elementary levels of education, many circus people exhibited an intuitive grasp of fundamental accounting principles, albeit in a rudimentary form. Nevertheless, since financial and management reporting practises were typically unsystematic, and even non-existent, in all but the largest circus enterprises, Australian circus management may not have been optimized.

UMA INVESTIGAÇÃO SOBRE O NÍVEL DE CONHECIMENTO E OBSERVÂNCIA DA APLICAÇÃO DOS PRINCÍPIOS FUNDAMENTAIS DE CONTABILIDADE EM ESCRITÓRIOS DE CONTABILIDADE

Accountancy as applied social science has an extremely important function in the world of business, since it is expected for it to produce information that can subsidize its users when taking decisions with the less possible risk. In view of this, this research aims at verifying if the theories related to Fundamental Accounting Principles – FAP -, the foundation of Accountancy, are being applied correctly in Accounting firms in the city of Cacoal, State of Rondonia, by aiming at knowing the level of accountants’ knowledge regarding the FAP and the appearance of fines and penalties of fiscal, tax or ethical character that arise as a result of their practice, in addition to the scientific learning and the profile of professionals responsible concerning the schooling degree and the search of sustained education, as well as still trying to know how such conduct may interfere in the quality of information rendered to its users. From the methodological point of view, the research is characterized for being bibliographical and performed in the field, as well as having an exploratory, descriptive and explanative character with the application of the deductive method and semi-structured collection instrument, and the non-intentional, probabilistic technique. It was possible to conclude that Accounting professionals in the city of Cacoal have sought new knowledge within the accounting and similar areas by using the results as a base, and also stimulating their employees in this sense by believing they can minimize failures and improve customers’ satisfaction concerning produced information in this way. As for the FAPs, they demonstrated reasonable knowledge, and there is a low incidence of penalties in their regard that does not exempt the need for deeper studies.

Accounting Issues: An Essay Series Part VI - Investments In Securities

This series is designed to restore to the introductory accounting course the theoretical structure now missing from most principles texts. Laux 2007(a) offers the justification, and thus far the series has addressed the other major assets—cash, accounts receivable, inventory, property, and intangible assets. "The Conceptual Framework at a Glance" section of the 2007 work uses the hierarchy of accounting characteristics (displayed on the following page) along with a mountain-hiking analogy to describe some of the daily accounting dilemmas encountered at the base of the mountain, potential measurement and classification issues associated with the adjusting process in the foothills of the journey, and the goal to be reached at the mountain top—reflecting economic reality, thereby making the information useful for decision makers. To that end, the current article briefly reviews the fundamental accounting rules for investments in marketable securities, followed by a section outlining the conceptual framework connections and measurement issues. Finally, the last section introduces some real-world examples of companies that have struggled with securities-related reporting. The section also looks at some of the literature devoted to investments, both conceptual and empirical.

Fair Depreciation: A Shapley Value Approach

We adopt the Shapley value approach to examine the fair allocation of the depreciation and amortization charges among the time periods of the asset's useful life. Essentially, the allocation under the Shapley value solution rewards each time period of the asset's useful life with a share of the earnings that corresponds to its responsibility in the earnings-generating process. The latter is thus consistent with the recent developments in accounting standards, which maintain that the depreciation and amortization methods should reflect the pattern in which the asset's economic benefits are consumed by the enterprise. Interestingly, we show that the Shapley value solution always conforms to a set of fundamental accounting requirements such as the matching principle and the impairment test. Moreover, we show that, unless the asset is associated with constant revenues and/or extremely profitable investments, the Shapley value solution can never coincide with the prevalent straight-line depreciation method. Finally, we identify the family of earnings patterns for which the Shapley value solution coincides with the equal surplus and the economic depreciation methods. Depreciation and amortization in this study apply to all types of assets (tangible and intangible); however, they are particularly significant for costly investments such as real estate, machinery, and customer relations.

Extracting Forward-Looking Information from Security Prices: A New Approach

ABSTRACT: This paper proposes a new index to extract forward-looking information from security prices and infer market participants’ expectations of future earnings. The index, called market-adapted earnings (MAE), utilizes stock returns and fundamental accounting signals to estimate market expectations of future earnings at the firm level. MAE outperforms time-series models (e.g., random-walk) in predicting future earnings. Results demonstrate the usefulness of MAE for firms that have no analyst following.

GAAP's Gap Part II: Accounting for Equity Transactions (Open Letter Re: FASB Preliminary Views 1550-100)

The Financial Accounting Standards Board (FASB) has long recognized shortcomings in fundamental accounting principles that are exacerbated by the proliferation of increasingly complex financial instruments. The FASB has been engaged since 1986 in a project to align financial reporting with economic substance and improve consistency. The FASB recently issued its Preliminary Views. Key points are: - After a 22 year effort, the result should be good. It is not. - A carve out is provided to allow separate consideration at a future date for the treatment of compensation options. Until then, option compensation accounting (SFAS 123R), though flawed, is exempted. Hot potato! The FASB Preliminary Views lists two fundamental premises of accounting that contribute to engineered earnings and inconsistent reporting: 1) The definition of equity, and 2) The exclusion of equity items from the income statement. The FASB's proposed solution is to redefine equity and deals with only the first premise while ignoring the second. If adopted, the result will be a tedious, case by case dispute on whether an instrument qualifies to be treated as equity, and a crop of new securities will surely arise to skirt the revised rules. Meanwhile, a simple, comprehensive opportunity (the claims approach, part of a 1990 FASB Discussion Memorandum) to modernize accounting by marking equity to market within the income statement has been scrapped.

Assessing the risk relevance of accounting variables in diverse economic conditions

PurposeThis paper aims to examine the contemporary association between accounting information and a number of measures of systematic (beta) risk that incorporate dynamic market features. The goal is to determine the fundamental accounting drivers of beta and to assess whether their explanatory variable power has changed or declined over time.Design/methodology/approachBeta estimates are calculated using adjustments for thin‐trading, central tendency, leverage, and time variance. Accounting risk variables are derived from theoretical foundations and prior empirical research, and classified as operating, financial or growth.FindingsResults show a strong association between accounting variables (operating and growth) and systematic risk that is consistent over time, but with some industry and size differences and possible country effects. Accounting variables are able to capture dynamic risk shifts and generally are able to outperform naïve M‐GARCH and industry betas in predicting next year's systematic risk.Practical implicationsInternal management and external decision making enable the development of more efficient ex‐post risk measures, isolating actual risk determinants rather than just determining the level of risk, overcoming the problem that conventional ex‐post measures cannot be used for non‐listed entities, initial public offering firms, or those that do not have sufficient trading history, reduces the noise found in traditional risk estimates that rely on historical security returns, and the development of trading and valuation strategies.Originality/valueThis is the first paper that assesses the association between a range of dynamic risk measures and accounting variables and tests whether this long‐run association has changed over time.

Using Top Ten Lists to Encourage Faith Integration Discussion in Economics Courses

This paper both documents and assesses the use of a role play simulation exercise that can easily be incorporated into the first week of the first course in accounting. The exercise actively involves students by having them assume roles and simulate transactions to start a business. In addition, the students also perform a record-keeping role. Both the medium of exchange and record-keeping are accomplished by using white, red and blue poker chips. A primary focus of the exercise is to learn how transactions affect the fundamental accounting equation (assets=liabilities+owners’ equity). In addition, several other fundamental accounting concepts are introduced. To assess if the exercise enhances student learning, other sections of the same accounting course learned identical subject matter with a lecture format. An assessment instrument was administered to both student groups. The results indicate that role play simulation enhances students’ transfer problem solving, but there is no evidence that it enhances conceptual recall beyond that which can be attained via a traditional lecture. In addition, there is evidence that the role play simulation exercise helps student better retain problem solving learning over a four week period.

Falsifications et manipulations comptables. La mesure du profit, un enjeu social (1856-1914)

Résumé Durant le xix e siècle, le développement des sociétés par actions et l’essor du marché financier confèrent à la comptabilité une dimension nouvelle. Seule garantie offerte aux tiers, le capital d’une société anonyme doit demeurer intact, sauf à devoir la dissoudre, et c’est à la comptabilité qu’il revient de fournir une mesure du résultat qui garantisse ce maintien. En outre, dès lors que les informations qu’elle produit sont susceptibles d’orienter les capitaux, la technique sort du champ étroit de l’entreprise et le contrôle de la mesure du profit devient un enjeu social majeur. D’autant, que faute de fondements scientifiques sérieux et en l’absence de toute réglementation spécifique ou presque, cette mesure est souvent l’objet de manipulations, voire de falsifications, dont les épargnants sont les premières victimes. Qu’il s’agisse de cas de surestimation des résultats ou, à l’opposé, de dissimulation de bénéfices. Si, face aux scandales et les réactions des intéressés, l’opinion s’en émeut parfois et si la réflexion sur la problématique de l’évaluation progresse durant le dernier quart du xix e siècle, l’État et le Parlement restent sourds à toutes les propositions de réglementation. Les milieux d’affaires y sont hostiles et c’est donc aux tribunaux qu’il revient de dire le droit en la matière ; confrontée à ces pratiques comptables, la jurisprudence précise quelques concepts fondamentaux. Ce n’est qu’après avoir pris lui-même place parmi les ayants droit aux bénéfices, après l’instauration de l’imposition des bénéfices durant le premier conflit mondial, que l’État s’est décidé à intervenir.

Value Relevance of Accounting Information and The Pricing of Indonesian Initial Public Offerings

The purpose of this study is to examine the relation between accounting measures of total firm risk and the value of firms making initial public offerings (IPOs). The existing explanations of the pricing of IPOs suggest that the value of IPOs is related to a number of fundamental accounting variables of the firms. A sample of 149 Indonesian IPO firms that went public during the period 1989-1997 is examined and is used to test the null hypothesis that the IPO’s price is not related to firm specific accounting risk measures. The results provide evidence that the IPOs’ accounting information is value relevant to the market price of the IPO. Earnings Per Share (EPS), Book Value of Equity (BVE), and financial leverage are significantly related to the level of offering price. The study concludes that the IPOs’ accounting information is value relevant about the offer and market prices of the IPO, which is in support to that of Kim et al. (1995) and Klein (1996).

Neural Network Earnings per Share Forecasting Models: A Comparative Analysis of Alternative Methods

ABSTRACTIn this paper, we present a comparative analysis of the forecasting accuracy of univariate and multivariate linear models that incorporate fundamental accounting variables (i.e., inventory, accounts receivable, and so on) with the forecast accuracy of neural network models. Unique to this study is the focus of our comparison on the multivariate models to examine whether the neural network models incorporating the fundamental accounting variables can generate more accurate forecasts of future earnings than the models assuming a linear combination of these same variables. We investigate four types of models: univariate‐linear, multivariate‐linear, univariate‐neural network, and multivariate‐neural network using a sample of 283 firms spanning 41 industries. This study shows that the application of the neural network approach incorporating fundamental accounting variables results in forecasts that are more accurate than linear forecasting models. The results also reveal limitations of the forecasting capacity of investors in the security market when compared to neural network models.

The Good and the Bad of Value Investing: Applying a Bayesian Approach to Develop Enhancement Models

Value investing was first identified by Graham and Dodd in the mid-30's as an effective approach to investing. Under this approach stocks are rated as being cheap or expensive largely based on some valuation multiple such as the stock's price-to-earnings or book-to-market ratio. Numerous studies have found that value investing does perform well across most equity markets but it is also true that over most reasonable time horizons, the majority of value stocks underperform the market. The reason for this is that the poor valuation ratios for many companies are reflective of poor fundamentals that are only worsening. The typical value measures do not provide any insights into those stocks whose performance is likely to mean-revert and those that will continue along their recent downhill path. The hypothesis in this paper is that the value stocks most likely to mean-revert are those that are financially sound. Further, it is proposed that we should be able to gain some insights into the financial strength of the value companies using fundamental accounting data. We apply a Bayesian model averaging approach to a set of fundamental accounting variables to forecast, the probability of each value stock outperforming the market. These probability estimates are then used as the basis for enhancing a value portfolio that has been formed using some valuation multiple. The positive note from our study of the US, UK and Australian equity markets is that it appears that fundamental accounting data can be used to enhance the performance of a value investment strategy. The bad news is that the sources of accounting data that play the greatest role in providing such insights would seem to vary both across time and across markets.

The “Incomplete Revelation Hypothesis” and Financial Reporting

INTRODUCTION The most common form of the Efficient Markets (EMH) states that market prices fully reflect all publicly available information (Fama 1970). The EMH has been highly influential among academics, but practitioners and regulators appear unconvinced. Investors work hard to identify mispriced stocks on the basis of public data, or pay others to do so, even though the EMH asserts that such efforts are wasted. Managers seek to boost stock prices by hiding bad news in footnotes, and regulators work hard to defeat such efforts, even though the EMH asserts that information is reflected in prices no matter how obscure its presentation. Beliefs about inefficiency play a central role in the debate over recognizing expenses for incentive stock options. Opponents of expensing argue that the resulting lower net income will inappropriately reduce market prices, while proponents argue the market does not fully recognize compensation costs reported only in footnotes. In efficient markets, however, expensing these costs has no direct effect on prices, as long as the details of the compensation are included in footnotes. The decision to expense option costs could reduce stock price indirectly, even in efficient markets, by affecting the terms of contracts between the reporting firm and other parties (Watts and Zimmerman 1986). However, few of the parties to the debate appear concerned about these effects. The academic community is showing increasing dissatisfaction with the EMH, swayed partly by evidence that prices underreact to large earnings changes, ratios of prices to fundamentals, and other statistics derived from fundamental accounting analyses. However, the EMH is still influential because there is no alternative theory that explains why we observe the inefficiencies we do. For example, why should the market underreact to large earnings changes, rather than overreact? Without a theory predicting how and why markets are inefficient, studies showing mispricing can be viewed as statistical flukes resulting from fishing expeditions (Fama 1998; Kothari 2001). In this paper, I present an alternative to the EMH called the Incomplete Revelation Hypothesis (IRH). The IRH asserts that statistics that are more costly to extract from public data are less completely revealed in market prices. The IRH can account for many of the phenomena that are central to financial reporting but inconsistent with the EMH. It predicts that investors devote substantial resources to identifying mispriced stocks on the basis of public data, that managers seek to boost stock prices by hiding bad news in footnotes, and that regulators may wish to defeat such efforts, because information that is hard to extract from financial statements will not be reflected in stock prices. The IRH also provides a number of novel and testable predictions that distinguish it from the EMH. THE INCOMPLETE REVELATION HYPOTHESIS The IRH is based on equilibrium outcomes in rational expectations models. (1) In these models, rational agents choose whether to collect information about the value of an asset. Those who choose to collect the information then trade the asset in a market that also includes traders. Noise traders are so named because they trade randomly, in response to liquidity shocks, portfolio rebalancing needs, or even irrational whims. This noise keeps prices in the market from revealing information completely, because traders who observe only price cannot tell whether prices are high because informed traders have good news, or because noise traders happen to be buying heavily. This uncertainty allows the informed traders to profit from their information advantage. A key result of noisy rational expectation models is that there is an equilibrium in which just enough traders collect information to make their trading gains equal to their collection costs. …

The designing of corporate accounting law in Japan after the Second World War

After the Second World War, during the neutralization of the controlled economy of wartime Japan, a design for a Corporate Accounting Law was elaborated by the Investigation Committee on the Business Accounting System. The Investigation Committee tried to establish not only new business accounting standards but also a central and independent administrative organ of corporate accounting regulation on the basis of the Corporate Accounting Law. The Corporate Accounting Law was expected to lay the legal foundation of the new corporate accounting regulation regime in Japan. Nevertheless, even though the original design of the fundamental accounting law was never realized, it should be considered the starting point for our understanding of external accounting history in post-war Japan.

The designing of corporate accounting law in Japan after the Second World War

After the Second World War, during the neutralization of the controlled economy of wartime Japan, a design for a Corporate Accounting Law was elaborated by the Investigation Committee on the Business Accounting System. The Investigation Committee tried to establish not only new business accounting standards but also a central and independent administrative organ of corporate accounting regulation on the basis of the Corporate Accounting Law. The Corporate Accounting Law was expected to lay the legal foundation of the new corporate accounting regulation regime in Japan. Nevertheless, even though the original design of the fundamental accounting law was never realized, it should be considered the starting point for our understanding of external accounting history in post-war Japan.

The Contribution of Fundamental Analysis in the Presence of Inflation and a Currency Devaluation

The primary purpose of this paper is to investigate the value relevance of fundamental analysis under the types of economic conditions that commonly occur in developing countries. By considering changes in key components of operating performance (e.g., changes in gross margin or changes in expenses relative to sales), fundamental analysis has the potential to capture more completely the value relevance of accounting information. Despite this potential, the literature on the value relevance of fundamental analysis is very limited in comparison to the vast literature investigating the value relevance of the two key summary measures provided in financial statements: earnings and book value. Furthermore, little is known about the advantage, if any, of fundamental analysis over summary measures in economic settings that are significantly different from that of the United States. This paper uses Mexico as a setting in which to explore further the value relevance of fundamental analysis. Mexico differs from the U.S. in two important respects that may influence the incremental value of fundamental analysis: First, during the 1990s, Mexican businesses had to cope with a rapidly changing business climate. Second, Mexican companies have reported replacement-cost, price-level-adjusted (RCPLA) information in the primary financial statements since 1984. Under RCPLA accounting, all balances reported on the financial statements, including the prior year amounts, are rolled forward into purchasing power at the end of the most recent period. We find that fundamental analysis has incremental value relevance in comparison to earnings. Of particular interest, fundamental signals based on line-item components of the 1994 financial statements, but not earnings, provided value relevant information about the effects of the December 1994 devaluation on the market's expectation about changes in future cash flows. This study makes a direct contribution to understanding the value relevance of fundamental analysis and accounting for changing prices. In addition, the study adds to a recent literature investigating the interaction between economic change and the value relevance of financial statement information.