GAAP Accounting Research Articles

Non-GAAP Earnings and Definite-Lived Intangible Asset Allocations in Mergers and Acquisitions

ABSTRACT We test whether firms that exclude the effects of amortization from non-GAAP earnings allocate more of an acquisition’s purchase price to definite-lived intangible assets (DLIA). This strategy can yield two potential benefits: it can (1) increase non-GAAP earnings by shifting depreciation of tangible assets, which is often included in non-GAAP earnings, to amortization of DLIA, which non-GAAP earnings exclude, and (2) decrease the likelihood of future impairments by shifting allocations from goodwill to DLIA. Consistent with expectations, we find that non-GAAP-reporting firms that exclude amortization from non-GAAP earnings allocate more of the purchase price to DLIA. We also find that these firms allocate less of the purchase price to depreciable assets and goodwill. Finally, we document earnings surprise and valuation benefits related to these allocation choices. Overall, our results provide new evidence about non-GAAP reporting and purchase price allocations and suggest that non-GAAP reporting can influence management’s GAAP accounting choices. Data Availability: All data are publicly available from sources described in the paper. JEL Classifications: M40; M41; M45.

RISK AUDIT IN COMMERCIAL ORGANIZATIONS

The purpose of the research is to analyze and distinguish certain types of risks that all commercial organizations are exposed to without exception. The methodology of the research - during the research, various methods of analysis were used: comparison, grouping, expert evaluation methods, etc. The results of the research - as a result of the study, for any risk factor, it is necessary to determine the probability of its manifestation, the nature of the impact (loss or profit) on the results of the organization's activity. The practical importance of the research - currently, commercial organizations in the republic must submit an auditor's opinion once a year. The proposed methods and tools can be used by all commercial organizations and entrepreneurs. The originality and scientific novelty of the research - in addition to external auditors, with the aim of increasing the role of state auditors, conducting and studying the records of operating state enterprises subject to state regulation or taxation, as well as private enterprises or individuals. The scope of the information provided or the rules for providing a qualified opinion, which implies that the audited company does not comply with GAAP Accounting principles, have been investigated.

CEO compensation and real estate prices: pay for luck or pay for action?

This paper uses variation in real estate prices to study Chief Executive Officer (CEO) pay for luck. We distinguish between pay for luck and pay for responding to luck (action) by exploiting US GAAP accounting rules, which mandate that real estate used in the firm’s operations is not marked-to-market. This setting allows us to empirically disentangle pay for luck from pay for action, as a change in the value of real estate is only accounted for when the CEO responds to changes in property value. We show that CEO compensation is associated with the following two managerial responses to changes in real estate values: (i) real estate sales and (ii) debt issuance. Overall, we show that CEOs are rewarded for taking value-enhancing actions in response to luck.

Recognition and Evaluation of Data as Intangible Assets

Internet-based companies such as Amazon, Facebook, and Tencent hold an enormous amount of consumer data that are utilized to create business value via big data analytics. Although some companies use big data to provide professional services, such as targeted advertising and product recommendations, according to the current CAS, IFRS, and U.S. GAAP accounting standards, these assets are not recognized as assets since they are generated internally. This paper starts with a discussion of how Amazon, Facebook, Tencent, and Walmart use big data to create value for their businesses and then argues why it makes sense to recognize big data as intangible assets. Possible methods of data asset evaluation and their implications for business managers are also explored.

The Impact of Non-Gaap Disclosure on the Purchase Price Allocation to Definite-Lived Intangible Assets in Mergers and Acquisitions

We test whether firms that exclude the effects of amortization from their non-GAAP earnings allocate more of an acquisition’s purchase price to definite-lived intangible assets and less to tangible assets and goodwill. This strategy yields two benefits. First, it increases non-GAAP earnings by shifting the depreciation of tangible assets, which non-GAAP earnings includes, to amortization, which non-GAAP earnings excludes. Second, it decreases the likelihood of future goodwill impairments by reducing goodwill, but does not decrease non-GAAP earnings. Consistent with expectations, non-GAAP firms that exclude amortization allocate more of the purchase price to definite-lived intangible assets, primarily by shifting away from tangible assets. However, managers are more likely to shift allocations away from goodwill when impairments are likely to be costlier. These results indicate that non-GAAP reporting can influence management’s GAAP accounting choices, which runs counter to the traditional view that non-GAAP reporting is a response to features of GAAP earnings.

Impact of corporate governance mechanisms on financial reporting quality: a study of Indian GAAP and Indian Accounting Standards

The present study examines the impact of corporate governance mechanisms on financial reporting quality under Indian GAAP and Indian Accounting Standards (Ind. AS). A sample of 97 companies listed on the Bombay Stock Exchange is selected. Corporate governance mechanisms have been considered as independent variables, and financial reporting quality is the dependent variable. Corporate governance is measured by board effectiveness (board size, independence, diligence, and expertise), audit committee attributes (size, independence, diligence, and expertise), foreign ownership, and audit quality. Descriptive statistics, correlation, and OLS regression are conducted to estimate the results. The study results reveal that board characteristics and audit committee attributes, except for audit committee diligence, have a significant effect on financial reporting quality. However, the impact of board diligence and audit committee attributes is negative. Foreign ownership has no contribution to financial reporting quality, but audit quality has a significant effect. The findings of the study have considerable implications for regulators, policymakers, managers, investors, analysts, and academicians. More emphasis should be given to compliance with Ind. AS, and an oversight body for compliance with Ind. AS should be established. AcknowledgmentThis publication was supported by Deanship of Scientific Research, Prince Sattam Bin Abdulaziz University, Alkharj, Saudi Arabia.

An empirical evaluation of financial reporting quality of the Indian GAAP and Indian accounting standards

The present study investigates financial reporting quality (FRQ) of Indian GAAP and Ind. AS. The study uses data of 450 companies listed on the Bombay Stock Exchange (BSE) over the period from 2011 up to 2016. This study is motivated by adoption of Ind. AS by listed companies that have net worth of 500 crores or more, which implemented in 2016. It examines FRQ pre- and post-conversion to Ind. AS. Descriptive statistics, correlation, and regression models are used to estimate the results. Further, paired sample t-test of residual values of regression models is used to evaluate FRQ of Indian GAAP and Ind. AS. The results indicate a significant difference of FRQ between Indian GAAP and Ind. AS. The findings reveal that adoption of Ind. AS has improved FRQ of financial statements. The study contributes to Ind. AS literature by establishing empirical evidence of FRQ of accounting standards, which has not been provided and investigated by prior studies.

An empirical evaluation of financial reporting quality of the Indian GAAP and Indian accounting standards

The present study investigates financial reporting quality (FRQ) of Indian GAAP and Ind. AS. The study uses data of 450 companies listed on the Bombay Stock Exchange (BSE) over the period from 2011 up to 2016. This study is motivated by adoption of Ind. AS by listed companies that have net worth of 500 crores or more, which implemented in 2016. It examines FRQ pre- and post-conversion to Ind. AS. Descriptive statistics, correlation, and regression models are used to estimate the results. Further, paired sample t-test of residual values of regression models is used to evaluate FRQ of Indian GAAP and Ind. AS. The results indicate a significant difference of FRQ between Indian GAAP and Ind. AS. The findings reveal that adoption of Ind. AS has improved FRQ of financial statements. The study contributes to Ind. AS literature by establishing empirical evidence of FRQ of accounting standards, which has not been provided and investigated by prior studies.

Combating the Teleological Drift of Life Insurance Solvency Regulation: The Case for a Meta-Risk Management Approach to Principles-Based Reserving

This Article presents the recent U.S. “principles-based reserving” (PBR) reform of life insurance solvency regulation as a case study of how regulatory systems can “drift” from their putative objectives when the complexity of the regulated market outpaces the capabilities of traditional regulatory tools to effectuate those objectives. As the life insurance industry developed new products and investment strategies to confront interest rate volatility and the competitive effects of deregulation, regulators perceived the traditional, rigid formula-based methodologies of statutory accounting for reserves – which comprise by good measure insurers’ largest set of liabilities – as increasingly out of touch with market realities. Under the PBR reform, the statutory accounting system will allow firms to account for their reserves based on their own probabilistic estimates of the future economic value of those liabilities, taking into account past experience and predictive statistical models used in the firms’ internal risk management systems. The statutory reserving regime is a linchpin of life insurance solvency regulation, so regulators should only change it so drastically if they are certain the new approach will promote solvency. The Article considers the PBR reform in this context.The Article begins by explaining the purpose of solvency regulation in the insurance industry (of which statutory accounting is a central pillar) as a public administrative intervention into the insurance market to remedy corporate governance gaps due to insurers’ unique capital structures. It then distinguishes statutory accounting system from GAAP accounting by elaborating the former’s traditional conservatism and emphasis on long-term viability and solvency over short-term optimization metrics such as share price and earnings. The Article then draws on “new governance” and “reliability” theories to analyze the PBR reform as an attempt to restore meaning to the statutory accounting system in the face of the new market complexities and dynamism by tapping into regulated firms’ proprietary risk management systems. The Article considers, and finds unlikely, the possibility that firms will themselves adopt a conservative, reliability-focused outlook that privileges long-term solvency over short-term optimization metrics. Under such circumstances, the central task for regulators should be to create a system of “meta-risk management” that aims to encourage the institutionalization of social responsibility and reliability on the part of industry actors. The Article explains how the PBR reform is unlikely to embed conservative reliability-focused principles into insurers’ corporate governance structure, and recommends several modifications that might increase PBR’s effectiveness. Whether statutory accounting can in fact recoup its conservative underpinning is but a single manifestation of a larger problematic concerning the viability of public regulatory control in light of the immanent instability of financial capitalism.

A Look Back at the Beginnings of EVA and Value‐Based Management

In this interview conducted five years ago, one of the pioneers of value‐based management discusses his life's work in converting principles of modern finance theory into performance evaluation and incentive compensation plans that have been adopted by many of the world's largest and most successful companies, including Coca‐Cola, SABMiller in London, Siemens in Germany, and the Godrej Group in India. The issues covered include the significance of dividend payouts (are dividends really necessary to support a company's stock price and, if so, why?) as well as the question of optimal capital structure (whether and why debt might be cheaper than equity).But the most important focus of the interview is corporate performance measurement and the use of executive pay to strengthen management incentives to increase efficiency and value.As Stern never tired of arguing, the widespread tendency of public companies to manage “for earnings”—or in accordance with what he refers to as “the accounting model of the firm”—often leads to value‐destroying decisions. As one example, the GAAP accounting principle that requires intangible investments like R&D and training to be written off in the year the money is spent is likely to cause significant underinvestment in such intangibles. At the same time, the failure of conventional income statements to reflect the cost of equity almost certainly encourages corporate overinvestment.Stern's solution to this problem was an executive incentive compensation plan whose rewards were tied to increases in a measure of economic profit called economic value added, or EVA, which research has shown to have a significance relation to changes both in share value and the premium of market value over book value. Moreover, by combining such a plan with a “bonus bank” that pays out annual awards over a multiyear period, boards could ensure that management will be rewarded not for good luck but for sustainable improvements in performance.

Beyond EVA

A former partner of Stern Stewart begins by noting that the recent acquisition of EVA Dimensions by the well‐known proxy advisory firm Institutional Shareholder Services (ISS) may be signaling a resurgence of EVA as a widely followed corporate performance measure. In announcing the acquisition, ISS said that it's considering incorporating the measure into its recommendations and pay‐for‐performance model.While applauding this decision, the author also reflects on some of the shortcomings of EVA that ultimately prevented broader adoption of the measure after it was developed and popularized in the early 1990s. Chief among these obstacles to broader use is the measure's complexity, arising mainly from the array of adjustments to GAAP accounting. But even more important is EVA's potential for encouraging “short‐termism”—a potential the author attributes to EVA's front‐loading of the costs of owning assets, which causes EVA to be negative when assets are “new” and can discourage managers from investing in the business.These shortcomings led the author and his colleagues to design an improved economic profit‐based performance measure when founding Fortuna Advisors in 2009. The measure, which is called “residual cash earnings,” or RCE, is like EVA in charging managers for the use of capital; but unlike EVA, it adds back depreciation and so the capital charge is “flat” (since now based on gross, or undepreciated, assets). And according to the author's latest research, RCE does a better job than EVA of relating to changes in TSR in all of the 20 (non‐financial) industries studied during the period 1999 through 2018.The article closes by providing two other testaments to RCE's potential uses: (1) a demonstration that RCE does a far better job than EVA of explaining Amazon's remarkable share price appreciation over the last ten years; and (2) a brief case study of Varian Medical Systems that illustrates the benefits of designing and implementing a customized version of RCE as the centerpiece for business management. Perhaps the most visible change at Varian, after 18 months of using a measure the company calls “VVA” (for Varian Value Added), has been a sharp increase in the company's longer‐run investment (not to mention its share price) while holding management accountable for earning an adequate return on investors’ capital.

CEO Compensation and Real Estate Prices: Pay for Luck or Pay for Action?

This paper uses variation in real estate prices to study CEO pay for luck. We distinguish between pay for luck and pay for responding to luck (action) by exploiting US GAAP accounting rules, which mandate that real estate used in the firm's operations is not marked-to-market. This accounting rule provides a setting that allows us to empirically disentangle pay for luck from pay for action in the context of real estate luck, as a change in the value of real estate is only accounted for when the CEO responds to changes in property value. We show that CEO compensation is associated with responses to luck by examining specific actions taken by the CEO in response to changes in real estate asset values: real estate sales, sale and lease back (SLB) transactions, and debt issues.

The International Standards on Auditing as a convergence parameter between US GAAP and IFRS

The present study involves the US GAAP and IFRS accounting frameworks, and how these are evaluated by accounting professionals in four (4) European countries, two of which have been severely impacted by the global economic crisis (Greece and Portugal) and two that remained relatively strong during the period of the European economic crisis (France and Germany). The main purpose of the study is to point out that the economy of a country does indeed affect the perception of listed companies towards a potential convergence. The issues that arise are of interest of the global accounting and auditing community, as well as this study. Academic literature has not shown much interest in recent years. In contrast, the professional bibliography is very rich and has greatly enhanced the bibliographic review. The results of the quantitative study reveal that there are differences between the factors affecting a potential convergence at a country level, as well as at an economy level. Stronger economies seem to pay more attention to economic and regulatory factors, and weaker economies seem more reluctant towards coordination and cooperation in order for the convergence to be achieved.

Value Relevance of Environmental Provisions Pre‐ and Post‐IFRS

AbstractThe purpose of this paper is to compare the value relevance of environmental provisions as recorded under Canadian/U.S. GAAP and IFRS accounting frameworks with consideration of the impact of voluntarily issuing stand‐alone sustainability reports. The value relevance of environmental provisions is tested using a modified Ohlson (1995) model. We exploit IFRS reconciliations as a quasi‐experimental setting to conduct this comparison. Results indicate that environmental provisions recorded under either framework only act as liabilities for oil and gas firms that release stand‐alone sustainability reports. For other firms in the oil and gas industry, and the mining industry, the liability nature of these provisions appears to be discounted by the market. Furthermore, for firms in the oil and gas industry that do not have stand‐alone CSR reports, provisions appear to be interpreted by the market as a costly signal about future growth. Instead of downwardly affecting market values, this information is associated with higher market values. In terms of the transition to IFRS, we find that, while the IFRS provisions are significantly higher than under former GAAP, they do not improve value relevance for investors. Accounting standard setters should consider examining the changes in the current standards from the original Canadian environmental provision reporting requirements under Capital Assets section 3060.39, as it was rightfully shown to be a relevant proxy for unbooked liabilities (Li and McConomy, 1999; Bewley, 2005) rather than earnings expectancy. The study builds upon prior research to examine the value of accounting standards that have gone through significant changes.

A Framework for Identifying Accounting Characteristics for Asset Pricing Models, with an Evaluation of Book-To-Price

The paper presents a framework for identifying accounting numbers that indicate risk and expected return. The framework establishes conditions under which book-to-price (B/P), so prominent in asset pricing, indicates expected returns: B/P indicates expected returns if it forecasts future earnings growth and the risk that the growth will not be realized. However, that condition is satisfied only under specific accounting conditions — it depends on the accounting for book value and associated earnings. The empirical analysis confirms that the conditions are satisfied under GAAP accounting, and so identifies book-to-price (B/P) as a valid risk characteristic for asset pricing. However, the framework also points to earnings-to-price (E/P) as a risk characteristic. Indeed, E/P, rather than B/P, is the relevant characteristic when there is no expected earnings growth, but the weight shifts to B/P with growth. The framework also enables the separation of the expected return for operating risk from that due to financing risk. With this separation, the paper revisits the puzzling negative relation that has been observed between leverage and realized returns, a finding that has been attributed to failure to control for operating risk. We find a positive relation between leverage and returns when operating risk characteristics identified by our framework are recognized.

Disclosure of risk information in the European banking sector

A debate on the scope of bank information disclosures seems to be essential, especially after the Global Financial Crisis. The adequate quantity of data provided to the public domain is a condition of transparency of the banking sector which should assure the optimization of market participants’ decisions. There is also a tendency to unify global accountancy standards, and they are expected to ensure the same scope of disclosed information for the global financial market. The aim of the study is to investigate if there are any differences with the number of risk disclosures among the banks using GAAP and IFRS accounting standards, and if more stable banking sectors tend to report a wider scope of data. Finding out the nature of the determinants of disclosures is an important aspect in terms of working out the procedures which will increase the transparency and stability of the financial markets.

The Implications of Voluntary Disclosure for Research on the Asymmetric Timeliness of Earnings

We document how disclosure of management earnings forecasts (MFs) affects the asymmetric timeliness of earnings measured using the Basu (1997) model. The rationale to expect an effect is that managers care about when good and bad news gets incorporated into price. Managers’ decision about when to disclose information via MFs impacts the measured asymmetric timeliness of their firms’ earnings for the period via the MFs effect on returns. This effect of managerial disclosure on asymmetric timeliness is distinct from managers’ decisions about when to recognize an item in earnings via GAAP accounting policy choices (e.g., write-offs and accruals). We examine the effect of MF disclosure empirically by forming subsamples partitioned on MF characteristics (e.g., horizon and news content). We find that measured asymmetric timeliness is insignificant for firms issuing MFs of future-year earnings (forward-looking MFs). Further analysis reveals that the weaker asymmetric timeliness of firms issuing forward-looking MFs is concentrated in bad news MFs, consistent with a downward bias in the asymmetric timeliness coefficient related to prices leading earnings more in periods with forward-looking MFs. Additional tests reveal that the dampening effect of forward-looking MFs on asymmetric timeliness is correlated with fundamental determinants of conservatism examined in prior research, and absent for book-based (i.e., financial statement) measures of asymmetric timeliness.

Letter From the Editor

Dear JCAF Reader, The primary theme in this issue features articles on financial reporting disclosures, practices, and managing IT change. Other topics include horizontal management, and a matrix accounting illustration. The first feature article provides a practical understanding of “GAAP Accounting for Tax Equity Investments in Partnerships and LLC's” by George L. Strobel II. This type of article brings to the readers of JCAF information that could be useful in managing many businesses. The intent of JCAF is to serve corporate accounting and finance executives with information that has utility for their organizations. This article was commissioned by the editor of JCAF. The editor encourages authors and readers to propose current interest topics that can be commissioned to accomplish an agreed purpose. The second feature article is classified as a refereed (R) article, which means it was subjected to a rigorous, double-blind peer review process using the highest level of academic standards adapted to a user journal. The editorial reviewed (ER) articles were reviewed using the highest level of applied clinical standards appropriate for corporate accounting and finance executives. Both categories are intended to provide useful information for preparers and users of financial data. The remaining articles are all ER classified articles, which means they have been reviewed and approved as high-quality user articles. I hope that readers enjoy and appreciate the entire content of this issue, as it contains a variety of subjects of importance. As always, our columnists continue to provide interesting and useful information in their areas of expertise. Respectfully, Jim Edwards Editor JCAF James B. Edwards, PhD, CPA, CMA, CIA, CMA, CGMA, CCA, CCP, is a Distinguished Professor Emeritus in the Darla Moore School of Business at the University of South Carolina. He has served as a corporate controller, partner in a CPA firm, vice president of a computer services firm, vice president of a computer software firm, and journal editor, as well as in management advisory services and corporate training.

Cross-market information transfers of ADR firms: An investigation of emerging market economies

Level II and III ADRs permit issuers to be listed on the major U.S. exchanges with the stipulation that they comply with extensive SEC disclosure requirements. Foreign private issuers are compelled to file a set of audited financial statements prepared in accordance with U.S. GAAP, or alternatively, IFRS or Home Country Accounting Principles with attendant reconciliation to U.S. GAAP prior to 2008. Although the Form 20-F reconciliation is discontinued in 2008 for IFRS filers, non-U.S. issuers are required to satisfy other Form 20-F stipulations such as expanded Item 17 and Item 18 disclosures. We conjecture that non-U.S. firms choosing to be listed on the major U.S. exchanges will incur the added costs associated with the supplemental disclosure requirements in order to attract sufficient investor attention as to have the disclosures impounded in the home country equity share price in the manner described by Fishman et al. (1989). Because a prominent attribute of ADR firms is that they benefit from multiple-market trading, we investigate whether the Form 20-F disclosure cross-market information transfers are associated with emerging market economy status. We employ models of the cross-market ADR and equity security share returns and trading volume controlling for the emerging economy status and incremental firm-specific SEC Form 20-F accounting principles disclosures. Preliminary results indicate that (1) U.S. listed ADR firms from emerging economies experience greater cross-market information transfers associated with the SEC Form 20-F filing, and (2) that the increased cross-market information transfers associated with the SEC Form 20-F filing are proportional to the difference in quality of accounting principles employed for home country reporting purposes vis-à-vis the accounting principles employed for SEC Form 20-F reporting purposes. Results are consistent with a feedback process through which the new information disclosed by the SEC Form 20-F reporting requirements in the ADR market attenuates the price discovery process in the home country equity market when the difference in information environment quality is large.

Accounting diversity: International student survey outcomes

The paper presents the results of the Polish-American survey focused on the problem of international accounting diversity. A survey was conducted on two undergraduate students groups taught respectively on Polish and U.S. GAAP accounting standards. The results showed that American students consider shareholders and managers as the main users of the financial statements, while Polish students think that tax authorities and managers are the main users. Both groups respect the Income Statement as important core of the financial statements. However, the Americans rely also strongly on the Statement of Stockholders’ Equity, while the Polish prefer more the Balance Sheet as a source of knowledge about the company performance. Moreover, we confirmed that cultural differences led to a different understanding of the word ‘probable’―which is more based according to the taught set of standards on a professional judgment than on the specific probability value. American students turned out to be less prudent in the area of accounting for write-offs. We also revealed that Polish and American students can have different attitudes to ethical issues in auditing―Americans showed more concern. We pointed out that the identified differences can be essential for reporting process by companies and capital groups operating not only on different accounting standards but also in different cultures.