Statement Of Financial Accounting Standards Research Articles

Do Investors Perceive Marking-to-Model as Marking-to-Myth? Early Evidence from FAS 157 Disclosure

Using disclosure mandated by Statement of Financial Accounting Standards (FAS) 157 Fair Value Measurements, I evaluate the concern that fair value estimates for assets and liabilities not traded in active markets, aka mark-to-model, are too unreliable to be used in financial reporting. I document a significant positive association between stock prices and fair values of net assets measured using unadjusted market prices (Level 1), other observable inputs (Level 2), and significant unobservable inputs (Level 3). While the estimated coefficients on the mark-to-model estimates (Levels 2 and 3) are consistently lower than those on the mark-to-market fair values (Level 1), the difference is significant only for Level 3 net assets. Furthermore, even at its maximum, the difference does not exceed 35% of the coefficient on Level 1 net assets. Additional analysis suggests that the valuation gap is more pronounced for firms with lower equity capital and fewer financial experts on the Audit Committee, as well as for companies that develop their mark-to-model estimates internally. I also document a significant positive association between Level 3 net gains and both quarterly returns and returns for the three-day period surrounding the filing of Form 10-Q. Collectively, the results suggest that equity investors find mark-to-model fair value estimates sufficiently reliable to be reflected in firm value.

Mark-to-Market Pricing: A Middle Ground

Statement of Financial Accounting Standards No. 157, <i>Fair Value Measurements</i>, was intended to improve fair value accounting by eliminating “diverse and inconsistent practices,” especially for items that are not actively traded, by requiring companies to value their assets based on market realities rather than financial projections or estimates. But critics have called for suspension of the standard until the market for mortgage-backed securities stabilizes. A different alternative would be to create flexibility in the standard so financial firms would have the ability to differentiate between bonds that were credit impaired and those that were liquidity impaired. By allowing financial firms to make such a distinction, the revised standard would help prevent the type of death spiral that has forced dozens of entities, including venerable banks and hedge funds, to sell their assets in illiquid markets at depressed prices. <b>TOPICS:</b>Portfolio construction, portfolio theory, fixed income and structured finance

Exploring the usefulness of comprehensive income: an empirical study

Statement of Financial Accounting Standards (SFAS) No. 130 and the International Accounting Standards Board (IASB) require companies to report their comprehensive income in their primary financial statements. The Financial Accounting Standards Board (FASB) permits companies to present comprehensive income in three different ways: 1) in the income statement; 2) in a separate statement of comprehensive income; 3) in the stockholders' equity statement. This paper focuses on testing whether the new comprehensive income reporting formats affect users' judgement when valuing companies. The results indicate that alternative presentation formats do not influence users' processing of comprehensive income information. In other words, reporting comprehensive income in a separate statement or in the income statement does not add more relevant value than reporting it in the stockholders' equity section.

Value Relevance of FAS 157 Fair Value Hierarchy Information and the Impact of Corporate Governance Mechanisms

Statement of Financial Accounting Standards No. 157 (FAS 157), Fair Value Measurements, prioritizes the source of information used in fair value measurements into three levels: (1) Level 1 (observable inputs from quoted prices in active markets), (2) Level 2 (indirectly observable inputs from quoted prices of comparable items in active markets, identical items in inactive markets, or other market-related information), and (3) Level 3 (unobservable, firm-generated inputs). Using quarterly reports of banking firms in 2008, we find that the value relevance of Level 1 and Level 2 fair values is greater than the value relevance of Level 3 fair values. In addition, we find evidence that the value relevance of fair values (especially Level 3 fair values) is greater for firms with strong corporate governance. Overall, our results support the relevance of fair value measurements under FAS 157, but weaker corporate governance mechanisms may reduce the relevance of these measures.

The Economic Consequences of SFAS No. 158

This study examines the economic consequences of Statement of Financial Accounting Standards No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans. SFAS No. 158 requires the funded status of postretirement benefit plans be reported on the face of the balance sheet. The study adds to the debate regarding the equivalence of recognition versus disclosure and to the ongoing discussion of postretirement benefit reporting. The study finds that managers responded to the requirement to recognize previously disclosed net pension and postretirement benefit obligations by first lobbying against the standard’s implementation and then by attempting to mitigate its negative impact by increasing the discount rate in subsequent periods. Firms with larger SFAS No. 158 balance sheet adjustments and more volatile pension assets and obligations were more likely to lobby and increase discount rates. The study further documents a negative stock price reaction around the release of the SFAS No. 158 exposure draft. The study finds that the market reaction is positively related to the SFAS No. 158 adjustment and it is driven by the OPEB adjustment rather than the pension adjustment. The findings presented in the study have important implications for the recognition versus disclosure debate, because they document a significant market reaction to the relocation of already disclosed information from the financial statements footnotes to the balance sheet.

New evidence pertaining to the prediction of operating cash flows

We investigate the ability of past operating cash flows (Model 1) and past earnings (Model 2) to generate predictions of operating cash flows from 1990 to 2004. We employ actual cash flow numbers reported in accordance with Statement of Financial Accounting Standards (SFAS) No. 95 in our primary analysis rather than using an algorithm to approximate operating cash flows (i.e., Kim and Kross J Acc Res 43:753–780, 2005; Dechow et al. J Acc Econ 25:133–168, 1998, among others). We derive out of sample predictions of operating cash flows both cross-sectionally similar to the approach of Kim and Kross (2005) and on a firm-specific time-series basis consistent with Dechow et al. (1998). Our predictive findings suggest: (1) cash-flow based models (Model 1) provide significantly more accurate predictions of operating cash flows than earnings-based models (Model 2); (2) time-series models significantly outperform cross-sectional models; (3) larger firms exhibit significantly more accurate cash-flow predictions than smaller firms; (4) firms with relatively shorter operating cycles exhibit significantly more accurate cash-flow predictions that firms with longer operating cycles consistent with Dechow (J Acc Econ 18:3–42, 1994); (5) we find no evidence of increased predictive power for either the cash-based or earnings-based prediction models across 1990–2004; (6) we also provide supplementary analyses to assess the impact on predictive performance when descriptive goodness-of-fit criteria are used instead of out-of-sample forecasts to assess predictive performance, and (7) we re-estimate the CFO prediction models using algorithmic CFO data instead of actual data.

Revised Accounting For Business Combinations

The Financial Accounting Standards Board (FASB) has recently issued Statement of Financial Accounting Standards No. 141 (Revised 2007) Business Combinations. The object of this Statement is to improve the relevance, representational faithfulness, and comparability of reported information about a business combination and its effects. This Statement replaces FASB Statement No. 141, but retains the fundamental requirements that the acquisition method of accounting (previously called the purchase method) be used for all business combinations. Some of the changes related to the accounting for business combinations as a result of the new requirements are discussed and illustrated below.

The Relationship between Fair Value, Market Value, and Efficient Markets*

ABSTRACTThis paper proposes that an assumption of reasonable market efficiency is at the essence of the relevance of fair value for financial reporting purposes. The paper's examination of this proposal begins with a review of recent academic literature on market efficiency, and on evidence of inefficiencies and their implications for the ability of the efficient market hypothesis to explain what market prices represent. It concludes that there is wide acceptance in this literature that a reasonable level of efficiency can generally be presumed to exist in active, well‐regulated capital markets.The paper examines the essential attributes of a reasonably efficient market for fair value measurement purposes, and some basic implications for its reliable estimation. This is done in comparison with the provisions of the fair value measurement standard of the Financial Accounting Standards Board (FASB) (Statement of Financial Accounting Standards [SFAS] No. 157). It is concluded that the concept of reasonable market efficiency could provide a sound conceptual framework for defining fair value that is founded in real, observable market prices. It is demonstrated that, in contrast, SFAS No. 157 does not provide a clear, unequivocal concept of fair value, and that it permits estimates of fair value that have no demonstrable basis in real, observable market prices. Nevertheless, it appears that arguments typically put forward by the International Accounting Standards Board and the FASB for the relevance of fair value for financial reporting purposes do imply a presumption of reasonably efficient markets.

Asset Write-Offs and Discretionary Accruals: Roles of Executives' Incentives, Corporate Governance, and Market Reaction*

This paper examines: (1) whether earnings management incentives affect the association between discretionary accruals and asset write-offs that fall under the auspices of the Taiwan's Statement of Financial Accounting Standards (SFAS) No. 34/35, (2) how corporate governance mechanisms react to management discretionary behaviors, and (3) whether the market response to write-off announcements has any relation to firms' existing governance structures. The results indicate that big bath (income smoothing) firms have a higher propensity to take SFAS No. 35 (SFAS No. 34) write-offs and select income-reducing discretionary accruals to manage earnings downward, relative to their respective counterparts. Additional analyses reveal that strong governance mechanisms seem to be more effectively to constrain the smoothing activities relative to the big bath behavior. The evidence also support the notion that write-off disclosures are regarded as revealing information about undesirable earnings management behavior, which investors believe can be constrained by a strong governance setting.

Value Relevance of FAS No. 157 Fair Value Hierarchy Information and the Impact of Corporate Governance Mechanisms

ABSTRACT: Statement of Financial Accounting Standards No. 157 (FAS No. 157), Fair Value Measurements, prioritizes the source of information used in fair value measurements into three levels: (1) Level 1 (observable inputs from quoted prices in active markets), (2) Level 2 (indirectly observable inputs from quoted prices of comparable items in active markets, identical items in inactive markets, or other market-related information), and (3) Level 3 (unobservable, firm-generated inputs). Using quarterly reports of banking firms in 2008, we find that the value relevance of Level 1 and Level 2 fair values is greater than the value relevance of Level 3 fair values. In addition, we find evidence that the value relevance of fair values (especially Level 3 fair values) is greater for firms with strong corporate governance. Overall, our results support the relevance of fair value measurements under FAS No. 157, but weaker corporate governance mechanisms may reduce the relevance of these measures.

Facts and Issues about Goodwill Impairment Losses in SFAS No. 142 Adoption Year

For most companies, fiscal year 2002 was the adoption year for Statement of Financial Accounting Standard (SFAS) No. 141: Business Combinations and No. 142: Goodwill and Other Intangible Assets. This article analyzes financial statements reported under the new rules and reaches the following conclusions: 1). In the adoption year, the impacts on reported earnings can be deep, but uneven across firms; some companies show dramatic negative impacts while most companies show mild positive impacts. 2). Measurement and disclosure of goodwill's fair value, and the basis for impairment losses, when necessary, becomes more technical and more demanding on statement users. 3). Goodwill fair value impairment losses take place across industries and do not seem to be related to industry economic performance. Overall, under the new rules, goodwill as an asset on the accounting book is more challenging and less predictable.

Time-series properties and predictive ability of quarterly cash flows

Abstract We provide descriptive and predictive evidence on the time-series properties and predictive ability of quarterly cash flows from operations (CFO) reported in accordance with Statement of Financial Accounting Standards (SFAS) No. 95. Previous work such as Hopwood and McKeown [Hopwood, W.S., & McKeown, J.C., (1992). Empirical evidence on the time-series properties of operating cash flows. Managerial Finance, 18, 62–78] and Lorek, Schaefer and Willinger [Lorek, K.S., Schaefer, T.F., & Willinger, G.L., (1993, January). Time-series properties and predictive ability of funds flow variables.” The Accounting Review, 68, 151–63], among others, has analyzed a proxy series (PCFO) for quarterly cash flows constructed via a relatively simplistic algorithm. We provide new evidence documenting that: (1) the time-series properties of quarterly CFO are at variance with the exclusively seasonal characterization of quarterly PCFO exhibiting both adjacent (quarter-to-quarter) and seasonal (quarter-by-quarter) relationships, (2) the Brown–Rozeff ARIMA model significantly outpredicts the random walk with drift model, seasonal random walk with drift model, and a disaggregated-accrual model, the multivariate time-series regression model (MULT) originally popularized by Lorek and Willinger [Lorek, K.S., & Willinger, G.L., (1996, January). A multivariate time-series prediction model for cash-flow data. The Accounting Review, 71, 81–101], (3) the forecast errors of larger firms are significantly smaller than the forecast errors of smaller firms, and (4) the predictive ability of the Brown–Rozeff model is robust when tested upon an expanded sample of firms (n = 745; 8940 firms/quarter predictions) obtained by eliminating the considerable data requirements of MULT.

Timeliness of impairment recognition: Evidence from the initial adoption of SFAS 142

Abstract This research investigates the timeliness of impairment recognition from the initial adoption of Statement of Financial Accounting Standards no. 142, Goodwill and Other Intangible Assets (SFAS 142). Using a sample of firms reporting goodwill at yearend 2001, we examine the lag between incorporation in returns and recognition in earnings of 2002 goodwill impairments to provide market-based evidence on the timeliness of goodwill impairments upon the adoption of the new rule. First, our results indicate that the market anticipated the initial adoption write-offs. Second, while the concurrent association between stock returns and newly incurred impairment losses indicates timely recognition of impairments after the new standard, the market also anticipated the new impairment losses subsequent to initial adoption. This indicates that timeliness can be improved further after the adoption of SFAS 142.

Accounting for derivative instruments and hedging activities (SFAS No. 133)

PurposeThe purpose of this paper is to examine the impact of firms using derivatives applying Statement of Financial Accounting Standards (SFAS) No. 133. It aims to measure the magnitude of cumulative effects of changes in accounting principle from the income statement in the year of adoption, market reaction to earnings announcements, and key financial ratios effects.Design/methodology/approachSearch of the Compustat Industrial database for firms reporting a cumulative effect of a change in accounting principle in their annual income statements for fiscal years ending after 15 June, 2000. We then examine the impact of firms using derivatives applying SFAS No. 133.FindingsThe sampled firms reported an absolute cumulative effect on income of $6.8 billion, 65 per cent of which was negative. Significant negative unexpected returns were observed around earnings announcement dates. Abnormal returns correlated with the cumulative effect, rather than with change in earnings per share from operations, showing that the surprise related to the accounting change. Ratio analyzes and regressions results show sampled firms with material unrealized gains and losses related to hedging with derivative instruments. Earnings‐related ratios, return on assets (ROA), return on equity (ROE) and measures of other comprehensive income decreased significantly from 2000 to 2001 after experiencing prior period significant increases.Practical implicationsThe results presented in the paper should lead to further research on the effect on new authoritative standards on the financial reporting process.Originality/valueRather than judge SFAS No. 133's relative merits and shortcomings, the Standard's actual (rather than predicted) effects were analyzed. Focus was on the magnitude of the impact of SFAS No. 133 and the effect on key financial ratios. The impact of adopting the Standard was analyzed and it was found that it violated a basic tenet of financial accounting pronouncements: a “value neutral” basis was examined.

FIN 48: The Impact On Staffing, Internal Control Processes And Expertise Of Privately-Held Companies

While FASB Interpretation 48 (FIN 48), Accounting for Uncertainty in Income Taxes-An Interpretation of Statement of Financial Accounting Standards (SFAS) 109, Accounting for Income Taxes applies to both privately-held and publicly traded companies, privately-held companies have characteristics that can impact implementation. This paper reports the findings of a survey of the top 100 privately-held companies to determine how these organizations are addressing the staffing of tax department personnel, process controls and knowledge acquisition during the implementation of FIN 48.

Managerial Empire Building and Firm Disclosure

ABSTRACTThis study tests the agency cost hypothesis in the context of geographic earnings disclosures. The agency cost hypothesis predicts that managers, when not monitored by shareholders, make self‐maximizing decisions that may not necessarily be in the best interest of shareholders. These decisions include aggressively growing the firm, which reduces profitability and destroys firm value. Geographic earnings disclosures provide an interesting context to examine this issue. Beginning with Statement of Financial Accounting Standards No. 131 (SFAS 131), most U.S. multinational firms are no longer required to disclose earnings by geographic area (e.g., net income in Mexico or net income in East Asia). Such nondisclosure potentially reduces the ability of shareholders to monitor managers' decisions related to foreign operations. Using a sample of U.S. multinationals with substantial foreign operations, we find that nondisclosing firms, relative to firms that continue to disclose geographic earnings, experience greater expansion of foreign sales, produce lower foreign profit margins, and have lower firm value in the post–SFAS 131 period. Our conclusions are strengthened by the fact that these differences do not exist in the pre–SFAS 131 period and do not relate to domestic operations. We find differences in the predicted direction only for foreign operations and only after adoption of SFAS 131. Our results are robust to the inclusion of an extensive set of control variables related to alternative corporate governance mechanisms, operating performance, and the firm's information environment. Overall, the results are consistent with the agency cost hypothesis and the important role of financial disclosures in monitoring managers.

Pricing and Mispricing Effects of SFAS 131

Abstract: We investigate the effects of the introduction of Statement of Financial Accounting Standards No. 131 (SFAS 131) on the market's valuation of foreign earnings. Thomas (1999) documents that investors discount the value of foreign earnings for US multinational companies. He conjectures but does not test the possibility that this finding is due to poor disclosure related to foreign operations. We find strong evidence that the introduction of the standard is positively associated with the pricing of foreign earnings. In addition, we use both the Mishkin (1983) test and a zero‐investment hedge portfolio test and find that investors' mispricing of foreign earnings lessens (and in fact disappears) after SFAS 131. This study is one of the first attempts to show that improved disclosure reduces mispricing.

Teaching The Interrelationships Among Costs, Expense, And Liability Of A Defined Benefit Pension Plan

The Financial Accounting Standards Board (FASB) recently issued Statement of Financial Accounting Standards No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (SFAS #158). Their intent is to comprehensively reconsider the accounting for postretirement benefit plans in phases. The first phase was to provide timely and significant improvements and resulted in SFAS #158. The object of this Statement is to improve the understandability and representational faithfulness of the amounts reported in the employer’s statement of financial position by recognizing as an asset or liability the overfunded or underfunded status of a defined benefit postretirement plan. The purpose of this paper is to provide a logical approach for teaching accounting for a defined benefit pension plan. This objective will be accomplished by providing a discussion with detailed illustrations of the interrelationships of the effects on income (both operating income and other comprehensive income) and the amount reported on the balance sheet.

Categorising intangible assets: are the new accounting standards consistent with practice?

This study combines a management perspective and real financial quantitative data to present an accounting classification for Intangible Assets (IAs). Contract capital provides an adjusting and complementary effect to other capital within IAs. Moreover, we discovered that if contract capital is solely considered without interaction effects, it could hardly demonstrate any effects on IAs. Thus, in order to examine Statement of Financial Accounting Standard (SFAS) No. 141 from the management perspective, we believe such a classification calls for further adjustments. The current regulations require that separate listings of IAs regarding contract capital should be altered so as to maximise the effects of classification.

Managerial Empire Building and Firm Disclosure

This study tests the agency cost hypothesis in the context of geographic earnings disclosures. The agency cost hypothesis predicts that managers, when not monitored by shareholders, will make self-maximizing decisions which may not necessarily be in the best interest of shareholders. These decisions include aggressively growing the firm, which reduces profitability and destroys firm value. Geographic earnings disclosures provide an interesting context to examine this issue. Beginning with Statement of Financial Accounting Standards No. 131 (SFAS 131), most U.S. multinational firms are no longer required to disclose earnings by geographic area (e.g., net income in Mexico or net income in East Asia). Such non-disclosure potentially reduces the ability of shareholders to monitor managers' decisions related to foreign operations. Using a sample of U.S. multinationals with substantial foreign operations, we find that non-disclosing firms, relative to firms that continue to disclose geographic earnings, experience greater expansion of foreign sales, produce lower foreign profit margins, and have lower firm value in the post-SFAS 131 period. Our conclusions are strengthened by the fact that these differences do not exist in the pre-SFAS 131 period and do not relate to domestic operations. We find differences in the predicted direction only for foreign operations and only after adoption of SFAS 131. Our results are robust to the inclusion of an extensive set of control variables related to alternative corporate governance mechanisms, operating performance, and the firm's information environment. Overall, the results are consistent with the agency cost hypothesis and the important role of financial disclosures in monitoring managers.