nep-acc New Economics Papers
on Accounting and Auditing
Issue of 2007‒06‒18
eight papers chosen by
Alexander Harin
Modern University for the Humanities

  1. Fair value accounting for financial instruments: some implications for bank regulation By Wayne Landsman
  2. Do accounting changes affect the economic behaviour of financial firms? By Anne Beatty
  3. Institution-specific value By Ken Peasnell
  4. Risk in financial reporting: status, challenges and suggested directions By Claudio E. V. Borio; Kostas Tsatsaronis
  5. Including estimates of the future in today's financial statements By Mary Barth
  6. The accrual anomaly – focus on changes in specific unexpected accruals results in new evidence. By Schøler, Finn
  7. What explains the US net income balance? By Alexandra Heath
  8. Risk and liquidity in a system context By Hyun Song Shin

  1. By: Wayne Landsman (University of North Carolina at Chapel Hill - Accounting Area)
    Abstract: I identify issues that bank regulators need to consider if fair value accounting is used for determining bank regulatory capital and when making regulatory decisions. In financial reporting, US and international accounting standard setters have issued several disclosure and measurement and recognition standards for financial instruments and all indications are that both standard setters will mandate recognition of all financial instruments at fair value. To help identify important issues for bank regulators, I briefly review capital market studies that examine the usefulness of fair value accounting to investors, and discuss marking-to-market implementation issues of determining financial instruments' fair values. In doing so, I identify several key issues. First, regulators need to consider how to let managers reveal private information in their fair value estimates while minimising strategic manipulation of model inputs to manage income and regulatory capital. Second, regulators need to consider how best to minimise measurement error in fair values to maximise their usefulness to investors and creditors when making investment decisions, and to ensure bank managers have incentives to select investments that maximise economic efficiency of the banking system. Third, cross-country institutional differences are likely to play an important role in determining the effectiveness of using mark-to-market accounting for financial reporting and bank regulation.
    Keywords: fair values, financial instruments, information asymmetry
    JEL: E58 G15 M41
    Date: 2006–08
  2. By: Anne Beatty (Ohio State University - Department of Accounting & Management Information Systems)
    Abstract: This study examines whether accounting changes result in changes in the economic behaviour of financial institutions. The results of several papers examining how banks respond to accounting changes that affect their regulatory capital ratios are consistent with Furfine's (2000) summary that "capital regulation, broadly speaking, can significantly influence bank decision-making." These papers do not attempt to disentangle the effects of capital regulation versus market discipline. This paper examines banks' response to recent changes in accounting for Trust Preferred Securities that effect how these securities are reported in the balance sheet but do not change the calculation of Tier 1 capital. This provides a good setting to examine whether accounting changes induce changes in banks' economic behaviour in the absence of an effect on regulatory capital. I test five hypotheses related to banks' decisions to issue Trust Preferred Stock during the period from 1997 through 2004. Specifically, I examine whether there was an overall decrease in banks' propensity to issue these securities after the accounting change, whether publicly traded banks and those that access the external debt markets were more likely to issue these securities before the accounting change but not after, and whether banks with low regulatory capital ratios and with high marginal tax rates were more likely to issue these securities both before and after the accounting change. The results suggest that accounting changes can lead to changes in banks' economic behaviour even when the change in accounting does not affect regulatory capital calculations. This is consistent with bank managers acting as if they are concerned with the markets' response to the numbers reported after the accounting change.
    Keywords: Bank capital, taxation, trust preferred securities, financial reporting
    JEL: G21 G32 M41
    Date: 2006–08
  3. By: Ken Peasnell (Lancaster University - Department of Accounting, Finance)
    Abstract: The introduction of a new accounting standard for financial instruments, has raised a number of issues related to the application of fair value principles. This paper discusses some of these issues which are generally related to the fact that "fair values" are not always easily defined or readily available. It concludes that the application of fair value for financial liabilities might present fewer complications if it is matched by similar valuation principles for financial assets. The issue of measurement error is more complicated as it can be related to whether valuations refer to exit value, as postulated by the IASB, or deprival value, which is more closely related to firm-specific valuation. Measurement error is magnified in the income statement and so will be any biases from the application of historical accounting for derivatives. Despite any measurement issues, the problem of institution-specific dimensions of value that looms so large in the case of non-financial enterprises and makes the systematic application of fair value accounting fraud with difficulty there, would seem to be much more manageable for financial institutions because of their familiarity with risk measurement and management techniques for financial instruments.
    Keywords: financial statements, institution-specific value, fair value, financial reporting
    JEL: E58 G15 M41
    Date: 2006–08
  4. By: Claudio E. V. Borio; Kostas Tsatsaronis
    Abstract: Advances in risk measurement technology have reshaped financial markets and the functioning of the financial system. More recently, they have been reshaping the prudential framework. Looking forward, they have the potential to reshape financial reporting too. Recent initiatives to improve financial reporting standards have brought to the fore significant differences in perspective between accounting standard setters and prudential authorities. Building on previous work, we argue that risk measurement and management technology can be instrumental in bridging this gap and, by the same token, in improving financial reporting. Risk measurement plays a crucial role in the measurement, verification and validation of valuations. It is the basis for giving more prominence to risk and measurement error information in public disclosures. And it could act as more of a focal point in the design of accounting standards, as greater consistency between sound risk management practices and accounting standards can help to narrow the wedge between accounting and underlying economic valuations.
    Keywords: risk measurement and management, accounting, regulation, financial reporting
    JEL: D52 G00 G12 G28 M41
    Date: 2006–08
  5. By: Mary Barth (Stanford Graduate School of Business)
    Abstract: This paper explains why the question is how, not if, today's financial statements should include estimates of the future. Including such estimates is not new, but their use is increasing. This increase results primarily because standard setters believe asset and liability measures that reflect current economic conditions and up-to-date expectations of the future will result in more useful information for making economic decisions, which is the objective of financial reporting. This is why standard setters seem focused on fair value accounting. How estimates of the future are incorporated in financial statements depends on the asset and liability measurement attribute, and on financial reporting definitions of assets and liabilities. The present definitions depend on identifying past transactions or events that give rise to expected inflows or outflows of economic benefits and, for inflows, control over the expected benefits. Thus, not all expected inflows or outflows of economic benefits are recognised. Note disclosures can help users understand recognised estimates, and can provide information about unrecognised estimates. Including more estimates of the future in today's financial statements would result in an income measure that differs from today's income, but arguably provides better information for making economic decisions.
    Keywords: financial statements, fair value, financial reporting
    JEL: E58 G15 M41
    Date: 2006–08
  6. By: Schøler, Finn (Department of Management Science and Logistics, Aarhus School of Business)
    Abstract: This paper deals with the accrual anomaly first documented by Sloan (1996), i.e. the finding that the stock market prices appear to overweigh the role of accruals persistence and under-weigh the role of operating cash flow persistence. In an analysis based on Danish financial statement data it is demonstrated that different specific components of earnings have significantly different earnings persistence characteristics and that these differences are not fully reflected in share prices. <p> In the analysis presented here the earnings persistence effect of two particular unexpected accrual components are specifically analyzed, namely the unexpected inventory accrual component and the unexpected accounts receivable accrual component, i.e. changes in accruals not motivated by corresponding changes in company activity-level. Additionally and for comparison, the accounting accruals are split into expected and unexpected accruals, estimated by the extended Jones model like in both some US-analyses and some international studies of the accrual anomaly phenomenon. <p> It is found that the persistence of earnings is decreasing in the magnitude of the unexpected accrual components of earnings and that the persistence of current earnings performance is particularly decreasing in the magnitude of unexpected changes in inventory. The special accrual parts are related to the perceptions of earnings persistence implicit in the market prices, and it is found that the differences in earnings persistence are not rationally reflected by share price differences
    Keywords: Discretionary accruals; Earnings management; Earnings Persistence; Accrual anomaly;
    Date: 2006–06–26
  7. By: Alexandra Heath
    Abstract: Despite a significant deterioration in the US net foreign asset position, there has not been a corresponding deterioration in the net income balance. In fact, there has generally been a net income surplus. Two factors have been particularly important for the positive net income balance over the past 15 years or so. The first is that the United States has a positive net external equity balance and a negative net external debt balance. This contributes to a net income surplus because the income yield on equity has been higher than the income yield on debt.
    Keywords: Net income balance, dark matter, income yields, foreign direct investment
    JEL: F32 F41
    Date: 2007–01
  8. By: Hyun Song Shin (Princeton University - Department of Economics)
    Abstract: This paper explores the pricing of debt in a financial system where the assets that borrowers hold to meet their obligations include claims against other borrowers. Assessing financial claims in a system context captures features that are missing in a partial equilibrium setting. It is possible for spreads to fall as debts rise, as debt-fuelled increases in asset prices and stronger balance sheets reinforce each other. Conversely, it is possible that de-leveraging leads to increases in spreads, as is often observed during crises.
    Keywords: systemic risk, leverage, asset prices, liquidity
    JEL: D5 G12 M4
    Date: 2006–08

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