Examining earnings quality within the financial reporting process Essay

Net incomes quality is of considerable involvement to participants in the fiscal coverage procedure, including standard compositors, preparers, hearers, regulators, analysts, and fiscal imperativeness observers. It is besides of involvement to accounting pedagogues and accounting research workers. As grounds of this involvement, we point to several analyses of net incomes quality, including Dechow and Schrand ( 2004 ) , Scipper and Vincent ( 2003 ) , and the 2002 particular issue of The Accounting Review devoted to research on net incomes quality. These analyses vary in the benchmark concept that net incomes is presumed to capture or depict, and in the grounds on net incomes quality that is presented or discussed.

Dechow and Schrand ( 2004 ) analyze net incomes quality from a fiscal analysis position. They take the position that net incomes are of high quality if they accurately annuitizing-of-value property with describing a normalized, sustainable ore representative net incomes figure that corresponds to lasting net incomes and they describe such an net incomes figure as being of high quality because it has three properties: it accurately reflects current public presentation, it indicates future public presentation, and it is a utile summery for measuring steadfast value. Our perspective complements that taken by Dechow and Schrand in that we associate net incomes quality with precise information about a concept that net incomes is intended to depict. In the context of Dechow and Schrand ‘s treatment, this concept would be lasting net incomes.

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In changeless, Scipper and Vincent ( 2003 ) see net incomes quality both from a determination usefulness position, following the Financial Accounting Standards Board ‘s ( FASB ) conceptual model, and from a Hichsian income position, following the thought that accounting net incomes should dependably stand for alterations in wealth. Using our position to their paper, the concept that is captured with preciseness by high quality net incomes would be wealth alterations. This would likely non match to the normalized or sustainable net incomes figure proposed by Dechow and Schrand. While Scipper and Vincent discourse some of the net incomes quality steps, they do non see the capital market effects of net incomes.

Finally, the American Accounting Association conference on Quality of Earrings resulted in a particular issue of The Accounting Review ( 2002 ) that contains six documents and related treatments that consider net incomes quality from a balance sheet position, from an international position, from an analyst expertness position, and from an net incomes direction position.

Our essay complements these documents and some others by associating the quality of reported net incomes under IFRS and US-GAAP. In general, the structural and organisational differences between IFRS and US-GAAP are in the literature largely described as rule versus regulation based. US-GAAP is described as regulation based, because of the comprehensiveness of the regulations compared to IFRS. In contrast with US-GAAP, IFRS is non a national set of criterions. Besides the IASB is non embedded in the national construction as is the instance with the FASB [ Helleman, 2006 ] . Furthermore, IFRS and US-GAAP have non the same acknowledgment and measuring regulations that affect the information content of the accounting Numberss. Based on an understanding between the two governments which develop IFRS and US-GAAP ( the International Accounting Standards Board or IASB severally the Financial Accounting Standards Board or FASB ) both accounting criterions include alterations in order to run into each another. But still of import differences continue to be between US-GAAP and IFRS.

Net incomes quality under US-GAAP

The phrase ”generally accepted accounting rules ” is a proficient term that encompasses the conventions, regulations, and processs necessary to specify accepted accounting pattern at a peculiar clip. It includes non merely wide guidelines of general application, but besides elaborate patterns and processs. Those conventions, regulations and processs provide a criterion by which to mensurate fiscal presentations. ( Auditing Standards Board, AU Section 411 )

For many decennaries, until the alterations being wrought by the new Codification being to be felt, GAAP has been created be the announcement of criterions and readings by the organic structures granted statutory and professional authorization to do such regulations. The FASB and AICPA both long adhered to rigorous due procedure when making new counsel in class A and class B GAAP. The end was and will go on to be, to affect components who would be affected by the freshly issued counsel so that the criterions created will ensue in information that reports economic activity every bit objectively as possible without trying to act upon behaviour in any peculiar way. Ultimately, nevertheless, the counsel is the judgement of the FASB of the AICPA, based on research, public input, and deliberation. The FASB ‘s due procedure processs are described function in the hereafter. Due procedure, nevertheless, will stay as a steering rule in the overall development of GAAP.

On July 1, 2009, the FASB Accounting Standards Codification became the individual official foundation of important, nongovernmental US by and large accepted accounting rules ( GAAP ) . It superseded all extant FASB, AICPA, EITF, and related literature. After this day of the month, merely one degree of important GAAP existed, excepting the supervising issued by the Securities and Exchange Commission ( SEC ) . In accomplished, hence, the officially five degrees US-GAAP hierarchy was compressed to tow degrees. The Codification did no alteration GAAP, but instead introduced a new construction, one that is organized into an easy accessible, under-friendly online research system. The codification reorganizes the big figure of distinct US-GAAP proclamations into approximately 90 accounting subjects, and shows all subjects utilizing a changeless construction.

By and large accepted accounting rules ( GAAP ) are the footing of fiscal accounting and represent federal fiscal accounting criterions. GAAP is important to US houses. GAAP is overall really wide in its techniques, as it requires being somewhat valid to many different types of industries. GAAP exist as principle-based or exact proficient petitions. Harmonizing to the fact that in many instances it is flexible and general, most concerns in the United States have to follow GAAP rules. By and large accepted accounting rules are wide-ranging but based on a little figure of basic rules that must be supported by all GAAP regulations, these rules are consistence, relevancy, dependability, and comparison. Consistency is all the information should be collected and presented the same in all periods. For illustration, a house can non alter the method they account for stock list from one period to another beyond stating it in the fiscal statements and holding a crusial motivation for the alteration. Relevance is the information presented in fiscal statements should be suited and lend a individual measuring the statements to make educated estimations harmonizing the hereafter fiscal province of a house. Reliability means fundamentally that the information exist in fiscal statements is dependable and verifiable by an independent party. Basically a house must O.K. that if an independent hearer were to establish their studies of the similar information that they would come up with the same consequences. Furthermore the by and large accepted accounting rule besides means that the house is stand foring a clear position of what truly go oning with their concern. Comparability is one of the most important GAAP classs and one of the chief causes holding something similar to GAAP is needed. By make certain comparison, a corporation ‘s fiscal statements and other paperss can be associated to similar companies inside its industry. The significance of this rule can non be overstated, as without comparison investors sould be non capable to acknowledge differences between houses within an industry to benchmark how a concern public presentation is compared to its equals. By and large accepted accounting rules warrants that all houses are on the same degree playing field and that the bing information is consistent, relevant, dependable, and comparable. Even if US-GAAP is merely exist in the U.S. , and other states have their ain type of GAAP that are related in intent, even if non ever in design.

Previous surveies that evaluate the quality of criterions across governments can approximately be divided into two groups: those comparing US-GAAP versus other local governments, and those comparing IFRS with local governments. Surveies that resort under the first group typically have two common characteristics. First, about all surveies are performed utilizing a sample of US and non-US companies listed on the same US stock exchange. Reason is that US stock exchanges have the interesting characteristic they allow foreign filers to describe under their local criterions, provided there is a rapprochement of net incomes and stockholders ‘ equity with US-GAAP. Second, quality is most frequently measured by using value relevancy theoretical accounts, looking at the association between stock monetary values and accounting informations.

In comparing UK and US-GAAP constructed net incomes and net incomes alterations, Pope and Rees ( 1992 ) , conclude that US-GAAP net incomes accommodations add merely marginally to the ability of net incomes to explicate returns. Comparing US-GAAP with multiple local GAAP systems, Amir et Al. ( 1993 ) find that the 20F rapprochements made by Non-US filers are reflected in stock monetary values and therefore are valued by the market. By contrast, Chan and Seow ( 1996 ) find net incomes based on local GAAP to hold greater information content than US GAAP.

Dividing up the group of foreign filers, Barth and Clinch ( 1996 ) papers fluctuations depending on the state of abode. For UK and Australian houses, the rapprochements are found to be valued more than for Canadian houses. Given that US-GAAP and Canadian GAAP are similar for many points, this determination suggests that the utility of rapprochements to US-GAAP lessenings, as the foreign GAAP is more closely comparable to US GAAP. Alford et Al. ( 1993 ) reach similar decisions when sing several European local GAAP systems. They conclude that net incomes based on Danish, German, Italian, Singaporean and Swedish GAAP contain less information and are less seasonably than US-GAAP net incomes, while net incomes based on local GAAP of Australia, France, the Netherlands and the UK are comparatively more enlightening and timely.

Overall, consequences about US stock exchanges seem to propose that from an investor ‘s perspective rapprochements add value. While all the above surveies compare US-GAAP to other accounting governments within a US stock exchange environment, Harris et Al. ( 1994 ) is the lone survey that analyzes across exchanges. Similar to the US stock exchange surveies, Harris et Al. ( 1994 ) buttocks quality by looking at the association between monetary values and net incomes. These associations are nevertheless non calculated for the full sample, but for the German and US stock market individually. They find that the explanatory power of German net incomes is comparable to US net incomes, but the explanatory power of stockholder ‘s equity in Germany is significantly lower than in the US.

Net incomes

Net incomes are of import to a house for the ground that they are used as a drumhead step of the public presentation of a house by a big assortment of users. When making research on the quality of accounting information, it is first of all of import how to find this quality. In academic literature, quality of the accounting information is really frequently determined by the quality of the reported net incomes. For this affair, research workers have made the quality of accounting information through empirical observation operational by developing several properties in order to find the earning quality. [ Schipper and Vincent, 2003 ]

However, the term gaining quality in itself has no established significance and has been used with different readings ; i.e. with the usage of different gaining prosodies or properties, each covering a different characteristic of the quality facets of net incomes. Because net incomes can be decomposed into hard currency flows and accumulations, several research workers use accumulations quality to pull decisions about the earning quality. [ Dechow Dichev, 2002 ; Francis et al. , 2004 ] . Other research workers in bend interpret the quality of net incomes when net incomes are relentless [ e.g. Penman, 2002, Richardson, 2003 ] Mikhail et Al. ( 2003 ) explain the quality of net incomes in footings of the prognostic ability of the net incomes. They view net incomes to be of high quality when a houses past net incomes are strongly associated with its future net incomes. Other research workers view net incomes to be of higher quality when net incomes are value relevant, i.e. the net incomes are strongly associated with the security monetary value. [ Francis and Schipper, 1999 ]

Sing the academic literature on accounting information quality, no agreed upon definition or model for finding the quality of reported net incomes exists. As a effect, research workers determine gaining quality in assorted ways, i.e. looking at different facets of gaining in line with their position of what are of import facets of net incomes. This study tries to give a general overview on the earning quality of IFRS and US-GAAP and will cover several gaining properties which in bend may give a general position on the quality of the reported net incomes. Francis et al conducted a research in 2004 where they discussed the most of import and widely used gaining properties in order to come up with a sum-up of seven gaining properties. Their research discusses seven gaining properties used in anterior research and are divided into two groups, the market- and accounting-based properties, each depicting a alone feature of net incomes. Most literature on gaining quality investigates one or two gaining properties, while Francis et al. supply a sum-up of seven properties that are discussed in academic research. For this ground and besides the fact that their research was widely referred to by other research workers in analyzing the earning quality construct followed after the publication of their research, the sum-up of widely used properties by Francis et Al will be used in order to pull out a suited model in finding the earning quality for IFRS and US-GAAP net incomes.

Similarities and Differences of IFRS and US-GAAP

IFRS and US-GAAP follow similar conventions on many revenue enhancement issues. Table 1 summarizes many of the cardinal similarities and differences between IFRS and US-GAAP. Though both models require a proviso for deferred revenue enhancements, there are differences in the methodologies.Source: IFRS: IAS 1, IAS 12, and IFRS 3

Comparison of IFRS and US-GAAP

The impact of accounting criterions used in a specific state or market can be tested by two different attacks. The first attack looks at the quality of net incomes before and after the debut of a different criterion. More specifically, this attack foremost determines the quality of the fiscal information of the former criterion ( e.g. local GAAP ) . After the debut of the new criterion ( e.g. US-GAAP ) quality of the fiscal information is measured once more. This attack is for case used in the survey of Jennings ( 2004 ) .

In their survey they investigate if the acceptance of IFRS increases the seasonableness and value relevancy of fiscal statements. Specifically, they examine whether IFRS net incomes are timelier and more value relevant for states with high revenue enhancement alliances. Tax statute law efficaciously determines fiscal accounting criterions in states with high revenue enhancement alliance. Firms in high revenue enhancement aligned states will seek to undervalue their house net incomes to minimise revenue enhancements, thereby cut downing the extent to which the fiscal statements reflect the economic value of the house. In literature it is frequently claimed that IFRS imposes a grade of freedom on how to use the regulations for finding the accounting informations in specific accounting state of affairss. The research of Jennings proves that as a effect high and low revenue enhancement aligned states will utilize the IFRS regulations otherwise in specific accounting state of affairss. States with high severally low revenue enhancement alliance are referred to as HIGH and LOW states. They find IFRS net incomes to be significantly more seasonably in HIGH states, due chiefly to quicker incorporation of economic losingss under IFRS. They besides find IFRS net incomes and book values to be more value-relevant than High states. [ Jennings, 2004 ]

The 2nd attack refering the comparing on different accounting criterions, the rating theoretical account is run at the same time on the two sets. This is possible when in one state or market two or more accounting criterions are being used. This is for case the instance in the former German New Market, where houses had to describe fiscal statements that are either IFRS or US-GAAP compliant.

The 2nd attack is besides used in this study where the sample is based on a group of houses listed on the DJ Eurostoxx 50 as discussed in chapter two. Firms listed on the DJ Eurostoxx 50 have to follow on one manus to IFRS regulations, consistent with the EU statute law. On the other manus, a big proportion of houses on the DJ Eurostoxx are listed on the US-Market every bit good, for which the houses have to describe in conformity with US-GAAP, consistent with SEC demands. The undermentioned subdivision will cover with anterior research on the country of the comparing of US-GAAP and IFRS net incomes utilizing the 2nd attack. Four surveies using this attack based on the comparing between IFRS and US-GAAP could be found in academic literature.

The first research found on the comparing of US-GAAP and IFRS was done by Harris and Muller in 1999, where they investigate if net incomes and book value on the US market prepared by foreign filers under IFRS are more value relevant than the net incomes prepared by US houses utilizing US-GAAP. To turn to these inquiries, Harris and Muller use a sample of foreign houses, for the period 1992-1996, listed in the US that prepare their place state fiscal statements utilizing IFRS and supply rapprochements to US-GAAP through Form 20-F fillings. The intent of this research was to supply grounds for the argument between the US SEC and NYSE on whether foreign houses should be allowed to name in the United states by merely utilizing IFRS. They found that IFRS accounting informations is more associated with price-per-share and security returns than US-GAAP accounting informations, i.e. IFRS is more value relevant than US-GAAP accounting informations. [ Harris and Muller, 1999 ]

In 2002 Leuz compares US-GAAP and IFRS in footings of information dissymmetry and market liquidness – two cardinal concepts in securities ordinance. They use houses trading in Germany ‘s New Market for the old ages 1999 and 2000. The houses must take between IFRS and US-GAAP in fixing their fiscal statements, but face the same regulative environment. Their findings do non bespeak that US-GAAP is of higher quality as often claimed. Analysiss of the scattering of analysts ‘ prognosiss, IPO dumping and houses ‘ criterion picks support these findings. Therefore, at least for New Market houses and based on the research workers ‘ quality rating theoretical account, IFRS and US-GAAP appear to be comparable. [ Leuz, 2002 ]

The 3rd survey was performed in 2006 by Van der Meulen et Al. In their survey, they compare the quality of US-GAAP and IFRS utilizing a sample consisting of German new market houses for the period between 1997 through 1999. They find that the quality of US-GAAP prepared fiscal statements and IFRS information is overall really comparable, based on several gaining quality properties such as accrual quality, value relevancy, doggedness and seasonableness. They found US-GAAP to be significantly more relentless than IFRS. [ Van der Meulen et al. , 2006 ]

Finally, the survey by Ndubizu ( 2006 ) compares the differences in value relevancy of net incomes prepared under US-GAAP Chile with IFRS in Peru. In their research, on informations from 1992 through 2000 on they observe that net incomes contain value-relevant information for investors in the two accounting governments. However, US-GAAP net incomes are more value relevant than the IFRS net incomes. They besides find that US-GAAP losingss in Chile are timelier than IFRS Numberss in Peru. The higher seasonableness is due to higher market sensitiveness to economic losingss ( income conservativism ) in Chile than in Peru. Therefore, the Chilean US-GAAP has higher quality accounting information than the Peruvian IFRS based on value relevant and seasonableness steps. [ Ndubizu, 2006 ]


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