Chapter 1: Introduction
In this literature review the subject conservativism in accounting will be discussed. Conservative accounting exist already for many old ages. Evidence is found that trading spouse in the early of the fifteenth century used conservative accounting ( Penndorf, 1930 ) . If it exits for so long so their has to be some ground why conservative accounting is still practiced. Watts ( 2003 ) provide those grounds of why conservative accounting is still applied and explained why it is an of import factor of accounting.
But what is conservative accounting? There is no general accepted definition but, several research workers have come with their definition of conservative accounting. Basu ( 1997 ) for illustration interpreted conservative accounting as followed: ”accountants ‘ inclination to necessitate a higher grade of confirmation for acknowledging good intelligence than bad intelligence in fiscal statements ” . In the literature reappraisal several other definition of accounting conservativism will be provided.
Conservative accounting is an of import rule of accounting hence there exits many research of this subject. The assortment of this subject is really big. For case research that studied the accounts of conservativism, or research that studied the nexus between conservativism and net incomes direction. Therefore I have narrowed the conservativism in this literature reappraisal to a few specific subjects. One of those subjects is conservativism and crisis. Those surveies have looked at conservativism during a crisis. The consequences were that companies report less conservative during a crisis. But those consequences are bases on the Asiatic crisis that occurred in 1997.
1.2 Research inquiry
A batch have changed in the past old ages from 1997 until 2011, for case the recognition crisis that has hit the economic system worldwide. But what was the impact for the accounting?
Therefore this literature reappraisal has the undermentioned research inquiry:
”What was the impact of the recognition crisis on accounting conservativism? ”
I expect that companies were less conservative during the crisis. This is consistent with the anterior research. Although those surveies were based on the Asiatic crisis and conducted in a different period. I expect that companies reacted the same in the recognition crisis as companies did in the Asiatic crisis.
This literature reappraisal is relevant for practicians, fiscal analyst, accounting pupils and other who are interested on the impact of the recognition crisis on accounting conservativism. As stated in the old paragraph there has been some research to conservative accounting in relation with a crisis. But those surveies where based on the Asiatic crisis. In this literature conservative accounting in relation with the recognition crisis will be studied. Therefore this literature reappraisal provides some new penetration on the relation between conservative accounting and crisis.
1.3 Structure
The construction of the literature reappraisal will be as followed. In the chapter two a theoretical background of conservative accounting will be provided. The definitions and accounts of conservativism will be discussed. Chapter three is about the method that step conservativism. The method and restrictions will be discussed in this chapter. The 4th chapter prior research on accounting conservativism will be presented. Finally chapter five consists of a short sum-up of the literature reappraisal.
Chapter 2: conservative accounting
In this chapter I will discourse the literature about conservativism. At the beginning of this chapter the accounting rule conservativism will be discussed. The grounds of bing of conservativism will be explained.
2.1 definitions
The trouble of the research of conservativism is that there is no specific definition for what conservativism is, although it is a really of import and good cognize feature of the Generally Accepted Accounting Principle ( Huang et al. , 2008 ) .
The FASB attempts to give an account of what conservativism is. Statement of Financial Accounting Concepts ( SFAC ) No.2 ( FASB, 1980 ) paragraph 95 provinces: “ if two estimations of sums to be received or paid in the hereafter are about every bit likely, conservativism dictates utilizing the less optimistic estimation ” .
This means that the company should take the lowest estimation. Therefore the company is being carefully in mensurating the assets and liabilities, or sums to be received or paid in the hereafter. As a consequence the hazard that the company has overstated his assets will be much lower. Even if something happens in the hereafter that could hold an impact on the company, the hazard of exaggerating is less.
Because of the fact that there is no exact definition of conservativism. Researcher has interpreted accounting conservativism in different ways.
Accountants have interpreted traditionally conservativism regulation as: “ anticipate no net income, but anticipate all losingss ” . ( Bliss, 1924 ) . This is conservativism is its utmost signifier, because you do n’t anticipate/ acknowledge any net incomes and that you recognize all losingss even if they are n’t yet verifiable. The net income will merely be recognized when they are wholly verifiable and there is a legal claim on the net income.
( Basu,1997 ) has interpreted this conservativism regulation in accounting as: ”the accounting inclination to necessitate a higher grade of confirmation to acknowledge good intelligence as additions that to acknowledge bad intelligence and losingss ” . For this reading he used several accounting conservativism examples for case: ( Accounting Principle Board ( APB ) sentiment 6, APB,1965 ) ”writing down of physical assets to reflect obsolescence of damages, but non appreciating them upwards. For this and other illustrations he concluded that conservativism consequences in a greater chance of more timely accounting acknowledgment of bad intelligence and good intelligence ( Basu, 1997 ) .
( Watts,2003 ) defines conservativism as followed. ”Conservatism is the asymmetrical confirmation demands for additions and losingss ” . This means that there exist a difference in demand for acknowledging net incomes and losingss. This definition allows different grades of conservativism. It depends on the grade of confirmation of net income and losingss. The greater the difference of confirmation the greater the grade of conservativism.
The definitions of ( Basu,1997 ) and ( Watts, 2003 ) are the most used definitions of conservativism in the recent documents and surveies. Therefore those definitions of conservativism will be further used for this paper.
In the accounting literature there is a differentiation made between conditional conservativism and unconditioned conservativism. Unconditional conservativism besides called antique ante or intelligence dependant and conditional conservativism besides referred as antique station or intelligence independent ( Beaver & A ; Ryan, 2005 ) . What is meant under unconditioned conservativism is the undermentioned: ”the preset understatement of the book value of net assets, as occurs with the immediate expensing of the cost of most intangibles ” ( Ryan, 2006 ) . This type of conservativism is besides referred as balance sheet conservativism. With conditional conservativism is meant the difference of timely acknowledgment of bad intelligence and goods intelligence besides called the asymmetrical seasonableness ( Ryan,2006 ) . Conditional conservativism is besides referred net incomes conservativism.
2.2 accounts of conservativism
As mentioned in the old portion of this paper. There is non a general definition of conservativism despite the fact that it is an of import rule. Conservatism has influenced accounting for many centuries. In fact it has influenced the accounting pattern for at least 500 old ages ( Basu, 1997 ) . There are historical records found of merchandising partnership in the early fifteenth century who pattern conservativism ( Penndorf, 1930 ) . With this records it is proven that conservativism in Europe exist for many old ages. The fact that conservativism exist for so many old ages must be a positive thing, because if it had a negative impact on accounting it would hold been deleted many old ages ago, as in line with accounting Darwinism that merely the fittest will last.
In the literature there exist several accounts for the being conservativism in accounting. Those accounts are: catching, judicial proceeding, revenue enhancement and accounting ordinance ( Basu,1997: Watts, 2003a & A ; B ) . In the following subdivision a will explicate and lucubrate each of the four accounts stated above.
2.2.1 Contracting
The first account is undertaking. ”Conservatism arises because it is portion of the efficient engineering employed in the organisation of the house and its contracts with assorted parties ” ( Watts, 2003a ) . With conservativism in accounting the moral jeopardy job is limited and bureau cost is reduced. Agency cost is based on the bureau theory ( Jensen and Meckling,1976 ) they define bureau relationship as: ”a contract under which one or more ( rules ) engage another individual ( the agent ) to execute some service on their behalf which involves deputing some decision-making authorization to the agent ” .
In other words this means that the agent ( director ) has to work for the involvement of the rule ( stockholders ) , but the agent has his ain involvement. Therefore the involvements of the agent en the rule are different and that can do costs. Those costs are called bureau cost. The moral jeopardy is that people act otherwise if they do non hold to pay for the cost or merely a little portion. As a consequence they do n’t bear the cost/risk. For illustration a director will put in a extremely hazardous undertaking, because the money is from the stockholders and if the investing turns out to be good he gets the credits but when it turns out to be negative the stockholders have lost their money non the director.
The job with moral jeopardy and bureau theory is that it comes from the information dissymmetry between the agent and the principal ( Jensen and Meckling ; 1976 ) . Directors have more information about the house than stockholders, because the directors are working at the house and hence cognize what is go oning. The stockholders rely on the information provided by the directors. This difference of information degree is called the information dissymmetry. ( Lafond and Watts, 2008 ) found grounds that this is a ground that conservativism is applied. In chapter four I will lucubrate the consequences some more.
Conservatism reduces the optimistically positions of the directors, because they have to acknowledge the full losingss and merely partially acknowledge additions. As a consequence the directors can pay fewer dividends to the stockholders and have less fillip wagess. The latter is besides called the compensation contracts ( Watts, 2003a ) .
Conservatism besides reduces the hazard for debt holders that, the direction over spend the money and that the assets are overstated. In other words the debt catching ( Watts 2003a ) . Again there is grounds that debt catching is linked with conservativism and that it consequences in benefits ( Beatty et al. , 2008 ; Zhang, 2008 ) . A concluding subgroup of catching is corporate administration. Timely signals of bad undertaking will be a consequence of conservativism. This protects the stockholders because, they can look into the bad undertaking and take appropriate actions ( Watts, 2003a ) .
2.2.2 Litigation cost
This account for conservativism expressions at the hazard of judicial proceedings. The hazard of judicial proceeding for exaggerating the assets and consequences is much higher than for minimizing the assets and consequences ( Watts, 2003a ) . The ground is that when the company overstated his assets and consequences and the market finds out that the company overstates their assets and consequences there will be a bead in the market value of the company. This bead of market value causes fiscal injury to stockholder. But when it ‘s the other manner around ( minimizing ) the company has really a bigger market value. Therefore the stockholders are non instantly harmed. As a consequence of exaggerating consequences in a higher judicial proceeding hazard. ( Chung et al.,2008 ) found grounds that there is a relation between judicial proceeding and conservativism.
2.2.3 Tax
Watts ( 2003a ) links conservativism with revenue enhancement for the undermentioned ground. Companies will take down their reported income to take down their nonexempt income. Therefore they defer the collectible revenue enhancements to the hereafter. As a consequence they have to pay a lower revenue enhancement in their current financial twelvemonth, because they have lowered their income by full acknowledging their cost and merely partially acknowledging their additions.
2.2.4 Accounting ordinance
In this concluding account for accounting conservativism Watts ( 2003a ) concludes that conservativism is besides a consequence of the regulations and ordinance. As mentioned earlier in paragraph 2.1 the illustration of the FASB that the company has to take the lowest of the two rating methods. This consequences in an understatement of the assets ( conservativism ) .
FASB is non the lone regulator with regulations that consequences in conservativism. For case the IFRS ( 2004 ) sees conservativism as the prudence rule. With this rule you have to be cautious with gauging the assets, so that assets are n’t overstated and liabilities are n’t unostentatious. As a consequence when you apply this rule from the IFRS you have to be conservative.
The ground that regulators prefers conservativism is that the political effects will be lower ( Watts, 2003a ) . When the regulations leads to exaggerating the populace will keep the regulators responsible for their losingss. Therefore the regulators prefer conservativism which consequences in fewer critics.
The catching and judicial proceeding account are the most of import grounds for conservativism, revenue enhancement and accounting ordinance have weaker grounds ( Watts, 2003a ) .
Chapter 3: measurement conservativism
In this chapter I will explicate and lucubrate some theoretical accounts that measures accounting conservativism. Those theoretical accounts uses different attacks but they are grouped into 2 chief subjects. Those are information position and the measuring position. In the following subparagraph a will seek to explicate those positions a spot further. After those positions I will briefly discus the market efficiency hypotheses followed by classification that Watts ( 2003b ) made of theoretical accounts that measures accounting conservativism. Finally the theoretical accounts will be discussed.
3.1 market-based accounting
Conservatism in accounting is a subject in market-based accounting research. In this research approach the focal point lays on the relation between portion monetary values and accounting Numberss.
The market-based attack uses the market efficiency theory from ( Fama et al. , 1969 ) . He provided three hypotheses of market efficiency. Those are: strong signifier of efficiency, semi strong efficiency and the weak signifier of efficiency. The strong signifier indicates that all available information including private and public information is right interpreted and rapidly spread. The semi strong indicates that non all private information is right interpreted and available. The weak signifier indicates that merely anterior information about the portion monetary values and trading volumes are reflected in the current portion monetary values.
The market-based attack has two positions those where already mentioned in the debut but, I will give an account of those positions. With the information position there is expected that when new information becomes available there will be a portion monetary value reaction. The new information must be utile otherwise it is n’t new information that leads to reactions of investors. ( Scott,2008 ) . The other position is the measurement position. The measuring position harmonizing to ( Scott,2008, P. 177 ) . ”to determination utility is an attack to fiscal coverage under which comptrollers undertake a duty to integrate current values into the fiscal statements proper, supplying that this can be done with sensible dependability, thereby acknowledging an increased duty to help investors to foretell steadfast public presentation and value ” .
Watts does n’t look at the differences in information position and measuring positions. Alternatively he categorized the methods used to mensurate conservativism in the undermentioned groups.
Net assets steps, Net incomes and accrual steps, Earnings/ stock returns relation steps ( Watts,2003b ) .
Under net assets step conservativism leads to understatement of net assets. They are valued below the market value. ( Watts, 2003 ) . One of those methods to mensurate conservativism was developed by the theory of Feltham and Ohlson ( 1995 ) the market to book ratio ( Givoly and Hayn,2000 )
Net incomes and accumulations steps. Under this method conservativism is seen as that net income are n’t to the full recognized but the losingss are to the full recognized. This consequences in an dissymmetry in accumulations because of the different intervention of net incomes and losingss. Conservatism can be measured as the negative periodic net accumulations and negative cumulative accumulations accumulated over periods ( Watts, 2003 ) . Several documents have used this method to mensurate conservativism such as ( Basu,1997 ; Givoly and Hayn, 2000 ; Ball and Shivakumar,2005 )
Earnings/stock return relation step. In this methods ”the stock market monetary values reflect the value alterations at the clip those alterations occur those alterations imply losingss or additions in assets value- stock returns be given to be timely ” ( Watts,2003, p.290 ) . There have been many fluctuations on this method but the method that had been largely applied in paper is the method of Basu ( 1997 ) .
In the undermentioned subparagraph I will discourse some of the methods that have been mentioned more and supply some others methods.
3.2 measuring method
In this paragraph the methods that are used to mensurate conservativism in accounting will be discussed in every subparagraph a different method is so farther elaborated. Finally some restrictions of the methods will be provided.
3.2.1 Basu Model
As already mentioned in paragraph 2.1 Basu ( 1997 ) construe accounting conservativism as the consequence that bad net incomes are more rapidly reflected so good intelligence. Therefore there is a systematic difference in the seasonableness and continuity in net incomes. Harmonizing to ( Basu,1997 ) stock monetary values reflect information received from beginnings other than current net incomes. This means that all publically available information is reflected in the portion monetary values. And due to conservatism there is an asymmetrical acknowledgment of goods intelligence and bad intelligence. Therefore Basu predict that the net incomes are more sensitive for bad intelligence than for good intelligence. To mensurate the conservativism he uses stock monetary values as a placeholder for good and bad intelligence ( Basu,1997 ) . The stock returns can be both positive and negative. When it is negative it is an indicant for conservativism, because losingss are recognized earlier so net incomes. Therefore you will acquire a negative stock return with losses/bad intelligence.
Basu ( 1997 ) uses the undermentioned expression: Xit / Pit 1 = I±o + I±1DRit + I?0Rit + I?1Rit*DRit
Xit / Pit 1 agencies: the net incomes per portion for house I in the financial twelvemonth t/ monetary value per portion at the beginning of the financial twelvemonth. The D is the silent person variable in the arrested development. The silent person variable is 1 or 0. This depends on the R. If R is positive so is will be 0 but when R is negative silent person variable is 1. R bases for the return. The return is the dividend and the difference in portion monetary value. Rit base for the house I in the period get downing 9 months before the terminal of the financial twelvemonth T and stoping 3 months after the financial twelvemonth terminal. Basu have made this differentiation of 9 and 3 months because the one-year study is expected between those two periods.
Basu expect that net incomes are more sensitive for bad intelligence so for goods intelligence. I?1 steps this difference in sensitiveness. Therefore the more conservative a house is the bigger I?1 will be. To farther bespeak the comparative sensitiveness he uses the undermentioned ratio ( I?1+ I?0 ) / I?0.
In his paper Basu made several anticipations and theoretical accounts. I have merely discussed the first anticipation and theoretical account because, the other anticipations and theoretical accounts are related to the first 1. And in other documents like ( Givoly and Hayn,2000 ; khan and Watts,2009 ) the first arrested development theoretical account is merely used or criticized. And the rearward earnings-returns arrested development from Basu ( 1997 ) is the most often used step for timely loss acknowledgment ( Dechow et al.,2010 ) .
3.2.1.1 restriction of the Basu theoretical account
Although the method of Basu ( 1997 ) with some fluctuations on his methodological analysis is used in many other surveies ( Watts, 2003b ) , there exist some critic on his method. In this subdivision a will supply some unfavorable judgment on the Basu method.
The first restriction of the method is that it depends on the stock monetary value motions for bad intelligence and good intelligence ( Givoly and Hayn,2000 ) . The restriction of this is the fact that bad intelligence is merely reflected by negative stock returns. In other words Basu assumes that every negative stock returns is bad intelligence and hence a signal for conservativism.
But the negative stock returns could besides be caused by different things such as a crisis, or another tendency. Ball and Shivakumar ( 2005 ) provided some more restrictions. The theoretical account can merely place the being of additions and losingss non whether if they are seasonably or non. And 2nd is that the theoretical account ca n’t separate between the net incomes and losingss constituents in to net incomes from random mistakes.
( Huang et al.,2008 ) says that the Basu theoretical account implicated that the house specific features ( size, purchase etc. ) are homogeneous, but those features are heterogenous. And eventually ( Givoly et al.,2007 ) and ( Dietrich et al. , 2007 ) provides some more unfavorable judgment. Givoly et Al. ( 2007 ) found other factors like clip periods, states and describing governments act upon the measuring method of Basu. ( Dietrich et al.,2007 ) conclude that the method of Basu consequences in prejudices and hence those prejudices steps conservativism.
3.2.2 Givoly and Hayn theoretical account
Givoly and Hayn ( 2000 ) use four methods to mensurate conservativism. one of those methods is the method from Basu discussed in the old subparagraph. The other three methods are degree of accrued negative non-operating accumulations, steps based on the time-series belongingss of net incomes and hard currency flows and market-to-book ratio. I will lucubrate each method in the following subparagraphs.
3.2.2.1 Non-operating accrual method
Accrual accounting is the antonym of hard currency accounting. With accrual accounting you match the cost and additions with existent income and disbursals. Cash flows are unaffected by accumulations ( Givoly and Hayn, 2000 ) . Therefore the accumulations could be seen as the difference of what the company really earns ( income ) and the hard currency flows. As a consequence of this you can utilize the accumulations as a step for conservativism which implicates that more negative accumulations leads to more conservativism and the other manner around. Givoly and Hayn ( 2000 ) use the undermentioned expression: non-operating accruals= entire accumulations ( before depreciation ) – operating accumulations
Entire accumulations ( before depreciation ) are: ( net income+ depreciation ) – hard currency flow from operation. Givoly and Hayn ( 2000 ) uses entire accumulations before depreciation because, the accumulations left are those of bad debt proviso and loss proviso.
Operating accumulations are: I” history receivable + I” stock lists + I” prepaid disbursals – I” history collectible – I” revenue enhancements collectible.
One restriction of this step of conservativism is, that this step is consistent with ‘big bath ‘ . And large bath is a consequence of net incomes direction and non of accounting conservativism ( Zhang, 2008 ) . Large bath theory is based on ( Healy,1985 ) , intending that new directors will take excess losingss and fault at that place predecessor. The consequence is that the directors have a bigger alteration of making their mark net income the undermentioned twelvemonth because of the excess right off/ losingss they have already recognized.
3.2.2.2 steps based on the time-series belongingss of net incomes and hard currency flows
This method consist of two measurement methods. I will discourse those two methods individually. The first method is the lopsidedness the 2nd is variableness.
Conservatism leads to full acknowledgment of losses/cost and partly acknowledgment with a hold of good intelligence. Because of this dissymmetry in acknowledging losingss and additions there exist a negative skewed distribution of net incomes ( Givoly and Hayn, 2000 ) . This means that net incomes do n’t hold a normal distribution. With a normal distribution the lopsidedness is 0. With a negative lopsidedness the left tail of the distribution is longer. And with a positive lopsidedness it is the other manner around. A negative lopsidedness will bespeak conservativism.
Givoly and Hayn ( 2000 ) uses the undermentioned expression to mensurate conservativism: [ E ( x-Aµ ) 3 ] /I?3
The x stands for return on assets ( ROA ) or hard currency flow from operation ( CFO ) /assets. The Aµ is estimated by the mean of the x distribution. The I? is estimated as the standard divergence of the distribution of ten.
One restriction of this step of conservativism is, that this step is once more consistent with ‘big bath ‘ ( Zhang, 2008 ) .
The 2nd method is the variableness method. Conservatism is measurement by the standard divergence of net income to entire assets ( ROA ) . A high criterion divergence is linked to conservativism ( Givoly and Hayn,2000 ) . Therefore a higher standard divergence leads to a higher accounting conservativism.
3.2.2.3 The market-to-book ratio
The concluding measuring method of accounting conservativism provided by Givoly and Hayn ( 2000 ) is the market-to-book ratio. They use the theoretical model of Feltham and Ohlson ( 1995 ) . With this method market-to-book ratio is used as a placeholder for accounting conservativism. Through accounting conservativism assets are undervalued because losingss are to the full incorporated and additions partly or delayed. This consequences in an undervaluation of the book value against the market value. This undervaluation is accounting conservativism. When the market-to-book ratio becomes higher there is expected that the conservativism will besides be higher.
One restriction of this method is that the market-to-book ratio could reflect market growing outlook alternatively of conservativism ( Givoly and Hayn, 2000 ) . The addition of the ratio could bespeak that the company merely has grown alternatively of increasing conservativism.
3.2.3 Khan and Watts theoretical account
The concluding measuring method I will discourse is the measuring of Khan and Watts ( 2009 ) . There method is based on the arrested development method of Basu ( 1997 ) , but they have modified the method so that they can mensurate steadfast twelvemonth degree conservativism. As one of the restrictions of the Basu theoretical account was that it does n’t look at house particular features ( Huang et al.,2008 ) .
Khan and Watts ( 2009 ) uses the undermentioned measuring of conservativism. they use the standard arrested development expression of Basu ( 1997 ) .
Eleven = I?1 + I?2DRi + I?3Ri + I?4Ri*DiRi + ei. vitamin E indicates the residuary mistake.
G_score= I?3 = Aµ1 + Aµ1Sizei + Aµ1 M/Bi + Aµ1 Levi
C_score= I?4 = I»1 + I»2Sizei + I»3 M/Bi + I»4 Levi
The C_score measures the firm-year conservativism. the G-score steps the seasonableness of good intelligence. The entire bad intelligence seasonableness is measured by the amount of the G_score and the C_score. The empirical calculators Aµ and I» are changeless across the houses. However they vary over clip because they are estimated from the one-year cross-sectional arrested developments. i= between 1-4. Size base for the natural log of market value of equity. Lev stands for the purchase. Leverage is the long term debt and short term debt deflated by the market value of equity. The M/B is the market-to-book ratio ( Khan and Watts,2009 ) . They have used those steadfast specific features because, those features are a placeholder for accounting conservativism. And more significantly those features vary with conservativism ( Khan and Watts, 2009 ) . Therefore they are of import house specific features that have an influence on the degree of accounting conservativism in a house. There exist many more steadfast specific features but, Khan and Watts have limited those variables for the ground of parsimoniousness. Meaning that with fewer variables they can utilize a bigger and complete sample size.
The C_score and the G_score are substituted into the arrested development expression. The concluding expression is so:
Eleven = I?1 + I?2DRi +Ri ( Aµ1 + Aµ1Sizei + Aµ1 M/Bi + Aµ1 Levi ) + DiRi ( I»1 + I»2Sizei + I»3 M/Bi + I»4 Levi ) + ( I?1 Sizei +I?2 M/Bi +I?3 Levi +I?4 DiSizei+I?5Di M/Bi + I?6 DiLevi ) + ei
In the concluding expression there are some excess footings included, because this expression includes interaction footings between returns and house features. Therefore the house features have to be individually controlled ( Khan and Watts, 2009 ) .
Chapter 4: overview of anterior research on conservativism
4.1 Introduction
As already mentioned in the paper conservativism is an of import rule for accounting, even though a clear definition of conservativism is losing. The fact that conservativism is of import and that the definitions are provided by research workers, has resulted in allot of research in accounting conservativism. The research subjects in accounting conservativism are really wide. For illustration some research is done to supply some account for conservativism. Others look at conservativism in relation with net incomes direction or the difference of conservativism between different states.
In this chapter I will discourse some documents that have done some research in the context of accounting conservativism. Some documents are already mentioned before, but in this subdivision the documents will be more detailed. And the consequences of those surveies will be farther discussed. The documents will be categorized in specific research subtopic of accounting conservativism. The categorizes are: the advancement of conservativism, unfavorable judgment on method that measures conservativism, accounts of conservativism and eventually conservativism and crisis. Every subparagraph will discourse a class in more item. In the appendix there will be a tabular array that provides an overview of the literature.
4.2 the advancement of conservativism
The first paper in this class is the paper from Basu ( 1997 ) . He used the rearward arrested development method to mensurate conservativism. He found that net incomes where two to six times as sensitive for negative returns so for positive returns, hence he concluded that accounting conservativism exists. The consequences where robust for several other methods. Basu besides concluded that positive net incomes are more relentless so negative net incomes. This difference implies that positive net incomes have a higher net incomes response coefficient significance that the unexpected unnatural net incomes are bigger for positive net incomes. Finally he concluded that accounting conservativism, in the United Stated of America ( USA ) , have increased in clip. For the last three decennaries ( ( the period 1963-1990 ) conservativism has increased, a possible ground could be the increased legal hearer ‘s legal liability exposure ( Basu, 1997 ) .
Givoly and Hayn ( 2000 ) had several methods to mensurate conservativism as stated in chapter three. They used several methods because, of the fact that an excepted definition of conservativism is losing. Givoly and Hayn found a tendency that over clip conservativism in accounting have increased. That is consistent with the determination of Basu ( 1997 ) . However Givoly and Hayn used several method of conservativism and they investigated a longer period 49 old ages ( 1950-1998 ) for houses in the USA. Givoly and Hayn think that the increasing conservativism is a consequence of the accountant inclination to exclude the intangibles from the accounting books of the house. And intangibles assets has become more outstanding for houses therefore the increasing conservativism could be explained by this factor.
Both documents are consistent with each other determination that accounting conservativism has grown over clip for house in the United States of America. But Basu ( 1997 ) thinks that the addition could be caused by the judicial proceeding hazard and Givoly and Hayn ( 2000 ) think that non acknowledging intangible assets could be the ground of increasing conservativism in accounting.
4.3 unfavorable judgment on method that measures conservativism
Dietrich et al. , ( 2007 ) examined the relationship between net incomes on stock returns and accounting conservativism. Many documents such as Basu ( 1997 ) found that bad intelligence is more timelier incorporated so good intelligence, hence asymmetrical seasonableness indicates accounting conservativism. But Dietrich et Al. ( 2007 ) found empirical grounds that the method timely loss acknowledgment is biased. And those prejudices are interpreted as grounds that accounting conservativism exists. Those prejudices are built-in related on the TLR method and hence irresolvable ( Dietrich et Al ( 2007 ) . They use a economic theoretical account that indicates the relation among the economic income, accounting net incomes, non-earnings information and stock returns. With this theoretical account accounting conservativism can be includes or excluded. To turn out that accounting conservativism is biased they used two trial sample of the twelvemonth 1963-1990 ( the same as Basu 1997 ) and 1991-2001. Both trial samples were tested with existent informations and simulated informations, as a consequence the could turn out the prejudices of timely loss acknowledgment. Therefore the consequences of this arrested development can non be interpreted as accounting conservativism. Finally Dietrich et Al ( 2007 ) suggested that research worker who wants to mensurate conservativism should used different methods such as market-to-book ratio or the negative non-operating accrual method.
The following paper that has besides some critics on the Basu ( 1997 ) seasonably loss acknowledgment ( TLR ) is that of Givoly et Al. ( 2007 ) . They have tested the power and the dependability of the TLR. To prove this they have used the arrested development expression of Basu ( paragraph 3.2.1 ) , for the trial period of 1950-2001 for houses in the USA, and have checked the sensitiveness of this expression against certain unrelated conservativism features. Those features where: collection consequence, the nature of the economic events consequence and the revelation policy consequence ( Givoly et al.,2007 ) . TLR uses stock returns as the step of conservativism, but those stock returns are aggregated informations. Therefore the TLR is mensurating informations that is gathered together to organize a entire measure.
Givoly et Al ( 2007 ) found grounds that the TLR is influenced by those features. Thus the TLR method leads to unnatural consequences. Their concluding decision was that the TLR measures merely a little fraction of conservativism, for that ground research worker should utilize more measuring method to capture conservativism. Otherwise when a research worker relies merely on a individual measuring method the consequence will take to wrong decision ( Givoly et al. , 2007 ) .
The concluding paper of this class is the paper of Huang et Al. ( 2008 ) . They investigated the heterogeneousness of the house specific features in the TLR. The used a modified arrested development theoretical account of Basu ( 1997 ) which includes some house specific features to mensurate the degree of conservativism of house in de USA in the period 1976-2005. Huang et Al ( 2008 ) conclude that the degree of conservativism is much lower as indicated in anterior research and that the degree of conservativism did non increase over clip. This is inconsistent with the determination of Basu ( 1997 ) and Givoly and Hayn ( 2000 ) . The ground could be that the sample period is different and more significantly Huang et Al. ( 2008 ) take into history that house particular features are n’t homogeneous. As a consequence of that the features will alter and are hence non the same for every house.
All three documents have remarks on the timely loss acknowledgment method. They are consistent that this method has several defects. However the documents indicate different defects. Changing from prejudices that are built-in on the method, to features that influence the method. And eventually non commanding for heterogeneousness of features.
4.4 accounts of conservativism
The first paper in this class will be Beatty et Al. ( 2008 ) .. Beatty et Al. ( 2008 ) used several methods to mensurate conservativism organize the period 1994-2004 and associate them to bureau cost. Agency cost are measured by contract specific and steadfast specific variables. They found grounds that conservative coverage is used with conservative debt compacts, by houses and loaner, to decide their bureau struggles. Finally Beatty et Al. ( 2008 ) concluded that contractual alterations entirely do non carry through loaners demands for conservativism. Meaning that loaners are in favor of conservativism and that they prefer conservativism in debt compacts and in fiscal coverage.
Zhang ( 2008 ) look into the benefits of conservativism in the debt catching procedure. He measures conservativism with several different methods for the period 1994-2003 and loan information for the debt catching procedure. Zhang ( 2008 ) found grounds that conservativism leads to take down involvement rates. This suggest that both loaners and borrowers benefit of conservativism. Otherwise loaners would non supply a lower involvement rate. This determination are consistent with ( Beatty et al. , 2008 ) , that debt catching in conservativism is utile. However the decision made by Zhang ( 2008 ) are based on a restricted sample. Therefore his decision could be biased through the little sample size.
Chung and Wynn ( 2008 ) conducted research on the nexus between conservativism and judicial proceeding. They have measured conservativism through the TLR and the judicial proceeding hazard was measured trough the amount of liability insurance coverage and the hard currency for damages for Canadian house for the old ages 1998-2004. Damagess are proviso taken by the company to counterbalance their director for legal liability costs. As a consequences when directors acted candidly they do n’t hold to pay for them self for the liability costs. Chung and Wynn ( 2008 ) used Canadian houses because for those steadfast their insurance informations is publically available. They found that houses with a high legal liability coverage are less conservative. Meaning that the hazard for legal liability for directors becomes lower when they have a high legal liability coverage and hence the net incomes became less conservative. The decision is that when a company has a high legal liability hazard, the company will be more conservative ( Chung and Wynn, 2008 ) .
Lafond and Watts ( 2008 ) studied the impact of information dissymmetry on conservativism. They used the TLR of Basu ( 1997 ) to mensurate conservativism and information dissymmetry was measured trough the PIN mark and the bid-ask spread for USA house in the period 1983-2001. The PIN mark is a step of unnatural order flow, which indicates that private information is used to sell or purchase stocks ( Lafond and Watts, 2008 ) . Lafond and Watts ( 2008 ) found grounds that dissymmetry is positively correlated to conservativism. This means that when dissymmetry of information is high, than conservativism in accounting will besides be high.
Khan and Watts ( 2009 ) have developed a steadfast twelvemonth step of conservativism. Khan and Watts have used the C_score method ( paragraph 3.2.3 ) for a sample of USA house for the period 1962-2005. They found that with the C-score they can foretell the flow of conservativism for a period of three old ages in front. They besides found grounds that companies with a high information dissymmetry have higher degree of accounting conservativism. Khan and Watts besides found that when a company has a high opportunity of judicial proceeding the company is more conservative. These consequences are consistent with anterior research of that of Chung and Wynn ( 2008 ) and Lafond and Watts ( 2008 ) .
All documents discussed in this class supply grounds that conservativism exists for a ground. Although the documents provide different accounts. They all concluded that conservativism in accounting have some benefits and hence conservativism is still used in accounting
4.5 conservativism and crisis
Gul et Al.[ 1 ]hold done research to the nexus between conservativism and audit fees in a period of a crisis. They have used the TLR of Basu ( 1997 ) to mensurate conservativism and used an audit fee arrested development theoretical account to capture the audit fee. Gul et Al. looked at listed Hong Kong houses for the period 1990-1997. Then they divided the sample into two period ( 1994-1995 ) and ( 1996-1997 ) . The first period are the non-downturn old ages and the latter are the downswing old ages which indicates the crisis twelvemonth ( Gul et al. ) . Gul et Al. found grounds that conservativism is lower during the crisis so the period before the crisis. And they found that the audit fees increases when conservativism decreases.
The paper of Herrmann et Al. ( 2008 ) studied the impact of the Asiatic crisis on the conservativism of the hearer. To mensurate conservativism they used a modified Basu ( 1997 ) theoretical account which includes silent person variables for large 4 audit houses. Herman et Al. ( 2008 ) looked at listed companies in Thailand for the period 1997-2003. They found that companies who are audited by a large 4 audit house are more conservative so companies who are audited by non large 4 audit houses. Herrmann et Al. ( 2008 ) found grounds that companies, audited by a large 4 audit house or non, are less conservative during a crisis and describe more conservative after the crisis. The grounds that houses are less conservative during crisis is consistent with the findings of Gul et al..
Eng et Al. ( 2010 ) besides found grounds that are consistent with the determination of Herrmann et Al. ( 2008 ) and Gul et al.. Harmonizing to Eng et Al. ( 2010 ) companies are less conservative during a crisis and they are more conservative after the crisis. Merely Eng et Al. ( 2010 ) found grounds that companies are even more conservative after the crisis so before the crisis. Their decision where made on a sample of listed houses in Hong Kong, Malaysia, Singapore and Thailand for the period 1995-2004. To mensurate conservativism they uses the Basu ( 1997 ) theoretical account and non runing accrual method from Givoly and Hayn ( 2000 ) .
The paper from Wu ( 2010 ) does n’t investigated if companies are less conservative during a crisis, but alternatively he studied the effects of conservativism during the fiscal crisis. He found grounds that companies who are more conservative suffer less during the fiscal crisis so companies who are less conservative. Therefore conservative accounting is an efficient mechanism to command the bureau costs ( Wu, 2010 ) . Therefore conservativism benefits the stockholders, because the bureau job is mitigated with conservativism. This determination is consistent with the account of conservativism ( paragraph 4.4 ) that conservative accounting has some benefits.
Wu ( 2010 ) used the C_score method ( Khan and Watts ) , the non runing accumulations method and the market to book ratio ( Givoly and Hayn, 2000 ) to mensurate conservativism. He looked at listed houses in the USA for the period October 2007- December 2008. He used this specific period because there is no official day of the month that indicates that the recognition crisis has begun. Therefore he started in October 2007 and ended in 2008, because the informations of 2009 was non yet available. As a consequence of the little sample size the determination of Wu ( 2010 ) could be biased and hence the incorrect decision where made.
The first three documents provided grounds that companies are less conservative during a crisis. Meaning that companies provide more good intelligence and delay with their bad intelligence during a crisis. And they found grounds that companies become more conservative after the crisis. Finally Wu ( 2010 ) provided grounds that more conservative house suffer less during a crisis so less conservative houses. He besides contributes some grounds that conservativism brings benefits to stockholders.
Chapter 5: Decision
At the beginning of the literature reappraisal accounting conservativism was discussed. Several definition were provided. Although a general recognized definition of conservativism is losing, conservativism can be seen as the higher confirmation demand for good news/ additions so the confirmation demand for bad news/ losingss.
Conservatism is a of import factor in accounting. Peoples already used conservative accounting in the early fifteenth century. Therefore at that place has to be a ground why conservative accounting exists. Those grounds are: catching, judicial proceeding, revenue enhancement and accounting ordinance.
There are several method to mensurate conservativism in accounting. The Basu ( 1997 ) theoretical account is the most popular one in researches. But you can besides mensurate conservativism with market-to-book ratio, not runing accumulations ( Givoly and Hayn, 2000 ) or C_score ( Khan and Watts, 2010 ) . All the methods have some restrictions. But more significantly is the fact that the methods merely measure a individual portion of accounting conservativism. Therefore you can non mensurate conservativism in entirety, when you use merely one individual method to mensurate conservativism ( Givoly et al. , 2007 ) .
There has been a batch of research on the subject conservativism. The anterior research of accounting conservativism indicates that conservativism has grown over clip. Besides they showed that there are restrictions on the timely loss acknowledgment method. Further the anterior research resulted in grounds that conservative accounting has benefits. Finally anterior research indicated that companies are less conservative during a crisis and more conservative after a crisis.
Research Design
As stated in the old chapter. Conservatism is an of import rule in accounting. It exist for many old ages. Conservatism is non merely of import for the company itself but, stockholder and debt holders besides benefit from conservativism. Prior research found grounds that companies are less conservative during a crisis. However those research was based on the Asiatic crisis. And hence had merely an impact on Asiatic states. Nowadays the recent recognition crisis had an world-wide impact. More significantly it had an impact on the western developed states.
Therefore I would wish to look into in this paper the undermentioned research inquiry: What was the impact of the recognition crisis on accounting conservativism?
I would anticipate that companies were less conservative during the crisis, what is consistent with anterior research. The lessenings in conservativism would be less than the lessening of conservativism in anterior research. Because the accounting ordinance has changed a batch during those old ages. And nowadays there are more in favor of just value accounting. Fair value accounting you can non be conservative because you have to utilize the market value.
The method I intent to utilize is the C_score ( Khan and Watts, 2009 ) , because they use steadfast specific features in the arrested development theoretical account. The original theoretical account from Basu ( 1997 ) had the restriction that it assumes that house features are homogeneous. While empirical grounds suggest that those features are heterogenous.
Because of the fact that one measuring method can non mensurate conservativism in entirety ( Givoly et al. , 2007 ) . I want to utilize a 2nd method to mensurate conservativism. This method will be the market-to-book ratio or the non operating accumulations method. It depends on the sum of informations that is available. For the first method less informations is needed so for the latter one.
For the sample I had in head to look at the listed companies in the Netherlands. I would wish to utilize the companies that are listed on the AEX, AMX and the ASCX. Those listed companies are working in many different industry sectors. Therefore you will acquire an little sample of Dutch houses, which are spread across a batch of different industries.
