Reporting Financial Performance

Round 1 of our joint program focused on Reporting Financial Performance and provided funding for five outstanding projects. In addition to receiving funding from KPMG, each team benefited from feedback provided by standard setters and leading scholars at four project events. The project deliverables were held at IAAER’s September 2005 International Research Conference for Accounting Educators in Bordeaux, France; at IAAER’s March 2006 workshop in New York City; at the August 2006 meeting of the American Accounting Association held in Washington, DC; and at the November 2006 IAAER World Congress of Accounting Educators held in Istanbul. 

• Original Call for Proposals

The following research teams participated in Round 1, with the resulting publications:

How Do Financial-Statement Data Inform Investors about Changes in Equity Value? Modeling and Empirically Testing the Relation between Operating Performance and Market Performance (Guochang Zhang and Peter Chen)

Abstract: Not available

Identifying Decision Useful Information With the Matrix Format Income Statement (Ann Tarca, Philip Brown, Phil Hancock, David Woodliff, Michael Bradbury, and Tony Van Zijl)

• Tarca, Ann, Woodliff, David R., Hancock, Phil, Brown, Philip R.,Bradbury, Michael E. and Van Zijl, Tony. Identifying Decision Useful Information with the Matrix Format Income Statement. Journal of International Financial Management & Accounting, Vol. 19, No. 2, pp. 184-217, June 2008.

Abstract: We conduct an experiment to investigate the potential benefits of an alternative format for the income statement, the matrix format, initially developed by the International Accounting Standards Board (IASB) and UK Accounting Standards Board in their joint project on performance reporting. Sophisticated financial statement users (financial analysts and professional accountants) and less sophisticated financial statement users (MBA students) were asked to extract information from a set of financial statements that included an income statement either in the IAS 1 format or in the matrix format. We find that the matrix format improves the accuracy with which users extract financial information. This result is driven by greater accuracy, for all user groups, on ‘‘below-theline’’ items. Furthermore, despite lack of familiarity with the matrix format, its use did not appear to affect the time taken, the ease of extracting financial information, or users’ task completion confidence; further experience with the matrix format could lead to benefits along these lines as well. Our findings may assist the FASB and IASB in their joint project on financial statement presentation.

What Performance Measure Attributes do Investors Value the Most? (Jan Barton, Bowe Hansen, Grace Pownall)

• Barton, Jan, Hansen, Thomas Bowe and Pownall, Grace. Which Performance Measures do Investors Value the Most - and Why? The Accounting Review, Vol. 83, No. 3, pp. 753-789, May 2010.

Abstract: We examine the value relevance of a comprehensive set of summary performance measures including sales, earnings, comprehensive income, and operating cash flows. We find that, while value relevance peaks for measures “above the line,” no single measure dominates around the world. Instead, a measure is more relevant when it captures, directly and quickly, information about firms’ cash flows. Specifically, for each performance measure by country, we estimate eight attributes commonly used to assess earnings quality. We find these attributes highly correlated—most of their variance is explained by only two principal factors. A factor capturing articulation with cash flows is positively associated with a measure’s value relevance; a factor reflecting the measure’s persistence, predictability, smoothness, and conservatism is negatively associated. Our results suggest that, when it comes to equity valuation, accounting researchers and standard-setters should focus not on what performance measure is “best” at a given point in time, but on the underlying attributes that investors find most relevant.

The Dynamic Effects of Other Comprehensive Income (Kimberly J. Smith and Denise A. Jones)

• Jones, Denise, and Kimberly J. Smith. Comparing the Value Relevance, Predictive Value, and the Persistence of Other Comprehensive Income and Special Items. The Accounting Review, Vol. 86, No. 6, pp. 2047-2073, November, 2011.

Abstract: Gains and losses reported as other comprehensive income (OCI) and as special items (SI) are often viewed as similar in nature: transitory items with little ability to predict future cash flows and minimal implications for company value. However, current accounting standards require SI gains and losses to be recognized in net income, while OCI gains and losses are deferred until realized. This study empirically compares OCI and SI gains and losses using a model that jointly estimates value relevance, predictive value, and persistence. Results show that both SI and OCI gains and losses are valuerelevant, but SI gains and losses exhibit zero persistence (i.e., are transitory), while OCI gains and losses exhibit negative persistence (i.e., partially reverse over time). Further, we find that SI gains and losses have strong predictive value for forecasting both future net income and future cash flows, while OCI gains and losses have weaker predictive value.

Disintegrated Performance Reporting (Leslie Hodder, Patrick E. Hopkins, and David A. Wood)

• Hodder, L., P.E. Hopkins, and D. Wood. The Effects of Financial Statement and Informational Complexity on Analysts' Cash Flow Forecasts. The Accounting Review Vol. 83, No. 4, 915-956, July 2008.

Abstract: We characterize the operating-activities section of the indirect-approach statement of cash flows as backward because it presents reconciling adjustments in a way that is opposite from the intuitively appealing, future-oriented, Conceptual Framework definitions of assets, liabilities, and the accruals process. We propose that the reversed-accruals orientation required in the currently mandated indirect-approach statement of cash flows is unnecessarily complex, causing information-processing problems that result in increased cash flow forecast error and dispersion. We also predict that the mixed pattern (i.e., +/-, -/+) of operating cash flows and operating accruals reported by most companies impedes investors’ ability to learn the time-series properties of cash flows and accruals. We conduct a carefully controlled experiment and find that _1_ cash flow forecasts have lower forecast error and dispersion when the indirect-approach statement of cash flows starts with operating cash flows and adds changes in accruals to arrive at net income and _2_ cash flow forecasts have lower forecast error and dispersion when the cash flows and accruals are of the same sign (i.e., +/+, -/-); with the sign-based difference attenuated in the forward-oriented statement of cash flows. We also conduct a quasi-experiment to test our mixed-sign versus same-sign hypotheses using archival samples of publicly available I/B/E/S and Value Line cash flow forecasts. We find that the passively observed samples of cash flow forecasts exhibit a similar pattern of mixed-sign versus same-sign forecast error as documented in our experiment.

Members of the IAAER KPMG Research Grant Program Round 1 Committee:

• Mary E. Barth, IASB Board Member and Atholl McBean Professor of Accounting, Stanford University
• Timothy B. Bell, Director, Assurance Research, KPMG International’s Audit & Advisory Services Center
• Katherine Schipper, Thomas Keller Professor of Business Administration, Duke University
• Donna L. Street (Program Coordinator), IAAER President and Mahrt Chair in Accounting, University of Dayton

Research on Defining, Recognizing and Measuring Liabilities

• Announcement: Grant Recipients
• Original Call for Proposals

The International Association for Accounting Education and Research (IAAER), in collaboration with KPMG, is pleased to announce our Research on Defining, Recognizing and Measuring Liabilities grant recipients. The program supports scholarly research directed at informing the IASB’s decision process for the Board’s projects related to Liabilities and Equities. Funded projects will be showcased at an IAAER mini-conference in London hosted by the Institute of Chartered Accountants in England and Wales on September 14, 2007, the American Accounting Association August 2008 conference in special sessions co-hosted by IAAER and the AAA International Accounting Section, and an IAAER mini-conference in Norwalk in October 2008.

The following research teams participated in Round 2, with the resulting working papers and publications:

Should Preferred Stock be Classified as a Liability? Evidence from Implied Cost of Common Equity Capital (C.S. Agnes Cheng (Louisiana State University); Kay Newberry and Cathy Zishang Liu (University of Houston), and Kenneth J. Reichelt (Louisiana State University),http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1014259, September 13, 2007.)

Abstract: The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are currently working together towards a comprehensive standard of accounting for financial instruments with characteristics of equity, liability, or both. An important facet of this project is to determine the appropriate liability vs. equity classification of preferred stock. In its preliminary views, the FASB has selected an ownership approach. Recent Board deliberations resulted in a majority vote (with two dissenting board members) for classifying even perpetual preferred stock as a liability under the ownership approach. We contribute to this important question by examining how the equity market, on average, incorporates different forms of preferred stock (and the components of their other liability obligations) into the cost of common equity capital (COCEC). Using a change model for a large sample of firms over the period 1980-2005, we find that COCEC increases with firms' preferred stock holdings. This finding holds whether the increase in preferred stock relates to shares that are redeemable, non-redeemable, or convertible. Our results suggest that a strict liability view of preferred stock is a viable classification scheme.

Accounting for Liabilities and Equity of Financial Institutions – Analyzing and Allocating Market and Credit Risk to Funding Instruments (Günther Gebhardt, Rolf Reichardt, and Michael Reiland (Universität Frankfurt am Main))

Abstract: Not available.

Does the Current Definition of Liabilities in the IASB’s Framework Provide an Adequate Basis for Estimating the Equity Value of the Firm When Using an Asset-Side Valuation Approach? (Mauro Bini, Francesco Momentè, and Francesco Reggiani (Università Bocconi); Emanuel Bagna (UTS))

• E. Bagna, M. Bini,  R. Bird, F. Momentè, and F. Reggiani  “Accounting for Employee Stock Options: What Can We Learn from Market’s Perceptions”, Journal of International Financial Management and Accounting, Vol. 21, No. 2, 274 – 306, Summer, 2010.

Abstract: The scope of this is paper is to provide new empirical evidence on the value relevance of employee stock options (ESOs) in Europe.We show, empirically, that the market participants when pricing a firm’s equity place approximately the same valuation weights on the ESO deferred compensation expense (the so called ‘‘ESO asset’’) and the compensation option liability (the so called ‘‘ESO liability’’). Our empirical findings support the theoretical work of Ohlson and Penman who suggest that the deferred compensation expense be treated as a contra-liability. The second contribution of our work rests on the nature of the ESO expense. We show that the distinction between persistent and non-persistent ESO expenses is of critical importance for the market participants. Accordingly, an improved accounting disclosure should assist the investors in assessing the long-term goals of the ESO plans at the firm level.

Distinguishing Liability from Equity in Co-operative Entities (Fernando Polo-Garrido and Juan Francisco Juliá Igual (Universidad Politécnica de Valencia); James H. Smith, John Maddocks, and J. Tom Webb (St. Mary’s University); Elizabeth A. G. Hicks (Mount Saint Vincent University); Germán López-Espinosa (Universidad de Navarra); Volker Heegemann (Federal Association of German Cooperative Banks))

• G. López-Espinosa, J. Maddocks,  and F. Polo-Garrido,  “Equity-Liabilities Distinction: The case for Co-operatives”, Journal of International Financial Management and Accounting, Vol. 20, No. 3, 274 – 306, Autumn, 2009.

Abstract: Members' shares in co-operative entities are financial instruments with particular characteristics. In this paper we analyse the relation between firm leverage and systematic risk to provide empirical evidence on the economic substance of the member shares of members of cooperatives. We have studied the characteristics of members' shares in six European countries: France, Germany, Italy, Portugal, Spain and United Kingdom. We have also conducted tests on co-operatives of these countries over the period 1993–2005. The study reports that in global terms the economic substance of the redeemable part of equity in co-operatives is not the same across countries. Therefore if accounting standards setters want to develop a global standard for co-operatives, a recommendation derived from this study would be to follow a probabilistic model to classify the redeemable part of co-operative financial instruments, where the entity does not have the unconditional right to refuse the redemption, or to report this part as an intermediate item with characteristics of debt and equity.

Risk Management Effects on Liabilities and Equity- Cost of Capital Implications (Paul J M Klumpes, Peng Wang, and Liyan Tang (Imperial College London))
Working paper: August 2008.

Abstract: We estimate the cost of capital for a sample of US S&P firms under various scenarios where change in pension Generally Accepted Accounting Principles (GAAP) can occur. We adjust the weighted cost of capital to allow for currently off balance sheet extended pension arrangements to be viewed as either insurance or own risk capital based structured finance instruments. We find that the estimated cost of capital is sensitive to: (a) alternative pension GAAP; (b) whether a firm’s pension exposure is classified primarily as a debt or equity instrument; and (c) the scope and nature of the pension plans being consolidated with the firm. We also find that the consolidating or merging both the value and risk of sponsored DC pension plans increases the strength of association with firm risk.

Members of the IAAER KPMG Research Grant Program Round 2 Committee:

• Mary E. Barth, IASB Board Member and Atholl McBean Professor of Accounting, Stanford University
• Timothy B. Bell, Director, Assurance Research, KPMG International’s Audit & Advisory Services Center
• Katherine Schipper, Thomas Keller Professor of Business Administration, Duke University
• Donna L. Street (Program Coordinator), IAAER President and Mahrt Chair in Accounting, University of Dayton

Informing the IASB Decision Process

The International Association for Accounting Education and Research (IAAER), in collaboration with KPMG LLP and the KPMG Foundation, is pleased to announce our Research Informing the IASB Decision Process grant recipients.

• Announcement: Round 3 Grant Recipients
• Abbreviated call for research proposals

How to Assess High Quality Financial Reporting? – An Analysis of Earnings Quality Metrics
Ralf Ewert, Karl-Franzens-University Graz, Austria
Andrea Szczesny, Julius-Maximilians-University Würzburg, Germany
Aljoša Valentinčič, University of Ljubljana, Slovenia
Alfred Wagenhofer, Karl-Franzens-University Graz, Austria

Ewert, Ralf, and Alfred Wagenhofer (2015): Economic Relations among Earnings Quality Measures, Abacus 51(3), 311-355.

Abstract: Empirical studies on earnings quality use various measures that capture particular dimensions of earnings quality. This paper provides a theoretical foundation to evaluate and compare several common earnings quality measures: value relevance, persistence, predictability, smoothness, and discretionary accruals. We use a rational expectations framework in which a manager has market price, earnings, and smoothing incentives and can bias earnings reports. Taking the information content of reported earnings as a natural benchmark, we determine how variations of management incentives, operating risk, and accounting noise affect earnings quality and examine whether the different measures point in the same or in the opposite direction. We find that value relevance and persistence are measures that are closely aligned with each other and with our benchmark, followed by predictability and smoothness. Discretionary accruals measures are less aligned because they are based on the level of accruals, which confounds their information content. Our results also support the notion that smoother earnings and higher discretionary accruals are associated with greater earnings quality.

An International Analysis of Alternative Pension Measures and Presentations
Carol Ann Frost, University of North Texas, USA
Elizabeth A. Gordon, Temple University, USA
Lili Sun, University of North Texas, USA

Bank Disclosure Quality and the Subprime Crisis
Beng Wee Goh, Singapore Management University, Singapore
Jeffrey Ng, Massachusetts Institute of Technology, USA
Kevin Ow Yong, Singapore Management University, Singapore

Fair Value Reclassifications of Financial Assets: Economic Determinants, Reporting Effects, and Capital Market Consequences
Holger Daske, Universitat Mannheim, Germany
Jannis Bischof, Universitat Mannheim, Germany
Ulf Brüggemann, Lancaster University, UK

Revenue Recognition in Long-term Construction Contracts
Yin Xu, Old Dominion University, USA
Timothy S. Doupnik, University of South Carolina, USA

Funding for this program is provided by KPMG LLP and the KPMG Foundation. Funded projects will be showcased in three highly visible events involving representatives from the IASB and other accounting standard setters as well as renowned accounting researchers. These include an IAAER by-invitation workshop in Palm Springs on January 28, 2010 preceding a joint IAAER meeting with the International Accounting Section of the American Accounting Association, a workshop held in Singapore during the IAAER World Congress of Accountants on either November 5 or 6, 2010, and a by-invitation mini-conference in either London or Norwalk during spring 2011. 

Members of the IAAER KPMG Research Grant Program Round 3 Committee:

• Mary E. Barth, former IASB Board Member and Atholl McBean Professor of Accounting, Stanford University
• Timothy B. Bell, Director, Assurance Research, KPMG International’s Audit & Advisory Services Center
• Katherine Schipper, Thomas Keller Professor of Business Administration, Duke University
• Donna L. Street (Program Coordinator), IAAER President and Mahrt Chair in Accounting, University of Dayton

Informing the IASB Decision Process

• Announcement: Round 4 Grant Recipients
• Full call for research proposals

The International Association for Accounting Education and Research (IAAER), in collaboration with the KPMG Foundation and KPMG International, is pleased to announce our Research Informing the IASB Decision Process grant recipients. Four research grants of $25,000 (U.S.) each have been awarded for the following research projects:

A Review of Academic Research on Statement of Cash Flow Reporting and Presentation Effects 
Jeffrey Hales (Georgia Institute of Technology) 
and Steven Orpurt (Arizona State University)

Own Credit Risk in Liability Measurement: Implications from International Reporting Practice for the Measurement Phase of the Conceptual Framework Project 
Holger Daske (University of Mannheim / London Business School) 
Jannis Bischof (University of Mannheim) 
and Ulf Bruggemann (Humboldt University of Berlin)

The Effect of Alternative Accounting Measurement Bases on Financial Statement Users’ Resource Allocation Decisions and Assessments of Managers’ Stewardship 
Patrick E. Hopkins (Indiana University) 
Jason Brown (Indiana University) 
and Leslie Hodder (Indiana University)

A Review of Academic Research on the Reporting of Cash Flows from Operations
Steven F. Orpurt (Arizona State University)

Presentation and Risk Relevance of Financial Derivative Exposures 
Tony Kang (Oklahoma State University) 
Michael Wolfe (Oklahoma State University)
and Gerald Lobo (University of Houston)

Determinants of Goodwill Impairment Incidence and Intensity: International Evidence

• Glaum, M., Landsman, W.R., Wyrwa, S., “Goodwill Impairment: The Effects of Public Enforcement and Monitoring by Institutional Investors,” The Accounting Review, forthcoming 2018.

Martin Glaum (Justus-Liebig-Universität Giessen)
Wayne Landsman (University of North Carolina - Chapel Hill)
Sven Wyrwa (Justus-Liebig-Universität Giessen)

Funding for this program is provided by the KPMG Foundation and KPMG International. Funded projects will be showcased at three events in London involving representatives from the IASB and renowned accounting researchers. These events include an IAAER by-invitation workshop in London hosted by the IASB on June 22, 2012. For more information contact Donna Street at dstreet1@udayton.edu.

Program Advisory Committee:

• Mary E. Barth - Joan E. Horngren Professor of Accounting, Stanford University (former member IASB)
• Holger Erchinger - Partner KPMG LLP New York
• Paul Pacter - International Accounting Standards Board
• Katherine Schipper (former member FASB) - Thomas F. Keller Professor of Accounting, Duke University
• Donna L. Street, Program Coordinator - Mahrt Chair in Accounting University of Dayton, IAAER Director of Research and Education Activities and Past President

Informing the IASB Decision Process

• Announcement: Round 5 Grant Recipients
• Call for Proposals

The International Association for Accounting Education and Research (IAAER), KPMG LLP 
and the KPMG Foundation are pleased to invite research proposals under the Informing the 
IASB Standard Setting Process Research Program. The program supports scholarly research 
directed at informing the IASB’s decision process on any current agenda item. Up to four
research grants will be awarded under this program. Funded projects will be showcased at three events hosted by the IASB in London. Funding for the program has been provided by KPMG LLP and the KPMG Foundation.

Informing the IASB Decision Process

• Announcement: Round 6 Grant Recipients
• Call for Proposals

Informing the IASB Standard Setting Process

• Announcement: Round 7 Grant Recipients
• Call for Proposals

Joint venture investments: An analysis of the level of compliance with the disclosure requirements of IFRS 12
Raquel Wille Sarquis (University of São Paulo)
Ariovaldo dos Santos (University of São Paulo)
Isabel Lourenço (University Institute of Lisbon)
and Guillermo Oscar Braunbeck (University of São Paulo)

The impact of the adoption of IFRS 11 on the comparability of accounting information
Raquel Wille Sarquis (University of São Paulo)
Ariovaldo dos Santos (University of São Paulo)
Isabel Lourenço (University Institute of Lisbon)
and Guillermo Oscar Braunbeck (University of São Paulo)

Informing the IASB Decision Process 
IASB Press Release 
Call for Proposals

Informing the IASB Standard Setting Process 
IAAER – KPMG Research Opportunities – Round 8 Grant Recipients Announced 

The International Association for Accounting Education and Research (IAAER), in collaboration with the KPMG International, is pleased to announce our Research Informing the IASB Decision Process grant recipients. Four research grants of $20,000 (U.S.) each have been awarded for the following research projects: 

Boundary of Climate-related Risks in the Financial Statements: Current Practice, Perspectives and Standard-setting Implications 

Marvin Wee (Australia National University, Australia) 
Lyndie Bayne (University of Western Australia, Australia) 
Prerana Agrawal (University of Western Australia, Australia) 
Niclas Hellman (Stockholm School of Economics, Sweden) 

Impacts of IFRS 9 Hedge Accounting Regulation on Non-financial Companies 

Lenka Ciperova (Prague University of Economics and Business, Prague)  
David Prochazka (Prague University of Economics and Business, Prague) 
Oto Krivanic (Prague University of Economics and Business, Prague) 

The Landscape of Intangibles Reporting 

Salma Ibrahim (Kingston University, UK) 
Mahmoud Elmarzouky (Aston University, UK) 
Mahmoud Al-Kilani (University of Applied Sciences and Arts Northwestern Switzerland, Switzerland) 
James Bowden (Strathclyde Business School, UK) 

Understanding Cash Flows: How Do Professional Investors Use Cash Flow Information? 
Shannon Garavaglia (University of Pittsburgh, USA) 
Cassie Mongold (University of Illinois Urbana-Champaign, USA) 
Spence Anderson (Indiana University, USA) 

Funding for this program is provided by the KPMG International. Funded projects will be showcased at three events involving representatives from the IASB and renowned accounting researchers. These events include two IAAER by-invitation workshops in London hosted by the IASB. For more information contact Donna Street at dstreet1@udayton.edu. 

Program Advisory Committee 

Mary E. Barth, Professor Emeriti Stanford University 
Holger Erchinger, Partner KPMG LLP 
Patrick Hopkins, Indiana University 
Anne McGeachin, IASB Technical Director 
Katherine Schipper, Duke University 
Donna L. Street, University of Dayton 
Ann Tarca, IASB