In our paper, The Effect of Audit Committee Industry Expertise on Monitoring the Financial Reporting Process, forthcoming in The Accounting Review, we examine the impact of audit committee (AC) industry expertise on the AC’s effectiveness in monitoring the financial reporting process. Despite the increased responsibilities, authority, independence, and financial expertise requirements placed on ACs by the Sarbanes-Oxley Act (SOX), ACs may, nonetheless, lack sufficient industry expertise to understand and thus properly monitor complex industry specific accounting issues. For instance, expertise in the retail industry may assist ACs to ensure that companies take an adequate write-down of inventory when their products face potential obsolescence. Similarly, revenue recognition, a prominent area of accounting manipulation (Beasley et al. 2000, 2010), entails an evaluation and understanding of the earnings process, which is tied to a company’s business processes that are often industry specific.
Posts Tagged ‘Accounting’
I want to commend the NACD on its mission to “advance exemplary board leadership” with the compelling vision of aspiring to “a world where businesses are sustainable, profitable, and trusted; shareowners believe directors prioritize long-term objectives and add unique value to the company; [and] directors provide effective oversight of the corporation and strive to deliver exemplary board performance.”
Audit committees are instrumental in achieving this vision and maintaining public trust and investor protection through their oversight of corporate financial reporting and auditing. I would also like to recognize the important role and difficult jobs that each of you have as audit committee members in these oversight functions, as well as the many other areas that are being assigned to audit committees during a time of ever increasing business complexity and risk.
Many academic researchers, policy makers, and other practitioners have concluded that fair value accounting can lead to suboptimal real decisions by firms, particularly financial institutions, and result in negative consequences for the financial system. This conclusion is sustained by the belief that fair value accounting was a major factor contributing to the 2008-2009 financial crisis by causing financial institutions to recognize excessive losses, which in turn caused excessive sales of assets and repayment of debt, thereby leading to procyclical accounting leverage. Leverage is procyclical when it decreases during economic downturns and increases during economic upturns. In our paper, Does Fair Value Accounting Contribute to Procyclical Leverage?, which was recently made publicly available on SSRN, we examine whether there exists any link between fair value accounting and procyclical accounting leverage.
To address this question, we develop a model of commercial bank actions taken in response to economic gains and losses on their assets throughout the economic cycle to meet regulatory leverage requirements. We focus on commercial banks because of the central role they play in the financial system and the allegation that their actions in response to fair value losses contributed to the financial crisis. Our model and empirical tests based on the model establish that procyclical accounting leverage for commercial banks only arises because of differences between regulatory and accounting leverage, and not because of fair value accounting.
In the six months since Mary Jo White was sworn in as the Securities and Exchange Commission’s 31st Chairman, the SEC has announced important new policies and initiatives as the agency has begun to utilize new enforcement authority under the Dodd-Frank Act and to redeploy resources. In recent weeks, White and Andrew Ceresney, Co-Director of the Division of Enforcement, have made important public announcements regarding enforcement priorities. Taken together, these policies, initiatives, and announcements signal a shift toward more aggressive enforcement. This advisory discusses these developments.
Approach to Enforcement
From the time of her nomination, White stressed that the SEC would take an aggressive approach to enforcement under her leadership. At her March 12, 2013 confirmation hearing, White pledged that one of her highest priorities as Chairman would be “to further strengthen the enforcement function of the SEC” in a way that is “bold and unrelenting.” White also stated that the SEC would pursue “all wrongdoers – individual and institutional, of whatever position or size” in order to deter wrongdoing and protect the integrity of financial markets. 
An issue of considerable interest to accounting researchers is the association between shareholders and firms’ financial reporting quality (FRQ). In our paper, Blockholder Heterogeneity and Financial Reporting Quality, which was recently made publicly available on SSRN, we examine a specific type of shareholder, blockholders, because (1) they offer a sample of shareholders that are expected to have a significant impact on firms’ financial reporting decisions and (2) we are able to track individual blockholders and their association with FRQ. As discussed in more detail below, these two sample design features allow us to provide a test of the extent to which (large) shareholders influence FRQ. Blockholders also provide an interesting and economically important sample because of their large presence in U.S. capital markets in recent years.
Measurement concepts in financial reporting are sorely needed. A key role of accounting is to depict economic phenomena in numbers, i.e., to develop measurements to report in financial statements. It is shameful that neither is there a conceptual definition of accounting measurement nor are there concepts guiding standard setters’ choice of measurement base. The Framework has a glaring hole until these concepts are developed. In the paper, Measurement in Financial Reporting: The Need for Concepts, which was recently made publicly available on SSRN, I offer a starting point for developing such concepts by focusing on how the objective of financial reporting, qualitative characteristics of useful financial information, and the asset and liability definitions can be applied to measurement. The Framework should be a coherent whole and, thus, any measurement concepts should flow from, be consistent with, and embody these concepts.
To date the focus of measurement in standard setting has been on individual assets and liabilities, and the lack of concepts for these measurements is obvious. However, aggregate amounts are also fundamental to financial reporting—financial reports include key aggregate amounts such as total assets, total liabilities, and net income. Changes in measurements of assets and liabilities during the reporting period also are fundamental because they determine items of income and expense as well as comprehensive income itself. Thus, if financial reports are to achieve their objective, measurement concepts need to deal with aggregate amounts and changes in measurements, as well as the implications of the measurements for the information revealed in a set of financial statements taken together.
On July 16, the Delaware Supreme Court  published an opinion that confirms and clarifies the scope of an accounting expert’s authority to resolve post-closing financial disputes that parties have agreed to submit for resolution under the terms of a definitive business acquisition agreement. This decision reaffirms alternative dispute resolution as the procedure of choice for quickly resolving complicated, technical financial issues that sometimes arise in the context of purchase price adjustments.
Post-closing purchase price adjustments are almost universally present in definitive agreements for the sale of a business.  These provisions—which include earn-out clauses, working capital adjustments, and debt/net debt true-ups—require an adjustment to the purchase price paid at closing, based on calculations relative to pre-closing targets, standards, or formulas. Such provisions set forth not only the methodology for determining the amount of the adjustment, but also a resolution process in the event the parties disagree on the amounts to be paid. These processes typically include (i) an exchange of the relevant financial calculations and access to work papers and supporting documentation, (ii) submission by the recipient party of objections to the calculation, (iii) a period of time within which the parties will attempt to resolve the dispute in good faith, and (iv) submission of the unresolved issues to a neutral accounting firm for ultimate resolution. 
The facts surrounding Bernie Madoff’s unprecedented fraud are well-known. Through a Ponzi scheme, he stole untold billions over decades. What is not as well-appreciated is that during the vast majority of this time, he operated solely as a registered broker-dealer. This led to the inevitable conclusion that the regulatory framework for broker-dealer custody required urgent strengthening.
The U.S. Securities and Exchange Commission (“Commission” or “SEC”) has finally adopted amendments to strengthen the framework governing broker-dealer custody practices to prevent another Madoff. The adoption of these amendments comes more than four and a half years after Madoff’s scheme came to light in December, 2008, and more than two years after they were proposed. As a Commissioner, I have often been asked about steps the Commission has taken to prevent another Madoff, and it has concerned me that these issues have not been addressed.
Theory suggests that Chief Executive Officers (CEOs) with short horizons with their firm have weaker incentives to act in the best interest of shareholders (Smith and Watts 1982). To date, research examining the “horizon problem” focuses on whether CEOs adopt myopic investment and accounting policies in their final years in office (e.g., Dechow and Sloan 1991; Davidson et al. 2007; Kalyta 2009; Antia et al. 2010). In our paper, Forecasting Without Consequence? Evidence on the Properties of Retiring CEOs’ Forecasts of Future Earnings, forthcoming in The Accounting Review, we extend this line of research by investigating whether retiring CEOs are more likely to engage in opportunistic forecasting behavior in their terminal year relative to other years during their tenure with the firm. Specifically, we contrast the properties (issuance, frequency, news, and bias) of earnings forecasts issued by retiring CEOs during pre-terminal years (where the CEO will be in office when the associated earnings are realized) with forecasts issued by retiring CEOs during their terminal year (where the CEO will no longer be in office when the associated earnings are realized). We also examine circumstances in which opportunistic terminal-year forecasting behavior is likely to be more or less pronounced.
Our predictions are based on several incentives that arise (or increase) during retiring CEOs’ terminal year with their firm. Specifically, relative to CEOs who will continue with their firm, retiring CEOs face strong incentives to engage in opportunistic terminal-year forecasting behavior in an attempt to inflate stock prices during the period leading up to their retirement. Deliberately misleading forecasts can be used to influence stock prices. Consistent with this argument, prior work shows that managers use voluntary disclosures opportunistically to influence stock prices (Noe 1999; Aboody and Kasznik 2000; Cheng and Lo 2006; Hamm et al. 2012) and that managers use opportunistic earnings forecasts to manipulate analysts’ (Cotter et al. 2006) and investors’ perceptions (Cheng and Lo 2006; Hamm et al. 2012) in an effort to maximize the value of their stock-based compensation (Aboody and Kasznik 2000). Moreover, because SEC trading rules related to CEOs’ post-retirement security transactions are less stringent than those in effect during their tenure with the firm, post-retirement transactions can be made before the earnings associated with the opportunistic forecast are realized and with reduced regulatory scrutiny.
Editor’s Note: The following post comes to us from Ron Shalev of the Department of Accounting at New York University, Ivy Zhang of the Department of Accounting at the University of Minnesota, and Yong Zhang of the School of Accounting and Finance at Hong Kong Polytechnic University.
In our paper, CEO Compensation and Fair Value Accounting: Evidence from Purchase Price Allocation, forthcoming in the Journal of Accounting Research, we investigate the influence of bonus intensity (i.e., the relative importance of bonus in CEO pay) and alternative accounting performance measures used in bonus plans on the allocation of purchase price post acquisitions. Upon the completion of an acquisition, the acquirer is required to allocate the cost of acquiring the target to its tangible and identifiable intangible assets and liabilities based on their individually estimated fair values. The remainder, namely, the difference between the purchase price and the fair value of net identifiable assets, is recorded as goodwill. The recognition of goodwill has different implications for subsequent earnings than that of other assets. Tangible and identifiable intangible assets with finite lives, such as developed technologies, are depreciated or amortized, depressing earnings on a regular basis. In contrast, goodwill is unamortized and subject to a periodic fair-value-based impairment test. As write-offs of goodwill impairment are infrequent (Ramanna and Watts, 2009), recording more goodwill generally leads to higher post-acquisition earnings.