Accounting rule making in the private sector : an evaluation of the significance of financial accounting standards in determining the net income of publicly owned corporations



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This dissertation evaluates the effect of the Financial Accounting Standards on the net income of corporations required to file reports with the Securities and Exchange Commission under the Securities Exchange Act of 1934. Under study were Standards No. 2 (research and development), No. 7 (development stage enterprises), No. 8 (foreign currency translation), No. 9 (deferred taxes, oil and gas industry), No. I I (transition for Standard No. 5 (contingencies)), and No. 12 (marketable securities). Standard No. 13 was omitted because it was not effective in 1976. My thesis, that the Standards have not had an impact on net income, was developed from observing that all Standards promoted balance sheet conservatism (i. e., minimizing total assets) and aimed at preventing income manipulation. Since those practices affected only the timing of income, no significant change was expected over the restated periods. I further hypothesized that the Standards reinforced consensus rule making—i. e., they codified what most corporations had been doing all along. In testing my hypotheses, I used two definitions of net income. The first is the common definition: income calculated according to the transaction-based, internal accounting model. Second, since the shareholders of actively traded corporations measure their return by the change in share value plus dividends received, that measure of net income (market return) was also employed. The relevance of accounting net income to the shareholders of these corporations was explored. Furthermore, two unexpected findings were discussed. An initial random sample indicated that the corporate population was not homogeneous because transactions affected by the Standards were present more often in the 3,400 corporations whose shares were actively traded, than in the remaining 6,200 corporations. Therefore, the corporate population was divided into traded and non-traded segments. I also noted that 36% of the corporations disclosed vested pension benefits $ 372 Million in excess of pension fund assets, in apparent noncompliance with APB Opinion 8 and the intent of the Employee Retirement Income Security Act of 1974. Sampling continued until there were 76 and 78 corporations in the traded and non-traded samples, respectively. Reports (where filed) were read for 1972 through 1976 to find accounting changes required by the Standards or voluntarily adopted. Month-end market prices and dividend data were obtained on the traded corporations sample for 1975 and 1976. Differences in net income (before and after various changes) were calculated and tested for significance. Regressions were run on various portfolios to test market impact of Standard No. 8 (the effects of other changes were not tested because of previous studies, insignificance, and manner of implementation). An estimated 3,900 corporations had Standards-related transactions (2/3 traded; less than 1/4 non-traded). The Standards were biased to affect the larger, traded, manufacturing corporation. The highest rate of required change (Standard No. 8) was estimated at 16% (of the traded corporations). Overall, less than 1/3 of the corporations were required to change accounting principles because of the Standards. No significant difference was found in the net income of those required to change by the Standards. But a voluntary change (LIFO) did result in significant differences in net income. Simultaneous F tests of regression coefficients (where an indicator variable was used as a surrogate for market expectation of increased income) were run on portfolios of corporations with and without foreign currency transactions. When the portfolio of corporations was further analyzed into those making required changes and those not having to change, the indicator variable became insignificant. The statements were rerun without the indicator. No significant differences were located in any of the F tests. These results support my hypothesis that the Standards have not had an effect on the reported net income of publicly owned corporations.