The Impact of Financial Accounting Standards on different account quality metrics

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The purpose of this research is to investigate the impact of nineteen accounting standards of the Financial Accounting Standard Board (FASB) on different account quality metrics. There are two factors that motivated this research. Firstly, the Generally Accepted Accounting Principles (GAAP) is being criticized as the factor that contributes in accounting and business failures. It is argued that these standards are complicated and hard to apply. Besides, it tends to be rule-based and consists of too many bright lines and exceptions. Secondly, the debate regarding accounting standard should be used in cross-border fillings also motivates this research to be conducted. The accounting qualities measured are analyst forecasts, the persistence of earnings, earnings response coefficients, accrual quality, and the explanatory power of valuation models. Besides, this research tends to focus more on over-time assessment of combined accounting quality that are affected by the nineteen general-purpose accounting standards over a long time. The result of this research can be used by policy makers to aid their standards setting decision. Based on the result of this research, investors will also get benefits as they can improve their understanding of the relationship between accounting standards and accounting quality. Below is the motivation and hypothesis of this research.

Motivation and Hypothesis

In order to look into the impact of accounting standards towards accounting quality, this research conduct an expanded investigation by reviewing all accounting standards issued from 1980 to 2005. From that, they evaluate the standards based on 5 dimensions of objective-based accounting standards. They are: the effect of standards to the disclosure, asset-liability orientation, bright lines, implementation guidance and also the inclusiveness of alternatives and exceptions.

Researchers look into objective-based and rule-based accounting standards in evaluating whether the standard increases disclosure. From their findings, they suggest that the objective-based standard has improved the disclosure of information which improves the accounting quality at the enhanced information environment.

Bright-line standards are unambiguous, requiring no judgment in their application which will result in prejudice and less representative reporting. In contrast, the balance sheet based approach has an asset-liability orientation which improves the truthfulness of the balance sheet and show a positive effect accounting qualities that are balance-sheet orientated. Anyhow, the existence of implementation guidance, alternatives as well as exceptions reduces comparability and therefore be linked with lower accounting quality. However, these 5 dimensions of accounting standards are not the key points in deciding the accounting quality but it also associated with the method to measure accounting quality.

If the measurement of the accounting quality metric is focusing on the balance sheet, we might observe enhancement owing to the improved measurements of assets and liabilities. However, the opposite result will occur if the accounting quality is derived from the income statement.

Thus, a hypothesis is made that "Accounting quality is not associated with the implementation of accounting standards."

Research Design

The research design consists of the measurement of accounting quality metrics and also the identification of accounting standard implementation dates. The accounting quality metrics employed by the researchers were analyst forecasts, the earning persistence, earnings response coefficients, accrual quality measure, and also the valuation model based on income statement and balance sheet. They then compared each accounting quality metric prior and after implementing the accounting standard. Below are the specific analyses for each accounting quality metric.

Analysts' Forecasts

This research's first two accounting quality metrics measurement are forecast error and forecast dispersion. One of the characteristics of accounting quality is the depth of information regarding future earnings. The researchers included the reporting of loss, earnings volatility, leverage value and also changes in earnings in their calculation. Besides, they also included a trend variable as the result of accounting quality may be changing over period unaffected by the accounting standards. In addition, they also included a variable that represents the implementation of accounting standard.


The earnings persistence in this context is based on the quality of accruals and earnings. Earnings persistence means the permanence of earnings in few different periods. Higher earnings persistence leads to a higher accounting quality. Earnings is defined as total cash flow and changes in working capital accruals. However, some of the accounting standards permit long-term accruals. Therefore, the researcher included income before extraordinary items, market-to-book ratio as well as the trend variable and accounting standards as their variable.

Earnings Response Coefficients (ERC)

Earnings Response Coefficients is considered as proxy for accounting quality. This is because it measures mapping of earnings into returns. Besides, it also contributes to useful information for decision making to equity investor. The researchers included the effect of accounting standard and also changes in earnings in order to obtain their incremental effects on ERCs.

Accrual Quality

Accrual quality measures the uncertainty in accruals accounting. Here, the researchers predicted that accrual quality will be negatively connected with smaller size firms, larger cash flow variability, reporting of losses and also longer duration of operating cycles. They also included a trend variable and an indicator variable that represents the effect of the accounting standard in this model.


The fifth accounting quality metric resulted from valuation model. It takes the balance sheet and earnings information into consideration. The researchers used a book value of equity model and also an earnings model. They also use a model incorporating both variables in this design. The explanatory powers from the estimations of these three models are then derived and further being compared before and after the implementation of each accounting standard.

Samples and Data

The researchers began their sample with Compustat firms. The data available are from 1976 to 2005. They first reduced observations that are lack of data. They then erased non-December year-ends data so that it will be easier for them to identify when specific accounting standards are applicable. In the end, their sample consists of 138,701 firm-year observations. In order to increase the accuracy and reliability of their test, the researchers formed different samples for each accounting quality metrics measured.


Out of the nineteen accounting standards that the researchers have discussed, there are more than one standard that will become effective in certain years. To determine whether the standards are significantly leading to change of accounting qualities, they take the average of the coefficients related with each respective accounting standard event, where the means are resulted by accounting quality metric such as analyst forecast-based measures, accounting based measures and valuation measures.

Based on Analyst Forecast-based Measures, the mean coefficient for forecast error is significant and negative. This indicates that the accounting standard setting process influences forecast errors, bringing a decrease in forecast errors. So, they reject null hypothesis. The mean coefficient for forecast dispersion is not significant. They accept the null hypothesis where accounting quality is not related with the implementation of accounting standard.

Three analysis approaches are categorized under Accounting-based Measures, which are persistence, ERCs, and accrual quality, provide different result on implementation of accounting standards, but overall indicate decreasing of accounting quality. First of all, the mean coefficient of persistence is not significant, due to the inconsistency of direction. So, they apply the null hypothesis here. Second, the mean coefficient of ERCs is significant and negative, meaning that there is change of accounting quality associated with implementation of accounting standards, which brings decreasing in future returns and accounting quality. Last, accrual quality provides significant and positive mean coefficient. They reject null hypothesis because there is a decrease in accrual quality associated with the implementation of the account standard.

Last but not least, results from first analysis that uses BVPS, EPS, and combined models show that there is no change on BVPS and combined models, but there is a significant decrease in explanatory power for EPS model after implementation of accounting standards due to the balance sheet focus in standard setting and possible detriment of the income statement. Results from second valuation measures that based on three valuation models show that only BVPS model has increased in explanatory power, but there is no difference in explanatory power for common source, EPS source and combined model. The results are consistent with FASB's focus on the balance sheet.

In conclusion, the researchers find that their findings are robust based on a number of sensitivity tests that they had perform. Their evidence is qualified because their classifications are necessarily judgmental and limited due to comparisons made over only eleven coefficients.


Generally, the research resulted in evidence that is consistent with FASB's balance sheet focus. The results are basically supporting the FASB's current standards, which emphasize more on assets and liabilities and expand disclosures. Besides, the decrease in accounting quality in regarding of persistence, accrual quality, and decrease in explanatory power of earnings also supported the balance sheet focus. The implementation of accounting standards will bring positive impact to accounting quality in the balance sheet focus. On the other hand, it will result in a negative impact if it is based on income statement approach.