History Of Accounting In India Accounting Essay

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Accounting is the language of business. Accounting standards form an important part of business and help us to read a firm. However, there are different accounting standards prevailing in different countries. Although there is a growing cry for a uniform accounting standards in the form of IFRS, we are still a far way away from it. This study examines the value relevance of the different accounting system in different countries. The countries chosen are India (following Indian GAAP), United States of America (following US GAAP), United Kingdom (following IFRS since 2005) and China (Using China GAAP).

These countries are in different stages of economic development and also form some of the areas attracting significant investments. The analysis is done using a model derived from the Edwards-Bell-Ohlson valuation framework. The relation of current earnings and lagged book values with the stock prices of listed companies of Nifty 50, S&P 500 index, FTSE 100 and Hang Seng index is tested. The accounting data is obtained from Bloomberg database.

Theoretically the value of a firm is widely accepted as the present value of future distributions from the company. If one had knowledge of such future distributions there would be no problem. A number of models have been developed that seek to explain value using contemporaneously observable numbers. Many such models have subsequently relied on accounting information as inputs into the valuation process. This is natural as accounting information purports to reflect the accumulation of value of a firm through time.

The EBO valuation model has a great utilitarian value because of its three features: (1) accounting numbers are linked directly to firm value with no assumptions about dividend-earnings relation; (2) firm value may be well-approximated over a finite horizon; and (3) firm value is theoretically not influenced by cross-sectional differences in accounting methods. The third feature is particularly important when we look at the valuation from the international perspective. The EBO model can be employed under different national accounting systems provided these systems will follow a clear surplus relation (CSR) in the future and are free from bias and able to capture firm value within a finite horizon. The third condition is availability of reliable and accurate earnings forecasts.

Accounting systems vary internationally in their faithfulness to the CSR and in the extent to which they exhibit conservative bias. Hence, it is possible that accounting numbers from some countries may provide better estimates of firm value than accounting numbers from other countries.

The variables which are collected are:

Book value data

Earnings per share (EPS)

Price of the share

Dividend paid per share

These values for the last day of the year are collected for every company in the index. The data was collected for the period 2001 to 2012. However for UK data from 2006 to 2012 was used as UK shifted to IFRS in 2005 and with lagged book value being used our first data point starts with 2006. If any of the variables was missing for a firm for that particular year, that reading was discarded. In the end we had 408 firm year observations for India, 4618 firm year observations for United States of America, 595 firm year observations for United States and 448 firm year observations for China.

The results show that both current earnings and lagged book values are significantly and positively related to prices in case of UK IFRS and US GAAP. However, a significant relation was not observed in case of book value for Indian companies in Nifty 50 and Hang Seng Index. This result will increase interest among IFRS supporters about its robustness and its ability to predict firm value much more effectively. We also see that the adjusted R2 value for the regression equation for UK IFRS is significantly more than the value obtained for US GAAP.

Table of Contents

List of Tables

Introduction

Accounting is the language of business. Accounting standards are an important part of financial reporting and help investors to make well-informed decisions. The importance of this fact is underlined by (Levitt, 1998, p. 1) who states that "educated investors need relevant, useful information to make their investment decisions" and that is according to Levitt what "high quality accounting standards deliver".

They not only safeguard investors and creditors who are keen to know how the business they are investing in is doing but it also helps them to ensure that their investment or lending to a business is (still) substantiated.

Good and consistent accounting standards are indeed vital to protect the investors. It is the topic of this essay to look at the development of accounting standards and the shifts in approaches in financial reporting through time. The focus then will be on the desirability of having a set of accounting principles rather than financial reporting based on rules, followed by a critical evaluation which highlights the advantages and disadvantages of having accounting standards of use to the investor.

Accounting standards evolved through time and there has been a change over the years in how to arrive at accounting standards. In the UK, the empirical inductive approach, focusing on creditors, looked at already existing practices and accounting standards were determined from these, a method which was used by accounting firms before the 1970s. This method contrasted with the deductive approach, adhered to in the 1970s, which was preferred by economists because of the focus on true income which was more useful for the investor but eventually did not prevail as it was not focused on practice. (Elliot & Elliot, 2009)

Nowadays, the focus has been on a general consensus which led to a conceptual framework which is promoted by the IASB containing a statement of principles. The Accounting Standards Board in the UK has drawn up a list of principles which is included in their "Statement of Principles for Financial Reporting" which is consistent with the IASB Framework. The ASB sees materiality as a threshold quality, relevance, reliability, comparability and understandability as important principles that make financial information useful and these principles are hugely similar to those of the IASB and show the benefits of accounting principles which provide key guidelines for the standard setters. Once one has arrived at a satisfactory set of principles, standard setters can formulate standards on the basis of those principles that practitioners can use for the purpose of financial reporting. However, standard setting has "both supporters and opponents" (Elliot & Elliot, 2009). The advantages are clearly comparability as financial results of companies can be compared more easily, credibility for the accounting profession that applies uniform accounting treatments, influence in that a conceptual framework is developed and discipline as the markets will closely watch what companies are doing as , subsequently, companies with insufficient accounting practices will be "disciplined" by the markets.

Notwithstanding the benefits of accounting standards to the investors, other disadvantages of having complex accounting standards exist. These are especially costs to the economy as a whole but also to businesses that have to comply with the accounting regulations. If a standard is changed to improve the situation in one part of the economy, this can lead to the problem that it will discriminate against another sector of the economy. There are also general costs involved to produce financial statements and this benefit should outweigh the costs that occur.

Too many or complex accounting standards, as described earlier on, can subsequently slow, especially small, businesses down although these are mostly allowed to have less financial reporting requirements (Elliott, 2009). But then accounting standards that are too lax may lead to more corporate scandals such as the case of Enron. Lochner (1990) recognises that "full and fair financial disclosure has been an integral part of the development of our efficient and successful securities markets". However, it is evident that accounting standards should be developed bearing in mind both their effectiveness helping to keep investors safe but also their costs involved for companies and the economy as a whole.

Because of different accounting standards used in different countries there are arguments for a common set of accounting standards and the forces that have promoted adoption of International Financial Reporting Standards (IFRS). The expected benefits of global accounting standards are compelling. The use of one set of high quality standards by companies throughout the world has the potential to improve the comparability and transparency of financial information and reduce financial statement preparation costs. When the standards are applied rigorously and consistently, capital market participants will have higher quality information and can make better decisions.

Thus markets allocate funds more efficiently and firms can achieve a lower cost of capital. These arguments have been used to support the adoption of International Financial Reporting Standards (IFRS) for financial reporting for consolidated listed entities in European Union (EU) member states (EC1606/2002). Other jurisdictions have cited similar reasons for adoption of IFRS (see Brown, 2011), reflecting the demand for high quality standards that can improve the quality and comparability of financial reporting and promote the development of national capital markets and the integration of markets internationally.

With different sets of accounting standards prevailing in different countries, in this work we try to evaluate which accounting standard is most effective in predicting the value of the firm. We have chosen four different economies following four different accounting standards. These four economies are:

India (Indian GAAP)

United States of America (US GAAP)

United Kingdom (IFRS)

China/ Hong Kong (China GAAP)

All of these four economies are in different stages of development and poses different challenges for accounting practices. A brief introduction of the four economies chosen is as follows:

INDIA

India has in recent years experienced strong economic growth, rising foreign exchange reserves, falling inflation, global recognition of its technological competence, and the interest shown by many developed countries to invest in the engineers and scientists produced in the country including setting up of new Research and Development centers.

Above all, as the largest democracy in the world, India has a reputation for providing leadership for one billion people in a country with different cultures, languages and religions. India's technological competence and value systems are highly respected.

Foreign institutional investors find investing in India attractive. Indians are also investing in companies abroad and are opening new business ventures. The Government of India is also committed to economic development by ensuring a growth rate of 7 to 8 per cent annually, enhancing the welfare of farmers and workers and unleashing the creativity of the entrepreneurs, business persons, scientists, engineers and other productive forces of the society. Today, India is one of the fastest growing economies in the world with a compounded average growth rate of 5.7 per cent over the past two decades. The Government of India has plans to transform India into a developed nation by 2020.

In India, accounting standards are issued by the Institute of Chartered Accountants of India based on IFRSs. Departures from the IFRS are made keeping in view the prevailing legal position and customs and usages in the country. A brief history of Indian Accounting is given in the Historical background section in the pages to follow.

United States of America (USA)

The purpose of this study is to examine the relation between accounting numbers derived from the financial statements of Polish listed companies and their market values. The analysis relies on the Collins et al. (1999) model derived from the Edwards-Bell-Ohlson (EBO) valuation framework, and applies accounting data fully compliant with EU regulation, i.e., prepared under The Act on Accounting of 1994. Our empirical tests show that current earnings and lagged book value are positively and significantly related to current stock prices.

Historical Background

History of Accounting in India

India's accounting profession is among the earliest to develop after the introduced of the Indian Companies Act in the mid-1800s, giving the accounting profession its start. Since then, considerable efforts have been made to align India's accounting and auditing standards and practices with internationally accepted standards. Indian accounting and auditing standards are developed on the basis of international standards; and the country has many accountants and auditors who are highly skilled and capable of providing international-standard services.

The Institute of Chartered Accountants of India (ICAI) set up the Accounting Standards Board (ASB) in 1977 to prepare accounting standards. In 1982, ICAI set up the Auditing and Assurance Standards Board (initially known as the Auditing Practice Committee) to prepare auditing standards. ICAI became one of the associate members of the International Accounting Standards Committee (IASC) in June 1973. The ICAI also became a member of the International Federation of Accountants (IFAC) since its inception in October 1977. While formulating accounting standards in India, the ASB considers International Financial Reporting Standards (IFRS) and tries to integrate them, to the extent possible, in the light of the laws, customs, practices and business environment prevailing in India.

The Accounting Standards Board has worked relentlessly to introduce an overall qualitative improvement in the financial reporting in the country by formulating accounting standards to be followed in the preparation and presentation of financial statements. So far, the Board has issued 29 Accounting Standards. Besides this, it has also issued various accounting standards interpretations and announcements, so as to ensure uniform application of accounting standards and to provide guidance on the issues concerning the implementation of accounting standards which may be of general relevance.

History of Accounting in USA

The U.S. Congress has been responsible for two major pieces of financial accounting regulation in the 20th century, starting with the Securities Act of 1934. This New Deal legislation created the Securities and Exchange Commission (SEC) as an oversight body for trading of stocks and bonds. An important mission of the SEC is to maintain transparency in financial reporting and stock information, requiring accurate accounting from firms on American stock exchanges. More recently, Congress passed the Sarbanes-Oxley Act of 2002 in response to accounting scandals at Enron and WorldCom. This legislation required internal accounting controls instituted by executives at businesses, accounting firms and consultancies based in the United States. Sarbanes-Oxley is designed to eliminate accounting tricks and discourage disconnects between executives and accountants that caused the controversies.

The American accounting profession has created several organizations since the Great Depression to set standards for its members. The Committee on Accounting Procedure was created in 1939 by the American Institute of Certified Public Accountants (AICPA) to settle philosophical disputes among American accountants. This committee lasted until 1951 and published 51 Accounting Research Bulletins addressing accounting issues in an ad hoc fashion. The AICPA created the Accounting Principles Board in 1959, a body that was responsible for popularizing generally accepted accounting practices (GAAP). The Financial Accounting Standards Board (FASB) was founded in 1973 to solve the problems of the first two generations of accounting boards. Instead of issuing proclamations and periodic notices, the FASB has been responsible for creating standardized rules and regulations for American accounting firms and departments.

Since 2008, the FASB issued the FASB Accounting Standards Codification, which reorganized the thousands of US GAAP pronouncements into roughly 90 accounting topics. In 2008, the Securities and Exchange Commission issued a preliminary "roadmap" that may lead the U.S. to abandon Generally Accepted Accounting Principles in the future (to be determined in 2011), and to join more than 100 countries around the world instead in using the London-based International Financial Reporting Standards. As of 2010, the convergence project was underway with the FASB meeting routinely with the IASB. The SEC expressed their aim to fully adopt International Financial Reporting Standards in the U.S. by 2014. With the convergence of the U.S. GAAP and the international IFRS accounting systems, as the highest authority over International Financial Reporting Standards, the International Accounting Standards Board is becoming more important in the U.S.

History of Accounting in UK

The Companies Act 1985 (CA 85) regulates the constitution and conduct of nearly all British business corporations i.e. limited liability and unlimited companies incorporated in Great Britain. Its provisions cover company formation, company administration, allotment of shares and debentures, accounts and audit and distribution of assets .CA 85 requires all limited companies to prepare annual accounts giving true and fair view.

Constitution of UK GAAP

In UK, there is no statutory or regulatory authority or definition as in US, Canada or New Zealand .UK GAAP is a dynamic concept changing as per changing circumstances. It goes far beyond rules and principles and encompasses contemporary permissible accounting practice.

Transition from UK GAAP to IFRS

A resolution was passed in European Parliament on 12th March 2002 wherein from 2005 all listed European countries will have to prepare consolidated financial statements under IAS.

History of Accounting in China

China's accounting history can be traced back 2000 years ago. The earliest word of "accounting" appeared in Western Zhou Dynasty (11th century BC to 770 BC). During the Tang Dynasty (AD618-907), there appeared "account book" for recording the annual fiscal revenues. Further development began from the Song Dynasty (AD 960-1279), such as the rather scientific bookkeeping method, and the four pillars accounts, was created. This method formed the basis of traditional Chinese accounting theory. During the Ming Dynasty (AD1369-1644), the bookkeeping method improved, and a new method, 'Long Men Zhang,' which was similar to the double-entry bookkeeping method, was later created.

Prior to 1911, Chinese society had been feudal for three thousand years, China's bookkeeping style, which was single-entry records based on the movement of money or physical goods-dominated, prevailed, while all book-keepers were the products of the master-apprentice training method. At the beginning of the 20th century, Western accounting methods such as the debit and credit double entry system was introduced to China, and Western accounting and auditing theories were adopted. Many Western countries had established concessions in China, causing an inflow of Western technology and capital, and fostering the development of indigenous industries.

Scholars who had received their education abroad returned to China and pioneered modern accounting education. Gradually, accounting majors and departments were established, with bookkeeping and accounting courses taught at the university and college levels. Contemporary accounting texts were introduced and double-entry bookkeeping was established. The first professional public accountants also appeared at this time. Certification was granted to those passing a qualifying examination and entitled the bearer to run an accounting firm and to offer accounting services to clients (Wei, 1991).

Legislation in finance and accounting were thus improved. Some laws such as Accounting Law (1935), Auditing Law (1938), Budgeting Law (1938), Final Accounts Law (1938), and Public Depository Law (1938), were publicized. The Civil Government published the Unified Accounting System for All Departments in Central in July 1937. However, modern accounting methods had not been fully developed in either accounting education or practice, and as being a semi-colonial and semi-feudal society, China's economy was not sufficiently developed. All this development stopped and changed to a new direction in 1949, when the Chinese Communist Party established People's Republic of China.

Since 1949, China's economy has undergone three periods of change: a socialist, centrally controlled, planned economy (1949-1978); socialist commodity economy (1978-1992); and socialist market economy (1992-present). In accordance with the development of China's economy, the development of China's accounting system has also experienced change: the "uniform accounting system" (1949-1978), which served for the centrally planned economy; the transition and the construction of accounting norms (1978-1992), which served for the commodity economy; and the construction of a new accounting system (since1992), which served for the socialist market economy towards internationalization. During the process of China's accounting development, some changes and adjustments were made in order to respond to China's political and economic movements and development.

The development of Chinese accounting system can be divided into two distinct periods with different legislation characteristics and contents. The year of 1979 could be the watershed of the two distinct periods.

Before 1979, China's economic system had been a planned socialist; the Party and the Central Government were the chief designers and conductor of China's economic system. The Central Government Political Bureau financial committee and the Ministry of Finance within the Central Government, which was established at the beginning the PRC, were authorized agencies in managing the national-wide accounting work. Unified accounting systems, which was a state controlled and tax driven financial reporting system served for the planned economy are exercised, but these unified accounting systems were only unified within the sectors, and were drafted by different sectors of the national economy, then approved and implemented by the MOF. The State Council and the MOF were the only issuers of accounting systems and regulations during this period.

After 1979, the economic system reform and open door incentives gradually evolved China's economic and legal system along with an accounting legal system. In 1985, the NPC issued PRC Accounting Law. This was the beginning of the Chinese accounting legal system construction. The accounting system reform, which turned the Chinese accounting system to a capital market oriented financial reporting system, served for the market-oriented economy in 1992, and brought China's accounting system more towards standardization and internationalization. Three tiers of accounting legislations system had been formed in China so far. In contrast with the old accounting system, the new accounting regulation system is being developed towards a legal one.

Since with the lot of talk going about one global accounting standard and all the countries going to converge to IFRS, we will also have a look at the historical convergence of accounting standards.

LITERATURE REVIEW

Paper Reviews

Accounting-based Valuation of Polish Listed Companies - Sylwia Gornik-Tomaszewski, Eva K. Jermakowicz

This study examines the value relevance of the new accounting system in Poland. Using a model derived from the Edwards-Bell-Ohlson valuation framework, the relation of current earnings and lagged book values with the stock prices of Polish listed companies is tested. The accounting data are derived from the financial statements prepared under The Act on Accounting of 1994, which assured a full compliance of the Polish accounting standards with the European Union directives. The results show that both current earnings and lagged book values are positively and significantly related to prices, and the magnitude of this relation is comparable to that reported in more advanced markets. Also, the incremental information content of lagged book value is greater than that of current earnings. Overall, it is found that the association of the accounting data produced under the new Polish accounting law with stock prices of listed companies is comparable in magnitude to that observed in more mature markets. These results should be of interest to international securities analysts, institutional and individual investors interested in the Polish capital market, as well as to the Polish authorities responsible for setting accounting standards.

Equity Valuation and Negative Earnings: The Role of Book Value of Equity - Daniel W. Collins, Morton Pincus, Hong Xie October 1988

This study provides an explanation for the anomalous significantly negative price-earnings relation using the simple earnings capitalization model for firms that report losses. Authors hypothesize and find that including book value of equity in the valuation specification eliminates the negative relation. This suggests that the simple earnings capitalization model is misspecified and the negative coefficient on earnings for loss firms is a manifestation of that misspecification. Furthermore, they provide evidence on three competing explanations for the role that book value of equity plays in valuing loss firms. Specifically, we investigate whether the importance of book value in cross-sectional valuation models stems from its role as (1) a control for scale differences (Barth and Kallapur 1996), (2) a proxy for expected future normal earnings (Ohlson 1995; Penman 1992), or (3) a proxy for loss firms' abandonment option (Berger et al. 1996; Barth et al. 1996; Burgstahler and Dichev 1997). Their results do not support the conjecture that the importance of book value in cross-sectional valuation stems primarily from its role as a control for scale differences. Rather, the results are consistent with book value serving as a value-relevant proxy for expected future normal earnings for loss firms in general, and as a proxy for abandonment option for loss firms most likely to cease operations and liquidate.

Accounting in Perfect and Complete Markets

John Fellingham, Kirk Philipich, Douglas Schroeder, Richard Young, 1997

This teaching note explores the relationship between market values and accounting numbers, simplifying and integrating the ideas in Demski (1992), Edwards and Bell (1961), Ohlson (1991), Ohlson (1995), Peasnell (1982), and Preinrich (1938). This note also illustrates cases where the logic of these papers, which exploits simplistic perfect and complete markets, can or cannot be used to interpret or justify current accounting practices. This note presents a simplified version of the Edwards-Bell-Ohlson (E-B-O) framework and illustrates how it may be used to clarify arguments that support or oppose specific accounting methods. The E-B-O framework is the name given to the ideas in Ohlson (1991), Ohlson (1995) and Edwards and Bell (1961). This work is also closely related to Feltham and Ohlson (1995, 1996), Peasnell (1982) and Preinrich (1938).

The main aspects of the E-B-O framework illustrated herein are as follows. In a simple economy, where the only consumption commodity is money to be delivered at some point in time and everyone faces the same common knowledge interest rate, the market value is equal to the present value of future cash flows associated with the asset. In this setting, there exists a set of accounting procedures such that accounting income is equal to the change in economic welfare of the owners of the firm. The accounting procedures call for valuing assets at market value and calculating income as the change in book value of owners' equity. Within this setting, accounting accruals arise not for "matching purposes," but because market value (or equivalently, the present value criterion) is forward-looking. Since the balance sheet mimics market value, it is the only financial statement needed to value the firm.

This note focuses on a particular aspect of accounting: the role of the market structure in interpreting accounting numbers. Specifically, it illustrates that in the highly stylized setting of perfect and complete markets the financial statements can easily be used to infer the economic value of the firm. But there are many other aspects of accounting that are also important. First, accounting provides structure that disciplines our planning for future economic events and our interpretation of economic events underlying the numbers reported in financial statements. An important example is the construction of a budget. We begin with a sales budget, add a cash collections/payments policy and an inventory policy, and accounts receivables, inventory values, and accounts payable follow. Add a cash inventory policy, and we quickly move from cash balances to financing decisions. And, of course, the balance sheet and income statement follow thereafter. It is easy to see how these steps in the budgeting process are influenced by the structure of accounting.

Second, accounting produces an income number which has many important properties. The income number may not only be important to individuals acting on their own behalf, but may also tell us something about the economy in the aggregate. For example, under certain conditions the income number is related to productive and social efficiency. Third, and perhaps most important, the structure of accounting is such that errors (unintentional or intentional) are unlikely to persist. For example, overstating ending inventory in one period overstates income in that period, but causes the next period's income to be understated (unless further inventory overstatements take place). Further, the numbers are generally auditable. Together these feature makes accounting especially valuable in dealing with stewardship problems.

Ijiri (1975) suggests that the most important aspect of accounting information is its ability to deal with concerns of accountability. Management may be tempted to bias their disclosures about the firm. It is important that accounting systems be designed to resist manipulation. In addition, accounting's real cutting power may lie "off the equilibrium path." That is, accounting's most important role may not be in producing an income number consistent with market value, but rather in disciplining non-accounting disclosures related to market value. It has been suggested that the double entry accounting system and historical cost approach are especially useful in this regard.

Further study of firm value in settings where market imperfections are present requires considerable additional structure. A preliminary effort in this direction is Farlee et al. (1996). Another worthwhile next step may be to study the relationship between accounting numbers and market value in a world of market incompleteness. However, making headway will not be easy, as the notion of equilibrium, as well as accounting, is relatively unexplored in incomplete markets.

Accounting Diversity and International Valuation - Richard Frankel, Charles M. C. Lee

This paper highlights a major issue in the form of International differences in accounting rules pose a significant challenge to investors interested in making cross-border comparisons of firm value. While current efforts to harmonize international standards are laudable, they are unlikely to completely eliminate cross-border accounting diversity. In this study, the authors suggest an alternative, and complementary, approach for coping with international diversity.

Their approach is based on the Discounted Residual Income or the Edwards-Bell-Ohlson (EBO) valuation model. The model is potentially attractive because, it provides a method for translating accounting numbers produced under alternative accounting systems into more comparable measures of firm value. However, the model must overcome a number of potential problems in actual implementation.

They discuss the practical problems that must be resolved in international implementations. Specifically, they identify three major areas of potential difficulty: 1) the availability of reliable earnings forecasts, 2) systematic violations of the clean-surplus assumption, and 3) "poor quality" accounting rules that result in delayed recognition of value changes. These difficulties can introduce noise into the estimation process, the extent of which is likely to be country-specific.

Finally, they provide preliminary empirical evidence on the efficacy of the model in cross border valuations and returns predictions. Despite the limitations discussed above, they find that firm value estimates based on the model are highly correlated with cross-border stock prices. Across 20 countries and over 8 years, their value estimate ("V") consistently dominates earnings and book value in explaining variations in stock prices. Most of the improvement arises from the use of forward-looking analyst forecasts of earnings rather than country specific discount rates. Furthermore, they show that V/P-based cross-country hedge strategies produce significant positive returns, suggesting that the model may be useful in global asset allocation decisions.

In this paper it is found that the average book-to-price ratio across individual countries is negatively correlated with their forecasted abnormal ROEs. Countries trading at higher premiums over reported book values tend to have higher forecasted ROEs relative to their costs of capital. Interestingly, it is also found that V/P rankings across countries are positively correlated with subsequent 12-month returns. Specifically, it is shown that a strategy of buying countries with high average V/Ps and shorting countries with low average V/Ps yields consistently positive and statistically significant returns over the sample period. While also positive, returns to similar trading strategies based on E/P or B/P ratios are far less stable. These results suggest that the EBO model is a potentially useful aid in assessing the relative attractiveness of aggregate country portfolios.

In sum, they conclude that the residual income model is a useful part of a broader solution to the problem of accounting diversity. The model helps highlight the fact that valuation is a forward-looking exercise that requires forecasts of both future earnings and discount rates. They show that sell-side analyst forecasts are a reasonable first proxy for these forward-looking earnings in international valuations. Specifically, they find that the bias and accuracy of analyst forecasts are no worse in most other countries than they are in the United States. In addition, they provide some evidence that the model operates better in common-law countries than in code-law countries.

The main lesson we can take from the analysis in this work is that accounting numbers produced under any system must be understood in context. Reported earnings, book values, and other numbers are not designed to communicate a firm's fundamental value, and should not be used naively as surrogates for firm value. Except under strong assumptions, none of these measures, taken alone, captures the concept of intrinsic firm value. However, when combined with forecasted earnings in a theoretically consistent framework, accounting numbers produced under a variety of systems all can be highly value-relevant.

In sum, the authors believe that the EBO model is a promising tool for international investment and global asset allocation decisions. It is conceptually superior to other accounting based valuation metrics for this purpose. Empirically, their results demonstrate that this model also exhibits surprisingly high resilience to cross-border accounting differences.

We are going to take forward this EBO model only in our analysis to compare the accounting standards of different countries.

An Evaluation Of The Value Relevance Of Consolidated Versus Inconsolidated Accounting Information: Evidence From Quoted Spanish Firms - Christina Abad, Amalia Garcia-Borbolla, Neil Garrod, Joaquina Laffarga, Manuel Larran and Juan Manuel Pinero Working Paper 2000/1

In this paper we investigate the value-relevance of consolidated versus parent company accounting information. In particular we investigate the value relevance of the minority interest components of net total assets and earnings as currently reported and under the full entity approach to consolidated reporting. An Edwards-Bell-Ohlson valuation framework is used to generate results. By this means we cast light on the suitability of accounting regulation being developed based upon the entity or parent company theories of consolidation. We carry out the analysis in the Spanish context and the sample contains 474 observations of non-financial firms quoted in the Madrid Stock Exchange for the period 1991-1997. The results from this analysis not only have domestic relevance but provide guidance of a more international nature relating to the impact of group definition, concepts of control and the most value relevant method of consolidated disclosure. The results show that, from a valuation perspective, consolidated information dominates unconsolidated, or parent company, information. However, neither the currently reported minority interest components of net total assets and earnings, nor their values under the full equity method of consolidation, are found to be value relevant. These results raise the question of whether group definitions based on the equity theory of consolidation are the most useful to investors. The research reported in this paper casts light on the suitability of accounting regulation being developed upon the entity or parent company theories of consolidation.

Under the parent company concept, the consolidated annual accounts are considered an extension of the individual annual accounts of the parent company. Thus, the consolidated information is considered complementary to the information disclosed in the parent company accounts. The focus of this theory is that the interest of the parent company in the subsidiary companies is purely financial in nature. Whilst not explicitly referred to in extant regulation, it is, by convention, the parent company theory which underpins much of existing accounting practice world wide

Under the entity approach, the group is considered to be the dominant economic unit and thus the consolidated annual accounts are considered to be the most suitable format for providing information about the financial situation of the parent. The focus of this theory is of the operating unit being the group rather than the parent.

Research Design

In this research we try to compare different accounting standards on the basis that how successful are they in predicting the firm value.

Because reliable analysts' forecasts are not readily available for all listed companies, we rely in this study on a following model derived from the EBO valuation framework by Collins et al. (1999)

Pt = β0 + β1Xt + β2BVt-1 + ɛt

where: Pt is cum-dividend stock price at time t, consisting of two components, year-end price per share pt, and dividend per share for year t, dt; Xt is current period bottom-line earnings per share; and BVt-1 is the book value of equity per share at the end of fiscal year t-1 (hereafter, lagged book value)

This equation can be specified as follows:

Abnormal earnings are defined as earnings in excess of the required rate of return on equity:

xta = xt - rbvt-1 (A1)

where:

xt = earnings for period t

r = cost of equity capital

bvt-1= lagged book value of equity at time t-1.

Consequently, expected future abnormal earnings are:

xt+Ï„ a = xt+Ï„ - rbvt+Ï„-1 (A2)

Current price is expressed by Ohlson (1991) as book value plus discounted

expected abnormal earnings:

Vt= bvt + Et(xt+Ï„a) (A3)

Ohlson (1995) shows that his equation can be also expressed as:

pt = bvt + α1xtα + α2vt (A4)

where:

vt = other value relevant information.

By substituting the abnormal earnings equation (A1) and the clean surplusequation (A5) presented below:

bvt = bvt-1 + xt - dt (A5)

into equation (A4) the following specification is obtained:

pt = bvt-1 + xt - dt + α1xt - α1rbvt-1 + α2vt (A4.1)

and, further:

pt + dt = (1 + α1) xt + (1 - α1r) bvt-1 + α2vt (A4.2)

If we make the following substitutions:

pt + dt = Pt (A4a)

α2vt = β0 + ɛt (A4b)

1 + α1 = β1 A4c)

1 - α1r = β2 (A4d)

the equation (A4.2) becomes:

Pt = β0 + β1Xt + β2BVt-1 + ɛt (A4.3)

which is the empirical model used in this study

Two additional arguments can be used to support our specification. First, although the EBO valuation model relies on forecasts of future earnings, not the current reported earnings, the current earnings can be thought of as the realizations of previously forecasted earnings. Second, use of lagged book value, as opposed to the current end-of-period book value, which includes current earnings, allows for clear distinction between pricing effects of earnings and book value of equity.

According to accounting literature, book value is important in the valuation models for at least three reasons. First, within the EBO framework, book value proxies for expected future normal earnings. Second, for financially distressed firms, book value is perceived as a proxy for a firm's liquidation value (Berger et al., 1996; Barth et al., 1996; Burgstahler and Dichev, 1997; Collins et al., 1999). And finally, it can be perceived as simply a control for scale differences in a cross-sectional valuation equation (Barth and Kallapur, 1996). Whatever the theoretical justification for inclusion of book value of equity in the valuation model, empirical studies conducted in recent years in the USA and abroad indicate alike that book value has significant explanatory power for prices and incremental information content over earnings (e.g., Bernard, 1995; Joos and Lang, 1994; Collins et al., 1997; King and Langli, 1998; Bao and Bao, 1998).

Data and Methodology

We selected four countries for our study, namely:

India

United States of America

United Kingdom

China

This is done because of the following reasons:

They all follow different accounting standards. While India is a natural choice it also follows Indian GAAP. UK has already converged to IFRS since 2005. US still follow US GAAP and China has its own set of accounting standards.

All of these countries are in different stages of development. US and UK are developed economies while China and India are developing and represents the surge in Asia.

These four countries are also hot destinations for investment. This research throws a light on how successful are the accounting standards in these countries to predict the firm value. Thus investors can gain confidence in the economy if the accounting standards are trustworthy.

After this we collect data for company from four different indices for the period 2001 to 2012.

These indices are:

India - Nifty 50

United States of America - S&P 500 index

United Kingdom- FTSE 100

China - Hang Seng Index

The variables which are collected are:

Book value data

Earnings per share (EPS)

Price of the share

Dividend paid per share

These values for the last day of the year are collected for every company in the index. Bloomberg terminal located at our college forms the source for all the data collected.

If any of the four data point is not available for any company in that particular year, that reading is discarded. After that various statistical tool including multiple regressions is used on the data to test the hypothesis.

Analysis & Result

INDIA

Our data consisted of Nifty 50 firms for the period 2001 to 2012. If any of the variables was missing for a firm for that particular year, that reading was discarded. In the end we had 408 firm year observations.

Table 1 provides descriptive statistics for the dependent variable, cum dividend price Pt, and its two components, fiscal year-end price per share pt, and dividend per share for year t, dt; as well as for the independent variables, current period bottom-line earnings per share Xt, and the lagged book value of equity per share BVt-1.

Table

Descriptive Statistics for Dependent and Independent Variables for India

pt

EPS

Xt

Lagged BV BVt-1

Dividend

dt

cum dividend price Pt

Mean

517.9303

36.18789926

155.9743755

7.402723775

525.3329934

Standard Error

27.85473

2.371079026

10.73364979

0.464964889

28.18073791

Median

323.715

20.8019

78.98795

4.45

330.265

Standard Deviation

562.638

47.89344866

216.8090982

9.391830375

569.2230033

Sample Variance

316561.5

2293.782425

47006.18504

88.2064778

324014.8275

Kurtosis

5.342291

10.89790733

13.64062775

30.06073436

5.304909126

Skewness

2.183139

2.810947036

3.294763381

4.007907275

2.178325668

Range

3441.03

406.4025

1586.3001

105

3470.9675

Minimum

1.72

-68.8065

2.9621

0

1.7825

Maximum

3442.75

337.596

1589.2622

105

3472.75

Count

408

408

408

408

408

All value figures are expressed in Indian Rupees (INR)

Variables are defined as follows:

Pt = stock price per share at the end of year t (pt), plus dividend per share for year t (dt);

BVt-1 = book value per share at the end of year t-1 (beginning of year t);

Xt = earnings per share for year t.

Table 2 presents Pearson product moment coefficients of correlation between all variables. We can notice one fact that cum dividend price is more strongly correlated with earnings per share that lagged book value in case of India.

Table

Correlation Matrix for India

 

pt

EPS

Xt

Lagged BV BVt-1

Dividend

dt

cum dividend price Pt

pt

1

EPS Xt

0.737657

1

Lagged BV BVt-1

0.619687

0.831864116

1

Dividend dt

0.696899

0.66726126

0.49926394

1

cum dividend price Pt

0.99993

0.740133167

0.620755491

0.705335977

1

Variables are defined as follows:

Pt = stock price per share at the end of year t (pt), plus dividend per share for year t (dt);

BVt-1 = book value per share at the end of year t-1 (beginning of year t);

Xt = earnings per share for year t.

Regression result for the Total Sample

The model used in this study expresses cum-dividend price (Pt) as a function of current earnings (Xt) and lagged book value (BVt-1). Examining the incremental explanatory power of these two independent variables required two additional equations expressing cum-dividend price as a function of earnings alone and lagged book value alone. We measure the incremental explanatory power of the earnings and lagged book value by decomposing the adjusted coefficient of determination, R2. The results of simple and multiple regression are presented in Table 3. The coefficients and t-statistics for all years combined, accompanied by decomposition of adjusted R2s.

We report an adjusted R2 value of 0.54 for the multiple regression with an F-value of 245.39 which is significant at 0.05 level. The coefficients are also significant however we do not get a significant coefficient for book value. We also see that the coefficients of both the variables are positive as we expected.

Independent regressions for EPS and book value are also significant and we see that EPS is related more closely to firm value in the case of India. F value for EPS comes out to be 491.82 at 0.05 significance level.

Table

Coefficient Estimates on Earnings and Lagged Book Value of Equity for the Total Sample (t-statistics in parentheses)

Pt = β0 + β1Xt + β2BVt-1 + ɛt

N

β0

β1

β2

Adj R2

F-value

408

206.15

8.63

0.04

0.54

245.39

(8.58)

(12.06)

(0.27)

408

207.0015262

8.79662743

0.546683

491.8271

(8.70)

(22.17)

408

271.1311097

1.629767

0.383823

254.525

(9.94)

(15.95)

We will see later, as we compare these observations with observations from other countries that in Indian GAAP EPS is positively and significantly associated with cum-dividend stock prices, as they are in the more mature economies.

United States of America

Our data consisted of S&P 500 firms for the period 2001 to 2012. If any of the variables was missing for a firm for that particular year, that reading was discarded. In the end we had 4618 firm year observations.

Table 4 provides descriptive statistics for the dependent variable, cum dividend price Pt, and its two components, fiscal year-end price per share pt, and dividend per share for year t, dt; as well as for the independent variables, current period bottom-line earnings per share Xt, and the lagged book value of equity per share BVt-1.

Table 5 presents Pearson product moment coefficients of correlation between all variables in the case of United States of America. We can notice one fact that cum dividend price is more strongly correlated with lagged book value as compared to earnings per share. This is opposite to what we observed in the case of India. Also lagged book value is very less correlated with EPS, which dissipates multicollinearity concerns.

Table

Descriptive Statistics for Dependent and Independent Variables for USA

EPS

Xt

Lagged Book Value

BVt-1

Dividend

dt

pt

cum dividend price

Pt

Mean

2.580008272

8.892755349

0.726290905

45.22019155

45.94648246

Standard Error

0.100498679

0.382274806

0.017341718

0.905448848

0.913519188

Median

2.05

5.57825

0.44

34.925

35.592

Standard Deviation

6.829474964

25.97781625

1.178471508

61.53056243

62.07898938

Sample Variance

46.64172829

674.8469373

1.388795096

3786.010113

3853.800923

Kurtosis

1978.837482

405.7235744

123.0096037

130.240634

130.1979521

Skewness

-33.48813346

17.16626426

8.389178917

9.81098336

9.800289133

Range

489.18

776.4387

26.61

1200.3432

1213.3432

Minimum

-371.58

-61.0063

0

0.2638

0.2638

Maximum

117.6

715.4324

26.61

1200.607

1213.607

Count

4618

4618

4618

4618

4618

All value figures are expressed in US Dollars (USD)

Variables are defined as follows:

Pt = stock price per share at the end of year t (pt), plus dividend per share for year t (dt);

BVt-1 = book value per share at the end of year t-1 (beginning of year t);

Xt = earnings per share for year t.

Table

Correlation Matrix for USA

 

EPS

Xt

Lagged Book Value

BVt-1

Dividend

dt

pt

cum dividend price

Pt

EPS

1

Lagged Book Value

0.034427737

1

Dividend

0.208967493

0.418945175

1

pt

0.494010164

0.535860181

0.457869054

1

cum dividend price

0.493612828

0.539079222

0.472807503

0.999857579

1

Variables are defined as follows:

Pt = stock price per share at the end of year t (pt), plus dividend per share for year t (dt);

BVt-1 = book value per share at the end of year t-1 (beginning of year t);

Xt = earnings per share for year t.

Regression result for the Total Sample

The model used in this study expresses cum-dividend price (Pt) as a function of current earnings (Xt) and lagged book value (BVt-1). Examining the incremental explanatory power of these two independent variables required two additional equations expressing cum-dividend price as a function of earnings alone and lagged book value alone. We measure the incremental explanatory power of the earnings and lagged book value by decomposing the adjusted coefficient of determination, R2. The results of simple and multiple regression are presented in Table 6. The coefficients and t-statistics for all years combined, accompanied by decomposition of adjusted R2s.

We report an adjusted R2 value of 0.51 for the multiple regression with an F-value of 2465 which is significant at 0.05 level. The coefficients are also significant for both the EPS and the lagged book value. We also see that the coefficients of both the variables are positive as we expected.

Independent regressions for EPS and book value are also significant and we see that book value is more closely related to firm value as compared to EPS in case of USA. F value for EPS comes out to be 1487 at 0.05 significance level and for Book Value comes out to be 1890.

Table

Coefficient Estimates on Earnings and Lagged Book Value of Equity for the Total Sample (t-statistics in parentheses) for USA

Pt = β0 + β1Xt + β2BVt-1 + ɛt

N

β0

β1

β2

Adj R2

F-value

4615

23.68

4.32

1.249104

0.516341

2465

(33.32)

(46.44)

(51.03)

4615

34.37

4.486873

 

0.24349

1487.024

 

(40.46)

(38.56)

 

 

 

4615

34.49

 

1.28

0.290453

1890.966

 

(42.40)

 

(43.48)

 

 

United Kingdom

Our data consisted of FTSE 100 firms for the period 2006 to 2012. We have started with 2005 here because United Kingdom shifted to IFRS in 2005 and with lagged book value data from 2005 we took other observations from 2006. If any of the variables was missing for a firm for that particular year, that reading was discarded. In the end we had 595 firm year observations.

Table 7 provides descriptive statistics for the dependent variable, cum dividend price Pt, and its two components, fiscal year-end price per share pt, and dividend per share for year t, dt; as well as for the independent variables, current period bottom-line earnings per share Xt, and the lagged book value of equity per share BVt-1.

Table

Descriptive Statistics for Dependent and Independent Variables for United Kingdom

EPS

Xt

Lagged Book Value

BVt-1

Dividend

dt

pt

cum dividend price

Pt

Mean

0.819021008

5.090648235

0.370346387

1024.910992

1025.281338

Standard Error

0.064225055

0.258391485

0.017498657

38.02193506

38.03368348

Median

0.4752

2.4765

0.208

709.5

709.687

Standard Deviation

1.566617478

6.30284578

0.426838114

927.4546833

927.7412582

Sample Variance

2.454290323

39.72586492

0.182190776

860172.1895

860703.8422

Kurtosis

31.8246324

6.28090778

7.238315664

6.065247565

6.059640554

Skewness

-2.0467043

2.341486266

2.448544726

2.01768025

2.016999764

Range

24.0476

44.7795

2.8

6559.095

6559.495

Minimum

-16.7126

-0.394

0

25.905

25.905

Maximum

7.335

44.3855

2.8

6585

6585.4

Count

595

595

595

595

595

Variables are defined as follows:

Pt = stock price per share at the end of year t (pt), plus dividend per share for year t (dt);

BVt-1 = book value per share at the end of year t-1 (beginning of year t);

Xt = earnings per share for year t.

Table 8 presents Pearson product moment coefficients of correlation between all variables in the case of United Kingdom. We can notice one fact that cum dividend price is more strongly correlated with lagged book value as compared to earnings per share. This is opposite to what we observed in the case of India. Also lagged book value is mildly correlated with EPS, which dissipates multicollinearity concerns.

Table

Correlation Matrix for United Kingdom

 

EPS

Xt

Lagged Book Value

BVt-1

Dividend

dt

pt

cum dividend price

Pt

EPS

1

Lagged BV

0.317109353

1

Dividend

0.516442696

0.66083688

1

Price

0.568510496

0.601453332

0.671263928

1

Cum Dividend Price

0.568572492

0.601571586

0.671516661

1

1

Variables are defined as follows:

Pt = stock price per share at the end of year t (pt), plus dividend per share for year t (dt);

BVt-1 = book value per share at the end of year t-1 (beginning of year t);

Xt = earnings per share for year t.

Regression result for the Total Sample

The model used in this study expresses cum-dividend price (Pt) as a function of current earnings (Xt) and lagged book value (BVt-1). Examining the incremental explanatory power of these two independent variables required two additional equations expressing cum-dividend price as a function of earnings alone and lagged book value alone. We measure the incremental explanatory power of the earnings and lagged book value by decomposing the adjusted coefficient of determination, R2. The results of simple and multiple regression are presented in Table 9. The coefficients and t-statistics for all years combined, accompanied by decomposition of adjusted R2s.

We report an adjusted R2 value of 0.52 for the multiple regression with an F-value of 321 which is significant at 0.05 level. The coefficients are also significant for both the EPS and the lagged book value. We also see that the coefficients of both the variables are positive as we expected.

Independent regressions for EPS and book value are also significant and we see that book value is more closely related to firm value as compared to EPS in case of UK. F value for EPS comes out to be 283 at 0.05 significance level and for Book Value comes out to be 336.

Table

Coefficient Estimates on Earnings and Lagged Book Value of Equity for the Total Sample (t-statistics in parentheses) for UK

Pt = β0 + β1Xt + β2BVt-1 + ɛt

N

β0

β1

β2

Adj R2

F-value

595

470.594

248.7497

68.94134

0.518966

321.4205

 

(13.55)

(13.99)

(15.60)

 

 

595

749.5128

336.7051

 

0.322133

283.2787

 

(21.20)

(16.83)

 

 

 

595

574.5159

 

88.54774

0.360812

336.3045

 

(14.69)

 

(18.33)

 

 

China - Hang Seng

Our data consisted of Hang Seng Index firms for the period 2001 to 2012. If any of the variables was missing for a firm for that particular year, that reading was discarded. In the end we had 448 firm year observations.

Table 10 provides descriptive statistics for the dependent variable, cum dividend price Pt, and its two components, fiscal year-end price per share pt, and dividend per share for year t, dt; as well as for the independent variables, current period bottom-line earnings per share Xt, and the lagged book value of equity per share BVt-1.

Table 11 presents Pearson product moment coefficients of correlation between all variables in the case of Hang Seng. We can notice one fact that cum dividend price is more strongly correlated with earnings per share as compared to lagged book value. This is similar to what we saw in the case of India. We also see that lagged book value and earnings per share are highly correlated with each other.

Table

Descriptive Statistics for Dependent and Independent Variables for Hang Seng

EPS

Xt

Lagged Book Value

BVt-1

Dividend

dt

pt

cum dividend price

Pt

Mean

2.160300446

14.99481

0.827604

31.90118

32.72878438

Standard Error

0.156809541

1.04548

0.053371

1.700478

1.741672044

Median

0.9793

7.14175

0.37535

16.4545

16.8595

Standard Deviation

3.319032384

22.12864

1.129659

35.99234

36.86424874

Sampl

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