Accounting: Facts and Literature

Accounting: Facts and Literature

Becoming a professional accountant is no easy task, however there are several pathways to achieve the coveted designation. Before, there were three designations: CA, CGA and CMA. Now, the three certifications have been blended in the CPA designation. A student with a degree with an accounting major can enrol in the CPA PEP program, while a student with a degree in another field may enrol into the CPA PREP program. Overall, there exists several modules, which must be completed with a certain minimum grade in order to eligible for the PEP program. The courses may be taken at CPA learning, or at accredited colleges and universities. But what is accounting? Below follows a brief review of some facts currently of interest to the accounting literature.

What effects does accounting conservatism have on financial statements and financial statements users? Ruch and Taylor (2015) analyzed several studies to answer the question. The authors defined accounting conservatism as a “downward bias in accounting of the net asset value relative to the economic asset value” (p. 20). In other words, accounting conservatism is expecting the worse, magnifying losses and considering profits unlikely. Further, conservatism may be conditional or unconditional, depending on whether financial news are incorporated into the calculation and reporting. Further according to the paper, conditional conservatism reduces earnings persistence and predictability, while unconditional conservatism is conducive to earnings management because of hidden reserves.

Alternatively, more research is needed to shed light on whether conditional conservatism in accounting facilitates earnings management through the “big bath”. The “big bath” is a term that describes the practice in accounting of making bad results even worse. Thus, the increase from one year to another appears more dramatic resulting in bigger bonuses for the company’s management. Also, new CEOs sometimes use this technique to blame the firms shortcomings on the previous CEO. Moreover, there appears to be a relationship between conditional conservatism and information asymmetry.

Jo-Vin as an expression of New York. Photo by Elena.

Ball & Sadka (2015) stress the importance of studying aggregate earnings. The authors state many interesting facts about earnings at the firm-level, for example that firms with higher earnings growth have higher stock returns as well, but the analysis is complicated by research conducted at the aggregate level. The relationship is of interest to investors in analyzing stocks they hold. Interestingly, the authors show that contemporaneous annual aggregate earnings are negatively correlated with aggregate returns, while a positive correlation is found for firm-level comparisons.

A recurring problem in accounting is earnings management, when deliberately false information is misrepresented in financial reports. The issue arises because of the agent-principal dilemma. Top management is interested in bonuses and salary increases, but they typically do not own the firm. Thus, they are tempted to misrepresent financial data through manipulation to make themselves look better in shareholders’ and company owners’ eyes. Researchers agree that portfolio diversification may attenuate the risk.

Another topic often discussed in accounting literature, namely corporate social responsibility (CSR) is often analyzed and cited. For instance, Huang and Watson (2015) discuss the matter and define CSR as a firms actions driven to achieve some social good beyond the interests of the firm. An example could be a bank becoming more green or environmentally friendly, not as required by law, but simply engaging in the endeavour on a purely voluntary basis to further a social good.

While some may think that accounting is boring, studying accounting and its academic literature may be quite fascinating. Hopefully, the present short essay briefly touches on some accounting facts. Going into more detail is beyond the scope of the present paper.

References:

• Huang, X. B. & Watson, L. (2015). Corporate social responsibility research in accounting. Journal of Accounting Literature, 34: 1-16.

• Ruch, G.W. & Taylor, G. (2015). Accounting conservatism: A review of the literature. Journal of Accounting Literature, 34: 17-38.

• Sadka, G. & Ball, R. (2015). Aggregate earnings and why they matter. Journal of Accounting Literature, 34: 39-57.