An analysis of the strengths and weaknesses of the research paper, "The Market Pricing of Accruals Quality", by Jennifer Francis, Ryan LaFond, Per Olsson, Katherine Schipper.
Abstract This paper analyzes the theoretical and methodological strengths and weaknesses of the research paper, "The Market Pricing Of Accruals Quality" by Jennifer Francis, Ryan LaFond, Per Olsson, Katherine Schipper. The paper summarizes the strengths of the research and underlines the weaknesses of the empirical method. Finally, this paper discusses the limitations of the theoretical approach.
Table of Contents:
Synthesis Of Strengths
Accruals Quality Has An Impact On The Information Risk And The Cost Of Capital
Innate Accruals Quality Has A Larger Impact Than Discretionary Accruals Quality Has
Methodological Weaknesses
The Specific Sample Cannot Be Applied Generally
Hypotheses And Methods Are Questionable
There Are Variances Between Empirical Findings And Other Results
Theoretical Limitations
Only The Systematic Component Of Earning Quality Risk Contributes To The Equity Risk Premium
The Relation Between Accruals Quality And Cost Of Capital Depends On The Fundamental Risk
Accruals Quality Is Neither A Priced Risk Factor Nor A Determinant Of The Cost Of Capital
From the Paper "In the paper Earnings quality and the equity risk premium: a benchmark model, Yee makes a distinction between the fundamental earnings and the reported earnings: the fundamental earnings are the accounting profits generating future dividend cash flows, while the reported earnings are the imperfect signal of fundamental earnings. He also makes the difference between the two sources of associated earnings risk: the fundamental risk and the earnings quality risk. The fundamental risk is the uncertainty of future dividends payments, whereas the earnings quality risk or information risk is the uncertainty that the reported earnings may not be announced quickly and precisely. Only the systematic components of earnings risk contribute to the equity risk premium, while all the components, either systematic or diversifiable, affect the earnings capitalization factors."
Abstract This paper explains that, in cash basis or cash accounting, businesses record transactions only if they involve the payment or receipt of cash, which does a poor job of matching revenues earned with money laid out for expenses. The author points out that, in accrual accounting, the economic impact of a transaction is recorded whether or not the transaction involves cash, which does a better job of matching revenues with expenses and of handling items such as property and equipment. The paper relates that the four statements used in the accrual method accounting are the balance sheet, the income statement, the statement of cash flows and the statement of stockholders' equity.
From the Paper "An example would be a purchase of supplies in July but the supplies are not sold until August. You receive the cash in August. However, when the books are closed all you have to show for July is an expense for supplies but no revenue to offset it, meaning there is a loss for that month. This can make it difficult for a business to determine whether or not it is earning a profit because all its business activity does not always fall on the same month. It also has trouble tracking anything other than cash. For example if you purchased equipment or property the cash method of accounting would show the purchase and disbursement in the month of purchase. These items, however, will be used over a period of time."
Abstract This paper presents the basic forms and methods of accounting for cash accounting and accrual-based accounting and compares the two. It examines which form of accounting is more beneficial to specific sectors of the economy and looks at the advantages and disadvantages of each.
From the Paper "In the cash basis of accounting, the business records are "cash in" (deposits to the bank account) called cash receipts, and "cash out" (checks) called cash disbursements. Cash receipts - Cash disbursement = Cash flow. Each month's cash flow is added to the preceding month's cash balance yielding the current month's cash balance.
The cash basis of accounting is more likely to be used by service businesses than by retail or manufacturing businesses. Service businesses usually do not need equipment and can sell a service they perform with nothing more than their own hands and minds. Think of people who are lawyers, writers, public relations and advertising personnel, and accountants."
Abstract This paper describes deferrals as prepaid expenses and accruals as accrued liability. It explains what these terms mean and how they are found on balance sheets. The paper gives examples of the terms that are described above.
Table of Contents:
Deferrals: Prepaid Expenses
1. Prepaid Expenses Recorded Initially as Assets
2. Prepaid Expenses Recorded Initially as Expenses
Deferrals: Unearned Revenues
1. Unearned Revenue Recorded Initially as Liabilities
2. Unearned Revenues Recorded Initially as Revenues
Accrued Liabilities
Accrued Assets
From the Paper "Tracy (1997) stated that accrued liabilities is a short-term liabilities that arise from the gradual buildup of unpaid expenses, such as vacation pay earned by employees or profit-based bonus plans that are not paid until the following year. Example of an accrued liability is the salary of the employees. The amounts of such accrued but unpaid terms at the end of the fiscal period are both an expense and a liability (Fess and Niswonger, 1986)."
Abstract This paper discusses the two large categories of accounting methods that companies tend to use, cash and accrual. The paper presents a definition of both concepts, as well as a comparison between the two methods. The paper offers general recommendations about when it is advisable to use one or the other. The paper contends that, nowadays, most companies use the accrual method.
From the Paper "The accrual methodology, on the other hand, "records income when the sale occurs, whether it be the delivery of a product or the rendering of a service on your part, regardless of when you get paid" . The expenses are similarly recorded when the liability is contracted. For example, in December, we buy equipment worth $20,000, payable over a period of six months. With the accrual accounting method, the respective expense is recorded in the month it was produced and not in every six months to follow during which the payments are made. One of the problems that may arrive when using the accrual method refers to the fact that sometimes the exact moment when the transaction or the liability was contracted is not known."
Abstract This paper defines and compares two concepts in accounting - the cash basis and the accrual basis. It shows that the cash basis of accounting is more likely to be used by service businesses than by retail or manufacturing businesses. The paper also provides an example in table form to show the differences between the two systems.
From the Paper "In short, under the cash method, a business reports income when it is received and reports expenses when cash is disbursed. Under the accrual method, a business reports income when the business has the right to receive the income and reports expenses when all events, which create the liability, have occurred and the amount of the expense is reasonably determinable."
Abstract This paper examines how Class Act's revenue from an agreement with Broadway Venues could be realized. It explores the background of the situation and alternatives. It also recommends an accrual method of recognizing the revenue.
From the Paper "Companies regularly enter into business agreements where payments are made over a period of time. Such agreements can take the form of leases where the payments are regular and made over a long-period of time or ..."
Abstract The issue of revenue recognition may seem, at first thought, trivial relative to the other areas of financial accounting. However, the way in which a company chooses to recognize its revenue can have a significant impact on the company's financial statements and may lead to an overstatement or understatement of revenues. The paper shows that with the increasing popularity of the internet, the issue of revenue recognition is becoming even more important as hundreds of small companies are now issuing stock and attracting small investors who might not have participated in the stock market previously. In addition, there is increased competition for funds among publicly held companies and being able to show higher revenues, rather than lower, can help a company both maintain a higher stock price and attract new investors. This research examines one Internet company, eBay and its approach to revenue recognition.
From the Paper "The most basic explanation of eBay is that it provides an on-line auction service. Sellers (who must register with the site) list items for sale and, optionally, a minimum price (as well as a reserve price below which they will not sell the item). Buyers have a predefined period of time during which they may bid on items after which eBay validates if a bid exceeded the minimum price and the reserve price (if a reserve price has been set). If the sale was successful according to these criteria, eBay notifies the buyer and seller through e-mail and they consummate the sale (arranging for shipment and payment) between them. At the time of the e-mail notification, eBay's involvement in the transaction is concluded. The site is not responsible for either payment or shipping (1999 Annual Report, 2000, p. 6)."
Abstract This paper analyzes the Government reporting model in Canada. Financial reporting is a must for the Government in order to keep record of its performance. The Government wants to adopt the accrual model of financial reporting. This business model of Government reporting is highly beneficial for the Canadian economy as it improves upon the functioning of not only the financial structure of public sector, but also its management.
Abstract Examines the use of business records as a tool of business management. Defines assets, liabilities, double-entry bookkeeping, balance sheet, accrual method of accounting, hands-on bookkeeping system, and check writing.
From the Paper "This research describes how to establish successful accounting practices for a small retail outlet that does not require the services of a full-time accountant. Poor financial record keeping is recognized as one of the major factors of small-business ..."
Abstract This paper discusses each of the following terms, expands on the definition, and explains why the concept is important to financial statements. The terms include Generally Accepted Accounting Principles (GAAP), Historical Cost, Accrual Basis vs. Cash Basis Accounting, and Current Assets and Liabilities vs. Non-Current Items. The paper locates the balance sheet, income statement, and statement of cash flows for Ford, Exxon-Mobil, and Microsoft. The paper examines whether net income or cash from operating activities is more useful for each of these companies.
From the Paper "The GAAP are not rules set in stone; rather, they are guidelines, or you might call them a group of objectives and conventions "that have evolved over time to govern how financial statements are prepared and presented," according to www.allbusiness.com. Theses principles are set by the Financial Accounting Standards Board (FASB), and the Securities and Exchange Commission (SEC) also provides input and guidance regarding the amendments to acceptable accounting practices. The GAAP serves as a guiding light for every business: when an accountant from outside the company is looking into its financial data and record-keeping, the company expects that accountant to be using GAAP. "Compliance with GAAP helps maintain creditability with creditors and stockholders," AllBusiness.com explains, "because it reassures outsiders that a company's financial reports accurately portray its financial position.""
This paper discusses revenue and expense recognition methods, both standard and percentage of completion criteria, and the pros and cons of expensing stock options.
930 words (approx. 3.7 pages), 4 sources, APA, $ 33.95
Abstract This paper explains that expenses are recognized in the same period in which the benefits derived from those costs are recognized (the matching principle) and, thus, recognition of expenses is dictated by revenue recognition; therefore, associations between revenues and costs must be established. The author points out the pros of expensing options include providing a level playing field so that companies, which use cash bonuses, and companies, which use stock options, each have an expense on the income statement; however, there are many significant challenges for a company that expenses options. The paper recommends that manufacturing companies use accrual basis accounting and follow GAAP guidelines for revenue and expense recognition and, with regards to expensing stock options, the company might explore the use of stock awards instead of stock options.
Table of Contents
Introduction
Revenue and Expense Recognition Methods
Expensing of Stock Options
Recommendations
From the Paper "The revenue recognition and matching principles mentioned above are used under the accrual basis of accounting. Under cash-basis accounting, revenue is recorded only when cash is received, and expenses are recorded only when paid. However, GAAP requires accrual basis accounting because the cash basis often causes misleading financial statements. With accrual basis, revenue must be recognized in the accounting period in which it is earned, not just when money is exchanged."
Abstract This paper explains that the American International Group--AIG, the world's largest insurer--was reported to have arranged deals to manipulate financial figure in its own records and those of General Re, a reinsurance company, resulting in financial fraud during the autumn of 2000. The author points out that AIG also was involved in another accounting fraud with Brightpoint Inc., which was reported by the Securities and Exchange Commission in 2003; AIG worked closely with the Brightpoint people to tailor an alleged insurance policy that let Brightpoint overstate its earnings by an amazing 61% in a cash circulation deal from Brightpoint to AIG and again back to Brightpoint. The paper defines receivables are monies due from the customers, which are tallied by invoices and happen due to operating cycle's process of selling inventory or services on terms that permit delivery before cash is collected.
Table of Contents
The General Re Fraud
The Brightpoint Fraud
Cash & Accrual Basis of Accounting
Receivables and Inventory
Fixed and Intangible Assets
Liability & Stockholders Equity
From the Paper "Under the cash method of accounting, the books are maintained on the actual cash flow. Income is recorded on its receipt and expenses enter the books on their actual payment. Whereas majority of the businesses use the accrual basis, the most correct method for the company depends on the sales volume, credit policy of the company and business structure. In case of the accrual method, income & expenses are recorded while they occur, notwithstanding whether there has been exchange of cash and an example of this is sale on credit. Accrual method is appropriate when the annual sales are more than $5 million and the business is a corporate organization. Besides, it is suggested that while selling on credit, matching of income and expenses during a given period must be done."
Abstract This paper explains to a manufacturing company how each of the following recommendations for recognizing revenue and expenses will assist the organization in meeting its goals. The paper also explains why alternative revenue recognition methods were not chosen.
1) Revenue Recognition Methods
2) Expensing Recognition Methods
3) Expensing of Stock Options
From the Paper "There are two different ways to recognize revenues. One way is the accrual accounting method. The other way to recognize revenues involves cash basis accounting. Al Rosen writes, in "Canadian Business", that under the accrual basis for accounting, revenue is recognized when either or both of the following conditions are met: the revenue is substantially earned or the revenue is realized or realizable. In other words, revenue is earned when products are delivered or services are provided. Under the accrual basis for accounting expenses must be..."
Abstract This paper reviews the current day issues surrounding asset valuation and accounting methodology. The paper discusses the various problems with accounting principles and the international financial reporting standards recently developed as a result of the constantly changing nature of the capital markets and major players and the inclusion of many other countries in the capital markets play arena.
From the Paper "This approach has become rather popular to trace "real business" progress, when numerous debt instruments and business approaches have changed. The fault of this approach is the risks which arise with cash receivable as the company shows to the investors and top management business progress as opposed to income received. The longer the company does not receive the money for having sold the product, the less is its' actual present value, while this is not considered. To minimize the affect of this, the companies are now restricted to a limited extent to the amount of transaction they can account for on accruals basis. Another way to minimize the misleading of the investors on the actual and true financial situation within the company, is introduction of several liquidity ratios and "bad debt" ratios which reflect the fact how company is able to achieve revenues, but also how fast and well the company is able to collect the money payable to the company and thus not lose any time value money worth. "
