Orapin Duangploy and Dahli Gray
ABSTRACT
The mandated adoption of International Accounting Standards (IAS) for Japanese corporations did not result in improved earnings that forecast predictability. These findings contradict the research findings of Ashbaugh and Pincus (2001). Herrmann, Inoue, and Thomas’ (2003) research findings support the need for mandating the adoption of IAS. They found that Japanese managers were ‘‘manipulating’’ reported earnings by managing the sale of fixed assets and marketable securities. Adoption of
Advances in International Accounting, Volume 20, 179–200 Copyrightr2007 by Elsevier Ltd.
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IAS decreases the availability of this practice and it was and is expected to increase disclosure and transparency. Increased disclosure and transpar- ency are expected to decrease financial analyst forecast errors, which did not decrease for 139 firms examined in this study for the timeframe of 1999–2002. This research finding does not support the idea that adoption of IAS improves financial information used in decision making relative to forecasting earnings. Assuming that increased predictability indicates higher quality reported earnings and enhanced usefulness of financial information, the mandated adoption of IAS did not result in these.
Assuming that adoption of IAS in Japan increased the level of transparency and disclosure by Japanese firms, which made it harder for Japanese firms to manage their earnings in order to meet the managerial earnings forecasts that these firms must make. Thus, after the adoption of IAS in Japan, forecast errors for managerial forecasts of earnings increased. This evidence is new to the literature.
INTRODUCTION
In Japan, corporate management must issue forecasts of operating income, current profit, and net income. Between 1999 and 2002 there were a number of significant changes to corporate financial reporting in Japan. These changes essentially involved the adoption of a number of important International Accounting Standards (IAS), which are listed in appendix.
This paper reports research findings which reveal that the mandated adoption of a set of IAS in Japan in the period 1999–2002 was not associated with an improvement in the accuracy of financial analysts’
forecasts of Japanese companies’ earnings. Ashbaugh and Pincus (2001) looked at a similar question, but examined a set of firms that voluntarily adopted IAS in the early 1990s. Their research findings revealed an increase in forecast accuracy. This study’s research findings contradict theAshbaugh and Pincus (2001) findings and thereby add an important new evidence to the existing literature.
The Japanese government requires managers in Japan to disclose annual and semiannual forecasts of operating income (OI), current profit (CP), and bottom-line net income (NI). Financial analysts at Toyo Keizai (http://
www.toyokeizai.co.jp/english/) revise quarterly forecasts based on these disclosures. The revised forecasts made in the winter quarterly update for the years 1999–2002 are used in this paper as the expectations against which
actual earnings (and earnings components of operating income and current profit) are compared to determine forecast errors.
Prior to the adoption of IAS, Japanese accounting standards were similar to German code law. The bank-based financial system in Japan was heavily protected by its government, which viewed earnings management as both legal and prudent. The adoption of IAS reflects the transformation of the Japanese financial system from a bank-centered system to a market-centered system. Usefulness of reported earnings emerges as a significant quality.
Hence, this study also investigates the usefulness of the accounting reforms from the predictability of earnings perspective.
The Japanese ‘‘Big Bang’’ in November 1996 reformed the corporate financial reporting system by embracing IAS. The International Accounting Standards Committee (IASC) developed IAS to generate more comparable financial information across national boundaries by requiring more transparency and disclosure. The reduction in the variation in measurement and greater disclosure practices will result in more predictable financial information (Ashbaugh & Pincus, 2001, p. 418). After the ‘‘big bang’’ reform, the Japanese financial reporting system is expected to provide a higher level of disclosure that is more in line with IAS. A number of changes in accounting standards became effective during 1999 and 2002 (seeappendix). Among the new accounting standards that became effective beginning on April 1, 1999 is the treatment of consolidated financial statements as the primary financial statements and income tax allocation (Japan Institute of Certified Public Accountants (JICPA) 1999, pp. 45, 32). The requirement of issuing semiannual consolidated financial statements became effective on April 1, 1999 (JICPA, 1999, pp. 45, 50). Another major group of accounting changes took place beginning April 1, 2000. These changes require fair value reporting of financial instruments and include the following: accounting for marketable securities and investment in securities, accounting for retirement obligations, and accounting for foreign currency transactions (JICPA, 1999, pp. 16, 28, 52, 40). Adopting new accounting rules for the treatment of the impairment of long-lived assets was proposed on April 1, 2002 and voluntary application was encouraged prior to the full application in the fiscal year 2005 (www.jetro.go.jp/usa, July 2002). Hence, with the exception of the impair- ment loss of assets, the majority of the impact of the accounting reforms will be reflected in the March 31, 2003 financial statements.
Ashbaugh and Pincus (2001) studied a sample of 80 non-US firms that switched from domestic generally accepted accounting principles (GAAP) to IAS and found that ‘‘prior to adopting IAS, the extent of differences in countries disclosure and measurement policies relative to IAS is positively
associated with analysts’ earnings forecast errors’’ (p. 431). They also
‘‘document a decrease in the absolute value of analyst forecast errors after firms adopt IAS’’ (Ashbaugh & Pincus, 2001). Consistent results were found even after they controlled for ‘‘the concurrent growth in news reports’’
Ashbaugh and Pincus (2001).
It is therefore expected that the accounting reform in Japan, though not in full compliance with the IAS, will increase the predictability of earnings (i.e., accuracy of forecasts).