The Relation between Other Comprehensive Income and Net Income

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4. Samples and Research Hypothesis

1 Samples In this research, samples firm years are selected according to criterions as follows. Firms in Tokyo stock exchange group 1 st section adopting SEC standards. The period for the analysis is from 1995 to 2007. Comprehensive income reporting was introduced from 1999 substantially in sample firms. Firm years when total asset, net income, unrealized gains and losses related to sale available security and its reclassification 76 item are available in the annual reports during 1995~2007. Firm years when unrealized gain and losses on exchange translation differences on foreign currency net investment and its reclassification is available in annual reports during 1999-2007. Firm years when unrealized gains and losses on cash flow hedge derivatives and its reclassification is available in annual report during 2002-2007. Inputting these samples with manual procedure 2 Research Hypothesis If managers think the transparency of financial performance is enhanced by comprehensive income reporting, it is presumed that the manipulation of net income by using other comprehensive income decreases after the period when introducing the comprehensive income reporting. Especially, according to FAS130, it was expected that the introduction of reporting comprehensive income would improve the traceability from other comprehensive income to net income =recycling or reclassification. Considering these aspects, more specifically, we present the following hypotheses. H: the magnitude of earnings management for net income by using other comprehensive income items scales down after the period when adopting comprehensive income reporting. 3 Research Model We examine the hypothesis by the following two methods. T-test for the average of reclassification items=realized gains and lossesrelated to other comprehensive income We calculated the percentage of the reclassification of available-for-sale-securities in net income Av1 i , turned the numbers to absolute value and conducted the t-test whether the difference|Av1 i -Av1 i-1 | of the averages was statistically significant or not after period when comprehensive income reporting was introduced1999~2007. Additionally for the period of 1999~2007, we also conducted the same test for the reclassification of exchange translation differences on foreign currency net investment |Av2i-Av2i-1|, and during the years 2002~2007 for the reclassification of cash flow hedge derivatives |Av3 i -Av3 i-1 |. Av1 i =|reclassification of available-sale-security i||net income i | Av2 i =|reclassification of exchange translation differences on foreign currency net investment i ||net income i | 76 Reclassification is a procedure in which other comprehensive income items, when turned into realized items, are charged to net income from other comprehensive income. 538 Av3 i =| reclassification of cash flow hedge derivatives i||net income i | Av: average, i: firm year Multiple linear regression analysis As an additional examination for robustness, we conducted multiple linear regression analysis considering the factors that are presumed to affect the reclassification of other comprehensive income items. Model: Yit= + 1 LVit+ 2 PBRit+ 3 D1it+ 4 D2it+ 5 YD1it+εit… Yit= + 1 LVit+ 2 PBRit+ 3 D1it+ 4 D2it+ 5 YD2it+εit… Yit= + 1 LVit+ 2 PBRit+ 3 D1it+ 4 D2it+ 5 YD3it+εit… Yit: |reclassification of available-for-sale-securities i ||net income i | of firm i in year t LV: liability to equity ratio PBR: Price to book ratio D1: if net income is negative or decreased more than 30 decrease over the previous year, 1. otherwise 0. D2: if there is more than 20 difference between reported net income and forecasted income, then 1; otherwise 0. YD1:if 1995~1998,then 0; otherwise 1 YD2:if 1995~2004,then 0; otherwise 1 YD3:if 1999~2004, then 0; otherwise 1 εit: disturbance term If the liability to equity ratio is high, it can be expected that managers tend to increase earnings in order to decrease interest rate or to borrow more loans, etc …. On PBR, if the firm ‘s growth potential is high, managers try to increase earnings in order to make it look like their firm keeps growing. When earnings are negative, decrease or have a large difference between its forecasted income, it is presumed managers tend to increase earnings. YD1, YD2, YD3 are dummy variables to examine whether there is a difference of earnings management by other comprehensive income items before and after introducing reporting comprehensive income. 5. Results and Implication 1 Results form t-test Figure 1 shows that before introducing comprehensive income reporting 1995~1998, the average of reclassification related to available-for-sale-securities is 18.702. On the other hand, after adopting comprehensive income reporting, the average is 12.567. And the difference between them is statistically significant 5. This result suggests that there is a possibility that the adoption of reporting comprehensive income affects the magnitude of earnings management with available- for-sale-securities and managers do not manipulate net income as much as before 77 . 77 It is conceivable that the tendency of reclassification of available-sale-security is influenced by the stock market trend. Then we examined it by analyzing the relation between the reclassification of available-sale-security per share and the average of Nikkei. The result is that the correlation coefficient is 0.11 and t-value is 0.382. Consequently, we conclude there is no strong relation between them.