Instructional material Technology infrastructures: internet. Formative evaluation Student evaluation: middle test, final test, Introduction

2497 Appendix 8. Data Flow Diagram Major Admin Lecturer Upload Modul Change Modul Delete Modul Transfer case Send result Student Download Modul ReadDiscuss Modul Result Answer Questioners Setting beginer and display setting Setting beginer and display setting Login Online learning Login To controll transfer Lecturer Own sending Sending Source: Processed Data, 2008 2498 HARMONIZATION OF ACCOUNTING STANDARDS AND EXTENSION OF EXTENSIBLE BUSINESS REPORTING LANGUAGE XBRL Saeed Jabbarzade Kangar lui PHD student and member of scientific broad IAU of urmia Akbar Pourreza soltan ahmadi Member of scientific broad IAU of Salmas Abstract: XBRL is a language based on XML for the electronic communication of business information. It is designed to improve the exchange, aggregation and analysis of corporate data requiring disclosure, through a uni que tagging structure that provides interoperability. But the proliferation of a multitude of XBRL taxonomies, based on different accounting principles, can risk the objectives of harmonization, comparability and reusability of the information that is sought with XBRL. It is there fore essential to develop harmonization accounting standards as a unique foundation on which the XBRL taxonomies can be established, so that it becomes possible to compare the financial information originating from various countries. Along these lines, harmonization of accounting standards can be created to establish a common ground for international firms and create a platform that would enhance the benefits of XBRL. This paper investigates the importance of accounting standards harmonization in extension of XBRL. Key words: Harmonization – Extensible business reporting language XBRL – Extensible markup language XML – Standards Introduction: XBRL Extensible business reporting language is a commercial branded language, based on XML, dvised with the aim of establishing standardized protocols for the transmission of accounting information 2499 through the internet. Currently, it is being promoted by the consortium XBRL international, which groups around 450 companies and organizations committed to extending the use of a standard taxonomy globally. XML is a meta language; in other words, it represents metadata that are essentially data about other data. These metadata play a fundamental role in facilitating the search for information on the internet. On this latter point, Alimohammadi 2003 notes that the internet lacks the necessary structure to allow users to rapidly find the information that they need, and metadata provide a possible solution for better organizing and retrieving digital information. Accordingly, XBRL as an adaptation of XML to the business world should allow financial information to be managed more effectively and efficiently. The principal components of XBRL are the items and the taxonomies. An item is a fact that makes reference to the entity that issues information by means of XBRL and a taxonomy is a set of elements that allows several different items of information to be represented in an XBRL document. These items can be associated with the auditing, elements of the financial statement themselves, and accounting policies. Each of this groups is included in a different taxonomy; some of them are universal in scope, while others are specific to nations or regions and allow the requirements of the accounting regulations in each environment to be represented; that is, they are in accordance with different sets of generally accepted accounting principles. At first sight, these adaptations may seem an advantage, but in reality they represent an impediment for achiev ing the full, comprehensive expansion and application of the standard. There fore, if the bases on which the XBRL taxonomies rest are different, users will not be able to compare the financial information corresponding to companies from several countries. A possible solution to this problem is the development of a toolset capable of translating the financial statements prepared under a set of accounting principles into another one. Along these lines, the IASC foundation XBRL team is developing theories and mechanisms to compare taxonomies and to signal equivalent concepts. However, this toolset is still under development Eccles et al., 2500 2001; Jensen and xiao ,2001, Unless a different approach is adopted, the objectives of harmonization, comparability and reusability of information that XBRL is intended to achieve will be put at risk. It is essential to develop a set of accounting principles and standards of universal character that would make possible the comparison of the financial information originating from many different countries. The concept of accounting standards harmonization Accounting harmonization is defined as ―a process of increasing the comparability of accounting practices by setting limites on how much they can vary. Harmonized standards and free of logical conflicts, and should improve the comparability of financial information from different countries‖ choi, frost meek, 2001, p291. Accounting harmonization is a process leading to the ultimate goal of increasing comparability of finan cial information across national borders. Accounting harmonization is a multi faceted concept, containing at least three components of accounting harmonization choi et al., 2001: 1 harmonization of accounting standards, which deals with measurement and disclosure; 2 harmonization of disclosures made by publicly traded companies in connection with securities offerings and stock exchange listings; and 3 harmonization of auditing standards. Countries with very similar accounting standards may not be comparable for reasons well beyond the similarity of the respective accounting standards. It is possible to have a situation of only apparent accounting harmonization if the standards are relatively similar, but if either the culture of compliance or the system of enforcement is inadequate. Development of an operational measure of accounting harmonization is a complex issue. Two sets of accounting standards may be ―in harmony‖ but may apply different sets of rules to the same situation since each national set of accounting standards allows degree of choice of treatment. Scholars canibano mora, 2000 note there are two forms of harmonization: de jure and de facto harmonization. De jure, or formal 2501 harmonization, refers to the harmonization of regulations. De fac to or informal harmonization, refers to the actual accounting practices of corporations. De facto and de jure harmonization can each be broken down into two components. The degree of disclosure and measurement criter: This results in four forms of accounting harmonization: 1 de jure measurement harmonization, which concerns regulations governing what is disclosed, 2 de jure measurement harmonization, which concerns regulations governing how reported quantities are measured, 3 de facto disclosure harmonization, which concerns what corporations actually disclose; and 4 de facto measurement harmonization, which concerns how corporations actually measure quantities. The concept of accounting convergence Recently, the term accounting harmonization has at times been by the term accounting convergence this term has been defined as: The process pursued by the international accounting standards board IASB of eliminating the present differences between national accounting standards and the avoidance of future differences to achieve international accounting harmonization Hussey ong,2005, p.229 In this sense, accounting convergence is a process that occurs at the standard setting level intended to achieve a state of de jure accounting harmonization. It is possible to measure de jure harmonization by focusing on the range of choices provided by various accounting standards. If we consider measurement as a system of assigning numbers to qualities of an object, we can consider a set of accounting standards as rules for measuring aspects of the financial condition of an organization. If the two measuring systems are equivalent, they should produce the same set of accounting numbers. For example, if U.S accounting standards and IFRS were equivalent, then net income reported under 2502 U.S accounting standards and net income reported under IFRS should be the same. If the two sets of accounting numbers are different under each set of accounting standards, then the measuring instruments are not equivalent. If the two sets of accounting standards are becoming harmonized over time, then it is likely that the numbers purporting to measure the same quality e.g. net income of an organization would be moving closer over time. This is the meaning of the term convergence. XBRL and opportunities and challenges XBRL Extensible business reporting language is the XML based solution being developed for business information reporting. XBRL uses XML based data tags to describe financial and other business information to facilitate external and internal reporting by companies. XBRL is an open specification, which means any one can develop applications using it, and is freely licensed in order to encourage wide acceptance. XBRL is expected to create significant benefits for all participants in the business information supply chain. Examples of the potential uses of XBRL include: - Internationalization of capital markets and external reporting. - Important to emerging markets to assess global capital markets. - Trust and creditability of financial information. - Important to market transparency and timely reporting. - XBRL links accounting with non accounting information. - Preparation of financial statements for statutory and other purposes. - Analyses of financial information e.g. equities research, investment management,. . . . Despite the clear benefits that XBRL provides for the business information supply chain, its current usage is very limited. In order for XBRL to be deployed success fully on a universal basis a number o f requirements must still be met, including the following: 2503 - Common specifications need to be developed. Although taxonomies need to be tailored to meet the requirements of particular industries or jurisdictions, all specifications should cue a similar X ML based framework. - Software applications that automate tagging of information with XBRL tags need to be developed. - Style sheets that can produce information in various different reporting formats need to be created. Accounting standards harmonization and extension XBRL XBRL is a language based on XML for the electronic communication of business information. It is designed to improve the exchange, aggregation and analyses of corporate data requiring disclosure, through a unique tagging structure that provides interoperability. Nowadays, there are many different XBRL taxonomies, based on different national accounting regulations. At first, these adaptions may seem an advantage but, actually, they represent an impediment for achieving the full, comprehensive expansion and application of the standard. If the bases on which the XBRL taxonomies rest are different, users will not be able to compare the financial information corresponding to companies from different countries. A possible solution to this problem is the development of toolset expable of translating the financial statements prepared under a set of accounting principles into another one. Along these lines, the IASC foundation XBRL team is developing theories and mechanisms to compare taxonomies and to signal equivalent concepts. However, this toolset has not been developed yet. Therefore, in order to fully exploit the capabilities of XBRL, it seems essential to create a common set of global accounting standards with the objective of facilitating the comparison firms from different countries Eccles et al., 2001. Only under the presence of such standards could the efficiency of XBRL be brought to exceed the desired levels. 2504 The internationally inclusive approach of the XBRL initiative means that there is an opening for global reporting of accounting information, if not under globally accounting standards. Understanding the mechanisms of internationalization of accounting information dissemination and the treatment of common elements under the various GAAPs recognized by XBRL will present major challenges to developing interoperable XBRL taxonomies and provides interesting research opportunities. The role of IFRS in extension XBRL It appears that IFRS, which to date is the best approach to those much wished for universal financial reporting standards, has become fundamental for achieving accounting harmonization on the world scale, and thus for being able to take maximum advantage of the potentialities of XBRL. If all companies were to utilize the same standard that, in turn, was based on the same rules or principles, the comparability of information would be possible at all levels. IFRS-GP Taxonomy International financial reporting standards, general purpose financial reporting for profit oriented entities, incorporating additional requirements for banks and similar financial institutions is itself based on IFRS. For this reason this taxonomy is of great importance in that it serves both to establish a common ground for international firms and to create a platform for the utilization of XBRL. IFRS-GP taxonomy prepared by the international accounting standards committee foundation IASCF, establishes an XBRL standard for the financial statements prepared according to the IFRS, and covers the balance sheet, income statement, cash flow statement and statement of changes in equity, together with accounting policies and explanatory disclosures. The objective of the IFRS-GP taxonomy is to capture the elements most commonly observed in general purpose financial statements used in practice. As a consequence, the IFRS-GP taxonomy includes, in addition to the elements prescribed by the IFRS guidelines, non authoritative common practices where the standards and interpretations are silent on 2505 common patterns of financial reporting, elements for structural completeness such a sub total, and elements required specifically for XBRL specification. Expansion forms of XBRL 1- Expansion of XBRL for different processes: As Fig.1 illustrates, the XBRL steering committee is expecting to expand the XBRL specification in other related financial domains. The box labeled XBRL for financial statements presents the initial XBRL activities. External financial reporting to external parties is, however, only one aspect of XBRL. The standard also has the potential to be used for tax filings or for other regulatory purposes, such as reports to the regulators of financial institution. Fig.1. Expansion of XBRL for different process. XBRL for GL journal entry reporting XBRL for financial statements XBRL for EDGAR filings Processe Business Operations Internal Financial External Financial Investment And lending XBRL for business event XBRL for tax filings 2506 Fig.1. Expansion of XBRL for different process. 2- Expansion of XBRL beyond financial reporting: Fig.2 illustrates expanding beyond financial reporting. The four blocks in the center of Fig.2 can be viewed as four cells in a 2×2 matrix. Vertically, reporting can be divided into external and internal. Horizontally, the contents of the reports could be divided between financial and operational. The larger arrow in the background of Fig.2 illustrates the evolutionary flow of the expanding XBML domain. Initially, XBRL is focused on external financial reporting. External Internal Financial Operational Today: XML Rendering of existing GAPP Reporting XML supporting GL level Information Exchange Standards Far Future: XML Supporting Emerging Business Performance Metrics External Financial Reporting Internal Financial Reporting External Business Performance Reporting Internal Business Operations Reporting Future: XML Supporting Standardized Business Event Vocabularies 2507 Conclusion: XBRL Extensible Business Reporting language is the XML based solution being developed for business information reporting. It is designed to improve the exchange, aggregation and analysis of corporate data requiring disclosure, through a unique tagging structure that provides interoperability. Since, the proliferation of a multitude of XBRL taxonomies can risk the objectives of standardization, comparability and reusability of the information that is sought with XBRL, it is essential to develop global accounting standards as a unique foundation on which the XBRL taxonomies can be established. The harmonization of accounting standards with creation of common ground for international firms, can increase the benefits of XBRL. As a final conclusion, a future scenario is proposed in which the reviews of the IFRS-GP taxonomy need to be continuous, or at least frequent, to be able to detect possible mis fits between the taxonomy and the reporting practices of companies that prepare their financial statements based on IFRS. References: 1- Alimohammadi D. Meta tag: a means to control the process of web indexing. Online Infrev 2003; 274:238-242. 2- IASB. Preliminary views on an improved conceptual framework for financial reporting: the objective of financial reporting and qualita tive characteristics of decision useful financial reporting information: 2006.available at www.iasb.orgnrrdonlyres4651adfc-ab83-4619-a75a- 4f279c175006odp conceptual framework.pdf accessed 5 December 2006. 3- Eccles RG, Herz PH, Keegan EM, Philips DMH, The value reporting revolution. NEW YORK: john wiley sons: 2001 chapter 6. 4-Choi, F.D, Frost, C.A., meek, G.K.2001. International accounting 4 th ed. Upper saddle River, NS: Pearson Education, Inc. 2508 5- Deloitee Touche Tohmatsu 2002. GAAP differences in your pocket: IAS and U.S GAAP. www.iasplus.comresourceIASUS.pdf, accessed October 18, 2002. 6- AICPA. Report of the special committee on financial reporting: improving business reporting a customer focus: meeting the information needs of investors and creditors NEW YORK, NY: American Institute of certified public Accountants, 1994. 7- XBRL International 2003. What is XBRL: overview transforming business reporting, Available http:www.xbrl.orgwhat is XBRLindex.asp?sid=39. 2509 ISLAMIC VIEW OF ACCOUNTING AND NEW THEORIES Yaghoub Aghdam , Member of science board of Islamic Azad University Iran-Sofyan branch Abstract: These years accounting has found more relationship with society, culture, religion, markets and economic. Some researches thought that concentraiztion of accounting and have consensus that can cause to simplifying on interpreting and understanding of themes and increase the authority and reliability of financial statements. There are some common points between some religions in doing trade and some common rules. That guide and help mans and corporate to do fairness transactions. In this way we survey some Islamic views that want people to do them for progressing and developing. In the last secti on we conclude that Islamic commands on contrasting with boarding and creating of resources inflow have relation with activity based costing ABC and just in time producing JIT Key words: International accounting, culture effects, just in time, hoard ing Islamic accounting at theoretical perspectives: These days there are many discussions in society about the effects of religious aspects of accounting. In some Islamic countries scientists believes that 2510 regarding of Islamic rationalities may have efficiency on accepting and doing of better accounting by Muslims. In these countries Islamic commands have more efficiency on humans lives and government has to establish Quran Sonnat. In this way some accounting scientists differentiate between Islamic and eastern economics. As mentioned in Islam, man is just trustshiper of god give recourses. But at eastern economy man is the final owner of resources and Muslims responsibility is for gods and people, in this way all Muslims corporations can just do legitimated transactions and are responsible for there transaction results to al; interested on corporation and god so the main instruments for that is known khoms and zakah. In the capitalist societies profit maximizing, personal interests are the base of economical movement but in Islamic view of economy society benefits, fairness, trustiness are main factors whom would be suspected. Some transactions like trading alcoholic, gavel, gambling are prohibited in Islam. There for economical activities would be based on no including those activities. So Islamic accounting determined as: systematic process of recording of legitimated transactions, measuring and reporting of financial statements. As mentioned some Islamic regards the main different between traditional and Islamic accounting is legitimated that is esoteric for understanding Islamic accounting and there would be explored some principles of this view of accounting. In many Islamic countries established some council for surveying 2511 transacting for recording Islamic legitimating on the other hand Islamic society cannot accept and support no legitimated transactions that some corporations do them. Muslims believe that all transactions that are prohibited on canon of Islam ,have losses for people and perfect likelihood society so they would be deposited for society .but accounting has to record and maintain results of both legitimated and non legitimated transactions . These days we can found some relation between Islamic commands for prohibited activities and benefits of that for society. These days scientists emphasis on losses of alcoholic on human organism. Zakah Another definition of Islamic accounting is a process of identifying, measuring and reporting legitimating of financial activities that are us ed to decision, measuring zakah and actual profit of Islamic investment based on Islam commands. So other goals of Islamic accounting is measuring Zakah. Zakah are commanded in Islam canon as a permanent factor of developing Islamic societies. So another function of accounting is measuring of Zakah as a regulator of worth among man. Recently zakah has been can centrated in so many Islamic countries. Pursuant of Islamic commands all Muslims that have residual benefits from some activities must pay some amounts as zakah for government, this is like tax that use for adjusting so worth between poor and rich people. Zakah is personal and there is not 2512 requirement for corporation to any Zakah. Main goal of Islamic accounting is usefulness for decision, agency function, and Islamic responsibility. Usefulness for decision: Islamic accounting goals for banks is determining propose of banks activity that would be charity loans. In this way all Islamic banks would consistent their activities with Islam commends and they have to achieve permit of shariah. So main purpose of Islamic banking reporting are: 1 Information about sharieh regarding in banks. 2 Information about economical resources and obligations and events. 3 Information required for determining zakah. 4 Information about cash in flow estimation. 5 Information about banks responsibility for resource keeping. 6 Information about social responsibity of banks. Some researchers believe that Islamic accounting theoretical framework that is prepared by Islamic accounting institutions is common with traditional accounting framework. In tradition view relevant information for users are whom that are related with financial position and performance may be that is one of difference between Islamic and traditional accounting also Islam and Muslim expect companies to have rational profit. Financial accounting proposes is preparing information needs of outside users that are environmental needs. So environmental factors are effective on accounting and if there is international need, accounting have in so many Islamic countries trading and corporation are 2513 like other countries and in many cases are common so Islamic accounting propose would corer all institutions information needs and we can not limit Islamic accounting proposes. In Islam canon maximizing of profit is not prohibited if that is in framework of Islam legitimating. In practice there is common motivated for Muslims in achieving profit and we can set some standard for special trades of Muslims like Islamic agreements standards. Some Islamic accounting researchers limit that just for zakah while that is not true and it would develop trading, taxing and even cost accounting and management like JIT, ABM. Further more Islamic accounting proposes can be used on usefulness for decision making is useful for responsibility. So information that are used for Muslim decision making would used for sharieh responsibility of Muslims. In this way some researchers discuss that word of Islam would be add to accounting and state of Islamic transaction accounting can be true. So some Islamic accounting and auditing institution set some standards for these transaction reordering. Because international accountings standards have not have related standards about Islamic agreements these institutions are active but it seemed there would be common standards included by IASB about Islamic transactions. Stewardship 2514 Stewardship accounting has theme at historic .in this concept human is stewardship of god for maintained of resources and has to create profit ability and efficiency of them as a social responsibility. In Islamic view stewardship means that all assets which owned by peoples are belong to god and people most do there agency task rightly and would be responsible for. in so many cases god transferred his rights to people and wants them to keep that in right way .on the other hand all resources which owned by people are belonged to all people as gifts from god for all kinds of people in this way worth can be adjusted by Islamic rules as gods commands at Quran and can notice to this that is one of major factors of permanent and sustainable development of economics and societies. Social accounting and Islamic accounting: Social contract theory: Lately there are a lot of variations in environmental and social revealing of companies. Social contracts theory supposes that conscience is the social insight in such an excellent way to who act legitimately and according to contract. Social contracts theory completely contact with environmental contracts assumption. This theory supposes that companies participate in social contrast agreeing with society in forming social, environmental demands to reach their goals and finally surviving of themselves. 2515 Definition of legitimacy theory: Social contract is done for arranging reciprocal effects of social. This contract was between citizens and actually is formal declaration of condition that is better for all of people and the role of democracy with attention to appealing of people is performed. It is also try to characterize the right of person, social and environmental groups in contravention agreement between social members. The legitimacy theory is appeared in context of reciprocal effects of organization, Society and environment which is state that organizations are trying continually for assuring that their activities are done as social appeals until they assure that there is positive understanding from their activities which have be done out of organizations activity. Organizations as small member of big ci rcumstance in which they have activity are controlled. This days not only the stockers are in contact with social contract but also adherent of environment are benefit from social contracts. However in past, benefit of companies was the only means of measuring the legitimacy of companies, todays institutions remain with legitimacy title to develop their activities in same form and size with goals of environmental and social system. Ignoring social contract means defeat in acting as expect of society and environment which may cause to delete some social contract and lose of activity license from society. This state appears when society knows that environmental expenses of company are more than its benefit for circumstance. Vice versa organizations and institutions which have 2516 successful connection with society and acted according social contract, have more benefit distribution than cost and expenditure for society and circumstance in suitable financial and social situation Environmental accounting: Any accounting information which is inform the decision makers and make noticeable perm in reaming the environmental reality, have two important characterizes: first, they are relate to accounting information, secondly, they are reliable. From accounting benefit view, successful institution is which increase production in maximum. While increase in volume of inputs accompany with increase in volume of outputs and financial border remain acceptable among dates and takes in accounting goods. In real economic situation, all inputs are from environment and all outputs are catches and distributed goods with terminated which are return to environment. From this view successful institution is one which has more destruction and effect in environment. Accounting measures them only where it can estimate this effect as element that can change into money. In other word when it can gain final cost, it can recognize them. Because it seems impossible to estimate any price for most of environment destroying element so they are delete . It seems that in modern accounting system, continually destroying of environment must be fallowed. Now one of discussable topic is environment reporting and 2517 increasingly environment auditing which is characterize other aspects of organizations and their activities. Lately noticeable increase is happened in accounting research, especially in environmental effect of organizations. Researcher pay most of their attention in environment investment, management of environment and its auditing form, environmental reporting, role of accounting in playing environmental responsibility of organizations, effects of environment accounting in both financial and auditing statement, insurance, bank debt, destruction of cutch and legitimacy. Conclusion : At the end we conclude that zakah and khoms are Islamic instruments that are made for adjusting worth and economic between all kind of human and because of Islam commands people have responsibility for good maintenance of all resources that are gifted from god. Also As mentioned above social and environmental accounting completely are related with resources that are trusteeship and gifts from god and emphasized at Islam commands for keeping rights god and people . So we can explode and include them in Islamic accounting too. As Islam keep so many importance for payment of labors fees and emphasized on preservation environment also have emphases on costumer right as mentioned: Woe to those that deal in fraud, Those who, when they have 2518 to receive by measure, from men, exact full measure, But when they have to give by measure or weight to men, give less than due. Do they not think that they will be called to account? On a Mighty Day, A Day when all mankind will stand before the Lord of the Worlds? Nay Surely the Record of the Wicked is preserved in Sijjin. And what will explain to thee what Sijjin is? There is a Register fully inscribed. Surah Al-Mutaffifin:1-9at the end we can receive some new theories of accounting base on Islam , like JIT systems that not having saved goods in stores is recommended and necessitated at Islam commandshoarding so Muslims can create resources inflow . References: 1. Choudhry, Nurun N. and Mirakhor, Abbas, 1997, Indirect Instruments of Monetary Control n an Islamic Financial System, Islamic Economic Studies, Vol. 4, No. 2; pp. 27-66. 2. El-Erian, Mohamed and Kumar, Monmohan S., 1970, Emerging Equity Markets in the Middle Eastern Countries, Staff Papers, International Monetary Fund, June 1997, pp. 313-343. 3. Iqbal, Zubair and Mirakhor, Abbas, 1987, Islamic Banking, IMF Occasional Paper No. 49 Washington: International Monetary Fund slamic Banker, No. 19, August 1997, p. 2. 4. Khan, Mohsin S.,1986, Islamic Interest-Free Banking, Staff Papers, International Monetary Fund, 33-1 1-27. 2519 5. and Mirakhor, Abbas, 1987, Theoretical Studies in Islamic Banking and Finance Houston Book Distribution Center. 6. Mirakhor, Abbas, 1993, Equilibrium in a Non-Interest Open Economy, Journal of King Abdulaziz University: Islamic Economics, No. 5, pp. 3- 24 7. , 1996, Cost of Capital and Investment in a Non-interest Economy, Islamic Economic Studies, Vol, 4 December, No. 1 8. Zaidi, Iqbal, 1988, Stabilization and Growth in an Open Islamic Economy, IMF Working Paper 8822 Washington: International Monetary Fund 9. nadir kazemzadeh arrasy2007: Environment accounting, tadbir journal no 135 . 10. Chiapas Caravan, Professor Ph.D2006:Affiliations Green accounting A helping instrument in European harmonization of environmental standards: Academy Of Economic Studies Of Bucharest, Regular Address: Calea Victoriei Nr. 224, Bl. D5, Ap. 3, Sector 1, Bucharest. 11. Mehenna,Y, and Vernon , P.Dorweiler. 2004 environmental accounting an essential component of business strategy. P p 66-74 12. . Gray, R.H., Owen, D.L. and Maunders, K.T. 1988. Corporate social reporting: emerging trends in accountability and the social contract. Accounting, auditing and accountability journal 1: 6 –20. 2520 ISSUES OF FINANCIAL LITERACY AND SUPERANNUATION Ms Ide Clinton Australian Catholic University ABSTRACT The purpose of this paper is to provide an exploratory of the financial capabilities of superannuates and the protection offered by Government and the Financial Services Industry in Australia. Interpretivism techniques have been used to examine various reports and websites provided by government authorities. Results indicate that even though financial literacy programs have been introduced and amendments to legislation to improve the protection of superannuation funds have been made, many people are still making incorrect investments regarding superannuation. This paper examines the need to increase financial literacy educational programs in the light of current demographic and economic trends. Keywords Financial Education, Financial Risk, Superannuation, Financial Service Industry, Fraud. Interpretivism. 2521 INTRODUCTION In Australia today, superannuants bear more risk in regards to their financial security than their parent‘s ever did. This has been brought about by government policies such as the deregulation of the banking and financial system and the introduction of self funded retirement in the form of superannuation. The deregulated financial market has brought about economic benefits for some but unfortunately for others it has brought their financial ruin, this is due to the lack of understanding of the financial risks, costs and rewards associated with their financial decision making. Issues of financial literacy are growing with the increase in complexity of the financial markets and regulation. Australia is confronting the social and economic issues associated with a large and rapidly growing aged population. Demographic trends indicate that by 2047, 42 of the population will be over the age of 65 years ABS 2005. People are living longer and retiring earlier and spending as much as one third of their life in retirement ABS 2006. Therefore, planning for retirement is important if superannuants want to maintain a good standard of living in retirement. 2522 Superannuation is compulsory for all working Australians and this puts the government under some obligation to protect these funds and educate consumers. Government policy is that superannuation is a desirable form of saving for retirement. Funds are deposited in entities within the Financial Service Industry FSI that in turn invest in the marketplace and charge fees for doing so but the risk associated with investment is born by the superannuant. The role of government and the Financial Service Industry has been poor in regards to the protection and education of consumers. This paper will focus on an exploratory investigation of the increase in financial risk of individuals with emphasis on superannuation and the role of regulatory bodies in protecting the public interest. A brief overview of the research method will be explained and a discussion on the regulatory bodies will follow. The third section of the paper will focus on some of the recent ‗scams‘ or fraudulent activities that have occurred causing some superannuants to lose their 2523 retirement savings. Finally some suggestions on policy changes and conclusions are drawn. BACKGROUND AND LITERATURE Over the past twenty years there has been a shift in financial risk from Government and corporations to the individual. In the past corporations would provide pensions on retirement in the form of defined benefit plans for their employees. The onus was on the employer to ensure that the employee would retire with adequate funds. The Government would provide modest pensions for those who did not qualify for a defined benefit plan. Over the past decade the shift of responsibility for retirement funds has been placed on the individual. Now employees have to ensure that they have adequate funds to maintain their lifestyle and health insurance in their retirement. At present there is more than 700 billion in the superannuation pool and that amount is growing by 50 billion a year. The biggest growth is in self-managed or do-it-yourself funds SMSF. While the idea of managing your own money may be desirable, experts 2524 warn it can be a trap for the unsophisticated superannuant who can lose all monies invested. In addition to the above circumstances the introduction of Super Choice and changes to Portability Provisions has given the majority of working Australia ns more control over the management of their superannuation benefits. Super Choice will allow the 9 million Australians‘ with superannuation to invest in any fund they wish. A loophole in the legislation allows people to gain access to their superannuation on ‗compassionate‘ or ‗hardship‘ grounds before they reached the official preservation age which is between 55 and 67 years of age depending on the individuals date of birth. Compassionate or hardship is defined as the inability to meet living expenses due to terminal illness or long- term unemployment and payments are generally limited to 10,000 per annum. The lure of control and access to superannuation funds to pay off mortgages and other accumulating debts has led some superannuants into making 2525 detrimental decisions when unaware of the stringent conditions as stated above. There are ‗financial advisors‘ who encourage people in financial strife to withdrawn their superannuation funds and charge a fee of 20 or more of the funds assets, only to find several months later a tax penalty for the early withdrawal of funds, which can be up 50 on the amount withdrawn. Also the deregulated innovative financial world has expanded the range of financial products and strategies available to superannuants, provid ing scope for better financial risk management but also allowing and encouraging via advertising greater financial risk taking Davis, 2007. Unfortunately, many superannuants that were born between 1946 and 1964 purchase products that are not suitable for their needs. Superannuants who are lacking financial literacy skills find it difficult to identify products and services that are appropriate to their needs; they are unsure about how best to access and evaluate independent advice; they make inappropriate financial decisions; 2526 and they fall victim to abusive practices and mis-selling FSA, 2005. More generally, the persistently high profit rates of financial institutions and the income of financial advisers raises the question of whether, despite competition in financial markets, many superannuants pay too much for the financial products they need or feel they need to purchase. The availability of ‗easy‘ income from less than informed superannuants leaves them vulnerable to unscrupulous conduct. ‗Superannuants face a wide range of alternative, heterogeneous; complex and can constantly changing financial products‘ Davis, 2007. Financial markets are intertwined with superannuation funds and government policies. The markets are mechanisms for investment of superannuation funds and have been producing healthy returns for investors up until recently. Government policies promote economic development and encourage savings to increase the living standards of the community. In addition some of the funds 2527 have been used to purchase shares in newly privatised state assets. When the market fails or there are unscrupulous financial advisors many superannuants can and have lost their life savings therefore having a significant social and economic cost. As a consequence the Government imposes more regulation which in some instances complicates policy and superannuants understanding. In the past few years there has been an increase in mortgage debt and consumer credit with some concerns raised over the lack of financial knowledge which has lead to some superannuants who are seeking to reduce their debt succumbing to immoral behaviour as mentioned above. In the current financial climate low levels of savings and increasing high interest rates are being experienced which have placed many Australians in an adverse financial position. Concept of Legitimacy 2528 Corporations and governments are artefacts of society that are enabled through legalisation and it has been argued by many authorities Shocker and Sethi 1973, Reich, 1998 that their existence depends on the willingness of society to continue to allow them to operate and as long as they hold a moral obligation to act in a in the responsible manner. The moral obligation forms a part of the social contract between business, government and society. This social contract forms the basis of many theories, eg. Legitimacy theory Dowling and Pfeffer, 1975, Guthrie and Parker, 1989, Matthews 1993, political economy theory Guthrie and Parker, 1990 accountability theory Gray et. al. 1995 and stakeholder theory Roberts, 1992. These theories have common characteristics but it is evident that the common theme is the relationship between stakeholders and the enabled bodies. Legitimacy theory is derived from the notion that corporations and governments will strive to legitimise their actions in society and has been defined by Dowling and Pfeffer as: 2529 A condition or status which exists when an entity‘s value system is congruent with a value system of the larger social system of which the entity is a part. When a disparity, actual or potential, exists between the two value systems, there is a threat to the entity‘s legitimacy 1975:1ββ Legitimacy theory posits that the legitimacy of a corporation and government to operate in society depends on an implicit social contract between the entities and society. These bodies lose their license to operate in society by breaching society‘s norms and expectations Kent and εonem, β007:7. Therefore, if a company or government perceives that its legitimacy is at threat it will alter its operations to conform to society‘s current values and norms. Organizations seek to establish congruence between the social values associated with or implied by their activities and the norms of acceptable behaviour in the larger social system of which they are a part. Insofar as these two values systems are congruent we can speak of organizational legitimacy. When an actual or potential disparity exists between the two value systems, there will exist a threat to organizational legitimacy. Dowling and Pfeffer, 1997:122 2530 This allows society to achieve a whole rang of social objectives that it otherwise could not do. Many organisations have taken actives roles in improving their communication channels in order to comply with societies expectations as Dowling and Pfeffer in their seminal paper on legitimacy theory make the following point; … since legitimacy is a constraint on behaviour, organizations in which values, output, or methods of operation are currently at variance with social norms and values will tend to alter these values, or methods of operations to conform to social values 1975:131. Suchman 1995 refers to a ‗generalised perception or assumption that the actions of an entity are desirable, proper, or appropriate within some socially constructed system of norms, values, beliefs and definitions‘ p. 574. Organisations will continually seek to ensure that they are perceived to be operating within the social values and norms of society. Unfortunately for organisations, these values and norms are not fixed but change over time, therefore requiring organisations to be responsive. ‗δegitimacy‘ is consider to 2531 be a resource on which an organisation is dependent for survival Dowling and Pfeffer , 1975; O‘Donovan, β00β therefore it is an attribute that is desirable for organisations to operate in society successfully. It could be said then that legitimacy theory is really based on management‘s perceptions on how society views the organisation. If society views the organisation in a negative manner then management will do everything in its power to be perceived as conforming to society‘s values and norms. However, the majority of research examines legitimacy on an organisation level and rarely at the level of an individual decision-maker. Devos et al. 2002 research about the degree of people‘s trust in institutions found that; .. trust in institutions was linked positively to values such as security, conformity, and tradition, but negatively to values such as self-direction. This supports the view that seeking security and conformity relates to stronger attachment to collectivities, while reliance on own judgment and individuality is compatible with a sceptical attitude towards institutions. p.481 2532 Devos et al research is insightful in that if government and organisations are not seen to be looking after society in relation to social and economic benefits then these bodies will risk disapproval. Society‘s values are constantly changing and organisations need to be reactive to these changes as Lindblom 1994 states Legitimacy is dynamic in that the relevant publics continuously evaluate corporate output, methods, and goals against an ever evolving expectation. The legitimacy gap will fluctuate without any changes in action on the part of corporation. Indeed, as expectations of the relevant publics change the corporations must make changes or the legitimacy gap will grow as the level of conflict increases and the levels of positive and passive support decreases p:3 MAINTAINING LEGITIMACY Lindblom 1994 identified four strategies for maintaining legitimacy. 1. educate and inform in response to the recognition that a legitimacy gap may exist 2. change the perception but not actually change behaviour misconceptions in the market place 3. deflecting attention from the issue and adapt a positive strategy to override any negative performance 4. change expectations unrealistic or incorrect expectations of the companies responsibility 2533 In order for the government to legitimise its changing role it has combined several government agencies to regulate and enforce legal requirements in the protection of 1.4 trillion dollars invested in superannuation assets APRA 2008 and also to protect the superannuants themselves. There are three major agencies that are involved in the regulating and protection of superannuation assets, The Australian Securities and Investment Commission ASIC which is responsible for market integrity and is the enforcer of regulations. The Australian Prudential Regulation Authority APRA is concerned with the quality of a financial institution‘s systems for managing the various risks in its business. The third body, the Australian Taxation Office ATO acts as a compliance overview on self-managed superannuation funds, employee superannuation contributions and tax rules in regards to early withdrawal of funds. 2534 By deregulating the financial industry, the government has made an implied statement that consumers will act in their own best interest based on disclosure supplied by the industry participants. The amount of government intervention over recent years has made superannuation and taxation regulations very complex. Unfortunately, it appears that many Australians lack the knowledge, experience and judgement to make informed decisions on financial matters. In the 2008 a survey of Adult Financial Literacy found that 20 of people surveyed where ‗unsure‘ of the type of superannuation fund they contributed to ANZ, 2008:69. In recent years there has been considerable attention paid by the FSI and the Government to the delivery of programs that enhance financial capability in the community. To this end the Government has established the Financial Literacy Foundation and various companies within the FSI have introduced programs such as the ANZ Money Minded. Money Minded consists of adult financial 2535 education programs that are developed to help people build their financial skills, knowledge and confidence in relation financial planning for now and the future. There are many reasons for these initiatives but in particular the ongoing changes and complex rules and regulations of superannuation are clearly affecting superannuation understanding. The Commonwealth Bank in one of its latest n ewspaper advertisements states‘ Retirement planning made simple, because most of us aren‘t fluent in gobbledygook‘ is a reflection on how one of Australian‘s major banks understands the difficulties that face superannuants in making financial decisions. A survey conducted by the Financial Literacy Foundation in 2005 found that 67 of respondents said they understood the principle of compound interest when asked to make a calculation only β8 were rated with a ‗good level‘ of comprehension. In 2007 a further study was conducted by the same body and it revealed 88 of the respondents were highly confident in their ability to protect their money and were able to recognise a scam or an investment scheme that 2536 seemed ‗too good to be true‘. But the same survey found that many participants were not confident in their ability to understand financial language which could indicate a higher degree of vulnerability to scams FLF, 2007. Superannuation is a complex issue and it is important to understand the financial capabilities of superannuants in order for the FSI and Government to delivery appropriate programs. It is also necessary to understand the role the FSI and Government play in the inclusion and exclusion of information and how they conduct their activities for the benefit of the community. The shortfall is between the FSI and Government expectations of Superannuants‘ financial capabilities and the ability of Superannuants to increase their own personal wealth for retirement. On the other hand Superannuants rely on Government and the FSI to act in their best interests. Even educated and well informed consumers cannot predict fraudulent behaviour. 2537 Figure 1 Gap of Confutation Figure 1 above illustrates the confutation gap that exists between the government, FSI and Superannuants. This is due to the increased responsibility on superannuants to provide financially for retirement, the rising number complex financial products available, the increase in risk and changes in legalisation including taxation law has lead to a confutation gap. Australians‘ ability to manage financial risk would also be helped by better government policy on financial education for consumers and control of products. There has been an increase in the options and complexity of financial products Government FSI Superannuants Confutation 2538 which can cause confusion by the sheer volume of information. Without education and expert independent advice, the range of choice available to investors may actually compound the problem Smith, 2008 RESEARCH METHOD To demonstrate the confutation gap an exploratory study utilising a ‗natural setting‘ which has been defined by Vogt, 199γ in Collis and Hussey, β009, p153 as a research environment that would have existed had researchers never studied it. The environment for this study is the relevant government agencies websites. This study undertakes a interpretivism focus ‗that explores the complexity of social phenomena with a view to gaining interpretive understanding. The research involves an inductive process with a view to providing interpretive understanding of social phenomena within a particular context. Collis and Hussy, 2009:57. Therefore this research method will lead to a board conclusion and hopefully lead to further research. 2539 EXPLORATORY OUTCOMES One of the major activities that Government and the FSI must perform is the protection of superannuants‘ funds. Whilst most of the information delivered to consumers is on the performance of their funds, not much information is made available to the com munity on the superannuation ‗scams‘. On the ASIC website some of the recent ‗scams‘ and prosecutions are;  Australians have lost at least 400 million to telephone investment fraud or cold calling scams over the last decade.  Advertising flyer promoting access to superannuation for a fee of 2,000.  Unlicensed financial advisors advising clients to withdrawn superannuation to pay off mortgage and other accumulated debt. 2540  Convincing superannuants to switch from their industry super fund to a retail super fund The above three cases are recent convictions, but unfortunately these practices have been in existence and known to some of the above authorities for nearly 10 years as presented on various government websites. Even though laws prohibiting the withdrawal of funds and financial literacy initiatives have been introduced clearly these strategies are not working as can be seen from some events of 16 years ago.  An accountant was convicted and sentenced to γ½ years imprisonment with a non-parole period of 27 months for fraudulently obtaining the payment of 2.5 million in superannuation benefits on behalf of 114 clients between August 1996 and October 1999. 2541  A Financial adviser was convicted of fraudulently inducing the payment of 62,000 in superannuation benefits on behalf of three of his clients and for theft of part of these payments in November and December 1999. He received a three month suspended sentence and ordered to pay 38,000 in compensation to the clients.  An insurance agent was convicted of fraudulently inducing the payment and theft of five clients superannuation benefits totalling 34,000. These offences, which occurred between August 1996 and February 1997, resulted in him receiving a four-month suspended sentence and order to pay compensation to the clients. In the early 1990‘s the Government set about establishing ‗tough‘ new regulations to control such scams and introduced financial regulation, including arrangements for market integrity, consumer protection, stability and competition. 2542 In response to the financial problems which occurred in the late 1980s and the expansion of superannuation, prudential regulation was upgraded through tougher capital requirements and structurally reformed through the consolidation, refocusing and better coordination of regulatory agencies. The greater range and complexity of products and, in some areas, concerns about more aggressive selling practices, have led to an increased focus on consumer protection. This has resulted in new consumer credit regulation and new rules for disclosure, codes of conduct and dispute resolution Australian Treasury, 1997 But it would appear that these ‗tougher capital requirements structural reforms‘ have not had the desired effect. For Government who has made supera nnuation compulsory and FSI who members are responsible for investing these funds they need to be more in tune with society‘s expectations, failure of superannuation funds could wipe out entire savings of some superannuants therefore having a social consequence. The Australian Tax Office β009 ATO website warns ‗beware of illegal schemes to withdraw your superannuation early ‘ and that; 2543 Both promoters and participants of these schemes are breaking the law and will face heavy penalties and potentially prosecution, even if the participant was unaware that their actions were against the law. Unfortunately the judicial system is lenient on such promoters and the ‗heavy penalties‘ do not compensate the victims. It is evident from the above that the Confutation Gap between Government, FSI and Superannuates is a serious social issue. SUMMARY AND CONCLUSIONS Unfortunately, these changes have not had the desired effect as can be seen from the first three cases on superannuation ‗scams‘ which occurred in β007. As stated above the role of Government is changing from a facilitator of goods and services to that of a protector of the community. There appears to be great hope and expectations placed on the outcomes of financial literacy programs provided by the FSI and the FLF but unfortunately the findings from the survey conducted by the FLF suggest that fewer Australians are confident in their ability to understand financial language, yet their confidence in related areas, 2544 e.g. recognising a scam and dealing with financial service provider, is comparatively high FLF, 2007 which exploratory evidence presented suggests is not the case. The Association of Superannuation Funds of Australia ASFA is critical of the consumer protection structure and cited recently tha t ‗poorly designed and complex information disclosure processes have long been the bane of effective decision making by consumers, Vamos, 2007. With billions of dollars tied up in superannuation it is evident from the above that government and the FSI ne ed to be more proactive in consumer protection and education. This paper is based on anecdotal evidence collected from various government bodies and regulatory authorities. However, it is indicative of an underlying problem that needs a more objective test for hardship and compassion and a federal agency body should be established to administer the early release of 2545 superannuation funds. More research is needed in this area so that strategies can be put in place to aid and protect superannuants. There appears to be a disjointed match between government legislation and the superannuation industry. The regulations have not improved the protection of funds and people are still being disadvantaged by the miss-appropriation of funds. What the government‘s intent and what is actually happening appears to be increasing the confutation gap of all parties involved. Areas of further research Challenges exist in trying to address financial literacy, particularly in light of changing knowledge demands in the twenty-first century. There needs to be mechanisms in place that allow superannuants to obtain independent advice and this advice needs to be in a format that is understandable and affordable to the individual. More research needs to be undertaken to ascertain the best 2546 method of delivering and information. Reliance on the internet as the major tool of communication appears not to be working. In relation to crime and superannuation this is an under-researched area which involves some difficult conceptual and methodological issues due whether the perpetrator is caught, charged and incarcerated. This will depend on the resources available to police superannuation funds and financial advisors and affects the availability of data. References ABS Australian Bureau of Statistics, 2006, Australian System of National Accounts 200506. Viewed March 2009 http:www.abs.gov.auausstatsabs.NSF7d12b0f6763c78caca257061001cc5 8851c21550f77fdea8ca2568a9001393e9OpenDocument Commonwealth of Australia, Financial Literacy Foundation, 2007, Financial literacy, Australians understanding money. 2547 ANZ Survey of Adult Financial Literacy in Australia, prepared by Roy Morgan Research, May 2008 Australian Prudential Regulation Authority, 2007, Mission Statement http:www.apra.gov.auaboutApra APRA Australian Prudential Regulation Authority, 2008, Superannuation assets fall in December quarter, but overall growth in 2007, http:www.apra.gov.aumedia-releases08_05.cfm date viewed 3032008 Australian Taxation Office, β009, What‘s new since yesterday? http:www.ato.gov.ausuperprofessionalswhatsnew.asp?tab=1 Australian Taxation Office, 2009, Beware of promoters offering early access to super, date viewed 162009 http:www.ato.gov.ausuperprofessionalscontent.asp?doc=content30476.htm Australian Treasury, 1997, The Financial System: Towards 2010 http:fsi.treasury.gov.aucontentFinalReport.asp - Date viewed 15122007 Australian Securities and Competition Commission, 2007 Mission Statement www.asic.gov.au 2548 Australian Securities and Competition Commission, 2007, ASIC and ATO warn consumers tempted by illegal early access super schemes Date viewed 13122007 http:www.fido.gov.aufidofido.nsfbyheadline07- 197+ASIC+and+ATO+warn+consumers+tempted+by+illegal+early+access+sup er+schemes?openDocument Australian Securities and Competition Commission, 2005, Super Choices: your super, your future, your choice, A joint release from ASIC and the office of Mal Brough, Minister for Revenue and the Assistant Treasurer http:www.fido.asic.gov.auasicasic.nsfbyheadline05- 111+Super+Choices:+your+super,+your+future,+your+choice?openDocument ASIC, 2007, A superannuation dream betrayed, http:www.fido.gov.aufidofido.nsfbyheadlineA+superannuation+dream+betra yed?openDocument . Date viewed 13122007 Collis, J, Hussey, R, 2009, Business Research, A Practical Guide for Undergraduate Postgraduate Students, 3 edn, Palgrave MacMillan, England Commonwealth of Australia, 1997, Financial System Inquiry Final Report, Wallis Report 2549 Davis, K, 2008, Increasing Household Financial Risk – An increasing Social Risk? Academy of Social Sciences in Australia, vol 26, no 3, pag es 19-32 Devos, T. Spini, D Schwartz, S. H., 2002, Conflicts among human values and trust in institutions, British Journal of social Psychology, Vol 41, Issue 4 http:search.ebscohost.comlogin.aspx?direct=truedb=pbhAN=8953226site =ehost-live . Date viewed 262009 Dowling, J. Pfeffer, J. 1975, Organisational legitimacy; social values and organisational behaviour, Pacific Sociological Review, vol 18 FSA Financial Services Authority, 2005, Measuring financial capability: an exploratory study, Personal Finance Research Centre, University of Bristol Gray, R. Kouhy, R. Lavers, S. 1995, Corporate social and environmental reporting: a review of the literature and longitudinal study of UK disclosure, Accounting, Auditing and Accountability Journal, vol 8. Guthrie, J. Parker, L. 1989 corporate social disclosure practice: a comparative international analysis, Advances in Public Interest Accounting, vo l 3 Kent, P, Monem R, 2007, What Drives TBL Reporting, Good Governance or Threat to Legitimacy? AFAANZ Conference 1-3 July Gold Coast Qld 2550 Lindblom, C.K. 1993, the implications of organisational legitimacy for corporate social performance and disclosure, Conference Proceedings, Critical Perspectives on Accounting Conference, New York. Mathew, M. R. 1993, Socially Responsible Accounting, Chapman Hall, London. O‘Donovan, G, β00β, Environmental disclosures in annual report: extending the applicability and predictive power of legitimacy theory, Accounting, Auditing and Accountability Journal , vol 15 Roberts, R., 1992, Determinants of corporate social responsibility disclosure: an application of stakeholder theory, Accounting, Organizations and Society, vol 17. The Wallis Report on the Australian Financial System, 1997, Parliament of Australia http:wopared.parl.netlibrarypubsrp1996-9797rp16.htmMAJOR Date viewed 14122007 Smith, M., 2008, Taking up the burden, Money Management, 2551 http:www.moneymanagement.com.auArticlesTaking-up-the- burden_0c05087c.html. Date viewed 2552008 Suchman, M. C. 1995, Managing legitimacy: strategic and institutional approaches, Academy of management review, vol 20 Vamos, P, 2007, The Association of Superannuation Funds Of Australia, Better Consumer Policy for Super Fund Members, Media release 13122007 http:www.superannuation.asn.aumr071213default.aspx 2552 LEASING IN TRANSITIONAL COUNTRIES – CASE OF BH Maja Letica, bsc. Mirela Mabic, bsc Jelena Brkić, bsc. Abstract Lease is defined as an agreement whereby the lessor conveys to the lessee, in return for a payment or series of payments, the right to use an asset for an agreed period of time. Leasing is used to finance a vast range of assets and leases can be tailored to meet the needs of clients, implying that almost any kind of good can in principle be leased. Among many reasons why to lease there are finacial reasons, efficiencies and advantages, quick application process, flexibility etc. Two major types of leasing are financial and operative leasing. Accounting treatment of the financial leasing stipulates that legal entity – the lessee shows vehicle, machine or equipment acquired through leasing arrangement as capital asset and as obligation to the leasing company. Monthly installment is booked separately on principal and interest. Interest with tax 2553 enters the cost, and principal decreases liabilities to the leasing company. The lessee calculates depreciation on the leased asset, as capital asset, in accordance with valid depreciation rates. On European leasing market, Bosnia and Herzegovina belongs to CESEE countries group Central Eeastern and South Eastern Europe, where currently, according to the statistics, is the biggest increase of leasing business. The value of the concluded leasing contracts in 2004 was 106.361 million Euros, while in 2005 the value was 185.025 million Euros, which is 74 more than in 2004. This fact proves that leasing business in Bosnia and Her zegovina is in increase. Key words: lease, leasing, financial lease, operating lease, IAS 17 2554 What is leasing The simple term lease covers a myriad of different contact types, the common feature of which is that the lessor retains the ownership of the leased asset throughout the life of the contract. With a multitude of definitions existing in local GAAP, fiscal legislations and in some cases within specific local legislative frameworks for leasing, the only common definition of a lease that can be given on the European level is that provided by IAS17, the international accounting standard for leases, where a lease is defined as an agreement whereby the lessor conveys to the lessee, in return for a payment or series of payments, the right to use an as set for an agreed period of time. Leasing is used to finance a vast range of assets and leases can be tailored to meet the needs of clients, implying that almost any kind of good can in principle be leased. 2555 Why to lease Financial reasons - not every company or individual is in position to buy equipment necessary for start, expansion or modernization of its business. Not every company has adequate collateral to offer as security for bank loans. Leasing represents the answer to such problems enabling lessees to acquire necessary equipment. Efficiencies and advantages - users of leased asset pay leasing installments out of the profit acquired via utilization of the leased asset. Very often, leasing secures 100 of the project financing. Leasing is in most cases offered without additional security means - one of the major advantages of leasing is that the lessor offers financing without requests for additional security since the lessor is the legal owner of the leased asset. In countries in transition, additional security is often requested, but in that case the security is significantly smaller than with traditional bank loans. Quick application processing - since in most cases the additional security is not needed, leasing can be concluded in simpler and quicker way than classic 2556 bank loans ideally, for just one day. In most cases the decision is made on the basis of the capability of the potential lessee to fulfill monthly obligations stipulated by the contract on leasing. Flexibility - leasing offers possibility to start or to develop business with minimum initial deposit down payment. Leasing installment plan can be modified to meet the specific needs of the lessee. Additional services such as more favorable maintenance of machines and equipment can be obtained via lessor‘s assistance, which cannot be expected with bank loans. Leasing categories Lease can be defined as written contract between two parties: lease company lessor and beneficiary of lease subject lessee. In this transaction the lessor acquires the equipment from the supplier and gives it to the lessee for use for certain period of time, while the lessee is obliged to make periodic payment to the lessor under conditions specified in the contract, in return. Lessee is choosing its own supplier of the subject and 2557 making its own price and delivery arrangements. After that, lessee is turning to the lessor with the offer of buying the subject on his behalf. The main principle of leasing business is: The lessor retains legal ownership over the leased asset, while the lessee acquires economic ownership. Two major types of leasing are:  Financial leasing  Operative leasing Financial leasing The lessor, upon the agreement concluded with the lessee, purchases the leased asset from the supplier and gives it to the lessee to use. The lessee uses the leased asset for business and thus acquires profit which allows the lessee to pay agreed fees to the lessor. During the payment period, the leased 2558 asset is legally owned by the lessor and the leased asset is booked and written off in the lessee‘s books. Usually but not obligatory, leasing contract stipulates that with payment of the last installment, the lessee automatically becomes the legal owner of the leased asset. Financial leasing is often defined as alternative way of financing new investments of enterprises. In comparison to the bank credits, financial leasing has many advantages for the lessor as well as for the lessee: quick and efficient application processing, flexibility, economical q uality etc. Summarizing:  Ownership over the leased asset is usually automatically transfered to the lessee upon the expiration of the contract on leasing  Time period of the contract on leasing is comparable to the assessed economic shelf life of the equipment. Operative leasing It is primarily intended for utilization of the leased asset with downpayment and future value. Operative leasing allows the lessee to return the leased asset or to 2559 renew the contract for the new, more modern leased asset upon the expiration of the contract. With operative leasing, installments are booked as cost and the leased asset is booked and written off in the lessor‘s books. Summarizing:  The lessor retains ownership over equipment even after the expiration of the contract on leasing  Time period of the contract is considerably shorter than the assessed economic shelf life of the equipment. Besides this basic classification of the types of leasing, there are other classifications based on characteristics of objects of leasing , duration period, the number of the engaged parties etc. Benefits of leasing Generally speaking, the economic importance of leasing derives from the fact it provides capital which is used for investment purposes. This in turn translates into a healthy economy, generates employment, and promotes innovation. 2560 The benefits of using lease finance include:  The possibility to finance 100 of the purchase price of an asset without having to offer any supplementary guarantees which would otherwise be an additional burden for the company seeking finance;  Allowing companies to manage their working capital by spreading payments over the life of the asset;  Making budgeting exercises easier as lease payments are regular and usually for a fixed amount;  Giving firms the opportunity to renew their equipment, making sure that they benefit from the latest available technologies;  Providing other sources of finance, independent from bank loans or credit lines, thereby conveying more freedom to the lessee;  Ensuring the lessee has a stable and certain source of funds that cannot be withdrawn as long as payments are made; 2561  The ability for the lessee to use equipment or other assets without having to worry about considerations linked to being an owner such as the disposal of the asset when it is no longer used;  Providing customers will a full package - a lease can also accompanied by an array of services, including the insurance and maintenance of the asset. A wide range of services can be combined with different types of leases;  Taking advantage of local fiscal treatment which implies that leasing can also be beneficial from a tax point of view;  Being the only available source of funds. In certain cases, particularly for smaller companies who have high growth potential, leasing may be the only way to finance their development;  Generally speaking, providing finance in circumstances when traditional bank facilities would not be granted as lessors have greater security due to the ownership of the asset. This also implies that leasing ma y be offered on better terms than other forms of finance. 2562 Leasing and accounting IAS 17 Accounting treatment of the financial leasing stipulates that legal entity – the lessee shows vehicle, machine or equipment acquired through leasing arrangement as capital asset and as obligation to the leasing company. Monthly installment is booked separately on principal and interest. Interest with tax enters the cost, and principal decreases liabilities to the leasing company. The lessee calculates depreciation on the leased asset, as capital asset, in accordance with valid depreciation rates. 2563 IAS 17 represented through picture 1: FINANCIAL AND OPERATING LEASE IN THE LESSEES FINANCIAL REPORTS FINANCIAL LEASE OPERATING LEASE DEFAULT EXCEPTIONAL DEFAULT EXCEPTIONAL 1 All ownership related risks and rewards are transferred Everything else is the same except: 1 Operating lease is the one that is not financial 1 Operating lease is treated as a financial lease if its the case of investment into real estate according to IAS 40 2 The ownership is transfered to the lessee by the end of the lease term 1 The ownership is not transffered to the lessee 2 All risk and rewards are not transferred to the lessee 2 The land and building elements are classified as one unit if the land price is negligible 2 It is recognised in the balance sheet of the lessee by present value of the maximum lease payment 3 Recorded as an asset by the lessee 3 The ownership is not transferred to the lessee 4 Recorded as an asset at the lower: 4 Its not recorded as an asset in the lessees balance sheet 3 The use of fair value model is mandatory IAS 40-34 a fair value of the asset practically by the purchase price without interest, increased by initial expences 5 The lease payments are recognised as an expense 6 The lessee is not depreciating the lease as an asset, the lessor is in charge of that b present value of the minimum lease payments 5 Depreciation policy is conducted by lessees according to IAS 16 and IAS 38 6 Land and building elements are classified separately 2564 Over 100 members of the asset finance industry and businesses from across Europe met in London 22 May this year, to debate the preliminary views on lease accounting that were published recently by the International Accounting Standards Board IASB and the Financial Accounting Standards Board F ASB – so called right of use model. They were joined by representatives of the IASB and European standard setters, together with leaders of the U.S. Equipment Leasing and Finance Association and the Australian Equipment Lessors Association. The European Forum, ―Putting δeasing on the δine‖, considered the standard setters‘ long-awaited discussion paper that focuses on putting all types of leases on firms‘ balance sheets. This would involve the several million businesses across Europe who lease or rent making significant changes to the way they account for leases of all types of assets, including cars, commercial vehicles, machinery, PCs and photocopiers. The European leasing industry is concerned that the standard setters are considering an excessively burdensome approach for accounting for leases. 2565 Leasing provides vital economic benefits for many businesses, and the Forum heard that there is a risk that these benefits could be undermined by unnecessary complexity. The main opinion of business people is that the focus for lease accounting should be on improvement and simplification, but complex new methods proposed by IASB board may make this vital form of business finance more difficult to use and more opaque for users of accounts. Leasing in BH It can be sad that leasing is relatively new business form in Bosnia and Herzegovina.The first leasing company on BH market was Volksbank Leasing, established at the beginning of 2001. Hypo-Alpe-Adria Leasing was established the same year in August. Another two leasing companies were established in 2003 – Euroleasing in March and Raiffeisen Leasing in November. In September 2005 CBS-NLB Leasing entered BH leasing market and HVB Leasing was established in January 2006. Majority of leasing companies are 2566 seated in Sarajevo except Euroleasing which is seated in Mostar. With their organizational units and branch offices these leasing companies are present in all bigger towns in BH: Banja δuka, εostar, Tuzla, Bihać, Zenica, etc. On European leasing market, Bosnia and Herzegovina belongs to CESEE countries group Central Eeastern and South Eastern Europe, where currently, according to the statistics, is the biggest increase of leasing business. The value of the concluded leasing contracts in 2004 was 106.361 million E uros, while in 2005 the value was 185.025 million Euros, which is 74 more than in 2004. This fact proves that leasing business in Bosnia and Herzegovina is in increase. For lack of legislation on leasing matters and in order to improve and develop leasing business and to achieve their common goals, three currently leading leasing companies in BH – Hypo-Alpe-Adria Leasing, Raiffeisen Leasing and Volksbank Leasing – established Association of Leasing Companies in Bosnia and Herzegovina in February 2005. The Association officially started to work in April 2005. In January 2006, Euroleasing from Mostar and CBS-NLB Leasing 2567 joined the Association, and it is expected that HVB Leasing will also join the Association in the following period. In accordance with their goals, the Association of leasing companies in BiH is engaged on international plan as well. In June 2005 the Association joined Leaseurope as associate member. Leaseurope Federation of European leasing associations from 30 countries was founded in 1972 and it is seated in Brussels.Today, Leaseurope presents 92 of leasing industry throughout the whole Europe and as an umbrella organization of European leasing market, Leaseurope unites around 1,200 leasing companies.As of 1 March 2006, the Association is a member of Chamber of Economy of Sarajevo Canton. Leasing in Bosnia and Herzegovina and in region Market share of the leading leasing companies in Bosnia and Herzegovina, Serbia and Montenegro and Croatia in, as well as the value of concluded leasing contracts in 2005 considered as crucial year for Bosnia and Herzegovina leasing market is shown in the following table: 2568 Company Bosnia and Herzegovina Serbia and Montenegro Republic Croatia Market share in 2005. Market share in 2005. Market share in 2005. Hypo Leasing 63 29,72 38,3 Raiffeisen Leasing 22 21,52 8,9 Volksbank Leasing 13 6,47 9 LB Leasing CBS 1 8,87 - HVB Leasing - 6,07 11 Euroleasing 1 - - Other - 27,35 32,8 Value of concluded contracts in 2005 in mil € 185,025 401,050 From annul reports we can see following: jan - jun 2008 2007 2006 2005 mil € mil € mil € mil € Vehicles 73,1 134,02 87,923 81,645 Equipment 45,4 89,466 58,258 78,214 Real estate 69,5 157,063 90,79 23,08 Other 1,4 6,556 2,004 2,08 UKUPNOTOTAL 189,4 387,105 238,975 185,025 EU leasing trends 2569 The relative importance of leasing and its contribution to the economy can be expressed in terms of what is referred to as a penetration rate. This is calculated by taking new European leasing business as a proportion of European investment to calculate the share of investment financed by leasing. Over past years, the European leasing penetration rate has risen steadily, reaching 19 at the end of 2006 compared to just under 12 at the end of 2000. This uninterrupted growth is proof that leasing is continuing to gain in popularity as a method of finance in Europe and Leaseurope expects this to continue in the future. Equipment lease finance in particular is an important source of funding, with leasing financing on average approximately 28 of equipment investment in Europe during 2006. Preliminary results for European leasing show that leasing remained a key source of finance for businesses‘ investment needs in β008. 2570 Preliminary market data from Leaseurope reveals that the portfolio of leased assets in Europe at the end of the β008 is estimated to be in the region of €780 billion, a 4.5 increase compared to the previous year. Conclusion In Bosnia and Herzegovina, a transitional country, lease is still being developed. The great leap has been done by establishing the Association whose effort contributed to developing appropriate legislative on both entities level and recently, on a national level. Since IFRSIAS were introduced in 2006, while period prior to this was covered by national standards, great effort was invested by professionals in charge so that every legal and accounting aspect of lease was introduced to public as clear and explicit as possible. New lease regulations by IASB are not considered so much positive here, and observed from the accountants and all of those who are trying to keep up with the trends through the data from financial reports point of view, certain changes would be very welcome. 2571 Recession, whose profound consequences are just starting to surface in the world economy, has led to light decrease in number of lease business so it is expected that the total number of lease jobs will be less than expected for year 2008 and 2009. However, it is indisputable that lease activities have major significance in business development in a transitional country as Bosnia and Herzegovina, where the enterprises are often blocked by lack of investment capital for equipment and further development. Having this fact in mind, all EU and world lease related changes should be carefully monitored and appropriately applied in Bosnia and Herzegovina economy. References 1. Belak, Vinko; Pehar, Maja: Lizing u sustavu PDV- a i međunarodnih računovodstvenih standarda, Fianncijski propisi i praksa br. 0106, Fircon d.o.o., Mostar, 2006. 2572 2. Horvat – Jurjec, Katarina: Računovodstvo najmova leasinga, RRiF br. 907, Zagreb, 2007. 3. Rajković – Burić, Ksenija: Leasing, Osiguranje: časopis za teoriju i praksu osiguranja br. 78, Zagreb, 2004. 4. Turčić, Zlatko: Financiranje hrvatskog brodarstva kreditnim leasingom, Naše more: pomorski znanstveni časopis br. γ4, Dubrovnik, β005. 5. www.leaseurope.org 6. www.leasing.org 2573 MATERIALITY DISCLOSURE THRESHOLDS AND DECISION-MAKING FOR ENVIRONMENTAL EVENTS Jeffrey Faux, Victoria University Abstract The accounting profession has been encouraged to develop standards and revise the notion of materiality with regard to environmental accounting Victoria Parliament, Public Accounts and Estimates Committee, 1999, p. 85. With this in mind it would be useful to determine a materiality disclosure threshold that affects decision-making for environmental events. To determine an appropriate threshold 1882 participants were surveyed and valid responses were received from 876 46.5 respondents. A vignette describing an environmental event facing a company was provided to participants who were asked whether the event was deemed to be material and, secondly, would the event initiate an action or no action decision. Results indicate that user groups consider the environmental event to be material at a threshold of 6. The determination of the event as material results in a ‗no action‘ decision that suggests isolated events of this size 2574 may not result in ‗action‘ decisions. The experimental research approach is limited by, the ability to generalize the findings and, the specific contextual nature of the event. Determining the threshold for disclosing an environmental event enables the establishment of regulated thresholds that are indicative of the needs of users. The use of an experimental approach reveals results regarding the decision-making process of users rather than respondents stating preferences and as a consequence this study adds constructively to the literature. Introduction The effect of environmental event materiality on the decision -making process of users has received minor attention from researchers and would be the logical investigative realm Dierkes and Antal, 1985. The differentiation between economic and environmental events has been described as significant rather than material Environmental Accounting Taskforce, 1998. Notwithstanding the semantic difference the benchmark criteria for disclosure of economic events is described 2575 as; above 10 material to decisions; below 5 immaterial to decisions; and, between 5 and 10 preparer discretion is to be exercised AASB 1031, 2004. This discretion may cause problems from the perspective of user decision-making in so much as several alternatives may result in less than satisfactory disclosure of events. In this paper the decision process of users is examined by considering event significance materiality in the context of an „action‟ or „no action‟ decision outcome. A decision outcome may take into account a succession or string of events that affect an entity or if an event is considered significant an isolated event may result in an „action‟ outcome. An in-isolation environmental clean-up event representing 6 of total revenue was provided to three user groups including shareholders, shareholderenvironmentalists and environmentalists. The experimental research model employed evaluates the effect of a single or in-isolation event on the decision-making of users which has 2576 implications for not only entity preparers but also regulators. The effect on the decision process is in terms of deeming the event significant in an environmental and economic context. The paper is structured in the following manner. The literature review discusses decision usefulness, the decision process and event significance. The research method includes a description of the surveyed groups, experimental model and the material discretion matrix used to evaluate the decision and significance of preparer discretion. Results are discussed in terms of the effect on economic and environmental decisions. The conclusion describes the limitations, implications for users, preparers and regulators, and further research opportunities in the area. 2577 Literature Review Whilst it may be presumed that the objective of financial reporting is the provision of information to interested parties, the theoretical un derpinning does not provide insights into users, their decisions or the presentation of information. Theories considered to be offering the social accounting and reporting researcher some insight have been drawn from social and political theory and include stakeholder theory, legitimacy theory and political economy theory. These theories are not seen as competing but rather as complementary Gray et al. 1995. However, from the perspective of users, the theories, whilst providing some justification for the provision of accounting information to groups other than groups whose interest is predominantly economic, offer little in respect of what, why and how information is used for decision purposes. Rather, the theories are predominantly about the interaction of power between society, management and users. 2578 Descriptions of the term ‗decision usefulness‘ are embedded in accounting conceptual frameworks AARF, SAC 2, 1990 that narrowly depict information useful for decisions as being only economic information as being decision useful. The concept of accountability through the antecedent term, stewardship, also has connotations of economic utility. The relationship between decision usefulness, accountability and stewardship is expressed by Stanton 1997, p. 684 and reflects the narrow perspective held of the purpose of reporting and accountability. Decision usefulness is the primary objective for financial reporting, having consumed the objective of accountability stewardship, so long held to be the justif ication for accounting. As an objective, decision usefulness reflects the utilitarian philosophy underlying most conceptual frameworks: concern is for the efficient allocation of resources which is in the interest of society as a whole. Accountability, o n the other hand, reflects concern for some individual interest. 2579 Accountability has been identified with a broader social as well as economic purpose that may well be the case with the notion of decision usefulness reflecting changing ideological attitudes and philosophies Goldberg, 1965. The reflection by Stanton that accountability is „concern for some individual interest‟ does not preclude that „interest‟ being decision-making. It is contended that issues of accountability shape future thinking thr ough retention of „memories‟ and, therefore, affect the individual decision process Chambers, 1966. Asking users what is useful for their decision-making seems to be a productive process that Dierkes and Antal 1985 identified. In their seminal research into developing a model for environmental reporting Dierkes and Antal 1985 acknowledge this situation stating ―that it is difficult for most people to envisage the potential usefulness and uses of a concept until it has been developed to a certain e xtent‖. δater in the paper it is stated that: 2580 In practice, key individuals in business and academics in particular have postulated information needs and determined how to meet them, with almost no attempts to obtain inputs and feedback from the potential target groups op cit., p29. However, the decision-useful approach has its detractors. Gray et al. 1996, p. 75 make the following statement: Decision usefulness purports to describe the central characteristics of accounting in general and financial statements in particular. To describe accounting as useful for decisions is no more illuminating than describing a screwdriver as being useful for digging a hole – it is better than nothing, and therefore useful, but hardly what one might ideally like for such a task. The subsequent issues arise from the above statement: 2581  That decision usefulness determines the characteristics and who shall participate in the use of financial statements.  The usefulness of accounting for decision-making is deteriorating.  Asking users to determine the usefulness of information is not a satisfactory research option. The last issue, whilst not directly mentioned in the above statement, underpins prior discussion in Gray et al. 1996. Alternative terms to decision usef ulness such as ‗user utility‘ Guthrie and Parker, 1990 and ‗usefulness and use‘ Dierkes and Antal, 1985 broaden the applicability of decision usefulness or user utility theory to include accounting for social and economic performance. This indicates that significant changes need to be made in areas such as accounting regulation and education. The changing demands on financial reporting, brought about by users interested not only in the economic performance of companies but also in the social performance, may present some interesting extensions to user utility theory. 2582 The plurality of purpose presently in financial reporting between decision usefulness and accountability is a dilemma that regulators and the profession need to sort out. A decision usefulness approach that allows for alternative decisions other than financial is considered a possible extension to user utility theory. An aspect of the decision process that is often disregarded is that the lack of action as a result of an event is a decision no action decision. It could also be construed that an action may be in response to a single disclosure of an event or a succession of events. This may not necessarily result in action but merely form part of the memories of the users that, in the future, may combine with other signals to create an outcome action decision. Making decisions regarding an entity is often a complex process and rather than use one source of information users may avail themselves of a range of information from diverse so urces. These ‗inputs‘ could be from external sources such as the state of world economies or from individual ideological 2583 belief structures. The notion of decision useful often implies some immediate decision outcome or action. In many instances, useful information may not result in an immediate outcome but form part of a future decision process. Users are individuals and may consider information differently, one individual may consider that an event warrants some form of negative action, another may consider the event positively and still another may consider the same event to be irrelevant. Accountants can merely disclose events as accurately as possible, within the constraints mentioned above, without bias and allow users to make their own judgements Chambers, 1966; Sterling, 1967; Houghton, 1989. A key facet of an event being decision useful is its significance or materiality. The Environmental Accounting Taskforce ICAA, 1998 chose the term ‗significant‘ as an alternative concept to ‗material‘ for environmental impacts of an entity. In conceptual framework projects a more legalistic description of materiality AARF, SAC 3, 1990 that connects disclosure with a 2584 consequence has been adopted as the following summation by Spacek 1969, p. 447 sets out: A material fact is a fact to which an average, reasonably prudent person would attach importance in determining a course of conduct to be taken or followed upon learning the fact, such as in deciding whether or not to buy or sell stock, or to lend or refuse to lend money, or to cancel a loan. The identified outcomes of ‗determining a course of action‘ are identified as, for example, buying or selling stock. Whilst supporting legalistic description of materiality no accommodation is made for the decision that does not have an outcome. Deciding whether to buy or sell shares involves a third possibility which is to hold or to take no action. This particular decision, while it involves no action and has no immediate consequences is, from the use r‘s point of view, the result of conscious and deliberate choice. 2585 Materiality guidelines AASB 1031, 2004 describe an event that is less than 5 of the base amount as not material, whilst an event greater than 10 of the base amount would be considered material. An event or item falling between 5 and 10 of the base amount is material and the preparer, considering the nature of the event, would exercise judgement as to whether disclosure of the event is necessary. However, the preparer, following the guidelines, may consider that the nature of an event would not materially affect the decisions of users when, in fact, users in exercising their judgement may believe the information to be material. Unfortunately, if preparers make the decision not to disclose an event, then the utility of the information to users cannot be determined. The importance of research in this area to determine event significance materiality and thresholds, from a user perspective, would be valuable not only for users but also for preparers in determining disclosure of events in the range 5 to 10. 2586 The importance of the nature and size of an event has been acknowledged in the Australian Accounting Standards AASB 1031, 2004. The type of event that should be disclosed is one that would materially affect the decisions of users. To assist in determining whether an event may affect the decisions of user threshold guidelines, as described above, are provided for preparers. The approach to materiality described above is reasonabl e in a legal context and practical from an accounting perspective because it provides clear threshold rules. Whilst providing regulators and accountants with workable arrangements the interests of users have received minimal attention. Materiality judgements are crucial in decision-making and failing to take account of user perspectives may render disclosures ineffectual for decision purposes. Conceptually, a broader description of materiality that includes the ‗no immediate action alternative‘ would be desirable and can only improve disclosure of material events. 2587 Deegan and Rankin 1997 asked shareholders, stockbrokers, analysts, academics, financial institutions and review organizations “whether environmental issues are material to their decisions co ncerning a company”. The results indicate that a rather high percentage of the user groups surveyed would use environmental information 66.7. The range between the economic-type decision groups 43.8 and the non-economic-type decision groups 83.0 is quite large. A study conducted by Faux 2002 asked users to indicate the threshold range for disclosure of environmental events. Five categories were provided: – 3; 4 – 6; 7 – 9; greater than 10; and, should not be disclosed. 73.4 of users surveyed indicated that they would like disclosures to be made in the first two categories that is 0 – 6. The difference between economic and non-economic user groups is blurred as a result of a mixed category but the economic user group indicated a preference for disclosure in the first two categories of 60.9. Both the above studies suffer from respondents stating their preferences rather 2588 than revealing results through a case scenario requiring respondents to make a decision. Deegan and Rankin 1997 requested that respondents indicate „real needs‟ rather than a „wish list‟ but never the less results are still stated. Studying the relationship between the regulated determination of the deeming of a material event and users‟ determination as to the usefulness in their decision-making of the deeming would extend the literature. In the light of the above studies Deegan and Rankin 1997, Faux 2002 and the recommendations of the Interim Report of the Inquiry into Environmental Accounting and Reporting Public Accounts and Estimates Committee of the Parliament of Victoria 1999 this area of study would be particularly useful. The conceptual confusion over decision usefulness and accountability functions of entity disclosures only serves to make it more difficult to establish practical disclosure requirements that meet the needs of users, preparers and regulators. 2589 The discussion of the disclosure of an event, from the preparer‟s perspective, provides three possible situations.  The event is greater than 10, is significant and material, and therefore will have an action decision outcome.  The event is in the 5-10 category and could be: o Not significant and not material with a no-action decision outcome. o Not significant and not material with an action decisio n outcome. o Significant and material with a no-action decision outcome. o Significant and material with an action decision outcome.  The event is less than 5 is not significant or material and therefore will have no decision outcome. 2590 The preparer‟s decision in the first and third possibilities is prescribed in the guidance provided in the commentary to AASB 1031 2004 and, therefore, quite clear. The second situation has several alternatives that may result in less than satisfactory disclosure of events from a user‟s perspective. The preparer‟s choice in deciding whether to disclose the event results in certain outcomes for users that have been described above. In Figure 1 the choices available to preparers are presented in matrix form to enable visual identification of the relationships that exist between event significance materiality and users‟ decisions. Take in Figure 1 The „type 1‟ event occurrence is the non-disclosure of an event by preparers and is unlikely to have an effect on users‟ decision-making. The non- disclosure would therefore be justified. The „nature‟ of the 2591 event in terms of a „type 2‟ situation is more relevant than the amount being disclosed. The significance materiality may not relate to the magnitude of the event as AASB 1031 2004, Para 4.1.3 states. In deciding whether an item or an aggregate of items is material, the nature and amount of the items usually need to be evaluated together. In particular circumstances, either the nature or the amount of an item or an aggregate of items could be the determining factor. „Type 3‟ and „type 4‟ events present preparers with a dilemma because users have deemed the event to be significant. If preparers disclose the event there is no problem. However, if the disclosure is not mad e then an event that affects decision-making is not disclosed. The issue becomes one of determining whether an environmental event in the 5-10 category would be considered by users to be materially 2592 significant and would the determination of significan ce cause an action or no action decision. Research Method The use of an experimental model has the benefit of revealing user intentions in a decision context whereas the studies of Deegan and Rankin 1997 and Faux 2002 suffer from respondents stating t heir preferences. However, generalizing the findings is constrained by the lack of external validity when using an experimental model. Providing participants with a clean-up environmental event is also problematic in that there are numerous possibilities for describing an environmental event. Considering the decision context as an isolated event rather than a sequence or string of events may also weaken the findings. However, the experimental model employed does explore the relationship between event size and decision usefulness. 2593 Two groups of users were surveyed in the experiment; shareholders and environmentalists. Shareholder participants were randomly drawn from the registries of three public companies, also selected at random, from the top 50 companies listed on the Australian Stock Exchange. The membership of a professional association of environmentalists served as the database of environmentalists and all members were surveyed. The survey was posted to 1882 participants and valid responses were received from 876 46.5 respondents. Through a filter in the survey a further group who exhibited characteristics of both groups shareholderenvironmentalists was established. Shareholder responses were 253, shareholder environmentalists amounted to 240 and responses from environmentalists were 383. A description of an in-isolation environmental situation facing a company was provided to participants in the form of a vignette and they were asked whether the event was thought to be significant and 2594 whether the event would initiate an action or no action response. The vignette concerned a company facing a „clean-up‟ event. The description of the event was approximately 20 lines in length which Milne and Chan 1999 describe as being the average length of an environmental disclosure. The detail of the vignette described an Australian retail petroleum company that was listed on the Australian Stock Exchange and confronted with a situation whereby a significant number of its city petrol stations showed signs of deterioration. The vignette continued with an explanation of the assessment and grading of contaminated petrol stations that saw low and medium polluted sites sold at a loss and clean-up of high polluted sites undertaken. The threshold for the event was 6 and the nature of the event can be easily identified as environmental allowing for the interpretation of the vignette and the making of environmental and economic decisions. The questions 2595 accompanying the vignette were as follows and allowed action and no action decisions to be made:  Is the event described considered significant? event significance  If no shares were held in the vignette company would you take an action on the basis of the environmental report? environmental decision  If shares were held in the vignette company would you take an action on the basis of the environmental report? economic decision Results The notion of expanding the user utility to include decisions other than financial was used in the possible response alternatives to the environmental and economic decisions. The environmental action decision provided a number of alternatives and the opportunity for respondents to 2596 specify an action decision they may take. The action alternatives were all coded one while the no action response was coded zero. The economic action decision was to either reduce or increase the holding and either response was coded one. The no action response was coded zero. The relationship between event significance and the dichotomised response to the environmental and economic decisions are described in Figure 1. The analysis draws on the contentious discretionary disclosure of events in the 5 - 10 region discussed earlier. To establish how many respondents were in each of the above categories a cross-tabulation was constructed based on Figure 1 to take account of the user group, whether the event was significant, and the decision outcome. The results for the environmental decision of this analysis appear in Table I. The cross-tabulation shows a rather high number of missing cases 176 or 20.01. There were 35 or 13.8 missing shareholders, 50 or 20.8 shareholderenvironmentalists and 91 or 23.8 environmentalists. 2597 Determining the significance materiality of the event and making both an environmental and economic decision with the same information acknowledges the flexibility of decision-making. Take in Table I 2598 The Type 1 situation is where users believe the event to be neither materially significant to their decisions nor would they take any action. A total of 13.6 of respondents identified a Type 1 occurrence. The largest group within this category was shareholders 17.0, followed by shareholderenvironmentalists 15.2 and finally environmentalists 9.9. This perhaps reflects the greater concern of environmentalists. Respondents supporting a Type 1 situation would support the company if it chose not to disclose the event. This situation does not present a problem for preparers; if they disclose the event there is no effect and if they do not disclose the event there is no effect. In the Type 2 scenario respondents deem the event not to be materially significant but would take an action decision. The Type 2 situation would be a concern in a decision context that is not in-isolation where the collective effect of a succession of events, whilst not on their own significant, would, at some stage, trigger a decision. However, this is not the case as the 2599 situation is in-isolation and, therefore, it is difficult to interpret this result even though it is quite low 2.9. The Type 3 situation, a materially significant event but no action decision deemed necessary, is the choice of 52.1 of respondents and, interestingly, the percentage of shareholders is

54.1, shareholderenvironmentalists 53.7 and environmentalists 49.7. The

vignette is an in-isolation event and it is difficult to determine the reason why, having identified the event as significant, a no action decision is taken. Perhaps the event is deemed important and will form part of the „memories‟ as Chambers 1966 suggests for a future decision. The Type 4 event is more easily interpreted, the event is significant and an action decision is made. The Type 4 situation has been selected by

31.4 of

respondents, 24.8 of shareholders,

29.5 of

2600 shareholderenvironmentalists and 37.7 of environmentalists. The trends in the Type 3 and 4 events support the interest of shareholderenvironmentalists and environmentalists in an environmental decision. The intriguing result is the high percentage of shareholders 78.9 that identify the environmental event as significant. With regard to event significance and the environmental decision the cross - tabulation reveals that 83.5 Type 3 + Type 4 total of users believe the event is significant. This is an important finding given that the significance of the event is 6 and that the nature of the event is environmental and would support suggestions from the Inquiry Victoria Parliament, Public Accounts and Estimates Committee, 1999 that environmental disclosures should be quantified at lower levels than those for financial reporting AASB 1031, 2004. Even though a very high number of respondents identified the event as significant material, 65.7 Type 1 + Type 3 total would take a 2601 no action decision. This could mean that whilst respondents feel the event is significant to decision-making they would like to wait and see what the company does with similar events or perhaps they feel that the company‘s actions are positive. The results from the event significance and the economic decision appear in Table II. The cross-tabulation has resulted in a much lower number of missing cases than the environmental decision 92 or 10.5. There were 19 or 7.5 missing shareholders, 33 or 13.8 shareholderenvironmentalists and 40 or 4.6 environmentalists. Interestingly, there is very little difference between the totals for the economic decision and those for the environmental decision. Take in Table II 2602 In the Type 1 situation 16.2 of shareholders, 10.6 of shareholderenvironmentalists and 9.9 of environmentalists consider to be of little concern for the reasons previously mentioned as the event is deemed not materially significant and no action would be taken. As with the environmental decision, the Type 2 occurrence for the economic decision is difficult to interpret but it is very low across all groups. The Type 3 situation identifies 54.7 of shareholders, 52.2 of shareholderenvironmentalists and 46.9 of environmentalists as deeming the event significant but taking no action. The reason for the no action decision in this circumstance is once again difficult to interpret but perhaps the event size and nature does not warrant an immediate action. The Type 4 event is not a confusing outcome and results indicate that 24.4 of shareholders,

33.3 of

shareholderenvironmentalists and 41.5 of environmentalists chose this option. 2603 The significance of the event with regard to the economic decision 86.4 = 50.6 + 34.2 differs from the environmental decision 83.5 = 52.1 + 31.4 only in the number of additional cases that have been included in Table II. The number of respondents that would take a no action decision was 62.6 Type 1 + Type 2 total op posed to 37.4 Type 2 + Type 4 total that would take an action decision. The majority of respondents once again chose a wait-and-see attitude. A summary of the findings determining the environmental event material significance and decision outcome are as follows:  Environmental decision; event significance Type 3 + Type 4 83.5 of users.  Environmental decision; no action outcome Type 1 + Type 3

65.7 of users.

2604  Economic decision; event significance Type 3 + Type 4 84.8 of users.  Economic decision; no action outcome Type 1 + Type 3

62.6 of users.

The results for the event described are conclusive and suggest that further consideration be given by preparers and regulators to environmental disclosures in the 5 - 10 range. The no action decision outcome reflects the need for more research on the decision process of users. Whilst statistical significance testing of the results may provide a level of certainty that descriptive statistics do not offer it is felt that the overwhelming results render further testing unnecessary. Conclusion Dierkes and Antal 1985 have suggested that whilst there is confusion regarding the best approach for deciding what and how to describe 2605 environmental events, asking users of reports is considered as the most likely method to result in outcomes in terms of decision-making. The intention in this study was to investigate the relationship between event significance materiality and a decision context. Regulations require certain levels of disclosure for economic events, and a suggestion from an Inquiry Victoria Parliament, Public Accounts and Estimates Committee, 1999 is that the accounting profession consider lower threshold levels for disclosing environmental events. Studies have considered the issue of material significance but have emphasised user preference rather than an experimental model which would indicate the relationships between decision-making and the material significance of events disclosed. The limitations of the experimental research approach have been discussed along with the ability of the findings to be generalised, the specific contextual nature of the vignette and that the event described in the vignette is in - isolation. 2606 An interesting outcome from the analysis of the findings is that the differences between the results in Table 1 and Table 2 are relatively minor. The Type 1 situation difference between user groups, and the economic and environmental decisions, is mainly shareholderenvironmentalists with a 4.6 variation. The Type 2 situation results are too small to be significant. The Type 3 occurrences main difference exists between environmentalists but once again is quite low at 2.8. Differences exist between shareholderenvironmentalists 3.8 and environmentalists 3.8 for the Type 4 situation but as with the other groups these results are relatively minor. This indicates that environmental information can be used for either environmental or economic decisions. The environmental event at 6 will affect both environmental and ec onomic decisions in similar ways. 2607 The findings indicate the importance of identifying no action as a decision response. Events between 5 and 10, regardless of whether they are environmental or economic, need to be disclosed because they are deemed significant by the user groups investigated as affecting decision-making. The results indicate that an in-isolation environmental clean-up event with a 6 threshold will affect the decisions of users in terms of the event significance and taking a course of action. This is an interesting finding for regulators as it confirms the suggestion stemming from the Inquiry Victoria Parliament, Public Accounts and Estimates Committee, 1999. Reporting entities should also be interested in the findings as it suggests they should be disclosing environmental events with much lower thresholds than 10. The above points must be considered in the light of the study limitations. Further studies could consider, given the take no action decision, a sequence of various envir onmental events with a range of thresholds. 2608 References Australian Accounting Research Foundation 1990, SAC 2 - Objectives of Financial Reporting, Accounting Standards Review Board and Public Sector Accounting Standards Board, AARF, Melbourne. Australian Accounting Research Foundation 1990, SAC 3 – Qualitative Characteristics of Financial Reporting, Accounting Standards Review Board and Public Sector Accounting Standards Board, AARF, Melbourne. Australian Accounting Standards Board 2004, Australian Accounting Standard AASB 1031: Materiality, AASB, Melbourne. Chambers, R. J. 1966, Accounting, Evaluation and Economic Behaviour, Scholars Book Co., Houston. Deegan, C., and Rankin, M. 1997, “The materiality of environmental information to users o f accounting reports”, Accounting, Auditing Accountability Journal, Vol. 10 No. 4, pp. 562-583. Diegling, P., Anderson, J. and Guthrie, J. 1996, “Accounting for public accounts committees”, Accounting, Auditing Accountability Journal, Vol. 9 No. 2, pp. 30-49. Dierkes, M., and A. Antal. 1985, “The usefulness and use of social reporting information”, Accounting, Organizations and Society, Vol. 10 No. 1, pp. 29-34. Environmental Accounting Taskforce, The Institute of Chartered Accountants in Australia 1998, The Impact of Environmental Matters on the Accountancy Profession: Discussion Paper, ICAA, Sydney. 2609 Faux, J. 2002, “A stakeholder perspective of material disclosure thresholds for environmental events”, Asian Review of Accounting, Vol. 10 No 2, pp 3-16. Gray, R., Kouhy, R. and Lavers, S. 1995, “Methodological themes: Constructing a research database of social and environmental reporting by UK companies”, Accounting, Auditing Accountability Journal, Vol. 8 No. 2, pp. 78-101. Gray, R., Owen, D. and Adams, C. 1996, Accounting and Accountability: Changes and Challenges in Corporate and Social Reporting, Prentice-Hall, London. Goldberg, L. 1965, An Inquiry into the Nature of Accounting, American Accounting Association, Iowa. Guthrie, J. a nd Parker, L. 1990, “Corporate social disclosure practice: A comparative international analysis”, Advances in Public Interest Accounting, Vol. 3, pp. 159-175. Houghton, K. 1989, An Empirical Inquiry into the Shared Meaning of Fundamental Accounting Terminology: Australian Evidence, paper presented to Accounting Association of Australia and New Zealand Annual Conference, Melbourne. Milne, M. and Chan, C. 1999, “Narrative corporate social disclosures: How much of a difference do they make to investment decision- making”, British Accounting Review, Vol. 31, pp. 439-457. Spacek, L. 1969, A Search for Fairness in Financial Reporting to the Public, Arthur Anderson Co., Chicago. Stanton, P. 1997, “Users‟ rights to published accounting information: 2610 Nat ure, justification and implications”, Accounting, Auditing Accountability Journal, Vol.10 No. 5, pp. 684-701. Sterling, R. 1967, “A statement of basic accounting theory: A review article”, Journal of Accounting Research, Spring, pp. 95-112. Victoria Parliament, Public Accounts and Estimates Committee. 1999, Interim Report of the Inquiry into Environmental Accounting and Reporting, Thirty-First Report to Parliament, Melbourne. Figure 1 Preparer Discretion at the 5-10 Event Disclosure Thresholds Decision 2611 Table I Event Significance and Environmental Decision Decision Significanc e No Action Action Not Significant TYPE 1 TYPE 2 User S SE E Tot S SE E Tot N 37 29 29 95 9 3 8 20 17.0 15.2 9.9 13.6 4.1 1.6 2.7 2.9 Significant TYPE 3 TYPE 4 N 118 102 145 365 54 56 110 220 54.1 53.7 49.7 52.1 24.8 29.5 37.7 31.4 Table II Event Significance and Economic Decision Decision Significanc e No Action Action Not Significant TYPE 1 TYPE 2 User S SE E Tot S SE E Tot N 38 22 34 94 11 8 6 25 16.2 10.6 9.9 12.0 4.7 3.9 1.7 3.2 Significant TYPE 3 TYPE 4 N 128 108 161 397 57 69 142 268 54.7 52.2 46.9 50.6 24.4 33.3 41.5 34.2 2612 MATHEMATICS IN ACCOUNTING AS A BIG UNANSWERED QUESTION Sony Warsono Arif Darmawan Muhammad Arsyadi Ridha ABSTRACT Mathematics has been employed in accounting for centuries. It was included in the double entry system in the Luca Pacioli‘s mathematics book but has not, so far, received appropriate attention in the development of modern accounting. The expanded accounting equation employed nowadays is considered a black-box, and there have been no significant improvements to the equation. This paper outlines the importance of the accounting equation in identifying the limitations of current accounting standards, particularly the definition of the elements of financial statements. Furthermore, this paper argues that the approach employed in the definitions of the elements of financial statements should be on the basis of information-base, instead of the use either the balance sheet or the income statement approach. Finally, the paper suggests that the application of mathematics in accounting be dealt with so that accounting will make a significant contribution to the academic world. Keywords: Expanded accounting equation, The Joint Project IASBFASB, Definitions of revenues and expenses, Mathematics in accounting 2613 INTRODUCTION The following question and statements in Accounting Horizons have inspired this paper. What is the most important accounting issue where we either think we understand it but in fact do not or have failed to consider the issue in anywhere near the depth it deserves? Panel on Big Unanswered Questions in Accounting —Genesis, Basu 2008, 426. ―Rules are fundamental to financial reporting, tax regulation, and auditing processes, and therefore the limitations of rule-based structures are of primary interest to accountants.‖ Rules and Accounting:Vagueness in Conceptual Frameworks, Penno 2008, 339 ―... Innovation is essential.... If it comes it will be from a small number of scholars who are willing to thumb their noses at the status quo.‖Is Accounting an Academic Discipline?, Demski 2007, 156 ―We could, if we wanted, use the double entry system to illustrate and access important theorems in mathematics ...‖ Is Accounting an Academic Discipline?, Fellingham 2007, 161 This paper employs the mathematical perspective especially the expanded accounting equation to reveal the incompleteness of current 2614 accounting standards in the elements of financial statements. Next, this paper states that efforts to develop accounting with a focus on the pillar of mathematics have not been taken far enough and this remains a big unanswered question. This paper is presented in the following order. Firstly, it discusses the current employment of mathematics in accounting. Secondly, it presents recent developments in the construction of standards in the elements of financial statements as undertaken by the Joint Project of International Accounting Standards Board and Financial Accounting Standards Board hereafter the Joint Project IASBFASB. Thirdly, it points out several examples of incompleteness of standards in the elements of financial statements which are liable to m ake the financial information incapable of reflecting the real business condition. Fourthly, it proposes the use of an information- base hereafter ―infobase‖ approach another word for ―database‖ to define the elements of financial statements. Fifthly, it uses a mathematical perspective, especially the expanded accounting equation, to meet two of some ideal objectives set up by the Joint 2615 Project IASBFASB. Finally, this paper claims that the disinterest in the central role of mathematics in accounting requires an immediate response. THE USE OF MATHEMATICS IN ACCOUNTING In Summa de Arithmetica, Geometria, Proportioni et Proportionalita, Luca Pacioli codified the double-entry systems which are based on the basic accounting equation Assets = Liabilities + Equity Peters and Emery 1978. This basic accounting equation BAE maintains that the assets on the left side of the equation reflect resources, whereas the liabilities and equity on the right side of the equation reflect financing sources. The firm‘s resources should always be equal to its financing sources. Furthermore, revenues increase equity, while expenses decrease it. On the basis of these rationalities, modern accounting textbooks present an expanded accounting equation EAE as follows. Assets = Liabilities + Equity + Revenues – Expenses ……. EAE Conventional 2616 The authors argue that the rationality employed to explain BAE is inconsistent with those employed to explain EAE, because expenses on the right side of the equation are not financing sources. Instead, expenses should represent the use of funds. Furthermore, the EAE can be presented as follows. Assets + Expenses = Liabilities + Equity + Revenues ……. EAE Mathematics We call this equation EAE εathematics because ―Pacioli, like other mathematicians of his time, did his utmost to avoid even the use of a symbol for minus, let alone a negative number.‖ Peters and Emery 1978, 4β6. Although mathematically both are correct, so far we do not find accounting textbooks which present the EAE Mathematics. The absence of accounting textbooks which employ EAE Mathematics reflects accounting teaching methods which simply emphasize rules. The authors argue that it would be more fitting to employ EAE Mathematics in the teaching of accounting. The use of EAE Mathematics may explain the rules about debits and credits so logically and easily that the need 2617 to memorize the rules is irrelevant. Furthermore, students may more easily understand why assets and expenses have the same rules in debits and credits; both elements represent the uses of funds. More importantly, the rationale employed to explain EAE Mathematics is consistent with those employed to explain BEA; the left side of the equation reflects the uses of funds, while the right side reflects the sources of funds Subramanyam and Wild 2009; Anthony et al. 2007. Unfortunately, current accounting practices give more emphasis to the development of rules rather than the development of mathematics, to the effect that EAE Conventional is in greater use. On the basis of EAE Mathematics, the teaching of accounting might simulate various transactions made by the firm. For example, an increase in expenses in the accounting equation followed by an increase in revenues may occur if there is a transaction of service exchange barter between two service firms. Likewise, an increase in expenses followed by an increase in equity may occur if the firm issues shares paid in the form of the buyer‘s services. These types of transactions cannot easily be found in accounting textbooks currently 2618 available. In short, it can be inferred that accounting is actually based on mathematics but accounting research and teaching nowadays do not fully or adequately explain the central role of mathematics. The accounting standards employ mathematics in defining the elements of financial statements. Equity is defined as net assets, namely ―the arithmetic difference between assets and liabilities …‖ Alfredson et al. β007, 76. Furthermore, revenues are conventionally defined as asset increases or liability decreases or a combination of both. Such a definition of revenues is based purely on the accounting equation; increases in revenues recognition of the occurrence of revenues on the right side of the accounting equation should be followed by asset increases on the left side of the equation or followed by liability decreases on the right side of the equation or a combination of both so that a balance in the accounting equation would be maintained. Unfortunately, the elements of financial statements, especially for revenues and expenses, are not adequately defined to the effect that accounting runs the risk of providing financial information which does not correctly represent the reality of business. 2619 The limitation of accounting standards in defining the elements of financial statements will be further discussed later in this paper. STANDARDS IN THE ELEMENTS OF FINANCIAL STATEMENTS The International Accounting Standards Committee IASC issued the conceptual framework in 1989. It was based on FASB, which adopted the balance sheet model of financial reporting Camfferman and Zeff 2007. More specifically, the definition of the elements of financial statements was based on the perspective of assets Alfredson et al. 2007. This happened beca use the standards considered economic resources or assets as ―central to the existence and operations of an individual entity‖ FASB 1985, par.11 and ―the lifeblood of a business enterprise‖ FASB 1985, par.15. Furthermore, the IASC was replaced by the International Accounting Standards Board IASB in 2001. Currently the Joint Project IASBFASB is redefining the elements of financial statements. The Joint Project IASBFASB tentatively adopted the following working definitions of asset and liability as f ollows. 2620 ―An asset of an entity is a present economic resource to which the entity has a right or other access that others do not have.‖ IASB – FASB 2008, Asset Definition ―A liability of an entity is a present economic obligation for which the entity is the obligor.‖ IASB – FASB 2008, Liability Definition Essentially the redefinition of the elements of asset and liability by the Joint Project IASBFASB was still based on the same perspective, namely the balance sheet orientation Dichev 2008. So far the work of the Joint Project IASBFASB is still continuing. The tentative definition of the elements of equity has not been issued. Several differences in the definition of other elements relating to equity will be discussed further as stated: ―The FASB Concepts Statements presently identify more elements than does the IASB Framework, and the two frameworks define differently those elements that are common. The Boards‘ approach will focus initially on converging and defining only those key elements that are defined today in the IASB and FASB Frameworks. As well, the Boards will need to consider the extent to which, and if so how, to define elements that are not defined today, such as comprehensive income.‖ IASB – FASB 2008, Next Steps – Other Elements 2621 Taking a close look at the definition of assets and liabilities made by the Joint Project IASBFASB, it is predicted that the Joint Project IASBFASB‘s efforts to define equity and other elements, including revenues – the IASB refers to them as income – and expenses, would still be based on the perspective of assets, unless the Boards ―expand their effort to a more thorough reassessment of their conceptual framework‖ Dichev β008, 454. In this case, it is very likely that equity will be defined as net assets, and revenues and expenses would be parts of the equity. LIMITATIONS OF STANDARDS IN THE ELEMENTS OF FINANCIAL STATEMENTS The use of the asset perspective to define the other elements of financial statements may result in an incomplete definition. In turn, accounting may provide financial information which does not faithfully represent the company‘s real condition. Many experts have revealed the inadequacy of accounting to 2622 represent the reality of business Ball 2008; Cheney 2009. Before pointing out the limitations of defining the revenues and expenses, we would like to present the definitions of revenues and expenses according to the FASB and IASC as follows. ―Revenues are inflows or other enhancements of assets of an entity or settlements of its liabilities or a combination of both from delivering or producing goods, rendering services, or other activities that constitute the entity‘s ongoing major or central operations.‖ FASB 1985, Par 78 ―Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.‖ in εirza et al. β008 ―Expenses are outflows or other using up of assets or incurrences of liabilities or a combination of both from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity‘s ongoing major or central operations.‖ FASB 1985, Par 80 ―Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or the incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participa nts.‖ in εirza et al. β008 2623 The above definitions are substantially similar, namely that the recognition of revenues and expenses should be followed by changes in assets andor liabilities. Such a definition disregards revenueexpense transactions that do not produce directly any change in assetsliabilities. Below are two cases which reveal limitations in the standards of the elements of financial statements, especially related to the definitions of revenues and expenses. Case I Business event A: Merchandising firm Q, which is in the business of selling computers, and merchandising firm R, which is in the business of selling furniture, barter their merchandises. According to the standards, both merchandising firms Q and R recognize this business event a s a revenue transaction, as in this event there is an increase of assets into each firm. 2624 Business event B: Service firm S, which is in the information technology consultation business, and service firm T, which is in the accounting consultation business, barter their main services. According to the standards, both firms S and T should not recognize this business event as a revenue transaction because there is no increase of assets or decrease of liabilities in each of these firms. Accordingly this business event cannot be classified as a revenue transaction by either firm. Business event C: Service firm S, which is in the accounting consultation business, is conducting barter with merchandising firm Q, which is in the business of selling computers. According to the standards, firm S should recognize this business event as a revenue transaction because there is an increase in assets in the form of computers. Firm Q, however, should not recognize this business event as a revenue transaction because there is ne ither an increase in assets nor decrease in liabilities even though firm Q delivers its services. This business event, therefore, is recognized as a transaction by firm S but cannot be recognized as such by firm Q. 2625 Case 2 Business event D: Service firm V, which is in the business of advertisement, purchases a number of firm W‘s shares with the intention to own them. The payment is made directly and fully in the form of advertising services delivered by firm V. Firm V should recognize this business event as a revenue transaction because there is an increase in assets in the form of share investment. According to the standards, however, firm W should not recognize this business event as an expense transaction because there is neither a decrease in assets nor an increase in liabilities as a result of this business event; what results is an increase in equity. Business event E: Service firm X, which is in the business of TV advertising, distributes revenue dividends in the form of services to firm Y, which own s more than 20 percent of the company shares. On the announcement date, firm Y immediately utilizes the revenue dividends. According to the standards, firm X should not recognize this business event as a revenue transaction because there is neither an increase in assets nor a decrease in liabilities; what results 2626 is an increase in dividends distribution. On the other hand, firm Y should recognize this business event as an expense transaction because the firm receives advertising services and there is a decrease in assets in the form of share investment equity method. Therefore this business event should be recognized as an expense transaction by firm Y but should not be recognized as a transaction by firm X. The illustrative cases above are simulations of transactions that may happen in business on the basis of the expanded accounting equation. In short, the recognition of revenues can be balanced not only by increases in assets or decreases in liabilities, but also by increases in expenses or decreases in equity. Likewise, the recognition of expenses can be balanced by decreases in assets, increases in liabilities, increases in equity, or increases in revenues. Therefore, the current definitions of the elements of revenues income and expenses are incomplete. This occurs because the standards argue that revenues and expenses should make a direct impact on the assets andor 2627 liabilities. The inadequacy of the definitions of revenues and expenses is also due to the placement of revenues and expenses under the category of equity. An extended effect of the limitation of standards is the lack of accounting textbooks that reveal the above transactions. This demonstrates that the inadequacy of the standards is likely to result in a serious risk to teaching because accounting rules ―provide an alternative way to organize and frame the teaching of accounting‖ Fellingham β007, 160. REDEFINING THE ELEMENTS OF FINANCIAL STATEMENTS One of the topics which is currently discussed in earnest by accounting experts is the approach that should be adopted in constructing financial statements Haka 2009. Current standards have opted for the balance sheet approach, while some others suggest the use of income statement approach see Dichev 2008; AAA FASC 2007. First and foremost, financial accounting should provide financial information, not just the balance sheet and income statement. Therefore, standards determined by the use of one perspective are 2628 likely to underestimate the importance of other perspectives. As demonstrated above, the use of the balance sheet perspective has rendered as un-coverable a large number of business events significantly related to revenues and expenses. Likewise, the use of the income statement approach is likely to underestimate the importance of business events related to assets, liabilities, and equity. To solve the problems related to the use of appropriate approaches in the definition of the elements of financial statements, we can take a lesson from the approach employed in data management. Early in the development of the computer, data management employed a file-oriented approach, which tied the data to the application that produced them. As a consequence, in order to access particular data with other applications the data must be converted f irst. The conversion process may cause changes to the original data. This file - oriented system was considered inefficient, highly susceptible to errors, redundant, etc Wilkinson et al. 2000. Modern data management uses a database approach, which separates data from the application that produced 2629 them. This approach makes it possible to produce data which are standardized, consistent, and integrated Romney and Steinhart 2009. An analogy can be made between the use of the balance sheet or income statement approach and the file-oriented approach. Mathematically, the expanded accounting equation shows that the elements of assets, expenses, liabilities, equity, and revenues are on the same level. The placement of one element above another element is inconsist ent with the accounting equation. Therefore, we argue that the approach employed in the definitions of the elements of financial statements should be on the basis of an ―infobase‖ another word for ―database,‖ which is already common in the literature of information systems, instead of the use either the balance sheet or the income statement approach. With this ―infobase‖ approach, the elements of financial statements are not tied to the financial information which has been produced. It is only at the end of the accounting period that these elements are designed to produce financial statements. 2630 The equation of Assets + Expenses = Liabilities + Equity + Revenues indicates that the left side of the equation reflects the uses of funds, while the right side of the equation reflects the sources of funds. Compared with the rationale currently employed in EAE, the authors argue that the above rationale is more consistent and acceptable. That rationale should, therefore, be employed in defining each element of financial statements. Besides, the current definition of the elements of financial statements is mechanistic rather than substantive, especially for the definitions of the elements of equity, revenues income and expenses. The mechanistic definition is not flexible enough for future development, and is incapable of providing any information about the subject to be defined. Using the ―infobase‖ approach, below are the definitions of the elements of financial statement are: a. Assets are uses of funds in the form of resources whose economic value can still be utilized in the future 2631 b. Expenses are uses of funds in the form of resources whose economic value has been utilized for the firm‘s activities within a particular period c. Liabilities are sources of funds from third parties acting as creditors d. Equity is sources of funds from the company‘s owner, retained earnings accumulated profits, and sources other than creditors e. Revenues are sources of funds from the firm‘s activities within a particular period This definition of elements of financial statements is more abstract, and covers many more business events than the current mechanistic definition allows for. MATHEMATICS AS A BIG UNANSWERED QUESTION Written documents show that accounting was included in δuca Pacioli‘s mathematic book Sangster et al. 2007. In its historical progress, however, accounting has developed a focus on rules Penno 2008. A large number of rules have been issued to the effect that accounting was well-known as a regulatory enterprise AAA FASC 2007. Nevertheless, the development of rules 2632 cannot completely protect the users of accounting information Scott 2009. Beside the focus on the development of rules, accounting has also developed an emphasis on vocational skills. The teaching of accounting, as a result, has focused largely on vocational skills Demski 2007, with little contribution to the academic world Fellingham 2007. ―Financial reporting is not an end in itself. It is a means of communicating to the users of financial reports information that is useful in making choices among alternative uses of scarce resources‖ FASB β006, OB6 and ―the objective of general purpose financial reporting is to provide financial information . . .‖ FASB β008, OBβ. Thus, financial accounting is a tool to be used to provide financial information. As a tool, accounting should be of the same nature as computing, aircraft technology, etc. All these technologies require established knowledge in order to function effectively; to give the best possible contribution to humanity, and to allow for continuous development. The authors argue that three major pillars should be developed in a balanced manner to enable accounting to be an academic discipline, namely mathematics, 2633 rules, and vocational skills. The Joint Project IASBFASB has been developing the Conceptual Framework for Financial Reporting that underlies financial reporting. Several topics are still debated up to the present. These debated topics usually come to tore when choosing among two extreme points which appear utterly irreconcilable but which eventually must be accommodated in order to serve the interests of all parties involved. For example, the Joint Project IASBFASB originally stated in the Preliminary Views of the Conceptual Framework for Financial Reporting that the potential users of financial reports include equity investors, creditors, suppliers, employees, customers, governments and their agencies and regulatory bodies, and members of the public FASB 2006, OB6. Later, the Joint Project IASBFASB revised the objective of external financial reporting is to provide information that is useful for capital providers including equity investors, lenders, and other creditors FASB 2008, OB6. Through development of the accounting equation, several objectives of the Joint Project may be achieved. Below are two of the Joint Project 2634 IASBFASB‘s objectives as mentioned in the Preliminary Reviews of the Conceptual Framework FASB 2006. Objective A: The objective of external financial reporting is directed to the needs of a wide range of users. As long as all sources of funds other than liabilities are contained in one element, namely the equity, it will be difficult for financial reporting to provide information which is useful to users other than equity investors and creditors. As the equity contains various sources of funds then the quality of information coming from the element may decrease. For example, current financial reporting is unable to provide a representative picture of the long-term contribution of the management to the company because their performance is periodically moved into the equity. We argue that this could be the reason for the emergence of conflicts between principals and agents. Likewise, current financial reporting is unable to provide information which is specific about governmental subsidies, donations or facilities received by the firm, as the information about governmental support is mixed up with 2635 information about other sources of funds in one big basket called ―equity‖. In this information era firms need information that is more detailed and comprehensive in order to make informed decisions. Had the accounting equation consisted of elements that represented specific types of users, then information that is useful to a wide range of users might have been produced. The accounting equation could be developed along the line of, for instance, Asset + Expenses = δiabilities + Owner‘s Capital + Revenues + Management Contribution accumulated profits + Governmental Fund + Residual Sources. Objective B: The qualitative characteristics of financial reporting information should be relevance, faithful representation, comparability, and understandability. As long as the elements of accounting equation consist of financial information employing various measurements, then it will be difficult to fulfill these qualitative requirements. For example, when assets cover several accounts that employ some measures then the assets are unable to fully meet both the characteristics of relevance and faithful representation. Likewise, the 2636 use of various measurements in one element may weaken the comparability and understandability of the financial reporting. This applies also to other elements in the accounting equation, both in the element of balanc e sheet and in that of income statements. Had the accounting equation consisted of various elements containing information measured with the same homogenous measuring tool, the accounting information produced may acquire the long-awaited characteristics of relevance, faithful representation, comparability, and understandability. For instance, the elements of assets are divided into two, namely value-based assets and historical-cost assets, and the elements of expenses are divided into two, namely accrual-based expenses and cash-based expenses. Elements of the value-based assets reflect the provision of information which is relevant for decision-making, while the elements of historical-cost assets reflect information which is relevant for faithful representation. 2637 CONCLUSION AND EXPECTATION The same thing, perceived differently, may produce different results. Unfortunately, this happens in accounting. The development of financial accounting with an overemphasis on rules has limited accounting simply to th e ―rules of the game‖, especially in the stock market. The use of a mathematical perspective, especially the accounting equation, reveals the limitations of the current standards in defining elements of financial statements. This paper also briefly discusses the use of the mathematical perspective to achieve the ideal objectives expected by the Joint Project IASBFASB. Accounting should use widely applied mathematical theorems. As a preliminary step, we should identify and discuss several persistent questi ons and problems, including standards, by using the mathematics perspective. Subsequently, the development of accounting along the line of the three major pillars, namely mathematics, rules, and vocational skills, should be undertaken in a balanced manner. In turn, as in computer technology, accounting should be 2638 able not only to function as a supporting tool to portray the reality of business, but also to function as an enabler and transformer. More than 80 years ago Henry Rand Hatfield 1924 believed th at double entry accounting –which is an application of mathematical theorems – constituted a significant intellectual contribution to the world in Fellingham 2007. Now it has become our duty to develop the accounting equation in such a way as to enable accounting to make a significant contribution to the development of the academic world. 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John Wiley and Sons, Inc. 2641 REVISIONS OF MANAGEMENT FORECASTS AND EARNINGS MANAGEMENT UNDER THE TOYOTA PRODUCTION SYSTEM IN THE JAPANESE AUTOMOBILE INDUSTRY Michio KUNIMURA ※ Mitsuru KUBO Meijo University June 14.2009 Abstract The Toyota Production System TPS has been widely used in the Japanese automobile industry. The TPS has a check mechanism for restraining earnings management. Does use of the TPS prevent earnings management? We examine the income smoothing behavior based on inventory and the revision behavior of management forecast in the Japanese automobile industry. Based on eight years of recent financial data, we clearly identify possible income smoothing beha vior under the potential handling of discretionary day‘s inventory = inventory’sales×γ65 and find possible pessimisticoptimistic revision behavior of management forecast with large increase decrease of discretionary accruals. Although we found such two behaviors in most of the groups studied, we could not identify above two behaviors in the Toyota group. The TPS may prevent earnings management based on inventory and accruals only in Toyota Group under the order-driven Toyota Production System. Keywords ：revision of management forecasts, earnings management, discretionary day‘s inventory, Toyota Production System ※ This paper is based on the valuable discussions among members of the Toyota Project on Meijo Process Management. we appreciate the comments of Makoto Kawada, Toshiharu Nakane, Toshio Ohashi, Noriyuki Imai, Masatomo Tanaka, and Tohru Niwa This project was supported by the 2007 research program C No. 17530349 and by the 2008 research program B No. 20330096 of The Ministry of Education and Science and by the 2007 Strategic Research Program funded by Meijo Un iversity. 2642 1. Skewed distribution of net income Yoshida and Kunimura 2008 examined the cross-sectional distribution of net income of listed firms in the Tokyo Securities Exchange and showed four cross-sectional distributions of net income scaled by beginning total assets, as seen in Figure 1. In Japan, a so- called ―accounting big bang‖ occurred in 1999. At that time, the main financial statements changed from parent company financial statements to consolidated financial statements. Panels a and c of Figure 1 show the large change of distribution from the period before the accounting big bang from 1991 to 1998 to the period after the accounting big bang from 1999 to 2006. The low frequency of net income in the left -hand side of zero net income in Panel c and the high frequency of net income in the right-hand side shows the loss avoidance behavior after the accounting big bang in the consolidated financial statements. The change shows the strong impact of the accounting big bang in Japan. Both Panels b and d of parent company financial statements show a large skew and do not show a change from the distribution in the period before the accounting big bang to the distribution in the period after the accounting big bang. The old statements remain important. The data in Figure 1 imply that the firm with potential losses in the bottom line of their income statement is apt to manipulate the bottom line from losses to small profit. Skewed distribution is the evidence of management behavior designed to avoid losses. Skewed net income may be a result of management earnings. However, we want to identify the cause of earnings management designed to find and improve the real activity in question. In this paper we examine earnings management through real activities manipulation of inventory in consolidated financial statements. figure 1 2643 2. Inventory manipulation In this paper we examine earnings management through real activities of inventory. An increase of inventory does not necessarily lead to an increase in net income. Therefore, we must first show the case of an income increase that occurs when inventory increases. Overproduction sometimes intentionally results in lower cost of goods sold than usual and increases profit Roychowdhury, 2006 through lower fixed overhead costs per unit. For example, top management hesitates to stop production lines under a lower level of realized sales than budgetary planned sales and artificially keeps the production level constant with unwelcome overproduction, that is, with a large amount of unnecessary inventory. In this case, a lower allocation rate of fixed overhead costs than necessary to meet expected demand results in higher inventory costs and higher net income. For instance, if the cost of goods sold is 9,000 units, inventory is 1,000 units finished goods base, and fixed overhead cost is 1,200 million yen, then the allocation amount of the fixed overhead cost to inventory is 1β0 million yen 1,000’9,000+1,000×1,β00=1β0. If overproduction leads to 3,000 units, the allocation amount is 300 million yen 3,000 ’ 9,000 +3 ,000 × 1,200 = 300. Ceteris paribus, the cost of inventory increases 180 million yen. The net income also increases by the same amount. We can exhibit many traditional manipulations on inventory which are not illegal but are highly strategic or intentional, such as the manipulation of the quality standard of a product, changing the accounting valuation procedure from FIFO to LIFO under an inflation period of time, and so on. Managers can also decrease their profit from adverse manipulations, such as from slim production, applying strict quality standards, changing from LIFO to FIFO, and so on. We find such relationships between earnings and inventory that an inventory increase usually leads to an earnings increase and, usually, an inventory decrease results in an earnings decrease. It is assumed that inventory change may be utilized as a typical component of income smoothing. 2644 On the other hand, the Just-In-Time system that is part of the Toyota Production System requires ―order-driven-production‖ Then, the JIT system has a check mechanism for restraining income smoothing by inventory change. Do managers have an incentive to use this relationship for income smoothing even under the Just-In-Time system in the Japanese automobile industry? The purpose of my research is to answer this question. 3. Discretionary models and the income smoothing hypotheses 3.1 Discretionary accruals ：the Modified DJ model Healy 1985 defined accruals as the difference between net income and cash flow from operations, as follows: Total Accruals TA = Net Income NI ― Cash Flow from Operation CFO ・・・・・・・ 1 Discretionary accruals as total accruals minus non-discretionary accruals that are a normal part of accruals reflecting working capital circulation, as follows: Discretionary Accruals DA Total Accruals TA ― Non-discretionary Accruals NDA ・・・・・・・・・・・・2 However, what is called the normal part of accruals is not clear. Healy applied the average value of five years of accruals, while DeAngelo 1986 used accruals from the last year. Jones 1991 regressed accruals on sales. In this study we use the new data of cash flow from operations only applicable for eight years. we have to avoid data loss from estimating the normal discretionary part and we choose to adopt DeAngelo‘s assumption. Next, we assume that accruals change proportionally to sales. This assumption is a simple application of Jones 1991, and thus we call my discretionary accruals model the Modified DJ model. 2645 Discretionary accruals: the Modified DJ model DA t S t TA t S t – TA t-1 S t- 1 ・・・・・・・・・・・・・・・・・3 γ.β Discretionary day‘s inventory This paper f ocuses on the day‘s inventory = inventory’sales×γ65 when examining the relationships between the introduction of the JIT System and income smoothing behavior by managers. Changes in the discretionary day‘s inventory ⊿⊿INV t S t may be a main component of discretionary accruals. The days inventory change ⊿INV t S t is a negative component of cash flow from operations in cash flow statements, and cash flow from operation is a negative component of accruals equation1. In this case the relationship between accruals and the day‘s inventory change is positive. The positive relationship may introduce a change in the discretionary day‘s inventory in equation 4 from the discretionary accruals of equation 3, as follows: Discretionary day‘s inventory change: the εodified DJ ・S model D ⊿INV t S t ⊿INV t S t – ⊿INV t -1 S t-1 ・・・・・・・・・・・・4 Strictly speaking, a more exact relationship exists between the day‘s inventory and the cost of goods sold. We also define the discretionary day‘s inventory = inventory’cost of goods sold×γ65 as a main component of accruals, as follows: Discretionary day‘s inventory change: the εodified DJ ・C model D ⊿INV t C t ⊿INV t C t – ⊿INV t -1 C t-1 ・・・・・・・・・・・・・・5 We cannot identify prior earnings before earnings management, and it is difficult to classify a firm-year an income increasing firm-year or an income decreasing firm-year by using post earnings after earnings management. We focus on the cash flow from operations, which is sometimes called hard profit. We introduce the following assumptions and hypotheses. 2646 3.3 Partition assumptions and the income smoothing hypotheses partition assumptions A firm-year with an earnings increase before potential earnings management is assumed to have positive ⊿CFO. A firm-year with an earnings decrease before potential earnings management is assumed to have negative ⊿CFO. Hypothesis 1: Discretionary Accruals DAS A firm-year makes income smooth by using discretionary accruals. Type a: conservative accounting Positive ⊿CFO leads to negative discretionary accruals DAS. Type b: window dressing Negative ⊿CFO leads to positive discretionary accruals DAS. Null Hypothesis 1 H1. There is no difference in mean values of discretionary accruals DAS between the positive ⊿CFO Group and negative ⊿CFO Group Hypothesis 2: Discreti onary Day‘s Inventory Change D ⊿INVS or D⊿INVC. A firm- year makes income smooth by using the discretionary day‘s inventory change. Type A: conservative accounting Positive ⊿CFO leads to a negative discretionary day‘s inventory change D⊿INVS or D ⊿INVC. Type B: window dressing Negative ⊿CFO leads to a positive discretionary day‘s inventory change D⊿INVS or D ⊿INVC. Null Hypothesis 2 HβS. There is no difference in mean values of the discretionary day‘s inventory change D ⊿INVS between the positive ⊿CFO Group and negative ⊿CFO Group 2647 HβC. There is no difference in mean values of the discretionary day‘s inventory change D ⊿INVC between the positive ⊿CFO Group and negative ⊿CFO Group We divide the firm-years sample into two groups for testing my two hypotheses. We call the positive firm-year group with a positive increment of cash flow from operations the positive ⊿CFO Group and the negative firm-year group with a negative increment of cash flow from operations the negative ⊿CFO Group. The above null hypothesis does not directly test the income smoothing hypothesis, but it does test a symptom of the income smoothing by using the discretionary day‘s inventory change. Here we dismiss the problem of errors in variables on cash flow from operations by using sales or cost of goods sold deflating CFO as the explanatory variables for testing the null hypotheses. 4. Data and day‘s inventory 4.1 Data We sample all 57 firms of the Japanese automobile industry listed on the first section of the Tokyo Stock Exchange from fiscal year March 2000 to fiscal year March 2008 in the Nikkei Needs Database. We classify these 57 firms into 26 firms of the Toyota group and 31 firms of other groups based on both capital - holdings and sales-production relationships. We ca n use only eight fiscal years‘ data after the accounting big bang in 1999, since we can use cash flow from operations in the cash flow statements. We have samples of 456 firm -years 57 firms×8 years, because the first-year data of cash flow from operations is utilized for the difference calculation. 4.2 Day‘s inventory ：descriptive statistics Table 1 shows the day‘s inventory inventorysales×γ65 of 456 firm-years in the Japanese automobile industry from fiscal year 2000 to fiscal year 2007. In this period of time the industry enjoyed aggressive direct investment in foreign countries with the gradual growth of overseas sales and profit. 2648 The average value of a day‘s inventory in the parent company is 16.β47 days, and the median is 13.640 days. These days nearly correspond to the period of time from the customer order to delivery to the customer in domestic sales. The average value of a day‘s inventory in consolidated financial statements is 26.569 days, and the median is 25.426 days. These periods of time may approximately correspond to above two weeks and another 10 days which may be necessary for shipping finished cars and their parts by balloon ships or other cargo ships. In particular, the average days of a day‘s finished goods and a day‘s raw materials are high and show, respectively, 11.136 days and 7.968 days in consolidated financial statements, mainly because of the shipping period. Table 1 Day‘s Inventory 4.3 The discretionary day‘s inventory change: spread sheet The main variable to be analyzed is the discretionary day‘s inventory change D ⊿INVS . We will examine the relationships between profitability, which is surrogated by cash flow from operations change ⊿CFO and the discretionary day‘s inventory change D ⊿INVS . Table 2 is a sample spreadsheet of Nissan Motor for testing hypotheses. If ⊿CFO is positive, discretionary accruals DAS and discretionary day‘s inventory change D ⊿INVS can be expected to be negative under possible conservative accounting by managers. We call these conditions ―Type a‖ for DAS and ―Type A‖ for D ⊿INVS. For example, the entry for the fiscal year of March 2007 in Table 2 shows negative 11.93 days of DAS, which corresponds to a positive ⊿CFO1,043-758. If ⊿CFO is negative, discretionary accruals DAS and the discretionary day‘s inventory change D ⊿INVS will be assumed to be positive under potential window dressing or under plausible gain tradi ng for increasing income. We call these conditions ―Type b‖ and ―Type B‖. For example, the entry for the fiscal year of εarch β005 in Table 2 shows positive 18.58 days of DAS, which corresponds to a negative ⊿CFO369- 797. The above four relationships can be identified for all firm-years except for DAS in fiscal year 2008 and for INVS in 2004. 2649 We can clearly identify ―a big bath‖ by the huge negative 57.94 days of DAS in fiscal year of March 2000 when the new COE Mr. Ghosn started his reform of Nissan εotor. In the following year, Table β shows a ―V character recovery‖ of net income of 331 billion yen with a big positive 73.98 days of DAS. However, the discretionary day‘s inventory change D ⊿INVS modestly exhibits positive 0.35 days, which is a much smaller number of days than the 73.98 days of discretionary accruals DAS in 2001. This discretionary accruals behavior may explain the true story of ―the Nissan‘s miracle recovery‖. Table 2 Nissan 5. Income smoothing results 5.1 Comparison of the positive ⊿CFO Group with the negative ⊿CFO Group in the discretionary accruals We will examine the following null hypothesis in this section: H1. There is no difference in mean values of discretionary accruals DAS between the positive ⊿CFO Group and negative ⊿CFO Group Table 3 exhibits a clear difference of the positive ⊿CFO Group with the negative ⊿CFO Group in mean values of discretionary accruals DAS on the total sample, Toyota group, and other groups. Positive ⊿CFO may lead to negative discretionary accruals DAS under conservative accounting. Negative ⊿CFO may lead to positive discretionary accruals DAS under window dressing accounting. In the case of the total sample, Table 3 shows the negative 3.850 days in positive ⊿CFO and positive 8.934days in negative ⊿CFO. The high t value more than two and the low p value less than one percent in Table 3 tell us that H1 is rejected at the one percent significance level. In that case it is assumed that discretionary accruals may make use of possible income smoothing. Positive ⊿CFO results in negative 3.829 days of discretionary accruals DAS and negative ⊿CFO results in positive 9.757 days of discretionary accruals DAS in the Toyota group. Positive ⊿CFO results in negative 3.869 days of discretionary accruals DAS and negative ⊿CFO results in positive 8.314 days of discretionary 2650 accruals DAS on other groups. We find no clear difference between the Toyota group and other groups. Why. Table 3 The concept of discretionary accruals has a strong power for detecting earnings management, but it is artificial for improving the business cycle. Next we apply this concept to the day‘s inventory. 5.2 Comparison of the positive ⊿CFO Group with the negative ⊿CFO Group in the discretionary day‘s inventory change based on sales In this section we will test the following null hypothesis: HβS. There is no difference in mean values of the discretionary day‘s inventory change D ⊿INVS between the positive ⊿CFO Group and negative ⊿CFO Group. Table 4 shows the difference of positive ⊿CFO Group with negative ⊿CFO Group in mean values of the discretionary day‘s inventory change D ⊿INVS on the total sample and other groups. In the case of the total sample, Table 4 shows the negative 0.242 days in positive ⊿CFO and positive 1.16 days in negative ⊿CFO. The t value more than two and the low p value less than one percent in Table 4 tell us that the H2S is rejected at the one percent significan ce level. In this case it is assumed that discretionary accruals may make use of possible income smoothing. Positive ⊿CFO results in positive not negative 0.046 days of the discretionary day‘s inventory change D ⊿INVS and negative ⊿CFO results in positive 0.528 days of the discretionary day‘s inventory change D ⊿INVS in the Toyota group. Positive ⊿CFO results in negative 0.500 days of discretionary accruals DAS and negative ⊿CFO results in positive 1.6γ5 days of the discretionary day‘s inventory change D ⊿INVS on other groups. The comparison of the Toyota group with other groups shows a different sign of discretionary day‘s inventory change D ⊿INVS. The Toyota group in positive ⊿CFO is not negative but is positive 0.046 days. Positive ⊿CFO does not lead to a negative discretionary day‘s inventory change D ⊿INVS in the Toyota group. The t value of 1,055 and the p 2651 value of 0.146 in Table 4 tell us that the H2S is rejected at the ten percent significance level. In this case the discretionary day ‘s inventory change D ⊿INVS might be used for possible income smoothing. I find a clear difference between the Toyota group and other groups. Additionally we will test the following null hypothesis: H2S1. H2S2, H2S3 There is no difference in mean values of the discretionary day‘s finished goods or work in process or raw materials change between the positive ⊿CFO Group and the negative ⊿CFO Group The above difference is clearer in the case of the components of inventory, that is, finished goods, work in process, and raw materials. Table 4 rejects these null hypotheses at the ten percent significance level for finished goods t value is positive, work in process p value is 0.088, and raw materials p value is 0.442 in the Toyota group, and they show clear evidence of income smoothing by finished goods, work in process, and raw materials on other groups. Table 4 5.3 Comparison of a positive ⊿CFO Group with a negative ⊿CFO Group in the discretionary day‘s inventory change based on cost of goods sold This section will show the result of testing the following null hypothesis: H2C. There is no differ ence in mean values of the discretionary day‘s inventory change D ⊿INVC between the positive ⊿CFO Group and negative ⊿CFO Group In the case of the total sample, Table 5 shows the negative 0.124 days in the positive ⊿CFO and positive 1.211 days in the negative ⊿CFO. The t value more than two and the low p value less than one percent in Table 5 tell us that the H2C is rejected at the one percent significance level. Positive ⊿CFO results in positive not negative 0.152 days of the discretionary day‘s inventory change D ⊿INVS and negative ⊿CFO results in positive 0.476 days of the discretionary day‘s inventory change D ⊿INVS in the Toyota group. Positive ⊿CFO results in negative 0.370 days of discretionary accruals DAS and negative ⊿CFO results in positive 1.76γ days of the discretionary day‘s inventory change D ⊿INVC in other groups. The t value of 0.561 and the p value of 0.288 2652 in Table 5 tell us that the H2C is not rejected at the ten percent significance level. Additionally, we will test the following null hypothesis: H2C1 H2C2, HC3 There is no difference in mean values of the discretionary day‘s finished goods or work in process or raw materials change between the positive ⊿CFO Group and negative ⊿CFO Group components of inventory, that is, finished goods, work in process, and raw materials. Table 6 does not reject the null hypotheses at the ten percent significance level for finished goods t value is positive, work in process p value is 0.175, and raw materials p value is 0.465 in the Toyota group. On the contrary, the table shows clear evidence of income smoothing by finished goods, work in process, and raw materials in other groups. Table 5 6. Limitation We identify positive ⊿CFO results in negative days of discretionary accruals DAS and negative ⊿CFO results in positive days of discretionary accruals DAS in the Toyota group. Positive ⊿CFO results in negative days of discretionary accruals DAS and negative ⊿CFO results in positive days of discretionary accruals DAS on other groups. We find no clear difference between the Toyota group and other groups. Why. The concept of discretionary accruals has a strong power for detecting earnings management, but it is artificial for improving the business cycle and the relationship between ⊿CFO and DA is self-evidently negative by definition of accruals equation 1. Then we apply this concept to the day‘s inventory. We identify the symptom of income smoothing behavior by possible handling of the day‘s inventory in the Japanese automobile industry, excluding the Toyota group. The discretionary day‘s inventory is explained by income smoothing behavior of managers in groups other than the Toyota group. However, generally speaking, in the less profitable period of time with negative ⊿CFO, the day‘s inventory inventorysales may 2653 increase because of the inventory increase and sales decrease, and in contrast, in the more profitable period of time with positive ⊿CFO, the day‘s inventory may decrease because of the inventory decrease and sales increase. This relationship can be said as the self-evident automatic earnings stabilizing system under the over-production hypothesis. We find an interesting fact that the TPS including JIT System of the Toyota group under order-driven TPS is more powerful than the stabilizing system. Under the following sections, we want to answer the question of why the Toyota group shows stronger prevailing power against income smoothing than other groups introducing the revision information of management forecast. 7, Discretionary accruals and the revision of management forecast 7.1 Partition by management forecasts We usually find management earnings forecasts at three times in May, November and next εarch for the fiscal year end by εarch γ1 by firm‘s summary management letter at the news-paper-crab in the Tokyo Securities Exchange. We define three partitions for revision of management forecasts as follows. Partition for November revision = earnings forecasts at May – earnings forecast at September b Panel of Table 6 Partition for March revision = earnings forecasts at May – earnings forecast at March c Panel of Table 6 Partition for May announcement = earnings forecasts at May – actual financial statements earnings at Maya Panel of Table 6 These partitions will divide optimistic firms which announce larger forecast s of net income at May than following revision to pessimistic firms which announce smaller forecast of net income at May than following revisions. Kato, Skinner and Kunimura 2009 September, Accounting Review finds that managers of firms with the worst profitability set the most optimistic forecasts for the next year. They find that managers who release initial earnings forecasts that are overly optimistic in one year are also likely to relea se overly optimistic forecasts the next year. They find difference from US data that in Japan, where 2654 litigation is not a factor, managers can ―walk down‖ forecasts more explicitly. We introduce new hypotheses on management forecasts. 7.2 Hypothesis 5: Discretionary Accruals DAS A pessimistic optimistic firm-year increases decreases income by increasing decreasing discretionary accruals. Null Hypothesis 6. There is no difference in mean values of discretionary accruals DAS between the pessimistic Group and optimistic Group. 7.3 Results We compare pessimistic Group with optimistic Group in the discretionary accruals. Then, we will test the following null hypothesis: H2S. There is no difference in mean values of the discretionary accruals between pessimistic Group and optimistic Group Table 6 Table 6 shows three revision results. We identify the large difference between pessimistic Group and optimistic Group in mean values of the discretionary accruals DA on the total sample and other groups. In the case of the other groups, Table 6 shows the negative 2.882, 5.862 and 3.800 days in optimistic Group and positive 2.681, 2.71096 and 1.986 days in pessimistic Groups. The t value of around two and the low p value less than 10 percent in Table 6 tell us that the H2S is rejected at the one percent significance level. In this case it is assumed that discretionary accruals may make use of possible income changes. However, in Toyota group, two revisions, a and b, show adverse relation. The comparison of the Toyota group with other groups shows a different sign of discretionary accruals DA. The optimistic group of Toyota group is not negative in two revisions. Optimistic group does not lead to negative discretionary accruals in the Toyota group. The low t value of three revisions and t he high p value in Table 6 tell us that the H2S is not rejected at the ten percent significance level. In this case the discretionary accruals might be used for possible income smoothing. We find a clear difference between the Toyota group and other groups . 2655 8. Conclusion Does TPS prevent earnings management? We examine earnings management behavior on inventory and the revision behavior of management forecast in the Japanese automobile industry. we clearly identify income smoothing behavior under the pote ntial handling of discretionary day‘s inventory = inventory’sales×γ65 and find pessimisticoptimistic revision behavior of management forecasts with large increase decrease of discretionary accruals. Although we found such two behaviors in most of the groups studied, we could not identify above two behaviors in the Toyota group. The TPS may prevent earnings management based on inventory and accruals only in Toyota Group under the order-driven Toyota Production System. 2656 References Burgstahler, D., and I. Dichev, 1997, Earnings management to avoid earnings decreases and losses, Journal of Accounting and Economics 24, 99-126 DeAngelo L., 1986, Accounting numbers as market valuation substitute, Accounting Review 61,400-420. Healy, P.M., 1985, The effect of bonus schemes on accounting decisions, Journal of Accounting Economics 7, 85-107. Jones, J., 1991, Earnings management during import relief investigations, Journal of Accounting Research 29, 193-228. Kato, Kazuo, Douglas J. Skinner and Michio Kunimura,2009 Management Forecasts in Japan: An Empirical Study of Forecasts that Are Effectively Mandated Accounting Review, September 2009 Roychowdhury, S., 2006, Earnings management through real activities manipulation, Journal of Accounting and Economics 42, 335-370. Yoshida, Y., and M. Kunimura, 2008, Distribution of net income, Journal of Meijo Research Institute, No. 8, 1-10. 2657 Figure 1 Distribution of annual net income scaled by beginning of total assets consolidated parent company a. fiscal years 1995-1999 b. fiscal years 1995-1999 2000 年度 対象：NIKKEI NEEDS 一般企業 当期利益：当期利益’期首総資産 c. fiscal years 2000-2006 d. fiscal years 2000-2006 Data ：NIKKEI NEEDS, firms without financial sectors scaled net income t = net income t ’total assets t-1 The extreme data of less than -0.1and more than 0.1 are not shown. From Yoshida and Kunimura 2008. 1 2 3 -.1 -.05 .05 .1 e 1 2 3 4 5 -.1 -.05 .05 .1 e 2 4 6 -.1 -.05 .05 .1 e 2 4 6 8 -.1 -.05 .05 .1 e 2658 Table 1 Days Inventoryy in Japanese Automobile Industry Consolidated days Inventory Finished Goods Work in Process Raw Materials Firm-year 456 217 208 209 Mean 26.569 11.136 6.553 7.968 Median 25.426 8.402 5.965 6.478 Mini 3.101 0.011 0.507 1.192 Max 81.172 47.430 22.989 27.150 Consolidated days Inventory Finished Goods Work in Process Raw Materials Firm-year 208 114 113 114 Mean 25.668 10.814 7.047 6.007 Median 23.561 9.984 6.147 5.193 Mini 3.782 0.149 0.507 1.192 Max 81.172 32.038 22.989 16.256 Consolidated days Inventory Finished Goods Work in Process Raw Materials Firm-year 248 103 95 95 Mean 27.325 11.493 5.965 10.321 Median 27.013 7.081 5.732 9.517 Mini 3.101 0.011 0.980 1.388 Max 65.548 47.430 14.653 27.150 Inventory Finished Goods Work in Process Raw Materials t value -1.313 -0.500 1.885 -5.768 p value 0.095 0.309 0.030 0.000 Parent company days Inventory Finished Goods Work in Process Raw Materials Firm-year 399 399 399 399 Mean 16.247 5.193 7.241 3.812 Median 13.640 4.337 5.109 2.929 Mini 2.369 0.000 0.166 0.094 Max 77.905 21.717 77.777 17.553 Consolidated fiscal year from 2000 to 2007, parent from 2000 to 2006 Nikkei needs data days inventory = Inventory sale 365 e Total Sample c Other Group d　 ifference test in eans between Toyota and ther onsolidated a Total Sample b Toyota Group 2659 Table β Discretionary day‘s inventory change D ⊿INVS 7201 Nissan Motor Corp. SalesS Ne Income INV INVS TA ＤＡ Ｓ ⊿ I V S ⊿ I VS a b c ⊿ d da365 b-c ⊿TA a 365 dtat-dt- 1at- 1365 ⊿⊿ I VS DA ⊿I V B Yen B Yen B Yen B Yen day B Yen day day day 2008.3 10824 482 1342 ＋ 1005 33.89 -860 9.37 -1.14 -3.01 A 2007.3 10,469 461 1,043 ＋ 1,005 35.03 -582 -11.93 1.87 -1.15 a A 2006.3 9,428 518 758 ＋ 856 33.16 -240 -14.81 3.02 -0.44 a A 2005.3 8,576 512 369 － 708 30.13 143 18.58 3.47 5.86 b B 2004.3 7,429 504 797 ＋ 543 26.67 -294 -10.49 -2.39 0.01 a 2003.3 6,829 495 575 ＋ 544 29.06 -80 -12.31 -2.40 -0.35 a A 2002.3 6,196 372 222 ＋ 534 31.46 150 -6.35 -2.05 -2.14 a A 2001.3 6,090 331 73 － 559 33.51 258 73.98 0.09 0.35 b B 2000.3 5,977 -684 292 547 33.42 -976 -57.94 -0.26 year Type CFO ⊿CFO CFO t ― CFO t-1 TA Net Income ― CFO = b-c ⊿TA ＤＡ b-c t ― b-c t-1 ＤＡＳ b - c t ― b - c t- 1 a×γ65 INVS da×γ65 ⊿INVS d t a t - d t-1 a t-1 ×γ65 D ⊿INVS ⊿INVS t - ⊿INVS t-1 2660 S: Sales, INV: Inventory, TA: Total Accruals, DA: Discretionary Accruals, CFO: Cash flow from Operation, ⊿：Differencet – t-1, t: time From the NIKKEI NEEDS database. Table 3 Discretionary accruals DA of positive ⊿CFO and negative ⊿CFO between the Toyota group and other groups ositive ⊿ egative ⊿ t value p value day day Total Sample -3.850 8.934 -10.931 0.000 Toyota Group -3.829 9.757 -11.005 0.000 Other Group -3.869 8.314 -6.799 0.000 Assumption A firm-year with earnings increase decrease before potential earnings management is assumed to have positive negative ⊿CFO. Hypothesis: H1. Positive negative ⊿CFO leads to negative positive discretionary accruals. Modified DJ model: DAS=TA t S t – TA t-1 S t-1 ……..γ DA: discretionary accruals, TA: total accruals S: sales ⊿：difference Sample: from fiscal year March 2000 to March 2008 in the Japanese automobile industry with 57 firms 456 firm-years Toyota Ｇ208, Other Ｇ248 2661 Table 4 Discret ionary day‘s inventory change D ⊿INVＳ of positive ⊿CFO and negative ⊿CFO between the Toyota group and other groups ⊿⊿I V S ositive ⊿ egative ⊿ t value p value day day Inventory Total Sample -0.242 1.160 -3.765 0.000 Toyota Group 0.046 0.528 -1.055 0.146 Other Group -0.500 1.635 -3.829 0.000 Finished goods Total Sample -0.308 0.579 -2.327 0.010 Toyota Group 0.012 -0.189 0.454 0.325 Other Group -0.674 1.219 -3.123 0.001 Work in process Total Sample -0.225 0.265 -2.394 0.009 Toyota Group -0.281 -0.004 -1.365 0.088 Other Group -0.155 0.503 -1.920 0.029 Raw material Total Sample 0.136 0.592 -2.012 0.023 Toyota Group 0.104 0.136 -0.146 0.442 Other Group 0.178 0.995 -2.285 0.012 Assumption: A firm-year with earnings increase decrease before potential earnings management is assumed to have positive negative ⊿CFO. Hypothesis: H2S. Positive negative ⊿CFO leads to negative positive D⊿INVS. Modified DJ-S model: D ⊿INVＳ=⊿INV t Ｓ t – ⊿INV t-1 Ｓ t-1 γ65……….;.4 INV: inventory, S: sales ⊿：difference Sample: from fiscal year March 2000 to March 2008 in the Japanese automobile industry with 57 456 firm-yearsToyota Ｇ208, Other Ｇ248 2662 Table 5 Discretionary day‘s inventory change D ⊿INVC of positive ⊿CFO and negative ⊿CFO between the Toyota group and other groups ⊿⊿I V ositive ⊿ egative ⊿ t value p value day day Inventory Total Sample -0.124 1.211 -3.068 0.001 Toyota Group 0.152 0.476 -0.561 0.288 Other Group -0.370 1.763 -3.257 0.001 Finished goods Total Sample -0.327 0.650 -2.134 0.017 Toyota Group 0.040 -0.296 0.614 0.270 Other Group -0.747 1.438 -3.042 0.002 Work in process Total Sample -0.217 0.244 -1.957 0.026 Toyota Group -0.295 -0.066 -0.939 0.175 Other Group -0.119 0.518 -1.660 0.050 Raw material Total Sample 0.213 0.655 -1.643 0.052 Toyota Group 0.138 0.116 0.087 0.465 Other Group 0.308 1.130 -1.822 0.037 Assumption: A firm-year with earnings increase decrease before potential earnings management is assumed to have positive negative ⊿CFO. Hypothesis H2C. Positive negative ⊿CFO leads to negative positive D⊿INVC. Modified DJ-C model: D ⊿INVC=⊿INV t C t – ⊿INV t-1 C t-1 γ65……….;.5 INV: inventory, C: cost of goods sold ⊿：difference Sample: from fiscal year March 2000 to March 2007 in the Japanese automobile industry with 57 firms 456 firm-years Toyota Ｇ208, Other Ｇ248 2663 Table 6 Discretionary accruals DA of optimistic management forecasts and pessimistic management forecasts between the Toyota group and other groups DA DA t value p value ay＜ S ay＞ S pessimistic optimistic day day Total Sample 1.716 -0.610 1.629 0.052 Toyota Group 0.498 1.881 -0.891 0.187 Other Group 2.681 -2.882 2.424 0.008 DA DA t value p value MFMay＜ MFNov MFMay＞ MFNov pessimistic optimistic day day Total Sample 1.796 -1.990 2.320 0.011 Toyota Group 0.608 1.537 -0.556 0.290 Other Group 2.710 -5.863 3.104 0.001 DA DA t value p value MFMay＜ MFMar MFMay＞ MFMar pessimistic optimistic day day Total Sample 1.497 -2.680 2.127 0.018 Toyota Group 1.058 -1.246 1.139 0.128 Other Group 1.987 -3.800 1.855 0.035 MF: Management Forcasts FS:Financial Statements TAt = It ｔ DAt = TAtSt-TAt-1St-1 partition variable net income Fiscal year end: March 31

b. MF at May - MF at November

c. MF at May - MF at March a. MF at May - FS at Next May

Number of firm-year sample… a. 285 b. 322 c. 180 2664 THE DEVELOPMENT AND EVALUATION OF INTELLECTUAL CAPITAL INDEX IN MALAYSIA Shamsuddin Amanuddin ¹ ٭, Zainal Abidin Zubaidah ², Huang Ching Choo ³ ¹ Department of Accounting, Universiti Tenaga Nasional UNITEN ² Faculty of Accountancy ARI, Universiti Teknologi MARA ³ Faculty of Accountancy ARI, Universiti Teknologi MARA Abstract Intellectual Capital IC, a value creato r of today‟s economy, is of critical importance to a company‟s long-term sustainability, profitability and growth. Though the value of companies has been shifting from tangible to the intangibles, many studies indicate that IC or IC components is not fully measured by the traditional financial statements due to its intangible nature see for example Guthrie Petty, 2000; Williams, 2001. As IC enables higher corporate value which results in better financial performance, it is essential to measure or value IC via a more creative tool such as IC Index Bontis, 2004 or Rating Edvinsson, 2002. An IC IndexRating provides management with a basis for optimising competitiveness of its companies by focussing on the potential value of IC. It also functions as a foundation to measure IC and its components maximising profits for companies. It should also help various groups in comparing the potential IC values of companies. The research will study the effect of intellectual capital on companies‟ performance in the Malaysian business environment. Components of IC are introduced and linked to the companies‟ competitiveness andor performance. The intent is to provide an exploratory foundation for the development of systems and processes useful for meaningful management of intellectual assets. Finally, the study shall make recommendation based on empirical findings for external reporting of intellectual capital. Keywords : Intellectual Capital, Malaysia 2665 ________________________________________________________________ _______ Corresponding author: Shamsuddin Amanuddin, College of Business Management and Accounting, Sultan Haji Ahmad Shah Campus, Universiti Tenaga Nasional, 26700 Bandar Muadzam Shah, Pahang, MALAYSIA Email: Amanuddinuniten.edu.my

CHAPTER 1: INTRODUCTION 1.1

Introduction Intellectual Capital IC, a value creator of today‘s economy, is of critical importance to a company‘s long-term sustainability, profitability and growth. Though the value of companies has been shifting from tangible to the intangibles, many studies indicate that IC or IC components is not fully measured by the traditional financial statements due to its intangible nature see for example Guthrie Petty, 2000; Williams, 2001. As IC enables higher corporate value which results in better financial performance, it is essential to measure or value IC via a more creative tool such as IC Index Bontis, 2004 or Rating Edvinsson, 2002. An IC IndexRating provides management with a basis for optimising competitiveness of its companies by focussing on the potential value of IC. It also functions as a foundation for modern business control system supplying clear and measureable goals to measure IC and its components maximising profits for companies. It should also help various groups in comparing the potential IC values of companies. Thus, the old axiom that ―something gets measured, gets managed‖ holds valid. Review on intellectual capital literature which has focus on performance measurement, shows that most of the studies concerning performance measurement have examined mature listed companies and had market value as one key indicator see e.g. Bontis et al. 2000; Hurwitz et al. 2002; Chen et al., 2005. Many of the studies support the hypothesis that intellectual capital has a positive impact on firm‘s financial performance and market value. There are of course contradictory results as well suggesting that more investment in intellectual capital is not always better Huang and Liu, 2005 and that not all elements of intellectual capital have positive impact on firm‘s financial performance Wang and Chang, 2005; Firer and Williams, 2003. Contradictory results may stem from the facts that the analyzed firms are from different regions, they are not in the same field of business or firms may undergo divergent growth stage. The critical competitive importance of intellectual capital in today‘s economy inidicates a need for high performance systems to manage them. Recent advances associated with total quality management, reengineering, learning organizations, and other initiatives have accomplished much. However, review from literature indicates that the management of intellectual capital is, at best, 2666 ad hoc in most organizations. One reason is that traditional accounting systems are not well equipped to measure or monitor most elements of intellectual capital. Anoher reason is that the management of intellectual capital is considered by many as synonymous with workforce management. However, intellectual capital encompasses more than people and, therefore, requires a more comprehensive approach. 1.2 The Proposed Study The research will study the effect of intellectual capital on companies‘ performance in the Malaysian business environment. Components and elements of intellectual capital are introduced in detail and linked to the issues raised in the analysis of competitiveness andor performance. In addition, methods of measuring intellectual capital at both the components and organization levels shall be presenteddeveloped. The intent is to provide an exploratory foundation for the development of systems and processes useful for meaningful management of intellectual assets. Finally, the study shall make recommendation based on empirical findings for external reporting of intellectual capital. The core of the thesis is to develop an intellectual index or rating for Malaysian companies. 1.3 Significance of the Study The results of this research should supplement interest groups in investing decisions and company valuations. The result which links IC value to performance and market value of companies will be used for prediction. The findings of this research will aid the profession in a more systematic external reporting of IC like disclosing IC Index in the annual reports in the future. 1.4 Summary This research hopes to develop an IC IndexRating for Malaysian companies. The result of this research should help interest groups in investing decisions and company valuations as well as make comparison among them. The result will also link IC value to performance and market value of companies. This research also intents to make recommendations to the Accounting profession for external reporting of IC in the annual reports of Malaysian companies indicating their IC index or rating. On the next section, a short review on relevant literature is given. After this, the research framework is considered. 2667

CHAPTER II: LITERATURE REVIEW 2.1

Introduction Recent changes in the global economy which charaterized by complex and dynamic competitive environment have led to the importance of knowledge- based resources as the true source in sustaining competitive advantage of the firm. With this growing need to support knowledge-based economy, the way business is carried out has to be reshaped as firm‘s core asset are now the intellectual capitals IC that generally made up of the combined knowledge of human, structural, and relational resources Abdul Latif Fauziah, 2007. Following this new development, Malaysia has also embarked on a mision to develop a knowledge-based society by launching a Knowlwdge-Based Economy Mater Plan in 2002 which outlines various strategies to accelerate the transformation of Malaysia to a knowledge-based economy Economic Planning Unit, 2002. It aims to achieve a sustainable economic growth where Malaysia can no longer rely on investment in capital or physical assets but rather growth must be driven by productivity and innovation supported by effective managment of both tangible and intangible resources particularly the IC. It is expected that the number of knowledge workers and new knowledge-based opportunities will increase in the near future of Malaysia and this new phenomenon will force firms to further develop and manage their IC. However, other than the concern on IC management, what is equally important is that the accounting discipline reflected in financial reporting as currently conceived can no longer provide what is being demanded by information users and investors. The studyresearch is trying to propose here is the need for a much more broadly conceived concept of firm value reporting in Malaysia based on the dual requirements of financial and operational reporting, and within this context, IC reporting. In Malaysia, as presently, not much is known as to the extent to which firms in Malaysia have adopted IC management and subsequently IC reporting. Thus, it is the purpose of this research to analyse the initiatives developed in Malaysia in relation to IC reporting practices and then propose a policy framework specifically in the development of Malaysia own IC reporting index for a consistent and comparable IC reporting among Malaysian firms that would allow for more meaningful decision making. The practical implication would be for enforcement bodies like Securities Exchange SE, Bank Negara Malaysia Central Bank of Malaysia, and Companies Commission of Malaysia to use this propose IC reporting index as a guideline in setting legal requirement for mandatory operational and IC reporting. This research will also become a reference framework in assessing information quality that is, inter alia, based on consistency, comparability, and comprehensiveness of reported information. 2.2 Intellectual Capital - Definition A review on literature indicates that there is a lack of a homogenous view on how to define, classify and value intangible assets or intellectual capital. It can 2668 be argued that definitions and classifications of intangible assets are made with respect to the specific purpose of each study see e.g. Kaplan and Norton 2004; Bontis and Fitz-enz 2002; Hurwitz, Lines, Montgomery and Schmidt 2002. The literature concerning intangible assets is widely encountered in the field of business research. One remarkable research project concerning intangible assets was the MERITUM-project – a project funded by European Union. The project‘s final report ―Guidelines for managing and reporting on intangibles‖ 2001 presents intellectual capital as a combination of three groups where intangible assets can be further derived from. In MERITUM- project‘s guideline intellectual capital refers to the combination of the human, structural and relational capital. A concept of intangible asset intangible refers to a factor asset arising either from human, structural or relational capital, which is used to create value. Human capital focuses on skills, experience, competence and innovation ability of personnel; structural capital consists of organizational processes and systems, software and databases, business processes and brands; relational capital includes customer reference lists, information on customer revenue potential and customer closeness. Though these elements are presented separately, they are bound with each other Guidelines for managing… β001; Rodov and δeliaert β00β. From management‘s perspective, intangibles are directly linked to internal strategic decision-making, whereas the importance of intangibles for investors is emphasized in investment decision-making process. Arvidsson 2003 studied extensively strategic management and measurementaccounting literature and found intangible assets classifications being developed either for the internal or external usage. The strategic management literature relates intangibles to the process of creating sustainable competitive advantage and corporate value, whereas measurementaccounting literature focuses on how intangibles can be structured and measured in the financial accounting and reporting context. This definition is of course not an exclusive one, leaving room for other definitions too. Figure 1 represents the classification structure for intangibles suggested by Arvidsson 2003. Figure 1. Classifications for Intangible Assets Listing-approach, comprehensive-approach and BSC-approach represent the classifications developed for internal usage – their origin lie in the strategic management literature. Management team and other employees involved in the strategic decision-making processes use listing-approach to propose sub-groups and then to sort intangibles into these sub-groups. In comprehensive approach intangibles importance in the value-creation process is emphasized and intangibles classifications are put forward as schemes, models or frameworks developed and designed to assist in the internal strategic decision-making process. Neither listing-approach nor comprehensive-approach has a 2669 measurability dimension that BSC-approach has. BSCapproach does not, however, try to value the intangible assets in currency units. It is distinguished from other approaches by the fact that it does not have an explicit focus on intangibles. Nevertheless, its customer, internal-business processes, and learning and growth perspectives have had substantial influence on the classifications of intangibles Arvidsson 2003. Three approaches described above refer to the strategic management literature and represent the classifications of intangible assets developed for the internal usage. In a similar manner, a threefold division-approach represents a classification developed for the external usage. Measurementaccounting literature has provided a base for this classification structure, where the dimensions of human capital, structural capital, and relational capital are emphasized. This categorization helps firms to communicate the presence and the importance of their intangible assets. Investors on the capital markets can utilize this structure to evaluate the firm‘s intangible assets and to better capture a value of the firm. Though the threefold division-approach has external usage status, its exploitation for internal use cannot be excluded Arvidsson 2003. Intellectual capital and intangible assets are often used as synonyms to describe the non-tangible factors of production that the firms make use of. However, when accounting is considered, a definition for both terms can be drawn. The International Accounting Standards Board defines an intangible asset as an identifiable non-monetary asset without physical substance held for use in the production or supply of goods or services, for rental to others, or for administrative purposes. In addition, FRIS 38 prescribes that intangible asset is a resource controlled by an enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise. These definitions draw a distinction between intellectual capital and intangible assets. The former includes all elements of non-tangible assets that the firm can utilize in its operations; in the latter elements that the firm does not control own are excluded, i.e. some elements of human capital. 2.3 Theoretical Background to the Study The investigation of IC reporting could probably best drawn from social and political theory most particularly the stakeholder theory and legitimacy theory. Stakeholder theory talks about how the organization owes accountability to all its stakeholders to provide information on how the organization‘s activities affect them Deegan, 2000. These should encourage voluntarily disclosures of IC as indicators of which stakeholders matter most to the firms and thus, those which firms may be seeking to influence. Legitimacy theory argues that firms can only continue to exist if the society in which they are based perceived the firms to be operating to a value system which is commensurate with the society‘s own value system. Thus, Guthries et al β004 argue that firms with high levels of IC will be more inclined to disclose their IC as they cannot 2670 legitimize their status through the traditional symbols of corporate success, the tangible assets. Instead, they need to communicate how the firm uses its IC to generate value. 2.4 Measuring and Reporting Intellectual Capital Practices Efforts to reconstruct firms annual reporting to include IC indicators were spearheaded in the early 1990s by a small number of firms which took a particular interest in thsi issue Guthrie and Petty, 2000. Annual Report is an ideal location for applying the IC model because they provide a good proxy with which to measure the comparative positions and trends of IC between firms, industries, and countries Abeysekera, 2001. This has been one reason why much of the published research on measuring and reporting of IC practices has used annual reports as a source documents to ascertain the status of the IC of firms, both within countries and between countries. Among IC reporting researches published in the last few years are located in Australia Gutrie Petty, 2000, Sri Langka Abeysekera Gutrie, 2000, and United Kingdom Williams, 2001. Most of these researches used framework developed by Sveiby 1997 i.e. the Intangibles Assets Monitor model in undertaking their research. One of the researches conducted by Gutrie and Petty 2000 in Australia revealed that key components of IC are poorly understood, inadequately identified, inefficiently managed and inconsistently reported. In fact, even the Australian best practice firm is in need of a comprehension management framework, especially for reporting IC information. There were also researches conducted in the area of human resource HR reporting, a subset of IC, in which has seen an increasing importance in Nordic countries in the 1990s, especially Sweeden see Sveiby, 1989 where companies took a lead in this respect by publishing statements about their HRs in their annual reports as an addition to the conventional financial statements. In Malaysia, as presently, not much is known as to the extent to which firms in Malaysia have adopted IC reporting but there are high possibility Malaysian firms that produce the Corporate Social Responsibility CSR reports to provide information on HR See Kamaluddin and Abdul Rahman, 2007. However, that does not mean there is no research being conducted in Malaysia on IC as most of the exixting research has put more focus on the IC management instead of IC reporting see Abdul Latif Fauziah, 2007. Recent study on IC is focus on the impact of the IC disclosures in the prospectus of the firms offering IPOs. Therefore, what this research trying to propose here is the need to create a better management of IC and better quality of financial reporting among the Malaysian companies by analyzing the initiatives developed in Malaysia in relation to IC reporting practices and propose a policy framework index specifically in the development of Malaysia own IC reporting Index for a consistent and comparable IC reporting among Malaysian firms that would allow for a more meaningful decision making. 2671

2.5 Development of Intellectual Capital Reporting

Measuring and assessing IC by firms have become more important with the adoption of International Financial Reporting Standards IFRSs by many countries including Malaysia. The prudent approach taken by IFRS especially in recognizing assets such as applying impairment test on assets and writing off intangibles which cannot be objectively verified in reference to an active market has altered the reporting value of firms rather than the fair value of the firm Abeysekera, 2007. This approach has also increased the ―unexplained‖ gap between the fair price and the reported value net book value of the firm. Since investors are not fully aware of the gap between fair value and the reported value, this information gap creates two broad classes on investors: those that have access to information relating to the ―unexplained gap‖ perhaps shared at private meeting and those that don‘t εary et al, β00γ. As investors have access to information that explicates the ―unexplained gap‖ can make better economic decisions as compared to those without the information, the need for better reporting has increased which lead to the development of external reporting that include IC Reporting. This new development could possibly create a competitive advantage to those firms that are able to produce such report. Firms have always used tools to assess their assets and with the increasing demand for IC reporting, a demand for a new managing and measuring tools for a special type of intangible resources, such as organizational knowledge, has existed. Among tools being introduced for managing firm‘s IC is the Skandia Navigator, the Intellect Model, and the Intangible Assets Monitor. Skandia Navigator model proposed by Edvinson and Malone 1997 exposes five scopes: financial, client, human, processes, and renewal and development as elements of the IC system, proposing for every one scope, a set of indicators. The model uses indicators of absolute measurement and efficiency indexes of IC. The main contribution of this model is its integrity, looking at the financial and non-financial perspectives of the organization that allows the estimation of market value of the firms Bontis, 2001. The Intellect Model 1998 developed in Spain in the workgroup of European Institute proposed three areas of IC: human, structural, and relational. Each area tries to give a preliminary order in elements which are then concreted in measurement indicators. The Intangible Assets Monitor Sveiby, 1997 commonly described as consisting of three capital categories: internal, external, and employee competence human capital. In an IC research conducted by Abeysekera 2007 on developed and developing countries, this IC model has been further divided into sub-categories. For instance, human capital was clustered into seven sub-categories i.e. training and development, entrepreneur skills, equity issues, employee safety, employee relations, employee welfare, and employee-related measurements. The training and development sub-category normally comprises know-how, vocational qualifications, career development and training programs while the equity issues can be traced down to issues relating to race, gender, religion, and disability. The employee relation covers union activity, employees being 2672 thanked, employees being featured and employee involvement in the community whereas the employee welfare sub-category consists of employee compensation plan, employee benefits, and employee share and option ownership plan. Lastly, the employee-related measurements sub-category comprises value-added by employees and executives, employee numbers, professional experience, eductaion levels, expert seniority, and age of employees Subbarao and Zeghal, 1997. The next section shall illustrate the research methodologies that will be carried out throughout the study. 2673

CHAPTER III: RESEARCH DESIGN AND METHODOLOGY 3.1

The purpose of the study, research questions and hypothesis The main objective of this projectresearch is to develop an IC IndexRating for Malaysian companies. Wit h the development of εalaysia into a ‗knowledge- based economy‘, companies have begun to recognise the importance of managing IC and it is appropriate to develop an IC Index for these companies. Other sub-objectives are to derive IC value using such Index and relate to performance and market value of these companies. Spesifically, the study embarks on the following objectives: 1. To identify the components and elements of IC of companies; 2. To develop a structured measurement tool for management of IC; 3. To assess the IC value of companies; 4. To relate IC value with performance, market value, etc. 5. To make recommendation based on empirical findings for external reporting of IC.

3.2 Research Hypotheses

The research aims to test the following hyphotheses: 1. The higher the value of IC, the higher the company‘s performance e.g. profitability, ROA 2. The higher the value of IC, the higher the company‘s market to book ratio MTBR or market value 3. There is a significant difference between the value of IC among different types of companies in Malaysia. Further hypothesis shall be developed later. 3.3 Research Methods The research will use a mixed method of investigation: 1. A list of IC elementscomponents will be developed from literature; 2. An empirical research via questionnaire on managers companies listed on the main board of Bursa Malaysia regarding IC elementscomponents and their measures used in practice; 3. A check list and score board will be developed and employed to measure companies‘ IC; 4. Some financial data such as MTBR, profit, etc will be obtained from DataStream. 2674 5. Content analysis of companies‘ annual reports will also be carried out to gaugeanalyse the level of IC repoting; The research will also be conducted via interviews and postal survey with the aid of questionnaires. 3.4 Sampling Procedure and Data Collection This research will use simple random sampling as the research is attempting to value IC of Malaysian public listed companies main board. Various methods of investigation such as self-administered andor postal survey and interviews will be employed. Interviews will be conducted on selected companies after preliminary survey. Other financial data such as market to book ratio MTBR, profit, etc will be obtained from DataStream. Strategic management and measurementaccounting literature both provide huge amounts of intellectual capital related information, which will be used to create an instrument IC-index for the measurement purpose. Studies among these areas and especially in the area of capital market research contain disclosure indexes, where items of intellectual capital exist. Although these indexes contain most often other elements as intellectual capital as well, they can be used to help the structural formation of the planned index. At this point of process it seems that there will be three main categories in this index – human, structural and relational capital – which all contain items of intellectual capital. A pilot study will verify that the questionnaire is properly designed and the items are understood in a proper manner. The pilot study also allows to add items of intellectual capital to the index that the respondents feel absent. Managers of financial and personnel administration should probably be stressed, when executing the survey. A 1-to-5 or 1-to-7 Disagree-Agree type scale δikert scale will be used to score firms‘ intellectual capital. 3.5 Data Analysis Besides descriptive statistics, quantitative analysis such as factor analysis and regression analysis will be conducted. Regression model for example can be used to test the importance of intellectual capital for companies‘ financial performance. Factors such as size, industry, ownership, etc can be used to split the data in more detail. Furthermore, each element of the IC Index can be tested separately to find out their importance for companies‘ financial performance. In addition, qualitative analysis will be conducted on the findings of interviews. 3.6 Potential Results of the Study First of all, this study aims to construe a deeper understanding of the role of intellectual capital in firm‘s business processes and financial performance. Some models of economics are used to describe the core functions and operational environment of firms, whereas models explaining firms‘ 2675 competitiveness are used to analyze the role and importance of organizational capabilities and resources in business processes. Elements and separate items of intellectual capital will be linked to the issues that have emerged from the competitiveness analysis. This is the conceptual contribution of the study. Secondly, the results of the survey could hint what kind of intellectual capital elements are vital for the companies that are engaged in business activities. As the survey covers companies in different size and industry, some information about the elements that trigger the performance may unfold as well. In addition, the survey is of course to find out, whether the intellectual capital affects firms‘ financial performance or not. The main objective of the study is to come up with the IC Index for Malaysian companies. This may interest firms, as intangibles are difficult to measure and control, and by that way lead to further research subjects. The Index may provide some consistency for the measurement and reporting of intellectual capital for companies. REFERENCES Abeysekera, I., 2001. A Framework to Audit Intellectual Capital, Journal of Knowledge Management Practice , Vol. 2. Abeysekera, I., 2007. Intellectual Capital Reporting between a Developing and Developed Nation, Journal of Intellectual Capital, Vol. 8, No.2, pp. 329-345. Abeysekera, I. Guthrie, J., 2000. Status of Intellectual Capital Reporting in Sri Langka – A Research Note, Working Paper, Sydney, Australia. Abdul Latif Salles Fauziah Selamat 2007. Intellectual Capital Management in Malaysian Public Listed Companies, International Review of Business Research Papers , Vol. 3, No. 1, pp. 266-27. Arvidsson, Susanne 2003 Demand and Supply of information on intangibles – The case of Knowledge-Intense Companies, PhD dissertation, Department of Business Administration, Lund University: Lund Business Press. Bontis, N., 2001. Assessing Knowledge Assets: A review of the Models Used to Measure Intellectual Capital, International Journal of Managment Reviews , Vol. 3, No. 1, pp. 41-60. Bontis, Nick – Keow, William Chua Chong – Richardson, Stanley 2000 Intellectual Capital and Business Performance in Malaysian Industries, Journal of Intellectual Capital , Vol. 1, Issue 1, 85 –100. Bontis, Nick – Fitz-enz, Jac 2002 Intellectual Capital ROI:A Causal Map of Human Capital Antecedents and Consequents, Journal of Intellectual Capital , Vol. 3, No. 3, 223 –247. Chen, Ming-Chin – Cheng, Shu-Ju – Hwang, Yuhchang 2005 An Empirical Investigation of the Re lationship between Intellectual Capital and Firms‘ 2676 Market Value and Financial Performance, Journal of Intellectual Capital, Vol. 6, No. 2, 159-176. Deegan, C. 2000. Financial Accounting Theory. McGraw-Hill, Sydney. Economic Planning Unit 2001. The Third Outline Perspective Plan 2001- 2010, Prime Minister‟s Department, Putrajaya, Malaysia. Edvinson, L Malone, M.S. 1997. Intellectual Capital: Realizing Your Company‟s True Value by Finding Its Hidden Brain Power. 1st Edition, Harper Collins Publishers, New York. Firer, Steven – Williams, Mitchell S. 2003 Intellectual Capital and Traditional Measures of Corporate Performanc, Journal of Intellectual Capital, Vol. 4, No. 3, 348 –360. Guidelines for Managing and Reporting on Intangibles. MERITUM-project. The Research Institute of the Finnish Economy . Guthrie, J. Petty, R. 2000. Intellectual Capital: Australian Annual Reporting Practices, Journal of Intellectual Capital, Vol. 1, No. 3, pp. 241-251. Guthrie, J. Petty, R., Yongvanich, K., Ricceri, F. 2004. Using Content Analysis as a Research Method to Acquire into Intellectual Capital Reporting, Journal of Intellectual Capital, Vol. 5, No. 2, pp. 282-293. Huang, Cheng Jen – Liu, Chun Ju 2005 Exploration for the Relationship between Innovation, IT and Performance, Journal of Intellectual Capital, Vol. 6, No. 2, 237 –252. Hurwitz, Jason – Lines, Stephen – Montgomery, Bill – Schmidt, Jeffrey 2002 The Linkage between Management Practices, Intangibles Performance and Stock Returns, Journal of Intellectual Capital, Vol. 3, No. 1, 51 –61. Kamaluddin, A. and Abdul Rahman, R. 2007. Intellectual Capital Reporting in Malaysia, Accountants Today, pp. 18-20. Rodov, Irena – Leliaert, Philippe 2002 FiMIAM: Financial Method of Intangible Assets Measurement, Journal of Intellectual Capital, Vol. 3, No. 3, 323 –336. Subbarao, A.V. Zeghal, D. 1997. Human Resource Information Disclosure in Annual Reports: An International Comparison, Journal of Human Resource Costing Accounting , Vol. 2, No.2, pp. 53-73. Sveiby, K.E. 1997. The Intangible Assets Monitor, Journal of Human Resource Costing Accounting , Vol. 2, No.1, pp. 7-97. Sveiby, K.E. 1989. The Invisible Balance Sheet: Key Indicators for Accounting, Control, and Valuation of Know-How Companies. Stockholm. 2677 Wang, Wen-Ying – Chang, Chingfu 2005 Intellectual Capital and Performance in Causal Models: Evidence from the Information Technology Industry in Taiwan, Journal of Intellectual Capital, Vol 6., No 2., 222 –236. Williams, S.M. 2001. Is Intellectual Capital Performance and Disclosure Practices Related?, Journal of Intellectual Capital, Vol. 2, No. 3, pp. 192- 203. List of Figure Classifications for Intangible Assets Arvidsson, 2003 Financial Accounting: External Usage, Measurement Accounting literature Human capital Management Accounting: Internal Usage, Strategic Management literature Relational capital BSC- approach Structural capital Comprehensive- approach Listing- approach Figure 1. Classifications for Intangible Assets Figure 1. Classifications for Intangible Assets 2678 THE EFFECT OF FINANCIAL CRISIS AT KOREAN STOCK MARKET Jang Hee Lee, Dongseo University Abstract In this study‘s analysis pre and post the Financial Crisis, the value correlations of the accounting information and the additional explanation ability of the fundamental variables were found to be very high after the Financial Crisis. The significant fundamental variables varied pre and post the crisis. Inventory SALINV was found to be significant before the Financial Crisis but was found insignificant after. On the other hand, Accounts Receivable ΔSALAR and Personnel Expenses ΔASLR were not significant before the Financial Crisis but significant after the crisis, and the signs also changed from negative - to positive +. Meanwhile, Gross Profits ΔGMSAL showed negative - coefficients before the crisis, but showed positive + coefficients after. Also, the results from conducting regression analysis using POST, which is the dummy variable representing the periods pre and post the Financial Crisis, show that Gross Profits PO STΔGMSAL, Sales POSTΔSALA, Cost of Sales POSTΔCGSA, Accounts Receivable POSTΔSALAR and Personnel Expenses POSTΔASLR showed positive + signs, but Equipment Investment POSTΔCAPEX and Assets POSTΔASA showed negative - signs.

1. Introduction

The Korean economy has been undergoing many changes since the 1997 Financial Crisis. Such radical changes in the capital market include expansion in foreign stock investments in stocks, full-scale advance of foreign financial institutions into the Korean market, selling off domestic enterprises overseas, and the expansion of foreign ownership rate in domestic enterprises. Owing to such rapid changes after the Financial Crisis, investment methods in the Korean stock market have also changed. As is the case with other countries, investment analysts of securities companies in Korea evaluate the intrinsic value of the enterprises through fundamental analysis using financial statements and the current investment opinions on applicable enterprises and industries. Generally after the crisis, investments in stocks are advised based on the opinions of these securities analysts. Particularly after the crisis, the country‘s securities companies made full- scale investments in establishing research centers competitively based on favorable business results following the stock market boom in 1998. Backed by the extensive investments in the business analysis sector, investment analysts have been greatly growing both qualitatively and quantitatively. Analysts utilizing fundamental analysis are considered the best analysts by media organizations. Based on such growths, research centers of securities 2679 companies have been able to conduct more systematic and logical corporate analyses. Accordingly, the use of corporate analysis reports has become generalized and the influence of investment analysts continues to expand. The investment analysts of securities companies utilized the fundamental analysis in order to find and analyze the stocks that deviate from intrinsic values as being overestimated or underestimated in the efficient market. The investment strategy that utilizes fundamental analysis suggests to buy underestimated stocks and to sell overestimated stocks. Meanwhile, focusing on profit information, researches have been made on the effect of information that began to support the utility of financial statements information in the study of accounting. Such research works were based on the assumption that the sum of the present value of future cash flows is the corporate value and that the profit information can be used as the replacing value of cash flows. In the actual capital market, however, the ability to explain the fluctuations of stock prices is found to be minimal. This is primarily due to the fact that prof it information is only one part of a company‘s economic value as contained in the financial statements but the stock prices reflect all information factors contained in the statements. In other words, profit data on the financial statements are important information with regard to the evaluation of corporate values but are only a part of various accounting information. Accordingly, in order to evaluate the utility of financial statements, all the pieces of information reflected in the financial statements should be used, and not only the ones on profit. From the viewpoint of fundamental analysis, this study observed that one can predict future profits by using the collection of information besides the information on stock prices alone on the assumption that stock prices do not sufficiently represent all the necessary information. This thesis therefore attempts to verify how much the Financial Crisis has influenced the effects of financial statements information in the country‘s capital market by utilizing the variables of fundamental analyses that have been generalized through the Financial Crisis. This thesis consists of the following. Chapter 1 explains research objectives and purposes; Chapter 2 explains the conceptual framework of performing the research and describes the research designs; Chapter 3 proves the analysis and presents the results of analysis; and Chapter 4 discusses the results of the research.

II. Research Design 1. Setting Up Hypotheses

Starting from the Financial Crisis that greatly changed the Korean economy, this research will verify whether there are any differences before and after the financial crisis in the use of the financial statements information that utilizes fundamental analysis variables. The reasons for verifying this are twofold. First, due to the Financial Crisis, the accounting transparency of domestic companies was emphasized, expectations for the local companies‘ accounting 2680 information were raised and the responsibility for inappropriate accounting was reinforced. Second, the domestic financial market environment has rapidly changed due to full-scale foreign investments. And, as investment analysts of securities companies have been engaged in full-fledged activities, fundamental analyses utilizing the financial statements have been very active. Actually, due to substantial business analysis investments since 1999, the business analysis sector of the domestic securities companies has been experiencing rapid quantitative expansion and qualitative growth. Also, the competitions among the investment analysts of securities companies have intensified due to several special events sponsored by news media such as the selection of the best analyst and other prize awards, which have caused general investors to recognize fundamental analysis. Based on this, additional and more diverse fundamental analysis data have been produced and transmitted through diverse channels to investors. So, Hypothesis 1 was set up since it was expected that there would be differences in the use of financial statements that utilize fundamental analysis variables before and after the Financial Crisis. Hypothesis 1: There are no differences in the use of financial statements that utilizes fundamental analysis variables before and after the Financial Crisis. Before the crisis, the local companies focused mainly on sales growth rather than on profitability in business management. Such expansion-oriented management led to over borrowing, which was one of the causes of the Financial Crisis. During the crisis however, the local enterprises lowered their debt ratio and focused on profit-oriented management rather than on sales growth. Investors also evaluated the companies and decided to make investments based on profitability rather than on sales or on the asset size of the companies concerned. Due to this, along with the utility of fundamental analysis variables, the variables representing profitability, Gross Profits ΔGεSAδ, Cost of Sales ΔCGSA, and Personnel Expenses ΔASδR are expected to be more significant during after the crisis. So, in addition to the above hypothesis, Hypothesis 2 was set up since it was expected that there would be differences in value correlations of Gross Profits ΔGεSAδ, Cost of Sales ΔCGSA and Personnel Expenses ΔASδR. Hypothesis 2: Of the fundamental analysis variables, there are no differences in the value correlations of the fundamental analysis variables representing profitability, Gross Profits ΔGεSAδ, Cost of Sales ΔCGSA and Personnel Expenses ΔASδR before and after the crisis. On the other hand, during crisis, the local companies lowered their debt ratios, sold off non-business properties and pushed forward restructuring, which are factors that favored the stock market. Variables representing an enterprise‘s external growth such as equipment investment ΔCAPEXA or assets ΔASA are expected to have negative - impact on the earning rates after the Financial Crisis. In addition therefore, Hypothesis 3 was set up since it was expected that there would be differences in the value correlations of 2681 Equipment Investment ΔCAPEXA or Assets ΔASA representing the external growth of a company before and after the Financial Crisis. Hypothesis 3: Of the fundamental analysis variables, there are no differences in the value correlations of the fundamental analysis variables representing an enterprise‘s external growth, Equipment Investment ΔCAPEXA or Assets ΔASA.

2. Selection of Variables

This research attempts to verify the utility of the financial statements by using a total of 16 fundamental analysis variables, which are made up of eight fundamental analysis variables that can be applied to the Korean market, 12 fundamental analysis variables are based on the expertise of American securities analysts presented in the dissertation of Lev and Thiagarajan 1993, and eight fundamental analysis variables that do not overlap with the other eight fundamental analysis variables of American securities analysts. In general, the distinction between good signal and bad signal is clear in the accounting profit information but unclear in the non-profit accounting information. Investment analysts of securities companies generally interpret accounting information that is based on fundamental analysis. For example, the imbalanced increase in inventory is interpreted as bad signal. Of course, such imbalance can be due to the managers‘ expected increase in sales. Although such interpretation is not always right, this research makes the necessary judgment regarding the signal of non-profit accounting information in accordance with the criteria that the securities analysts use to distinguish between good signal and bad signal when conducting fundamental analysis. In general, a sharp increase in inventory more than net sales means the company is experiencing sales difficulties. Moreover, such imbalanced increase in inventory will force management to attempt to maintain the level of inventory, which will reduce profit. Besides, an increase in inventory will lower future profit due not only to the opportunity cost of inventory purchase, inventory storage costs, inventory diminution and loss but also to the reserve of overhead costs allotted to inventory. Accordingly, in general, the increase in inventory is regarded as a bad signal and the decrease in inventory is a good signal. In this research, the rate of increase in sales less the rate of increase in inventory is denoted as ΔSAδINV. Accordingly, as mentioned above, the value of the variable resulting from the increase in inventory is expected to be negative - or as a bad signal, and the value of the variable resulting from the decrease in inventory is expected to be positive + or as a good signal. It is expected to have the same effect on the fluctuation of stock prices. The rate of increase in inventory is calculated by dividing the change in the inventory amount at the end of the current year t compared with the inventory amount at the end of the immediate previous year by the inventory amount at the end of the immediate previous year. This can be expressed as: ΔSAδINV t = Inventory t – Inventory t-1 Inventory t-1 2682 This equation shall be used to determine the rate of increase in sales and all the other fundamental analysis variables that are discussed below. Table 1 below summarizes the investment analysts of securities companies that are used in this research. Table 1: Definition of Fundamental Analysis Variables Fundamental Analysis Variables Measurement of Variables 1. Inventory The increase rate of sales – the increase rate of inventory 2. Accounts Receivable The increase rate of sales – the increase rate of accounts receivable 3. Equipment Investment The increase rate of equipment investment – the increase rate of equipment investment of the same industry 4. Gross Profits The increase rate of gross profits – the increase rate of sales 5. Selling and Administrative Expenses The increase rate of sales – the increase rate of sellingadministrative expenses 6. Bad Loan Reserves The increase rate of bad loan reserves – the increase rate of accounts receivable 7. Effective Corporate Tax Rates Before tax net profit per sharestock price of the immediate prior year 8. Labor and Personnel The increase rate of sales compared with immediate prior year per employee 9. Sales The increase rate of sales – the increase rate of sales of the same industry 10. Accounts payable The increase rate of sales – the increase rate of accounts payable 11. Cash Flow The increase rate of cash flow compared with the immediate prior year per share 12 Liquidity The increase rate of current assets – the increase rate of current liabilities 13. Debt The increase rate of liabilities – the increase rate of current liabilities 14. Cost of Sales The increase rate of cot of sales of the same industry – the increase rate of cost of sales 15. Personnel Expenses The increase rate of personnel expenses of the same industry – the increase rate of personnel expenses 16. Assets The increase rate of assets – the increase rate of assets of the same industry Variables 1to 8 are the variables used by Lev and Thiagarajan, and variables, 9 to 16 are used by Korean investment analysts that do not overlap with 1 to 8.

3. The Enterprises Analyzed

Among the enterprises listed on the Korea Stock Exchange from January 1, 1992 to December 31, 2001, the sample enterprises include the companies settling accounts in December and whose stock prices and financial statements data are included in the database of the enterprises information warehouse TS2000 of the Korea Listed Companies Association, excluding the following companies: 1 Banks, investment finance companies, securities companies and insurance companies. Financial industries and similar services