of users. Economic decision; no action outcome Type 1 + Type 3 of users.
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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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