Impact of accounting changes: an earnings perspective

Abstract

The view presented in the financial statements is influenced significantly by the accounting policies adopted in their preparation. With the strong emphasis on Suring that the financial statements reflect the "economic reality" on the enterprise, the changes in accounting methods assume considerable importance. Hence accounting method changes due: the years constituted an important area of research in the broad domain of corporate financial reporting in the United States. The research in India on financial reporting is meager and is still in a state of infancy. In the absence of any previous empirical research on this topic in our country, the primary objective of the study is to understand and explain the possible determinants of the changes in these accounting methods. The study is conducted from the perspective of the effect of accounting changes on earnings. The Focus is not on the substantive nature of accounting changes, but rather on the impact they make on the earnings. To provide proper explanation, these is a need For a Framework or a model which can accommodate and explain the phenomenon- The paradigm that was most extensively used in earlier empirical works on accounting method changes is that of "Income-Smoothing". This paradigm is used as the basic building block to serve as theoretical anchorage. Using this anchorage, appropriate modified m0dEl5 are developed which attempt to explain the phenomenon of accounting changes. The major Findings of the study are: (1) The reference point for the current year's earnings seems to be the previous year's reported earnings. (2) In cases where current year's earnings arc lower than previous year's reported earnings, the accounting changes almost invariably arc aimed at increasing the level of earnings. (3) In cases where current year's earnings are already higher than the previous years reported warnings, the accounting changes are employed both to enhance as well as reduce the earnings. (4)There seems to exist a "desirable" zone of earnings above the level of previous year's earnings towards which the companies 506m then gravitate through the employment of accounting changes. (5)The exclusively upward nature of accounting changes in years of lower profits (compared to the previous year) Suggests that the managers scam to believe that the capital market can be influenced by the accounting changes.