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Discussion of Segment Disclosure Quantity and Quality under IFRS 8: Determinants and the Effect of Financial Analysts' Earnings Forecast Errors
ACCOUN-00766; No of Pages 2 The International Journal of Accounting xxx (2016) xxx–xxx
Contents lists available at ScienceDirect
The International Journal of Accounting
Discussion of Segment Disclosure Quantity and Quality under IFRS 8: Determinants and the Effect of Financial Analysts' Earnings Forecast Errors Giorgio Gotti College of Business Administration, University of Texas at El Paso, United States
a r t i c l e
i n f o
Available online xxxx
a b s t r a c t Andre, Filip, and Modovan (2016) explores the characteristics—quality and quantity—of segment disclosures under IFRS 8 and their usefulness to financial analysts in accurately estimating earnings per share (EPS). The authors measure quantity of disclosures as the number of segmentlevel line items disclosed in financial statements and quality as the cross-segment variation in profitability. The results provide evidence that managers solve the issue of proprietary costs by decreasing either the quantity of disclosure below the level of standards' guidance or the quality of disclosures on operating segments, thus reducing the overall information included in disclosures. Results also show that it is difficult even for a sophisticated group of financial statement users such as financial analysts to fully understand the quality of segment disclosures and that too much disclosure quantity might create a “foggy” environment, where even sophisticated investors can have troubles using disclosed information to forecast earnings. © 2016 Published by Elsevier Inc.
1. Introduction I am pleased to offer comments on Andre, Filip, and Modovan (2016), which I discussed at the 2014 The International Journal of Accounting Symposium held in Sao Paulo (Brazil). One of the first points to highlight is that the analysis of the paper relies on the assumption that it is easier for managers to exercise their discretion on quality than on quantity of disclosures. Furthermore, the results presented in the paper offer evidence of how difficult it is, even for sophisticated investors, to understand the quality of managers' disclosures. It's worth reminding readers here that the Financial Accounting Standards Board (FASB) stated in the Statement of Financial Accounting Concepts No.1, Objectives of Financial Reporting by Business Enterprises (FASB, 1978), that the primary objective of accounting data is to provide information to help present and potential investors, creditors, and other constituents to assess the amounts, timing, and uncertainty of future net cash flow to the related enterprise (paragraph 37). Previous research (Dechow, Kothari, & Watts, 1998, among many) provides evidence that accrual earnings are a better predictor of future operating cash flow than current operating cash flow. In this context, it is easier to understand the importance of the research question in the paper and how results provided related to the informativeness of segment disclosure quality and quantity are relevant to standard setters and users of financial information in assessing the usefulness of a newly adopted standard—IFRS 8.
2. Supplemental analysis In my discussion of the paper at the Symposium, I mentioned that one of the key points of the paper—and one that might create some issues with the readers—is the definition and measure of quality: what is considered high quality for a user with specific information needs might (or might not) be high quality for another user with different information needs.
http://dx.doi.org/10.1016/j.intacc.2016.10.007 0020-7063/© 2016 Published by Elsevier Inc.
Please cite this article as: Gotti, G., Discussion of Segment Disclosure Quantity and Quality under IFRS 8: Determinants and the Effect of Financial Analysts' Earnings Fo..., The International Journal of Accounting (2016), http://dx.doi.org/10.1016/ j.intacc.2016.10.007
2
G. Gotti / The International Journal of Accounting xxx (2016) xxx–xxx
To start to tackle this issue, I suggested going to the Statement of Financial Accounting Concept No. 8, Chapter 1: The Objective of General Purpose Financial Reporting (FASB, 2010), to build from there a definition of accounting quality. In the statement, FASB points out that the objective of general-purpose financial reporting is to report financial information about the enterprise that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity. The authors base their definition and measure of quality on the work of Ettredge, Kwon, Smith, and Stone (2006), where quality is associated with cross-segment profit variability. The intuition underlying this measure is that cross-segment profit variation is a measure of segment profitability disclosure transparency, where high variation in profitability is associated with high transparency, and low variation in profitability is associated with low transparency. The question that I had for the authors during my discussion of the paper at the Symposium was whether their measure of quality is actually measuring the usefulness of financial information disclosures to present and potential investors and other creditors—or just the transparency of segment profitability. I suggested that they measure (at least as a sensitivity test) the quality/usefulness of accounting information to investors adopting the earnings response coefficient as a measure of quality, even with all the shortcomings of this measure that is likely not able to disentangle the two characteristics. Moreover, the paper considers “length of the annual report” as the proxy for disclosure level (high/low). The paper should have discussed why this proxy is the right measure, presenting the results of relevant literature on the topic and whether there is any alternative measure that could have been considered for this study. The paper mentions that too much information is detrimental to financial analysts because it creates information overload. The paper should have discussed any related literature that supports this argument. Conceptually, I find a difference between the measure of disclosure policy (high/low) and the argument of information overload. High disclosure policy can provide more information, whereas increased information might create information overload. The paper should have clarified more on the above topics. 3. Conclusion Andre et al. (2016) extends accounting literature by examining the interplay of quality and quantity of managers' segment disclosures. Moreover, the authors provide evidence on how these disclosure qualities in IFRS 8—based on how managers are managing company's decisions and firm's business model—are understood by a group of sophisticated investors such as financial analysts. The implications of the results of this paper might be of interest to standard setters (International Accounting Standards Board, Financial Accounting Standards Board, Securities and Exchange Commission) that have adopted the business model disclosures and might be interested in the consequences of their decisions. References Andre, P., Filip, A., & Moldovan, R. (2016). Segment disclosure quantity and quality under IFRS 8: Determinants and effect of financial analysts' earnings forecast errors. The International Journal of Accounting (in press). Dechow, P. M., Kothari, S. P., & Watts, R. L. (1998). The relation between earnings and cash flows. Journal of Accounting and Economics, 25(2), 133–168. Ettredge, M. L., Kwon, S. Y., Smith, D. B., & Stone, M. S. (2006). The effect of SFAS No. 131 on the cross-segment variability of profits reported by multiple segment firms. Review of Accounting Studies, 11(1), 91–117. Financial Accounting Standards Board (FASB) (1978, November). Statement of financial accounting concepts no.1. Objectives of financial reporting by business enterprises. Financial Accounting Standards Board (FASB) (2010, September). Financial reporting concepts statement no. 8. Conceptual framework for financial reporting.
Please cite this article as: Gotti, G., Discussion of Segment Disclosure Quantity and Quality under IFRS 8: Determinants and the Effect of Financial Analysts' Earnings Fo..., The International Journal of Accounting (2016), http://dx.doi.org/10.1016/ j.intacc.2016.10.007
Contents lists available at ScienceDirect
The International Journal of Accounting
Discussion of Segment Disclosure Quantity and Quality under IFRS 8: Determinants and the Effect of Financial Analysts' Earnings Forecast Errors Giorgio Gotti College of Business Administration, University of Texas at El Paso, United States
a r t i c l e
i n f o
Available online xxxx
a b s t r a c t Andre, Filip, and Modovan (2016) explores the characteristics—quality and quantity—of segment disclosures under IFRS 8 and their usefulness to financial analysts in accurately estimating earnings per share (EPS). The authors measure quantity of disclosures as the number of segmentlevel line items disclosed in financial statements and quality as the cross-segment variation in profitability. The results provide evidence that managers solve the issue of proprietary costs by decreasing either the quantity of disclosure below the level of standards' guidance or the quality of disclosures on operating segments, thus reducing the overall information included in disclosures. Results also show that it is difficult even for a sophisticated group of financial statement users such as financial analysts to fully understand the quality of segment disclosures and that too much disclosure quantity might create a “foggy” environment, where even sophisticated investors can have troubles using disclosed information to forecast earnings. © 2016 Published by Elsevier Inc.
1. Introduction I am pleased to offer comments on Andre, Filip, and Modovan (2016), which I discussed at the 2014 The International Journal of Accounting Symposium held in Sao Paulo (Brazil). One of the first points to highlight is that the analysis of the paper relies on the assumption that it is easier for managers to exercise their discretion on quality than on quantity of disclosures. Furthermore, the results presented in the paper offer evidence of how difficult it is, even for sophisticated investors, to understand the quality of managers' disclosures. It's worth reminding readers here that the Financial Accounting Standards Board (FASB) stated in the Statement of Financial Accounting Concepts No.1, Objectives of Financial Reporting by Business Enterprises (FASB, 1978), that the primary objective of accounting data is to provide information to help present and potential investors, creditors, and other constituents to assess the amounts, timing, and uncertainty of future net cash flow to the related enterprise (paragraph 37). Previous research (Dechow, Kothari, & Watts, 1998, among many) provides evidence that accrual earnings are a better predictor of future operating cash flow than current operating cash flow. In this context, it is easier to understand the importance of the research question in the paper and how results provided related to the informativeness of segment disclosure quality and quantity are relevant to standard setters and users of financial information in assessing the usefulness of a newly adopted standard—IFRS 8.
2. Supplemental analysis In my discussion of the paper at the Symposium, I mentioned that one of the key points of the paper—and one that might create some issues with the readers—is the definition and measure of quality: what is considered high quality for a user with specific information needs might (or might not) be high quality for another user with different information needs.
http://dx.doi.org/10.1016/j.intacc.2016.10.007 0020-7063/© 2016 Published by Elsevier Inc.
Please cite this article as: Gotti, G., Discussion of Segment Disclosure Quantity and Quality under IFRS 8: Determinants and the Effect of Financial Analysts' Earnings Fo..., The International Journal of Accounting (2016), http://dx.doi.org/10.1016/ j.intacc.2016.10.007
2
G. Gotti / The International Journal of Accounting xxx (2016) xxx–xxx
To start to tackle this issue, I suggested going to the Statement of Financial Accounting Concept No. 8, Chapter 1: The Objective of General Purpose Financial Reporting (FASB, 2010), to build from there a definition of accounting quality. In the statement, FASB points out that the objective of general-purpose financial reporting is to report financial information about the enterprise that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity. The authors base their definition and measure of quality on the work of Ettredge, Kwon, Smith, and Stone (2006), where quality is associated with cross-segment profit variability. The intuition underlying this measure is that cross-segment profit variation is a measure of segment profitability disclosure transparency, where high variation in profitability is associated with high transparency, and low variation in profitability is associated with low transparency. The question that I had for the authors during my discussion of the paper at the Symposium was whether their measure of quality is actually measuring the usefulness of financial information disclosures to present and potential investors and other creditors—or just the transparency of segment profitability. I suggested that they measure (at least as a sensitivity test) the quality/usefulness of accounting information to investors adopting the earnings response coefficient as a measure of quality, even with all the shortcomings of this measure that is likely not able to disentangle the two characteristics. Moreover, the paper considers “length of the annual report” as the proxy for disclosure level (high/low). The paper should have discussed why this proxy is the right measure, presenting the results of relevant literature on the topic and whether there is any alternative measure that could have been considered for this study. The paper mentions that too much information is detrimental to financial analysts because it creates information overload. The paper should have discussed any related literature that supports this argument. Conceptually, I find a difference between the measure of disclosure policy (high/low) and the argument of information overload. High disclosure policy can provide more information, whereas increased information might create information overload. The paper should have clarified more on the above topics. 3. Conclusion Andre et al. (2016) extends accounting literature by examining the interplay of quality and quantity of managers' segment disclosures. Moreover, the authors provide evidence on how these disclosure qualities in IFRS 8—based on how managers are managing company's decisions and firm's business model—are understood by a group of sophisticated investors such as financial analysts. The implications of the results of this paper might be of interest to standard setters (International Accounting Standards Board, Financial Accounting Standards Board, Securities and Exchange Commission) that have adopted the business model disclosures and might be interested in the consequences of their decisions. References Andre, P., Filip, A., & Moldovan, R. (2016). Segment disclosure quantity and quality under IFRS 8: Determinants and effect of financial analysts' earnings forecast errors. The International Journal of Accounting (in press). Dechow, P. M., Kothari, S. P., & Watts, R. L. (1998). The relation between earnings and cash flows. Journal of Accounting and Economics, 25(2), 133–168. Ettredge, M. L., Kwon, S. Y., Smith, D. B., & Stone, M. S. (2006). The effect of SFAS No. 131 on the cross-segment variability of profits reported by multiple segment firms. Review of Accounting Studies, 11(1), 91–117. Financial Accounting Standards Board (FASB) (1978, November). Statement of financial accounting concepts no.1. Objectives of financial reporting by business enterprises. Financial Accounting Standards Board (FASB) (2010, September). Financial reporting concepts statement no. 8. Conceptual framework for financial reporting.
Please cite this article as: Gotti, G., Discussion of Segment Disclosure Quantity and Quality under IFRS 8: Determinants and the Effect of Financial Analysts' Earnings Fo..., The International Journal of Accounting (2016), http://dx.doi.org/10.1016/ j.intacc.2016.10.007