Presents an interview with Professor Herbert A. Simon of Carnegie Mellon University, Pittsburgh, Pennsylvania. Impact of information technologies on organizations; Views on the relative importance of the evolutionary and design perspective of institutional literature; Assessment of the impact of information technologies on accounting and control.
Presents a linear aggregation model of valuation of assets to help understand how the minimum mean squared error valuation rule is affected by various parameters that characterize the economy and the circumstances under which historical-cost valuation rule yields a statistically more precise estimate of the unobserved economic value of firms' assets than the current valuation rule.
[Errors arise in measuring changes in prices of assets due to imperfection and incompleteness of asset markets. Furthermore, the rates of price-change, and the magnitudes of errors of measurement vary and are often correlated across assets. Suppose we characterize an economy by means and variances of price changes for individual goods and of measurement errors in these changes as well as by the degree of diversification in the asset portfolios held by individual firms. In such an economy, the linear valuation rule that yields the most efficient estimate of change in the economic value of these asset portfolios is the one that minimizes the mean squared error (MSE). This paper presents a linear aggregation model of valuation to help understand how the minimum MSE valuation rule is affected by various parameters that characterize the economy, and the circumstances under which historical-cost valuation rule yields a (statistically) more precise estimate of the unobserved economic value of firms' assets than the current valuation rule. The analytical findings of the paper are consistent with the reluctance of accountants to depart from historical cost in spite of the existence of low inflation, and in spite of scholarly critiques of this valuation rule by Chambers (1966), Edwards and Bell (1961), Sterling (1970) and others. They are also consistent with the use of specific price indexes by most firms to prepare SFAS 33 disclosures. Several testable implicatons of the results are provided. A direct comparison of the characteristics of valuation rules is complicated by the heterogeneity of the decision contexts in which accounting numbers are used. We use the mean squared error (MSE) between the principal value and its various estimators to rank the latter. Using this criterion, previous simpler models that ignore the presence of measurement errors in price changes have shown that the use of increasingly detailed price indexes yields more precise valuation; current valuation is the most precise valuation rule because it uses the most detailed set of indexes (Sunder 1978). We show that this basic result does not hold when the measurement of price changes is subject to errors. As the magnitude of these measurement errors increases relative to the magnitude of price changes, the most accurate valuation rule requires a less detailed set of price indexes. A key implication of this result is that the existence of inflation or deflation is not sufficient for general-price-level valuation, specific-price-index valuation, or current valuation to dominate historical-cost valuation as an estimator of the economic value of firms' assets. Historical-cost valuation is dominated by others only when the magnitude of price changes are large relative to the errors of measurement in price changes.]
A model for estimating the change in the economic value of a firm due to the adoption and use of last in, first out (LIFO) under conditions of certainty has been presented. The model requires single-point estimates of three parameters: the marginal tax rate, the cost of the basic inventory and the ratio of the cost of capital of the firm to the anticipated rate of inflation. In estimating the effect of LIFO on the economic value of the firm, the analysis has been limited to the net present value of future cash flows. Any additional risk that the firm may have to bear due to uncertainty in the future rates of inflation and, therefore, in the effect of LIFO on the firm has not been considered. Indeed, there is some empirical evidence available to indicate that the adoption of LIFO is accompanied not only by an increase in the market value of the firm, but also by an increase in the market risk of its ownership shares. The critical assumptions of the model are that the physical quantity of inventory remains constant and the rates of price change, discount and taxation are known deterministically.
The article focuses on properties of accounting numbers in costing in petroleum industries. Financial reporting and accounting practices used in the petroleum industry differ both among firms within the industry and also from practices of other industries in several respects. One area of difference is accounting for prediscovery costs. Because such costs are relatively large and because a large degree of uncertainty is associated with the potential benefits sought by incurrence of such costs, this area has provoked many practices; most can be grouped either as successful-efforts costing or full-costing practices. The practice of capitalizing only those prediscovery costs, which are directly identifiable with discovery of a commercial reserve and treating all other costs as operating expense is referred to as successful-efforts costing. On the other hand, the practice of capitalizing all prediscovery costs irrespective of their result is called the full-costing method. The study described in the paper is an attempt to analyze the effect of using the alternative methods on various accounting variables.
During an inflationary period, changes to the last in, first out (LIFO) method of inventory valuation generally result in reduction of reported earnings and in deferment of tax payments. If the investors rely on the reported earnings, the stock price of the firms which change to the LIFO method will decrease and if they rely on the economic value of the firms, the stock price will increase. Several studies of the relationship between accounting changes and stock price behavior have been conducted by using a research design, as of April 1975. The design involves the use of the market model to isolate the stock price changes associated with specific events from the market-wide price changes. The article attempts to measure the association between the accounting and price changes by abstracting the effect of risk changes. This is accomplished by estimating the time path of the relative risk of stocks during the months surrounding the date of accounting change. The problem of estimating the relative risk of stocks when it is not constant is considered in another section of the article. Conclusions of the study about the relationship between stock price behavior and accounting changes are presented in the last section.
This paper provides a critical review of the FASB's Statement on Objectives and of its Exposure Draft on the elements of financial accounting. First, the FASB's statements are compared with those of the previous authoritative bodies. Little that is new and little that can be expected to aid in the resolution of accounting issues can be found in the FASB's Statements. If the previous authoritative statements on objectives (and conceputal framework) can be adjudged failures, there is reason to believe that the present effort will have a similar future. Second, the reasons for such failure are considered and it is found that objectives of financial accounting do not have an unambiguous interpretation. Several explanations as to why accountants continue to seek an authoritative definition of objectives (and conceptual framework) are offered and some modest proposals for the "objectives of the FASB" are discussed at the end of the paper.
Claims about the benefits to be derived from dichotomizing income into current operating profit (COP) and holding gain (HG) are examined in this article. Separability of an asset from the risk of change in its price is shown to be a necessary and sufficient condition for separate evaluation of the operating and holding decisions with respect to the asset. When risk is separable, the appropriate breakdown of income into operating and holding components is defined. When the risk is not separable, no meaningful breakdown is possible. Other claims for a COP-HG dichotomy, e.g., the usefulness of COP in making various business decisions and interfirm and interperiod comparisons, are shown to be unjustified. In the absence of benefits, the direct cost of compiling data positively unattractive. The arbitrary nature of this dichotomy is illustrated through the construction of an equally defensible alternative.
The article reviews the book "Performance Measurement of the Petroleum Industry," by Alan R. Beckenstein, Leslie E. Grayson, Susan M. Overholt and Timothy F. Sutherland.