Knowledge that Transforms

Goal Congruence, Uncertainty, Risk-taking, Implied risk preference

Auditing, Substantive test, Sampling plan, Dollar-Unit Sampling

Cost variance, Internal control, Managerial interference, Materiality

Special items, Extraordinary items, Market efficiency, Disclosures

Several recently reported studies have considered whether changes in accounting methods by firms whose securities are publicaly traded have led to any discernible response in the form of shifts in share prices. (I) These studies have been framed in differing terms, and have looked at share price movements under a variety of conditions. But a common finding has been that changes in accounting methods do not appear to have had much of an effect on stock market prices. This paper presents some evidence of changes in accounting method which lead to shifts in stock prices. It describes an examination of movements in share prices of a sample of relatively large Australian public companies which announced upward asset revaluations during the period 1960-70. This examination revealed that announcements of asset revaluations were associated with substantial upward movements in stock prices, and that these shifts in stock prices were generally sustained in the post-announcement months. Furthermore, the stock market appears to digest this new information quickly into stock prices as the adjustment was almost complete at the close of the announcement month. Further analysis suggested that the observed movements in stock prices could not be attributed entirely to such additional information signals as earnings and dividend changes. Nor were the results explained by induced changes in volatility which could conceivably result from the release of revaluation information. Given that the revaluations reflected changes in the worth of assets which had predominantly taken place but had not been recorded during prior accounting periods, then the findings are consistent with claims that the failure of accounting to systematically provide contemporary information about the affairs of firms can deprive the stock market of valuable information and lead to the inequitable treatment of individual investors.

Internal Information systems, Competitors, Valuation

Auditing, Sampling plan, Materiality, Dollar-Value sampling

Budgeting, Human behavior, Internal control

Business combination, Pooling criteria, APB Opinion No. 16, Pooling of interest

In a previous paper,' I demonstrated how the problems faced by the auditor of a firm's published annual financial statements in deciding (1) how much audit evidence to obtain and (2) what set of balance sheet valuation numbers to choose in the light of this audit evidence can be regarded as a problem in Bayesian point estimation. In effect, the auditor was viewed as picking a vector of numbers (the balance sheet) to summarize his posterior probability distribution (i.e., posterior to his audit examination) of those balance sheet parameters for which he is held responsible by the nature of his audit engagement. He does this subject to a loss function whereby he is penalized for discrepancies between the balance sheet numbers so chosen and their subsequent realization. Given the professional nature of the auditor's engagement, it seems reasonable to suggest that this loss function really derives from the various financial statement users. If they rely on the audited statements as inputs into decisions when those statements contain auditor's errors, they will suffer an opportunity loss of expected utility. This raises the question, of course, of who these users are and how financial statement errors operate to cause utility losses. The approach in this paper is to pick a specific, well-defined normative decision problem for which audited financial statements have the potential to be useful and find the loss function that is implicit in it. The problem I have chosen is an individual's consumption-investment