This article discusses the theories of market crisis and the depression of balance sheets. The period of deflation should be a means of testing scientific opinions regarding the balance sheet. The replacement costs are approved on the basis of establishing price policies that is considered on two viewpoints, depending upon the objectives desired - as to the price calculations, and as to operating results in the accounts. In respect of price calculations, the majority of theoretical economists recognize the correctness of the theory today, even by those who consider the acquisition cost as the only true and real cost factor in the accounting computation of operating results. The advocate of the cost price theory keeps as an asset the 500 units of merchandise, the balance sheet value of which has no bearing on this question of price calculation. A full consideration of the causes of the depression would make it clear that the sting of the present crisis is in no way decreased by merely applying economist Fritz Schmidt's economic theory and the use of index numbers to show the present financial condition of businesses. The application of Schmidt's theory would of course improve the accounting procedure and the preparation of financial statements, and would help to clear up the managerial and economic condition of businesses when inventories are high and changes in capital structure take place suddenly.
This article describes legal and economic concepts of the balance sheet in Germany. he balance sheet is essentially a scheme for classifying property and capital, and is not vitally concerned that different amounts of property came in to the business at different dates. Therefore those who hold to these views are faced with no problems of valuation. Knowledge of current values for assets and capital is not absolutely essential to management. Although for certain purposes current values may be needed, it is more important to have a proper classification of the items of property and capital and to preserve the comparability of successive statements. A dynamic balance sheet must be supreme for the use of the manager because his decisions are dictated by his struggle for profit. The clear and concise ideas of writers who take the management point of view of accounting point out the proper course to follow. Legal requirements are obviouslyto be satisfactorily met, but the manager'svaluation problems can be best solved bythe application of economic principals.
[This paper investigates the extent to which models based on financial and market variables predict auditors' decisions to issue qualified audit reports in situations involving contingencies or uncertainties. A probit model is developed with the dependent variable indicating whether the firm received a qualified opinion, and the independent variables representing publicly available financial and market variables. The estimated model distinguishes between unqualified (clean) opinions and first-time qualifications and between types of qualifications (e.g., going concern, litigation, asset realizing, and multiple qualifications) in the year of the qualification, for both an estimation sample and a holdout sample. The predictive accuracy of the estimated model is evaluated in terms of misclassification costs for alternative costs of type I and type II errors and for specific prior probabilities of qualified and clean opinions.]
This paper investigates the extent to which models based on financial and market variables predict auditors' decisions to issue qualified audit reports in situations involving contingencies or uncertainties. A probit model is developed with the dependent variable indicating whether the firm received a qualified opinion, and the independent variables representing publicly available financial and market variables. The estimated model distinguishes between unqualified (clean) opinions and first-time qualifications and between types of qualifications (e.g., going concern, litigation, asset realizing, and multiple qualifications) in the year of the qualification, for both an estimation sample and a holdout sample. The predictive accuracy of the estimated model is evaluated in terms of misclassification costs for alternative costs of type I and type II errors and for specific prior probabilities of qualified and clean opinions.
[This paper examines the impact of product mix heterogeneity (PMH) on manufacturing overhead costs (MOHC) in three plants of a textile firm. An approach for measuring PMH is adapted from the group technology literature of operations. Factor analysis of product engineering specifications identifies seven forms of PMH for woven fabrics. Regression analysis indicates that two of the seven forms of heterogeneity are costly: differences in processing efficiency and in customer-specified quality requirements. The new measures of PMH perform better in estimating MOHC than the traditional measure of PMH, the number of products produced. Finally, the paper provides evidence that experience producing a heterogeneous mix of products mitigates costs of PMH.]
Some corporate decisions increase stockholder wealth while reducing the wealth of bondholders. When wealth transfers are large enough, stock prices can rise from decisions that reduce firm value. Yet, rational bondholders understand that actions taken after issuance will tend to increase stockholder wealth, and they forecast the value effects of future decision when bonds are sold. In an efficient market, the bond price at issuance reflects an unbiased forecast of the effects of such future actions. Thus, on average, bondholders will not suffer losses, although the firm (and hence its stockholders) must bear the costs of nonoptimal decisions motivated by wealth transfers from debtholders. Therefore, effective control of this bondholder-stockholder conflict can increase firm value. Bond covenants that constrain activities such as asset sales or dividend payments are examples of voluntary contracts that can reduce the costs generated when stockholders of a levered firm follow a policy that deviates from maximization of the firm's value. The cost-reducing benefits of covenants accrue to the firm's owners through the higher price the bonds command when issued. Furthermore, if covenants lower the costs that bondholders incur in monitoring managers, these cost reductions also are passed to stockholders through higher bond prices at issuance. Therefore, in structuring an optimal debt contract, the firm's managers face a trade-off between increased proceeds from the debt issue and reduced flexibility with respect to future policy choices. The constraints imposed through covenants are frequently specified in terms of accounting numbers. Debt covenants that employ accounting numbers are conventionally divided into (1) affirmative covenants, which require firms to maintain specified levels of accounting-based ratios, and (2) negative covenants, which limit certain investment and financing activities unless specified accounting-based conditions are met. For example, negative covenants restrict the payment of dividends, the disposition of assets, the issuance of additional debt, and merger activity; affirmative covenants specify minimum working capital and net worth requirements. Although standard covenants in debt issues require that accounting numbers be consistent with generally accepted accounting principles (GAAP), they normally do not prohibit managers from switching between accepted methods. In some bank-loan agreements, firms are required only to provide unaudited, internally generated financial statements, but the contract also requires the firm to maintain substantially the same set of GAAP. If a change becomes necessary, the bank must be notified in writing prior to the change with the reasons detailed (see Zimmerman 1975). Since different accounting techniques imply different accounting numbers, firms have incentives to relax onerous constraints through the choice of accounting techniques. Academic accountants have devoted substantial effort to obtain empirical evidence on the importance of debt agreements in determining accounting policy. (Watts and Zimmerman 119861 and Christie [19901 provide reviews.) Initial studies adopted indirect methods to account for the effect of debt covenants on accounting decision by using the firm's debt-equity ratio as an explanatory variable in cross-sectional regressions. This ratio is a proxy for closeness to covenant constraints, as well as for the expected costs should a breach occur. Duke and Hunt (1990) and Press and Weintrop (1990) offer evidence to support the use of the debt-equity ratio as a proxy for the closeness to debt covenant constraints. Christie (1990) documents significant support for this debt hypothesis by aggregating cross- sectional studies of accounting choice, generally concluding that the larger the firm's debt-equity ratio, the more likely the firm's managers are to select accounting procedures that shift reported earnings to the current period from future periods. Researchers have generally interpreted support for this debt hypothesis as evidence that managers act opportunistically. However, Watts and Zimmerman (1990) question whether the documented association is misinterpreted by researchers. Rather than reflecting managerial opportunism, the evidence may reflect the association among firms' investment opportunity sets, financial policies, and their efficient set of accounting methods. Even in theory, it is difficult to distinguish between opportunism and contracting efficiency as determinants of accounting policy choice. Given positive contracting costs, there will be a positive efficient amount of opportunism. Distinguishing between opportunism and efficiency is difficult in empirical work also. For example, a significant relation between accounting policy choice and leverage could indicate that managers of firms with high leverage act opportunistically in selecting accounting techniques to reduce costs imposed by constraints in debt covenants. Alternately, it could indicate that corporations for which a particular set of accounting techniques is efficient also tend to be those firms for which high leverage is efficient. Firms examined in these cross-sectional studies are not necessarily close to their debt covenant constraints at the date examined. When firms are not close to debt covenant constraints, managerial opportunism is a less plausible explanation for the documented association between leverage and accounting choice. Yet, since it is costly for firms to switch back and forth between accounting procedures, firms that switch accounting methods to delay default are likely to continue to employ incomes increasing accounting procedures, even if default is no longer likely (see Sweeney 1992). A firm's current accounting policies thus should depend on its historical choices and the time series of variables hypothesized to influence accounting policy. Therefore, cross-sectional studies do not provide the most direct or most powerful tests of the relation between accounting choice and debt contracts. Recent studies overcome a number of limitations inherent in cross sectional analyses by examining accounting-based defaults in debt covenants. Careful examination of the default process, its causes and cures, provides evidence on important aspects of the lending process. In this article, 1 review this developing literature to provide a richer under-standing of the costs of leverage. These costs have important implications. For accountants, they offer potential explanations of a firm's accounting policy choice; for financial economists, they enrich our understanding of the firm's optimal capital structure.
[Some corporate decisions increase stockholder wealth while reducing the wealth of bondholders. When wealth transfers are large enough, stock prices can rise from decisions that reduce firm value. Yet, rational bondholders understand that actions taken after issuance will tend to increase stockholder wealth, and they forecast the value effects of future decision when bonds are sold. In an efficient market, the bond price at issuance reflects an unbiased forecast of the effects of such future actions. Thus, on average, bondholders will not suffer losses, although the firm (and hence its stockholders) must bear the costs of nonoptimal decisions motivated by wealth transfers from debtholders. Therefore, effective control of this bondholder-stockholder conflict can increase firm value. Bond covenants that constrain activities such as asset sales or dividend payments are examples of voluntary contracts that can reduce the costs generated when stockholders of a levered firm follow a policy that deviates from maximization of the firm's value. The cost-reducing benefits of covenants accrue to the firm's owners through the higher price the bonds command when issued. Furthermore, if covenants lower the costs that bondholders incur in monitoring managers, these cost reductions also are passed to stockholders through higher bond prices at issuance. Therefore, in structuring an optimal debt contract, the firm's managers face a trade-off between increased proceeds from the debt issue and reduced flexibility with respect to future policy choices. The constraints imposed through covenants are frequently specified in terms of accounting numbers. Debt covenants that employ accounting numbers are conventionally divided into (1) affirmative covenants, which require firms to maintain specified levels of accounting-based ratios, and (2) negative covenants, which limit certain investment and financing activities unless specified accounting-based conditions are met. For example, negative covenants restrict the payment of dividends, the disposition of assets, the issuance of additional debt, and merger activity; affirmative covenants specify minimum working capital and net worth requirements. Although standard covenants in debt issues require that accounting numbers be consistent with generally accepted accounting principles (GAAP), they normally do not prohibit managers from switching between accepted methods. In some bank-loan agreements, firms are required only to provide unaudited, internally generated financial statements, but the contract also requires the firm to maintain substantially the same set of GAAP. If a change becomes necessary, the bank must be notified in writing prior to the change with the reasons detailed (see Zimmerman 1975). Since different accounting techniques imply different accounting numbers, firms have incentives to relax onerous constraints through the choice of accounting techniques. Academic accountants have devoted substantial effort to obtain empirical evidence on the importance of debt agreements in determining accounting policy. (Watts and Zimmerman [1986] and Christie [1990] provide reviews.) Initial studies adopted indirect methods to account for the effect of debt covenants on accounting decision by using the firm's debt-equity ratio as an explanatory variable in cross-sectional regressions. This ratio is a proxy for closeness to covenant constraints, as well as for the expected costs should a breach occur. Duke and Hunt (1990) and Press and Weintrop (1990) offer evidence to support the use of the debt-equity ratio as a proxy for the closeness to debt covenant constraints. Christie (1990) documents significant support for this debt hypothesis by aggregating cross-sectional studies of accounting choice, generally concluding that the larger the firm's debt-equity ratio, the more likely the firm's managers are to select accounting procedures that shift reported earnings to the current period from future periods. Researchers have generally interpreted support for this debt hypothesis as evidence that managers act opportunistically. However, Watts and Zimmerman (1990) question whether the documented association is misinterpreted by researchers. Rather than reflecting managerial opportunism, the evidence may reflect the association among firms' investment opportunity sets, financial policies, and their efficient set of accounting methods. Even in theory, it is difficult to distinguish between opportunism and contracting efficiency as determinants of accounting policy choice. Given positive contracting costs, there will be a positive efficient amount of opportunism. Distinguishing between opportunism and efficiency is difficult in empirical work also. For example, a significant relation between accounting policy choice and leverage could indicate that managers of firms with high leverage act opportunistically in selecting accounting techniques to reduce costs imposed by constraints in debt covenants. Alternately, it could indicate that corporations for which a particular set of accounting techniques is efficient also tend to be those firms for which high leverage is efficient. Firms examined in these cross-sectional studies are not necessarily close to their debt covenant constraints at the date examined. When firms are not close to debt covenant constraints, managerial opportunism is a less plausible explanation for the documented association between leverage and accounting choice. Yet, since it is costly for firms to switch back and forth between accounting procedures, firms that switch accounting methods to delay default are likely to continue to employ income-increasing accounting procedures, even if default is no longer likely (see Sweeney 1992). A firm's current accounting policies thus should depend on its historical choices and the time series of variables hypothesized to influence accounting policy. Therefore, cross-sectional studies do not provide the most direct or most powerful tests of the relation between accounting choice and debt contracts. Recent studies overcome a number of limitations inherent in cross-sectional analyses by examining accounting-based defaults in debt covenants. Careful examination of the default process, its causes and cures, provides evidence on important aspects of the lending process. In this article, I review this developing literature to provide a richer understanding of the costs of leverage. These costs have important implications. For accountants, they offer potential explanations of a firm's accounting policy choice; for financial economists, they enrich our understanding of the firm's optimal capital structure.]
[The performance of audit tasks has been modeled as a function of the auditor's ability, knowledge and experiences (Libby 1993). Thus, an important aspect of assigning audit tasks is identifying the levels of knowledge and types of experience an auditor must have to achieve a sufficiently high level of performance (Abdolmohammadi and Wright 1987). An objective of the current study is to determine whether auditors' knowledge of basic accounting principles and error frequencies improves over the course of their early careers so as to enhance performance of a common analytical procedure, ratio analysis. Research in psychology suggests that two characteristics of a task (say, analytical procedures) could diminish the accuracy with which auditors learn error frequencies from experience and apply their knowledge to a task. First, auditors' memories of financial statement errors are encoded while they perform other information-processing activities. These competing task demands could use enough of an auditor's information-processing capacity to diminish both the accuracy with which memory traces of errors are encoded and the accuracy of their knowledge of error frequency (Naveh-Benjamin and Jonides 1986). Second, auditors must consider a variety of evidence when performing analytical procedures. In diagnostic tasks like ratio analysis, inordinate attention is given to evidence that is highly diagnostic of low-frequency events, causing an "inverse base rate effect" in which auditors consider such events as more likely (Medin and Edelson 1988). Assessing the extent to which either of these characteristics of the analytical procedures context prevents auditors from learning and applying error frequency knowledge is a second objective of this study. To test hypotheses about these objectives, an experiment is conducted in which experienced auditors, accounting students, and non-accounting students learn the frequencies of financial statement errors through their experience in solving a series of problems using ratio analysis. Subjects are then tested for their accuracy in using frequency information by having them diagnose novel combinations of the same evidence. Other subjects perform similar tasks for an abstract medical diagnosis to provide a benchmark for comparison. The results indicate that differences in accounting knowledge influenced the subjects' performance of ratio analysis, and that neither potential source of inaccurate learning of event frequency knowledge holds in this setting. That is, subjects learned frequencies in the presence of competing task demands, and the inverse-base rate effect was not observed. These results suggest that experienced, but not novice, auditors use both their superior knowledge of accounting and of error frequencies learned through experience. Another implication is that the performance of novice auditors may be improved by increasing their knowledge of basic accounting principles and error frequencies.]