Presents a letter to the editor in response to an article related to regression analysis.

The article reports on the results of an analysis of the switch to straight-line depreciation from accelerated depreciation by several steel companies in 1968. Measuring the impact of the change in depreciation accounting is a relatively clear-cut and objective procedure. Attempting to determine the reasons for the switch to straight line is a much more elusive task. Many would speculate that the chief motive behind the change was the desire to increase profits. In general, an examination of the annual reports of the companies involved reveals that none offer this as the reason for the move to straight-line. The particular set of accounting alternatives used by a firm can be thought of as adding a unique "quality dimension" to the earnings. The more conservative the accounting alternatives, the higher are the "quality" of the earnings. Thus, the switch to straight line depreciation from accelerated depreciation would reduce the quality of the earnings and therefore also reduce the rate at which they are valued.

The accounting fraternity has employed regression analysis rather infrequently. This article presents an application of multiple regression analysis to cost control. The context of the application is the consumer finance industry where extensive decentralization makes effective cost control extremely important. The consumer finance industry is made up of companies whose principal activity is making personal installment cash loans under state small loan laws. The cost behavior model employed in this article is developed from the results of multiple regression analysis of cost and other operating data of branch offices of a major consumer finance chain. While the consumer finance industry is used as the basis, it should be emphasized that the procedure outlined would be applicable to other types of businesses as well. The article shows that an important requirement for the applicability of the procedure is the existence of a relatively large number of homogeneous operating units. Consumer finance companies meet this requirement particularly well. However, other types of business also operate with large numbers of homogeneous units-food including service chains and lodging chains. The procedure outlined would, therefore, be applicable to them as well.

Reviews the book "Information for Decision Making--Quantitative and Behavioral Dimensions," 2nd ed., edited by Alfred Rappaport.

In recent years, several studies have appeared which provide some support for an inverse relationship between earnings variability and share price.' That is, increased variability in reported earnings, other things equal, appears to reduce the price of a firm's shares. A rationale for this behavioral phenomenon has been suggested by several accounting writers. Almost two decades ago Hepworth contended that :2

ABSTRACT: This study tests the proposition that the 20 percent ownership percentage criterion for application of the equity method influences firm investment decisions. A sample distribution of firm investment positions indicates an unusually heavy concentration of positions at or near 20 percent. The characteristics of 19 to 19.99 percent investees (carried at cost) are then contrasted with 20 to 20.99 percent investees (carried at equity) on dimensions of profitability and earnings covariability. The results suggest that the extent-of-holding dimension of firm investment decisions is influenced by the ownership criterion. This finding implies that the underlying standard (APB 18) has an economic consequence. This result should be of interest to accounting scholars, as well as of potential value to the FASB as it reconsiders accounting standards for consolidations and the equity method.

[This study tests the proposition that the 20 percent ownership percentage criterion for application of the equity method influences firm investment decisions. A sample distribution of firm investment positions indicates an unusually heavy concentration of positions at or near 20 percent. The characteristics of 19 to 19.99 percent investees (carried at cost) are then contrasted with 20 to 20.99 percent investees (carried at equity) on dimensions of profitability and earnings covariability. The results suggest that the extent-of-holding dimension of firm investment decisions is influenced by the ownership criterion. This finding implies that the underlying standard (APB 18) has an economic consequence. This result should be of interest to accounting scholars, as well as of potential value to the FASB as it reconsiders accounting standards for consolidations and the equity method.]

Reviews the book "Essays in British Accounting Research," edited by Michael Bromwich and Anthony G. Hopwood.

The article comments on the paper "Segmental Financial Disclosure by Diversified Firms and Security Prices," by R.F. Kochanek, published in the April 1974 issue of the journal "The Accounting Review." Kochanek studied the relationship between segmental disclosure by diversified companies and the forecastability of their earnings. Kochanek's test of the impact of segmental disclosure on earning forecasts employs an indirect measure of the forecastability of earnings. While Kochanek's sample companies are diversified, some would appear to fall primarily into industry groups which vary in earnings volatility. The possible impact of number of segments or industry factors on earnings forecastability bears on Kochanek's results only if quality of reporting varies systematically with number of segments or industry affiliation. To test for this, the authors computed the correlation between number of product lines and Kochanek's disclosure scores. Kochanek executed a creative but inadequately controlled piece of research in attempting to study this relationship.

This article presents information on the smoothing hypothesis in accounting. This hypothesis assumes that managers perceive their performance measure to be a decreasing function of earnings variability. Based upon this assumption, managers could be expected to make accounting policy decisions which tend to smooth reported earnings. The focus of this paper is on the differential impact of the cost versus the equity method of accounting for unconsolidated subsidiaries. Assuming that dividends typically fluctuate less than earnings, one might reason that the cost method would generally result in smoother reported earnings for the parent. However, closer examination shows that even if subsidiary dividends fluctuate less than subsidiary earnings, the equity basis can still result in smoother reported earnings. The least squares criterion was used to develop a linear relationship between earnings and time on each basis. The slope co-efficient of the line was used as an estimate of the rate of growth in before-tax earnings. Thus, each firm had a growth rate estimate for each valuation basis. The variability of earnings about the linear trend line described above provided the basis for a measurement of earnings variability. The actual measure of earnings variability used was the mean square error (MSE) of earnings about the linear trend line standardized by dividing by average earnings over the time period considered.