Corporate Financial Reporting and Performance

A New Approach

Önder Kaymaz, Özgür Kaymaz, A. R. Zafer Sayar

• Publisher: Palgrave Pivot
• Year: 2015
• Print ISBN: 9781137515322
• eBook ISBN: 9781137515339
• Topic: Business
• Subtopic: Accounting
• Index: Business

Globalization and the accompanying investment facilities available have resulted in rapid popularity for international financial reporting standards (IFRS). However, differences often exist in terms of what firms report, and once inconsistency between tax regulations and financial reporting regulations occur, differences between taxable and accounting practices are inevitable. This book introduces a new approach to corporate financial reporting by investigating goal incongruence (GING) in the context of the principal and agent (PA) setting. The authors argue that improving the method for the disclosure of information would not only increase the quality of corporate financial information and reporting but also reduce the possibility of any GING arising. This book presents the financial implications of international accounting and financial reporting standards (IAS and IFRS), presenting numerous real-life situations, cases, examples and implications to reveal how GING might influence the implementation of corporate financial reporting of profit volumes and sizes, which are the leading drivers of and widely accepted proxies for corporate financial performance.

1

Introduction

Abstract: The first chapter, Chapter 1, is comprised of three sections. It makes the introduction. The first section provides a detailed background on our understanding of corporate financial reporting and performance as well as the interface between them given international financial accounting and standards (IAS and IFRS). The second section sets the main research goals and establishes the research objectives. It provides the motivations inspiring this very book. The third section presents the organization and structure of this book. Chapter 1 stresses the salience and relevance of globalization, explores some of its important effects in our financial world and vouches for a new approach. It lays the foundations on examining the strong bond between corporate financial performance and corporate financial reporting.

Kaymaz, Önder, Özgür Kaymaz and A. R. Zafer Sayar. Corporate Financial Reporting and Performance: A New Approach. Basingstoke: Palgrave Macmillan, 2015. DOI: 10.1057/9781137515339.0005.

This chapter has three sections. Section 1 provides a detailed background. Section 2 describes the research goals and objectives and discusses the motivations behind this book. Section 3 describes how the book is organized and structured.

1.1Background

In today’s world, things change incredibly quickly. However, we are adapting to these daily changes faster than we ever would have imagined. Globalization, a term commonly used by almost everyone to refer to everything, has made the world a unique place for quickly exchanging ideas, and the powerful variety of these ideas is unquestionable. Accounting, finance, economics, international relations, politics and all related fields belonging to the social sciences have surely been influenced by this magical word: globalization.

A common reflection of globalization in the financial world is the need for a global corporate financial understanding and reporting. Global corporate financial reporting is increasingly recognized as being linked to International Financial Reporting Standards (IFRS), which technically pertain to the implementation side of the International Accounting Standards (IAS). As their names clearly suggest and advocate, the IAS and IFRS were introduced in the financial arena to yield common accounting measurements that could be agreed upon and adopted by the vast majority of global financial institutions and organizations. IFRS was first introduced in Europe and then rapidly spread across the globe, including to the United States and many other countries. They have become a global financial reporting framework that is gaining momentum every day (e.g., FASB at www.fasb.org).

IFRS has experienced such swift popularity perhaps because of globalization and what it entails, as mentioned above. For one, globalization undoubtedly offers unlimited investment facilities because the main philosophy underlying globalization is to consider the entire global economy as an all-in-one investment hub.

People thus needed to discover a tool to guarantee and manage common financial knowledge, at least to a reasonably high degree. They thought that a tool that generated common knowledge would be the primary way to ensure highly compatible financial statements. Highly compatible statements are meant to secure the highest level of financial integrity, consistency and comparability.

Thus, these standards were established to make compatibility possible in the following ways: (1) the financial statements that a given corporation would report in one country would feature properties that were identical to those in the financial statements that a different corporation would report in another country, and (2) looking at a financial statement reported by a given corporation in one country, a person who was not a resident of that country and had no knowledge of its language would be able to clearly and accurately understand and interpret that statement after obtaining a translated version. With this very challenging (and ground-breaking) idea in the financial sphere, the IAS and IFRS were born and have continued advancing. In other words, the major motive underlying the creation of IFRS has been the worldwide standardization of corporate financial reporting and its implementation. This idea presents challenges, as everyone needs to agree on these standards.

Before IFRS, every country had its own customs, legislation, accounting practices and financial judgement. However, many countries adopted some basic principles that they thought should strictly hold for any business reporting its financial statements. These principles were commonly known as the generally accepted accounting principles (GAAP). GAAP are still a part of IFRS in many judiciary outlets, as the transition is not yet entirely complete. The transition began with the convergence of GAAP-driven corporate financial statements and reporting and IFRS. It is now known as its first-time adoption (e.g., KGK at www.kgk.gov.tr, FASB at www.fasb.org, IFRS at www.ifrs.org).

Every country had its own GAAP until IFRS was introduced. For instance, the HGB (Handelsgesetzbuch: German Commercial Code) in Germany was and is still a major part of the German GAAP. BAFIN (Bundesanstalt Fuer Finanzdienstleitungsaufsicht), which is the Federal Financial Supervisory Authority, has been the main supervisory board for auditing a wide range of companies in the financial services industry. A similar structure was previously implemented in the United Kingdom. Until recently, the Financial Services Authority (FSA) audited firms in the financial sphere (e.g., Bafin at www.bafin.de, Kaymaz and Karaibrahimoglu, 2011).

The Securities and Exchange Commission (SEC) Code has become an integral part of the US GAAP, particularly for listed (public) companies that trade in the stock exchanges in the United States. In addition to the regulatory arrangements stipulated by the SEC, regulations initiated by the Financial Accounting Standards Board (FASB) have also been in place, especially for the private sector, for more than three decades. Similarly, the Financial Reporting Council (FRC) in the United Kingdom acts as a standard setter. The Capital Markets Law (SPK) and Commercial Code (TTK) in Turkey have also become major parts of the Turkish GAAP. The Public Oversight Accounting and Auditing Standards Authority (KGK) (an independent authority) recently implemented the Turkish Accounting Standards (TAS) and Turkish Financial Reporting Standards (TFRS), along with other standards (e.g., SEC at www.sec.gov, FASB at www.fasb.org, KGK at www.kgk.gov.tr, SPK at www.spk.gov.tr).

However, despite the fact that each country had its own financial reporting customs, because of the potential generalizability of their GAAP, it was still possible to have partial comparability among the corporate financial statements of different economies with different judicial (reporting- and tax-wise) regimes—although full comparability was de facto impossible. Therefore, before the emergence of IFRS, there was still a tendency to use unique financial reporting. In other words, the transition from various extant financial reporting systems to IFRS was something that was expected and in the works for quite a long time.

IFRS was first considered for the major corporations/large enterprises (LEs), perhaps because they are the major businesses that lead economies with their workforces, market power, production facilities and funds raised. They are the forces catalysing economic growth and development. Furthermore, in many countries, they are listed companies whose stocks are fluctuating in stock exchanges and capital markets. For this reason, what they do, how they do it and even why they do it matter for their investors and regulators, among others; hence, the data that they regularly publish and report to different stakeholders strictly concern its users. All of these factors combine to make the major corporations impressive in the eyes of the standard setters, the regulators involved and the practitioners concerned.

Nonetheless, IFRS has also been designated for non-major corporations, including small and medium-sized enterprises (SMEs). In fact, worldwide, SMEs overwhelmingly outnumber LEs.

By definition, IFRS is based on the idea of full disclosure. The disclosure of corporate financial information is an immediate need when developing IFRS or setting up any corporate financial reporting. The release and dissemination of financial information in a timely, appropriate and accurate manner is especially critical for stakeholders in public companies, as they are major (large-scale) corporations. Among their leading stakeholders are shareholders, investors and creditors. For this reason, without a decent disclosure framework, any corporate financial reporting scheme, especially IFRS, will not work. Therefore, we can argue that if the corporate financial disclosure system is more suitable, then the IFRS is implemented more efficiently and effectively.

On the other hand, SMEs are smaller than LEs and do not lead economies. Unlike those of LEs, SMEs’ technical capacities are usually insufficient: their production facilities are quite restricted; their financing structures are unbalanced and their equities are often inadequate to survive in the markets that they enter. In addition, contrary to LEs, they have slim chances of creating employment. Although it will be hard for SMEs to totally comply with IFRS in the near future, IFRS is still envisaged for use in SMEs, as mentioned earlier. IFRS has been developed with the aim of addressing and covering business of (1) any type and (2) scale that must comply with financial reporting (e.g., Kaymaz and Karaibrahimoglu, 2011).

Corporate financial performance and its measurement have always been important for businesses and their stakeholders. Corporate profits, one way or another, have been widely recognized as financial highlights that signal corporations’ financial performances. The higher a business’s profits, the more successful it is considered to be. However, a business’s financial success relies on many things. Regardless, profits always rank first or at least top of list of many other highlights. This focus on profits is especially true in LEs in general and in public companies in particular. The financial information released by public companies whose stocks are traded in stock and capital markets is of immeasurable significance for their shareholders, investors and creditors, among other stakeholders. In addition, the full disclosure of corporate financial performance information is first and foremost published as a component of the financial information released to the public.

As an extension of corporate financial reporting practices and implementations, we observe that firms often differ in terms of what they report. Irrespective of their significance, these differences require some customizations in the reported incomes/revenues, expenses/costs and, in turn, profits. Indeed, even though firms report their financial performance activities in fairly convenient ways, they might still have problems with their reported bottom lines. The root cause of these problems lies rather in the definitions of accounting and taxable profits. Accounting profits are reported corporate profit figures that follow corporate reporting customs, regulations, arrangements and, ultimately, practices. However, taxable profits are the corporate profit figures that happen to be created, as opposed to those that follow tax laws. Once divergences or inconsistencies between tax regulations and financial reporting regulations occur, the differences between taxable and accounting practices will be inevitable.

This book adopts a new vision to develop a better understanding of accounting and taxable profits, which are both related to corporate financial performance. This vision shows that the goal incongruence (GING) issue, crossing the interests of the principal with those of the agent, might cause significant variation in the level of corporate profits and thus introduce a dichotomy: accounting profits versus taxable profits. We therefore consider any practice that involves the improper handling of corporate financial performance reporting to be GING. Handling a given corporation’s financial earnings indicators therefore relates but is not limited to issues such as financial recognition, financial reporting, accruals, earnings quality, mandatory disclosure, voluntary disclosure, tax shelters, earnings repatriations (relocations or shifts), earnings strips and any other (legally) unacceptable practices.

Following the aforementioned considerations, this book introduces a new approach to corporate financial reporting by investigating GING in consideration of the principal-agent (PA) setting, as explained earlier. We argue that a better way of disclosing information will not only increase the quality of corporate financial information and reporting but also reduce the possibility of any GING arising.

In this book, to deeply examine the theoretical and analytical frameworks on which real-life applications have been documented to be based, we consider the PA setting to play a primary role. We also show the financial implications in accordance with a consideration of international accounting and financial reporting standards (IAS and IFRS). In addition to these theorizations and analyses, we present numerous real-life situations, cases, examples and implications. The next section presents the goals and the objectives that this book strives to accomplish.

1.2Objectives

As mentioned in previous discussions, this book seeks to show the strong bond between corporate financial performance and corporate financial reporting in the presence of GING. It introduces a new approach by theorizing about and analysing the suggested linkage and presents many cases and examples to demonstrate what it might imply and how it might be applied to or be implemented in the real world.

This book has several aims. First, it aims to show the strong linkage (bond) between corporate financial performance and corporate financial reporting in the presence of GING. For example, it seeks to show how GING might give rise to significant differences in the definitions of corporate financial performance. These differences are shown to occur in the case of accounting and taxable profits. In other words, this book strives to determine the reasons for the differences between reported accounting profits and taxable profits. It shows how GING might play an important role in profit changes. Even though we acknowledge that GING may not be the only reason for these profit changes, it is arguably one of the most important drivers with influential effects in the financial world.

Second, this book aims to show how to measure the effect or the degree of the effect of GING. To this end, we benefit from the emerging concept of treasury loss, which pertains to the difference between accounting profits and taxable profits. We also discuss its legal implementations and implications, as well as its significance and relevance to the subject matter. Third, this book strives to document real-life situations, cases or other evidence related to how GING might influence the implementation of corporate financial reporting of profit volumes/sizes, which are the leading drivers of and widely accepted proxies for corporate financial performance.

As mentioned above, this book adopts a new vision to develop a better understanding of varying corporate financial performance results, such as accounting and taxable profits. We use a catch-all definition and thus consider such business practices to be GING, which might significantly alter corporate financial performance. In other words, we argue that GING might trigger corporate accounting profits to be significantly different from corporate taxable profits.

Such a scope will also include all/any practices and approaches affecting the magnitude, quality, stream, flow and quantity of the financial earnings. These considerations encompass approaches based on good or bad faith. Therefore, our definition of earnings manipulation/management is broader than and different from that in the extant literature. This broad definition has been chosen to ensure the replicability, generalizability and validity of our examinations to the greatest ex...

Table of contents

• Cover
• Title
• 1  Introduction
• 2  Theory and Analysis
• 3  GING and Corporate Earnings
• 4  The Model
• 5  Applications
• 6  Conclusion
• Bibliography
• Index