Connection between commonly used financial ratios and misrepresentation of financial statements of collapsed corporations

This paper unravels dynamic and intriguing shifts in the use of financial ratios in signaling corporate collapse. An empirical examination of the anecdotal evidences from notable recent corporate collapses coupled with the short-lived usefulness of financial ratios in various prediction models suggest that companies(1) that deliberately misrepresent their financial statements may have taken cues from the ratios that are commonly investigated. This proposition is supported by an extensive examination of over 50 studies conducted between 1968 and 2002. The erosion in the reliability of numbers in financial statements has led to significant distortions in the predictive power of financial ratios when used in signaling corporate collapse. Recent collapses such as Parmalat in Europe, Enron and WorldCom in the U.S. and HIH in Australia, present yet another reminder that financial statement items are being misrepresented. These are all large corporations with well-established household names, and are for sure closely monitored by financial communities around the globe. Nevertheless, a common thread seems to link the collapse of these companies: none of these collapses were foreseen by credit rating agencies or foretold by the widely accepted bankruptcy prediction models. Why? This paper attempts to use some anecdotal evidence in order to provide logical explanations to the existence of such a common thread. It argues that there appears to be anecdotal evidence to suggest that directors of publicly listed companies that have collapsed may have deliberately misrepresented financial statement items.

Connection between commonly used financial ratios and misrepresentation of financial statements of collapsed corporations

This paper unravels dynamic and intriguing shifts in the use of financial ratios in signaling corporate collapse. An empirical examination of the anecdotal evidences from notable recent corporate collapses coupled with the short-lived usefulness of financial ratios in various prediction models suggest that companies(1) that deliberately misrepresent their financial statements may have taken cues from the ratios that are commonly investigated. This proposition is supported by an extensive examination of over 50 studies conducted between 1968 and 2002. The erosion in the reliability of numbers in financial statements has led to significant distortions in the predictive power of financial ratios when used in signaling corporate collapse. Recent collapses such as Parmalat in Europe, Enron and WorldCom in the U.S. and HIH in Australia, present yet another reminder that financial statement items are being misrepresented. These are all large corporations with well-established household names, and are for sure closely monitored by financial communities around the globe. Nevertheless, a common thread seems to link the collapse of these companies: none of these collapses were foreseen by credit rating agencies or foretold by the widely accepted bankruptcy prediction models. Why? This paper attempts to use some anecdotal evidence in order to provide logical explanations to the existence of such a common thread. It argues that there appears to be anecdotal evidence to suggest that directors of publicly listed companies that have collapsed may have deliberately misrepresented financial statement items.

The impact of the adoption of IAS 19 employee benefits on annual financial statements: an examination of Australian and United Kingdom companies

International Financial Reporting Standards (IFRS) have been adopted by a number of countries as a means of harmonising financial statements around the world. Proponents of IFRS suggest many benefits upon their adoption. This paper examines the effect of the adoption of IFRS on aspects of the company's financial statements, in particular, the adoption of the IFRS relating to post employment benefits and its effects on debt/equity ratios.

This study compared the reporting practices of a number of Australian and UK companies and found that for most companies there was a substantial increase in liabilities, a decrease in shareholders' equity and a corresponding increase in debt/equity ratios after the IFRS were adopted.

Financial statements in less developed countries : what do preparers demand?

This study reports on an empirical investigation of the characteristics, attitudes, and beliefs of preparers of external financial reports in a less developed country. The basic research instrument consisted of a questionnaire in two parts: the first addressing attitudes of professional accountants toward annual financial reports generally; the second, more specifically measuring the importance of the information items to preparers. Our results suggest that the independent auditor is the most influential group in decision-making processes. As in many developed countries, the auditor’s report and the regulatory framework are considered to have a major influence on financial reporting practices. Preparers believe that a lack of knowledge of external users’ needs and lack of reporting standards and accepted accounting principles are the main concerns with corporate financial reports in Iran. The results showed that the balance sheet, auditors’ report, and income statement in that order are the three most important parts of the annual reports.

Application of the reporting entity concept and lodgement of special purpose financial statements

This Research Report analyses the application of the reporting entity concept and the adoption of special purpose financial reporting, particularly by entities lodging financial statements with the Australian Securities and Investments Commission (ASIC) and with state-based regulators in Australia’s three most populous states, namely, Consumer Affairs Victoria, NSW Fair Trading and Queensland Office of Fair Trading. This Report does not cover entities that have their equity interests traded in a public market, such as listed companies, and some other entities with ‘public accountability’.

Effects of financial disadvantage on use and non-use of after hours care in Australia

Policy addressing the provision of primary care after hours (AH) is currently in flux because of concerns about equity of access and cost. In this study we examine the effects of socioeconomic disadvantage on access to AH care and episodes of not seeking AH care when needed among users and non-users of AH care. The effects of health on these relationships were also explored. The total sample consisted of 5538 users of AH care and 891 non-users of AH care who were randomly selected for telephone interviews. Factors determining AH care included accessibility that is structural barriers to use of care such as distance and transport, as well as affordability and availability. Logistic regression was used to determine the impact of financial disadvantage on episodes of not seeking AH care. Barriers to use of AH care and household health were subsequently added to the models to assess their impact. The results suggested that there were inequities in access to AH care but these were a function of barriers to AH care use rather than financial disadvantage per se. Accessibility and availability were significant barriers to use of AH clinics among both user and non-user samples. Affordability was only a significant barrier among users of AH care. The study suggests that policy aimed at reducing these barriers may effectively address inequities in AH care but that to be optimally effective policy change would also need to be accompanied by changes in consumer awareness.

Exempt treatment of financial intermediation services under a value-added tax: an assessment of alternatives

Most countries with a value-added tax (VAT) exempt financial intermediation services from the tax. While exemption is generally perceived to be undesirable, it is also widely regarded as unavoidable because of technical difficulties in applying VAT to these services. This article reviews the standard rationale for exempt treatment and then considers the relative merits of two recent challenges raised in the tax literature. The first challenge involves the application of cash flow taxation to financial intermediation services in a manner that is consistent with an invoice/credit VAT (which is the dominant form). The second challenge proposes a comprehensive system of zero-rating of financial intermediation services, which is supported by a characterization of the household consumption of such services as non-taxable. The author argues that each of these alternatives to an exemption system suffers from both theoretical and practical implementation difficulties that make maintenance of exempt treatment the preferred approach, at least in the short term. There is, however, a simpler alternative to these fundamental reform options, involving modification of just one aspect of an exemption system to relieve some of its more problematic aspects. Many of the interpretative problems and associated inefficiencies that plague an exemption system arise from the need to distinguish between taxable and exempt financial services. The author argues that these difficulties can be eliminated, to a large extent, by basing the distinction on the form of prices. In support of this approach, he points out that it is consistent with the underlying reasons for the application of exempt treatment. The author considers a number of other possible modifications, but these are either rejected outright or viewed with a healthy skepticism. For example, the author is critical of the apparent rationale for the application of cash flow taxation to property and casualty insurers. He also rejects proposals that accept some looseness in the formulaic allocation by financial intermediaries of the costs of business inputs between exempt and taxable services for input credit purposes. In his view, an explicit reliance on pricing structures to draw the boundary between exempt and taxable services is preferable to the provision of relief for blocked input tax credits of financial intermediaries. Finally, the author is skeptical of the case for a policy response intended to address the tax bias under an exemption system for financial intermediaries to insource supplies.

Response : A defensible and workable approach to the income tax treatment of financial instruments

It is a privilege to have the opportunity to respond to the comments on my monograph1 provided by Mark Gergen, Glenn May, and Gordon Longhouse. Their comments, which are inevitably coloured by their very different perspectives, reflect the considerable expertise that each one of them has in the area of the income taxation of financial instruments. Indeed, it is with some hesitation that I offer a response in defence of various portions of the analysis presented in my monograph in support of some pretty modest proposals in this extremely difficult area of income tax law. Although I spent considerable time exploring some necessary first principles and their implications for the design of a system for the income taxation of financial instruments, I made several concessions to certain practical constraints that led me to support, in some measure, the status quo reflected in certain of the existing literature, as well as the legislation in a select group of countries. On the assumption that many readers may be unfamiliar with the monograph, I propose to respond by outlining much of my analysis in the monograph and the proposals that are the logical outcome. Throughout the outline, I will highlight and respond to what I see as the important points of difference emphasized by Gergen, May, and Longhouse.

Dimensions of financial competence

Whether or not someone has the ability to look after his or her own financial affairs is one of the most common problems brought before courts and tribunals in Australia. At present, there is no agreed-upon objective standard for assessing financial competency. The aims of this study were twofold: (1) to clarify which financial skills and tasks are considered important to adults in the Australian community when assessing financial competence; and (2) to evaluate a model of financial competence proposed by Webber, Reeve, Kershaw and Charlton. Professional service providers and students judged the importance of 61 skills, tasks and characteristics related to financial competence. The results supported a 6-factor model of financial competence. The findings suggest that it is possible to identify agreed-upon criteria for financial competency and provide a first step towards the development of a valid scale of financial competency.

A comprehensive formal ranking of the popularity of financial ratios in multivariate modeling of corporate collapse

This paper provides a fonnal ranking of the popularity of financial ratios in modeling corporate collapse. The analysis identified 48 financial ratios and ranked them according to their usefulness as portrayed in 53 studies that have utilized such ratios in modeling corporate collapse. The methodologies adopted in those studies are predominantly of the "multivariate" type. The 53 studies extend from 1966 to 2002, inclusive.

The dynamics of adult education : effectiveness of financial education seminars

This study examines the impact of adult education seminars in superannuation investments for retirement has on the investment intentions and decision making of those adults attending the seminars.  The socio-political context of the data is that of an aging population and a future government being unable to afford the current level of age pensions being paid, and attempting to encourage individuals to plan and provide for their own financial well-being in retirement.  Three themes emerged from the data and were seen to be representative of the major issues found in adult education for financial self-sufficiency: education for knowledge, education for decision making, and education for action.  In an attempt to measure the immediate impact of the seminar on the attendees decision making, the investment intentions of seminar attendees were captured at the start and end of the seminar. This was followed up three months later to see whether the intentions expressed at the end of the seminar had been implemented.  The immediate impact of the seminar was to encourage the respondents to express an intention to increase their investment strategy, however when the follow-up was done three months later, the results were mixed. Some respondents who did not express an intention to change their investment strategy actually made changes, and other respondents who did express an intention to make a change, did not do so.

Environmental reporting initiatives: towards triple-bottom line reporting or the intergration of financial and environmental performance

This objective of this study was to investigate the quantity and quality of voluntary environmental disclosures in the annual reports of the top 500 firms listed by market capitalisation on the Australian Stock Exchange. The periods examined were those immediately prior and subsequent to the release of the Exposure Draft Coalition for Environmentally Responsible Economics (CERES) Global Reporting Initiatives(GRI) issued in March 1999. Using content analysis to focus on the environmental aspects, and drawing heavily on the research of Gamble et al (1995), the study compared 425 annual reports over a two year period and 60 environmental reports, in order to explore reporting practices in the periods surrounding this intervention. The results suggest a trend to triple bottom reporting, and a significant change in the quality and quantity of environmental information, albeit in specific categories.