Fudged Accounting Theory

Fudged write up Theory and Corporate supplement Audra Ong and Roger Hussey raise This orbit is a follow-up of the denomination Fudged history Theory yard from the UK in the journal of attention look for (Ong, 2003). In that article, an analysis of the flexibility at bottom the UK regulations, which eitherowed companies to wasting disease unlike explanation give-and-takes for nonphysical asset amplifications, was illustrated to sign fudged account speculation (Murphy, 1990).This paper extends that earliest work by examining the linkup amidst corporate supplement and business human alliance choice in the UK at a catamenia when the extant be system measuring stick for manipulatemliness, SSAP22 account statement for Good leave behind (ASC, 1989), permitted 2 very different accounting treatments. As a issuance, newly(prenominal) nonphysicals, intermiticularly brands, could avoid the regulatory strictures. For the parade take away, a serial of hyp otheses relating to corporate supplement and capitalisation of nonphysical assets were analyzeed.The results of the enter paper assert fudged accounting theory by providing try that thither is a affinity amidst the widespread capitalization of thanksgiving/brands and the family with supplement. The results butt on that financial managers volition tend to adopt accounting practices that result in harder equaliser wheel polls. Keywords leverage, Fudged accounting system, impalpable Assets, Brands/ saving grace, diet/ sw wholeow/Media Industries, internationalist reportIntroduction The importance of Fudged be Theory in infrastanding the accounting treatment of nonphysical assets has been discussed in an in the beginning paper by Ong (2003) in the journal of precaution explore. The purpose of the interpret paper is to investigate whether there is statistical certainty that companies benefit nonphysical assets for the betterment of their residue carpe nters planes in a peak of on the loose(p) accounting regulations or ambiguity in regulations. This has been set as fudged accounting theory (Murphy, 1990 Tollington, 1999).Audra Ong Roger Hussey University of Windsor, Odette calling School, 401 Sunset Avenue, Windsor, Ontario, N9B 3P4 Canada In this study, the UK was elect beca hire accounting for free grace was regulated under SSAP 22 invoice for grace issued by the bill Standards citizens committee (ASC) in 1984, which was subsequent revised in 1989. This standard whollyowed unlike treatments companies could either write grace of God at present against militia in the difference bed sheet thus bypassing the profit and loss account or capitalize it as an asset on the balance sheet depicted object to amortization.To add to the confusion, the standard did non make to some other intangible assets and few companies chose to discover brands from good exit and treat them as everlasting items on the balance sheet wi th no amortization (Barwise et al. , 1989 Paterson, 2003). This presented a signifi finishter balance sheet with no impact on the income statement. To use up the study, the maven-year reports and accounts for the five-year period 1993-97 for 143 companies listed on the capital of the coupled Kingdom roue Exchange were analyzed. Using the foregoing work of Archer et al. (1995), a series of hypotheses were effected and psychometric essayinged.As the precedent is sexual sex actly weensy and is non-parametric in nature, the chi-squ bed test victimization Yates chastisement was employed to test the hypotheses. After a brief review of the literary works, the look for forge of this study is explained. The main part of the paper, go under the heading of Results and Discussion, is concerned with test a turning of hypotheses. Previous look into Conside proportionalityn of intangible assets has been dominated by uncertainty over the leave accounting treatment of good le ave al wizing (Egginton, 1990). In the UK, the much(prenominal) or less acrimonious surround is fuelled by unafraid opinions rather than facts.The depth and range of opinions has been well(p) documented in the academic literature (Damant, 1990 Napier & Power, 1992 McCarthy & Schneider, 1995 Hussey & Ong, 1997, Ong 2001 Oldroyd, 1998 Joachim Hoegh-Krohn & Knivsfla, 2000 Cravens & Guilding, 2001) as well as in professional reports (Coopers & Lybrand, 1990 Tonkin & Robertson, 1991 Hussey, 1994). The publication of SSAP 22 did brusque to calm the debate. Under that standard, companies faced the offensive alternatives of writing off goodwill against reserves and weakening their balance sheets or amortizing against earnings.Consequently, intangible assets such as brands and publication titles began to issue on the balance sheets of a number of well-known companies. Identification of such items as intangible assets, separate from goodwill meant that they did not f wholly under th e conveyments of SSAP 22. The intangible assets could stay put on the balance sheet indefinitely, unless there was a permanent evil in nourish. This contention that the appearance of brand valuations on the balance sheet had been motivated by the desire to correct or remedy the balance sheet has been evident in several studies.Emanating mainly from the debt covenant lift and the early work of Zmijewski and Hagerman (1981), studies eat shew support for the debt covenant surmisal (Mather and Peasnell, 1991) and evidence that a partys end to spate 4, minute 3 declination 2004 capitalize brands was influenced by London Stock Exchange rules on acquisitions and disposals (Muller, 1999). There has been some debate on the importance of intangible assets in private debt contracts (Citron, 1992 Day and Taylor, 1995).The study which nearly closely relates to the present enquiry and shargons the aforementioned(prenominal) theoretical foundation was publish by Archer et al (199 5) and was base on work conducted on 71 annual reports of UK and French companies for the period 1988-92. This sooner research concluded that a sort with high leverage is more(prenominal) probable to capitalize goodwill and/or brands than a group with low leverage. The results, however, were stronger where goodwill and brands were coalesced although it is potential that the differing regulations in the devil countries whitethorn defend distorted the data. interrogation Design The annual reports and accounts for the five-year period 1993-97 of 143 companies in the aliment, crisp and media industries were obtained. much(prenominal) period of time is chosen as the debate on the most eliminate accounting treatment for goodwill and intangible assets was at its greatest and accounting practices were the most varied during this period. It likewise immediately preceded the changes to accounting introduced by federal official 10 free grace and intangible asset Assets issued by the ASCs successor, the account Standards Board (ASB, 1997) and federal official 11 check of Fixed Assets and Goodwill (ASB, 1998).Industries for the study have been chosen whose products are highly brand and also where companies in the industries have been strong in acquisitive activities. The caller-out profiles and promulgated financial information of these 143 companies were checked to see which companies capitalized intangible assets for the entire five-year period 1993-97. The relevant population, which capitalizes intangible assets, is 15 food and foxable companies and 28 media companies, resulting in a ingrained of 43 companies.It should be noted that the remain 100 companies either did not capitalize intangible assets in any one year, or only capitalized intangible 157 assets for part of the five-year period post -1993. Care has been taken above in explaining the standard use in this study because of its congressly beautiful surface. Although this may be reg arded as a limitation of the subsequent analysis, a non-parametric test is used in the analysis of individualistic industries and this is generally regarded as defensible and pleasurable in such circumstances.Yates correction has also been applied to the chi-square tests to achieve conservatism in establishing signifi coffin nailce so that the results provide be regarded as conservative and less probably to overstate the importance of the findings. Correlation tests are only conducted on the aggregate sample of twain industries. The leverage ratio was delimitate as debt expressed as a percentage of capital employed (Reid and Middleton, 1988) because this interpretation was used in earlier studies and it provides a high distributor point of precision.Results and Discussion supplement and capitalization The following two hypotheses were established in respect of the possible association between leverage and brands H1 A company with high leverage is no more probably to capi talize intangible assets than a company with low leverage. H2 A company with high leverage is no more credibly to capitalize goodwill/brands than a company with low leverage. To test these hypotheses the average(a) leverage was established for the aggregation of companies capitalizing intangible assets, and for those companies not capitalizing the same.In some instances the median(a) leverage did not provide a ingredient of the sample to provide a able number in each cell. In those instances a cut-off leverage take aim was selected to reckon cells of sufficient size and this is explained where it occurs. Contingency tables were constructed for the chisquared test and the results are described below. In all instances, Yates correction was applied. Media manufacture Hypotheses 1 and 2 were tried separately on the Media perseverance and on the Food and fuddle Industry. The results for the media patience for all intangible assets are shown in circumvent 1.In this test, the median leverage for the media fabrication was 28%. The chi-square test was solid at the 0. 01 take with a chi-square element of 6. 86447 and 1 peak of freedom. The null hypothesis tail end indeed be rejected and we underside rent that high-leveraged companies are more likely to place intangible assets on the balance sheet than low-leveraged companies in the media industry. dining table 2 carries out the same test for the same industry but analyzes only those companies capitalizing goodwill and/or brands. In this instance the median leverage was 31% and this was change magnitude to 32% to ensure cells of adequate size.The chi-square test was fundamental at the 0. 01 level with a chi-square factor of 7. 286 and 1 degree of freedom. The null hypothesis fag therefore be rejected and we can accept that high-leveraged companies are more likely to place goodwill/ brands on the balance sheet than low-leveraged companies in the media industry. dining table 1 Contingency circ umvent for Media Industry viewing Leverage and capitalization of all impalpable Assets Capitalizing Leverage 28% Leverage ? 28% spy anticipate Observed pass judgment 914. 26 1913. 74 non capitalizing 1812. 74 712. 6 derive 27 26 158 diary of care Research Table 2 Contingency Table for Media Industry Showing Leverage and Capitalization of Goodwill and/or Brands Capitalizing Leverage 32% Leverage ? 32% Observed expect Observed Expected 59. 93 149. 07 non capitalizing 1813. 07 711. 93 Total 23 21 Table 3 Contingency Table for Food and Drink Industry Showing Leverage and Capitalization of all Intangible Assets Capitalizing Leverage 26% Leverage ? 26% Observed Expected Observed Expected 510. 74 104. 26 Not capitalizing 4842. 26 1116. 74 Total 53 21Table 4 Contingency Table for Food and Drink Industry Showing Leverage and Capitalization of Goodwill and/or Brands Capitalizing Leverage 18% Leverage ? 18% Observed Expected Observed Expected 59. 80 72. 20 Not capitalizing 5348. 20 610. 80 Total 58 13 Food and Drink Industry The next two tables are concerned with the Food and Drink Industry. The median observe for leverage was calculated at 18% for all intangible assets and in the following table an arbitrary cut-off head up of 26% has been selected to ensure cells of adequate size and Table 3 shows the result for those companies capitalizing all intangible assets.The chi-square test was significant at the 0. 01 level with a chi-square factor of 11. 292 and 1 degree of freedom. The null hypothesis can therefore be rejected and we can accept that highly leveraged companies are more likely to place intangible assets on the balance sheet than low-leveraged companies in the food and drink industry. Table 4 shows the results for those companies capitalizing goodwill and/or brands in the food and drink industry. In this instance the median leverage level of 18% was accepted for the calculations. Volume 4, Number 3 December 2004 The chi-square test was signifi cant at the 0. 1 level with a chi-square factor of 7. 604 and 1 degree of freedom. The null hypothesis can therefore be rejected and we can accept that highly leveraged companies are more likely to place goodwill/ brands on the balance sheet than low-leveraged companies in the food and drink industries. Capitalization as a help of the Level of Leverage Two except hypotheses had been established found on the supposal explored by Archer et al. (1995) that the economic regard as of intangible assets was a head for the hills of leverage, in other words the higher the leverage ratio the higher the value of intangible assets.H3 The value of intangible assets will be associated with the level of leverage. H4 The value of goodwill and/or brands will be associated with the level of leverage. 159 These hypotheses have been tested in previous research with clean contradictory results. It was considered that this study with its larger sample and separate focus on two industrial sectors mi ght provide more conclusive results. Additionally, it was decided to extend the variable stars. introductory studies have concentrated only on the unassailable value of intangible assets i. e. the sacrosanct amount appearing in the balance sheet. For the resent study a new variable of relative value was introduced and to test these hypotheses two aspects of the value of intangible assets were considered i. e. a) its absolute value, i. e. the amount capitalized in the balance sheet (INTASS) b) its relative value, calculated by expressing intangible assets as a percentage of tot frozen assets (INTFIX). Both Industries Table 5 shows the correlation based on our 43 companies, which capitalize all intangible assets Table 5 Leverage as a Function of All Intangible Assets (Both industries) shift Gear 1. 0000 (43) P=. .0179 (43) P= . 909 . 3229 (43) P= . 035 Intass . 0179 (43) P= . 09 1. 0000 (43) P= . .1876 (43) P= . 228 Intfix . 3229 (43) = . 035 . 1876 (43) P= . 228 1. 0000 (43) P = . appears to have stronger explanatory power. It is therefore possible to state that a relationship does comprise between the level of leverage and the relative value of intangibles. In addition to looking at the sample of companies capitalizing all intangible assets, the same analysis has been conducted on the sample of 31 companies capitalizing only goodwill and/or brands. The results are shown below in Table 6. Table 6 Leverage as a Function of Goodwill / Brands (Both Industries) Gear Gear 1. 0000 (31) P= . -. 0176 (31) P= . 24 . 3275 (31) P= . 067 Intass -. 0176 (31) P= . 924 1. 0000 (31) P= . .1573 (31) P= . 390 Intfix . 3275 (31) P= . 067 . 1573 (31) P= . 390 1. 0000 (31) P= . Intass Intfix Intass Once again, Table 6 does not express a significant relationship between leverage and the absolute value of goodwill/brands. However, the association between leverage and the relative value of intangible assets is significant at 6. 7% level. It is therefore possible to state that a relationship does exist between the level of leverage and the relative value of goodwill/brands although it is less strong than that with all intangible assets.The above exam of the four hypotheses provides evidence that there is a relationship between leverage and the capitalization of intangible assets and there are differences between the two industries used in this study. The present research has also extended previous work of Archer et al b y introducing a new variable INTFIX and demonstrating that capitalization of intangible assets is a function of the relative value of intangible assets to meliorate assets. The evidence from this study therefore provides support for the fudged accounting theory. IntfixTable 5 does not demonstrate a significant relationship between leverage and the absolute value of intangible assets. However, the association between leverage and the relative value of intangibles is significant at 3. 5% level. This would suggest that the measure of relati ve value 160 diary of Management Research Implications The International Dimension Given the debate on the appropriate accounting treatment of intangible assets and the obvious deficiencies of the provisions of SSAP 22, it is not surprising that the national accounting standard body in the UK was compelled to introduce a substantial regulatory change.federal official 10 and FRS 11 have replaced SSAP 22. Essentially, FRS 10 requires goodwill and intangible assets to be accept and capitalized over 20 years. This presumption can be rebutted, however, and a longer brio or an indefinite life can be selected. In these circumstances, an annual impairment review must be conducted as specified under FRS 11. At the international level, goodwill and intangible assets were inaugural addressed by IAS 22 strain Combinations and IAS 38 Intangible Assets by the International history Standards Board (IASB) respectively. IAS 22 was issued in 1993 and revised in 1998.IAS 38 was issued for the r unner time in 1998. In sue 2004, however, the IASB published IFRS 3 trade Combinations (which supersedes IAS 22) in concert with related amendments to IAS 36 and IAS 38 as part of Phase 1 of the IASBs project on Business Combinations. IFRS 3 contains some significant differences compared to FRS 10 (Simmonds and SleighJohnson, 2003) as the former proposes that goodwill will only be subject to impairment testing and must not be amortized. In addition, goodwill and other identified intangibles, which are similar in nature, will be subject to different accounting treatments.This reduces comparability and reliability and creates a atrocious risk of accounting arbitrage or fudged accounting. The current IASB proposals in IFRS 3 demo only Phase 1 and, thus, the ASB will consider replacing UK standards only when both Phases 1 and II are complete. Therefore, UK companies should not have to change to the IFRS 3 based on Phase 1. Although IFRS 3 differs from FRS 10, the former achieves a h igh degree of convergence with FAS 141 Business Combinations (FASB, 2001) and FAS 142 Goodwill and other Intangible Assets (FASB, 2001) in the US.With respect to managers, the presentation of IFRS 3 is expected to have grave implications for brand managers and owners as well as the way trademarks are valued and accounted for (Haigh and Rocha, 2004). In particular, the separate recognition of trademarks and other acquired intangibles, together with annual impairment tests, will require companies to establish robust valuation methodologies for intangible assets in order to withstand increased scrutiny in the market.Conclusion This study compares practices in accounting for intangible assets in two industries known for their propensity to capitalize those assets in their balance sheets. The study covered the period from 199397 when the debate and uncertainty on appropriate accounting treatment was at its height. The annual reports of 143 UK companies were selected to investigate whe ther there was an association between leverage and capitalization of intangible assets. The results demonstrate that companies with high leverage in both industries are more likely to capitalize intangible assets, particularly goodwill and brands.A relationship between capitalizations of intangible assets as a function of leverage when the absolute value of intangible assets is used was not established. However, the present study added to our knowledge by demonstrating that the use of the relative value of intangible assets to fixed assets as a variable reveals that capitalization is a function of leverage. The findings from this study both confirm and extend the earlier research by Archer et al. It demonstrates that the topic of capitalization of intangible assets remains a high-yield area for the accounting researcher.The present study establishes that there are industry differences and one can speculate that these may be due to a number of factors such as acquisition activity wi thin the industry, marketing strategy in relation to brands and financial structures and motivations. An extension of the work using the variable Volume 4, Number 3 December 2004 161 INTASS could lead to illumination of the key reasons. 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Simmonds, A. and Sleigh-Johnson, N. 2003), Fundamentally impaired, Accountancy, June 100-101. Tollington, T. (1999), The Brand Accounting Sideshow, The Journal of Product and Brand Management 8(3) 204-218. Tonkin, D. & Robertson, B. (1991), Brands & Other Intangible Fixed Asset in Financial Reporting 1990-91, ICAEW, London p. 328. Zmijewski, M. and Hagerman, R. (1981), An Income outline Approach to the Positive Theory of Accounting Standard Setting/ Choice, Journal of Accounting and Economics 3 129-149. Volume 4, Number 3 December 2004 163 Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.