Empirical Evidence on Usefulness of Accounting Information
Accounting is a system that involves tracking the financial information of businesses through summarizing the activities of businesses and interpreting the financial information which is useful to managers and other decision makers in the market. Accounting is a language of business as it communicates information to stakeholders of businesses. Financial performance heavily affects stakeholders, and its evaluation is the basis of making business decisions. Accounting plays a key role to both managers and other users of financial information like creditors. To managers, relevant accurate and timely financial information helps them carry out their responsibilities which are mainly making decision. Accountants work hand in hand with all other financial areas of a business involving human resources and marketing and hence it works as a representation of the overall working of a business which can be used for efficient running of an organization. Financial information is also helpful to users outside the organization. Firm’s income statements, balance sheets, and statement cash flow are helpful in judging the financial status of an organization and shows a firm’s financial worthiness which tells if one can with it.
Accounting information has a wide range of users with the capital providers the main users in making investment decisions. The main capital providers of companies are professional equity investors, private equity investors, and internal equity and trade creditors ( Cascino et al.2014). In making decision, these capital providers evaluate the financial information in different ways, and their objectives compete when they are using different sources of information. Financial information has unique characteristics which differentiate it from other information. Financial information is regarded as very important in financial decision making and for contracting purposes and additionally, it is true to say it is the only source. Moreover, intermediaries that deliver this information to potential users both credit and equity market are very influential which makes it difficult to identify a typical user. Recent research has concentrated more on evaluating the usefulness of accounting information to investors with less attention to the importance of this informational in attending to creditors needs. Thus, it can be said decision behaviors for investors and creditors is not equally investigated. This affects its usefulness to both parties. This paper is going to discuss how useful empirical evidence of financial information are to both in investors’ and creditors and identify any gaps in studies concerning financial information needs and usefulness.
Discussion of Empirical Evidences
Investors and creditors are the main users of financial information who are assumed to be mainly interested in the figures, timing and any future uncertainties. When giving empirical evidences, accounting recognizes that the financial reporting system chosen has both private and social consequences. They are aware their financial information has different impacts on different groups of people. The choice of the system is carefully selected to influence these effects. Thus it is, therefore, a political act as well as an economic act. Today accounting information is directed more to the primary users who are the creditors and investors, and these users do not fully represent the political actions of accounting but the economic functions.
According to Gordon’s dividends valuation model, accounting data and models are useful in determining the relationship between the data and the value of the firm (Penman 2015). In other words, it is useful in firm valuation. The valuation model gives an implication that the current value of the firm to stakeholders represents the future dividend expectations by stakeholders. From Gordon’s valuation model, the accounting information in determining the value of the firm helps in weighing expected future dividends and act as a function of future incomes. The current accounting information is, therefore, useful in predicting future earnings with respect to present earnings (Penman 2015).From this perspective, it is clear that accounting information is useful in valuing the performance of the firm in future. Investors and creditors can predict how the firm will function in future by gauging its current stability and influencing factors.Moreso, these users can further get evidence from the performance history of the organization and see whether its performances is deteriorating or improving. Financial information is, therefore, useful in determining the economic activity of the firm and its potential for success.
In any organization, the most used models for measuring accounting tension are cash flows and stocks. Views from flows and stocks are useful in analyzing issues when it comes to financial reporting. The two main approaches used to analyze issues in financial reporting are income statement approach and balance sheet approach. The income statement provides an organization’s expenses and revenues while the balance sheet values the firm’s assets and liabilities (Kusano 2012). These approaches are useful in calculating the equity value from the book value of the net sets. This valuation is done using the market prices. This helps users especially the creditors know the worthiness of a firm and if it is feasible to work with. The equity value can also be estimated by capitalization if the current earnings are expected to persist therefore indicating permanent earnings. These uses are the ideal situations where equity value based on current earnings assume perfect and complete market. In reality, however, markets are never perfect or complete. Investors use current information to forecast the stream of future incomes and actually allocate these cash flows to each period. Although investors are usually well informed about their investment projects, it is impossible to predict future market trends in their investment decisions.Kusano (2012) suggested the use of both net assets and income in estimating the equity value so that when ideal accounting models based on flow and stocks are incorporated, real accounting models exists in between.
Investors and creditors analyze accounting information of a company and use the adopted systems to assess the performance of a company. An example is financial ratios which are used to determine the financial standing of a company (Karilainen 2014).Creditors and investors are major actors in the economy, and the accounting information is essential to them in making decisions. It allows them to estimate possible future returns and also know how their capital is going to be used once committed. In order to attract these players, firms may be tempted to cheat or give wrong valuations of their statements. This is one of the reasons the transparency issues have been raised to understand whether the information presented by firms is true and therefore useful to creditors and investors. Creditors use financial statement when they decide to begin lending, and Karilainen (2014) implied that financial statements and specifically the income statement, the balance sheet, and the cash flow statement, are the are most frequently used to assess the stage of a company.
Maaloul and Zéghal (2015) criticizes that accounting information has lost relevance to the users. The study explains that the balance sheet has been stable in its relevance, but the income statement can just be used for current purposes. In this regard, I think the economy is changing the factors that were affecting the financial status of an organization earlier on have changed. Today factors like inflation and competition play a major role in impacting the financial position of a firm especially if a firm do not keep its operation relative to those influencing factors. This makes it too difficult for investors and creditors to predict how a firm might adjust to those factors and if the future is visible. It is important to assess and consider if financial statements are still primary sources of information for its uses and whether there is other ways the users can get information that is satisfactory useful. Studies have focused on ways that resolve transparency and usefulness issues. According to Chen et al., (2011), Financial Reporting Quality (FRQ) has been found to be effective in investment efficiency in U.S publically traded companies. This journal reveals studied that show lower FRQ in private firms, it also shows that FRQ is lower in countries with low investor protection and with strong conformity tax and financial reporting rules. The journal used firm-level data from the World Bank and found empirical evidence that positive FRQ positively affects the efficiency of investments.
The strongest empirical evidence is in capital market research concerning accounting earning numbers on a yearly basis. The study of Ball (2013) showed that the magnitude and direction of these accounting earnings were associated with changes in security prices. The capital market research uses the assumption that equity market is efficient. Market efficiency is defined as per the efficient market hypothesis and market impounds the information into share price upon release. Information in accounting equity market is assumed as semi-strong, and therefore the efficient and relevant information is not ignored by the market. This allows investors to use such information for assessing risk and returns. Capital market research has proved to be an evident proposition in market foresting. The accounting information is important in linking investment decision-useful to investors.
Investor and creditors are the main users of accounting information in decision making, and its usefulness is key in the economy. The current financial information of any company had been useful in predicting the future potential performance of a business and since the outcome of prediction is not guarantee if this information is independently used, the users are nowadays incorporating other influencing factors to be closer to the real outcome. Transparency issue has been a concern and honesty of companies especially in the private companies is not guaranteed. This is what prompted users of financial information to consider governed institution so that they can get financial quality reporting. Key empirical evidence especially the capital market research has also been useful in creditors and investor decision making. So far it is clear financial information is and remains critical, and a key to its users and quality should be enhanced for example through investor protection governance. This will shape the economy and prevent any future uncertainties within the economy due to misleading financial information. Additionally, the accounting information will remain relevant to its users and its roles will be maintained.
Ball, R., 2013. Accounting informs investors and earnings management is rife:
Two questionable beliefs. Accounting Horizons, 27(4), pp.847-853.
Cascino, S., Clatworthy, M., García Osma, B., Gassen, J., Imam, S. and Jeanjean, T.,
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Chen, F., Hope, O.K., Li, Q. and Wang, X., 2011. Financial reporting quality and
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Karilainen, M., 2014. Usefulness of Financial Accounting Information in
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Kusano, M., 2012. Does the balance sheet approach improve the usefulness of
accounting information? The Japanese Accounting Review, 2(2012), pp.139-152.
Maaloul, A. and Zéghal, D., 2015. Financial statement informativeness and
intellectual capital disclosure: An empirical analysis. Journal of Financial
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Penman, S. H., 2015. Valuation models. The Routledge Companion to Financial Accounting Theory. London: Routledge. p.236. https://books.google.co.ke/books?hl=en&lr=&id=ezisCQAAQBAJ&oi=fnd&pg=PA236&dq=Gordon%E2%80%99s+dividends+valuation+model+journal&ots=tVJZHNXVYU&sig=6yVmTq5c6HOW73xUgOpJdHyHOls&redir_esc=y#v=onepage&q&f=false