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A conceptual framework of accounting policy choice under SSAP 20


George Iatridis
University of Thessaly, Volos, Greece, and

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Nathan Lael Joseph


Aston University, Birmingham, UK
Abstract
Purpose To provide a framework of accounting policy choice associated with the timing of adoption of the UK Statement of Standard Accounting Practice (SSAP) No. 20, Foreign Currency Translation. The conceptual framework describes the accounting policy choices that rms face in a setting that is inuenced by: their nancial characteristics; the exible foreign exchange rates; and the stock market response to accounting decisions. Design/methodology/approach Following the positive accounting theory context, this paper puts into a framework the motives and choices of UK rms with regard to the adoption or deferment of the adoption of SSAP 20. The paper utilises the theoretical and empirical ndings of previous studies to form and substantiate the conceptual framework. Given the UK foreign exchange setting, the framework identies the initial stage: lack of regulation and exibility in nancial reporting; the intermediate stage: accounting policy choice; and the nal stage: accounting choice and policy review. Findings There are situations where accounting regulation contrasts with the needs and business objectives of rms and vice-versa. Thus, rms may delay the adoption up to the point where the increase in political costs can just be tolerated. Overall, the study infers that rms might have chosen to defer the adoption of SSAP 20 until they reach a certain corporate goal, or the adverse impact (if any) of the accounting change on rms nancial numbers is minimal. Thus, the determination of the timing of the adoption is a matter which is subject to the objectives of the managers in association with the market and economic conditions. The paper suggests that the exibility in nancial reporting, which may enhance the scope for income-smoothing, can be mitigated by the appropriate standardisation of accounting practice. Research limitations/implications First, the study encompassed a period when rms and investors were less sophisticated users of nancial information. Second, it is difcult to ascertain the decisions that rms would have taken, had the pound appreciated over the period of adoption and had the rms incurred translation losses rather than translation gains. Originality/value This paper is useful to accounting standards setters, professional accountants, academics and investors. The study can give the accounting standard-setting bodies useful information when they prepare a change in the accounting regulation or set an appropriate date for the implementation of an accounting standard. The paper provides signicant insight about the behaviour of rms and the associated impacts of nancial markets and regulation on the decision-making process of rms. The framework aims to assist the market and other authorities to reduce information asymmetry and to reinforce the efciency of the market. Keywords Accounting standards, Accounting policy Paper type Research paper

The authors gratefully acknowledge the nancial support provided by the Economic & Social Research Council (ESRC) of the UK for carrying out this research. The ESRC is not responsible for any statements in this study.

Managerial Auditing Journal Vol. 20 No. 7, 2005 pp. 763-778 q Emerald Group Publishing Limited 0268-6902 DOI 10.1108/02686900510611276

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1. Introduction Positive theories of accounting choice make several empirical predictions regarding managerial behaviour in the presence of nancial incentives and accounting change. A useful implication of the work in this area is whether a particular accounting method/rule has real economic consequences, such that users of accounting information, who are exposed to the new accounting rule, revalue the rms stock. The economic consequences of alternative accounting methods have been taken to include not only the impact of accounting change on cash ows, but also the impact of accounting change on political costs, contractual arrangements, etc. (see, e.g. Ricks, 1982). Much of the observed empirical regularities are consistent with theory. For example, Watts and Zimmerman (1978) make predictions regarding the likelihood that a rm will present its nancial reports in a manner that will ensure that the agency costs among managers, shareholders and bondholders are minimised. In this case, one can predict the attitude of managers towards an accounting standard that is likely to adversely affect a rms leverage and debt covenant arrangements when the rm is already highly geared. This study puts forward a conceptual framework that incorporates similar theoretical issues, but focuses primarily on the economic and nancial constraints imposed by SSAP 20, which is concerned with the accounting treatment of foreign exchange (FX) differences for UK rms. The conceptual framework has two important advantages. Firstly, it puts forward a comprehensive framework, in which the issues that are relevant for accounting choice are viewed on an overall basis. There is however no assumption that existing theories are complete or that the variables used to test such theories are adequate. Secondly, the framework attempts to iron out some of the conicting evidence found in the literature. For example, theory predicts that the higher the rms leverage is, the more likely it is that managers will choose income-increasing accounting methods, so as to reduce the risk of violating the debt covenants. However, managers are likely to have more information about the rm than outsiders, and this in turn can affect their choice of accounting methods (see, e.g. Holthausen, 1990). If managers are able to plan the timing of adoption, it is likely that rms will incur little or no contractual costs, thereby mitigating the need to renegotiate their contractual obligations. Under this condition, capital markets are unlikely to signal to the implementation of the standard, as the stock market would have already impounded that information into the rms stock price. This paper also provides an interpretation of managers accounting policy choice in line with their corporate goals, given their expectations of FX rates, the impact of the timing of adoption on rms nancial reports and the associated sign of foreign subsidiaries net assets/liabilities. If managers have more information about the rm than outsiders, they are likely to manipulate the timing of the adoption in order to minimise any adverse effects associated with accounting change. These accounting issues are important, particularly because they have not been explored empirically before in the UK setting. The structure of the paper is as follows: section 2 provides the theoretical background of the study together with a survey of the literature. Sections 3 and 4 present the setting for the conceptual framework and the research sample respectively.

The conceptual framework is presented in section 5, while the conclusions of the study are presented in section 6. 2. Theoretical background An important motivation of this study is the extent to which accounting policy changes can lead to economic consequences. Such economic consequences include: (1) The potential for the revaluation of a rms stock conditioned on the accounting change. (2) The extent to which managerial and investment decisions would need to be altered to minimise the adverse effects of the accounting change. Item (1) relates to the new information conveyed by the accounting change, such that analysts would revise their expectations of the rms earnings in the light of such change. For item (2), it is hypothesised that the economic consequences of accounting change could be mitigated by consciously timing the accounting change to suit the investment decisions of the rm. So, the conceptual framework is important in this setting as it can provide a basis for the analysis of the UK stock market response to SSAP 20. Alternatively, managers can resort to accounting methods, such as smoothing and risk management, to mitigate the effects of accounting policy change on the rms earnings and investment decisions. Both aspects (above) have important implications for the location of translation differences in the reported nancial statements and the timing of adoption of SSAP 20. The debate regarding the location of translation differences that arise on consolidation of the nancial results of foreign subsidiaries has been very controversial. Beaver and Wolfson (1982) among others, have argued that the impact of all FX rate uctuations on company accounts should be reported in the income statement. Also, Wojciechowski (1982) and Callaghan and Bazaz (1992) observe that the translation differences are in the nature of income and thus should be reported in the income statement[1]. In contrast, Lipe (1986), Garlicki et al. (1987), and Soo and Soo (1994) argue that the translation differences introduce volatility in the income statement, and suggest that they should be reported separately and recognised in the reserves. Following the US experience, the recognition of translation gains and losses in the P&L under the Statement of Financial Accounting Standards (SFAS) No. 8 (issued in 1975) introduced volatility and created noise in the reported earnings (see Collins and Salatka, 1993; Bazaz and Senteney, 1995). As translation differences may not be directly associated with the business strategies and performance of the foreign subsidiaries of the parent rm, their recognition in the consolidated income statement might create some distortion, and in turn affect the quality of analysts earnings forecasts (see, e.g. Ayres and Rodgers, 1994). SSAP 20 considers it more appropriate to recognise translation differences in the balance sheet. An assessment of the nancial characteristics of the adopters of SSAP 20 and the accounting measures that determined the timing of their adoption is likely to generate several interpretations of managerial behaviour and accounting policy choice. Bruinstroop and Godfrey (1992) nd that the changes in FX accounting policies of Australian mining rms were associated with changes in nancing and production

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decisions for which the accounting policies would have (adverse) impacts. The study points to a view that the change of accounting policy associated with SSAP 20 was planned, which in turn can lead to information asymmetry, if indeed the stock market did not anticipate such a process. Thus, the conceptual framework suggests that changes in the accounting policy choices of rms would depend on several factors including: . the expected impact of FX rate changes on the rms value; . the potential economic consequences of (non-) adoption including political costs; and . managers perceptions of the stock market response, given the decision to time the adoption. Accounting policy choice is also closely associated with the rms compensation and debt covenant arrangements as well as the pricing of the rms stock (see, e.g. Fields et al., 2001; Lambert, 2001). Following the implications of the agency theory (see Jensen and Meckling, 1976), managers would tend to structure their decisions taking into account the related implications for external parties. Where possible, managers might also attempt to inuence or manipulate the rms accounting numbers (see Healy, 1985; Fields et al., 2001) to show an improvement in the rms performance. The exibility in nancial reporting together with information asymmetry and the apparent lack of a strict regulatory framework can enhance the scope for judgement, subjectivity and/or earnings management/income-smoothing. The exibility in nancial reporting can allow the use of accounting methods that favourably affect the interests of both managers and shareholders (Malmquist, 1990; Christie and Zimmerman, 1994). For example, higher reported earnings can positively impact on management compensation plans, rms stock returns and shareholders wealth. 3. Background to the conceptual framework The conceptual framework seeks to interpret accounting policy choices in relation to the timing of adoption of SSAP 20. According to Glaser and Strauss (1967), the employment of empirical results in the development of theoretical frameworks can lead to the construction of valid and reliable theories. The accounting literature is used to validate and strengthen the structure of the conceptual framework, making use of new and existing empirical results[2]. This paper seeks to tie the resultant framework with the relevant accounting literature where necessary. According to Cameron and Quinn (1988), the structure of theories based on empirical ndings can lead to creative thinking and novel theories. The development of a theoretical framework based on empirical results can shape the perceptions and issues under consideration (Bartunek, 1988). Such theoretical frameworks are testable, in the sense that their methodology, hypotheses and results have been veried during the theory-building stage (Eisenhardt, 1989). Where there is inadequate experience or prior research regarding a specic issue or problem, theories that are based on the resultant empirical evidence can be appropriate and insightful (Eisenhardt, 1989). The validity of a theoretical framework would depend on the robustness of the

methodology, the signicance of the results and on whether the ndings support the theory. These issues have particular relevance for the development of the conceptual framework. 4. Research sample and limitations The analysis covers the period 1 April 1981 to 31 March 1985. For this period, the full data set comprises of 114 industrial companies, whose shares were listed on the London Stock Exchange. SSAP 20 became ofcially operational on 1 April 1983. The MBS Microche service identied 56 rms that adopted SSAP 20 in the period 1 April 1982 to 31 March 1983 (early adopters). Only 22 rms adopted the standard in the ofcial year of adoption, i.e. 1 April 1983 to 31 March 1984 (normal adopters). Also, a number of rms (36) did not adopt SSAP 20 in the ofcial period of adoption. These rms adopted the standard in a later period and particularly in the period 1 April 1984 to 31 March 1985 (late adopters). The analysis focuses on those rms that adopted the standard in any nancial year between April 1981 and March 1985. The companies annual nancial statements could not be obtained in their physical form for the period under investigation, so the microche service at the Manchester Business School (MBS) was used to generate the data for the model. This service provides miniaturised exact copies of the notes to the published accounts and the exact accounting entries for translation differences in the original published accounts. This information allowed the identication of the timing of adoption for each rm in the sample. The sample excludes nancial institutions, such as banks and insurance companies, as their accounting measures may have different meanings compared to those of industrial rms. The rms in the sample are from a number of industries including textile, retail, chemical and electrical rms (see Appendix). The study is limited in the following respects. Firstly, the study encompassed a period when rms and investors were less sophisticated users of nancial information. Secondly, it is difcult to know the decisions that rms would have taken had the pound appreciated over the period of adoption and had the rms incurred translation losses rather than translation gains. The details in Table I show the percentages of adopters that exhibited translation gains for the period from 1981 to 1985. In general, the percentage of late adopters that displayed translation gains tended to be larger relative to other types of adopters. Thirdly, in certain cases, it is difcult to identify the true motives behind rms decisions or interpret managers behaviour. Fourthly, for the period under investigation, the data available on the MBS microche service as well as the disclosure of accounting information in the nancial statements were limited. As a result, this reduced the sample size to 114 rms. The sample that has been

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Firm type/year Early adopters Normal adopters Late adopters

1981/1982 (%) 73 82 85

1982/1983 (%) 82 91 90

1983/1984 (%) 82 69 97

1984/1985 (%) 82 77 94 Table I. The percentages of adopters that exhibited translation gains for the period from 1981 to 1985

Note: The ofcial period of adoption was 1 April 1983 to 31 March 1984

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used in this study, however, does represent and describe the accounting practice of rms over the period under analysis. 5. A conceptual framework Against this background, the paper presents the conceptual framework in Figure 1. Three stages can be identied that can lead to a change in accounting policy and the determination of the timing of adoption of the standard. It must be stressed that the boundaries set for each stage may overlap, and therefore they may not be precise. The stages are as follows. 5.1 Initial stage: exibility in nancial reporting At the earliest point in time, rms are faced with the accounting issues associated with reporting translation differences, but without a regulatory framework for dealing with them[3]. This is depicted as the initial stage in Figure 1. Thus, there would be exercise of discretion and wide variation in the accounting treatment of translation differences. For example, for the accounting year that ended 31 March 1983 (prior to the adoption of SSAP 20), some rms recognised translation differences as part of ordinary income or prot before tax. Some other rms recognised such differences as part of extraordinary income in the income statement, and still some others incorporated such items in the reserves. The ndings give an indication of the extent to which accounting policy varied. At this stage, the open-ended exibility in reporting practices had to some extent allowed rms to implement the accounting methods that suited their corporate objectives. For example, Brayshaw and Eldin (1989) found that most UK rms recognised translation differences as an after tax item in the income statement as a means of smoothing income. Firms might also resort to hedging and income smoothing to minimise the adverse nancial effects of the chosen accounting policy. However, the costs that result from the employment of hedging practices may introduce volatility in the earnings, and thus lead to a negative stock market reaction. The inconsistency in the accounting treatment of translation differences before SSAP 20 would have resulted in users of accounting information attributing different meanings to the nancial performance of rms. Such inconsistency would have implications for the comparability and reliability of the nancial results as well as for the pricing of stocks. Thus, interested parties, such as rms, stakeholders, regulatory bodies, etc., would call for an accounting standard in order to mitigate the problems posed by the variation in accounting practice[4]. A consistent regulatory framework would reinforce the objectives of harmonisation and assist international investors and other market participants to access and evaluate the related accounting information (see McLeay et al., 1998). 5.2 Intermediate stage: accounting policy choice The intermediate stage depicts the point at which an accounting standard is put in place but with an advanced warning of a possible ofcial implementation date (see Figure 1). Managers are left with the exibility of timing the adoption, which in turn would depend on the rms nancial characteristics and managerial perceptions of the associated stock market response. So, a rm might adopt early if the impact is

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Figure 1. A conceptual framework of adoption, timing and accounting choice

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considered not to have adverse effects on nancial performance, while other rms might adopt late if it is perceived that immediate adoption would adversely affect nancial performance (see Ali and Kumar, 1994). For some rms, the new accounting standard would formalise their existing accounting method. For example, this study has found that 104 UK rms had adopted a form of SSAP 20 between April 1979 and March 1981. Some rms would still implement the standard after the ofcial date or not at all. Here, the assumption is that to adopt is the optimal decision. Given this regulatory framework, i.e. SSAP 20, rms would seek to time the adoption to suit their needs and reduce any negative impact of the standard on their nancial results, since wholesale adoption might adversely affect their investment plans, and in turn result in an unfavourable stock market reaction. Here, managers might also hedge to facilitate the timing of adoption, and thereby minimise the variability of balance sheet values. Given the features of SSAP 20, hedging would be expected to be minimal in the preparation for the implementation date. Firms might continue to hedge well beyond the adoption period, but the stock market is only likely to penalise the rms stock if hedging is costly. Thus, accounting policy choice that aims to maximize the shareholders wealth and to reduce information asymmetry would incur both preparation and proprietary costs (see Bartov and Bodnar, 1996), which in turn would increase the required rate of return. As most rms in the sample exhibited a positive net foreign asset balance, the difculty for managers was whether the pound would appreciate or depreciate in the year of adoption[5]. This would have implications for the magnitude of the translation losses/gains. If managers manipulate the earnings due to the need to meet analysts earnings forecasts (see Lev, 1992), then managers concern with overoptimistic forecasts might lead to the late adoption of income-decreasing accounting methods[6]. For UK rms, this seems likely given the positive net overseas nancial asset balance and the depreciation of the pound against a basket of currencies over the period of the study (see Figure 2). Managers will also manage the reported earnings to ensure that shareholders are not sceptical about their managerial ability and performance (Burgstahler and Dichev, 1997). The planned timing of adoption would therefore depend on rms corporate goals, such as to achieve a certain level of protability and dividend payout before adoption, and to inuence their leverage measures and nancial position. Indeed, this study has found that, in general, this tends to apply for all early, normal and late adopters. The timing of adoption would also depend on the expected movements in FX rates, since this is likely to reect the expected translation gain/loss. The adoption of the standard at or before the ofcial date would have required the recognition of the translation gains, which UK rms had experienced (Table I), in the reserves and thus would be expected to lead to the reduction of any available distributable prots. Overall, however, the study has found that for rms, such as normal and late adopters, the adoption of the standard did not adversely affect the level of protability. Also, some rms might choose to delay the adoption up to a point where political cost considerations are at a minimum in order to reinforce their earnings and nancial position. Generally, large rms are more sensitive to political costs than small rms (see Zimmerman, 1983; Ndubizu et al., 1993). The study has found that large rms were

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Figure 2. Bank of England multilateral sterling index 1 March 1982 to 1 April 1985

more likely to adopt before the ofcial date than small rms. Thus, large rms were more inclined to change their accounting policies to avoid adverse reactions from investors (see also Petroni, 1992; Adiel, 1996). It stems from the study that early adopters tended to be larger than normal and late adopters (see Ayres, 1986). The reduction of earnings volatility is important for the welfare of both managers and shareholders. The recognition of translation gains and losses in the balance sheet would make earnings less volatile and potentially easier to predict. This would tend to reduce the risk of bankruptcy or debt covenant violation. Firms that experience FX exposure and exhibit high leverage measures would be expected to favour those policies that reduce the variability in earnings (see Dhaliwal, 1982; Holthausen, 1990). Hence, SSAP 20 would tend to stabilise the prot gure and also to improve the rms nancial position. This would also be expected to have positive effects on protability and dividend payout measures. Further, following the fact that most rms exhibited translation gains over the period of the study, rms that did not adopt the standard would incur higher taxes. Conversely, the recognition of translation gains in the reserves would tend to result in a more stable taxable prot and lower tax liabilities. Also, the adoption of SSAP 20 and the lower variability in the income statement would tend to favourably affect managers compensation and shareholders wealth (see also Matsunaga, 1995). Overall, the study has found that adopters tended to exhibit higher protability and leverage measures than non-adopters. Breaking down the set of

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adopters, the study has also found that early adopters exhibited higher protability and leverage measures than normal and late adopters. Early adopters also displayed higher compensation measures compared to normal adopters (see also Ayres, 1986). In the case of home currency appreciation, rms would also be inclined to adopt for the reasons mentioned above. Also, in the case they had exhibited translation losses, rms would still tend to adopt SSAP 20 in order to avoid negatively affecting their prots. It follows that in the attempt to reduce earnings volatility, the adoption of SSAP 20 might also reduce the related political and agency costs. This may be an interesting research question, but it does not fall within the scope of this study. 5.3 Final stage: accounting choice and policy review At the nal stage, managers will consider whether the implementation of the standard had the desired effects both in terms of its impact on nancial performance and the stock market response (see Figure 1). Following the income-stabilising effects of the standard, the UK stock market reaction to SSAP 20 would be expected to be positive. It is noteworthy that the relevant US accounting standard, SFAS 52, which exhibits signicant similarities with SSAP 20, was greeted positively by the US stock market (see, e.g. Kim and Ziebart, 1991). SFAS 52 was issued before SSAP 20, so it may be that the UK rms and market participants have been aware of the US experience associated with SFAS 52[7]. As such, the UK stock market might have anticipated the implications of SSAP 20 and therefore impounded the related information into the stock prices. This in turn would have allowed rms to plan the timing of adoption and the stock market to anticipate the accounting change effect. If the adoption of the standard were planned, rms would have little or no need to renegotiate contractual obligations, or hedge translation exposure[8] in order to minimise the effects of the accounting policy change. The anticipation of SSAP 20 and the subsequent incorporation of the standards effects in the stock returns prior to the ofcial adoption could lead to a weak market response[9]. Assuming that the capital market effects are a function of the effects of the accounting change contained in the nancial statements (see also Salatka, 1989), the lack of a stock market response would imply that the accounting change has no nancial effects for the related period under investigation. In brief, the nal stage implies an outcome that reects the interaction between managers decisions and the expected movement in FX rates and stock prices. Figure 1 also depicts the point at which interested parties would undertake a review and evaluation of the effects of implementing the standard. For example, whether or not the standard attained the desired effect would be of interest to accounting standards setters. Managers will also review whether the rms nancial performance, following adoption, and the associated stock market response are both in line with their expectations. Where the effects of the standard appear unfavourable, managers and other interested parties would lobby accounting standards setters to introduce a modication to the standard or to abolish it. In regard to the UK setting, SSAP 20 is still in power and gives guidance to rms with regards to the nancial reporting of foreign exchange. The UK Financial Reporting Standard (FRS) No. 13 (issued in 1998) does not replace SSAP 20. It deals with issues relating to the disclosure of nancial

instruments, including, of course, nancial instruments on foreign exchange. Therefore, in the UK setting, SSAP 20 exhibits signicant relevance for nancial reporting, and generates economic consequences, such as reduction of earnings volatility and subsequent income statement stabilisation, which tend to substantially affect rms nancial performance. It is evident that earlier or later most rms did adopt SSAP 20, while there are a signicant number of rms, which had adopted a form of the standard long before its ofcial issue (see section 5.2). The introduction of an accounting standard might not fully generate the desired effects for all rms and it might not necessarily mitigate the use of hedging practices. Indeed, managers perception about the expected FX rate variability (see Hakkarainen et al., 1998) appears to inuence the extent to which rms use hedging. Thus, after SSAP 20 some rms have continued to hedge balance sheet exposure, since reserve and leverage ratios are considered to be important for debt covenant arrangements and dividend distribution (see Collier et al., 1990). 6. Conclusions The conceptual framework sought to put into context the accounting policy choices that rms face in their nancial, economic and regulatory environments with regards to the accounting treatment of translation gains and losses. The framework was generalised using both existing theoretical work as well as new and existing empirical evidence. In this way, the paper has sought to take account of the many inuences that can affect managerial decisions. There are situations where accounting regulation does not adequately capture the needs of users. Similarly, rms business plans and objectives might not match the aims of accounting regulation. Thus, rms may delay the adoption up to the point where the increase in political costs can just be tolerated. In certain cases, the exibility in nancial reporting may enhance the scope for judgement, subjectivity and income-smoothing. It is a matter as to whether or not the stock market sees through the particular type of accounting method that rms have used. Following the US experience and SFAS 52, the UK stock market is likely to have anticipated the implementation of SSAP 20, and thus, the accounting impact might have been impounded into the stock prices. Therefore, the study suggests that managers might have planned the timing of adoption, so that the accounting change would have minimal adverse impacts on rms accounting and nancial numbers. This study has signicant implications. Managers decision-making is closely dependent upon the economic and market conditions that prevail within the marketplace at a given time period (see Ceglowski, 1989). It follows thus, that the movements in FX rates can signicantly affect their behaviour and accounting policy choice. The conceptual framework provides signicant insight about the behaviour of rms and the associated impacts of nancial markets and regulation on the decision-making process of rms. This information is important for the accounting standards setters when they prepare or review a change in the accounting regulation or set an appropriate date for the implementation of an accounting standard. The ability of the standard setting body to understand the needs of the market participants and respond to the rapid economic and nancial changes would tend to reduce the

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regulatory costs and enhance the quality of nancial reporting. This should be the challenge of the accounting profession, since there is a strong need to come up with accounting regulation that adequately meets users needs. So, the accounting standards that are issued should be such that they reinforce the underlying welfare effects, ensure that the accounting information conveyed in the nancial statements reects managers decision-making, and assist investors in making predictions about rms future performance.
Notes 1. Callaghan and Bazaz (1992) argue that the inclusion of translation gains and losses in the consolidated income statement would result in a more consistent interpretation of the impact of FX rate changes on the rms market value. Also, Hirst and Hopkins (1998) report that a clear display of the comprehensive income approach would tend to provide information about earnings management (see also Dhaliwal et al., 1999). 2. This is similar in spirit to the approach of Yin (1981), who analysed the development of theories based on case studies. 3. This study has avoided the issues associated with transaction gains and losses since UK rms have consistently recognised transaction differences in the income statement, and there is a general agreement that this is where such differences should be located. 4. Rotenberg (1998) reports that a reduction in the exibility of nancial reporting is likely to impose costs on companies that have translation exposure. However, such costs would be expected to be relatively smaller compared to the benets of reducing earnings volatility (that SSAP 20 implies) and making nancial statements comparable. 5. Choosing the timing of adoption based on the expected behaviour of FX rates suggests that FX rates are predictable. Empirical work that employs lter rules generally indicates some level of inefciency in the FX rate movements (see, e.g. Kwok and Van de Gucht, 1991). Furthermore, some evidence indicates that in certain cases predictable price trends exist in FX rates, which in turn can be forecast to some extent (Joseph, 2001). 6. Ayres and Rodgers (1994) found a negative relation between analysts forecast errors and the income effect of SFAS 52. Of course, the accuracy of the forecast would depend on the ability of analysts to predict the timing of adoption and to assess the impact of the standard on earnings. 7. Managerial actions and investor behaviour might have also been inuenced by the information contained in exposure drafts, such as Exposure Draft (ED) No. 16 Supplement to Extraordinary Items and Prior Year Adjustments (1975), ED 21 Accounting for Foreign Currency Transactions (1977) and ED 27 Accounting for Foreign Currency Translations (1980), which preceded the ofcial issue of SSAP 20. 8. The survey of the rms in the sample indicates that for the period 1 April 1982 to 31 March 1983, 19 out of the 56 early adopters hedged translation exposure. For the previous period, i.e. 1 April 1981 to 31 March 1982, only 16 early adopters hedged translation exposure. While ve out of the 22 normal adopters hedged translation exposure in their actual adoption period, the respective gure for the late adopters (36) that hedged translation exposure was 10. Overall, there was a tendency for rms to hedge less translation exposure nearer their actual adoption period. 9. The market response may also be neutral in the case where rms are not so interested in translation exposure as opposed to other types of exposure. Khoury and Chan (1988) and Joseph and Hewins (1991) have shown that in certain cases rms tend to be interested more in economic or transaction exposure compared to translation exposure.

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SSAP 20

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Appendix
Early adopters Aerospace and defence Automobiles Beverages Chemicals Construction and building materials Distributors Diversied industrials Electronic and electrical equipment Engineering Food Health care Household products Leisure Media Mining Oil and gas Packaging Pharmaceuticals Real estate Retailers Software Support services Textiles Transport Total number of rms 1 5 6 3 4 10 3 1 3 2 3 1 2 1 6 3 2 56 Normal adopters 1 2 4 2 1 4 1 4 2 1 22 Late adopters 2 3 1 1 1 5 3 3 2 1 1 3 1 5 1 3 36

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Table AI. Sample industrial sectors

Note: The sample of rms covers the accounting periods from 1981 to 1985

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