Qualified Accounting Changes and Investor Assessments of Financial Performance and Representational Faithfulness

Posted: 28 Oct 2002

See all articles by Frank D. Hodge

Frank D. Hodge

University of Washington - Michael G. Foster School of Business

Roger D. Martin

University of Virginia - McIntire School of Commerce

Jamie H. Pratt

Indiana University - Kelley School of Business - Department of Accounting

Date Written: October 2002

Abstract

In this study we examine how an audit qualification of an accounting change affects investor assessments of the firm's current and future financial performance, and the representational faithfulness of the change. We investigate this issue for income-increasing and income-decreasing accounting changes, and across four apparent reporting strategies: reporting aggressively, taking a bath, creating hidden reserves, and employing no apparent strategy. Our results show that the effect of the qualification on assessments of current and future performance depends on whether the accounting change increases or decreases reported net income. When an income-increasing accounting change is qualified, investors decrease their assessments of current and future financial performance; when an income-decreasing accounting change is qualified, investor assessments of financial performance are either unaffected or decreased depending on the apparent reporting strategy. We also find evidence that assessments of representational faithfulness relate positively (negatively) to assessments of financial performance when accounting changes are income increasing (decreasing), and under all conditions qualifications reduce investor assessments of representational faithfulness. Avenues for future research are also discussed.

Keywords: accounting changes, audit reports, financial performance, representational faithfulness

JEL Classification: D80, M41, M49

Suggested Citation

Hodge, Frank Douglas and Martin, Roger Dean and Pratt, James H., Qualified Accounting Changes and Investor Assessments of Financial Performance and Representational Faithfulness (October 2002). Available at SSRN: https://ssrn.com/abstract=337462

Frank Douglas Hodge

University of Washington - Michael G. Foster School of Business ( email )

Paccar Hall 540, Box 353200
Seattle, WA 98195-3200
United States
206-616-8598 (Phone)
206-685-9392 (Fax)

Roger Dean Martin (Contact Author)

University of Virginia - McIntire School of Commerce ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States

James H. Pratt

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States
812-855-2657 (Phone)
812-855-8679 (Fax)

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
2,261
PlumX Metrics