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A conceptual framework of accounting policy choice under SSAP 20
George Iatridis
University of Thessaly, Volos, Greece, and



Nathan Lael Joseph
Aston University, Birmingham, UK
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 firms face in a setting that is influenced by: their financial characteristics; the flexible 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 firms with regard to the adoption or deferment of the adoption of SSAP 20. The paper utilises the theoretical and empirical findings of previous studies to form and substantiate the conceptual framework. Given the UK foreign exchange setting, the framework identifies the initial stage: lack of regulation and flexibility in financial reporting; the intermediate stage: accounting policy choice; and the final stage: accounting choice and policy review. Findings – There are situations where accounting regulation contrasts with the needs and business objectives of firms and vice-versa. Thus, firms may delay the adoption up to the point where the increase in political costs can just be tolerated. Overall, the study infers that firms 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 firms’ financial 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 flexibility in financial 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 firms and investors were less sophisticated users of financial information. Second, it is difficult to ascertain the decisions that firms would have taken, had the pound appreciated over the period of adoption and had the firms 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 significant insight about the behaviour of firms and the associated impacts of financial markets and regulation on the decision-making process of firms. The framework aims to assist the market and other authorities to reduce information asymmetry and to reinforce the efficiency of the market. Keywords Accounting standards, Accounting policy Paper type Research paper

The authors gratefully acknowledge the financial 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

who are exposed to the new accounting rule. Ricks. There is however no assumption that existing theories are complete or that the variables used to test such theories are adequate.7 764 1. given their expectations of FX rates. etc. If managers are able to plan the timing of adoption. the more likely it is that managers will choose income-increasing accounting methods. particularly because they have not been explored empirically before in the UK setting. in which the issues that are relevant for accounting choice are viewed on an overall basis. 1990). The economic consequences of alternative accounting methods have been taken to include not only the impact of accounting change on cash flows. A useful implication of the work in this area is whether a particular accounting method/rule has real economic consequences. (see. but also the impact of accounting change on political costs. In this case. Introduction Positive theories of accounting choice make several empirical predictions regarding managerial behaviour in the presence of financial incentives and accounting change. which is concerned with the accounting treatment of foreign exchange (FX) differences for UK firms. capital markets are unlikely to signal to the implementation of the standard. managers are likely to have more information about the firm than outsiders. one can predict the attitude of managers towards an accounting standard that is likely to adversely affect a firm’s leverage and debt covenant arrangements when the firm is already highly geared.g. Watts and Zimmerman (1978) make predictions regarding the likelihood that a firm will present its financial reports in a manner that will ensure that the agency costs among managers. it is likely that firms will incur little or no contractual costs. such that users of accounting information. Under this condition. . contractual arrangements.MAJ 20. Firstly. The structure of the paper is as follows: section 2 provides the theoretical background of the study together with a survey of the literature. For example. Holthausen. and this in turn can affect their choice of accounting methods (see. it puts forward a comprehensive framework. so as to reduce the risk of violating the debt covenants. theory predicts that the higher the firm’s leverage is. These accounting issues are important. revalue the firm’s stock. as the stock market would have already impounded that information into the firm’s stock price. the impact of the timing of adoption on firms’ financial reports and the associated sign of foreign subsidiaries’ net assets/liabilities. 1982). but focuses primarily on the economic and financial constraints imposed by SSAP 20. the framework attempts to iron out some of the conflicting evidence found in the literature. If managers have more information about the firm than outsiders. Much of the observed empirical regularities are consistent with theory. This study puts forward a conceptual framework that incorporates similar theoretical issues. they are likely to manipulate the timing of the adoption in order to minimise any adverse effects associated with accounting change. shareholders and bondholders are minimised. For example. thereby mitigating the need to renegotiate their contractual obligations. Secondly. This paper also provides an interpretation of managers’ accounting policy choice in line with their corporate goals.g. e. The conceptual framework has two important advantages. Sections 3 and 4 present the setting for the conceptual framework and the research sample respectively. e. However.

and in turn affect the quality of analysts’ earnings forecasts (see. and suggest that they should be reported separately and recognised in the reserves.The conceptual framework is presented in section 5. Lipe (1986). Item (1) relates to the new information conveyed by the accounting change. 1993. managers can resort to accounting methods. 2. have argued that the impact of all FX rate fluctuations on company accounts should be reported in the income statement. So. such that analysts would revise their expectations of the firms’ earnings in the light of such change. and Soo and Soo (1994) argue that the translation differences introduce volatility in the income statement. Beaver and Wolfson (1982) among others.g. (1987). the recognition of translation gains and losses in the P&L under the Statement of Financial Accounting Standards (SFAS) No. Bruinstroop and Godfrey (1992) find that the changes in FX accounting policies of Australian mining firms were associated with changes in financing and production SSAP 20 765 . 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. 1995). 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]. Also. An assessment of the financial 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. Following the US experience. Alternatively. their recognition in the consolidated income statement might create some distortion. For item (2). Theoretical background An important motivation of this study is the extent to which accounting policy changes can lead to economic consequences. Both aspects (above) have important implications for the location of translation differences in the reported financial statements and the timing of adoption of SSAP 20. Such economic consequences include: (1) The potential for the revaluation of a firm’s stock conditioned on the accounting change. 8 (issued in 1975) introduced volatility and created “noise” in the reported earnings (see Collins and Salatka. Ayres and Rodgers. while the conclusions of the study are presented in section 6. Bazaz and Senteney. such as smoothing and risk management. In contrast. SSAP 20 considers it more appropriate to recognise translation differences in the balance sheet. As translation differences may not be directly associated with the business strategies and performance of the foreign subsidiaries of the parent firm. 1994). Garlicki et al. 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 firm. (2) The extent to which managerial and investment decisions would need to be altered to minimise the adverse effects of the accounting change. to mitigate the effects of accounting policy change on the firm’s earnings and investment decisions. The debate regarding the location of translation differences that arise on consolidation of the financial results of foreign subsidiaries has been very controversial. e.

The flexibility in financial reporting can allow the use of accounting methods that favourably affect the interests of both managers and shareholders (Malmquist. and . managers’ perceptions of the stock market response. For example.g. Following the implications of the agency theory (see Jensen and Meckling. 1976). According to Glaser and Strauss (1967). Christie and Zimmerman.. 2001). 2001. given the decision to time the adoption. Such theoretical frameworks are testable. Where possible. hypotheses and results have been verified during the theory-building stage (Eisenhardt.MAJ 20. 1985. 3. theories that are based on the resultant empirical evidence can be appropriate and insightful (Eisenhardt. The accounting literature is used to validate and strengthen the structure of the conceptual framework. managers would tend to structure their decisions taking into account the related implications for external parties. if indeed the stock market did not anticipate such a process. 1989). The validity of a theoretical framework would depend on the robustness of the . 2001) to show an improvement in the firm’s performance.7 766 decisions for which the accounting policies would have (adverse) impacts. firms’ stock returns and shareholders’ wealth. 1989). This paper seeks to tie the resultant framework with the relevant accounting literature where necessary. in the sense that their methodology. higher reported earnings can positively impact on management compensation plans. which in turn can lead to information asymmetry. the employment of empirical results in the development of theoretical frameworks can lead to the construction of valid and reliable theories. Where there is inadequate experience or prior research regarding a specific issue or problem. The development of a theoretical framework based on empirical results can shape the perceptions and issues under consideration (Bartunek. Accounting policy choice is also closely associated with the firm’s compensation and debt covenant arrangements as well as the pricing of the firm’s stock (see. Background to the conceptual framework The conceptual framework seeks to interpret accounting policy choices in relation to the timing of adoption of SSAP 20. managers might also attempt to influence or manipulate the firm’s accounting numbers (see Healy. The study points to a view that the change of accounting policy associated with SSAP 20 was planned. Lambert. subjectivity and/or earnings management/income-smoothing. Fields et al. e. making use of new and existing empirical results[2]. According to Cameron and Quinn (1988). the expected impact of FX rate changes on the firm’s value. the potential economic consequences of (non-) adoption including political costs. the conceptual framework suggests that changes in the accounting policy choices of firms would depend on several factors including: . The flexibility in financial reporting together with information asymmetry and the apparent lack of a strict regulatory framework can enhance the scope for judgement. . 1988).. Thus. Fields et al. the structure of theories based on empirical findings can lead to creative thinking and novel theories. 1994). 1990.

4. so the microfiche service at the Manchester Business School (MBS) was used to generate the data for the model. Research sample and limitations The analysis covers the period 1 April 1981 to 31 March 1985. The percentages of adopters that exhibited translation gains for the period from 1981 to 1985 Note: The official period of adoption was 1 April 1983 to 31 March 1984 . Fourthly. The analysis focuses on those firms that adopted the standard in any financial year between April 1981 and March 1985. SSAP 20 became officially operational on 1 April 1983. it is difficult to identify the true motives behind firms’ decisions or interpret managers’ behaviour. a number of firms (36) did not adopt SSAP 20 in the official period of adoption. In general. such as banks and insurance companies. Secondly. These firms adopted the standard in a later period and particularly in the period 1 April 1984 to 31 March 1985 (late adopters). 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. in certain cases. The sample that has been SSAP 20 767 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. whose shares were listed on the London Stock Exchange. Thirdly. This information allowed the identification of the timing of adoption for each firm in the sample. 1 April 1983 to 31 March 1984 (normal adopters). the study encompassed a period when firms and investors were less sophisticated users of financial information. The sample excludes financial institutions. For this period. the percentage of late adopters that displayed translation gains tended to be larger relative to other types of adopters. the data available on the MBS microfiche service as well as the disclosure of accounting information in the financial statements were limited. as their accounting measures may have different meanings compared to those of industrial firms. The details in Table I show the percentages of adopters that exhibited translation gains for the period from 1981 to 1985. Also. for the period under investigation. The firms in the sample are from a number of industries including textile. Firstly.methodology. The study is limited in the following respects. the full data set comprises of 114 industrial companies. i. The MBS Microfiche service identified 56 firms that adopted SSAP 20 in the period 1 April 1982 to 31 March 1983 (early adopters). this reduced the sample size to 114 firms. it is difficult to know the decisions that firms would have taken had the pound appreciated over the period of adoption and had the firms incurred translation losses rather than translation gains. As a result. The companies’ annual financial statements could not be obtained in their physical form for the period under investigation. chemical and electrical firms (see Appendix). the significance of the results and on whether the findings support the theory.e. Only 22 firms adopted the standard in the official year of adoption. retail. These issues have particular relevance for the development of the conceptual framework.

and still some others incorporated such items in the reserves. the paper presents the conceptual framework in Figure 1. However. which in turn would depend on the firm’s financial characteristics and managerial perceptions of the associated stock market response. the open-ended flexibility in reporting practices had to some extent allowed firms to implement the accounting methods that suited their corporate objectives.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 official implementation date (see Figure 1). 1998).. and therefore they may not be precise. Managers are left with the flexibility of timing the adoption. etc. The stages are as follows. Thus. regulatory bodies. Three stages can be identified that can lead to a change in accounting policy and the determination of the timing of adoption of the standard. Brayshaw and Eldin (1989) found that most UK firms recognised translation differences as an after tax item in the income statement as a means of smoothing income. At this stage. firms are faced with the accounting issues associated with reporting translation differences.MAJ 20. for the accounting year that ended 31 March 1983 (prior to the adoption of SSAP 20). 5.. So. The findings give an indication of the extent to which accounting policy varied. 5. For example. some firms recognised translation differences as part of ordinary income or profit before tax. there would be exercise of discretion and wide variation in the accounting treatment of translation differences.7 used in this study. such as firms. does represent and describe the accounting practice of firms over the period under analysis. Firms might also resort to hedging and income smoothing to minimise the adverse financial effects of the chosen accounting policy. Thus. stakeholders. 5. Some other firms recognised such differences as part of extraordinary income in the income statement. It must be stressed that the boundaries set for each stage may overlap. the costs that result from the employment of hedging practices may introduce volatility in the earnings. would call for an accounting standard in order to mitigate the problems posed by the variation in accounting practice[4].1 Initial stage: flexibility in financial reporting At the earliest point in time. 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. interested parties. however. 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 financial performance of firms. A conceptual framework Against this background. a firm might adopt early if the impact is 768 . For example. This is depicted as the initial stage in Figure 1. but without a regulatory framework for dealing with them[3]. Such inconsistency would have implications for the comparability and reliability of the financial results as well as for the pricing of stocks. and thus lead to a negative stock market reaction.

A conceptual framework of adoption.SSAP 20 769 Figure 1. timing and accounting choice .

1994). this study has found that 104 UK firms had adopted a form of SSAP 20 between April 1979 and March 1981. large firms are more sensitive to political costs than small firms (see Zimmerman. the difficulty for managers was whether the pound would appreciate or depreciate in the year of adoption[5]. Managers will also manage the reported earnings to ensure that shareholders are not sceptical about their managerial ability and performance (Burgstahler and Dichev. For some firms. The planned timing of adoption would therefore depend on firms’ corporate goals. The study has found that large firms were . the assumption is that to adopt is the optimal decision. Some firms would still implement the standard after the official date or not at all.7 770 considered not to have adverse effects on financial performance. Indeed. i.e. such as normal and late adopters. managers might also hedge to facilitate the timing of adoption. The timing of adoption would also depend on the expected movements in FX rates. which in turn would increase the required rate of return. normal and late adopters. since wholesale adoption might adversely affect their investment plans. hedging would be expected to be minimal in the preparation for the implementation date. the new accounting standard would formalise their existing accounting method. Here. 1983. Generally. Firms might continue to hedge well beyond the adoption period.MAJ 20. 1992). Given this regulatory framework. and thereby minimise the variability of balance sheet values. and to influence their leverage measures and financial position. 1993). As most firms in the sample exhibited a positive net foreign asset balance. Given the features of SSAP 20. Ndubizu et al. such as to achieve a certain level of profitability and dividend payout before adoption. this tends to apply for all early. some firms 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 financial position. firms would seek to time the adoption to suit their needs and reduce any negative impact of the standard on their financial results. For example. 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. SSAP 20. Here. 1996). 1997). The adoption of the standard at or before the official date would have required the recognition of the translation gains. while other firms might adopt late if it is perceived that immediate adoption would adversely affect financial performance (see Ali and Kumar. which UK firms had experienced (Table I). in the reserves and thus would be expected to lead to the reduction of any available distributable profits. but the stock market is only likely to penalise the firm’s stock if hedging is costly.. this seems likely given the positive net overseas financial asset balance and the depreciation of the pound against a basket of currencies over the period of the study (see Figure 2). This would have implications for the magnitude of the translation losses/gains. Also. If managers manipulate the earnings due to the need to meet analysts’ earnings forecasts (see Lev. this study has found that. in general. Overall. For UK firms. Thus. the study has found that for firms. however. and in turn result in an unfavourable stock market reaction. since this is likely to reflect the expected translation gain/loss. the adoption of the standard did not adversely affect the level of profitability. then managers’ concern with overoptimistic forecasts might lead to the late adoption of income-decreasing accounting methods[6].

1992. 1996). SSAP 20 would tend to stabilise the profit figure and also to improve the firms’ financial position.SSAP 20 771 Figure 2. Adiel. the study has found that adopters tended to exhibit higher profitability and leverage measures than non-adopters. Conversely. Thus. 1986). large firms were more inclined to change their accounting policies to avoid adverse reactions from investors (see also Petroni. Breaking down the set of . the recognition of translation gains in the reserves would tend to result in a more stable taxable profit and lower tax liabilities. It stems from the study that early adopters tended to be larger than normal and late adopters (see Ayres. firms that did not adopt the standard would incur higher taxes. Hence. Also. Holthausen. This would tend to reduce the risk of bankruptcy or debt covenant violation. Further. The reduction of earnings volatility is important for the welfare of both managers and shareholders. 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. Overall. 1995). 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. Bank of England multilateral sterling index 1 March 1982 to 1 April 1985 more likely to adopt before the official date than small firms. 1990). 1982. This would also be expected to have positive effects on profitability and dividend payout measures. following the fact that most firms exhibited translation gains over the period of the study. The recognition of translation gains and losses in the balance sheet would make earnings less volatile and potentially easier to predict.

but it does not fall within the scope of this study. Early adopters also displayed higher compensation measures compared to normal adopters (see also Ayres. the UK stock market might have anticipated the implications of SSAP 20 and therefore impounded the related information into the 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. 1986). Where the effects of the standard appear unfavourable. Also. Kim and Ziebart. Managers will also review whether the firm’s financial performance. SFAS 52. following adoption.g. was greeted positively by the US stock market (see. firms would also be inclined to adopt for the reasons mentioned above. in the case they had exhibited translation losses. If the adoption of the standard were planned. This in turn would have allowed firms to plan the timing of adoption and the stock market to anticipate the accounting change effect. the final stage implies an outcome that reflects the interaction between managers’ decisions and the expected movement in FX rates and stock prices. It follows that in the attempt to reduce earnings volatility.3 Final stage: accounting choice and policy review At the final stage. and the associated stock market response are both in line with their expectations. the study has also found that early adopters exhibited higher profitability and leverage measures than normal and late adopters. 1991). managers will consider whether the implementation of the standard had the desired effects both in terms of its impact on financial performance and the stock market response (see Figure 1). or hedge translation exposure[8] in order to minimise the effects of the accounting policy change.MAJ 20. the adoption of SSAP 20 might also reduce the related political and agency costs. In the case of home currency appreciation. e. whether or not the standard attained the desired effect would be of interest to accounting standards setters. The anticipation of SSAP 20 and the subsequent incorporation of the standard’s effects in the stock returns prior to the official adoption could lead to a weak market response[9].7 772 adopters. managers and other interested parties would lobby accounting standards setters to introduce a modification to the standard or to abolish it. It is noteworthy that the relevant US accounting standard. firms would still tend to adopt SSAP 20 in order to avoid negatively affecting their profits. In brief. In regard to the UK setting. Following the income-stabilising effects of the standard. This may be an interesting research question. SFAS 52 was issued before SSAP 20. 5. 1989). For example. the UK stock market reaction to SSAP 20 would be expected to be positive. SSAP 20 is still in power and gives guidance to firms with regards to the financial reporting of foreign exchange. The UK Financial Reporting Standard (FRS) No. firms would have little or no need to renegotiate contractual obligations. the lack of a stock market response would imply that the accounting change has no financial effects for the related period under investigation. which exhibits significant similarities with SSAP 20. 13 (issued in 1998) does not replace SSAP 20. Assuming that the capital market effects are a function of the effects of the accounting change contained in the financial statements (see also Salatka. It deals with issues relating to the disclosure of financial . As such. so it may be that the UK firms and market participants have been aware of the US experience associated with SFAS 52[7].

the UK stock market is likely to have anticipated the implementation of SSAP 20. The framework was generalised using both existing theoretical work as well as new and existing empirical evidence. Conclusions The conceptual framework sought to put into context the accounting policy choices that firms face in their financial. SSAP 20 exhibits significant relevance for financial reporting. the accounting impact might have been impounded into the stock prices. the study suggests that managers might have planned the timing of adoption. Similarly. and thus. In this way.instruments. It is a matter as to whether or not the stock market sees through the particular type of accounting method that firms have used. after SSAP 20 some firms have continued to hedge balance sheet exposure.2). In certain cases. including. which tend to substantially affect firms’ financial performance. such as reduction of earnings volatility and subsequent income statement stabilisation. financial instruments on foreign exchange. Therefore. firms may delay the adoption up to the point where the increase in political costs can just be tolerated. the flexibility in financial reporting may enhance the scope for judgement. It is evident that earlier or later most firms did adopt SSAP 20. so that the accounting change would have minimal adverse impacts on firms’ accounting and financial numbers. 1998) appears to influence the extent to which firms use hedging.. economic and regulatory environments with regards to the accounting treatment of translation gains and losses. 1990). subjectivity and income-smoothing. 1989). 6. 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. This study has significant implications. that the movements in FX rates can significantly affect their behaviour and accounting policy choice. It follows thus. There are situations where accounting regulation does not adequately capture the needs of users. of course. The conceptual framework provides significant insight about the behaviour of firms and the associated impacts of financial markets and regulation on the decision-making process of firms. The introduction of an accounting standard might not fully generate the desired effects for all firms and it might not necessarily mitigate the use of hedging practices. Managers’ decision-making is closely dependent upon the economic and market conditions that prevail within the marketplace at a given time period (see Ceglowski. since reserve and leverage ratios are considered to be important for debt covenant arrangements and dividend distribution (see Collier et al. in the UK setting.. managers’ perception about the expected FX rate variability (see Hakkarainen et al. Following the US experience and SFAS 52. Indeed. which had adopted a form of the standard long before its official issue (see section 5. Thus. firms’ business plans and objectives might not match the aims of accounting regulation. and generates economic consequences. The ability of the standard setting body to understand the needs of the market participants and respond to the rapid economic and financial changes would tend to reduce the SSAP 20 773 . the paper has sought to take account of the many influences that can affect managerial decisions. while there are a significant number of firms. Thus. Therefore.

Also. which preceded the official issue of SSAP 20. e. However. . Rotenberg (1998) reports that a reduction in the flexibility of financial reporting is likely to impose costs on companies that have translation exposure. 16 “Supplement to Extraordinary Items and Prior Year Adjustments” (1975). 7. 4. 2. the respective figure for the late adopters (36) that hedged translation exposure was 10. 1 April 1981 to 31 March 1982. Choosing the timing of adoption based on the expected behaviour of FX rates suggests that FX rates are predictable. While five out of the 22 normal adopters hedged translation exposure in their actual adoption period.e.. 2001). The survey of the firms in the sample indicates that for the period 1 April 1982 to 31 March 1983. Furthermore.MAJ 20. This should be the challenge of the accounting profession. 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 firm’s market value. ensure that the accounting information conveyed in the financial statements reflects managers’ decision-making. Overall. Of course.7 774 regulatory costs and enhance the quality of financial reporting. since there is a strong need to come up with accounting regulation that adequately meets users’ needs. 1999). Ayres and Rodgers (1994) found a negative relation between analysts’ forecast errors and the income effect of SFAS 52. 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. i. such as Exposure Draft (ED) No. 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. 6. and assist investors in making predictions about firms’ future performance. who analysed the development of theories based on case studies. there was a tendency for firms to hedge less translation exposure nearer their actual adoption period. only 16 early adopters hedged translation exposure. Managerial actions and investor behaviour might have also been influenced by the information contained in exposure drafts. such costs would be expected to be relatively smaller compared to the benefits of reducing earnings volatility (that SSAP 20 implies) and making financial statements comparable.g. Notes 1. 8. For the previous period. and there is a general agreement that this is where such differences should be located. This is similar in spirit to the approach of Yin (1981). This study has avoided the issues associated with transaction gains and losses since UK firms have consistently recognised transaction differences in the income statement. So. 19 out of the 56 early adopters hedged translation exposure. Kwok and Van de Gucht. some evidence indicates that in certain cases predictable price trends exist in FX rates. 3. The market response may also be neutral in the case where firms are not so interested in translation exposure as opposed to other types of exposure. ED 21 “Accounting for Foreign Currency Transactions” (1977) and ED 27 “Accounting for Foreign Currency Translations” (1980). 5. 9. which in turn can be forecast to some extent (Joseph. Empirical work that employs filter rules generally indicates some level of inefficiency in the FX rate movements (see. the accounting standards that are issued should be such that they reinforce the underlying welfare effects. 1991). Khoury and Chan (1988) and Joseph and Hewins (1991) have shown that in certain cases firms tend to be interested more in economic or transaction exposure compared to translation exposure.

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Sample industrial sectors Note: The sample of firms covers the accounting periods from 1981 to 1985 .7 Appendix Early adopters Aerospace and defence Automobiles Beverages Chemicals Construction and building materials Distributors Diversified 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 firms – 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 36 778 Table AI.MAJ 20.

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