comparability definition and meaning

International Accounting Standards and International Financial Reporting Standards are the accounting standards that are universally accepted with adjustments according to the specific regulations of different countries. Accounting comparability can be defined as the extent to which the information provided in the financial statements is comparable across different firms and time periods. Comparability plays a crucial role in the agenda of accounting regulators, as highlighted, for example, by the Conceptual Frameworks of the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB). In a recent article, we critically review the academic literature on accounting comparability; we discuss the problem of measurement, the economic determinants and consequences.

The ultimate goal of standardized accounting principles is to allow financial statement users to view a company’s financials with certainty that the information disclosed in the report is complete, consistent, and comparable. Accounting information provides useful information about business transactions and events. Those who provide and use financial reports must often select and evaluate accounting alternatives.

Qualitative Characteristics of Accounting Information

A change in the accounting policies of an entity may be required in order to improve the reliability and relevance of financial statements. A change in the accounting policy may also be imposed by changes in accountancy standards. In these circumstances, the nature and circumstances leading to the change must be disclosed in the financial statements.

They give a certain threshold of the firm’s growth rate below (above) which the cost of capital decreases (increases) in the precision of public disclosure. They also emphasize the different effects of the public disclosure level on the welfare of current shareholders and future shareholders.4 Two important features distinguish our research from the above papers. First, the above papers all focus on how the level or precision of information disclosure affect the cost of capital, while our research examines these relationships from the perspective of comparability. Second, our research also investigates how the accounting standards quality affects these relationships. By showing that current investors and new investors have different and even conflicting demands for comparability, our study also contributes to the necessity of making a distinction among the users of accounting information. Thus, our study has important implications for accounting standards setters and information disclosure regulators, and it provides some insight for related empirical research on the relationship between accounting standards, comparability and the cost of capital.

ACTIVELY PARTICIPATING IN THE DEVELOPMENT OF IFRS

Comparability is one of the enhancing qualitative characteristics of useful financial information. Comparability allows users to compare financial position and performance across time and across companies. – Assume that company A uses the FIFO inventory method and company B uses the LIFO inventory method for valuing its inventory. All else being equal, company B’s financial statements would most likely show less income because of a higher cost of goods sold. In order to compare these statements properly, you must convert one of their inventory methods to match the other. In the United States, generally accepted accounting principles (GAAP) are regulated by the Financial Accounting Standards Board (FASB).

• This paper also contributes to the literature on the economic consequences (in particular, the cost of capital) of accounting standards.
• The lower the level of internal control is, the more obvious the inhibitory effect of accounting information comparability on cost stickiness is.
• In today’s society, corporate annual reports are in excess of 100 pages, with significant qualitative information.
• Overall, it is still unclear how accounting standards affect the cost of capital through comparability.
• Moreover, the effects of comparability on the cost of capital and investor welfare are enhanced when firms’ idiosyncratic accounting measurements are highly volatile and/or correlated.

Using raw and industry-adjusted effective tax rates to proxy tax avoidance, we find that firms with more aggressive tax avoidance strategies have substantially lower accounting comparability. The evidence also shows that the negative effect of tax avoidance on accounting comparability is driven by firms with aggressive tax planning strategies beyond the industry norm. In addition, using an alternative accounting comparability measure as a function of pre-tax income, we find that the negative effect of tax avoidance behavior is not limited to the reported tax expense, but involves the overall financial reporting system.

Qualitative characteristics of non-GAAP disclosures and non-GAAP earnings quality

Prior research documents that high-quality information is positively related to ERC (Francis et al., 2007) and analysts’ responsiveness around the earnings announcements (Zhang, 2008). We identify an additional determinant of the intensity of investors’ and analysts’ reactions to earnings announcements. Privately held companies and nonprofit organizations also may be required by lenders or investors to file GAAP-compliant financial statements. For example, annual audited GAAP financial statements are a common loan covenant required by most banking institutions. Therefore, most companies and organizations in the U.S. comply with GAAP, even though it is not a legal requirement. Generally accepted accounting principles (GAAP) are uniform accounting principles for private companies and nonprofits in the U.S.

We use the short-window earnings response coefficient (ERC) as a direct measure of investors’ decision usefulness of accounting information following earnings announcements (Collins and Kothari, 1989, Francis et al., 2007, Kothari, 2001). This paper also contributes to the literature on the economic consequences (in particular, the cost of capital) of accounting standards. Some empirical studies show that the mandatory adoption of IFRS reduces the cost of capital (Daske et al., 2008, 2013; Li, 2010). In Li (2010)’s additional analyses, he https://simple-accounting.org/comparability-principle/ finds that increased disclosure and enhanced information comparability are two mechanisms behind the cost of equity reduction after IFRS adoption in the EU. In his theoretical study, Zhang (2013) examines how the quality of accounting standards affects the cost of capital, real investment and welfare in a large economy. He shows that improving accounting standards causes an expansion of the real economy, but firms in certain risk classes end up with higher costs of capital and lower values, some of which are crowded out from the economy.

Board diversity and financial statement comparability: evidence from China

Comparability analysis is a sophisticated research technique, and institutional investors have the expertise, resources, and ability to conduct such analysis in their valuation process (Kim and Verrecchia, 1994). Prior studies find that institutional traders make superior investment decisions (Bhattacharya, 2001, Mikhail et al., 2007). Therefore, the complementary role of comparability predicts that the relation between https://simple-accounting.org/ comparability and ERC will be stronger for firms with high investor sophistication. Also, the literature suggests that private information about a firm’s unobservable growth potential affects the choice of peer firms (Boni and Womack, 2006, De Franco et al., 2015). As a result, information asymmetry among investors increases the uncertainty about the selection of peer firms due to the presence of private information.

But the valuation of earnings declines significantly when managers use more atypical accounting choices. For firms with low accounting comparability, we estimate the stock price goes up by $4.04 for a $1 increase in EPS. First, by facilitating benchmarking across firms, higher comparability ensures that investors can access more relevant peer and overall industry information. Second, it lowers investors’ firm-specific information processing costs and thereby facilitates a more precise valuation of financial information. Financial statements of one accounting period must be comparable to another in order for the users to derive meaningful conclusions about the trends in an entity’s financial performance and position over time. Comparability of financial statements over different accounting periods can be ensured by the application of similar accountancy policies over a period of time.

Disclosure, liquidity, and the cost of capital

To test accounting comparability in investor valuation decisions, we estimated a value relevance model using over 31,000 observations between 1996 and 2015. In this model, a firm’s stock price is a function of its earnings, book value of equity, and their interaction with accounting comparability. The difference between comparability and consistency is that comparability refers to the method of comparing two or more companies according to their position. On the other hand, consistency is defined as the similarity in policies and procedures of a firm, which aids the users in comparing the financial statements of a specific accounting period. You are asked to compare these competitors and determine which company is a better investment.

In Europe and elsewhere, International Financial Reporting Standards (IFRS) are established by the International Accounting Standards Board (IASB). Our results show that accounting comparability enhances the value relevance of earnings more when the firm’s auditor is a “city industry specialist” that also audits the firm’s local industry peers. High accounting comparability firms trade at smaller bid–ask spreads, have lower stock price crash risk, and pay lower loan spreads. Accounting principles refer to the rules and principles that the company must adhere to while reporting the financial data in the accounting reports. It escorts the companies the way to record the accounting transactions in the books of accounts.

HOW THE FASB SEEKS GREATER COMPARABILITY

They believe because companies do not have to follow specific rules that have been set out, their reporting may provide an inaccurate picture of their financial health. In the case of rules-based methods like GAAP, complex rules can cause unnecessary complications in the preparation of financial statements. These critics claim having strict rules means that companies must spend an unfair amount of their resources to comply with industry standards.

• The most notable principles include the revenue recognition principle, matching principle, materiality principle, and consistency principle.
• Comparability of information disclosure is incorporated into the price, which allocates the related risk among current investors and new investors.
• This makes it easier for investors to analyze and extract useful information from the company’s financial statements, including trend data over a period of time.
• Our estimates show that the average firm’s stock price rises by $5.40 for a $1 earnings per share (EPS) increase.
• Gao (2010) studies how the disclosure quality affects the cost of capital and investor welfare based on a representative firm in a production economy.