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LITERATURE REVIEW TOPIC: Effect of Accounting Reforms on Financial Health of Public Sector Units

Introduction: The Accounting reforms are expansion of accounting rules that will dominate the financial measures for both Individual economic entities and national economies. The accounting standards are not always same. Any accounting standard may significantly affect any number of a companys day-to-day operations and may even impact the reported profitability of the business itself. This empirical research will help us us to find out the various changes of the recent accounting standards on Ind AS. As we are studying both IFRS and Ind AS, it will give the major difference between the IFRS and Ind AS. We have selected few Public sector units for our research. It will help us to find out the financial health performance of the companies before and after the change of the accounting standards. A lot of literature talks about the accounting reforms related to Lease accounting, Stock Options, retirement benefits etc which are all extensions of international accountings effort to make financial statements more transparent to investors. An accounting reforms in US and UK and across international arena usually inspires similar accounting changes on India and impact Indian Companies. These ongoing accounting reforms are an extension of ongoing convergence of worldwide accounting principles with IFRS. Literature Review With respect to such accounting reforms literature supports a lot of evidence with different outcomes in different countries and hence provides a basis for comparisons for e.g. In an early ex post study, Abdel-khalik (1981) found that company management responded to the introduction of SFAS 13 by structuring new lease contracts, and renegotiating existing lease contracts, to avoid capitalisation of leases. There was evidence that more assets were bought, or constructed, instead of being leased and also evidence of changes in capital structure. Imhoff and Thomas (1988) examined capital structure changes in response to SFAS 13 (Lease accounting), documenting a systematic substitution from finance (capital) leases to operating leases and non-lease sources of finance. In the UK, Garrod (1989) found that managers reacted to the introduction of SSAP 21 by reducing their non-lease debt prior to first disclosure of their lease information.

Nelson (1963) examined the impact of lease capitalization on the debt-equity ratio of eleven US companies, finding a significant change in the rankings. Ashton (1985) estimated the effect of finance lease capitalization on six ratios for 23 UK companies, finding a significant impact only on the gearing ratio. More recent studies focus on the impact of operating lease capitalization. Imhoff et al. (1991) develop a method for the constructive capitalization of operating leases, using this to estimate the impact on two ratios (return on assets and debt-equity ratio) for 14 US companies. Material differences are found for both high and low operating lease use companies. A subsequent paper found the income effects to be substantial and unpredictable in direction (Imhoff et al., 1997). Beattie et al. (1998) and Goodacre (2003) analyse UK data using the Imhoff et al. (1991) method, adapted to suit the UK setting. Both studies examine nine ratios: profit margin, three return ratios, asset turnover and four gearing measures. Beattie et al.s (1998) findings, based on 1994 data for 232 industrial and commercial companies, show a significant impact for all ratios except return on capital employed and interest cover. One gearing measure showed a massive 260% change following capitalization. The findings for the 102 companies in the retail sector were even more marked, with all nine ratios showing a significant change (Goodacre, 2003). Dresdner Kleinwort Benson (1998) examines the impact of operating lease capitalization on 27 large UK retail companies, using a simple multiple of annual operating lease rental obligations. It is reported that net debt would be in excess of 100% of equity market capitalization in many cases. With the exception of Ashton (1985), which may be subject to sample selection bias, all studies reported significant impacts on ratios. However the major impact is upon risk measures, rather than performance measures. There is mixed evidence of market price reaction to lease accounting information, and this derives from tests using rather old data (Ro, 1978; El-Gazzar, 1993;and Garrod, 1989). There is also little evidence of an impact on market-based risk measures (Abdel-khalik, 1981; Finnerty et al., 1980). Other market-based studies report quite strong evidence that the market already incorporates footnote operating lease disclosures in its assessment of equity risk in both the UK (Beattie et al., 2000) and the US (Bowman, 1980; Ely, 1995; Imhoff et al., 1993). Potential economic consequences were identified from the G4+1 discussion paper (ASB, 1999), from published responses to this (Finance & Leasing Association, 1999) and from prior research (Taylor and Turley, 1985; Beattie et al., 1998). Goodacre suggested that profit margins, return on assets and gearing measures would all be significantly affected if operating leases were required to be recognised on the lessees balance sheet rather than merely disclosed in a footnote (Imhoff et al., 1991; Beattie et al., 1998; Goodacre, 2003).

Millimans (2006) study of 100 large U.S. corporations outlines the much needed reforms in pension accounting. The study shows many firms are showing pension liabilities on their balance sheets that bear very little resemblance to their economic liability for retirement benefits. Carpanter and Mahanoy studied economic consequences of move of pension accounting from a cost approach to an accrual approach. Absence of full accrual recognition of pension expenses and liabilities was shown to have caused a significant decrease in the reported owner's equify (Carpenter & Mahoney, 2004). Soroosh and Espahbodi (2007) analysed that the application of SFAS 158 to the financial statements of Merck in 2004 and found out the changes would increase the net liability status of the pension fund and cause a decrease in owners equit y of $1.8 billion. In addition, the debt/equity ratio would increase by 48%, from 1.32 to 1.95, and the debt/assets ratio would increase by 17% from 0.54 to 0.63. The authors further state that Mercks results would be typical of all firms with similar pension plans. Maria Juliana Sandu (2012) studies economic consequences of pension accounting in their study in United States. This paper documents identified and anticipated economic consequences of recent pension accounting changes like shifts between different types of pension plans (from defined benefit to defined contribution), changes in the governance structure between the sponsoring organization and the pension fund (less accountability by pension fund), more incentives for earrings management, and changes in investments strategies by sponsoring organizations (from equity to bonds). Recent proposals for regulatory changes (i.e., IAS 19 revised) head towards an excessive conservatism and hence diminished neutrality. The author took a sample of top 10 US funds for his investigative studies. Ole Kristina Hope (2003) studied relationship between accounting policy disclosures and analysts forecasts and found that accounting policy disclosures are incrementally useful to analysts over and above all other annual report disclosures. These findings suggest that accounting policy disclosures reduce uncertainty about forecasted earnings. The author studied an international sample of 1059 Firms from US and Japan, Australia and Norway. Edward M Werner (2011) studied the value relevance of pension accounting information. The purpose of their study is to examine, in the context of movement towards a fair-value based pension accounting standard, the value relevance of both recognized and disclosed pension accounting information. Using hand-collected data from Fortune 200 firms, this study includes both recognized and disclosed pension accounting measures (aggregated and disaggregated) in multivariate regression models. The investigation employs tests of relative and incremental value relevance in both equity and credit rating evaluation contexts. Findings

indicate that pension information recognized under a fair-value-based accounting model is no more or less value relevant than pension information recognized under the SFAS 87 model. Also, the disclosed off-balance sheet pension amount is incrementally value relevant for determining share prices. However, it is not value relevant for the credit rating decision. The limitation is that this study tests the relevance and reliability of accounting information jointly. Theoretically, however, relevance and reliability affect information usefulness and, thus, valuation decisions independently. This paper yields a number of significant implications for standard setters. Satyajit Dhar and Subhabrata De (2011) in their paper Stock option compensation: Impact of expense recognition on performance indicators of companies listed in India discusses the impact on selected financial performance indicators of Indian firms adopting employee stock option (ESO) schemes, if they recognize expenses and adopting fair-value method of accounting pursuant to International Financial Reporting Standard (IFRS) 2. The research has found that there is a significant impact on the diluted EPS negatively (i.e. decrease) if the expenses are recognized. Similarly both return on Equity (ROE) and return on assets (ROA) would decrease if the expenses are recognized. The sample chosen was top 30 firms in India listed on BSE. The research titled The new accounting standard for earnings per share and its potential implications (Dong-Woo, Lee and Lau, Richard, Accounting and Business research, 1997) Studies the new standard, SFAS 128, that affects the way US companies report their earningsper-share numbers. It is a major revision and it is intended to end complicated provisions that were often misinterpreted. The paper compares the new and old standards and discusses the potential effect of the new standard on the price-earnings ratios of companies. Laureen Maines in her empirical Evaluation of the IASB's Proposed Accounting and Disclosure Requirements for Share-Based Payment discusses about the International Accounting Standards Board (IASB) exposure Draft, Share based payment which addresses accounting and disclosure requirements for share based payments. This paper evaluates both grant-date valuation and exercise-date valuation. It suggests that grant-date valuation with no subsequent adjustments for equity based share payments leads to an artificial distinction between cash-settled and equitysettled options when their underlying economics are identical. Stephen Bryan (2007) in his empirical How the New Pension Accounting Rules Affect the Dow 30's Financial Statements discusses about a new standard SFAS 158(introduced in 2006) which deals with accounting for Defined Benefit Pension and Other Postretirement Plans requires balance-sheet recognition of the funded (or unfunded) status of pension and other postemployment benefits plans. This paper discusses the impact of SFAS 158 on some financial ratios of Dow-30 companies. On an average owners equity is reduced by 12% and total liabilities increased by 4%. The retained earnings were reduced by 16 %( average). The deferral

of unrecognized gains and losses is responsible for the largest share of the understatement, almost 96%. Sarah L. C. Zechman in her paper The Relation between Voluntary Disclosure and Financial Reporting: Evidence from Synthetic Leases discusses how the use and voluntary disclosure of synthetic leases is affected by incentives to defer cash outows and manage the nancial statements by keeping debt off the balance sheet. The paper predicts that firms with higher payment deferral incentives will use synthetic leases in conjunction with more informative disclosure. The sample of study was a set of 50 firms representative of the market in US. Dan S Dhaliwal, Inder K Khurana (2011) examines whether firms with low public disclosure exhibit greater reliance on funds from private debt markets. A traditional view is that private lenders, compared to public lenders, specialize in lending to firms with information problems. Hence, low-disclosure firms will find it advantageous to raise funds through private lenders. Another view notes that, while public disclosure improves firm information environment, it could also hurt a firms competitive position. Consequently, private debt markets are argued to be cost-advantageous to lowpublic disclosure firms because these firms can benefit from conveying firm-specific information privately without incurring the costs of public disclosure. The authors evaluate this disclosuredebt placement relation using a sample of private and public debt issuances. Besides disclosure, firm financial statements also represent an important source of firm-specific information. As such, the authors examine whether the impact of disclosure policy on the debt placement decision varies between firms with low and high accounting quality. Their study finds low-disclosure firms are more likely to choose private debt, controlling for accounting quality and the impact of firm disclosure on the debt placement decision is more pronounced for firms with lower accounting quality.

Research Motivation: The literature study shows that a very few research studies have been done on accounting reforms in the field of lease accounting, pension reforms and investment accounting etc the world over. Especially there is a paucity of studies on accounting reforms literature in India. This work aims to study its impact on stock return to provide further literature in this field. Also many of the aforesaid empirical researches have been done with regard to convergence with international accounting standards (IFRS) and were majorly done since 2004. Objectives of the Study Objectives of the study are as under.

1) 2) 3)

To study the impact of accounting reforms (lease, accounting, pension reforms) on Indian companies. To study the impact of disclosures on financial health of Indian companies. To do a comparative analysis of Indian private companies, Indian PSUs and International Companies.

This paper attempts to study the ongoing international debate concerning lease accounting, retirement benefits and investment accounting. The paper attempts to find out the potential value generation and value erosion due to these accounting reforms and how these reforms bring about a correct picture of intrinsic value of the company to the shareholders. We plan to study a group of Indian public sector units and find out changes in their financial health and markets reaction in tune with changes in accounting policies above.

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