Usefulness of Accounting Estimates: A Tale of Two Countries (China and India)

Usefulness of Accounting Estimates: A Tale of Two Countries (China and India)

A Study on China and India

Florencia Borland

University of Belize
Usefulness of Accounting Estimates: A Tale of Two Countries (China and India)

Li Li Eg1 and Thanyaluk Vichitsarawong2 conducted an exploratory study of China and

India as the two largest emerging economies of BRIC (Brazil, Russia, India and China) to

examine the quality or usefulness of accounting estimates. The purpose of this exploratory study

is to see how well accounting estimates are able to predict future earnings and cash flows during

a selected period of 2003-2013. One would think that the results of this study would yield a

similar positive outcome of these two economies since there were four prediction models used,

which are similar to Lev. Li. And Sougiannis (2010) and Sougiannis (2014); not so.

It is note worthy to mention that during the sample period of 2003-2013, there was a

financial crisis that occurred from December 2007 to June 2009. As a result of this, the study

was completed in two parts known as the pre-financial crisis (2003-2006) and post-financial

crisis (2010-2013). Inclusion of the financial crisis would have had an adverse effect on the true

outcome of the study. The sample period of this study saw that the accounting standards of these

two countries are relatively different from each other and that of the International Financial

Reporting Standard (IFRS). It was not until after the second sample period of 2010-2013 that

India was provided the option to submit their consolidated financial results either in accordance

with the accounting standards of IFRS or with the accounting standards specified in Section

211(3C) of the Companies Act, 1956. While China’s new accounting standards of 2006 have

become substantively aligned with IFRS but did not fully adopted their standards.

This article sets out to prove whether or not accounting estimates is best suited to predict

future earnings and cash flows by using data from China and India’s main stock exchanges.

While this study was being conducting, researchers began to see that accounting estimates

performed better in predicting future earnings in the post-financial crisis that the earlier period.

2
Usefulness of Accounting Estimates: A Tale of Two Countries (China and India)

Many factors were taken into consideration when conducting the study from what to use

as the starting point of the calculations, the methods to be used, to the types of industries data

taken from the “Datastream” database. The article first provided a breakdown of the variables

that made up the formulas used in the four prediction models. In all models, researchers made

sure that these models were relative to each other in order to obtain the sample estimate. From

the sample estimate, they were able to run each model for every firm and sample years.

Next, they explained that some firms were excluded as they did not use local accounting

standards as well as data that were missing data. In addition, companies that operated in the

financial service, real estate and insurance sectors we also excluded as they had to comply with

specific rules and regulations. What they were left with firms that operated in industries such as

industrial goods, basic resources, and health care industries, etc amongst others that made up a

minimum of sixty percent of the sample of both countries.

The Out-of-Sample Prediction results were presented in two parts: earnings before

extraordinary items (EARN) and net cash flow from operations (CFO). ‘EARN’ showed that in

India, the models were able to show a more accurate and efficient result in indicating accounting

numbers in the post-financial crisis than the pre-financial crisis. However, the results were not

positive for China. As the study progressed throughout the years and calculations were done for

China’s firms, researchers began to notice that the overall accuracy, bias and efficiency of

accounting numbers after the financial crisis period did not improve.

What the researchers concluded in respect to the other half of the study was that the

prediction models were able to also yield a positive outcome for India in the ‘post-period’ than in

3
Usefulness of Accounting Estimates: A Tale of Two Countries (China and India)

the pre-financial crisis period. China, on the other hand, the prediction models were still unable

to provide a positive and an improvement in results in the ‘pre-period’.

So why didn’t the four prediction models provide a similar, more positive conclusion for

selected firms of both countries? The major contributing factor is that the accounting systems

that firms of each country used is different from that of the accounting standards of the

International Financial Reporting Standard that was used to conduct this study. What could have

assisted the research was that in 2010, firms in India were given the option on how to submit

their consolidated financials. Their option was to either submit their consolidated financials in

accordance with the accounting standards in Section 211 (3C) of the Companies Act, 1956 or in

accordance with that of IFRS. China did not adopt the IFRS, they instead rolled out their new

accounting standards in 2006 that resembled that of the IFRS but not quite the same. Even with

this change, the exploratory study was unable to find accounting estimates useful in China.

Another contributory factor to the unsuccessfulness of the usefulness of accounting

estimates in the early years was that there were a lot of data missing that could have helped. It

was not until the accounting standards were changed in some form or another, that the

predictions became more accurate and effective. However, this was still did not work out too

well for China.

It is with high hope that data gathered during this study, be a stepping stone in another

study where validity of using accounting estimate can be successful as one set of accounting

standards is being used by all countries involved.