Accounting window dressing has been always concerned by lots of shareholders and regulation agency. Especially according to the Statement of Financial Accounting Standard NO.34 (SFAS NO.34), the implementation requires public companies to disclose their usage of derivatives in Taiwan since 2006. Recent years there has beena substantial shift from amortized cost-based accounting to primarily fair value-based accounting for financial instruments. The new accounting standard requires that firms classify investment securities into three categories based on their intent to hold the securities, including: 1. Financial assets at fair value through profits and loss (for-trading financial asset) 2. Available-for-sale financial assets 3. Held-to-maturity financial assets. The financial assets at fair value through profits and loss and available-for-sale financial assets are accounted for at fair value.
And the held-to-maturity financial assets could be accounted for at amortized historical cost. The financial assets accounted for at fair value with unrealized gain and loss will be recognized on the balance sheet as part of investment portfolio and as a part of book value of shareholders’ equity.
The implementation of SFAS NO.34 asks managers to classify the investment portfolio clearly. If the manager classifies the investment securities into available-for-sale category, the unrealized gain or loss will increase or decrease the shareholders’
equity. This may increase the volatility of shareholders’ equity and affect other key numbers that investors will concern. Because the unrealized gains or loss will recognize in the shareholders’ equity instead of income statement directly, this will have less influence on the net income, with no direct influence on the stock price. On the other hand, the managers primarily seeking to mitigate the volatility of accounting will classify the investment securities into for trading category. But the managers still have to face the problem of liquidity risk if they classify the portfolio as held-to-maturity. If the managers classify the portfolio into the category of financial assets at fair value through profits and loss, the financial assets accounted for at fair value with unrealized gains and loss will be recognized on the income statement so that will influence the volatility of net income. And the volatility of net income will make investors worry about the company’s ability to profit. So when the managers decide to
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classify the securities into the category of financial assets at fair value through profits and loss, they have to concern about the volatility of net income.
We know that most insurance companies invest lots of financial portfolio in the securities like treasury bonds, corporate bonds, and government bonds. The insurance companies have to make sure that they could meet the reserve for life insurance liability. The insurance companies have to manage their assets for long-term to make sure that they will have the ability to meet the potential liability in the future. As a result, they invest in a lot of long-term financial assets, especially in bonds and other securitization products or marketable securities. We know that those investments are always influenced by lots of different factors like interest rate, economic growth or other macroeconomic factors, even the specific factor of individual investment. The investment performance will represent the ability of the managers in company. So the managers have the intention to do the window dressing for financial reports. There are many literatures about the actions of the managers to do the window dressing in financial report. They use different methods to make the number look better and meet the needs of investors.
In this dissertation we want to know which type of company will tend to classify the security portfolio into available-for-sale category or what type of company will tend to classify the security portfolio into held-to-maturity financial category. We also want to know after the implementation of SFAS NO.34, whether the insurance company managers intend to classify the financial assets into the available-for-sale category in order to prevent the net income from plummeting. And this could further cover the difficult situation of the insurance company. We doubt reasonably that most insurance companies want to sustain the net income and profits, so they don't expect the large change of the company’s earning and hope the stock price will not fluctuate sharply. Thus they have the intention to do the earnings management. We want to know whether the implementation of SFAS NO.34 will increase the ability and control power of earnings management for insurance company.
Many insurance companies experienced a large loss in financial portfolio nominal value during the financial crisis in 2008. After the financial crisis, our regulation agency decides to make some change about reclassification according to the international accounting standard NO.39 “financial instrument: recognition and measurement” The accounting research and development foundation publish the2nd revision of SFAS NO.34 in 2008, which releases the original restriction of the
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Our research is different from the previous literatures (Jordan, 2011a; Jordan, 2011b; Huang, 2011); we develop several different proxies from the previous researches to measure the situation that the insurance company may intend to classify the financial assets into the different categories. Most investment securities for insurance companies can be divided into two categories: available-for-sale financial asset category and for-trading financial asset category. We further clarify the relationship of gains trading between different insurance companies with different financial situation and different need of liquidity. We try different proxies to measure the liquidity and risk tolerance to identify the reasons why insurance company managers will make up the financial reporting.
. The revision has a big influence on the financing industry. The regulation asks the companies to recognize the financial asset according to different valuation methods. The original value recognition should be based on the original acquisition cost. But the afterward valuation has to be based on fair value for some financial asset classify category.
1According to the 2nd revision of SFAS NO.34, there are two situations that will allow companies to reclassify the financial assets at fair value through profits and loss into the other category, like available-for-sale financial assets or held-to-maturity financial assets. The first one, if the company has the intention or ability to hold the financial assets until foreseeable future or maturity date, and the financial assets qualified the regulation of account receivables or lending. The second one, in some very specific situation, like global financial crisis. On the other hand, the 2nd revision of SFAS NO.34 also allow the company reclassify the financial assets like available-for-sale into the lending and account receivables if the company has the intention and ability to hold the financial assets until foreseeable and maturity. Although the revision releases the regulation of reclassification, it still asks much disclosure information about the reclassifying financial assets. The disclosure information includes all the book value, fair value change, and the realized profits and loss of the income statement.
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With the globalization of enterprises, the accounting rules in different countries are in line with the International Accounting Standard (IAS). The accounting rule in our country also implements SFAS NO.34 to meet the trend of international accounting rule. The SFAS NO.34 was mainly revised from international financial reporting standard NO.39 “financial instruments: recognition and measurement”. SFAS NO.34 starts to introduce the concept of fair value of the financial assetsin order to increase the transparency and information quality of financial report. However, after the implementation of SFAS NO.34, there are some queries about this accounting standard. Especially after the financial crisis in 2008, many critics doubt that the fair value measurement of financial assets will make the financial crisis even more serious.
We have three parts in the chapter. The first part we try to explore the definition of the earnings management. We will review some of the literatures that focus on the insurance companies earning management. The second part we will review the literatures about international financial accounting principles and statement of financial accounting standard, which regards to the financial asset classification, recognition, and measurement. The last part, we will review the literature regarding the implementation and the revision of SFAS NO.34 in Taiwan.
The earning management literatures try to understand why managers want to manipulate earning, and how they do so and the consequence of this behavior. There are no universal definitions for earning management. Beattie et al. (1994) notes that it is “a process of taking deliberate step within the constraints of generally accepted accounting principles to bring about a desired level of reported earnings.” Healy and Wahlen (1999) review many literatures and have a more detailed definition about earning management. They say “Earnings management occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers”. This further discloses the content of earning management. When the managers want to use judgment in financial reporting, it