Analysts' responses to alternative methods of reporting unrealised gains and losses on derivatives.
With the publication of two statements on accounting for derivatives (SFAS 133 and SFAS138), the Financial Accounting Standards Board (FASB) has taken another substantial step on thepath toward its goal of requiring the reporting of all financial instruments at market value, generallywith unrealized gains and losses included in income. This study investigates whether reporting anunrealized gain or loss in a separate line item on the income statement, as opposed to disclosureonly in a footnote, affects how financial analysts use and evaluate information on such gains andlosses. The vehicle for this research is unrealized gains or losses on derivatives. The study consistedof short financial analysis cases, presented to financial analysts and executives primarily throughmail surveys. Each subject received one of the four different possible combinations of derivativegain or loss and disclosure type. When the unrealized derivative gain/loss was included as aseparate line item in the income statement, analysts included the gain/loss significantly more oftenin their PIE ratios, and were more likely to list the derivative as afactor affecting their investmentrecommendation, than when the derivative gain/loss was disclosed only in afootnote. Moreover,regardless of disclosure type, analysts included unrealized losses on derivatives in their PIE ratiossignificantly more often than unrealized gains, and were more likely to list the derivative as afactoraffecting their investment recommendation when there was a loss as opposed to a gain. Perhapsmore interesting, given the FASB 's disclosure rules in Statement 133 (FASB, 1998), was the fact thatwhen the gain/loss was presented as a separate line item in the income statement a substantialminority of analysts (44 percent) chose to exclude the gains from their PIE ratios, whereas only i7percent chose to exclude losses. Finally, results from a subset of participants who were asked tothink aloud while analyzing the case suggest that analysts are less likely to consider informationregarding derivatives when it is contained only in afootnote. in addition, the protocols suggest thatif participants acquire the information on derivatives, they may give as much as, if not moreconsideration to that information, and evaluate it more negatively, when it is disclosed in a footnoterather than on the income statement.This study contributes to knowledge in the area of financial statement disclosure in twoprimary ways. First, it provides evidence with respect to disclosure alternatives for unrealized derivative gains and losses that is consistent with inferences drawn from prior capital marketsstudies regarding disclosure issues, and indicates that disclosure format may affect analysts' useof information, contrary to a strict interpretation of the efficient markets hypothesis. Second, itsuggests that a substantial minority of analysts seem toprefer to exclude unrealized derivative gainsand losses, particularly gains, when evaluating earnings for analysis, especially if the amount ofthose gains and losses is clearly disclosed and readily available. This further supports the need forfull disclosure of unrealized derivative gains and losses included in income.
|Year of publication:||
|Authors:||Bierstaker James ; Thosar Satish ; Wiest David|
|Type of publication:||Other|
Saved in favorites
Similar items by subject
Find similar items by using search terms and synonyms from our Thesaurus for Economics (STW).