Exploring the Changes in the Value Relevance of Direct Cash Flows under the Accounting Standards of Business Enterprises in China Yu SONG

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1 2017 International Conference on Education Innovation and Economic Management (EIEM 2017) ISBN: Exploring the Changes in the Value Relevance of Direct Cash Flows under the Accounting Standards of Business Enterprises in China Yu SONG , Jiangsu University, 301 Xuefu Road, Jingkou District, Zhenjiang, Jiangsu, China Keywords: Direct cash flow, Accounting standards of business enterprises (ASBE), Value relevance, Chinese stock market. Abstract. This study is designed to investigate whether the value relevance of direct cash flow statement has changed after the implementation of the Accounting Standards of Business Enterprises (ASBE) in China. Through the empirical research of the firms listed in both A and B share in Shanghai and Shenzhen stock markets, it is found that the value relevance of direct cash flow has increased after the ASBE. The core direct cash flow and the direct cash flow components also show an increase in the value relevance after the ASBE. The results of the research indicate that the direct cash flow statement is playing a more powerful role in Chinese stock market after the adoption of ASBE by providing more useful information for account users. The study is attempted to provide reasonable support for IASB and FASB to mandate the direct method of cash flow statements. Introduction Over the past few decades, the quality of accounting information has been improved by numerous of the countries in order to increase its value relevance. The International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) have taken effective actions to enhance the structure of financial reporting and the disclosure of information and so on. In China, there is also increasingly demand of information from the users of financial reports due to the rapid development of the stock market. In order to cope with the demand for the stock market, the Ministry of Finance of China set out a new accounting standard, the Accounting Standards of Business Enterprises (ASBE) in 2006, which has gained a significant process of convergence with the International Financial Reporting Standards (IFRS) and significantly increased the quality of accounting information. However, the academics have not achieved an agreement on how the value relevance of balance sheet and income statement has changed. Therefore, as Thomas (1982) mentioned, the direct cash flow statements may become more value relevant, since the historically operating cash flows may give the users of accounts a more stable source of accounting information. In addition, the IASB and FASB are now on their way of making the direct method as the mandatory method for calculating the cash flows cause they found a growing number of supporters for the direct method. Since all the listed companies are required to use the direct method to calculate the operating cash flows in China, this paper, therefore, is designed to examine the value relevance of direct cash flows in China, exploring whether its value relevance has changed after the implementation of the ASBE. Furthermore, the IASB and FASB may take the best advantage of this study for their recent concerns on mandating the direct method of cash flow statements. Sample and Data Sample Selection By dropping the companies which lack off financial data, this study used the rest 1596 companies data before the ASBE ( ) and 2268 companies data after the ASBE ( ) which listed in Shanghai and Shenzhen A and B stock markets to discover the change of the value 250

2 relevance of the direct cash flows under ASBE. To sum up, financial data from (1596*7+2268*7) firm years are tested in this study. Data Sources All the financial data of the listed companies in this dissertation are from the CSMAR database from the year of 2000 to year The empirical research uses Microsoft Excel 2013 to do basic analysis, the SASS to further process the data and run the regression. Method and Model Development Return model and price model are the two most frequently used models among researchers in accounting. This study selects the price model designed by Feltham and Ohlson, since the return model can only be used to evaluate the value relevance of earnings; while the price model can be used to provide value relevance of numerous of accounting information. In view of the models set out by Barth and Clinch (2009), this study starts by using the share price as a summary measure of information relevant to investors and investigate the value relevance of net assets and operating incomes based on Eq. 1: Pit = α+β1tnait +β2oicit +εit (1) Where Pit is the closing share price 3 months after the fiscal year-end of firm i at time t. TNA is the net asset at the financial year-end, which is calculated as the total assets minus total liabilities. OIC is the reported operating income at accounting year-end, which is also included in the regression presented by Clinch et al. (2002). Besides, α and εit are used to obtain the unexplained part of share price by TNA and OIC. Eq. 2 introduces intangible assets into the regression to see whether there is a change in the intangible assets: Pit = α+β1nait +β2niait +β3oicit +εit (2) Where NA is the net assets preclude intangible parts, which is calculated as TNA minus NIA. NIA is the reported net intangible assets at accounting year-end. According to Clacher et al. (2013), Eq. 3 directly examines the value relevance of operating cash flows, with operating income being disaggregated into operating cash flows and accruals: Pit = α+β1nait +β2niait +β3ocfit +β4accit +εit (3) Where OCF is the reported net operating cash flow at fiscal year-end. ACC is the total accruals calculated as OIC minus OCF. Eq. 4 disaggregated the operating cash flows into core and non-core cash flows following Cheng and Hollie (2008) in order to examine the value relevance of core operating cash flows: Pit = α+β1nait +β2niasit +β3coreocfit +β4ncoreocfit +β5accit +εit (4) Where COREOCF is the net core operating cash flows calculated as the cash received from customers and cash paid to employees and suppliers. NCOREOCF is the net non-core operating cash flows calculated as the OCF minus COREOCF. Eq. 5 follows Krishnan and Largay III (2000), and Arthur et al. (2010) by further disaggregating operating cash flows into the direct cash flow components reported in the direct cash flow statements: Pit= α+β1nait +β2niait +β3cshrcit +β4cshpesit + β5txpit + β6oocfit +β7accit +εit (5) Where core direct cash flows are disaggregated into CSHRC and CSHPS. CSHRC is the cash received from customers; CSHPES is the cash paid to employees and suppliers. Non-core direct cash flows are disaggregated into TXP and OOCF. TXP is the reported net taxes paid and OOCF is the reported other operating cash flows at financial year-end. 251

3 Empirical Results As shown below, table 1 to 5 sum up the empirical results for the five models of this study both before and after ASBE. The tables contain the coefficients, the p value of two tailed t-tests and the adjusted R 2 for the pre-and post-asbe years and the pooled years. Pre-ASBE period is composed from Jan to Dec. 2006; post-asbe is from Jan to Dec. 2013, both for 7 years. The pooled period is from Jan to Dec D represents the dummy variables, which take the value of their corresponding explanatory variable post-ifrs, and zero otherwise. The two-tailed p-values are presented in asterisks (***p < 0.01, **p < 0.05, *p < 0.1). As can be seen from Table 1, the coefficients for net assets are negative for both pre- and post-asbe, which shows an opposite result against most of the literatures. However, they are not too negative ( for pre-asbe and for post-asbe), which is verified by some literatures. Papadaki and Siougle (2007) got negative coefficient for net assets too, finding that the reason of the negative net assets is the existence of the loss firms. Besides, from the dummy variable D_TNA (0.037), which is positive and significant, we can conclude that the value relevance of the net assets has increased after the adoption of the ASBE. Hence, even its coefficients for pre-and post- ASBE are negative, it does not have much impact on the result that needs to be chalked up. Table 1. Value relevance of operating incomes and net assets before and after the implementation of ASBE. P it =α+β 1TNA it +β 2OIC it +ε it Intercept *** *** *** TNA *** *** *** OIC *** *** *** D_Intercept *** D_TNA ** (0.0131) D_OIC *** VIF n Adjusted R In Table 1, the coefficients for operating incomes are positive and significant for both pre- and post-asbe periods, which means operating income is value relevant both before and after the adoption of ASBE. The dummy variable for operating incomes, D_OIC is also positive and significant, reaching at 99% confidence level. Table 2 shows that the value relevance of operating incomes has increased significantly after the adoption of ASBE. The coefficients for intangible assets are negative for both pre- and post-asbe years, which might be due to the fact that the number of losing firms included in the research since intangible asset is a part of net asset. From the dummy variable of intangible assets, D_NIA, which is positive and significant, we can conclude that the value relevance of intangible assets has increased after the adoption of ASBE. Furthermore, the coefficient of the dummy variable of operating income is the highest in this regression (1.3), which is much bigger than that of intangible assets. The net assets, on the other hand, lose its significance after the adoption of ASBE. Therefore, operating incomes show the highest increased value relevance after the ASBE when intangible asset is introduced into the regression. 252

4 In Table 3, for net assets and intangible assets, their coefficients for pre- and post-asbe periods are negative. However, theirs value relevance have increased after the adoption of ASBE since their dummy variables are positive and significant, which is consistent with the previous findings. As can be seen from the Table 3, the coefficients for operating cash flows are positive and significant before and after the ASBE (1.405 and 2.002), and the dummy variable of it is also positive and significant (1.354). Therefore, the operating cash flow is value relevant both before and after the ASBE, with its value relevance significantly increasing after the adoption of ASBE. Table 2. Value relevance of operating incomes, net assets and intangible assets before and after the implementation of ASBE. P it =α+β 1NA it +β 2NIA it +β 3OICit +ε it Intercept *** *** *** NA *** *** *** NIA *** ** (0.0148) (0.2164) OIC *** *** *** D_Intercept *** D_NA (0.1035) D_NIA * (0.0892) D_OIC *** VIF n Adjusted R Table 3. Value relevance of operating cash flows, accruals, net assets and intangible assets, before and after the implementation of ASBE. P it =α+β 1NA it +β 2NIA it +β 3OCF it +β 4ACCit +ε it Intercept *** *** *** NA *** *** *** NIA *** ** (0.0274) (0.3253) OCF *** *** *** ACC *** *** *** D_Intercept *** D_NA ** (0.0409) D_NIA (0.1185) D_OCF *** D_ACC *** VIF n Adjusted R

5 Table 4 further disaggregates the operating cash flows into core and non-core direct cash flows. Different from Table 1 to 3, net assets and intangible assets in Table 4 both have positive and significant coefficients after the adoption of ASBE. The findings indicate that, after disaggregating the operating cash flow, the net asset and intangible asset begin to have value relevance after ASBE. As for the accruals, the regression result is the same as shown in Table 3. In Table 4, the coefficients for core operating cash flows are positive and significant for both preand post-asbe periods. Moreover, the coefficient for its dummy variable is also positive at 99% confidence level. As a result, the core direct cash flows remain the value relevance after the adoption of ASBE, with its value relevance increasing remarkably after the ASBE. At the same time, the non-core direct cash flows shows a same result as core direct cash flow, which has an increased value relevance after the implementation of ASBE. Table 4. Value relevance of core and non-core operating cash flows, accruals, net assets and intangible assets, before and after the implementation of ASBE. P it =α+β 1NA it +β 2NIAS it +β 3COREOCF it +β 4NCOREOCF it +β 5ACCit +ε it Intercept *** *** *** NA * (0.0783) *** (0.0011) (0.8887) NIA *** * (0.0822) *** COREOCF *** *** *** NCOREOCF *** *** *** ACC *** *** *** D_Intercept *** D_NA *** D_NIA *** D_COREOCF *** (0.0004) D_NCOREOCF *** D_ACC *** VIF n Adjusted R In Table 5, the direct cash flow components are CSHRC and CSHPES, which are the key components of core operating cash flows, and TXP and OOCF, which are the major components of non-core operating cash flows. In Table 5, the coefficient of dummy variable for the cash received from customers is negative (-0.027); whereas, the coefficient of dummy variable for cash paid to employees and suppliers is positive (1.439), both of which are significant. Although one of them is negative, the mean of the two dummy variables is significantly positive (0.706), which shows a significant increase of their value relevance as components of core operating cash flows. 254

6 As shown in Table 5, the coefficient for CSHRC is negative, which is , with coefficient for TXP also being negative (-0.454). However, the coefficient for CSHPES is significantly positive, which is By summarizing the three coefficients together, we can get the mean of 0.320, which is positive and significant. Therefore, although there are two coefficients that are negative, the positive one (CSHPES) shows a strong positive relevance, which neutralizes the negative effects of the other two variables. Accordingly, the coefficient for the dummy variable for the direct cash flow components is generally positive, which confirms that the value relevance of direct cash flow components has increased after the adoption of ASBE. Table 5. Value relevance of direct cash flow components, accruals, net assets and intangible assets, before and after the implementation of ASBE. P it=α+β 1NA it +β 2NIA it +β 3CSHRC it +β 4CSHPES it + β 5TXP it + β 6OOCF it +β 7ACC it +ε it Intercept *** *** *** NA * (0.0723) ** (0.0211) (<0.2254) NIA *** (0.0013) * (0.0555) (<0.2665) CSHRC *** (0.0038) *** *** CSHPES *** (0.0458) *** *** TXP *** *** *** OOCF (0.2974) (0.1700) (<0.3887) ACC *** *** *** D_Intercept *** D_NA *** D_NIA (0.6597) D_CSHRC *** D_CSHPES *** D_TXP *** D_OOCF (0.1457) D_ACC *** VIF n Adjusted R

7 Summary The results of the research indicate that the direct cash flow statement is playing a more reinforcing role in Chinese stock market after the implementation of ASBE. It could provide useful information for users of accounts, so that they could rely more on the stable information provided by the direct cash flow statement, except for the balance sheet and income statement. Besides, the IASB and FASB may make the best use of the research result of this study to cater support for their concerns on mandating the direct method of cash flow statements. Acknowledgement I would like to express my gratitude to all those who helped me during the writing of this dissertation. I gratefully acknowledge the help of Professor Zhang, who has offered me valuable suggestions in the academic studies at University of Leeds, UK. Also, I would like to express my thanks to my parents and friends who have always been supporting and caring me. References [1] Chalmers, K. et al. Intangible assets, IFRS and analysts earnings forecasts. Accounting & Finance. 52(3)(2012) [2] Cheng, C.A. and Hollie, D. Do core and non-core cash flows from operations persist differentially in predicting future cash flows?. Review of Quantitative Finance and Accounting. 31(1)(2008) [3] Clacher, I. et al. The value relevance of direct cash flows under international financial reporting standards. Abacus. 49(3)(2013) [4] Clinch, G. et al. The usefulness of direct and indirect cash flow disclosures. Review of Accounting Studies. 7(4)(2002) [5] Nie, P. et al. China's Progress with IFRS Convergence: Interviews with Chinese Professors. Issues in Accounting Education. 28(2)(2013), [6] Ohlson, J.A. Earnings, book values, and dividends in equity valuation. Contemporary accounting research. 11(2)(1995) [7] Papadaki, A. and Siougle, G. Value relevance of price, earnings and book values in the Athens Stock Exchange. Managerial Finance. 33(5)(2007), [8] Thomas, B.S. Reporting cash flow information. Journal of Accountancy (pre-1986). 154(000005)(1992)