Question

Review the organization and financials of a chosen university. Describe some performance measures that might be used in assessing whether this university operates effectively. Using these measurements, how do you think the university is doing??

Answer 1

The primary objective of financial reporting is to provide high-quality financial reporting

information concerning economic entities, primarily financial in nature, useful for

economic decision making (FASB, 1999; IASB, 2008). Providing high quality financial

reporting information is important because it will positively influence capital providers

and other stakeholders in making investment, credit, and similar resource allocation

decisions enhancing overall market efficiency (IASB, 2006; IASB, 2008).

Although both the FASB and IASB stress the importance of high-quality financial

reports, one of the key problems found in prior literature is how to operationalize and

measure this quality. Because of its context-specificity, an empirical assessment of

financial reporting quality inevitably includes preferences among a myriad of constituents

(Dechow and Dichev, 2002; Schipper and Vincent, 2003; Botosan, 2004; Daske and

Gebhardt, 2006). Since different user groups will have dissimilar preferences, perceived

quality will deviate among constituents. In addition, the users within a user group may

also perceive the usefulness of similar information differently given its context. As a

result of this context and user-specificity, measuring quality directly seems problematic

(Botosan, 2004). Consequently, many researchers measure the quality of financial

reporting indirectly by focusing on attributes that are believed to influence quality of

financial reports, such as earnings management, financial restatements, and timeliness.

One explanation for these inconsistent results is that the indirect measures used in

the empirical analyses focus on specific attributes of financial reporting information that

are expected to influence the quality of financial reporting, such as earnings management,

financial restatements, and timeliness (e.g. Barth et al., 2008; Schipper & Vincent, 2003;

Cohen et al., 2004; Nichols & Wahlen, 2004). However, none of these measurement

methods enables a comprehensive assessment of financial reporting quality including all

qualitative characteristics as defined in the Exposure Draft ‘An improved Conceptual

Framework for Financial Reporting’ [ED] of the FASB and the IASB (IASB, 2008). Inter

alia, earnings management detection tools highlight the importance of earnings quality

rather than financial reporting quality as overarching objective (Krishnan & Parsons,

2008; Burgstahler et al., 2006; Healy & Wahlen, 1999). Earnings quality is defined as

“the degree to which reported earnings capture economic reality, in order to appropriately

assess a company’s financial performance” (Krishnan & Parsons, 2008). However,

financial reporting quality is a broader concept that not only refers to financial

information, but also to disclosures, and other non-financial information useful for

decision making included in the report. Therefore, in the ED both the FASB and the

IASB (2008) explicitly express their desirability of constructing a comprehensive

measurement tool to assess the quality of financial reporting considering all dimensions

of decision usefulness. Hence, this measurement tool considers all the qualitative

characteristics because these characteristics determine the decision usefulness of financial

reporting information (IASB, 2008).

The primary aim of the present study is to contribute to improving measurement

of financial reporting quality. For this reason we operationalize the financial reporting

quality in terms of the fundamental characteristics (i.e. relevance and faithful

representation) and the enhancing qualitative characteristics (i.e. understandability,

comparability, verifiability and timeliness) as defined in the ED (IASB, 2008). A 21-item

index constructed allows us to examine to what extent financial reports meet each of the

qualitative characteristics separately and in combination. We use 231 annual reports from

companies listed at US, UK, and Dutch stock markets in 2005 and 2007 to test the

Literature overview of measurement methods to assess the quality of financial

reporting

In 2002, the IASB and the FASB showed their commitment towards developing a

common set of high-quality accounting standards, which could be used worldwide. As a

consequence of the joint project to converge the more principles-based IFRS and the

more rules-based US GAAP, both boards agreed to develop new joint Conceptual

Framework, which includes the objectives of financial reporting and the underlying

qualitative characteristics on which accounting standards ought to be based. In May 2008,

the FASB and the IASB therefore published an exposure draft of ‘An improved

Conceptual Framework for Financial Reporting’ [ED] (IASB, 2008; FASB, 2008a). This

Conceptual Framework represents the foundations of the accounting standards. “The

application of objectives and qualitative characteristics should lead to high-quality

accounting standards, which in turn should lead to high-quality financial reporting

information that is useful for decision making” (FASB, 1999; IASB, 2008). Furthermore,

the conceptual framework ought to contribute to decision making of constituents, when

transactions or events occur for which no accounting standards are available (yet).

According to the ED, providing decision-useful information is the primary objective of

financial reporting. Decision-useful information is defined as “information about the

reporting entity that is useful to present and potential equity investors, lenders and other

creditors in making decisions in their capacity as capital providers” (IASB, 2008: 12). In

line with the ED and recent literature, we define financial reporting quality in terms of

decision usefulness (e.g. Beuselinck & Manigart, 2007; Jonas & Blanchet, 2000;

McDaniel et al., 2002).