Historical cost measurement and the use of DuPont analysis by market participants

Abstract

We investigate whether historical cost measurement of assets lowers the usefulness of DuPont analysis for investors. Because firms report assets at modified historical cost under US GAAP, accounting ratios can be biased upward when assets have appreciated. Thus, variation in asset turnover, which is the DuPont ratio most affected by asset measurement, can be due to both economic forces and measurement effects. We assess the extent of measurement effects using the average age of a firm's assets and find that asset turnover ratios are higher and more persistent for firms with older assets. Forecast errors of asset turnover are associated with the change in asset age, and these forecast errors are positively associated with contemporaneous and future returns. Our results are weaker in non-US samples, in part reflecting deflation and upward revaluations, consistent with our US results capturing biased asset turnover ratios due to historical cost measurement.

Accounting-Based Downside Risk, Cost of Capital, and the Macroeconomy

“…Our evidence on firms' downside fundamental risk sheds new light on the growing interdisciplinary research on the link between accounting and the macroeconomy, with implications for equity valuation (e.g., Chordia and Shivakumar 2005;Kothari et al 2006;Hirshleifer et al 2009;Konchitchki 2011Konchitchki , 2013Ang et al 2012;Konchitchki and Patatoukas 2014a, b;Li et al 2014;Curtis et al 2015;Shivakumar and Urcan 2015). In particular, we identify a source of firm-level risk that is linked to firms' sensitivities to downside macroeconomic patterns.…”

Accounting Valuation and Cost of Capital Dynamics: Theoretical and Empirical Macroeconomic Aspects. Discussion of Callen

“…Recently, there has been a growing academic and professional interest along three Macro‐Accounting dimensions: Macro‐to‐Micro, for example, how inflation informs accounting results, stock valuation, and cash flows’ prediction of individual firms (Konchitchki, , ; Curtis et al, ), how incorporating macro information improves forecasting of firm fundamentals (Konchitchki, ; Li et al, ), and how a firm's sensitivity to downward macroeconomic conditions affects its stock valuation (Konchitchki et al, ); Micro‐to‐Macro, for example, how contextual accounting analysis of firms located within a geographic region helps understand regional housing market fluctuations (Konchitchki, ), and how accounting results of individual firms help predict GDP growth (Konchitchki and Patatoukas, ,b); other Macro‐Accounting, for example, how a wisdom‐of‐crowd technique for aggregating information across firms or experts provides incremental ability to value firms and predicts their accounting performance (DeFond et al, ). …”

“…For more detailed information about this research front, see, for example, Kothari et al (), Ball et al (), Hirshleifer et al (), Shivakumar (, ), Cready and Gurun (), Konchitchki (, , ), Kothari and Lester (), Konchitchki and Patatoukas (,b), Li et al (), Curtis et al (), and Konchitchki et al ().…”

Financial Reporting in Hyperinflationary Economies and the Value Relevance of Accounting Amounts: Hard Evidence From Zimbabwe

“…Finally, our work contributes to a growing body of research on macro-accounting by examining the link from macroeconomic data (i.e., inflation) to firm-level data (i.e., information in earnings and book values). In particular, using published actual accounting amounts, we inform recent work on (1) how inflation affects firm-level performance, future cash flow prediction and stock returns (Konchitchki 2011;2013;Curtis et al 2015), (2) how the prediction of firm fundamentals is enhanced by integrating macro information (Konchitchki 2011;Li et al 2014), and (3) how a firm's sensitivity to downward macroeconomic conditions affects its stock returns . We also inform the research on a link that operates in the opposite direction, that is, from the micro-(firms) to the macro-level (e.g., Konchitchki and Patatoukas 2014a, b;Patatoukas 2014;Gallo et al 2016) by providing evidence that inflation (a macro-level factor) affects the value relevance of firm-level accounting amounts.…”