Accounting Income Numbers Case Study

Question 1. What is the purpose and intended contribution of the paper?

Ray Ball and Phillip Brown conducted a research in accounting to identify the usefulness of accounting numbers and the impact that they had on share prices. Before the research was done, the accounting profession was unaware of the impact that income statements and balance sheet figures, which were reported to the public had on the share prices. Also the accounting research was based solely on a few assertions and developed arguments. Some believed that accounting income numbers had no value because each firm valued them differently and there were no standard procedures across the field. However these assertions were not checked and substantiated by real world environments.

This means that if people expected good news from the company prior to the announcements, the share prices would rise and if they expected bad news from the company the share prices would fall. Therefore the information put out by the accountants was declared worthless. Ray Ball and Phillip Brown, two PhD students at the University of Chicago, started a paper research in 1966 which concluded in 1968, entitled “An Empirical Evaluation of Accounting Income Numbers” because they wanted to show how these income numbers are constructive and are not necessarily useless. This research is conducted to see if accounting income numbers really do have an impact on stock and if they will increase in value, decrease in value or not change. They came to realise that the usefulness of accounting numbers can be categorized as either timeliness or content. To conduct their research they compared the firm specific changes in stock prices with the unexpected change in the accounting income numbers. The time span for these changes

These categories are timeliness and content. Before this research was done, the information from the accounting research was based more on timeliness than on content. Ball and Brown agreed that accounting income numbers had no value based on the timeliness factor of the usefulness of information. They agreed because all of the information given in the financial statements at the end of the financial year was already incorporated in the stock prices. Also 85%-90% of the information in the accounting income numbers is already captured in the stock prices. This is done by interim reports to reveal the profitability and performance of the company before the end of financial year when the financial statements are issued. The market has then turned to these interim reports and other sources rather than waiting on announcements from the company; with that being said the importance of income numbers on stock prices is not based on timeliness. However Ball and Brown’s research showed that the content of accounting numbers is considerable. About 50% or more of the information from the firm specific component of the stock price is captured in the income numbers. Also, accounting income numbers are useful when the expected income and the change in actual income numbers are different, because the market’s reaction moves in the same direction as the unexpected