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RESEARCH REPORT NO.1
ARE FINANCIAL REPORTS
STILL USEFUL TO INVESTORS?
DECISION-
USEFULNESS
IN FINANCIAL
REPORTS
© 2018 Monash University (ABN 12 377 614 012); The University of Melbourne (ABN 84 002 705 224). Used under licence.
The reproduction, adaptation, display, communication or sale of these materials (‘the Materials’) is strictly prohibited unless expressly permitted under Division 3
of the Copyright Act 1968 (Cth). For permission to reproduce any part of the Materials, please contact the copyright owners identified above.
These Materials have been created for academic purposes only and are not intended to constitute legal or professional advice. CPA Australia does not warrant or
make representations as to the accuracy, completeness, suitability or fitness for purpose of the Materials and accepts no liability or responsibility for any acts or
omissions made in reliance of the Materials. Where any law prohibits the exclusion of such liability, CPA Australia limits its liability to the resupply of the information.
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 3
TABLE OF CONTENTS
1. EXECUTIVE SUMMARY 4
2. INTRODUCTION 5
3. UNITED STATES-BASED EVIDENCE 7
4. AUSTRALIAN-BASED EVIDENCE 8
5. WHY THE DIFFERENCE BETWEEN THE UNITED STATES AND AUSTRALIA? 14
6. CONCLUSION 15
7. REFERENCES 16
8. GLOSSARY 17
9. AUTHORS 18
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 4
For decades, financial reports have been
accepted by investors and other external
stakeholders as the primary window into
a company’s financial performance and
position. In addition to being a critical
information source of a company’s financial
health, financial reports are also considered
an important mechanism to maintain the
integrity of capital markets around the world.
Recently, however, questions have been
raised around the continuing usefulness of
financial reports to investors. Some academic
studies point to evidence indicating a decline
in usefulness of financial reports to investors
over time. Other reports seek to explain a loss
of relevance of financial information due to
the increasing number of information sources
available to investors, and others interested
in corporate financial information.
The views emerging about financial reports
around the world also resonate within the
Australian financial reporting environment.
With this in mind, a team of academics from
the University of Melbourne and Monash
University have undertaken academic
research, with the support of CPA Australia,
to establish whether financial reports remain
useful to Australian investors. Contrary to
findings elsewhere, the Australian study
establishes that financial reports remain
useful to investors, and remain so over time.
This report is the first in a series of reports
commissioned by CPA Australia and provides
a summary of key findings of whether and, if
so, how, financial statements are useful for
equity investors in Australia.
1.0 EXECUTIVE SUMMARY
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 5
Annual financial reports are still a mainstay
of corporate reporting, with companies
investing considerable time and effort in their
preparation. However, there has been recent
criticism that annual financial reports are
becoming increasingly less decision-useful
and less relevant to users.
Various reasons have been given for this
perceived decline in usefulness, including:
• inability to capture corporate value
increasingly comprised of knowledge-
based intangible assets;
• lack of timeliness, as users now have
access to more timely alternative sources
of information;
• rise in alternative measures (i.e., non-
GAAP measures) that act as potential
substitutes to statutory information
provided in financial reports; and
• increasing complexity and length,
particularly in relation to note disclosures.
As part of the growing debate about, and
concern over, the usefulness of financial
reporting, academics both in Australia and
overseas are undertaking research to provide
evidence of whether the relevance of financial
reports to investors has declined over time,
with interesting findings.
To examine the research question of whether,
and, if so, how financial statements are useful for
equity investors in Australia, a team of Australian
academics adopted a mixed method research
approach comprising two methods.
First, the authors examined the value
relevance of primary accounting variables to
determine whether there has been a change
in the relevance of Australian companies’
financial reports for capital market decisions.
Consistent with prior studies, the primary
variables that are examined are net income,
shareholders’ equity and operating cash
flows. These are key accounting amounts
traditionally synonymous with evaluating
company performance and position.
1 Yin (2013), Galletta (2013), Schultze and Avital (2011).
The Australian academics follow prior
research and examined time-series trends
in value relevance of annual financial
reports. This was achieved by examining the
association each year between share price
and the two key accounting amounts of
reported net profit and shareholders' equity.
This archival method is based on the annual
financial statements of ASX-listed companies
over a 24-year period, spanning 1992-2015
and resulted in 29,838 observations, which
is, on average, 1,243 listed firms per year.
This method enables the authors to
determine whether, and the extent to which,
annual financial statements are decision-
useful for equity investors in Australia.
Second, to gain an understanding of how
and why annual financial statements are
decision-useful for investor decision making,
including the types of information relied
upon, the authors conducted a series of
interviews with investors, regulators and
practitioners. A total of 17 interviews were
conducted across investors (7), regulators (5)
and practitioners (5) yielding nearly 70,000
words of transcripts. Commonalities across
the different stakeholder groups provide
strong evidence from which conclusions can
be drawn.
The authors developed a semi-structured
interview protocol drawing on prior literature
and consultation with experts in the practice
of financial reporting and regulation.
The interview protocol was pilot-tested
with experienced representatives from
stakeholder groups to reach a stable and
well-functioning protocol. Consistent with
good research practice for interview-based
research1, the authors began with broad
open-ended questions (e.g. “What is the
process you undertake to evaluate a company
for investment purposes? What information
do you use in this process?”). This helped to
ensure that the interviewees were not unduly
prompted or primed to focus on financial
statements. Only later in the protocol did
2.0 INTRODUCTION
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 6
the authors narrow to address specific
questions about the role of financial
statements. Importantly, both in the use
of broad open-ended initial questions,
and in subsequent more specific questions
regarding financial statement, the protocol
was worded so as not to bias responses
either for or against the role of financial
statements in investor decision making.
The use of a standard protocol ensured there
was a base set of questions that were asked
of all interviewees. The protocol comprised
seven main questions, with prompts to
ensure elaboration by the interviewee on
issues of particular concern. The conduct of
the interview bore out the appropriateness
of the protocol, as the natural progression
of the interviewees' unprompted discourse
often pre-emptively mirrored the order of
our questions.
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 7
In their recent book titled “The end of
accounting and the path forward for investors
and managers”, Baruch Lev and Feng Gu
paint a bleak future for financial reports.
The authors investigate whether there has
been a deterioration in the relevance of
financial reports as an input to the investment
decisions of equity investors. To do this, the
authors undertake regression analysis and
calculate, over time, the extent to which
companies’ share prices incorporate reported
net profit and shareholders’ equity – two
key accounting numbers contained within
financial reports.
As depicted in Figure 1 below, their findings
show a significant decline in the relevance
of these numbers to equity investors, as
their incorporation into share prices (the
R-square) falls over time. For example, in the
1950’s, reported net profit and shareholders’
equity explain over 90 per cent of share price
information (on average), whereas by 2013
reported net profit and shareholders’ equity
only explain approximately 50 per cent of a
company’s share price. The authors attribute
these findings primarily to those reasons
given above, and call for a revamp in the
type of report prepared to communicate
information to users.
3.0 UNITED STATES-BASED EVIDENCE
FIGURE 1:
POWER OF NET INCOME AND BOOK VALUE COMBINED IN EXPLAINING
SHARE PRICES (US EVIDENCE)
ADJUSTED R² OF REGRESSION OF CORPORATE MARKET VALUE ON REPORTED EARNINGS
AND BOOK VALUE 1950-2013
P
E
R
C
E
N
TA
G
E
R
²
0%
40%
50%
60%
70%
80%
90%
100%
1950 55 60 65 70 75 80 85 90 95 2000 05 10 2013
YEAR
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 8
4.1 DECISION-USEFULNESS OF ANNUAL
FINANCIAL STATEMENTS TO INVESTOR
DECISION- MAKING
4.1.1 Archival evidence on the combined
relevance of net income and shareholders’
equity
The authors follow the research approach
of Lev and Gu, and find that reported net
profit and shareholders’ equity are relevant
for investment decisions, and remain so over
time. As Figure 2 indicates, reported net profit
and shareholders’ equity are consistently
incorporated into companies’ share prices
over the time period examined. The results
show that the mean Adjusted R2 is 64 per cent.
This means that, on average, a company’s
financial performance and position, measured
as reported net income and shareholders’
equity respectively, explain 64 per cent of a
company’s share price. These results contrast
with the US-based research outlined above.
As shown in Figure 2, this result for the
combined value relevance of net income and
book value of equity has remained relatively
constant over time in Australia, ranging from
a high of 73.2 per cent in 1994 to a low of
48 per cent in 2001. For 2015, the most recent
year examined, on average, a company’s
financial performance and position explains
61 per cent of a company’s share price, which
is consistent with the long-term average.
4.0 AUSTRALIAN-BASED EVIDENCE
FIGURE 2:
POWER OF NET INCOME AND BOOK VALUE COMBINED IN EXPLAINING
SHARE PRICES (AUSTRALIAN EVIDENCE)
Overall, the archival results show that financial
reporting has not declined in relevance in
Australia over the period studied.
Accordingly, in contrast to much of the prior
literature that finds a decreasing trend in the
combined value relevance of earnings and
book value of equity1, we find no evidence
that value relevance has decreased across
time for net income and book value of
1 See for example Lev and Zarowin (1999), Balachandran and Mohanram (2011) and Lev and Gu (2016).
equity combined. This result is particularly
interesting given the significant increase in
available information for investors over the
time period studied.
This result suggests that the limitation of
the timeliness of the release of financial
information is not as important for investor
decision making as has been previously argued.
2
2
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
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R-SQUARE OF ANNUAL REGRESSIONS OF CORPORATE MARKET VALUE ON REPORTED
NET INCOME AND BOOK VALUE, 1992-2015
R
-S
Q
U
A
R
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DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 9
4.1.2 Interview-based evidence on the
relevance of annual financial statements
Interviewees typically viewed the financial
statements as having a confirmatory role in
assessing performance, and that the historical
basis of these statements provided the initial
input to the investment models investors
develop and use for investment purposes.
As comments from investors revealed:
Clearly financial information is, by and
large, the thing that you’re going to at
least be primarily concerned about.
(Investor 1)
The financials … are the thing that give us
confidence. The audited financials are the
thing that give us confidence that debts
will be repaid, that there are sustainable
earnings that will fund future dividends
and capital growth… It’s the thing that
gives us confidence to invest. So, I think
the entire system is crucial to us forming a
view on the fair value of an investment that
we might make. (Investor 2)
Regulators and auditors had views consistent
with those of the investors:
If I had to put a percentage on [the role
of the financial statements], it’s three-
quarters confirmatory. But… to me that
doesn’t diminish its role because I think if
there were audited financial statements
the users might say they don’t look at
them and they just go to investor briefings,
but that’s where all the numbers come
from. (Regulator 1).
It should be the first thing anybody
reads. Well, obviously, I think it provides
a pretty comprehensive track record… of
results, financial position being reported
to the market. So … I’ve always seen
it as confirming a report card. So, it’s
confirming maybe what professional
investors and others are estimating
as [what is] actually happening in the
business. (Auditor 2)
While recognising the foundational role of
audited financial statements, investors are
not naïve as to their limitations:
Audited financial statements are the go-to
…. It’s the best we have. It’s an imperfect
world … but they’re a critical part of what
we use. (Investor 7)
Likewise, issues around the backward-looking
focus and timeliness were echoed by auditors
and regulators, but did not seem to detract
from the critical role played by financial
statements:
So, it is a little bit backward looking
because, by definition, it’s the historical
financial statements. It’s not next
year’s financial statements so investors
obviously are looking more at future
cash flows and value. So, I see it mainly
as a confirmation… But it provides a
pretty good way to explain the business.
I think a lot of decisions and professional
investors … are going to be based
on understanding the track record
that companies or management have
demonstrated in the past. So, I think it’s
quite important. (Auditor 2)
The financial report is a point in time.
Yes, it’s historical and by the time it comes
out you know it is a bit of a lag … but, in
the end, it’s a true point in time – it’s got
the independent assurance…It’s all about
confident, informed markets and investors.
And the way I look at it is a key component
of that is the financial report. (Regulator 4)
The interview evidence supports a consistent
view across the stakeholder groups that the
financial statements are the foundation for
investor decision making – a necessary, but
not sufficient, basis for predicting future
performance of an entity.
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 10
4.2 DECISION-USEFULNESS OF THE
BALANCE SHEET AND PROFIT AND
LOSS STATEMENT TO INVESTOR
DECISION-MAKING
4.2.1 Archival evidence on the
separate relevance of net income
and shareholders’ equity
Having established that the combined
relevance of net income and shareholders’
equity has not declined in Australia, the
next aspect examined by the research is
whether this finding is driven by net income
or shareholders’ equity (or both) maintaining
value relevance over the sample period. That is,
to examine whether the importance of these
elements has changed over time.
Figure 3 shows the results where the effect
on share price of reported net income and
shareholders’ equity are analysed, separately,
on an annual basis.
Our results from the archival analysis show that
both shareholders' equity and net income
are decision-useful for equity investors in
making investment decisions in Australia.
The results show that the mean Adjusted
R2 for book value of equity is 60 per cent,
and for net income the mean Adjusted R2 is
52 per cent. In other words, on average, a
company’s financial position alone, measured
as book value of equity, explains 60 per cent
of a company’s share price, while financial
performance alone, measured as net income,
explains 52 per cent of a company’s share price.3
As shown in Figure 3, the association between
a company’s share price and reported
shareholders’ equity has declined over the
sample period, as reflected in its reduced
ability to explain company share prices.
However, the association between a company’s
share price and reported net income has
remained relatively stable over time.
Figure 3 also shows that the greater predictive
ability of shareholders’ equity to explain
company share prices is declining over time
to a level comparable with that of net income.
In fact, there is no discernible difference
between these two items in 2015. In 2015,
shareholders’ equity explains 49 per cent
of the share price and net income explains
46 per cent of share price. This indicates that
both elements are similarly important for
investor decision making.
FIGURE 3:
POWER OF NET INCOME AND BOOK VALUE INDIVIDUALLY IN EXPLAINING
SHARE PRICES (AUSTRALIAN EVIDENCE)
BVE
NI
0.8
0.6
0.4
0.2
0
R-SQUARE OF SEPARATE ANNUAL REGRESSIONS OF CORPORATE MARKET VALUE ON
REPORTED NET INCOME AND BOOK VALUE, 1992-2015
19
92
19
93
19
94
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3 The decision-usefulness of the financial position for equity valuation as measured by explanatory power of 60 percent could be overstated.
Current share prices are a positive function of past earning growth. This past earning growth is included in current retained earnings and therefore
a mechanical relation will arise between current book value of equity and current share price due to the use of earnings in the past to value a share.
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 11
Overall, our archival findings indicate that
reported net income and book value of equity
are important inputs in explaining a company’s
share price. Moreover, in more recent times
these accounting numbers are becoming
similarly important, perhaps suggesting that
investors rely equally on these accounting
numbers for decision making purposes.
4.2.2 Interview-based evidence on the
relevance of the balance sheet and profit
and loss statement
The evidence from the interviews provide
further insight into the role of net income
(profit and loss) and shareholders' equity
(balance sheet). Consistent with the archival
research the interviews evidenced that,
at least for investors, the profit and loss
statement and the balance sheet were
similarly important for investment decision
making. Most interviewees commented that
investors would use all aspects of financial
statements in combination:
a large proportion of investors these
days use the income statement but…a
lot of value investors…use the balance
sheet more heavily. But it’s definitely a
combination of the two. (Investor 5)
Indeed, as one investor noted the
interdependencies require consideration
of all the financial statements:
I don’t see how people could use any
one statement in isolation of the others.
(Investor 4)
Notably, investors used the different financial
statements to inform themselves about
different aspects of a business. For example:
The profit and loss gives us a good sense
of a company’s ability to pay its future
debts, … but the balance sheet gives
us a good sense of whether there are
assets that we are a little nervous about
like stranded assets or things like that.
(Investor 2)
Furthermore, investors noted that the relative
importance of the balance sheet or profit or
loss would be industry dependent, and driven
by the characteristics of individual companies.
For example:
…in the end game, you’re forecasting
cash flows and valuing those, but
generally you’ll do that via the income
statement. This changes when you have
a balance sheet driven business so for
banking, insurance, to a large degree,
firms that generate value from fair value
to equity investments…. you’ll tend to
focus primarily on book value rather than
income statement. (Investor 1)
All three stakeholder groups recognised that
the focus in the financial statements was also
moderated by the nature of the investment
decision, e.g., long-term versus short-term:
It depends on the investors. So, some
investors are investing for the long-
term, obviously, so I think they’ll look
at the quality of the profitability of the
company… whereas others are looking
at the shorter-term results… If it is a yield
investment they’ll focus on the profitability
and things like that but if it’s for the longer
term I think they look at the quality of the
assets and the quality of the profit and loss
… How predictable that is going forward.
(Auditor 4)
Overall, evidence from the field interviews
indicates that both the income statement (net
income) and the balance sheet (shareholders'
equity) are seen to have a key role in investor
decision making. This is consistent with the
archival results which indicate that both
statements are becoming similarly important
for investment decision making purposes.
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 12
4.3 DECISION-USEFULNESS OF CASH
FLOWS TO INVESTOR DECISION-MAKING
4.3.1 Archival evidence on the relevance
of operating cash flows
The results from the archival analysis show the
relevance of operating cash flows for equity
investors in making investment decisions in
Australia. The results show that the mean
Adjusted R2 is 49 per cent. This means that,
on average, a company’s operating cash flows
explain 49 per cent of a company’s share price.
As shown in Figure 4 below, this result for
operating cash flows are less stable than
reported net income, ranging from a high
of 62.2 per cent in 2004 to a low of 28.6 per
cent in 2000. For 2015, the most recent year
examined, on average, a company’s operating
cash flows explain 48 per cent of a company’s
share price, which is consistent with the long-
term average.
As Figure 4 depicts, it seems that since
2004 operating cash flows have increased
in value relevance in Australia. Prior to this
date, however, operating cash flows were,
on average, more volatile in explaining, and
less able to explain, company share prices.
FIGURE 4:
POWER OF OPERATING CASH FLOWS IN EXPLAINING SHARE PRICES
(AUSTRALIAN EVIDENCE)
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R-SQUARE OF SEPARATE ANNUAL REGRESSIONS OF CORPORATE MARKET VALUE ON
OPERATING CASH FLOWS, 1992-2015
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DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 13
4.3.2 Interview-based evidence on the
relevance of cash flows
While the interview evidence, unsurprisingly,
concurs that cash flows are important in
investment decision making, it reveals a more
nuanced view. Specifically, while cash flows
are important it does not necessarily mean
that the cash flow statement is as important.
For example:
I think cash is always king. You always
have to look at … what the cashflows are,
where they’re coming from. If it’s a cash
producing business, but you always have
to come back to the balance sheet with
respect to valuations because if something
is producing … cash then the question is –
well, what are we paying for that? (Investor 7)
While investors did not identify the cash
flow statement as more important than
other financial statements, this was often
not how auditors and regulators thought
investors would view the cash flow statement.
For example:
Cash flows would have to be the thing
[investors] look at over and above
everything else because they’re real.
(Regulator 1)
The apparent lack of focus on the cash flow
statement was perplexing to one practitioner:
I always think it’s funny when in the
financial services, [investors] come up with
a measure called cash earnings, where
there actually is a cash flow statement
which is supposed to show cash earnings.
And, so, the fact that people are trying
to come up with another form of cash
earnings is, to me, a bit of a nonsense…
Personally, I think that the profit and loss
needs the context of a cash flow and I
think that the cash flow is under focused
on. And the reason for that is because
people are trying to adjust their profit and
loss to come up with EBITDA. And, when
they’re coming up with measures like
EBITDA, they’re trying to come up with
a proxy for cash flow and I think the cash
flow statement already gives you good
information on the cash flows of a firm.
Whereas an EBITDA, at the end of the day:
taxes – they have to pay them, interest
–well the finding is something that has
to be paid for… (Auditor 1)
The cash flow statement, however, is not
without its limitations. As one auditor
succinctly described it:
I don’t think enough investors really look
at the cash flow statement. (Auditor 4)
In summary, the interviews support the
importance of cash flows in investment
decision making, but not exclusively
cash flow as reported in the cash flow
statement. As a result, there appears to
be a misconceived perception amongst
regulators and practitioners as to the
importance that investors place on the
role of the cash flow statement in investor
decision making, and the role of cash flows
versus the role of the income statement
and balance sheet.
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 14
There might be several reasons for the
difference between our findings and those
of Lev and Gu. First, there are differences
between the two countries regarding
the type of accounting standards. In the
United States (US), reported net profit and
shareholders’ equity are calculated using US
GAAP, which are often referred to as ‘rules-
based’ standards. In Australia, however, net
profit and shareholders’ equity are calculated
using IFRS-based accounting standards,
which are often referred to as ‘principles-
based’ standards and have a primary focus
of capturing a transaction’s substance over
form. Second, differences in the countries’
capital markets could also be a contributing
factor, with the US market being more liquid
than Australia’s with more frequent trading
occurring based on information, some of
which is non-accounting, obtained from
various sources. Third, reported net profit,
shareholders’ equity and operating cash flows
may still be key accounting numbers Australian
investors rely on to make investment
decisions, while US investors consider other
firm fundamentals, including intangibles-
related amounts. Finally, differences in the
sample periods between the US (1950 – 2013)
and Australian (1992 – 2015) studies may also
be a contributing factor, as any decline in
decision-usefulness may be more discernible
over a longer sample period.
5.0 WHY THE DIFFERENCE
BETWEEN THE UNITED STATES
AND AUSTRALIA?
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 15
While financial reports have been criticised
for increasingly not meeting the needs of
users, recent Australian evidence indicates
they are still of relevance to investors.
While the results suggest there is room for
improvement, the findings do not mark
the end of accounting as we know it, as
has been the call from some industry and
academic writers. The existing research in
this report is based on the combined and
separate decision-usefulness of net income
(P&L) and shareholders’ equity (B/S) for
valuation, as well as the decision-usefulness
of operating cash flows. In the next phase
of the research project, the authors will
be looking at the decision-usefulness of
alternative performance metrics including
EBIT and EBITDA.
6.0 CONCLUSION
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 16
Balachandran, S., and P. Mohanram. 2011.
Is the decline in value relevance of accounting
driven by increased conservatism? Review of
Accounting Studies 16: 272-301.
Galletta, A. 2013. Mastering the semi-structured
interview and beyond: From research design
to analysis and publication. NYU Press.
Lev, B. and P. Zarowin. 1999. The boundaries
of financial reporting and how to extend them.
Journal of Accounting Research 37(2): 353-385.
Lev, B., and F. Gu. 2016. The End of Accounting
and the Path Forward for Investors and
Managers. John Wiley & Sons, Inc. Hoboken,
NJ, USA.
Schultze, U., and M. Avital. 2011. Designing
interviews to generate rich data for information
systems research. Information and Organization
21 (1):1-16.
Yin, R. K. 2013. Case study research: Design and
methods: Sage publications.
7.0 REFERENCES
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 17
8.0 GLOSSARY
ASX Australian Stock Exchange
B/S Balance Sheet
EBIT Earnings Before Interest and Taxation
EBITDA Earnings Before Interest, Taxation, Depreciation and Amortisation
P&L Profit and Loss
R-squared The extent to which variation in the dependent variable is
associated with variation in the explanatory variables.
Regression analysis A statistical technique that examines the correlation between
a dependent variable (e.g., share price) and one or more
explanatory variables (e.g., net profit and shareholders’ equity)
US GAAP United States Generally Accepted Accounting Principles
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 18
9.0 AUTHORS
PROFESSOR MICHAEL DAVERN
Professor Michael Davern holds the Chair of Accounting and Business
Information Systems in the Faculty of Business and Economics, at the
University of Melbourne where he is a co-founder of the Melbourne
Centre for Corporate Governance and Regulation. The overarching
theme of his research is the role of data and information in business
decision making by both external and internal stakeholders,
including in areas such as investment decision making, enterprise risk
management, and business analytics. He has board level experience
with several privately held investment companies, a superannuation
fund, and a charitable not-for-profit. Michael’s research and executive
education work has included collaboration and support from EY,
Microsoft, NAB, PETRONAS, and CUA, among others.
NIKOLE GYLES
Nikole Gyles is an Enterprise Fellow in the Department of Accounting,
University of Melbourne. Nikole’s background is as an accounting
standard-setter (2011 – 2016) and Big 4 accounting practice (2004 –
2011). Her current role as Enterprise Fellow has a focus on developing
engagement with the University by contributing to Industry-related
research activities, such as the AASB Research Forum. The role also
involves leading, and contributing to, University-Industry linkages,
partnerships and networks and Executive Education for Industry.
In this role, Nikole aims to help ensure that research undertaken
provides insights into relevant issues faced by standard-setters,
regulators and/or practitioners and to develop high-quality thought
leadership that contributes to the future of financial reporting.
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 19
DR DEAN HANLON
Dean Hanlon is a senior lecturer in the Department of Accounting,
Monash University. He has been recognised for his pedagogy at the
faculty, university and national level as the recipient of several teaching
excellence awards. Dean’s current research interests are in taxation
and financial reporting. He has presented his research at numerous
international and domestic conferences, having won best paper
awards on several occasions. He has been the recipient of several
competitive industry-based research grants and has published his
research in journals including Accounting and Finance, Australian Tax
Forum, Australian Tax Review, Journal of Accounting and Public Policy,
Journal of Contemporary Accounting and Economics, and Pacific-Basin
Finance Journal.
PROFESSOR MATTHEW PINNUCK
Matthew is Professor of Financial Accounting and Head of Department
of Accounting, University of Melbourne.
Matthew’s research cuts across the areas of financial accounting and
capital markets, asset pricing and the performance of fund managers,
audit markets and the measurement and valuation of greenhouse gas
emissions. This research has been published in premier international
journals including Accounting Review, Accounting Organizations and
Society and Journal of Finance and Quantitative Analysis.
Matthew has a significant amount of past and on-going direct
engagement with industry including, most recently, involvement in the
audit industry with issues associated with fees setting and low-balling
and with CPA Australia in developing models to estimate greenhouse
gas emissions (supported by a large ARC Linkage Grant). Matthew
is also involved in teaching financial accounting across the under-
graduate, post-graduate, and research higher degree programs.
ACKNOWLEDGEMENTS
The authors would like to thank CPA Australia and Ram Subramanian,
Policy Advisor - Reporting at CPA Australia for their contribution to the
research project and this report.
cpaaustralia.com.au CPAH2933_7.2018
ARE FINANCIAL REPORTS
STILL USEFUL TO INVESTORS?
DECISION-
USEFULNESS
IN FINANCIAL
REPORTS
© 2018 Monash University (ABN 12 377 614 012); The University of Melbourne (ABN 84 002 705 224). Used under licence.
The reproduction, adaptation, display, communication or sale of these materials (‘the Materials’) is strictly prohibited unless expressly permitted under Division 3
of the Copyright Act 1968 (Cth). For permission to reproduce any part of the Materials, please contact the copyright owners identified above.
These Materials have been created for academic purposes only and are not intended to constitute legal or professional advice. CPA Australia does not warrant or
make representations as to the accuracy, completeness, suitability or fitness for purpose of the Materials and accepts no liability or responsibility for any acts or
omissions made in reliance of the Materials. Where any law prohibits the exclusion of such liability, CPA Australia limits its liability to the resupply of the information.
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 3
TABLE OF CONTENTS
1. EXECUTIVE SUMMARY 4
2. INTRODUCTION 5
3. UNITED STATES-BASED EVIDENCE 7
4. AUSTRALIAN-BASED EVIDENCE 8
5. WHY THE DIFFERENCE BETWEEN THE UNITED STATES AND AUSTRALIA? 14
6. CONCLUSION 15
7. REFERENCES 16
8. GLOSSARY 17
9. AUTHORS 18
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 4
For decades, financial reports have been
accepted by investors and other external
stakeholders as the primary window into
a company’s financial performance and
position. In addition to being a critical
information source of a company’s financial
health, financial reports are also considered
an important mechanism to maintain the
integrity of capital markets around the world.
Recently, however, questions have been
raised around the continuing usefulness of
financial reports to investors. Some academic
studies point to evidence indicating a decline
in usefulness of financial reports to investors
over time. Other reports seek to explain a loss
of relevance of financial information due to
the increasing number of information sources
available to investors, and others interested
in corporate financial information.
The views emerging about financial reports
around the world also resonate within the
Australian financial reporting environment.
With this in mind, a team of academics from
the University of Melbourne and Monash
University have undertaken academic
research, with the support of CPA Australia,
to establish whether financial reports remain
useful to Australian investors. Contrary to
findings elsewhere, the Australian study
establishes that financial reports remain
useful to investors, and remain so over time.
This report is the first in a series of reports
commissioned by CPA Australia and provides
a summary of key findings of whether and, if
so, how, financial statements are useful for
equity investors in Australia.
1.0 EXECUTIVE SUMMARY
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 5
Annual financial reports are still a mainstay
of corporate reporting, with companies
investing considerable time and effort in their
preparation. However, there has been recent
criticism that annual financial reports are
becoming increasingly less decision-useful
and less relevant to users.
Various reasons have been given for this
perceived decline in usefulness, including:
• inability to capture corporate value
increasingly comprised of knowledge-
based intangible assets;
• lack of timeliness, as users now have
access to more timely alternative sources
of information;
• rise in alternative measures (i.e., non-
GAAP measures) that act as potential
substitutes to statutory information
provided in financial reports; and
• increasing complexity and length,
particularly in relation to note disclosures.
As part of the growing debate about, and
concern over, the usefulness of financial
reporting, academics both in Australia and
overseas are undertaking research to provide
evidence of whether the relevance of financial
reports to investors has declined over time,
with interesting findings.
To examine the research question of whether,
and, if so, how financial statements are useful for
equity investors in Australia, a team of Australian
academics adopted a mixed method research
approach comprising two methods.
First, the authors examined the value
relevance of primary accounting variables to
determine whether there has been a change
in the relevance of Australian companies’
financial reports for capital market decisions.
Consistent with prior studies, the primary
variables that are examined are net income,
shareholders’ equity and operating cash
flows. These are key accounting amounts
traditionally synonymous with evaluating
company performance and position.
1 Yin (2013), Galletta (2013), Schultze and Avital (2011).
The Australian academics follow prior
research and examined time-series trends
in value relevance of annual financial
reports. This was achieved by examining the
association each year between share price
and the two key accounting amounts of
reported net profit and shareholders' equity.
This archival method is based on the annual
financial statements of ASX-listed companies
over a 24-year period, spanning 1992-2015
and resulted in 29,838 observations, which
is, on average, 1,243 listed firms per year.
This method enables the authors to
determine whether, and the extent to which,
annual financial statements are decision-
useful for equity investors in Australia.
Second, to gain an understanding of how
and why annual financial statements are
decision-useful for investor decision making,
including the types of information relied
upon, the authors conducted a series of
interviews with investors, regulators and
practitioners. A total of 17 interviews were
conducted across investors (7), regulators (5)
and practitioners (5) yielding nearly 70,000
words of transcripts. Commonalities across
the different stakeholder groups provide
strong evidence from which conclusions can
be drawn.
The authors developed a semi-structured
interview protocol drawing on prior literature
and consultation with experts in the practice
of financial reporting and regulation.
The interview protocol was pilot-tested
with experienced representatives from
stakeholder groups to reach a stable and
well-functioning protocol. Consistent with
good research practice for interview-based
research1, the authors began with broad
open-ended questions (e.g. “What is the
process you undertake to evaluate a company
for investment purposes? What information
do you use in this process?”). This helped to
ensure that the interviewees were not unduly
prompted or primed to focus on financial
statements. Only later in the protocol did
2.0 INTRODUCTION
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 6
the authors narrow to address specific
questions about the role of financial
statements. Importantly, both in the use
of broad open-ended initial questions,
and in subsequent more specific questions
regarding financial statement, the protocol
was worded so as not to bias responses
either for or against the role of financial
statements in investor decision making.
The use of a standard protocol ensured there
was a base set of questions that were asked
of all interviewees. The protocol comprised
seven main questions, with prompts to
ensure elaboration by the interviewee on
issues of particular concern. The conduct of
the interview bore out the appropriateness
of the protocol, as the natural progression
of the interviewees' unprompted discourse
often pre-emptively mirrored the order of
our questions.
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 7
In their recent book titled “The end of
accounting and the path forward for investors
and managers”, Baruch Lev and Feng Gu
paint a bleak future for financial reports.
The authors investigate whether there has
been a deterioration in the relevance of
financial reports as an input to the investment
decisions of equity investors. To do this, the
authors undertake regression analysis and
calculate, over time, the extent to which
companies’ share prices incorporate reported
net profit and shareholders’ equity – two
key accounting numbers contained within
financial reports.
As depicted in Figure 1 below, their findings
show a significant decline in the relevance
of these numbers to equity investors, as
their incorporation into share prices (the
R-square) falls over time. For example, in the
1950’s, reported net profit and shareholders’
equity explain over 90 per cent of share price
information (on average), whereas by 2013
reported net profit and shareholders’ equity
only explain approximately 50 per cent of a
company’s share price. The authors attribute
these findings primarily to those reasons
given above, and call for a revamp in the
type of report prepared to communicate
information to users.
3.0 UNITED STATES-BASED EVIDENCE
FIGURE 1:
POWER OF NET INCOME AND BOOK VALUE COMBINED IN EXPLAINING
SHARE PRICES (US EVIDENCE)
ADJUSTED R² OF REGRESSION OF CORPORATE MARKET VALUE ON REPORTED EARNINGS
AND BOOK VALUE 1950-2013
P
E
R
C
E
N
TA
G
E
R
²
0%
40%
50%
60%
70%
80%
90%
100%
1950 55 60 65 70 75 80 85 90 95 2000 05 10 2013
YEAR
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 8
4.1 DECISION-USEFULNESS OF ANNUAL
FINANCIAL STATEMENTS TO INVESTOR
DECISION- MAKING
4.1.1 Archival evidence on the combined
relevance of net income and shareholders’
equity
The authors follow the research approach
of Lev and Gu, and find that reported net
profit and shareholders’ equity are relevant
for investment decisions, and remain so over
time. As Figure 2 indicates, reported net profit
and shareholders’ equity are consistently
incorporated into companies’ share prices
over the time period examined. The results
show that the mean Adjusted R2 is 64 per cent.
This means that, on average, a company’s
financial performance and position, measured
as reported net income and shareholders’
equity respectively, explain 64 per cent of a
company’s share price. These results contrast
with the US-based research outlined above.
As shown in Figure 2, this result for the
combined value relevance of net income and
book value of equity has remained relatively
constant over time in Australia, ranging from
a high of 73.2 per cent in 1994 to a low of
48 per cent in 2001. For 2015, the most recent
year examined, on average, a company’s
financial performance and position explains
61 per cent of a company’s share price, which
is consistent with the long-term average.
4.0 AUSTRALIAN-BASED EVIDENCE
FIGURE 2:
POWER OF NET INCOME AND BOOK VALUE COMBINED IN EXPLAINING
SHARE PRICES (AUSTRALIAN EVIDENCE)
Overall, the archival results show that financial
reporting has not declined in relevance in
Australia over the period studied.
Accordingly, in contrast to much of the prior
literature that finds a decreasing trend in the
combined value relevance of earnings and
book value of equity1, we find no evidence
that value relevance has decreased across
time for net income and book value of
1 See for example Lev and Zarowin (1999), Balachandran and Mohanram (2011) and Lev and Gu (2016).
equity combined. This result is particularly
interesting given the significant increase in
available information for investors over the
time period studied.
This result suggests that the limitation of
the timeliness of the release of financial
information is not as important for investor
decision making as has been previously argued.
2
2
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
R-SQUARE OF ANNUAL REGRESSIONS OF CORPORATE MARKET VALUE ON REPORTED
NET INCOME AND BOOK VALUE, 1992-2015
R
-S
Q
U
A
R
E
19
92
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DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 9
4.1.2 Interview-based evidence on the
relevance of annual financial statements
Interviewees typically viewed the financial
statements as having a confirmatory role in
assessing performance, and that the historical
basis of these statements provided the initial
input to the investment models investors
develop and use for investment purposes.
As comments from investors revealed:
Clearly financial information is, by and
large, the thing that you’re going to at
least be primarily concerned about.
(Investor 1)
The financials … are the thing that give us
confidence. The audited financials are the
thing that give us confidence that debts
will be repaid, that there are sustainable
earnings that will fund future dividends
and capital growth… It’s the thing that
gives us confidence to invest. So, I think
the entire system is crucial to us forming a
view on the fair value of an investment that
we might make. (Investor 2)
Regulators and auditors had views consistent
with those of the investors:
If I had to put a percentage on [the role
of the financial statements], it’s three-
quarters confirmatory. But… to me that
doesn’t diminish its role because I think if
there were audited financial statements
the users might say they don’t look at
them and they just go to investor briefings,
but that’s where all the numbers come
from. (Regulator 1).
It should be the first thing anybody
reads. Well, obviously, I think it provides
a pretty comprehensive track record… of
results, financial position being reported
to the market. So … I’ve always seen
it as confirming a report card. So, it’s
confirming maybe what professional
investors and others are estimating
as [what is] actually happening in the
business. (Auditor 2)
While recognising the foundational role of
audited financial statements, investors are
not naïve as to their limitations:
Audited financial statements are the go-to
…. It’s the best we have. It’s an imperfect
world … but they’re a critical part of what
we use. (Investor 7)
Likewise, issues around the backward-looking
focus and timeliness were echoed by auditors
and regulators, but did not seem to detract
from the critical role played by financial
statements:
So, it is a little bit backward looking
because, by definition, it’s the historical
financial statements. It’s not next
year’s financial statements so investors
obviously are looking more at future
cash flows and value. So, I see it mainly
as a confirmation… But it provides a
pretty good way to explain the business.
I think a lot of decisions and professional
investors … are going to be based
on understanding the track record
that companies or management have
demonstrated in the past. So, I think it’s
quite important. (Auditor 2)
The financial report is a point in time.
Yes, it’s historical and by the time it comes
out you know it is a bit of a lag … but, in
the end, it’s a true point in time – it’s got
the independent assurance…It’s all about
confident, informed markets and investors.
And the way I look at it is a key component
of that is the financial report. (Regulator 4)
The interview evidence supports a consistent
view across the stakeholder groups that the
financial statements are the foundation for
investor decision making – a necessary, but
not sufficient, basis for predicting future
performance of an entity.
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 10
4.2 DECISION-USEFULNESS OF THE
BALANCE SHEET AND PROFIT AND
LOSS STATEMENT TO INVESTOR
DECISION-MAKING
4.2.1 Archival evidence on the
separate relevance of net income
and shareholders’ equity
Having established that the combined
relevance of net income and shareholders’
equity has not declined in Australia, the
next aspect examined by the research is
whether this finding is driven by net income
or shareholders’ equity (or both) maintaining
value relevance over the sample period. That is,
to examine whether the importance of these
elements has changed over time.
Figure 3 shows the results where the effect
on share price of reported net income and
shareholders’ equity are analysed, separately,
on an annual basis.
Our results from the archival analysis show that
both shareholders' equity and net income
are decision-useful for equity investors in
making investment decisions in Australia.
The results show that the mean Adjusted
R2 for book value of equity is 60 per cent,
and for net income the mean Adjusted R2 is
52 per cent. In other words, on average, a
company’s financial position alone, measured
as book value of equity, explains 60 per cent
of a company’s share price, while financial
performance alone, measured as net income,
explains 52 per cent of a company’s share price.3
As shown in Figure 3, the association between
a company’s share price and reported
shareholders’ equity has declined over the
sample period, as reflected in its reduced
ability to explain company share prices.
However, the association between a company’s
share price and reported net income has
remained relatively stable over time.
Figure 3 also shows that the greater predictive
ability of shareholders’ equity to explain
company share prices is declining over time
to a level comparable with that of net income.
In fact, there is no discernible difference
between these two items in 2015. In 2015,
shareholders’ equity explains 49 per cent
of the share price and net income explains
46 per cent of share price. This indicates that
both elements are similarly important for
investor decision making.
FIGURE 3:
POWER OF NET INCOME AND BOOK VALUE INDIVIDUALLY IN EXPLAINING
SHARE PRICES (AUSTRALIAN EVIDENCE)
BVE
NI
0.8
0.6
0.4
0.2
0
R-SQUARE OF SEPARATE ANNUAL REGRESSIONS OF CORPORATE MARKET VALUE ON
REPORTED NET INCOME AND BOOK VALUE, 1992-2015
19
92
19
93
19
94
19
95
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3 The decision-usefulness of the financial position for equity valuation as measured by explanatory power of 60 percent could be overstated.
Current share prices are a positive function of past earning growth. This past earning growth is included in current retained earnings and therefore
a mechanical relation will arise between current book value of equity and current share price due to the use of earnings in the past to value a share.
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 11
Overall, our archival findings indicate that
reported net income and book value of equity
are important inputs in explaining a company’s
share price. Moreover, in more recent times
these accounting numbers are becoming
similarly important, perhaps suggesting that
investors rely equally on these accounting
numbers for decision making purposes.
4.2.2 Interview-based evidence on the
relevance of the balance sheet and profit
and loss statement
The evidence from the interviews provide
further insight into the role of net income
(profit and loss) and shareholders' equity
(balance sheet). Consistent with the archival
research the interviews evidenced that,
at least for investors, the profit and loss
statement and the balance sheet were
similarly important for investment decision
making. Most interviewees commented that
investors would use all aspects of financial
statements in combination:
a large proportion of investors these
days use the income statement but…a
lot of value investors…use the balance
sheet more heavily. But it’s definitely a
combination of the two. (Investor 5)
Indeed, as one investor noted the
interdependencies require consideration
of all the financial statements:
I don’t see how people could use any
one statement in isolation of the others.
(Investor 4)
Notably, investors used the different financial
statements to inform themselves about
different aspects of a business. For example:
The profit and loss gives us a good sense
of a company’s ability to pay its future
debts, … but the balance sheet gives
us a good sense of whether there are
assets that we are a little nervous about
like stranded assets or things like that.
(Investor 2)
Furthermore, investors noted that the relative
importance of the balance sheet or profit or
loss would be industry dependent, and driven
by the characteristics of individual companies.
For example:
…in the end game, you’re forecasting
cash flows and valuing those, but
generally you’ll do that via the income
statement. This changes when you have
a balance sheet driven business so for
banking, insurance, to a large degree,
firms that generate value from fair value
to equity investments…. you’ll tend to
focus primarily on book value rather than
income statement. (Investor 1)
All three stakeholder groups recognised that
the focus in the financial statements was also
moderated by the nature of the investment
decision, e.g., long-term versus short-term:
It depends on the investors. So, some
investors are investing for the long-
term, obviously, so I think they’ll look
at the quality of the profitability of the
company… whereas others are looking
at the shorter-term results… If it is a yield
investment they’ll focus on the profitability
and things like that but if it’s for the longer
term I think they look at the quality of the
assets and the quality of the profit and loss
… How predictable that is going forward.
(Auditor 4)
Overall, evidence from the field interviews
indicates that both the income statement (net
income) and the balance sheet (shareholders'
equity) are seen to have a key role in investor
decision making. This is consistent with the
archival results which indicate that both
statements are becoming similarly important
for investment decision making purposes.
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 12
4.3 DECISION-USEFULNESS OF CASH
FLOWS TO INVESTOR DECISION-MAKING
4.3.1 Archival evidence on the relevance
of operating cash flows
The results from the archival analysis show the
relevance of operating cash flows for equity
investors in making investment decisions in
Australia. The results show that the mean
Adjusted R2 is 49 per cent. This means that,
on average, a company’s operating cash flows
explain 49 per cent of a company’s share price.
As shown in Figure 4 below, this result for
operating cash flows are less stable than
reported net income, ranging from a high
of 62.2 per cent in 2004 to a low of 28.6 per
cent in 2000. For 2015, the most recent year
examined, on average, a company’s operating
cash flows explain 48 per cent of a company’s
share price, which is consistent with the long-
term average.
As Figure 4 depicts, it seems that since
2004 operating cash flows have increased
in value relevance in Australia. Prior to this
date, however, operating cash flows were,
on average, more volatile in explaining, and
less able to explain, company share prices.
FIGURE 4:
POWER OF OPERATING CASH FLOWS IN EXPLAINING SHARE PRICES
(AUSTRALIAN EVIDENCE)
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
R-SQUARE OF SEPARATE ANNUAL REGRESSIONS OF CORPORATE MARKET VALUE ON
OPERATING CASH FLOWS, 1992-2015
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DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 13
4.3.2 Interview-based evidence on the
relevance of cash flows
While the interview evidence, unsurprisingly,
concurs that cash flows are important in
investment decision making, it reveals a more
nuanced view. Specifically, while cash flows
are important it does not necessarily mean
that the cash flow statement is as important.
For example:
I think cash is always king. You always
have to look at … what the cashflows are,
where they’re coming from. If it’s a cash
producing business, but you always have
to come back to the balance sheet with
respect to valuations because if something
is producing … cash then the question is –
well, what are we paying for that? (Investor 7)
While investors did not identify the cash
flow statement as more important than
other financial statements, this was often
not how auditors and regulators thought
investors would view the cash flow statement.
For example:
Cash flows would have to be the thing
[investors] look at over and above
everything else because they’re real.
(Regulator 1)
The apparent lack of focus on the cash flow
statement was perplexing to one practitioner:
I always think it’s funny when in the
financial services, [investors] come up with
a measure called cash earnings, where
there actually is a cash flow statement
which is supposed to show cash earnings.
And, so, the fact that people are trying
to come up with another form of cash
earnings is, to me, a bit of a nonsense…
Personally, I think that the profit and loss
needs the context of a cash flow and I
think that the cash flow is under focused
on. And the reason for that is because
people are trying to adjust their profit and
loss to come up with EBITDA. And, when
they’re coming up with measures like
EBITDA, they’re trying to come up with
a proxy for cash flow and I think the cash
flow statement already gives you good
information on the cash flows of a firm.
Whereas an EBITDA, at the end of the day:
taxes – they have to pay them, interest
–well the finding is something that has
to be paid for… (Auditor 1)
The cash flow statement, however, is not
without its limitations. As one auditor
succinctly described it:
I don’t think enough investors really look
at the cash flow statement. (Auditor 4)
In summary, the interviews support the
importance of cash flows in investment
decision making, but not exclusively
cash flow as reported in the cash flow
statement. As a result, there appears to
be a misconceived perception amongst
regulators and practitioners as to the
importance that investors place on the
role of the cash flow statement in investor
decision making, and the role of cash flows
versus the role of the income statement
and balance sheet.
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 14
There might be several reasons for the
difference between our findings and those
of Lev and Gu. First, there are differences
between the two countries regarding
the type of accounting standards. In the
United States (US), reported net profit and
shareholders’ equity are calculated using US
GAAP, which are often referred to as ‘rules-
based’ standards. In Australia, however, net
profit and shareholders’ equity are calculated
using IFRS-based accounting standards,
which are often referred to as ‘principles-
based’ standards and have a primary focus
of capturing a transaction’s substance over
form. Second, differences in the countries’
capital markets could also be a contributing
factor, with the US market being more liquid
than Australia’s with more frequent trading
occurring based on information, some of
which is non-accounting, obtained from
various sources. Third, reported net profit,
shareholders’ equity and operating cash flows
may still be key accounting numbers Australian
investors rely on to make investment
decisions, while US investors consider other
firm fundamentals, including intangibles-
related amounts. Finally, differences in the
sample periods between the US (1950 – 2013)
and Australian (1992 – 2015) studies may also
be a contributing factor, as any decline in
decision-usefulness may be more discernible
over a longer sample period.
5.0 WHY THE DIFFERENCE
BETWEEN THE UNITED STATES
AND AUSTRALIA?
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 15
While financial reports have been criticised
for increasingly not meeting the needs of
users, recent Australian evidence indicates
they are still of relevance to investors.
While the results suggest there is room for
improvement, the findings do not mark
the end of accounting as we know it, as
has been the call from some industry and
academic writers. The existing research in
this report is based on the combined and
separate decision-usefulness of net income
(P&L) and shareholders’ equity (B/S) for
valuation, as well as the decision-usefulness
of operating cash flows. In the next phase
of the research project, the authors will
be looking at the decision-usefulness of
alternative performance metrics including
EBIT and EBITDA.
6.0 CONCLUSION
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 16
Balachandran, S., and P. Mohanram. 2011.
Is the decline in value relevance of accounting
driven by increased conservatism? Review of
Accounting Studies 16: 272-301.
Galletta, A. 2013. Mastering the semi-structured
interview and beyond: From research design
to analysis and publication. NYU Press.
Lev, B. and P. Zarowin. 1999. The boundaries
of financial reporting and how to extend them.
Journal of Accounting Research 37(2): 353-385.
Lev, B., and F. Gu. 2016. The End of Accounting
and the Path Forward for Investors and
Managers. John Wiley & Sons, Inc. Hoboken,
NJ, USA.
Schultze, U., and M. Avital. 2011. Designing
interviews to generate rich data for information
systems research. Information and Organization
21 (1):1-16.
Yin, R. K. 2013. Case study research: Design and
methods: Sage publications.
7.0 REFERENCES
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 17
8.0 GLOSSARY
ASX Australian Stock Exchange
B/S Balance Sheet
EBIT Earnings Before Interest and Taxation
EBITDA Earnings Before Interest, Taxation, Depreciation and Amortisation
P&L Profit and Loss
R-squared The extent to which variation in the dependent variable is
associated with variation in the explanatory variables.
Regression analysis A statistical technique that examines the correlation between
a dependent variable (e.g., share price) and one or more
explanatory variables (e.g., net profit and shareholders’ equity)
US GAAP United States Generally Accepted Accounting Principles
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 18
9.0 AUTHORS
PROFESSOR MICHAEL DAVERN
Professor Michael Davern holds the Chair of Accounting and Business
Information Systems in the Faculty of Business and Economics, at the
University of Melbourne where he is a co-founder of the Melbourne
Centre for Corporate Governance and Regulation. The overarching
theme of his research is the role of data and information in business
decision making by both external and internal stakeholders,
including in areas such as investment decision making, enterprise risk
management, and business analytics. He has board level experience
with several privately held investment companies, a superannuation
fund, and a charitable not-for-profit. Michael’s research and executive
education work has included collaboration and support from EY,
Microsoft, NAB, PETRONAS, and CUA, among others.
NIKOLE GYLES
Nikole Gyles is an Enterprise Fellow in the Department of Accounting,
University of Melbourne. Nikole’s background is as an accounting
standard-setter (2011 – 2016) and Big 4 accounting practice (2004 –
2011). Her current role as Enterprise Fellow has a focus on developing
engagement with the University by contributing to Industry-related
research activities, such as the AASB Research Forum. The role also
involves leading, and contributing to, University-Industry linkages,
partnerships and networks and Executive Education for Industry.
In this role, Nikole aims to help ensure that research undertaken
provides insights into relevant issues faced by standard-setters,
regulators and/or practitioners and to develop high-quality thought
leadership that contributes to the future of financial reporting.
DECISION-USEFULNESS IN FINANCIAL REPORTS – RESEARCH REPORT NO.1 | 19
DR DEAN HANLON
Dean Hanlon is a senior lecturer in the Department of Accounting,
Monash University. He has been recognised for his pedagogy at the
faculty, university and national level as the recipient of several teaching
excellence awards. Dean’s current research interests are in taxation
and financial reporting. He has presented his research at numerous
international and domestic conferences, having won best paper
awards on several occasions. He has been the recipient of several
competitive industry-based research grants and has published his
research in journals including Accounting and Finance, Australian Tax
Forum, Australian Tax Review, Journal of Accounting and Public Policy,
Journal of Contemporary Accounting and Economics, and Pacific-Basin
Finance Journal.
PROFESSOR MATTHEW PINNUCK
Matthew is Professor of Financial Accounting and Head of Department
of Accounting, University of Melbourne.
Matthew’s research cuts across the areas of financial accounting and
capital markets, asset pricing and the performance of fund managers,
audit markets and the measurement and valuation of greenhouse gas
emissions. This research has been published in premier international
journals including Accounting Review, Accounting Organizations and
Society and Journal of Finance and Quantitative Analysis.
Matthew has a significant amount of past and on-going direct
engagement with industry including, most recently, involvement in the
audit industry with issues associated with fees setting and low-balling
and with CPA Australia in developing models to estimate greenhouse
gas emissions (supported by a large ARC Linkage Grant). Matthew
is also involved in teaching financial accounting across the under-
graduate, post-graduate, and research higher degree programs.
ACKNOWLEDGEMENTS
The authors would like to thank CPA Australia and Ram Subramanian,
Policy Advisor - Reporting at CPA Australia for their contribution to the
research project and this report.
cpaaustralia.com.au CPAH2933_7.2018
