An empirical investigation into differences between companies that elected an early compliance with SFAS 52 and companies not electing an early compliance

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Virginia Polytechnic Institute and State University

The latest foreign currency translation standard, Statement of Financial Accounting Standard No. 52 (SFAS 52), promulgated in December of 1981, was issued in response to harsh criticisms of its predecessor, Statement of Financial Accounting Standard No. 8 (SFAS 8). Large foreign currency translation gains and losses, resulting from the use of the temporal translation method, were required to be reported in net income under the al1—inclusive income concept mandated by SFAS 8. In contrast, SFAS 52 adopted the functional currency approach whereby companies whose functional currency is the local currency are required to use the current rate method, generally resulting in only minor translation gains and losses that are required to be reported in a separate component of stockholders' equity.

This study compares seven specific financial attributes between 83 Fortune 500 companies electing a December 31, 1981, compliance and 103 Fortune 500 companies not opting for a 1981 adoption.

Univariate t—tests on each attribute indicate the strongest difference between the two groups is in the foreign currency translation gains and losses for 1981. The multivariate Hotelling T2 test simultaneously compared differences in the seven attributes for the two groups. Test results indicate the two groups of companies are different.

Since the "yo-yo" effect on earnings was an often cited reason for opposing SFAS 8, differences in the volatility in reported earnings between the two groups for the five-year period covered by SFAS 8 (1976-1980) were examined using three different measures. The overall conclusion was that companies adopting the standard early did not have more volatility in earnings than the other group during the period that SFAS 8 was in effect.

Security price reactions to the early adoption were also investigated. Surprisingly, a strong market reaction was indicated. Significant differences between the cumulative average residuals (CARs) for the two groups began two weeks prior to year-end and continued for five months. The CARs for the group that adopted SFAS 52 early generally performed better than expected whereas the residuals for the companies that continued to report under the temporal method were worse than expected.