be levied against earnings in year t under the of cost or value accounting regime. new, “lower market” Here both rv and sc are assumed to be zero so long as market value exceeds the book value that would have been reported under the Feltham and Ohlson accounting regime. If market value is less than the Feltham and Ohlson book value then we assume that the difference between market value and the Feltham and Ohlson book value is written off entirely. Given the non-linear nature of the rv and sc functions one can no longer derive a precise analytical formula for the valuation equation. In order to demonstrate the effects of the change in the first order accounting regime we consider a particular scenario in which, in the absence of the special charge, the book value would remain constant between time point t-1 and time point t. Note, crucially, that if this is true for one value of then it must be true for any other value. Proposition 2. Given the assumptions of the Feltham and Ohlson (1995b) accounting model, and assume that book value under the Feltham and Ohlson model would be constant between time point t-1 and time point t. Then, when a special charge is introduced in year t, the likelihood of observing an asymmetric relation between the deflated earnings for year t and the stock price relative for year t is negatively related to the level of ex-ante conservatism. Proof Assuming a constant, Feltham and Ohlson regime, book value between time point t-1 and time point t there are only four logically possible scenarios. Vt greater than oat and Vt-1 greater than oat-1. In this scenario there will be no revaluation at time t-1 and no special charge at time t. The empirical relation between returns and deflated earnings will be symmetric and linear. Vt greater than oat and Vt-1 less than oat-1. In this scenario the assets will be re-valued downward at time point t-1 but there will be no special charge. Vt will increase (since, by assumption, Vt>oat = oat-1>Vt-1). In this scenario the relation between stock returns and deflated earnings will be linear. As in scenario 1, there will be no ex-post conservatism effect.
be levied against earnings in year t under the new, “lower of cost or market” value accounting regime. Here both rv and sc are assumed to be zero so long as market value exceeds the book value that would have been reported under the Feltham and Ohlson accounting regime. If market value is less than the Feltham and Ohlson book value then we assume that the difference between market value and the Feltham and Ohlson book value is written off entirely. Given the non-linear nature of the rv and sc functions one can no longer derive a precise analytical formula for the valuation equation. In order to demonstrate the first order effects of the change in the accounting regime we consider a particular scenario in which, in the absence of the special charge, the book value would remain constant between time point t-1 and time point t. Note, crucially, that if this is true for one value of then it must be true for any other value. Proposition 2. Given the assumptions of the Feltham and Ohlson (1995b) accounting model, and assume that book value under the Feltham and Ohlson model would be constant between time point t-1 and time point t. Then, when a special charge is introduced in year t, the likelihood of observing an asymmetric relation between the deflated earnings for year t and the stock price relative for year t is negatively related to the level of ex-ante conservatism. Proof Assuming a constant, Feltham and Ohlson regime, book value between time point t-1 and time point t there are only four logically possible scenarios. Vt greater than oat and Vt-1 greater than oat-1. In this scenario there will be no revaluation at time t-1 and no special charge at time t. The empirical relation between returns and deflated earnings will be symmetric and linear. Vt greater than oat and Vt-1 less than oat-1. In this scenario the assets will be re-valued downward at time point t-1 but there will be no special charge. Vt will increase (since, by assumption, Vt>oat = oat-1>Vt-1). In this scenario the relation between stock returns and deflated earnings will be linear. As in scenario 1, there will be no ex-post conservatism effect.
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