To examine cross-country variation in the level and type o f dirty surplus accounting practices, I construct a fully articulated dataset o f movements in shareholders’ funds. The data is obtained from Datastream for European countries and Compustat for the
18 Exam ples o f com panies with contracts to transfer earnings are: Duewag, 1996 (Datastream code: 936476) and Friatec, 1999 (Datastream code: 309899).
U.S., supplemented with extensive hand-collected data taken from the com panies’ published financial statements (via Thomson Research / Global Access).
I obtain a set o f fully articulated data on book values, net incomes, dirty surplus flows and net distributions for each company and year in the following way. (For ease o f notation, company subscripts are suppressed. All variables should be interpreted as realisations for company i.). First, the sources o f periodic changes in shareholders' funds are assigned to one o f three categories at time t: net income (NT),
net capital distributions (D), or total dirty surplus flows (TDSF). Second, the dirty surplus flow category is decomposed into five categories as described below. Decomposing the CSR yields the following identity:
B t = B t- 1+ X t ~ D t
= Bt_x+ N It + TDSFt - Dt (3.1)
= Bt_{ + N It + PYAt - G W t - G M t + ARt + O TH t - Dt ,
where:
B - Book value o f shareholders’ funds;
X = Clean surplus earnings;
D = Dividends net o f equity issues;
N I = N et income or clean surplus earnings excluding dirty surplus flows;
PYA = Prior-year adjustments (i.e. differences between the opening book
value o f equity at the start o f a period and the corresponding closing book value o f equity at the end o f the previous period);
G W = Goodwill written-off, net o f goodwill written back on disposal;
G M = Issue o f equity unrecognised due to merger accounting, measured as the excess o f the market value o f equity issued in respect o f transactions accounted for as mergers over the increase in equity recognised in the financial statements in respect o f the mergers;
AR - Asset revaluations;
O TH = 'Other dirty surplus flows' (including foreign currency translation differences, adjustments for marketable securities, adjustments related to minimum pension liabilities, subsidies, and certain consolidation adjustments);
TDSF = ( Total dirty surplus flows, as previously defined, equal to PYA - G W - G M + AR + OTH.
I employ the general expression (3.1) as the basis to measure the dirty surplus flows for each company and year using the data that it is possible to obtain via the databases. This is supplemented with hand-collected data from the financial statements in order to correct database errors and obtain the missing data. Since components o f dirty surplus flows and disclosure requirements vary across countries, different data collection procedures are required for different countries. The following sub-sections outline the procedures used for each country examined.
3.3.2.1 U.S. data
For U.S. companies it was possible to collect a large part o f the data from Compustat. The data were then checked and corrected in accordance with the published financial statements. Based on previous attempts to measure dirty surplus items in the U.S. (Dhaliwal, et al., 1999; Hand and Landsman, 1998; Biddle and Choi, 2002), expression (3.1) is redefined as follows (Compustat items in parentheses):
Bt = Bt_: +NIt -D V t +CSTt +CSUt -T R St +CUR, +MSECt +PENt +DIFt +GMt -G M V
where:
B = Book value o f common shareholders’ funds (#60);
N I = Net income (#172) after deducting preferred dividends (#19);
D V = Common dividends (#21);
C ST = Movements in common stock (change in #85);
C SU = Movements in capital surplus (change in #210);
TRS = Movements in treasury stock (change in #88);
CUR = Foreign currency translation differences (change in #230);
M SEC = Adjustment for marketable securities (change in # 2 3 8 );19
P E N = Adjustments related to minimum pension liabilities: measured as the change in additional minimum pension liability in excess o f unrecognised prior service costs (#297 - #298, if negative);20
D IF = Other movements in shareholders' funds, measured as the difference
between the flows referred to above and the change in book value between the end o f the prior period and the end o f the current period, as reported by Compustat. Because this residual item may include both capital transactions (including changes in the book value o f equity due to mergers) and dirty surplus flows, I investigate its nature in each case by checking the published financial statements and reclassifying D IF
where appropriate;
G M = Issue o f equity unrecognised due to merger (pooling-of-interests) accounting. This item enters in expression (3.2) twice, once as a positive item to be treated as part o f equity issues, and once as a negative item to be treated as a negative dirty surplus flow akin to a write-off o f purchased goodwill. This item is equal to the excess o f (1)
19 In some cases I observe that Com pustat items #230 and #238 are not in accordance with the published financial statements. In these cases, I correct Com pustat data #230 and #238 to be in accordance with the figures reported in the financial statements.
20 This calculation operationalises pension costs in accordance with SFAS 130, section P I 6, paragraph 131.
the proceeds o f the share issue related to the merger, estimated by reference to data from Center for Research in Security Prices (CRSP), on numbers o f shares in issue and share price, over (2) the increase in the book value o f equity relating to the merger, as obtained by inspection o f the financial statements.
Items in expression (3.2) feed into those in expression (3.1) as follows next. The net income item (.NI) in expression (3.1) comprises the corresponding item in expression (3.2). The prior-year adjustment item (.PYA) comprises components o f D IF in (3.2) that were identified as relating to prior-year adjustments. The item 'issue o f equity unrecognised due to merger accounting' (GM) comprises the corresponding item in (3.2). The 'other dirty surplus flows' item (OTH) comprises the items described as
CUR, M SEC, P E N and certain components o f D IF from (3.2). The item 'dividend net o f equity issues' (D) in expression (3.1) comprises the following items from (3.2): D V
plus TRS less G M less CST less CSU. Goodwill write-offs and asset revaluations are not permitted in the U.S.
3.3.2.2 U.K. data
The data for U.K non-financial companies was available via Datastream. Nevertheless, it was necessary to analyse the financial statements in order to reclassify the residual item ‘other changes in shareholders’ funds’ as either capital movements or dirty surplus flows. For U.K. financial companies, most o f the data is hand-collected from the financial statements. Based on expression (3.1), U.K. data are collected using the expression below (Datastream items in parentheses):
B t = Bt_x + N It - DVt + CAPt + PYAt - GWt + ARt + OTHER, + OCB Vt + G M t - G M ,,
where:
B - Book value o f common shareholders’ funds. This is obtained from Datastream for non-financials (#1107), and collected manually from published financial statements for financials. The book value is adjusted to include the creditor for ordinary dividend payable;21
N I = N et income. Obtained from Datastream for non-financials (#1087) and collected manually from published financial statements for financials;
D V = Ordinary dividends (#187), less the increase in the creditor for ordinary dividend payable (see definition o f B V above);
CAP = Capital issues (exclusive o f movements in non-comm on capital). Obtained from Datastream for non-financials (#1101 - [change in #306 + change in #302]) and collected manually from published financial statements for financials;
PYA = Prior-year adjustments. Identified from Datastream in the case o f non financials and collected manually from published financial statements for financials;
G W = Goodwill written-off, net o f goodwill written back on disposal.
Obtained from Datastream for non-financials (#1103 - #1102) and collected manually from published financial statements for financials;
A R = Asset revaluations. Obtained from Datastream for non-financials (#1099) and collected manually from published financial statements for financials;
21 M arket value at year-end reflects the cum-dividend value o f the com pany at that date but, in accordance with U.K. GAAP, U.K. companies report year-end book value net o f dividends payable. In order to make book value consistent with market value, I estimate the creditor for ordinary dividend by m ultiplying the total dividend payable (#382) by the ratio o f (1) ordinary dividend expense in the year (#187) to (2) total dividend expense in the year (#187+#181).
OTHER = Other flows. Obtained from Datastream for non-financials (#1098 + #1100) and collected manually from published financial statements for financials;
O C BV= Other changes in book value. This Datastream item (#1104) comprises
both dirty surplus flows and capital items. All items in this category are reclassified, either to 'other dirty surplus flows' or to 'capital issues';
G M = Issue o f equity unrecognised due to merger accounting. The issue o f equity unrecognised due to merger (pooling-of-interests) accounting is dealt with as with the U.S. data. In the case o f the U.K., the proceeds o f the share issue related to the merger are estimated by reference to data on numbers o f shares in issue and share price obtained from Datastream.
The items described in expression (3.1) as net income (NT), prior-year adjustments
(PYA), goodwill (GW), issue o f equity unrecognised due to merger accounting (GAT),
and asset revaluations (AR) comprise the corresponding items from expression (3.3). The 'other dirty surplus flows' item (OTH) comprises OTHER and certain components o f O C BV from (3.3). The item 'dividend net o f equity issues' (D) in (3.1) comprises the following items from (3.3): D V less CAP less GAT less certain components o f
OCBV.
3.2.2.3 French and German data
The m ajority o f the data were collected manually from the financial statements for the French and German companies. The framework used for collection o f data is the same as that represented in expression (3.3), except for two items. First, as no instances o f merger accounting arise in the data for either country, the item denoted GAT is
unnecessary and therefore omitted. Second, there is an additional term (EUR) that captures small changes in book value arising from the introduction o f the single currency in January 1999, where Datastream converts all pre-1999 data reported in domestic currencies into Euros using a fixed exchange rate.22 The expression to obtain the dirty surplus flows for France and Germany is as follows:
B t = Bt_x + N It - DVt + CAP. + PYAt - GW,
(3.4)
+ ARt + O TH ERt + OCBVt + EU Rt . K J
The item OTHER in expression (3.4) represents one o f the more material dirty surplus flow categories for French and German companies. For French companies, this category includes items such as currency translation differences, subsidies, regulated provisions (provisions or reserves required by regulators for taxes, pensions and retirement purposes), consolidation adjustments and changes in accounting policies as a result o f new accounting regulations (e.g. CRC 99-02).23 For German companies, it includes unrealised appreciation in investments and various consolidation adjustments.
As with the U.K., the items described in expression (3.1) as net income (N1), prior-year adjustments (PYA), goodwill (GW), and asset revaluations (AR) comprise the corresponding items in expression (3.4). The 'other dirty surplus flows' item
(OTH) comprises OTHER, EUR and certain components o f O CBV from (3.4). The item 'dividend net o f equity issues' (D) comprises the following items from (3.4): D V
less CAP less certain components o f OCBV.