College of Administration and Finance Sciences Assignment 3 Deadline: 30/04/2022 @ 23:59 Course Name: Accounting Research and practice Student’s Name: Course Code: ACCT 403 Student’s ID Number: Semester: II CRN: Academic Year: 1443 H For Instructor’s Use only Instructor’s Name: Habiba Moabber Students’ Grade: Interview Methods & Statistics Accounting Worksheet

Description

Questions for written submission:
? What are the main risks you identify with Bastion Finance and the proposed
investment?
? Would you recommend to Mr. Parker that he buy into Bastion Finance and why?
(one paragraph).3 attachmentsSlide 1 of 3

Bastion Finance Case Year 7 – Financials Receipts Cash Receipts: From New Term Deposits From Loan Customers Total Receipts: Cash Disbursements: Interest Payments Salaries, Wages, Taxes, Other Total Disbursements Cash Increase over the Year ADD: Beginning Cash Balance Cash Available During the Year $10.0 116.9 $126.9 $50.2 $ 2.3 $52.5 $74.4 $81.1 $155.5 Cash Flow Cash Receipts: From New Term Deposits From Loan customers Total Receipts Cash Disbursements: Interest Payments Salaries, Wages, Taxes, Other New Loans Made Dividends Paid Total Disbursements Cash Decrease over the Year Beginning Cash Balance Ending Cash Balance $10.0 116.9 $126.9 $50.2 2.3 130.0 7.0 $189.5 $62.6 81.1 $18.5 Accrued Interest Income LOANS: 506 405 601 602* 603* 604 605 $36.0 28.6 76.9 52.1 x .10 x .15 x .13 x .15 57.2 x .13 96.9 x .10 45.6 x .14 $3.6 4.3 10.0 3.9 3.7 9.7 6.4 New* VAR 130.0 x.13 8.5 Total Interest Revenue $50.1 * New loans issued July 1, Loans 602 and 603 paid June 30. Income Statement Revenues: Interest Income Loan Fees (8% of new loans) Operating Revenue Expenses: Interest Expense Salaries and Wages Other Operating Expenses Operating Income Income Tax Net Income $50.1 10.4 $60.5 $50.6 1.7 0.6 $52.9 $ 7.6 ? $ 7.6 Statement of retained earnings Beginning Retained Earnings Plus: Net Income Less: Dividends Ending Retained Earnings $7.0 7.6 -7.0 $7.6 Ending Loans Receivable Loan Beg. Bal. Loan Fees 405 $28.6 506 36.0 601 76.9 604 96.9 605 45.6 New 130.0 $10.4 Total Loans Receivable Accrued Int. $4.3 3.6 10.0 9.7 6.4 8.5 Ending Bal. $32.9 39.6 86.9 106.6 52.0 148.9 $466.9 Balance Sheet Assets: Cash Loans Receivable Total Assets Liabilities: Interest Payable Term Deposits Total Liabilities Owner’s Equity: Common Stock Retained Earnings Total Liabilities and Equity $ 18.5 466.9 $485.4 $ 12.6 465.0 $477.6 $ 0.2 7.6 $485.4 Bastion Finance Resources Author: Shane Moriarity & Andrew Slessor Online Pub Date: May 08, 2017 | Original Pub. Date: 2013 Subject: Financial Accounting, Financial Statement Analysis Level: | Type: Indirect case | Length: 1202 Copyright: © 2013 IMA Educational Case Journal. All rights reserved. Organization: Bastion Finance | Organization size: Region: Northern America | State: Industry: Financial service activities, except insurance and pension funding Originally Published in: Moriarity, S. , & Slessor, A. ( 2013). Bastion Finance. IMA Education Case Journal, 6( 1), Article 1. Publisher: Institute of Management Accountants DOI: http://dx.doi.org/10.4135/9781526426802 | Online ISBN: 9781526426802 SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases © 2013 IMA Educational Case Journal. All rights reserved. This case was prepared for inclusion in SAGE Business Cases primarily as a basis for classroom discussion or self-study, and is not meant to illustrate either effective or ineffective management styles. Nothing herein shall be deemed to be an endorsement of any kind. This case is for scholarly, educational, or personal use only within your university, and cannot be forwarded outside the university or used for other commercial purposes. 2021 SAGE Publications Ltd. All Rights Reserved. The case studies on SAGE Business Cases are designed and optimized for online learning. Please refer to the online version of this case to fully experience any video, data embeds, spreadsheets, slides, or other resources that may be included. This content may only be distributed for use within Florida International Univ. http://dx.doi.org/10.4135/9781526426802 Page 2 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases Resources Exhibit 1: Annual Summary Financial Statements Bastion Finance: Summary of Audited Financial Statements ($ Millions) Income Statements Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Revenues Interest Income 4.3 19.0 28.3 36.4 39.2 46.7 Loan Fees 5.2 15.4 8.0 11.2 20.0 22.8 Operating Revenue 9.5 34.4 36.3 47.6 59.2 69.5 Interest Expense 4.5 15.8 24.7 31.7 41.5 48.7 Salaries and Wages 0.7 0.8 0.9 1.1 1.3 1.5 Other 0.2 0.2 0.2 0.3 0.3 0.5 Operating Expenses 5.4 16.8 25.8 33.1 43.1 50.7 4.1 17.6 10.5 14.5 16.1 18.8 Bad Debts 0.0 0.0 0.0 0.0 3.9 6.3 Income Tax 0.0 0.0 0.0 0.0 4.8 1.6 Net Income 4.1 17.6 10.5 14.5 7.4 10.9 1.1 5.7 5.2 5.7 6.1 Expenses Operating Income Statements of Retained Earnings Beginning Retained Earnings 0.0 Page 3 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases Net Income 4.1 17.6 10.5 14.5 7.4 10.9 Dividends 3.0 13.0 11.0 14.0 7.0 10.0 1.1 5.7 5.2 5.7 6.1 7.0 Cash 2.9 2.0 71.8 96.2 102.4 81.1 Loans Receivable 74.5 232.9 264.8 312.6 349.3 393.3 Total Assets 77.4 234.9 336.6 408.8 451.7 474.4 Interest Payable 1.1 4.0 Term Deposits 75.0 225.0 325.0 395.0 435.0 455.0 Total Liabilities 76.1 229.0 331.2 402.9 445.4 467.2 Common Stock 0.2 0.2 0.2 0.2 0.2 0.2 Retained Earnings 1.1 5.7 5.2 5.7 6.1 7.0 Ending Retained Earnings Balance Sheets Assets Liabilities 6.2 7.9 10.4 12.2 Owner’s Equity Total Liabilities and Equity 77.4 234.9 336.6 408.8 451.7 474.4 Exhibit 2: Information from the Company’s Annual Report to Shareholders. Bastion Finance Fiscal Year The fiscal year for Bastion Finance runs from March 16 through March 15. To avoid confusion, dates are not used in the following discussion. Instead, references are made to each full fiscal year of operation. Thus Year Page 4 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases 1 refers to the firm’s first full year of business and Year 6 to its most recently completed year. Company Regulatory Matters The company is organized as a commercial investment company. It is not subject to regulatory oversight as a bank. Securities regulations require that term investors be supplied with a current prospectus. Depositor’s investments are not insured or guaranteed by any governmental agency. Company Shareholders Shares in Bastion Finance are not listed on any exchange nor are they publicly traded. Private transactions between individuals have occurred infrequently. As of the end of Year 6, the firm is aware of 15 individuals owning shares—most consist of very small holdings. The five largest shareholders and their holdings are: Shares Eric Lombard % 1,290,000 43% Walter Carson 1,050,000 35% Lance Edwards 300,000 10% LeRoy Fisk 150,000 5% Linda Hobbs 60,000 2% In Year 3, Linda Hobbs purchased 60,000 shares from Walter Carson for $2,816,000, a price representing eight times per share earnings for Year 2. At the end of Year 4, LeRoy Fisk purchased 150,000 shares from Walter Carson for $7,250,000, a price representing 10 times the estimated per share earnings for Year 4. Several smaller trades have occurred at various prices over the past six years. Board of Directors Six individuals serve on the company’s Board of Directors. Directors who are not managers are paid an annual retainer of $25,000 per year and receive 1,000 shares in the firm. The Chair of the Audit Committee and the Chair of the Compensation Committee each receive an additional fee of $5,000. The total fees earned in Year 6 and shareholdings as of the end of Year 6 for each of the directors are given below. Fees Shareholding Eric Lombard, Chairman of the Board $— 1,290,000 Walter Carson, Chief Executive Officer — 1,050,000 Page 5 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases Brendon Sheppard 25,000 6,000 Susan Richee, Chair of the Audit Committee 30,000 2,000 Bruce Ludlow, Chair of the Compensation Committee 30,000 3,000 Gordon Meyers 25,000 5,000 Executive Compensation The firm has only four executive-level employees. The compensation for the executive officers for the past two years was as follows: Year 5 Year 6 Eric Lombard, Chairman of the Board $350,000 $400,000 Walter Carson, Chief Executive Officer $350,000 $400,000 Paul Brekkar, Legal Officer $180,000 $200,000 Denise Horton, Finance Officer $135,000 $150,000 The Compensation Committee reviews the compensation levels paid by a sample of 10 other firms in the industry. It is the Board’s policy to maintain executive compensation at levels competitive with comparator firms. Notes to Financial Statements The preparation of our financial statements in conformance with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions affecting the amounts to be reported. Actual results may differ from those estimates. The company prepares its financial reporting accounts on an accrual accounting basis. It prepares its tax return using cash-basis accounting. Deferred taxes are not material and are not recognized in the accounts. The firm faces a tax rate of 30% on income. The company has no fixed assets. The firm’s premises, furniture, office equipment, and all fittings are leased. Lease obligations are $215,000 for Years 7 through 10 and $135,000 for Years 11 through 14. We are exposed to claims and litigation arising in the ordinary course of business and use various methods to resolve these matters in a manner which we believe best serves the interest of the firm. We do not believe any pending claim or action will have a material adverse effect on the firm. The firm has been experiencing an increase in the cost to acquire term deposits. Management has been Page 6 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases successful in passing the increase onto the firm’s borrowers. The average annual interest rates paid and earned for the past six years are given below along with the average maturities. Interest is paid quarterly to depositors and is received at maturity from borrowers. Term Depositors Loan Customers Year Annual Interest Paid Average Maturity (Months) Annual Interest Earned Average Maturity (Months) 1 8% 18 11% 21 2 9% 19 12% 25 3 9% 16 12% 25 4 9% 15 12% 24 5 10% 13 13% 19 6 11% 12 13% 26 Bastion Finance has received an unqualified audit opinion from its auditor, Goodman Cole, in each of its six years of operation. Loans Outstanding at Year End The loan cards from the firm’s Loan Book for all of the loans outstanding as of the end of Year 6 are reproduced below. (Dollar amounts are shown in millions rounded to one decimal.) Loan Cards for Outstanding Loans Loan Number 405 Principal Amount Year Granted 4 Year for Repayment Interest Rate 12%** Loan Origination Fee Borrower Prestige Development Loan $20.0 M Scheduled 5 $1.6 M Principal Officers Cornelius Bowden, Sandy Maier, and Anthony Page 7 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases Roest Transactions Loan Balance Year Description 4 Loan Principal $20.0 $20.0 4 Loan Origination Fee $1.6 $21.6 4 Interest $0.6 $22.2 5 Interest $2.7 $24.9 6 Interest $3.7 $28.6 Notes: Builder has encountered severe stability problems in the geological substrata of the building site. Project delayed indefinitely. **Interest rate raised to 15% as of start of Year 6. Loan Number 601 Principal Amount $65.0 M Year Loan Granted 6 Year for Scheduled Repayment 8 Interest Rate 13% Loan Origination Fee Borrower Kingsland Hotels Principal Officers James Franklin and Jacqueline Bell $5.2 M Transactions Year Description 6 Loan Principal Page 8 of 13 Loan Balance $65.0 $65.0 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases 6 Loan Origination Fee $5.2 $70.2 6 Interest $6.7 $76.9 Notes: Loan Number 602 Principal Amount $45.0 M Year Loan Granted 6 Year for Scheduled Repayment 7 Interest Rate 15% Loan Origination Fee Borrower Green Lane Apartments Principal Officers Wang Lim, Henry Shi, and Chong Xie $3.6 M Transactions Year Description Loan Balance 6 Loan Principal $45.0 $45.0 6 Loan Origination Fee $3.6 $48.6 6 Interest $3.5 $52.1 Notes: Loan Number 603 Principal Amount $50.0 M Year Loan Granted 6 Year for Scheduled Repayment 7 Interest Rate 13% Loan Origination Fee Borrower Lumineria Partners Page 9 of 13 $4.0 M Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. Principal Officers SAGE Business Cases Madeleine Lindquist and Heidi Coleman Transactions Year Description Loan Balance 6 Loan Principal $50.0 $50.0 6 Loan Origination Fee $4.0 $54.0 6 Interest $3.2 $57.2 Notes: Loan Number 604 Principal Amount Year Granted 6 Year for Repayment Interest Rate 10% Loan Origination Fee Borrower Dorchester Management Company Principal Officers Gordon Reynolds, Phillip Greene, and Walter Carson Loan $85.0 M Scheduled 9 $6.8 M Transactions Loan Balance Year Description 6 Loan Principal $85.0 $85.0 6 Loan Origination Fee $6.8 $91.8 6 Interest $5.1 $96.9 Page 10 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases Notes: Loan Number 605 Principal Amount $40.0 M Year Loan Granted 6 Year for Repayment 9 Interest Rate 14% Loan Origination Fee Borrower Hampton Arms Apartments Principal Transactions Scheduled $3.2 M Officers Anne Ward, Paul McLeahy, and Hamilton Wood Transactions Loan Balance Year Description 6 Loan Principal $40.0 $40.0 6 Loan Origination Fee $3.2 $43.2 6 Interest $2.4 $45.6 Notes: Company Risk Factors Bastion Finance is exposed to several sources of risk in its ordinary course of business. These include credit risk, interest rate risk, liquidity risk, and general business risk. Credit risk refers to the potential that some of our customers may default on the loans we have made to them. This risk is augmented by our focus on second mortgages and our concentration in a narrow market segment. Interest rate risk means that we may not be able to maintain a profitable spread between our cost of borrowing and the returns from lending. Liquidity risk arises because we borrow from term depositors on maturities ranging from 6-18 months while our loans to developers may extend for multiple years. General business risk is inherent in the competitive nature of our industry. We cannot be assured that our term depositors or loan customers will continue to conduct business with us rather than with one or more of our competitors. Bastion Finance is not exposed to foreign exchange risk and does not engage in derivatives trading. Exhibit 3: Loan Cards for Defaulted Loans Page 11 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases Loan Number 303 Principal Amount $25.0 M Year Loan Granted 3 Year for Scheduled Repayment 4 Interest Rate 12% Loan Origination Fee $2.0 M Borrower Phoenix Horizons Principal Officers Linda Gibson and Phillip Greene Transactions Year Description Loan Balance 3 Loan Principal $25.0 $25.0 3 Loan Origination Fee $2.0 $27.0 3 Interest $1.6 $28.6 4 Interest $3.4 $32.0 5 Interest $1.9 $33.9 5 Repayment $30.0 $3.9 5 Loss Write Off $3.9 — Notes: Holder of the first mortgage foreclosed the property. There were insufficient funds to fully re-pay our second mortgage. Loan Number 502 Principal Amount $65.0 M Year Loan Granted 5 Year for Scheduled Repayment 6 Page 12 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. Interest Rate 13% Borrower Westwood Shopping Complex Principal Officers Phyllis and David Edins SAGE Business Cases Loan Origination Fee $5.2 M Transactions Year Description Loan Balance 5 Loan Principal $65.0 $65.0 5 Loan Origination Fee $5.2 $70.2 5 Interest $5.9 $76.1 6 Interest $3.9 $80.0 6 Repayment $73.7 $6.3 6 Loss Write Off $6.3 — Notes: Proceeds from the sale of the complex failed to cover the full development costs. The company went into liquidation. PDF 1. Bastion CS Update 12-10-2020 http://dx.doi.org/10.4135/9781526426802 Page 13 of 13 Bastion Finance Bastion Finance Case Author: Shane Moriarity & Andrew Slessor Online Pub Date: May 08, 2017 | Original Pub. Date: 2013 Subject: Financial Accounting, Financial Statement Analysis Level: | Type: Indirect case | Length: 1202 Copyright: © 2013 IMA Educational Case Journal. All rights reserved. Organization: Bastion Finance | Organization size: Region: Northern America | State: Industry: Financial service activities, except insurance and pension funding Originally Published in: Moriarity, S. , & Slessor, A. ( 2013). Bastion Finance. IMA Education Case Journal, 6( 1), Article 1. Publisher: Institute of Management Accountants DOI: http://dx.doi.org/10.4135/9781526426802 | Online ISBN: 9781526426802 SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases © 2013 IMA Educational Case Journal. All rights reserved. This case was prepared for inclusion in SAGE Business Cases primarily as a basis for classroom discussion or self-study, and is not meant to illustrate either effective or ineffective management styles. Nothing herein shall be deemed to be an endorsement of any kind. This case is for scholarly, educational, or personal use only within your university, and cannot be forwarded outside the university or used for other commercial purposes. 2021 SAGE Publications Ltd. All Rights Reserved. The case studies on SAGE Business Cases are designed and optimized for online learning. Please refer to the online version of this case to fully experience any video, data embeds, spreadsheets, slides, or other resources that may be included. This content may only be distributed for use within Florida International Univ. http://dx.doi.org/10.4135/9781526426802 Page 2 of 4 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases Abstract An opportunity has arisen to purchase a stake in Bastion Finance. The seller of a minority interest in the firm has provided summary financial statements and copies of selected internal documents. Students are asked to use the information to prepare forecasted financial statements, to identify and evaluate risks associated with the investment, and to make a recommendation of whether the opportunity should be pursued. Although Bastion Finance is not a real firm, the case is based on actual practices that have occurred in the industry as revealed through court cases and media commentaries. The case is suitable for second-level, undergraduate cost/managerial courses or courses in forensic accounting. Case You are a management accountant at Parker Plastics. A few days ago the founder, James Parker, asked you to stop by his office: “This past weekend a neighbor mentioned that he owns a 10% stake in Bastion Finance that he would like to sell. He inquired if I would be interested in purchasing the holding. He said it has been paying a generous dividend. I am thinking that the investment could provide a stable source of cash flow for our company. I would like you to review their operations and let me know what you think of the potential. Start by preparing an estimate of what you think their financial statements will look like for next year. I realize the result will only be as good as your assumptions. But if your assumptions are reasonable, the estimated statements should provide a good starting point for deciding whether to pursue an investment in the company.” Mr. Parker went on to say that the 10% stake is currently owned by his neighbor, Lance Edwards. You immediately recognized his name. Lance is one of the country’s most popular professional football players. Back in your office, you called Lance to arrange a meeting to learn more about Bastion Finance. Lance was happy to meet with you and has been very cooperative in answering your questions and passing on the information he has about the company. Lance mentioned that he is approaching the end of his football career and is now looking for a new challenge. He wants to build a major state-of-the-art athletic training facility for promising young athletes. He plans to fund this venture by selling his stake in Bastion Finance. Bastion Finance was formed just over six years ago by Eric Lombard and Walter Carson. They each contributed $100,000 in return for a 50% share in the new corporation. Then they each donated a 5% stake to Lance in exchange for an agreement by Lance to regularly appear on TV, radio, and in print advertising on behalf of Bastion Finance. Lance does not participate in the management of the firm nor does he serve on the Board of Directors. The agreement for Lance to provide promotional services has recently expired and Lance is now ready to move on with his plans for his new business. You learn that Bastion Finance raises cash by selling debentures to investors at interest rates well above those available from banks or insured financial institutions. The interest rates are advertised in the business section of several newspapers, but funds are formally solicited through a prospectus. Most of Bastion’s investors are retirees, many of whom make their investments through commission-based financial advisors. Although investors are actually purchasing fixed-period debentures, management refers to them as depositors. Bastion is not a bank. It provides no banking-type services for depositors nor does it have a physical facility for one-on-one personal service. Consequently, the firm is not subject to banking regulations. The funds acquired from depositors are lent to property developers. Bastion concentrates its lending to developers needing second mortgages. These developers typically take out a first mortgage for a project from a traditional bank or insurance company. But these institutions generally limit the amount they will loan on a project to 80% of the construction costs. For well-capitalized developers, this is sufficient for them to proceed with a project by combining the borrowed funds with their own capital. Yet Bastion lends to those Page 3 of 4 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases developers who must borrow 100% of their construction costs. Bastion provides the additional funds as a second mortgage. These are high-risk mortgages. In the event a development fails to be profitable, the second mortgage holder gets repaid only to the extent that the proceeds from the sale of the development exceed the amount owed on the first mortgage. All of a development’s assets are typically pledged as collateral to the first mortgage holder and a developer who must take a second mortgage usually has little or no capital of their own at stake. This added risk of being “second in line” means that market interest rates for second mortgages are much higher than the prevailing rates on first mortgages. Bastion’s business plan is to take advantage of these higher rates while being judicious in its selection of which developers to fund. Developers are attracted to Bastion because it does not require developers to make any payments for interest, fees, or principal until a project is completed and sold (but interest is accrued and compounded annually). Lance said that the company was a success from the start. “It far surpassed Eric and Walter’s expectations. But they are generous in giving me a great deal of credit for their success. They said many of my older fans were eager to invest in a company that I endorsed. The growth rate in deposits in the first couple of years was remarkable and the firm has consistently maintained a large cash balance. The company cites this large cash holding as evidence of the firm’s solid financial position.” Because Bastion Finance is closely held, it is not required to prepare a formal annual report for public distribution. Yet Lance receives copies of each updated prospectus provided to depositors. These prospectuses contain audited financial statements. In addition, each year he receives a supplementary report containing information thought to be of interest to shareholders. Lance provided you copies of the investor prospectuses. From them, you have prepared the summary financial statements given in Exhibit 1. He also provided you with the supplementary shareholders’ information he received for Year 6. It is appended as Exhibit 2. Lance laughed and said he also kept souvenir copies of the loan cards for two loans that were not fully repaid. These are presented in Exhibit 3. Lance said, “In both cases, Walter pointed out that Bastion made money on these loans—just not in the full amount that had been anticipated.” You returned to your office after the meeting with Lance and reviewed the materials he had given you. It is now time to formulate estimated financial statements for Year 7. You have lots of data available, but you will have to use judgment in making some required forecasts. Required • 1. Prepare forecasted financial statements for Year 7 (cash flow statement, income statement, and balance sheet). Prepare a brief justification for each assumption that you make when forecasting a specific value. • 2. Use the insights you have gained from preparing the forecasted financial statements to identify the risks and concerns that should be brought to Mr. Parker’s attention. • 3. Based upon an evaluation of the potential risks and returns, recommend whether the investment in Bastion should be pursued. About IMA® With a worldwide network of more than 65,000 professionals, IMA (Institute of Management Accountants) is the world’s leading organization dedicated to empowering accounting and finance professionals to drive business performance. IMA provides a dynamic forum for professionals to advance their careers through CMA® (Certified Management Accountant) certification, research, professional education, networking, and advocacy of the highest ethical and professional standards. For more information about IMA, please visit www.imanet.org. http://dx.doi.org/10.4135/9781526426802 Page 4 of 4 Bastion Finance

UNFORMATTED ATTACHMENT PREVIEW

Marks Obtained/10 Level of Marks: High/Middle/Low Instructions – PLEASE READ THEM CAREFULLY • The Assignment must be submitted on Blackboard (WORD format only) via allocated folder. • Assignments submitted through email will not be accepted. • Students are advised to make their work clear and well presented, marks may be reduced for poor presentation. This includes filling your information on the cover page. • Students must mention question number clearly in their answer. • Late submission will NOT be accepted. • Avoid plagiarism, the work should be in your own words, copying from students or other resources without proper referencing will result in ZERO marks. No exceptions. • All answered must be typed using Times New Roman (size 12, double-spaced) font. No pictures containing text will be accepted and will be considered plagiarism). • Submissions without this cover page will NOT be accepted. College of Administration and Finance Sciences Question 1 What are the sources used to generate archival research? [3 marks] Answer Question 2 Explain why archival study will normally have more external validity than experimental or simulation approaches? [2 marks] Answer Question 3 Describe the examiner profiles [3 marks] Answer: 3089-prelims.qxd 4/2/03 4:42 PM Page i RESEARCH METHODS IN ACCOUNTING MALCOLM SMITH SAGE Publications London • Thousand Oaks • New Delhi 3089-prelims.qxd 4/2/03 4:42 PM Page ii © Malcolm Smith 2003 First published 2003 Apart from any fair dealing for the purposes of research or private study, or criticism or review, as permitted under the Copyright, Designs and Patents Act, 1988, this publication may be reproduced, stored or transmitted in any form, or by any means, only with the prior permission in writing of the publishers, or in the case of reprographic reproduction, in accordance with the terms of licences issued by the Copyright Licensing Agency. Enquiries concerning reproduction outside those terms should be sent to the publishers. SAGE Publications Ltd 6 Bonhill Street London EC2A 4PU SAGE Publications Inc 2455 Teller Road Thousand Oaks, California 91320 SAGE Publications India Pvt Ltd B-42, Panchsheel Enclave Post Box 4109 New Delhi 110 017 British Library Cataloguing in Publication data A catalogue record for this book is available from the British Library ISBN 0 7619 7146 7 ISBN 0 7619 7147 5 (pbk) Library of Congress Control Number available Typeset by C&M Digitals (P) Ltd., Chennai, India Printed in Great Britain by The Cromwell Press Ltd, Trowbridge, Wiltshire 3089-prelims.qxd 4/2/03 4:42 PM Page iii This book is dedicated to Beth, Cedric and Alice 3089-prelims.qxd 4/2/03 4:42 PM Page iv 3089-prelims.qxd 4/2/03 4:42 PM Page v Contents List of Figures xi List of Tables xii Acknowledgements xiii Preface xiv 1 Introduction and Overview Theory as testable explanation A critical approach to accounting research 1 6 8 2 Developing the Research Idea The research sequence Emergence of the research topic Conceptual frameworks The structure of DNA: the development of new theory The Bradman problem: the development of new strategies The longitude problem: implementing solutions Strategic management accounting 16 16 20 24 30 31 34 36 3 Theory, Literature and Hypotheses Sources of theory Searching the literature Modelling the relationship Developing the hypotheses Validity concerns 39 39 47 47 52 53 4 Data Collection and Analysis Sample selection Measurement issues Data management Descriptive statistics Differences in sample means Measures of association Analysis of variance Multivariate model building 55 56 56 59 60 64 69 73 75 3089-prelims.qxd 4/2/03 4:42 PM vi Page vi Contents 5 Research Ethics in Accounting The ethics quiz Informed consent Ethical guidelines 91 92 95 97 6 Experimental Research The problem statement Theory and context Experimental design The validity trade-off Quasi-experimental research 100 101 101 104 108 113 7 Survey Research Mail surveys Design and planning issues Pilot testing Data collection Measurement error Interview methods 117 117 120 122 123 126 128 8 Fieldwork Case study methods The qualitative analysis protocol Grounded theory Verbal protocol analysis 131 134 136 139 140 9 Archival Research Cross-section data Time-series data The validity trade-off in archival research Content analysis Critical analysis 142 143 144 146 147 150 10 Supervision and Examination Processes The role of the supervisor Examiner profiles The examination process 152 153 159 160 11 Turning Research into Publications Why publish? Where to publish? What to publish? How to publish? Concluding remarks 165 165 166 172 176 179 3089-prelims.qxd 4/2/03 4:42 PM Page vii Contents vii Appendix 1: Ranking of Accounting Journals 180 Appendix 2: Sample Paper (1) 182 Appendix 3: Sample Paper (2) 202 References 209 Index 230 3089-prelims.qxd 4/2/03 4:42 PM Page viii 3089-prelims.qxd 4/2/03 4:42 PM Page ix List of Figures Figure Figure Figure Figure Figure Figure Figure Figure Figure 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 The research sequence The positivist approach Alternative research methods Kolb’s Learning Cycle The deductive process The conceptual schema Measurement issues The Harvey-Jones approach to problem-solving Generalised process–improvement sequence 17 19 20 25 26 26 28 37 37 Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9 3.10 Searching for construct validity Voluntary disclosure and reciprocal causality Intervening variables and causality Non-financial focus as an intervening variable Moderated causal relationship Size, industry and culture moderating performance Influence of extraneous variables Economic conditions as extraneous variables Multiple independent variables Modelling the recruitment process 41 48 49 49 49 50 50 51 51 52 Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 4.11 4.12 Significance of test of proportion χ2-test for difference in frequencies Test of significance of correlation coefficient t-test for difference in means t-test for paired-case difference in means Mann–Whitney U-test for difference in means Product–moment correlation coefficient (Pearson’s r) Coefficient of rank correlation (Spearman’s rho) Measure of association within contingency tables One-way analysis of variance (ANOVA) The Kruskal–Wallis multiple sample test Summary of regression results for charity shops case study 62 63 65 66 67 68 70 71 72 74 76 82 3089-prelims.qxd 4/2/03 4:42 PM Page x List of Tables Table 1.1 Three alternative approaches Table Table Table Table Summary of significance tests by measurement level Measures of association by measurement level ANOVA summary table Summary of multivariate model-building methods by measurement level 4.1 4.2 4.3 4.4 Table 10.1 Expectations of supervisor and candidate 5 62 70 75 77 155 3089-prelims.qxd 4/2/03 4:42 PM Page xi Acknowledgements This book could not have been written without the help of numerous colleagues, most notably Bev Schutt and Paul Martin from the University of South Australia. Thanks are also owed to Glen Lehman, Linley Hartmann, Bruce Brown and Bruce Gurd at UniSA, and to David Russell, Ashok Patel and Elaine Harris at the Leicester Business School. However, as is normal, all errors and omissions remain the responsibility of the author. 3089-prelims.qxd 4/2/03 4:42 PM Page xii Preface This book aims to provide an insider’s view of the research process, by focusing on actual choices made in the conduct of accounting research projects, together with a realistic perception of what might go wrong, even with careful planning. We must, however, acknowledge that no single author can be an expert in all research methods; this author is no exception. My own publications will readily reveal a preponderance of studies concerning experimental methods and the use of archival data; there are fewer instances of studies using survey and field study methods. It would be unwise of me to claim expertise in the implementation of all such methods, so this book must necessarily lean heavily on the work of others. For the same reasons, and because of pressure of space, this book does not address issues of finance, capital markets research, or stockprice-related accounting research on the fringes of finance. Most other texts in this area are long, over-theoretical and not particularly user-friendly. This book aims to address these issues by adopting a practical approach which takes the reader from the initiation of the research idea right through to the publication of the research findings. The intended readership is wide, embracing instructors, doctoral candidates, and academics starting, or re-starting, their research careers. Although the focus, and examples, are mainly accounting based, much of the material will also be relevant to more general business applications, of particular interest to those pursuing a Doctorate of Business Administration (DBA) qualification. The practical examples employed are usually UK or Australia-based, these being the two countries in which I have extensive, current experience of teaching, supervision and examining, but the principles should normally adapt easily to alternative environments. An early distinction between ‘methods’ and ‘methodologies’ in research is essential because the two are so often confused, or else used interchangeably. Research methods are concerned with the technical issues associated with the conduct of research; research methodology is concerned with the philosophies associated with the choice of research method. This book is almost exclusively concerned with the former and, after Chapter 1, deliberately neglects the philosophical foundations of research except where reference thereto is unavoidable. Chapter 2 examines the research idea, and the documentary sources which might aid their development. A number of examples, many from nonaccounting environments, are used to illustrate the research sequence, and to examine research that is seeking either to improve outcomes, to explain improved outcomes through new theory, or to examine the improvement 3089-prelims.qxd 4/2/03 4:42 PM Page xiii Preface xiii process itself. Theoretical frameworks and research models are used extensively here to help the reader to picture the key variables and relationships underlying their research. Theory is the focus of Chapter 3, on the basis that ‘good research is founded on good theory’. The chapter addresses the sources of the theory widely applied in accounting research, but drawn from other disciplines. In the space available it can only hope to give a flavour of the diversity which is available; indeed, it prompts us to suggest that ‘theory in accounting research’ might provide a suitable follow-up text in its own right! Recognition of the importance of theory, reliability and validity as desirable characteristics of accounting research lead, in Chapter 4, to the issues of data collection, management and analysis necessary to conduct hypothesis testing. This chapter is unashamedly quantitative in nature, but the relative strengths of qualitative analysis are addressed in subsequent chapters. Chapter 5 addresses the increasingly important ethical considerations which underpin the conduct of accounting research, and the subsequent publication of research findings. It highlights the confusion which is still apparent among many academics as to what constitutes unethical conduct, and specifies the necessary guidelines for good practice. Chapters 6 to 9 are devoted, respectively, to the core forms of accounting research: experimental, survey-based, fieldwork and archival. Numerous examples are used to demonstrate the relative advantages of alternative methods so that researchers can both make an informed choice and justify their preferred approach. Research can be based on quantitative or qualitative methods, and both should be equally acceptable as long as the most appropriate method has been chosen. Richardson (1996, p. 4) notes that ‘work on how science really gets done’ (such as that described in Chapter 2 based on Watson, 1968) shows that even though we are in an extreme ‘positivist’ domain, interpretive knowledge is still important in the development of new theory. The majority of the readers of this text will likely be doctoral candidates so Chapter 10 is devoted to supervisor–candidate relationships, highlighting the mutual responsibilities of both parties to the supervision process, from the outset right up to the examination process. Publication is the natural target output of the research process, and Chapter 11 addresses the complexity of the publication process. In doing so it recognises that we are working in a dynamic process; what was once acceptable in accounting research is no longer so because of a more appropriate emphasis on research ethics; what is publishable, at all or in specific journals, changes too, both with the passage of time and the passing of particular journal editors. Many journals remain very conservative in the type of research they will publish, often on the grounds that it is difficult to demonstrate that ‘new’ methods constitute ‘good’ research in the same way as the traditional methods. But this situation is changing gradually – the wider opportunities for publishing case-based research in recent years provides evidence of this. However, the renewed emphasis on journal and university rankings, and associated funding systems based on the quality of publications, provides fresh difficulties. 3089-prelims.qxd xiv 4/2/03 4:42 PM Page xiv Preface The provision of ‘acceptable journals’ listings by many universities, and the prohibition of publication elsewhere, perpetuates the position of the wellestablished journals, while making it extremely difficult for the editors of other journals to attract quality submissions. The opportunities for innovative new journals are also severely diminished in such circumstances. Contributions to the profession by academic accountants are generally not well regarded, either by one’s colleagues or by government bodies providing funding based on publications performance, even though, arguably, the education of the potential employers of our students might be seen as an important part of our jobs. So journalistic pieces in practitioner magazines and workshops to professional audiences count for close to nought – even though the individuals concerned would never read a refereed journal or attend an academic conference. We need to exploit the available media to get our message, and the power of research findings, over to those implementing change in an unbiased way, before the consultants get in on the act! This process must be of mutual benefit to all parties, but if the practitioners feel they are being short-changed, or even used, then future collaborative efforts will be threatened. It is just such attitudes which generate the ‘them and us’ cultures leading to accusations of academics being out of touch with reality. In this context it is interesting to note the changes taking place within professional journals: there were once two such journals called Management Accounting, but now there are none, the US version becoming Strategic Finance and the UK one Financial Management. With moves to term ‘accounting’ as ‘assurance services’ it will surely not be long before some of the professional bodies themselves follow their journals with the removal of the word ‘accounting’ from their titles. Communication problems also remain. The timeliness and relevance of much of the content of the refereed literature does little more than suggest that it is written by academics, only for the consumption of other academics! Most practitioners do not have an appreciation of research methods, nor do they read the refereed literature, so important findings and recommendations often do not reach the individuals who can make sure it has the greatest impact. A number of journals have emerged with the express intention of providing readable research for practitioner audiences, but even these have tended to become more academic and less readable over relatively short time periods. This book aims to provide a treatment of research methods that will be of use to both accounting practitioners and those contemplating the conduct of research projects. Space restrictions mean that this slim volume cannot hope to tackle all of the detail of the application of different research methods, or the associated intricacies of complex quantitative methods. But if its use causes one paper to be published that would otherwise have gone unpublished, then all will have been worthwhile. Malcolm Smith 1 Introduction and Overview CHAPTER CONTENTS • Theory as testable explanation • A critical approach to accounting research 6 8 A number of authors (e.g., Brownell, 1995, p. 2) describe accounting researchers as ‘parasites’ who prey on the work of others to generate their findings. The term may be an overstatement, but as with most rash generalisations it contains more than a germ of truth: accounting researchers have little theory of their own (they rely on economics, finance, psychology, sociology and organisational behaviour as their major sources); they have no methods of their own (they are all adapted from the natural and social sciences); and they have few instruments of their own (with many of these originating in or adapted from the organisational behaviour literature). Merchant (quoted in Brownell, 1995, p. 140) even suggests that organisational behaviourists are much better at developing survey instruments than their accounting counterparts. The overall aim of this book is to facilitate the conduct of applied research studies in accounting, and to do this we must recognise our reliance on work in other disciplines. To accomplish this aim, a number of subordinate objectives may be identified, all of which will contribute to the overall goal: • an understanding of contemporary research ideas in accounting, so that readers can identify and define research problems and prepare strategies for their solution; • an awareness of alternative research methods, to facilitate the selection of the most appropriate method for addressing particular research questions; • an ability to review existing research and to offer critiques of articles published in refereed journals; and • an appreciation of the ethical constraints on the conduct of accounting research. 2 Research Methods in Accounting Research in accounting is concerned with solving problems, investigating relationships and building a body of knowledge. Because we rely to such a great extent on prior research in the natural and social sciences to do so, this volume will take a similar approach in leaning on work in other disciplines where it helps to inform accounting research. Bennett (1991) identifies four basic levels of research: • Description – concerned with the collection and reporting of data related to what is, or was, the case. This would include means and standard deviations of individual variables, and correlations between pairs of variables. • Classification – still descriptive, but easing the reporting process, and highlighting similarities and clustering through grouping and classifying (e.g., through the familiar cross-tabulation facility in most basic statistical packages). • Explanation – an attempt to make sense of observations by explaining the relationships observed and attributing causality based on some appropriate theory. • Prediction – going beyond the understanding and explaining of the prior stage, to model observations in a way that allows testable predictions to be made of unknown events. We return to this structure in Chapter 4 when discussing alternative quantitative methods, but an early distinction between ‘explanation’ and ‘prediction’ is appropriate here, because, as in the natural sciences, we are able to make excellent predictions of accounting behaviour without the backing of a sound underpinning theory. Bankruptcy prediction modelling provides an excellent example. A number of researchers (e.g., Altman, 1968; Taffler, 1983) have developed models that have proved very successful in identifying ‘distressed’ companies – those companies that will fail in the short term. These models are statistically excellent but the theory underpinning their content, in terms of the ratios to be used and the variables they represent, is extremely weak; the essential problem is that such theories as we have (e.g., Blum, 1974; Myers, 1977; Scott, 1981) do not generate very good predictive models! Good research generates the sound evidence needed to overturn or revise existing theories. These assertions will, in turn, yield to revised theories based on better evidence, so that healthy competition between rival ideas will lead to better explanations and more reliable predictions. Two major processes of reasoning, ‘deductive’ (theory to observation) and ‘inductive’ (observation to theory), are important for theory construction and observation testing. Inductive reasoning starts with specific observations (data) from which theories can be generated; a generalisable pattern may emerge from further observations and repeated testing for compliance. The natural sciences, for example astronomy, provide numerous examples of inductive reasoning, thus Hawking (1998) provides a number of fascinating examples of theories revised, or still in question, with implications for the progress of accounting research. However, he notes that generalisations made on the basis of induction Introduction and Overview 3 can never be regarded as ‘certain’, since just one contrary instance can cause them to be overturned: • Big Bang versus Steady State. From the late 1940s to the mid-1960s two competing theories were prominent in offering alternative explanations of the origins of the universe. The ‘Big Bang’ theory recognised a singular event as causing an ever-expanding universe in which matter (notably galaxies) becomes continuously more widely dispersed. The ‘Steady State’ theory, attributed to Bondi, Gold and Hoyle, on the other hand, suggested that matter was continuously being created to fill the gaps between existing galaxies. They argued that the universe had no beginning, and had been forever expanding, with new matter being created out of apparently empty space. The Steady State theory importantly provided testable hypotheses in suggesting that the universe should look the same at all times and from wherever it was viewed. But surveys of radio waves in the early 1960s showed that sources were more numerous in the past, and that there were many more weak (distant) sources than strong (close) ones. Further, microwave radiation studies in 1965 demonstrated that the universe did not have a common density – it had been much denser in the past. These observations provided disconfirmations of the Steady State theory, causing its abandonment. • Newton’s Laws of Physics. New theory emerges when a new observation arises which does not correspond with existing theory. Once the technology permitted accurate observations of the planet Mercury to be made, it was clear that there were small differences between its observed motion and that expected under Newton’s Theory of Gravity. Einstein’s general theory of relativity matched the observed motions of the planet in a manner that Newton’s theory did not, providing confirmation for the new theory. • The Wave Theory of Light. We can attempt to explain the behaviour of light in terms of its being composed of either ‘waves’ or ‘particles’. Each view produces a plausible explanation of behaviour – both of which are needed to affirm existing properties – but they are incompatible explanations which cannot exist simultaneously. New theories are required (possibly those associated with parallel universes) for a complete understanding of the incompatibility. Deductive reasoning, on the other hand, starts with the theory and proceeds to generate specific predictions which follow from its application. The predictions can be verified, or otherwise, from subsequent observation. For example, in his seminal paper, Healy (1985) used agency theory to develop a bonus hypothesis which could be substantially verified through observations of how managers manipulated their accounting earnings to optimise their short-term bonus performance. 4 Research Methods in Accounting However, such a strict division of reasoning processes is not always helpful because interdependencies almost always exist: induction will usually imply some knowledge of theory in order to select the data to be observed (a common criticism of grounded theory advanced in Chapter 8); deduction will be dependent on the selection of the initial hypotheses for testing. Even without such problems, the scientific position of ‘objective measurement’ has come under repeated attack, in both natural and social sciences, because the act of observation is itself ‘theory-laden’ and influenced by the motives and preferences of the observer. For example, Hopwood (1987), in management accounting, and Hines (1988), in financial accounting, argue that accounting helps to create the ‘facts’ that it is supposedly reporting. More radical approaches (e.g., Tinker and Niemark, 1987) suggest that accounting distorts practice in a systematic manner. Such concerns have aided the development of new approaches: an interpretive perspective and a critical perspective. • An interpretive perspective – From an interpretive perspective, human actions are the result of external influences. These actions have both intentions and reflections, and take place within a structure of rules which binds the participants. The task of the researcher goes beyond measurement to developing an understanding of the situation. To do this effectively, active participation, rather than detached observation, may be required. Since the ‘action’ may be interpreted ambiguously when taken out of context, this perspective places the fundamental emphasis on the understanding of the process. In an accounting context, Arrington and Francis (1989) provide an example of this approach. • A critical perspective – The critical approach expands on the scope of the interpretive approach by focusing on the ownership of knowledge and the associated social, economic and political implications. An empirical approach is criticised on the grounds that the research process is value-laden, and that the acquisition of knowledge provides the opportunity to oppress those being researched. In an accounting context, Tinker (1980) provides an example of this approach. Table 1.1 summarises the differences in research assumptions, process and outcomes associated with each of these three major approaches. Kuhn (1970) suggests that researchers are concerned with problem-solving within a single framework of widely accepted beliefs, values, assumptions and techniques. This shared framework, or view of the world, he termed a paradigm, so that a ‘paradigm shift’ corresponds with some revolution where the existing framework and theories can no longer cope with the volume of disconfirming evidence. Kuhn neatly illustrates such a shift by reference to a simple psychology experiment: Subjects viewed cards from a deck. The deck included some unusual cards, including black hearts and red spades, but the subjects were not informed in Introduction and Overview 5 TA B L E 1 . 1 Three alternative approaches (adapted from Connole, 1993, p. 37) Positivist 1. 2. 3. 4. 5. 6. 7. What is the approach modelled on? Classical investigation founded in the physical sciences. What does it assume about reality? Reality is unitary and it can only be understood by empirical and analytic methods, i.e., the scientific approach. What is the foundation of data? Disciplined rules for observation. How is observation done? Through clear and unambiguous rules which are not modified by the setting and are totally independent of it. What is generated? Evidence and generalisable laws which are not affected by contexts and have nothing to do with the way in which they were discovered in the first place. Objectivity depends upon the removal of error and bias which is related specifically to the logic of observation and measurement. What interests are inherent? Prediction and control, technically exploitable knowledge, and explanation. What values are inherent? Science and scientific knowledge are inherently value-neutral. Interpretive Critical Historical, literary and existential studies in which the subjective understandings of subjects are significant. Marxist and interpretive studies which focus on the insights and judgements of the subjects. There are multiple realities which require multiple methods for understanding them. There are multiple realities which are made problematic through distorted communication. Meanings are the basis of data: meaning precedes logic and fact. Meanings are found in language and social behaviour and they precede logic and fact. Through the social, linguistic and cognitive skills of the researcher. Interpretive methods, plus critical self-reflection concerning the grounds of observation. Knowledge which is dependent on the process of discovery. The integrity of the findings depends upon the quality of the social, linguistic and cognitive skills of the researcher in the production of data analyses and conclusions. Knowledge which falls within the interpretive framework, but which also serves the purposes of assisting personal liberation and understanding, and emancipation from forces constraining the rational independence of individuals. Understanding at the level of ordinary language and action. Discovering the meanings and beliefs underlying the actions of others. Interpretive interests and those which underliey other forms of inquiry. Radically improving human existence. Practical and public involvement in knowledge formation and use. Science and scientific knowledge have both to be interpreted in terms of values they represent. Science and knowledge are never value-neutral: they always represent certain interests. 6 Research Methods in Accounting advance about their presence. Initially the subjects saw only ‘hearts’ and ‘spades’, because they believed that only ‘red hearts’ and ‘black spades’ existed; only with repeated viewing did they grasp that these cards were not typical of a normal deck. Then they could recognise the cards that existed rather than the ones they were expecting. In accounting research the parallels might be the paradigm shifts associated with the ideas introduced by Ball and Brown (1968) and the difficulty they had in getting a paper published which questioned the existing paradigm by showing a link between stock prices and accounting earnings, through the abnormal performance index. A similar, though perhaps less radical, movement is associated with Watts and Zimmerman (1978) and their popularisation of agency theory in an accounting environment. What is inescapable is that we are dealing with people, and in the research community

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College of Administration and Finance Sciences Assignment 3 Deadline: 30/04/2022 @ 23:59 Course Name: Accounting Research and practice Student’s Name: Course Code: ACCT 403 Student’s ID Number: Semester: II CRN: Academic Year: 1443 H For Instructor’s Use only Instructor’s Name: Habiba Moabber Students’ Grade: Interview Methods & Statistics Accounting Worksheet

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Questions for written submission:
? What are the main risks you identify with Bastion Finance and the proposed
investment?
? Would you recommend to Mr. Parker that he buy into Bastion Finance and why?
(one paragraph).3 attachmentsSlide 1 of 3

Bastion Finance Case Year 7 – Financials Receipts Cash Receipts: From New Term Deposits From Loan Customers Total Receipts: Cash Disbursements: Interest Payments Salaries, Wages, Taxes, Other Total Disbursements Cash Increase over the Year ADD: Beginning Cash Balance Cash Available During the Year $10.0 116.9 $126.9 $50.2 $ 2.3 $52.5 $74.4 $81.1 $155.5 Cash Flow Cash Receipts: From New Term Deposits From Loan customers Total Receipts Cash Disbursements: Interest Payments Salaries, Wages, Taxes, Other New Loans Made Dividends Paid Total Disbursements Cash Decrease over the Year Beginning Cash Balance Ending Cash Balance $10.0 116.9 $126.9 $50.2 2.3 130.0 7.0 $189.5 $62.6 81.1 $18.5 Accrued Interest Income LOANS: 506 405 601 602* 603* 604 605 $36.0 28.6 76.9 52.1 x .10 x .15 x .13 x .15 57.2 x .13 96.9 x .10 45.6 x .14 $3.6 4.3 10.0 3.9 3.7 9.7 6.4 New* VAR 130.0 x.13 8.5 Total Interest Revenue $50.1 * New loans issued July 1, Loans 602 and 603 paid June 30. Income Statement Revenues: Interest Income Loan Fees (8% of new loans) Operating Revenue Expenses: Interest Expense Salaries and Wages Other Operating Expenses Operating Income Income Tax Net Income $50.1 10.4 $60.5 $50.6 1.7 0.6 $52.9 $ 7.6 ? $ 7.6 Statement of retained earnings Beginning Retained Earnings Plus: Net Income Less: Dividends Ending Retained Earnings $7.0 7.6 -7.0 $7.6 Ending Loans Receivable Loan Beg. Bal. Loan Fees 405 $28.6 506 36.0 601 76.9 604 96.9 605 45.6 New 130.0 $10.4 Total Loans Receivable Accrued Int. $4.3 3.6 10.0 9.7 6.4 8.5 Ending Bal. $32.9 39.6 86.9 106.6 52.0 148.9 $466.9 Balance Sheet Assets: Cash Loans Receivable Total Assets Liabilities: Interest Payable Term Deposits Total Liabilities Owner’s Equity: Common Stock Retained Earnings Total Liabilities and Equity $ 18.5 466.9 $485.4 $ 12.6 465.0 $477.6 $ 0.2 7.6 $485.4 Bastion Finance Resources Author: Shane Moriarity & Andrew Slessor Online Pub Date: May 08, 2017 | Original Pub. Date: 2013 Subject: Financial Accounting, Financial Statement Analysis Level: | Type: Indirect case | Length: 1202 Copyright: © 2013 IMA Educational Case Journal. All rights reserved. Organization: Bastion Finance | Organization size: Region: Northern America | State: Industry: Financial service activities, except insurance and pension funding Originally Published in: Moriarity, S. , & Slessor, A. ( 2013). Bastion Finance. IMA Education Case Journal, 6( 1), Article 1. Publisher: Institute of Management Accountants DOI: http://dx.doi.org/10.4135/9781526426802 | Online ISBN: 9781526426802 SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases © 2013 IMA Educational Case Journal. All rights reserved. This case was prepared for inclusion in SAGE Business Cases primarily as a basis for classroom discussion or self-study, and is not meant to illustrate either effective or ineffective management styles. Nothing herein shall be deemed to be an endorsement of any kind. This case is for scholarly, educational, or personal use only within your university, and cannot be forwarded outside the university or used for other commercial purposes. 2021 SAGE Publications Ltd. All Rights Reserved. The case studies on SAGE Business Cases are designed and optimized for online learning. Please refer to the online version of this case to fully experience any video, data embeds, spreadsheets, slides, or other resources that may be included. This content may only be distributed for use within Florida International Univ. http://dx.doi.org/10.4135/9781526426802 Page 2 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases Resources Exhibit 1: Annual Summary Financial Statements Bastion Finance: Summary of Audited Financial Statements ($ Millions) Income Statements Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Revenues Interest Income 4.3 19.0 28.3 36.4 39.2 46.7 Loan Fees 5.2 15.4 8.0 11.2 20.0 22.8 Operating Revenue 9.5 34.4 36.3 47.6 59.2 69.5 Interest Expense 4.5 15.8 24.7 31.7 41.5 48.7 Salaries and Wages 0.7 0.8 0.9 1.1 1.3 1.5 Other 0.2 0.2 0.2 0.3 0.3 0.5 Operating Expenses 5.4 16.8 25.8 33.1 43.1 50.7 4.1 17.6 10.5 14.5 16.1 18.8 Bad Debts 0.0 0.0 0.0 0.0 3.9 6.3 Income Tax 0.0 0.0 0.0 0.0 4.8 1.6 Net Income 4.1 17.6 10.5 14.5 7.4 10.9 1.1 5.7 5.2 5.7 6.1 Expenses Operating Income Statements of Retained Earnings Beginning Retained Earnings 0.0 Page 3 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases Net Income 4.1 17.6 10.5 14.5 7.4 10.9 Dividends 3.0 13.0 11.0 14.0 7.0 10.0 1.1 5.7 5.2 5.7 6.1 7.0 Cash 2.9 2.0 71.8 96.2 102.4 81.1 Loans Receivable 74.5 232.9 264.8 312.6 349.3 393.3 Total Assets 77.4 234.9 336.6 408.8 451.7 474.4 Interest Payable 1.1 4.0 Term Deposits 75.0 225.0 325.0 395.0 435.0 455.0 Total Liabilities 76.1 229.0 331.2 402.9 445.4 467.2 Common Stock 0.2 0.2 0.2 0.2 0.2 0.2 Retained Earnings 1.1 5.7 5.2 5.7 6.1 7.0 Ending Retained Earnings Balance Sheets Assets Liabilities 6.2 7.9 10.4 12.2 Owner’s Equity Total Liabilities and Equity 77.4 234.9 336.6 408.8 451.7 474.4 Exhibit 2: Information from the Company’s Annual Report to Shareholders. Bastion Finance Fiscal Year The fiscal year for Bastion Finance runs from March 16 through March 15. To avoid confusion, dates are not used in the following discussion. Instead, references are made to each full fiscal year of operation. Thus Year Page 4 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases 1 refers to the firm’s first full year of business and Year 6 to its most recently completed year. Company Regulatory Matters The company is organized as a commercial investment company. It is not subject to regulatory oversight as a bank. Securities regulations require that term investors be supplied with a current prospectus. Depositor’s investments are not insured or guaranteed by any governmental agency. Company Shareholders Shares in Bastion Finance are not listed on any exchange nor are they publicly traded. Private transactions between individuals have occurred infrequently. As of the end of Year 6, the firm is aware of 15 individuals owning shares—most consist of very small holdings. The five largest shareholders and their holdings are: Shares Eric Lombard % 1,290,000 43% Walter Carson 1,050,000 35% Lance Edwards 300,000 10% LeRoy Fisk 150,000 5% Linda Hobbs 60,000 2% In Year 3, Linda Hobbs purchased 60,000 shares from Walter Carson for $2,816,000, a price representing eight times per share earnings for Year 2. At the end of Year 4, LeRoy Fisk purchased 150,000 shares from Walter Carson for $7,250,000, a price representing 10 times the estimated per share earnings for Year 4. Several smaller trades have occurred at various prices over the past six years. Board of Directors Six individuals serve on the company’s Board of Directors. Directors who are not managers are paid an annual retainer of $25,000 per year and receive 1,000 shares in the firm. The Chair of the Audit Committee and the Chair of the Compensation Committee each receive an additional fee of $5,000. The total fees earned in Year 6 and shareholdings as of the end of Year 6 for each of the directors are given below. Fees Shareholding Eric Lombard, Chairman of the Board $— 1,290,000 Walter Carson, Chief Executive Officer — 1,050,000 Page 5 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases Brendon Sheppard 25,000 6,000 Susan Richee, Chair of the Audit Committee 30,000 2,000 Bruce Ludlow, Chair of the Compensation Committee 30,000 3,000 Gordon Meyers 25,000 5,000 Executive Compensation The firm has only four executive-level employees. The compensation for the executive officers for the past two years was as follows: Year 5 Year 6 Eric Lombard, Chairman of the Board $350,000 $400,000 Walter Carson, Chief Executive Officer $350,000 $400,000 Paul Brekkar, Legal Officer $180,000 $200,000 Denise Horton, Finance Officer $135,000 $150,000 The Compensation Committee reviews the compensation levels paid by a sample of 10 other firms in the industry. It is the Board’s policy to maintain executive compensation at levels competitive with comparator firms. Notes to Financial Statements The preparation of our financial statements in conformance with generally accepted accounting principles (GAAP) requires management to make estimates and assumptions affecting the amounts to be reported. Actual results may differ from those estimates. The company prepares its financial reporting accounts on an accrual accounting basis. It prepares its tax return using cash-basis accounting. Deferred taxes are not material and are not recognized in the accounts. The firm faces a tax rate of 30% on income. The company has no fixed assets. The firm’s premises, furniture, office equipment, and all fittings are leased. Lease obligations are $215,000 for Years 7 through 10 and $135,000 for Years 11 through 14. We are exposed to claims and litigation arising in the ordinary course of business and use various methods to resolve these matters in a manner which we believe best serves the interest of the firm. We do not believe any pending claim or action will have a material adverse effect on the firm. The firm has been experiencing an increase in the cost to acquire term deposits. Management has been Page 6 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases successful in passing the increase onto the firm’s borrowers. The average annual interest rates paid and earned for the past six years are given below along with the average maturities. Interest is paid quarterly to depositors and is received at maturity from borrowers. Term Depositors Loan Customers Year Annual Interest Paid Average Maturity (Months) Annual Interest Earned Average Maturity (Months) 1 8% 18 11% 21 2 9% 19 12% 25 3 9% 16 12% 25 4 9% 15 12% 24 5 10% 13 13% 19 6 11% 12 13% 26 Bastion Finance has received an unqualified audit opinion from its auditor, Goodman Cole, in each of its six years of operation. Loans Outstanding at Year End The loan cards from the firm’s Loan Book for all of the loans outstanding as of the end of Year 6 are reproduced below. (Dollar amounts are shown in millions rounded to one decimal.) Loan Cards for Outstanding Loans Loan Number 405 Principal Amount Year Granted 4 Year for Repayment Interest Rate 12%** Loan Origination Fee Borrower Prestige Development Loan $20.0 M Scheduled 5 $1.6 M Principal Officers Cornelius Bowden, Sandy Maier, and Anthony Page 7 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases Roest Transactions Loan Balance Year Description 4 Loan Principal $20.0 $20.0 4 Loan Origination Fee $1.6 $21.6 4 Interest $0.6 $22.2 5 Interest $2.7 $24.9 6 Interest $3.7 $28.6 Notes: Builder has encountered severe stability problems in the geological substrata of the building site. Project delayed indefinitely. **Interest rate raised to 15% as of start of Year 6. Loan Number 601 Principal Amount $65.0 M Year Loan Granted 6 Year for Scheduled Repayment 8 Interest Rate 13% Loan Origination Fee Borrower Kingsland Hotels Principal Officers James Franklin and Jacqueline Bell $5.2 M Transactions Year Description 6 Loan Principal Page 8 of 13 Loan Balance $65.0 $65.0 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases 6 Loan Origination Fee $5.2 $70.2 6 Interest $6.7 $76.9 Notes: Loan Number 602 Principal Amount $45.0 M Year Loan Granted 6 Year for Scheduled Repayment 7 Interest Rate 15% Loan Origination Fee Borrower Green Lane Apartments Principal Officers Wang Lim, Henry Shi, and Chong Xie $3.6 M Transactions Year Description Loan Balance 6 Loan Principal $45.0 $45.0 6 Loan Origination Fee $3.6 $48.6 6 Interest $3.5 $52.1 Notes: Loan Number 603 Principal Amount $50.0 M Year Loan Granted 6 Year for Scheduled Repayment 7 Interest Rate 13% Loan Origination Fee Borrower Lumineria Partners Page 9 of 13 $4.0 M Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. Principal Officers SAGE Business Cases Madeleine Lindquist and Heidi Coleman Transactions Year Description Loan Balance 6 Loan Principal $50.0 $50.0 6 Loan Origination Fee $4.0 $54.0 6 Interest $3.2 $57.2 Notes: Loan Number 604 Principal Amount Year Granted 6 Year for Repayment Interest Rate 10% Loan Origination Fee Borrower Dorchester Management Company Principal Officers Gordon Reynolds, Phillip Greene, and Walter Carson Loan $85.0 M Scheduled 9 $6.8 M Transactions Loan Balance Year Description 6 Loan Principal $85.0 $85.0 6 Loan Origination Fee $6.8 $91.8 6 Interest $5.1 $96.9 Page 10 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases Notes: Loan Number 605 Principal Amount $40.0 M Year Loan Granted 6 Year for Repayment 9 Interest Rate 14% Loan Origination Fee Borrower Hampton Arms Apartments Principal Transactions Scheduled $3.2 M Officers Anne Ward, Paul McLeahy, and Hamilton Wood Transactions Loan Balance Year Description 6 Loan Principal $40.0 $40.0 6 Loan Origination Fee $3.2 $43.2 6 Interest $2.4 $45.6 Notes: Company Risk Factors Bastion Finance is exposed to several sources of risk in its ordinary course of business. These include credit risk, interest rate risk, liquidity risk, and general business risk. Credit risk refers to the potential that some of our customers may default on the loans we have made to them. This risk is augmented by our focus on second mortgages and our concentration in a narrow market segment. Interest rate risk means that we may not be able to maintain a profitable spread between our cost of borrowing and the returns from lending. Liquidity risk arises because we borrow from term depositors on maturities ranging from 6-18 months while our loans to developers may extend for multiple years. General business risk is inherent in the competitive nature of our industry. We cannot be assured that our term depositors or loan customers will continue to conduct business with us rather than with one or more of our competitors. Bastion Finance is not exposed to foreign exchange risk and does not engage in derivatives trading. Exhibit 3: Loan Cards for Defaulted Loans Page 11 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases Loan Number 303 Principal Amount $25.0 M Year Loan Granted 3 Year for Scheduled Repayment 4 Interest Rate 12% Loan Origination Fee $2.0 M Borrower Phoenix Horizons Principal Officers Linda Gibson and Phillip Greene Transactions Year Description Loan Balance 3 Loan Principal $25.0 $25.0 3 Loan Origination Fee $2.0 $27.0 3 Interest $1.6 $28.6 4 Interest $3.4 $32.0 5 Interest $1.9 $33.9 5 Repayment $30.0 $3.9 5 Loss Write Off $3.9 — Notes: Holder of the first mortgage foreclosed the property. There were insufficient funds to fully re-pay our second mortgage. Loan Number 502 Principal Amount $65.0 M Year Loan Granted 5 Year for Scheduled Repayment 6 Page 12 of 13 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. Interest Rate 13% Borrower Westwood Shopping Complex Principal Officers Phyllis and David Edins SAGE Business Cases Loan Origination Fee $5.2 M Transactions Year Description Loan Balance 5 Loan Principal $65.0 $65.0 5 Loan Origination Fee $5.2 $70.2 5 Interest $5.9 $76.1 6 Interest $3.9 $80.0 6 Repayment $73.7 $6.3 6 Loss Write Off $6.3 — Notes: Proceeds from the sale of the complex failed to cover the full development costs. The company went into liquidation. PDF 1. Bastion CS Update 12-10-2020 http://dx.doi.org/10.4135/9781526426802 Page 13 of 13 Bastion Finance Bastion Finance Case Author: Shane Moriarity & Andrew Slessor Online Pub Date: May 08, 2017 | Original Pub. Date: 2013 Subject: Financial Accounting, Financial Statement Analysis Level: | Type: Indirect case | Length: 1202 Copyright: © 2013 IMA Educational Case Journal. All rights reserved. Organization: Bastion Finance | Organization size: Region: Northern America | State: Industry: Financial service activities, except insurance and pension funding Originally Published in: Moriarity, S. , & Slessor, A. ( 2013). Bastion Finance. IMA Education Case Journal, 6( 1), Article 1. Publisher: Institute of Management Accountants DOI: http://dx.doi.org/10.4135/9781526426802 | Online ISBN: 9781526426802 SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases © 2013 IMA Educational Case Journal. All rights reserved. This case was prepared for inclusion in SAGE Business Cases primarily as a basis for classroom discussion or self-study, and is not meant to illustrate either effective or ineffective management styles. Nothing herein shall be deemed to be an endorsement of any kind. This case is for scholarly, educational, or personal use only within your university, and cannot be forwarded outside the university or used for other commercial purposes. 2021 SAGE Publications Ltd. All Rights Reserved. The case studies on SAGE Business Cases are designed and optimized for online learning. Please refer to the online version of this case to fully experience any video, data embeds, spreadsheets, slides, or other resources that may be included. This content may only be distributed for use within Florida International Univ. http://dx.doi.org/10.4135/9781526426802 Page 2 of 4 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases Abstract An opportunity has arisen to purchase a stake in Bastion Finance. The seller of a minority interest in the firm has provided summary financial statements and copies of selected internal documents. Students are asked to use the information to prepare forecasted financial statements, to identify and evaluate risks associated with the investment, and to make a recommendation of whether the opportunity should be pursued. Although Bastion Finance is not a real firm, the case is based on actual practices that have occurred in the industry as revealed through court cases and media commentaries. The case is suitable for second-level, undergraduate cost/managerial courses or courses in forensic accounting. Case You are a management accountant at Parker Plastics. A few days ago the founder, James Parker, asked you to stop by his office: “This past weekend a neighbor mentioned that he owns a 10% stake in Bastion Finance that he would like to sell. He inquired if I would be interested in purchasing the holding. He said it has been paying a generous dividend. I am thinking that the investment could provide a stable source of cash flow for our company. I would like you to review their operations and let me know what you think of the potential. Start by preparing an estimate of what you think their financial statements will look like for next year. I realize the result will only be as good as your assumptions. But if your assumptions are reasonable, the estimated statements should provide a good starting point for deciding whether to pursue an investment in the company.” Mr. Parker went on to say that the 10% stake is currently owned by his neighbor, Lance Edwards. You immediately recognized his name. Lance is one of the country’s most popular professional football players. Back in your office, you called Lance to arrange a meeting to learn more about Bastion Finance. Lance was happy to meet with you and has been very cooperative in answering your questions and passing on the information he has about the company. Lance mentioned that he is approaching the end of his football career and is now looking for a new challenge. He wants to build a major state-of-the-art athletic training facility for promising young athletes. He plans to fund this venture by selling his stake in Bastion Finance. Bastion Finance was formed just over six years ago by Eric Lombard and Walter Carson. They each contributed $100,000 in return for a 50% share in the new corporation. Then they each donated a 5% stake to Lance in exchange for an agreement by Lance to regularly appear on TV, radio, and in print advertising on behalf of Bastion Finance. Lance does not participate in the management of the firm nor does he serve on the Board of Directors. The agreement for Lance to provide promotional services has recently expired and Lance is now ready to move on with his plans for his new business. You learn that Bastion Finance raises cash by selling debentures to investors at interest rates well above those available from banks or insured financial institutions. The interest rates are advertised in the business section of several newspapers, but funds are formally solicited through a prospectus. Most of Bastion’s investors are retirees, many of whom make their investments through commission-based financial advisors. Although investors are actually purchasing fixed-period debentures, management refers to them as depositors. Bastion is not a bank. It provides no banking-type services for depositors nor does it have a physical facility for one-on-one personal service. Consequently, the firm is not subject to banking regulations. The funds acquired from depositors are lent to property developers. Bastion concentrates its lending to developers needing second mortgages. These developers typically take out a first mortgage for a project from a traditional bank or insurance company. But these institutions generally limit the amount they will loan on a project to 80% of the construction costs. For well-capitalized developers, this is sufficient for them to proceed with a project by combining the borrowed funds with their own capital. Yet Bastion lends to those Page 3 of 4 Bastion Finance SAGE © 2013 IMA Educational Case Journal. All rights reserved. SAGE Business Cases developers who must borrow 100% of their construction costs. Bastion provides the additional funds as a second mortgage. These are high-risk mortgages. In the event a development fails to be profitable, the second mortgage holder gets repaid only to the extent that the proceeds from the sale of the development exceed the amount owed on the first mortgage. All of a development’s assets are typically pledged as collateral to the first mortgage holder and a developer who must take a second mortgage usually has little or no capital of their own at stake. This added risk of being “second in line” means that market interest rates for second mortgages are much higher than the prevailing rates on first mortgages. Bastion’s business plan is to take advantage of these higher rates while being judicious in its selection of which developers to fund. Developers are attracted to Bastion because it does not require developers to make any payments for interest, fees, or principal until a project is completed and sold (but interest is accrued and compounded annually). Lance said that the company was a success from the start. “It far surpassed Eric and Walter’s expectations. But they are generous in giving me a great deal of credit for their success. They said many of my older fans were eager to invest in a company that I endorsed. The growth rate in deposits in the first couple of years was remarkable and the firm has consistently maintained a large cash balance. The company cites this large cash holding as evidence of the firm’s solid financial position.” Because Bastion Finance is closely held, it is not required to prepare a formal annual report for public distribution. Yet Lance receives copies of each updated prospectus provided to depositors. These prospectuses contain audited financial statements. In addition, each year he receives a supplementary report containing information thought to be of interest to shareholders. Lance provided you copies of the investor prospectuses. From them, you have prepared the summary financial statements given in Exhibit 1. He also provided you with the supplementary shareholders’ information he received for Year 6. It is appended as Exhibit 2. Lance laughed and said he also kept souvenir copies of the loan cards for two loans that were not fully repaid. These are presented in Exhibit 3. Lance said, “In both cases, Walter pointed out that Bastion made money on these loans—just not in the full amount that had been anticipated.” You returned to your office after the meeting with Lance and reviewed the materials he had given you. It is now time to formulate estimated financial statements for Year 7. You have lots of data available, but you will have to use judgment in making some required forecasts. Required • 1. Prepare forecasted financial statements for Year 7 (cash flow statement, income statement, and balance sheet). Prepare a brief justification for each assumption that you make when forecasting a specific value. • 2. Use the insights you have gained from preparing the forecasted financial statements to identify the risks and concerns that should be brought to Mr. Parker’s attention. • 3. Based upon an evaluation of the potential risks and returns, recommend whether the investment in Bastion should be pursued. About IMA® With a worldwide network of more than 65,000 professionals, IMA (Institute of Management Accountants) is the world’s leading organization dedicated to empowering accounting and finance professionals to drive business performance. IMA provides a dynamic forum for professionals to advance their careers through CMA® (Certified Management Accountant) certification, research, professional education, networking, and advocacy of the highest ethical and professional standards. For more information about IMA, please visit www.imanet.org. http://dx.doi.org/10.4135/9781526426802 Page 4 of 4 Bastion Finance

UNFORMATTED ATTACHMENT PREVIEW

Marks Obtained/10 Level of Marks: High/Middle/Low Instructions – PLEASE READ THEM CAREFULLY • The Assignment must be submitted on Blackboard (WORD format only) via allocated folder. • Assignments submitted through email will not be accepted. • Students are advised to make their work clear and well presented, marks may be reduced for poor presentation. This includes filling your information on the cover page. • Students must mention question number clearly in their answer. • Late submission will NOT be accepted. • Avoid plagiarism, the work should be in your own words, copying from students or other resources without proper referencing will result in ZERO marks. No exceptions. • All answered must be typed using Times New Roman (size 12, double-spaced) font. No pictures containing text will be accepted and will be considered plagiarism). • Submissions without this cover page will NOT be accepted. College of Administration and Finance Sciences Question 1 What are the sources used to generate archival research? [3 marks] Answer Question 2 Explain why archival study will normally have more external validity than experimental or simulation approaches? [2 marks] Answer Question 3 Describe the examiner profiles [3 marks] Answer: 3089-prelims.qxd 4/2/03 4:42 PM Page i RESEARCH METHODS IN ACCOUNTING MALCOLM SMITH SAGE Publications London • Thousand Oaks • New Delhi 3089-prelims.qxd 4/2/03 4:42 PM Page ii © Malcolm Smith 2003 First published 2003 Apart from any fair dealing for the purposes of research or private study, or criticism or review, as permitted under the Copyright, Designs and Patents Act, 1988, this publication may be reproduced, stored or transmitted in any form, or by any means, only with the prior permission in writing of the publishers, or in the case of reprographic reproduction, in accordance with the terms of licences issued by the Copyright Licensing Agency. Enquiries concerning reproduction outside those terms should be sent to the publishers. SAGE Publications Ltd 6 Bonhill Street London EC2A 4PU SAGE Publications Inc 2455 Teller Road Thousand Oaks, California 91320 SAGE Publications India Pvt Ltd B-42, Panchsheel Enclave Post Box 4109 New Delhi 110 017 British Library Cataloguing in Publication data A catalogue record for this book is available from the British Library ISBN 0 7619 7146 7 ISBN 0 7619 7147 5 (pbk) Library of Congress Control Number available Typeset by C&M Digitals (P) Ltd., Chennai, India Printed in Great Britain by The Cromwell Press Ltd, Trowbridge, Wiltshire 3089-prelims.qxd 4/2/03 4:42 PM Page iii This book is dedicated to Beth, Cedric and Alice 3089-prelims.qxd 4/2/03 4:42 PM Page iv 3089-prelims.qxd 4/2/03 4:42 PM Page v Contents List of Figures xi List of Tables xii Acknowledgements xiii Preface xiv 1 Introduction and Overview Theory as testable explanation A critical approach to accounting research 1 6 8 2 Developing the Research Idea The research sequence Emergence of the research topic Conceptual frameworks The structure of DNA: the development of new theory The Bradman problem: the development of new strategies The longitude problem: implementing solutions Strategic management accounting 16 16 20 24 30 31 34 36 3 Theory, Literature and Hypotheses Sources of theory Searching the literature Modelling the relationship Developing the hypotheses Validity concerns 39 39 47 47 52 53 4 Data Collection and Analysis Sample selection Measurement issues Data management Descriptive statistics Differences in sample means Measures of association Analysis of variance Multivariate model building 55 56 56 59 60 64 69 73 75 3089-prelims.qxd 4/2/03 4:42 PM vi Page vi Contents 5 Research Ethics in Accounting The ethics quiz Informed consent Ethical guidelines 91 92 95 97 6 Experimental Research The problem statement Theory and context Experimental design The validity trade-off Quasi-experimental research 100 101 101 104 108 113 7 Survey Research Mail surveys Design and planning issues Pilot testing Data collection Measurement error Interview methods 117 117 120 122 123 126 128 8 Fieldwork Case study methods The qualitative analysis protocol Grounded theory Verbal protocol analysis 131 134 136 139 140 9 Archival Research Cross-section data Time-series data The validity trade-off in archival research Content analysis Critical analysis 142 143 144 146 147 150 10 Supervision and Examination Processes The role of the supervisor Examiner profiles The examination process 152 153 159 160 11 Turning Research into Publications Why publish? Where to publish? What to publish? How to publish? Concluding remarks 165 165 166 172 176 179 3089-prelims.qxd 4/2/03 4:42 PM Page vii Contents vii Appendix 1: Ranking of Accounting Journals 180 Appendix 2: Sample Paper (1) 182 Appendix 3: Sample Paper (2) 202 References 209 Index 230 3089-prelims.qxd 4/2/03 4:42 PM Page viii 3089-prelims.qxd 4/2/03 4:42 PM Page ix List of Figures Figure Figure Figure Figure Figure Figure Figure Figure Figure 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 The research sequence The positivist approach Alternative research methods Kolb’s Learning Cycle The deductive process The conceptual schema Measurement issues The Harvey-Jones approach to problem-solving Generalised process–improvement sequence 17 19 20 25 26 26 28 37 37 Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure 3.1 3.2 3.3 3.4 3.5 3.6 3.7 3.8 3.9 3.10 Searching for construct validity Voluntary disclosure and reciprocal causality Intervening variables and causality Non-financial focus as an intervening variable Moderated causal relationship Size, industry and culture moderating performance Influence of extraneous variables Economic conditions as extraneous variables Multiple independent variables Modelling the recruitment process 41 48 49 49 49 50 50 51 51 52 Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure Figure 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 4.11 4.12 Significance of test of proportion χ2-test for difference in frequencies Test of significance of correlation coefficient t-test for difference in means t-test for paired-case difference in means Mann–Whitney U-test for difference in means Product–moment correlation coefficient (Pearson’s r) Coefficient of rank correlation (Spearman’s rho) Measure of association within contingency tables One-way analysis of variance (ANOVA) The Kruskal–Wallis multiple sample test Summary of regression results for charity shops case study 62 63 65 66 67 68 70 71 72 74 76 82 3089-prelims.qxd 4/2/03 4:42 PM Page x List of Tables Table 1.1 Three alternative approaches Table Table Table Table Summary of significance tests by measurement level Measures of association by measurement level ANOVA summary table Summary of multivariate model-building methods by measurement level 4.1 4.2 4.3 4.4 Table 10.1 Expectations of supervisor and candidate 5 62 70 75 77 155 3089-prelims.qxd 4/2/03 4:42 PM Page xi Acknowledgements This book could not have been written without the help of numerous colleagues, most notably Bev Schutt and Paul Martin from the University of South Australia. Thanks are also owed to Glen Lehman, Linley Hartmann, Bruce Brown and Bruce Gurd at UniSA, and to David Russell, Ashok Patel and Elaine Harris at the Leicester Business School. However, as is normal, all errors and omissions remain the responsibility of the author. 3089-prelims.qxd 4/2/03 4:42 PM Page xii Preface This book aims to provide an insider’s view of the research process, by focusing on actual choices made in the conduct of accounting research projects, together with a realistic perception of what might go wrong, even with careful planning. We must, however, acknowledge that no single author can be an expert in all research methods; this author is no exception. My own publications will readily reveal a preponderance of studies concerning experimental methods and the use of archival data; there are fewer instances of studies using survey and field study methods. It would be unwise of me to claim expertise in the implementation of all such methods, so this book must necessarily lean heavily on the work of others. For the same reasons, and because of pressure of space, this book does not address issues of finance, capital markets research, or stockprice-related accounting research on the fringes of finance. Most other texts in this area are long, over-theoretical and not particularly user-friendly. This book aims to address these issues by adopting a practical approach which takes the reader from the initiation of the research idea right through to the publication of the research findings. The intended readership is wide, embracing instructors, doctoral candidates, and academics starting, or re-starting, their research careers. Although the focus, and examples, are mainly accounting based, much of the material will also be relevant to more general business applications, of particular interest to those pursuing a Doctorate of Business Administration (DBA) qualification. The practical examples employed are usually UK or Australia-based, these being the two countries in which I have extensive, current experience of teaching, supervision and examining, but the principles should normally adapt easily to alternative environments. An early distinction between ‘methods’ and ‘methodologies’ in research is essential because the two are so often confused, or else used interchangeably. Research methods are concerned with the technical issues associated with the conduct of research; research methodology is concerned with the philosophies associated with the choice of research method. This book is almost exclusively concerned with the former and, after Chapter 1, deliberately neglects the philosophical foundations of research except where reference thereto is unavoidable. Chapter 2 examines the research idea, and the documentary sources which might aid their development. A number of examples, many from nonaccounting environments, are used to illustrate the research sequence, and to examine research that is seeking either to improve outcomes, to explain improved outcomes through new theory, or to examine the improvement 3089-prelims.qxd 4/2/03 4:42 PM Page xiii Preface xiii process itself. Theoretical frameworks and research models are used extensively here to help the reader to picture the key variables and relationships underlying their research. Theory is the focus of Chapter 3, on the basis that ‘good research is founded on good theory’. The chapter addresses the sources of the theory widely applied in accounting research, but drawn from other disciplines. In the space available it can only hope to give a flavour of the diversity which is available; indeed, it prompts us to suggest that ‘theory in accounting research’ might provide a suitable follow-up text in its own right! Recognition of the importance of theory, reliability and validity as desirable characteristics of accounting research lead, in Chapter 4, to the issues of data collection, management and analysis necessary to conduct hypothesis testing. This chapter is unashamedly quantitative in nature, but the relative strengths of qualitative analysis are addressed in subsequent chapters. Chapter 5 addresses the increasingly important ethical considerations which underpin the conduct of accounting research, and the subsequent publication of research findings. It highlights the confusion which is still apparent among many academics as to what constitutes unethical conduct, and specifies the necessary guidelines for good practice. Chapters 6 to 9 are devoted, respectively, to the core forms of accounting research: experimental, survey-based, fieldwork and archival. Numerous examples are used to demonstrate the relative advantages of alternative methods so that researchers can both make an informed choice and justify their preferred approach. Research can be based on quantitative or qualitative methods, and both should be equally acceptable as long as the most appropriate method has been chosen. Richardson (1996, p. 4) notes that ‘work on how science really gets done’ (such as that described in Chapter 2 based on Watson, 1968) shows that even though we are in an extreme ‘positivist’ domain, interpretive knowledge is still important in the development of new theory. The majority of the readers of this text will likely be doctoral candidates so Chapter 10 is devoted to supervisor–candidate relationships, highlighting the mutual responsibilities of both parties to the supervision process, from the outset right up to the examination process. Publication is the natural target output of the research process, and Chapter 11 addresses the complexity of the publication process. In doing so it recognises that we are working in a dynamic process; what was once acceptable in accounting research is no longer so because of a more appropriate emphasis on research ethics; what is publishable, at all or in specific journals, changes too, both with the passage of time and the passing of particular journal editors. Many journals remain very conservative in the type of research they will publish, often on the grounds that it is difficult to demonstrate that ‘new’ methods constitute ‘good’ research in the same way as the traditional methods. But this situation is changing gradually – the wider opportunities for publishing case-based research in recent years provides evidence of this. However, the renewed emphasis on journal and university rankings, and associated funding systems based on the quality of publications, provides fresh difficulties. 3089-prelims.qxd xiv 4/2/03 4:42 PM Page xiv Preface The provision of ‘acceptable journals’ listings by many universities, and the prohibition of publication elsewhere, perpetuates the position of the wellestablished journals, while making it extremely difficult for the editors of other journals to attract quality submissions. The opportunities for innovative new journals are also severely diminished in such circumstances. Contributions to the profession by academic accountants are generally not well regarded, either by one’s colleagues or by government bodies providing funding based on publications performance, even though, arguably, the education of the potential employers of our students might be seen as an important part of our jobs. So journalistic pieces in practitioner magazines and workshops to professional audiences count for close to nought – even though the individuals concerned would never read a refereed journal or attend an academic conference. We need to exploit the available media to get our message, and the power of research findings, over to those implementing change in an unbiased way, before the consultants get in on the act! This process must be of mutual benefit to all parties, but if the practitioners feel they are being short-changed, or even used, then future collaborative efforts will be threatened. It is just such attitudes which generate the ‘them and us’ cultures leading to accusations of academics being out of touch with reality. In this context it is interesting to note the changes taking place within professional journals: there were once two such journals called Management Accounting, but now there are none, the US version becoming Strategic Finance and the UK one Financial Management. With moves to term ‘accounting’ as ‘assurance services’ it will surely not be long before some of the professional bodies themselves follow their journals with the removal of the word ‘accounting’ from their titles. Communication problems also remain. The timeliness and relevance of much of the content of the refereed literature does little more than suggest that it is written by academics, only for the consumption of other academics! Most practitioners do not have an appreciation of research methods, nor do they read the refereed literature, so important findings and recommendations often do not reach the individuals who can make sure it has the greatest impact. A number of journals have emerged with the express intention of providing readable research for practitioner audiences, but even these have tended to become more academic and less readable over relatively short time periods. This book aims to provide a treatment of research methods that will be of use to both accounting practitioners and those contemplating the conduct of research projects. Space restrictions mean that this slim volume cannot hope to tackle all of the detail of the application of different research methods, or the associated intricacies of complex quantitative methods. But if its use causes one paper to be published that would otherwise have gone unpublished, then all will have been worthwhile. Malcolm Smith 1 Introduction and Overview CHAPTER CONTENTS • Theory as testable explanation • A critical approach to accounting research 6 8 A number of authors (e.g., Brownell, 1995, p. 2) describe accounting researchers as ‘parasites’ who prey on the work of others to generate their findings. The term may be an overstatement, but as with most rash generalisations it contains more than a germ of truth: accounting researchers have little theory of their own (they rely on economics, finance, psychology, sociology and organisational behaviour as their major sources); they have no methods of their own (they are all adapted from the natural and social sciences); and they have few instruments of their own (with many of these originating in or adapted from the organisational behaviour literature). Merchant (quoted in Brownell, 1995, p. 140) even suggests that organisational behaviourists are much better at developing survey instruments than their accounting counterparts. The overall aim of this book is to facilitate the conduct of applied research studies in accounting, and to do this we must recognise our reliance on work in other disciplines. To accomplish this aim, a number of subordinate objectives may be identified, all of which will contribute to the overall goal: • an understanding of contemporary research ideas in accounting, so that readers can identify and define research problems and prepare strategies for their solution; • an awareness of alternative research methods, to facilitate the selection of the most appropriate method for addressing particular research questions; • an ability to review existing research and to offer critiques of articles published in refereed journals; and • an appreciation of the ethical constraints on the conduct of accounting research. 2 Research Methods in Accounting Research in accounting is concerned with solving problems, investigating relationships and building a body of knowledge. Because we rely to such a great extent on prior research in the natural and social sciences to do so, this volume will take a similar approach in leaning on work in other disciplines where it helps to inform accounting research. Bennett (1991) identifies four basic levels of research: • Description – concerned with the collection and reporting of data related to what is, or was, the case. This would include means and standard deviations of individual variables, and correlations between pairs of variables. • Classification – still descriptive, but easing the reporting process, and highlighting similarities and clustering through grouping and classifying (e.g., through the familiar cross-tabulation facility in most basic statistical packages). • Explanation – an attempt to make sense of observations by explaining the relationships observed and attributing causality based on some appropriate theory. • Prediction – going beyond the understanding and explaining of the prior stage, to model observations in a way that allows testable predictions to be made of unknown events. We return to this structure in Chapter 4 when discussing alternative quantitative methods, but an early distinction between ‘explanation’ and ‘prediction’ is appropriate here, because, as in the natural sciences, we are able to make excellent predictions of accounting behaviour without the backing of a sound underpinning theory. Bankruptcy prediction modelling provides an excellent example. A number of researchers (e.g., Altman, 1968; Taffler, 1983) have developed models that have proved very successful in identifying ‘distressed’ companies – those companies that will fail in the short term. These models are statistically excellent but the theory underpinning their content, in terms of the ratios to be used and the variables they represent, is extremely weak; the essential problem is that such theories as we have (e.g., Blum, 1974; Myers, 1977; Scott, 1981) do not generate very good predictive models! Good research generates the sound evidence needed to overturn or revise existing theories. These assertions will, in turn, yield to revised theories based on better evidence, so that healthy competition between rival ideas will lead to better explanations and more reliable predictions. Two major processes of reasoning, ‘deductive’ (theory to observation) and ‘inductive’ (observation to theory), are important for theory construction and observation testing. Inductive reasoning starts with specific observations (data) from which theories can be generated; a generalisable pattern may emerge from further observations and repeated testing for compliance. The natural sciences, for example astronomy, provide numerous examples of inductive reasoning, thus Hawking (1998) provides a number of fascinating examples of theories revised, or still in question, with implications for the progress of accounting research. However, he notes that generalisations made on the basis of induction Introduction and Overview 3 can never be regarded as ‘certain’, since just one contrary instance can cause them to be overturned: • Big Bang versus Steady State. From the late 1940s to the mid-1960s two competing theories were prominent in offering alternative explanations of the origins of the universe. The ‘Big Bang’ theory recognised a singular event as causing an ever-expanding universe in which matter (notably galaxies) becomes continuously more widely dispersed. The ‘Steady State’ theory, attributed to Bondi, Gold and Hoyle, on the other hand, suggested that matter was continuously being created to fill the gaps between existing galaxies. They argued that the universe had no beginning, and had been forever expanding, with new matter being created out of apparently empty space. The Steady State theory importantly provided testable hypotheses in suggesting that the universe should look the same at all times and from wherever it was viewed. But surveys of radio waves in the early 1960s showed that sources were more numerous in the past, and that there were many more weak (distant) sources than strong (close) ones. Further, microwave radiation studies in 1965 demonstrated that the universe did not have a common density – it had been much denser in the past. These observations provided disconfirmations of the Steady State theory, causing its abandonment. • Newton’s Laws of Physics. New theory emerges when a new observation arises which does not correspond with existing theory. Once the technology permitted accurate observations of the planet Mercury to be made, it was clear that there were small differences between its observed motion and that expected under Newton’s Theory of Gravity. Einstein’s general theory of relativity matched the observed motions of the planet in a manner that Newton’s theory did not, providing confirmation for the new theory. • The Wave Theory of Light. We can attempt to explain the behaviour of light in terms of its being composed of either ‘waves’ or ‘particles’. Each view produces a plausible explanation of behaviour – both of which are needed to affirm existing properties – but they are incompatible explanations which cannot exist simultaneously. New theories are required (possibly those associated with parallel universes) for a complete understanding of the incompatibility. Deductive reasoning, on the other hand, starts with the theory and proceeds to generate specific predictions which follow from its application. The predictions can be verified, or otherwise, from subsequent observation. For example, in his seminal paper, Healy (1985) used agency theory to develop a bonus hypothesis which could be substantially verified through observations of how managers manipulated their accounting earnings to optimise their short-term bonus performance. 4 Research Methods in Accounting However, such a strict division of reasoning processes is not always helpful because interdependencies almost always exist: induction will usually imply some knowledge of theory in order to select the data to be observed (a common criticism of grounded theory advanced in Chapter 8); deduction will be dependent on the selection of the initial hypotheses for testing. Even without such problems, the scientific position of ‘objective measurement’ has come under repeated attack, in both natural and social sciences, because the act of observation is itself ‘theory-laden’ and influenced by the motives and preferences of the observer. For example, Hopwood (1987), in management accounting, and Hines (1988), in financial accounting, argue that accounting helps to create the ‘facts’ that it is supposedly reporting. More radical approaches (e.g., Tinker and Niemark, 1987) suggest that accounting distorts practice in a systematic manner. Such concerns have aided the development of new approaches: an interpretive perspective and a critical perspective. • An interpretive perspective – From an interpretive perspective, human actions are the result of external influences. These actions have both intentions and reflections, and take place within a structure of rules which binds the participants. The task of the researcher goes beyond measurement to developing an understanding of the situation. To do this effectively, active participation, rather than detached observation, may be required. Since the ‘action’ may be interpreted ambiguously when taken out of context, this perspective places the fundamental emphasis on the understanding of the process. In an accounting context, Arrington and Francis (1989) provide an example of this approach. • A critical perspective – The critical approach expands on the scope of the interpretive approach by focusing on the ownership of knowledge and the associated social, economic and political implications. An empirical approach is criticised on the grounds that the research process is value-laden, and that the acquisition of knowledge provides the opportunity to oppress those being researched. In an accounting context, Tinker (1980) provides an example of this approach. Table 1.1 summarises the differences in research assumptions, process and outcomes associated with each of these three major approaches. Kuhn (1970) suggests that researchers are concerned with problem-solving within a single framework of widely accepted beliefs, values, assumptions and techniques. This shared framework, or view of the world, he termed a paradigm, so that a ‘paradigm shift’ corresponds with some revolution where the existing framework and theories can no longer cope with the volume of disconfirming evidence. Kuhn neatly illustrates such a shift by reference to a simple psychology experiment: Subjects viewed cards from a deck. The deck included some unusual cards, including black hearts and red spades, but the subjects were not informed in Introduction and Overview 5 TA B L E 1 . 1 Three alternative approaches (adapted from Connole, 1993, p. 37) Positivist 1. 2. 3. 4. 5. 6. 7. What is the approach modelled on? Classical investigation founded in the physical sciences. What does it assume about reality? Reality is unitary and it can only be understood by empirical and analytic methods, i.e., the scientific approach. What is the foundation of data? Disciplined rules for observation. How is observation done? Through clear and unambiguous rules which are not modified by the setting and are totally independent of it. What is generated? Evidence and generalisable laws which are not affected by contexts and have nothing to do with the way in which they were discovered in the first place. Objectivity depends upon the removal of error and bias which is related specifically to the logic of observation and measurement. What interests are inherent? Prediction and control, technically exploitable knowledge, and explanation. What values are inherent? Science and scientific knowledge are inherently value-neutral. Interpretive Critical Historical, literary and existential studies in which the subjective understandings of subjects are significant. Marxist and interpretive studies which focus on the insights and judgements of the subjects. There are multiple realities which require multiple methods for understanding them. There are multiple realities which are made problematic through distorted communication. Meanings are the basis of data: meaning precedes logic and fact. Meanings are found in language and social behaviour and they precede logic and fact. Through the social, linguistic and cognitive skills of the researcher. Interpretive methods, plus critical self-reflection concerning the grounds of observation. Knowledge which is dependent on the process of discovery. The integrity of the findings depends upon the quality of the social, linguistic and cognitive skills of the researcher in the production of data analyses and conclusions. Knowledge which falls within the interpretive framework, but which also serves the purposes of assisting personal liberation and understanding, and emancipation from forces constraining the rational independence of individuals. Understanding at the level of ordinary language and action. Discovering the meanings and beliefs underlying the actions of others. Interpretive interests and those which underliey other forms of inquiry. Radically improving human existence. Practical and public involvement in knowledge formation and use. Science and scientific knowledge have both to be interpreted in terms of values they represent. Science and knowledge are never value-neutral: they always represent certain interests. 6 Research Methods in Accounting advance about their presence. Initially the subjects saw only ‘hearts’ and ‘spades’, because they believed that only ‘red hearts’ and ‘black spades’ existed; only with repeated viewing did they grasp that these cards were not typical of a normal deck. Then they could recognise the cards that existed rather than the ones they were expecting. In accounting research the parallels might be the paradigm shifts associated with the ideas introduced by Ball and Brown (1968) and the difficulty they had in getting a paper published which questioned the existing paradigm by showing a link between stock prices and accounting earnings, through the abnormal performance index. A similar, though perhaps less radical, movement is associated with Watts and Zimmerman (1978) and their popularisation of agency theory in an accounting environment. What is inescapable is that we are dealing with people, and in the research community

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