Accounting for Extraordinary
Items
231
present pattern of high incidence of EI, comparability of the financial statements of Singapore companies with companies in similar industries in other countries could be affected. Although our studies indicate little signs of earnings management based on the totality of evidence gathered, adopting a more restrictive standard is a definite way of limiting, if not totally eliminating, earnings management possibilities. Adoption of PAS 19 will curb these problems since there will be greater constraints and less flexibility in the use of EI. Taken together, all these will give investors greater confidence in the published financial statements. However, implementing PAS 19 has its share of drawbacks too. PAS 19 may be a little too restrictive in its efforts to limit the list of possible EI, reducing the options essentially to only expropriation of assets and natural disasters. The adoption of PAS 19 would lead to erratic earnings as infrequent items which were earlier classified as EI would now be put under operating income. This would include items like discontinuance of a product line or disposal of a subsidiary. Currently, such rare occurrences are not included and the operating income figure is shielded from sudden large fluctuations. With the proposed definitions of EI, however, earnings over a number of periods may become erratic due to the sudden huge amounts involved by including once excluded items. Our explanations of the current behavior of accounting practitioners included the assumption of Efficient Market Hypothesis (EMH). It is assumed that Singapore, being a financial centre, has a fairly efficient market and transactions with no cash-flow implications will have minimal effects on share prices and firm value. However, if this assumption is relaxed, the introduction of PAS 19 would have an impact on the EPS figures. This would affect share prices of listed companies. Theoretically, there is no change of fundamental or intrinsic value because it is just a reclassification of items. However, assuming inefficient markets, there may be a severe impact on share prices because investors usually rely on the EPS as an indicator of the financial status of a company. If a new EI standard were to be proposed and implemented, comparative EPS figures should be disclosed in the initial few years of implementation. That is, two sets of EPS figures ought to be reported. One set would be the EPS figures calculated based on a new and restricted definition of EI while the other set would be the EPS figures calculated based on the existing definition of EI in SAS 8. This will smooth the implementation process of a new standard on EI and allow firms and their investors time to adjust to the transition. The disclosure of comparative EPS figures will also prevent naive investors from making misleading interpretations based on just the new EPS figures.