Amis 2011

THE BUCHAREST
ACADEMY OF ECONOMIC
STUDIES
FACULTY OF ACCOUNTING
AND MANAGEMENT INFORMATION
SYSTEMS
Proceedings
of the International Conference
ACCOUNTING AND MANAGEMENT
INFORMATION SYSTEMS
AMIS 2011
The sixth edition
June 8-9, 2011

The Bucharest Academy of Economic Studies
Piaa Roman No. 6, Sector 1
Bucharest, Romania
ISSN 2247 6245
ISSN-L 2247 6245
Organizing Committee
Pavel NASTASE
Vasile RAILEANU
Catalin ALBU
Nadia ALBU
Dana BOLDEANU
Daniela CALU
Costin CIORA
Iulia JIANU
Florin MIHAI
Iuliana SANDU
Andrei STANCIU
ASE Bucharest
ASE Bucharest
ASE Bucharest
ASE Bucharest
ASE Bucharest
ASE Bucharest
ASE Bucharest
ASE Bucharest
ASE Bucharest
ASE Bucharest
ASE Bucharest
Scientific Committee
President
Pavel NASTASE
ASE Bucharest
Romania
University of Birmingham
INTEC Paris
ASE Bucharest
University of Queensland
University of the West of Timisoara
ASE Bucharest
ASE Bucharest
ESSEC Paris
INTEC Paris
Marmara University
University of Amsterdam
ASE Bucharest
Transilvania University, Brasov
Bowling Green University
University Babes-Bolyai, Cluj
ASE Bucharest
University of Orlans
Istanbul University
HEC Geneva
ASE Bucharest
ASE Bucharest
ASE Bucharest
ASE Bucharest
Dayton University
ASE Bucharest
ASE Bucharest
ASE Bucharest
University Babes-Bolyai, Cluj
University A.I. Cuza, Iasi
ASE Bucharest
University of Amsterdam
Loyola University
United Kingdom
France
Romania
Australia
Romania
Romania
Romania
France
France
Turkey
The Netherlands
Romania
Romania
United States of America
Romania
Romania
Romania
France
Turkey
Switzerland
Romania
Romania
Romania
Romania
Romania
Romania
Romania
Romania
Romania
Romania
Romania
The Netherlands
Members
David ALEXANDER
Alain BURLAUD
Raluca DIMITRIU
Robert FAFF
Nicoleta FARCANE
Liliana FELEAGA
Niculae FELEAGA
Andrei FILIP
Philippe GERMAK
Oktay GVEMLI
Allan HODGSON
Bogdan IONESCU
Dorin LIXANDROIU
Alan LORD
Dumitru MATIS
Ana MORARIU
Mihaela MUNTEAN
Marc NIKITIN
Recep PEKDEMIR
Bernard RAFFOURNIER
Vasile RAILEANU
Mihai RISTEA
Vasile ROBU
Camelia STOICA
Donna STREET
Claudia Elena SERBAN
Brndusa STEFANESCU
Petru STEFEA
Ilie TAMAS
Adriana TIRON TUDOR
Alexandru TUGUI
Eugeniu TURLEA
Eddy VAASSEN
Lee YAO
CONTENTS
Preface
12
PS1 Auditing
Chairperson: David PROCHAZKA, University of Economics, Prague, Czech Republic
14
AUDIT COMMITTEES AS INCREASING VECTORS OF FINANCIAL

INFORMATION QUALITY
Neluta MITEA
15
THE FINANCIAL AUDITORS RISK BEHAVIOUR THE INFLUENCE

OF AGE ON RISK BEHAVIOUR IN A FINANCIAL AUDIT CONTEXT
Iancu Octavian IONESCU
Eugeniu TURLEA
32
THE INVESTIGATION OF ROMANIAN AUDITORS' PERCEPTIONS

OVER THE INTERNAL AUDIT PRACTICES AN ATTEMPT TO IDENTIFY THE BEST PRACTICES
IN THE CONTEXT OF CORPORATE GOVERNANCE
Cristina BOTA-AVRAM
45
PS2 Public accounting

Chairperson: Rzvan MUSTA, Babes-Bolyai University, Romania
68
PUBLIC SECTOR PERFORMANCE FROM THE PERSPECTIVE

OF CORPORATE SOCIAL RESPONSIBILITY A EUROPEAN
AND NATIONAL APPROACH
Eugeniu TURLEA
Aurelia STEFANESCU
Monica DUDIAN
Mihaela MOCANU
Adriana CALU
69
IMPROVEMENT IN ACCOUNTING SYSTEM AND PERFORMANCE

MANAGEMENT OF IRANS UNIVERSITIES IN THELIGHT OF
CONTINGENCY THEORY
Martin BROAD
Abbas ALIMORADI
91
THE ERA OF INTERNAL AUDIT IN THE PUBLIC FINANCE SECTOR

IN POLAND
Agnieszka SKOCZYLAS
Wojciech NOWAK
114
BOUNDRIES REGARDING THE IMPLEMENTATION

OF THE NATIONAL STRATEGY FOR THE FINANCIAL REPORTING
OF THE PRIVATE SECTOR ENTITIES
Ramona LAPTES
Adriana Florina POPA
133
~3~
PS3 Financial analysis I

Chairperson: Petru OPRIS, West University of Timioara, Romania
149
FINANCIAL RATIOS AND MARKET VALUATION

ON EMERGENT MARKETS: THE ROMANIAN CASE
Bogdan DIMA
Petru OPRIS
150
A HYBRID DEVICE OF SELF ORGANIZING MAPS (SOM)

AND MULTIVARIATE ADAPTIVE REGRESSION SPLINES (MARS)
FOR THE FORECASTING OF FIRMS BANKRUPTCY
Javier de ANDRES
Fernando SNCHEZ-LASHERAS
Pedro LORCA
Francisco Javier DE COS-JUEZ
162
THE RELEVANCE OF COMPANY EVALUATION METHODS

IN CONDITIONS OF ECONOMIC INSTABILITY. EMPIRICAL STUDY
ON THE COMPANIES QUOTED IN THE BUCHAREST STOCK
EXCHANGE
Marilena MIRONIUC
Mihai CARP
Ioan-Bogdan ROBU
183
FINANCIAL RISK ANALYSIS AT THE STOCK EXCHANGE LISTED

COMPANIES IN THE PASSENGER ROAD TRANSPORTATION
INDUSTRY
Vlad IORDACHE
Vasile ROBU
Costin CIORA
201
PS4 IFRS I
Chairperson: David ALEXANDER, University of Birmingham, UK
BENEFITS AND COSTS OF PREPARING IFRS STATEMENTS
BY NON-LISTED COMPANIES: EVIDENCE FROM THE CZECH
REPUBLIC
David PROCHZKA
PS5 Fair value
Chairperson: Mihaela DUMITRANA, Academy of Economic Studies, Bucharest,
Romania
THE IMPACT OF THE ED/2009/5 FAIR VALUE MEASUREMENT
ON THE PROFESSIONALS
Mirela PAUNESCU
Mirela NICHITA
PS6 Management information systems I
Chairperson: Pavel NASTASE, Bucharest Academy of Economic Studies, Romania
AN ENTERPRISE ONTOLOGICAL APPROACH FOR SEMANTIC WEB
Adrian COZGAREA
Gabriel COZGAREA
Delia BABEANU
~4~
210
211
229
230
248
249
ENTERPRISE 2.0 IS THE MARKET READY?

Dragos Marian MANGIUC
258
NON-TECHNICAL CHALLENGES IN ADOPTING ENTERPRISE 2.0

275
CRITICAL SUCCESS FACTORS FOR THE ORACLE DATABASE

AUDIT
Simona Felicia UNCHIASU
Pavel NASTASE
287
PS7 Financial instruments

Chairperson: Florin VASVARI, London Business School, UK
302
USE OF FINANCIAL SECURITIES IN THE CZECH REPUBLIC: SOME

EVIDENCE FROM SMES
Ji STROUHAL
Marie PASEKOV
Eva HRUBOOV
Carmen Giorgiana BONACI
303
THE FINANCIAL INNOVATION AND THE DYNAMIC CAPITAL

MARKET
Flavia Mirela BARNA
Miruna Lucia NACHESCU
317
A SELECTION FUZZY MODEL INVOLVING ASSETS AND PROJECTS

Adrian Victor BDESCU
Radu Nicolae CRISTEA
Dana-Maria BOLDEANU
334
THE ROLE OF FINANCIAL DESCRIPTORS IN THE OPTIMAL

PORTFOLIO SELECTION
Bogdan DIMA
Flavia BARNA
Horatiu REGEP
347
PS8 Intellectual Capital

Chairperson: Niculae FELEAGA, Bucharest Academy of Economic Studies, Romania
368
INTELLECTUAL CAPITAL DISCLOSURE: EUROPEAN EVIDENCE

Liliana FELEAGA
Niculae FELEAGA
Voicu Dan DRAGOMIR
Luciana Maria RABU
369
INTELLECTUAL CAPITAL: THE ANNUAL REPORTING PRACTICES

Nicoleta Maria IENCIU
Dumitru MATI
380
DETERMINANTS OF INTELLECTUAL CAPITAL DISCLOSURE IN

THE CASE OF ROMANIAN COMPANIES
Maria Cristina MORARIU
395
~5~
PS9 IFRS II
Chairperson: Dumitru MATIS, Babes-Bolyai University, Romania
IMPACTS AND CHANGES IN THE ACCOUNTING POLICIES AFTER
THE IAS ADOPTION: A COMPARISON BETWEEN THE
MANUFACTURING AND THE COMMERCIAL SECTOR IN GREECE
Sotirios KARATZIMAS
Stella ZOUNTA
Vagia KYRIAKIDOU
PS10 Performance management
Chairperson: Petru STEFEA, West University of Timisoara, Romania
416
417
431
VALUE AND PERFORMANCE IN A REGULATED ENVIRONMENT:

THE CASE OF TELECOMMUNICATIONS IN ROMANIA
Alina Carmen ALMASAN
Corina GROSU
432
QUO VADIS IN MEASURING BUSINESS PERFORMANCE? A

PRACTICAL SOLUTION FOR THE IT SECTOR
Oana-Adelina FLORICIOIU
Radu-Daniel LOGHIN
444
EFFECTIVE AND EFFICIENT TOOLS IN HUMAN RESSOURCES

MANAGEMENT CONTROL
Mihaela Adriana DUMITRANA
Gabriel RADU
Mariana Elena GLAVAN
Gabriel JINGA
458
FLEXIBILIZING THE TERMINATION OF THE EMPLOYMENT

CONTRACT: PROS AND CONS
Raluca DIMITRIU
466
PS11 Management information systems II

Chairperson: Iuliana IONESCU, Bucharest Academy of Economic Studies, Romania
481
A CASE STUDY FOR START-UP COMPANIES IMPLEMENTING EBUSINESS TECHNOLOGIES

Carmen TIMOFTE
482
ANALYZING E-COMMERCE PROTOCOLS

Carmen TIMOFTE
488
MODELING ON A SEMANTIC-BASED REPRESENTATION OF

PEDAGOGICAL OBJECTS E-LEARNING-TYPE IN
ORGANIZATIONAL MEMORY: CONNECTING ONTOLOGY WITH
LOM META-DATA
Iuliana IONESCU
Vasile FLORESCU
Bogdan IONESCU
Ofelia Ema ALECA
496
~6~
SEMANTIC ANNOTATION AND ASSOCIATION OF WEB

DOCUMENTS: A PROPOSAL FOR SEMANTIC MODELING IN THE
CONTEXT OF E-RECRUITMENT IN THE IT FIELD
Bogdan IONESCU
Iuliana IONESCU
Vasile FLORESCU
Andrei TINCA
514
DECISIONS DRIVE SUCCESS

Dragos STOICA
Pavel NASTASE
532
PS12 Corporate governance and ethics

Chairperson: Nicoleta FARCANE, West University of Timisoara, Romania
544
CORPORATE VALUES, THE COMPANIES FRAMEWORK

OF ETHICAL BEHAVIOUR
Elena Roxana ANGHEL-ILCU
545
HOW CAN CORPORATE GOVERNANCE MITIGATE FRAUD?

Victoria STANCIU
Ali EDEN
Veronica IVANCENCO
565
ETHICS AND RESPONSIBILITY IN IT

Valerica MARES
Marius Daniel MARES
580
CORPORATE GOVERNANCE PRINCIPLES: AN EVOLUTIONARY

APPROACH IN TERMS OF DIRECTORS-MANAGERS RELATIONSHIP,
IN THE DEVELOPING ECONOMIC CONTEXT OF 21ST CENTURY
Maria GROSU
Roxana-Manuela DICU
Daniela MARDIROS
593
PS13 Issues in financial accounting

Chairperson: Tudor GRECU, KPMG Romania
612
IMPACT OF FUNDED STATUS OF PENSIONS ON BORROWING

COSTS OF STATES
Maria-Iuliana SANDU
613
THE IMPACT OF UNREALISED FOREIGN EXCHANGE

DIFFERENCES
Georgiana TOADER
Mihaela Adriana DUMITRANA
619
VALUE RELEVANCE OF CONSOLIDATED VERSUS PARENT

COMPANY FINANCIAL STATEMENTS
Victor-Octavian MULLER
629
THE ADVANTAGES VS. THE DISADVANTAGES OF OUTSOURCING

THE ACCOUNTING AND FINANCIAL SERVICE
Vasile-Daniel PAVALOAIA
Ioan ANDONE
650
~7~
PS14 Management information systems III

Chairperson: Javier DE ANDRES, University of Oviedo, Spain
AUDITING NEW INFORMATION TECHNOLOGY SOLUTIONS FOR
ECONOMIC GROWTH
Delia BABEANU
Gabriel COZGAREA
Adrian COZGAREA
Ilie TAMAS
Nicolae DAVIDESCU
A TEST OF DIFFERENT MODELS FOR THE ESTIMATION OF THE
LABOR COSTS OF SOFTWARE PROJECTS
Javier de ANDRES
Pedro LORCA
659
660
679
694
IT COMPLEXITY AND COSTS

Marius Daniel MARES
Valerica MARES
PS15 XBRL
Chairperson: Sorin BRICIU, 1 Decembrie 1918 University, Alba Iulia, Romania
702
THE EFFICIENCY OF SMALL AND MEDIUM ENTERPRISES BY

THE IMPLEMENTATION OF WEB-BASED ACCOUNTING
Sorin BRICIU
Florin MIHAI
Constantin GROZA
703
13 YEARS AFTER: AN XBRL LITERATURE REVIEW AND

OVERVIEW
Claudia URDARI
Adriana TIRON TUDOR
720
THE INFLUENCE OF FIRM-SPECIFIC CHARACTERISTICS ON THE

EXTENT OF VOLUNTARY DISCLOSURE IN XBRL: AN EMPIRICAL
ANALYSIS OF SEC FILINGS
Devrimi KAYA
732
PS16 SMEs
Chairperson: Jiri STROUHAL, University of Economics Prague, Czech Republic
758
OBLIGATION OR OPPORTUNITY FOR DRAWING THE CASH-FLOW

STATEMENT. THE CASE OF ROMANIAN SMALL AND MEDIUM
ENTERPRISES
Adina POPA
Rodica BLIDISEL
Nicoleta FARCANE
Dan STIRBU
759
ROMANIAN PROFESSIONAL ACCOUNTANTS PERCEPTION

ON THE DIFFERENTIAL FINANCIAL REPORTING FOR SMALL
AND MEDIUM-SIZED ENTERPRISES
Stefan BUNEA
Marian SACARIN
Mihaela MINU
770
~8~
ACCOUNTING PRINCIPLES AND BOOK-TAX (DIS)CONNECTION

IN ROMANIA
Costel ISTRATE
PS17 Financial analysis II
Chairperson: Sotirios KARATZIMAS, University of Aegean, Greece
787
804
FUNDAMENTAL DETERMINANTS OF CAPITAL STRUCTURE

CHOICE: A SURVEY OF ROMANIAN COMPANIES
Marilen PIRTEA
Cristina NICOLESCU
Claudiu BOTOC
805
IMPACT OF LONG-TERM INVESTMENT DECISIONS ON

PROFITABILITY AND COMPETITIVE ADVANTAGE IN BUSINESS.
CASE STUDY IN THE MINING INDUSTRY IN ROMANIA
Oana-Adelina FLORICIOIU
Radu-Daniel LOGHIN
821
INCLUDING BEHAVIOURAL ELEMENTS IN ASSET ALLOCATION

PROCESS
Aurora MURGEA
833
PS18 Education
Chairperson: Alain BURLAUD, INTEC Paris, France
860
ACCOUNTING STUDENTS ACADEMIC PERFORMANCE: A BATTLE

BETWEEN PERCEPTIONS? A ROMANIAN RESEARCH NOTE
Razvan V. MUSTATA
Alexandra MUTIU
Dumitru MATIS
861
PERCEPTION OF THE ROMANIAN ACCOUNTANTS REGARDING

THE FINANCIAL ACCOUNTING EDUCATION
Paul DIACONU
Vasile GORGAN
Catalina GORGAN
Nicoleta COMAN
Codrina SANDRU
880
MANAGEMENT VIEW RELATED TO HIGHER EDUCATION

AN ANALYSIS OF THE ROMANIAN BUSINESS PERCEPTIONS
Mihaela STET
Alexandra ROSU
892
SOCIAL NETWORKING IMPACT ON EDUCATIONAL PROCESSES

IN ROMANIA
Florin MIHAI
Andrei STANCIU
Ofelia Ema ALECA
900
~9~
THE BEGINNINGS OF TRANSYLVANIAN CLUJ ACCOUNTING

SCHOOL
Teodora Viorica FARCAS
Adriana TIRON TUDOR
PS19 Financial markets
Chairperson: Andrei FILIP, ESSEC Paris, France
916
939
FINANCIAL MARKET EFFICIENCY AND PERSPECTIVES

ON IFRS ADOPTION. CASE STUDY FOR THE UNITED KINGDOM,
THE UNITED STATES OF AMERICA AND JAPAN
Stefana DIMA (CRISTEA)
Bogdan DIMA
Otilia RMT
940
PROPERTIES OF ANALYSTS FORECASTS FOR ROMANIAN LISTED

COMPANIES: HOW MUCH DO FIRM-SPECIFIC FACTORS MATTER?
Mihaela IONASCU
959
NET INCOME VERSUS COMPREHENSIVE INCOME FOR

PROFESSIONAL INVESTORS
Iulia JIANU
Ionel JIANU
Ionela GUSATU
966
PS20 Environmental accounting

Chairperson: Massimo POLLIFRONI, University of Turin, Italy
EXPLORATORY STUDY ON SOCIAL AND ENVIRONMENTAL
REPORTING OF EUROPEAN COMPANIES IN CRISES PERIOD
Camelia Iuliana LUNGU
Chirata CARAIANI
Cornelia DASCALU
Raluca Gina GUE
988
989
A COMPLEX APPROACH TO CLIMATE CHANGE EXTERNALITIES

Florian COLCEAG
Cornelia DASCALU
Chirata CARAIANI
Camelia Iuliana LUNGU
Raluca Gina GUE
1006
DIFFERENCES REGARDING ENVIRONMENTAL REPORTING:

THE CASE OF ROMANIAN ORGANIZATIONS
Ionel-Alin IENCIU
1024
ENVIRONMENTAL SUSTAINABILITY AND SOCIAL

RESPONSIBILITY: A THEORETICAL PROPOSAL
FOR AN ACCOUNTING EVALUATION
Massimo POLLIFRONI
1042
THE IMPACT OF THE SUSTAINABLE DEVELOPMENT

ON THE FINANCIAL STATE OF THE COMPANY SECTOR STUDY
Petru STEFEA
Cristina CIRCA
1061
~10~
EMPIRICAL STUDY REGARDING KEY INDICATORS

CORRELATIONS FOR SUSTAINABLE PERFORMANCE BUDGETING
Violeta CIMPOERU
Maria RADU
Valentin CIMPOERU
PS21 Management information systems IV
Chairperson: Felicia ALBESCU, Bucharest Academy of Economic Studies, Romania
MANAGEMENT INFORMATION SYSTEMS
AN APPROACH INSIDE AND OUTSIDE THE ORGANIZATIONAL
Georgiana Andreea CIOAN
Ilinca HOTARAN
BEYOND REPORTING IN BUSINESS INTELLIGENCE:
INTELLIGENCE THROUGH ANALYTICS
Irina Bogdana PUGNA
Felicia ALBESCU
Robert SOVA
PS22 Management accounting
Chairperson: Mathew TSAMENYI, University of Birmingham, UK
1075
1089
1090
1110
1125
SURVEY OF THE PRODUCT COSTING METHODS USED

IN CZECH REPUBLIC
Boris POPESKO
Petr NOVAK
1126
THE ROLE OF COSTS AND CONTROL IN ENSURING A

SUCCESSFUL MANAGEMENT IN THE DECISIONAL PROCESS
Stefania-Eliza BANA (PANCIU)
Florinel Marian SGARDEA
1135
THE CHANGE IN MANAGEMENT ACCOUNTING IN ROMANIA

Madalina DUMITRU
Daniela CALU
Gorgan CATALINA
Adriana CALU
Georgiana TOADER
1149
~11~
Accounting and Management Information Systems (AMIS)

International Conference
The AMIS International Conference organized by the Faculty of Accounting and
Management Information Systems of the Bucharest Academy of Economic Studies,
Romania, has already become an established milestone within the Romanian
accounting research environment. As such, it has already reached its 6th edition since
its inception in 2006. All submissions/reviewing processes are handled on-line, with a
high-quality double-blind review process ensured by esteemed national and
international reviewers. For this years edition, we have attracted 155 participants
from various parts of the world (including Europe, USA, Asia and Australia), thus
ensuring good geographical coverage. Only full papers in English are to be submitted
for the conference, in various domains such as: financial reporting, managerial
accounting, auditing, financial analysis, management information systems, and
business law. The criteria considered in the review process are: the technical
correctness, the novelty and originality, the importance to the field, the organization
and the clarity of the paper, the relevance of references, and the quality of results. For
each criterion a mark is awarded, and a weighted average is then produced
electronically. Comments from the reviewers are also mandatory and are available in
the on-line system to authors, who can then incorporate them in the revisions of their
work. All editions have websites that can be accessed via www.amis.ase.ro/.
We have continued to obtain for this years edition of the conference the participation
of many international scholars. These are:
Professor Mary BARTH, Stanford University, United States of America, the
conference keynote speaker;
Professor David ALEXANDER of the University of Birmingham, United
Kingdom;
Professor Alain BURLAUD, Director of INTEC/CNAM of Paris, France;
Professor David CAIRNS London School of Economics, the United Kingdom;
Assistant Professor Andrei FILIP ESSEC (Ecole Superieure des Sciences
Economiques et Commerciales) Business School, Paris;
Professor Donna STREET, University of Dayton, United States of America;
Professor Mathew TSAMENYI University of Birmingham, United Kingdom;
Assistant Professor Florin VASVARI London Business School, United Kingdom.
Their participation is extremely encouraging and beneficial to our delegates. They
have offered extensive feedback and have ensured a good conference experience to
conference participants.
This years keynote speaker is Dr. Mary Barth, the Joan E. Horngren Professor of
Accounting at the Stanford University, Graduate School of Business (GSB). Prof.
Barth was a member of the International Accounting Standards Board (IASB) from its
inception in 2001. Currently, she serves as the Academic Advisor to the IASB.
Professor Barths research is published in a variety of journals and has won several
awards, including the American Accounting Associations (AAA) Competitive
Manuscript Award and, on two occasions each, the AAA Wildman Medal Award and
the Best Paper Award of the Financial Accounting and Reporting Section of the AAA.
She is the Accounting Department Editor of Management Science, has been an

Associate Editor of The Accounting Review, and is on the Editorial Boards of several
other academic journals. Professor Barth is a recipient of the GSBs MBA
Distinguished Teaching Award and PhD Faculty Distinguished Service Award, and
served as a Senior Associate Dean for Academic Affairs at the GSB from 2002 until
2009. Professor Barth is a Vice President of the International Association for
Accounting Education and Research and is active in the AAA, having served as Vice
President and as Chair of several committees. Professor Barths research focuses on
financial accounting and reporting issues, particularly topics of interest to accounting
standard setters. Such topics include using fair values in financial reporting, stockbased compensation, recognition versus disclosure, asset securitizations, asset
revaluations, the information roles of accruals and cash flows, the relation between
financial statement quality and cost of capital, and issues related to global financial
reporting and convergence.
All the other international guests have extensive experience and have published in top
journals in a variety of fields related to accounting. Prof. Donna Street, Prof.
David Alexander and Assist. Prof. Andrei Filip published their work in the field of
financial reporting with a focus on International Financial Reporting Standards, Prof.
Alain Burlaud and Prof. Mathew Tsamenyi are especially focused on managerial
accounting, while Prof. David Cairns is additionally interested in the field of auditing.
It already became customary for our conference to introduce new events every
edition. In this respect, we are proud to host in conjunction with this years edition:
a Joint IAAER - IFRS Foundation IFRS Framework-Based Teaching Workshop,
in which three teams of authors guided the audience through the designing of
Framework-based IFRS teaching cases;
an ACCA IAAER Seed Grant Program for Early Career Researchers
Deliverable, that continues and extends on the last years IAAER-ACCA-KPMG
Early career researcher consortium. Five teams of authors who received funding
from the ACCA and mentorship from internationally recognized mentors
reported now on the development of their research;
an Academic Performance and Evaluation Panel, during which panelists
discussed various aspects related to evaluation the work of academics, in an
internationalized and competitive context.
The next years edition is scheduled to take place on June 13-14 2012. We are
committed to continue to play an increased role in advancing accounting research in
Central and Eastern Europe, and we will continue to collaborate in this respect with
the International Association for Accounting Education and Research (IAAER),
whose Director of Research and Educational Activities, Dr. Donna Street, is a
constant presence at and support to our events. Our collaboration has continued on the
same fruitful grounds with the Association of Chartered Certified Accountants
(ACCA) and KPMG Romania. All these organizations are dedicated to the
development of accounting research and practice worldwide, and are committed to
strengthen the collaboration with our institution for the years to come. I am convinced
that our partnership will be one of many satisfactions.
Prof. univ. dr. Pavel NASTASE
Conference Chair
~13~
PS1 Auditing
Chairperson:
David PROCHAZKA, University of Economics, Prague, Czech
Republic
AUDIT COMMITTEES AS INCREASING VECTORS OF

FINANCIAL INFORMATION QUALITY
Neluta MITEA
THE FINANCIAL AUDITORS RISK BEHAVIOUR

THE INFLUENCE OF AGE ON RISK BEHAVIOUR IN A
FINANCIAL AUDIT CONTEXT
Iancu Octavian IONESCU
Eugeniu TURLEA
THE INVESTIGATION OF ROMANIAN AUDITORS'

PERCEPTIONS OVER THE INTERNAL AUDIT
PRACTICES - AN ATTEMPT TO IDENTIFY THE BEST
PRACTICES IN THE CONTEXT OF CORPORATE
GOVERNANCE
Cristina BOTA-AVRAM
AUDIT COMMITTEES AS INCREASING VECTORS

OF FINANCIAL INFORMATION QUALITY
Neluta MITEA1
Andrei aguna University in Constana, Romania
ABSTRACT
Capital markets feel a current need to dispose of high quality information. As a response to
this need, this paper proposes the intervention of audit committees whose main objective
consists in monitoring the financial activity. The present study offers interesting insights by
examining the relevant ideas developed previously in the literature with the scope of
understanding, reinterpreting and rediscovering from interesting points of view the audit
committees major role in increasing the quality of financial information. Audit committee
represents one of the mechanisms controlling managers opportunistic behavior, under the
circumstances of agency theory and information asymmetry. By conducting this study I
wanted to reinforce the role of specialized literature and of empirical researches in
determining new solutions and hypothesis regarding audit committee effectiveness.
KEYWORDS: audit committee, audit committee effectiveness, agency theory, information

asymmetry, financial information
INTRODUCTION
In the last years we have been witnessing a significant increase of general interest in
corporate governance. The reason for this interest lies on the economic environments
concern regarding the multitude and the deep consequences of the financial scandals
that started, in general, from the accounting and financial frauds. Notable
bankruptcies are also a consequence of the lack of integrity characterizing the
accounting professionals and companies management. It is well known that, under
managers or shareholders pressures, they used to practice a creative accounting and
also fraudulent financial reporting. Their purpose was to manipulate stock prices for
listed companies. Therefore, at present, we could all notice a strong concern in the
economic environment for the way by witch managers are controlled and supervised
in their actions and decisions taken. In this respect, the audit committees role
becomes essential for the right functioning of financial reporting process. Although
the responsibility for annual financial statements comes to the management of the
organization, a major role in securing the financial information users of statements
reality comes to auditors.
Financial scandals generated a number of deep debates at national and international
levels, on themes like: the importance of corporate governance, the structure of
supervising committees, the relations between audit committees and the participants
to financial reporting process. However, the financial information crisis tends to
1
Correspondence address: Nelua MITEA, Andrei aguna University in Constana, Romania; email:
nelutamitea@yahoo.com
~15~
discredit the audit function whose role consists in monitoring the quality of published
financial statements. In this context characterized by the loss of financial information
credibility, we are witnessing a significant effort aiming to redefine the internal
governance bodies, by introducing audit committees in the bosom of companies
boards. The genesis of audit committees suggests that their inclusion in the structure
of corporate governance should be understood as part of the reaction to corporate
abuses occurring over the last three decades. The audit committee was an attempt to
specifically designate responsibility for accounting-related matters, to provide a
reporting structure for insiders that would circumvent managerial retribution and to
supervise relations with the external auditors. Comprehensive regulatory changes
brought on by recent corporate governance reforms have broadly redefined and reemphasized the roles and responsibilities of all participants to the financial reporting
process. Therefore, the international academic environment is nowadays preoccupied
by the concept of audit committee, because it is used to affirm that the quality of
financial reporting depends on the characteristics of audit committees. This committee
has as objectives, the increase of financial statements credibility, and the assistance
of enterprises boards in the exercise of their actions and diligences, but also the
protection of internal and external auditors independence from managers pressures.
The present paper proposes an analysis framework concerning audit committees
contributions, in terms of audit quality and financial information quality too. On the
other hand, this study intends to inform the accounting professionals about the present
existent perception concerning the role of audit missions. I also studied the audit
committees tasks and its imperative characteristics (independence, expertise and
competence, financial experience, involvement degree). All these factors do influence
the reduction of failures in audit work. The different criteria enounced form altogether
the measures for audit committee effectiveness. By having appeal to the empirical
research studies, I arrived to assess the main action levers of audit committee. An
independent audit committee offers the premise to get reliable accounting information
and also relevant and pertinent financial statements. The originality of this paper
consists in evaluating the circumstances under which the audit committee might
improve the quality of financial information. The orientation of this approach
supposes a confrontation of economic theories, namely the agency theory and the
information asymmetry. In the conditions of agency relations, the audit committee is
supposed to act effectively.
In theory, this study continues the research directions of authors like Knapp (1991),
Pig (2003), Chemangui (2004), Manita (2008) and also those of Turley and Zaman
(2007) and others. However, the originality of this paper consists in studying the audit
committee by conducting the research demarche towards the audit process analyzes.
Turley and Zaman (2007) addressed audit committees especially by the perspective of
agency relations. The purpose of Turley and Zamans researches focused on the
identification of conditions and processes affecting the audit committees potential
effectiveness. The results of the researches highlight the importance of informal
processes around the audit committees and also the impact of this committee on
corporate governance. The informal connections between the members of audit
committees and management, could serve at the maximization of audit committee
effectiveness. These qualitative researches do not foresee a generalization of the
results, but they support us to perceive exactly the factors influencing the
effectiveness or the lack of effectiveness concerning audit committees. For this goal, I
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took into account the essential role of audit committee manifested by the virtue of its
privileged access to the accounting and financial information and of its central place
in the companies control and supervising process.
RESEARCH METHODOLOGY
From an operational viewpoint, I was interested in choosing an adequate research
method which could have helped me in tracing potential solutions aiming to improve
financial information credibility, by the means of audit committees. Because of the
fact that this paper does not represent an empirical study, but a fundamental research
item, I proceeded to a history of literature addressing the subject of audit committees
and of financial information quality in order to draw conclusions highlighting the
research results. Especially the results of this study could participate at the
identification of future research perspectives. First of all, I identified the theme chosen
in the specialized literature. As a consequence, I used as research methodology, the
inductive research which supports the main idea concerning the generalization of
conclusions as a result of the literature analysis. The summary of scientific documents
was realized by having consulted specialized magazines, other sources of
documentation and also an important number of items and research studies. On the
basis of this synthesis, I proved the capacity of the audit committee to increase the
integrity of internal and external audit functions and, in the same time, I analyzed the
relations between the audit committee and its attributes concerning the quality of
financial information. At the end of this study, I proceeded to draw some conclusions
in order to highlight the contribution of the present paper to a better understanding of
the audit committees role according to its own limits.
1. AUDIT COMMITTEE AN INCREASING VECTOR OF FINANCIAL
INFORMATION QUALITY
Recent financial scandals have disrupted both the concept and techniques for
measuring the audit quality. These scandals have led international professionals and
also the academic environment to redefine regulations and assessing mechanisms
concerning audit quality. Therefore, in the middle of professionals preoccupations,
there is audit committee, because it is considered that its characteristics do influence
the quality of financial statements. The scandals dating from the early 2000s sowed
doubts connected to the effectiveness of those committees. Famous cases with strong
impact on the credibility of financial information transmitted to investors, in addition
to Enron case, are also those of dot-com series and Credit Lyonnais (2001), Toshihide
Iguchi and Daiwa Bank (1995), Hollinger International Inc. (2004), Flaming Ferraris
(1999), Parmalat (2003), World Com (2001). Among the main causes of financial
scandals there are the information asymmetry and the opportunistic behavior of the
agents. Studying the causes and effects of these failures in question, specialists arrived
to propose possible solutions to agency problems, including audit monitoring and
performances measurement. As regards monitoring activity, the problems which are
held to be taken into account, concern internal and external bodies involved and their
independence (especially for financial audit). For the measurement of performances,
the latter depends on information entered and on instruments used.
As a result of financial scandals, the Sarbanes-Oxley Act arises in the U.S.A (2002,
SOX). Its purpose consists in establishing improved standards for all American public
~17~
companies (including non-American companies that are listed on U.S. stock market),
for their management and for public accounting firms. The law covers such issues as
auditor independence, corporate governance, internal control and the improved
disclosure of financial statements. There are similar regulations in other countries
such as: the so-called J-SOX in Japan, CLERP9 in Australia, LSF (La Loi de Scurit
Financire) in France, Bill 198 in Canada. This concept occurs more often in Romania
too, because of the multinationals. With the Sarbanes-Oxley Act, audit committee
became the legal body responsible for monitoring and control (Prat dit Hauret &
Komarev, 2005). The audit committees responsibilities consist in supervising
financial reporting issued by the entities, monitoring the relations with internal and
external auditors, supervising policies and practices of detecting and preventing
financial errors and frauds, respecting business ethics. In Europe, by the means of the
8th Directive revised by the European Parliament, listed companies are required to
establish audit committees starting from July 2008. Romania feels also the necessity
to strengthen the role of audit committee in supervising risks management and in
improving the communication with entities management. Nowadays Romania is in
line with international practices in risk management and corporate governance by the
means of an entire series of legislative acts. Thus, according to Ordinance no 90/2008,
entities of public interest are required to monitor the effectiveness of the internal
control system; this monitoring activity will be included in the audit committees
tasks.
According to the International Standard on Auditing no 260 (ISA 260),
Communication of audit matters to those charged with governance, the auditor
should communicate audit issues of governance interest, issues arising from the audit
of financial statements. In the respect of this ISA, the term of governance will be used
for describing the role of persons in charge with supervising, control and management
of an organization. Those charged with governance should be sure that the entity is
able to achieve its objectives regarding the reliability of financial reporting, the
effectiveness and the efficiency of operations, the compliance with the applicable law.
The auditor must prove professional reasoning in order to communicate audit matters
of governance interest, considering the structure of every entity, the circumstances of
audit engagement and any relevant legal issue. Audit committees members are
supposed to know the best practices for this vital function of the organizations.
The objective of this paper is not only to achieve a synthesis of international empirical
researches studies that approached the subject of audit committees. The present study
intends to fix the conditions under which audit committee could improve the quality
of the financial information. In this regard, I considered as dominant current, positive
inspiring and interpreting works. Positive studies are based, in general, on the
qualitative analysis of information about the subject matter, information from archives
and databases. The goal of the positive studies consists in identifying statistical
regularities between the audit committees characteristics, on the one hand, and the
quality of audit process and of financial information, on the other hand. There are
authors who dedicated their studies to the functioning of audit committees. Therefore,
we could appreciate that audit committees activity should be regarded in function of
its effectiveness and performance and, that is why, an important role in such a context,
comes to the questioning process adopted by the audit practitioners (Spira, 2003).
Other authors have tried to identify the factors influencing the potential
effectiveness of audit committees. The members of audit committee must demonstrate
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independence, competence, professional and moral tenure. In spite of some

shortcomings, the informal links between audit committees members and
management could serve to the effectiveness maximization. Therefore, audit
committee might be seen as a valuable tool interfering in governance (Magrane &
Malthus, 2010). There are certain complementarities between the independence and
the competence of audit committees members: independence is viewed according to
audit committees involvement in taking decisions, while competence is foreseen in
the committees obligation to review tasks and activities connected to internal audit
(Goodwin, 2003). Following the systemic vision of the authors discussed above, we
could notice that the role of audit committees consists in coordinating the obligations
of internal and external auditors in order not to affect the integrity of audit process,
but to increase its usefulness. The introduction of the Sarbanes-Oxley Act was an
occasion to oblige responsible bodies to announce the internal control errors and
weaknesses. Therefore, entities that have published the cases connected to the
weaknesses of the internal control have formed the basis for numerous research
studies. Starting from them, we could conclude that there is a possible link between
the internal control weaknesses and the audit committee effectiveness. Studies that
followed the introduction of SOX consider the audit committee as a preventive factor
for internal control weaknesses. There are some studies confirming those results
(Zhang et al., 2007). Audit committees size and its competences are the factors
influencing the rapid and effective correction of internal control weaknesses (Goh,
2009). In the meantime, auditors professional reasoning is proportional to their
expertise (DeZoort, 1998). This author assumes that the members of audit committees
proving experience in auditing and internal control, are able to make judgments closer
to those coming from the external auditors, the latter being considered the truest
specialists in the field. Moreover, less experienced individuals, might make difficult a
rigorous control. In a more recent study, the researchers highlight that audit
committees members are mainly based on intuition in the process concerning the
establishment of professional reasoning and that the key element of committees
effectiveness consists in members ability to put challenging questions (Gendron et
al., 2004). The research models Ive studied prove that financial and extra-financial
expertise of audit committees members does represent the key factor of this body
effectiveness, the internal control quality depending on this factor. In this respect, the
members of audit committees are required to orient internal audit efforts towards the
detection of financial errors and weaknesses.
There are research studies indicating the positive effects of the Sarbanes-Oxley Act on
the financial reporting process, on capital cost and on companys value (Bedard,
2006; Ashbough-Skaife et al. 2007; Cohen et al. 2008). The authors examine the SOX
impact by having appeal to a comparison between external auditors current
experiences and their interactions with the various mechanisms of corporate
governance (board, audit committee etc.). As well as the auditors experience, that of
management reveals the fact that the compliance to legislative acts has a positive
impact on the relation between audit committee and external auditors and also
between audit committee and companys board. Cohen et al. (2008) notice that, in
general, audit committee does not participate directly to the resolution of conflicts
between auditors and management, preferring to be just informed about the eventual
misunderstandings that could appear. In case of a conflict, audit committee becomes a
true relay of spontaneous information for internal audit responsible (Turley & Zaman,
2007). The improvement of internal costs effectiveness resulting from SOX adoption,
~19~
contributes to the decrease of information risk as well as to that of capital (AshbaughSkaife et al, 2007). Concerning the relation between audit committee and external
auditors, research studies show us that this relation is more formalized. This aspect
starts from the premise that external auditor represents the main actor of certification
process. Therefore, the quality of the audit mission depends on the external auditors
independence. The Sarbanes-Oxley Act limits a parallel consultancy activity
conducted by external auditors within the same organization. Audit committee will
intervene in the conflict arising between external auditor and management, protecting
auditors independence. When audit committees members prove serious auditing
knowledge and a strong economic formation, they tend to sustain external auditors
(DeZoort, 1998). On the other hand, when the audit committees members were
managers of companies in the past, is much easier for them to fraternize with the
audited entitys management (DeZoort, 1998). Globally, studies point out that audit
committees members are increasingly tempted to defend external auditors opinion
when we observe an increase of their competences in auditing but also a manifestation
of their independence. Therefore, this paper highlights the idea that audit committee
must have a financial expert as member who possesses either professional
qualification or experience in preparing, auditing, analyzing or evaluating financial
statements but also it should have an understanding of audit committee functions.
Audit committees members should make every effort to promote the audit quality, by
imposing specific conditions to external auditors aiming to cover risk areas. In the
meantime, audit committee should optimize external control program. According to
SOX, audit committee is responsible for external auditor remuneration. Therefore, the
committee is held to prove its effectiveness, by establishing an agreed price justifying
the work and also the results. From research studies, we could notice that in the
U.S.A. there are accentuate complementarities between audit committees
independence and external audit expenditures. The presence of an audit committee
increases fees corresponding to the global audit effort and reduces the fee to be paid
for the complexity of the mission (Collier & Gregory, 1996).
As a conclusion for this first part of the paper, I sustain that audit process is a complex
one and that audit committee has a vital role for determining the quality of audit
mission and of financial information. An audit committee could be defined as subcommittee in the governing body that will make arrangement for internal audit and
facilitate the completion of external audit. Audit committees try to enhance the ability
of the board to fulfill its legal responsibilities and ensure the credibility and
objectivity of the financial reporting. The quality of audit process depends largely on
auditors quality (independence, competence, expertise and ethics), but also on the
organization of this process. Audit committees members seem to break down audit
process considering established procedures and proposed accounting adjustments.
However, a particular attention should be paid to the relationship between audit
committee and external and internal auditors. Audit committees expertise in auditing
and economics could influence the quality of audit mission and also the quality of
financial information.
2. AUDIT COMMITTEE FACE TO FRAUDULENT FINANCIAL
STATEMENTS
The emergence of a financial accounting is historically connected to the development
of corporations inducing the need to communicate financial information towards
~20~
shareholders as companies owners and also towards other interested parties. In

literature there are a number of studies that place financial information in its real
context, marked by constraints and imperfections. Seen as a typical information
system, accounting differs from other information systems on three levels: by the
specificity of the principles supporting the profession; by the specificity of processed
data and by the specificity of processing methods (Grenier, 2000: 1122). Therefore,
Grenier and Bonnebouche are the promoters of a scheme including accounting
principles in the representation process. These principles interpose between the
reality to be represented and the observer (at the level of observation principles
prudence, quantification), between the reality and the informations user (at the level
of principles concerning representations construction), or between the user and the
observer (at the level of deontological principles sincerity, regularity) (Grenier,
2000: 1123). Listed companies from modern economy surpass the legal reporting
duties and develop a true financial communication strategy (Guimard, 1997: 342).
Fraudulent financial statements represent a threat for users trust. Those statements
have captured the attention of business community, accounting professionals,
academic environment and also of regulators. At present, we could notice the
necessity to prevent financial frauds and to detect those strategies able to keep away
this type of incidents. Fraud risk could be reduced by combining detection and
prevention measures. Michael R. Young (2003) who has spent almost twenty years
defending accounting firms accused of fraud recognizes that the introduction of the
Sarbanes-Oxley Act could be useful. Experience proves us that violation of laws and
regulations is, in general, the result of deficiencies within corporate governance and
internal control. Independence and financial sophistication of members are regarded
as challenges for audit committees. Therefore, in order to get a future success, audit
committees should ensure that the organization has determined initially a viable audit
function.
However, audit committees presence in the bosom of companies aims to prevent the
production and transmission of fraudulent financial statements. Audit committee is
held to make sure that financial statements are not the result of accounting errors or
frauds. Some authors have studied the usefulness of an audit committee in preventing
frauds. Audit committee could play a significant role in preventing, detecting and
investigating frauds. As long as we are talking about prevention, the main aspect for
audit committees in preventing frauds consists in observing management and external
auditors expectations. In addition, it is necessary for an audit committee to manifest
zero tolerance when it detects errors; audit committee should take seriously into
account any attempt to defraud, to investigate it subsequently and to act accordingly
to the importance of the event.
Two empirical studies validate the audit committee usefulness (McMullen, 1996;
Uzun et al., 2004) and other two deny this usefulness (Beasley, 1996; Carcello &
Nagy, 2004). McMullen (1996) detects a significant negative relation between the
presence of an audit committee and fraud. The lack of reliability regarding financial
information has less severe consequences. However, not the same thing occurs when
correcting accounting results. Firms with audit committees are associated with fewer
shareholder lawsuits alleging fraud, fewer quarterly earnings restatements, fewer SEC
(Security Exchange Commission) enforcement actions, fewer illegal acts and fewer
instances of auditor turnover when there is an auditor-client accounting disagreement
(McMullen, 1996). Research studies follow various types of measures when they
~21~
address audit committee independence. Uzun et al. (2004) discuss about frauds, while
other authors are preoccupied with the measure of correcting the results (Agrawal &
Chadha, 2005). However, no less important are the contributions of entirely
independent audit committees regarded as a factor of fraud prevention (Abbott et al.,
2000). They show that companies getting audit committees composed of independent
directors are less sanctioned for fraudulent reporting. Audit committees
independence affects both companies management earnings and investors
perceptions. A good audit committee would affect shareholders perception
concerning auditors, especially in those circumstances in which shareholders might
experience a greater threat to auditors independence (Raghunandan & Rama, 2003).
Audit committees are held to select auditors. If the reputation of audit committees
members depended on the quality of audit mission results, surely audit committees
would be interested in selecting the best auditors. An auditor could be appreciated
according to his capacity to detect and to report errors and omissions in financial
statements (Chersan, 2009). There are other research studies demonstrating that audit
committees discipline is strongly linked to the organization of internal governance.
An entirely independent audit committee will allow the prevention of accounting
irregularities, unless the CEO is not involved in selecting board members (Carcello &
Nagy, 2004). Further studies present less extreme consequences. The presence of a
financial expert in audit committee might reduce the likelihood of correcting the
accounting results (Abbott et al., 2004; Agrawal & Chadha, 2005). Herdman (2002),
chief accountant of SEC (Securities and Exchange Commission) highlighted the
importance of audit committees in post-SOX era sustaining that the role of audit
committee is one essential for enduring the integrity of published financial statements
on which investors are based. At a different level, Sheela Thiruvadi (2008) examined
the impact of gender differences on audit committees characteristics. The authors
have shown that those committees managed by women, act differently from
committees managed by men. The composition of audit committees evolves according
to companys nature (size, growth etc) and to the environment in which it operates
(Deli & Gillan, 2000). The likelihood that there is an entirely independent audit
committee is associated in a negative way to companys growth opportunities and in a
positive way to companys size (Deli & Gillan, 2000). Some researches results might
help the policy-makers, the investors and companies management to focus on audit
committees characteristics which could be crucial for the ethical behavior of the
entire body (Persons, 2009).
Without going too far with frauds cases or that regarding the violation of accounting
principles, some authors have studied only the practices of the opportunistic
management. If an audit committee was equipped with a rigorous capacity to follow
the accounting policies, it should provide constraints on opportunistic and
discretionary behavior. From the analysis I conducted, I arrived to conclude that
accounting practices are less discretionary when the audit committees level of
financial experience is higher (Bedard et al., 2004). An accounting manipulation with
an opportunistic purpose could represent, in extremis, a case of financial fraud.
Examples on this subject are the situations in which the management of the results
permits to companies managers to increase financial information relevance by
highlighting false future returns. In order to reduce risks, audit committees members
are supposed to communicate in time to managers, to internal and external auditors
the accounting problems and shortcomings. However, other studies go further, taking
into account different competence forms of audit committee, such as governance
~22~
expertise which could control the management of the accounting result (Bedard et al.,
2004; Yang & Krishnan, 2005). As a consequence, the level of expertise, and
especially the accounting expertise of audit committees members, does represent an
important element in preventing the results manipulation which will influence the
quality of the financial information. The reliability of financial information is thus
considered a fundamental attribute depending on a series of factors. The mere
presence of the audit committee is able to improve both the financial information
reliability (fewer accounting irregularities and cases of results manipulations) and its
relevance.
As a conclusion of this second part of the paper, I appreciate that audit committees
role is not one neutral to the quality of audit process and of financial information. So,
audit committee could play a very important role for mitigating agency problem. It
could also replace many deficiencies of a particular company which are the causes of
agency problem. Deficiency may be lack of independence of external auditor or lack
of efficiency in the internal control systems. Although audit committees could not
have prevented the financial scandals, the empirical research studies confer to those
committees a certain effectiveness and usefulness for companys governance systems.
The members of audit committees should cultivate closes relations with the CEO and
the CFO, with internal and external auditors in order to solve the difficulties and
shortcomings. Therefore, it is imperative for audit committees members to be
informed of all significant matters relating to financial reporting. The prevention of
accounting errors and frauds depends on audit committees characteristics. However,
a fully independent audit committee does not succeed in entirely eliminating
fraudulent financial reporting.
3. THE QUALITY OF AUDIT COMMITY IN CONDITIONS OF AGENCY
THEORY AND INFORMATION ASYMMETRY
The researches on audit committees role and on financial information quality get new
meanings for positive theories. On this line, this paper retains the agency theory and
the information asymmetry. Financial informations characteristics are strongly
linked, in this case, to interest conflicts arising between actors involved in the
economic process. Auditing is a solution to information asymmetry problems which
occur between managers and shareholders or between managers and the others.
Jensen and Meckling (1976) start their research from the hypothesis that auditing
represents a monitoring activity contributing to the increase of companys value. On
the basis of its role as corporate governances mechanism, auditing is focused on the
reduction of agency costs (Jensen & Meckling, 1976; Fama & Jensen, 1983) and on
guarantying informations reliability and relevance to the informations users. This
information is supposed to correspond to the true and fair view. Research demarches
started, usually, from the premise that economic actors do not have a free access to
financial information. The consequences of this observation highlight the idea that
information itself has a cost. Information available on market is partial and
asymmetric. The theory of information asymmetry is based on Akerlofs study (1970)
which analyses buyers and sellers behavior by abandoning the hypothesis of perfect
information in order to suppose consumers uncertainty regarding the quality of
purchased goods (Raimbourg, 1997: 190). The hypothesis of information asymmetry
is strongly linked to the agency theory and to the existence of agency relations. The
agency theory was established by Jensen and Meckling in 1976. The authors offered a
~23~
new vision on organizations, with significant consequences at the analyzed level of

financial communication. The agency theory is concerned with a contractual
relationship between two or more persons under which, one or more persons, called
the agent(s), is (are) supposed to perform some services on behalf of the principal.
Both the agent and the principal are assumed to be rational economic persons
motivated by self-interests (Jensen & Meckling, 1976). And agency theory suggests
that, owing to the separation of corporate management and ownership, shareholders
require protection because managers may have agendas different from their owners,
and thus they might not always act in the owners best interests (Fama & Jensen,
1983; Jensen & Meckling, 1976). These authors define the agency relation as a
contractual relation whereby one or more persons named principal employ/s another
person named the agent in order to exercise in his/their name a certain task implying
the delegation of decision-making power to the agent (Jensen and Meckling, 1976).
According to this theory, it is supposed that agents act on behalf of the shareholders,
respecting the interests of the latter. However, management could prove an
opportunistic behavior, putting the spotlight on their interests, looking for getting
personal advantages, such as remuneration, financial benefits and professional
prestige. Those advantages seem unprofitable for the entity because of the fact that
they increase companys costs. In order to minimize the risks, the principal will put in
application a number of measures intended to determine the agent to reveal all the
information. There are some empirical studies confirming the fact that, in general,
shareholders are interested in maintaining entities control by reducing the
informations transparency (Haniffa & Cooke, 2002; Makhija & Patton, 2004).
By analyzing the agency problem, this paper aims to show that Jensens agency
theory has evolved continuously, arriving to present itself as an organizational theory
including two different research currents: a purely economic theory centered on
markets functioning and a research theory associated to psychology, sociology,
anthropology and biology. The research theory highlights human behavior both on
individual level and on the social one. The studies in the field show that managers
arrive to build a set of opportunities, at the expense of the principal (the shareholders).
This paper considers that the principal is disadvantaged because of information
asymmetry. The sources of the conflicts arisen between the principal and the agent are
externalities coming from asymmetries of information, differences in attitudes
towards risk, differences in decision-making rights. This paper proposes a solution in
order to solve the organizational shortcoming, by finding cheaper ways such as the
effective and useful audit committees. The latter is held to provide accurate, complete
and fair information to the shareholders concerning enterprises situation, starting
from the moral obligation of audit committees members to manifest independence
(Domnioru & Vntoru, 2008). However, there are other authors who expressed their
skepticism about auditors independence within audit process, because of companys
superior position (Nichols & Price, 1976). The conflict arising between managers and
auditors has been associated by researchers to the imbalance characterizing the
rapport of forces between them (Nichols & Price, 1976). We could notice that, behind
the closed doors of listed companies, there is the true and fair view or the so-called
faithful image guarded by managers as a result of audit committees intervention.
The correspondence between the true and fair view and the economic reality depends
on audit committee. At this point, it is the turn for morality, competence (Gendron et
al., 2004) and for audit committees independence to enter the game of the
~24~
information asymmetry. According to those characteristics enounced above, the

companies destiny will be decided soon.
There are also authors considering that the agency relation appears when an
individual (or an enterprise) entrusts to another part the management of its own
interests (Raimbourg, 1997: 188). Agency theory becomes crucial when we add the
context of information asymmetry. As shown in some research studies (Marois &
Bompoint, 2004), agency theory has sense only under the circumstances of an
imperfect and asymmetric information between the parties involved (the agent has a
superior knowledge of the task to be fulfilled than the principal). In such a framework,
the authors address a particular importance to agency costs (including expenditures
supervision by the principal, expenditures incurred by the staff in order to keep in
touch with the principal; eventual losses). The agency costs in any enterprise will
depend on the lack of information about the agents activities, on the costs of
monitoring and analyzing the managements performance, on the costs of devising a
bonus scheme which rewards the agent maximizing the principals welfare and on the
costs for determining and enforcing policy rules. An audit committee is a solution to
reduce the problem of incentives (Fama & Jensen, 1983). The greater is the proportion
of outside dispersed shareholders, the more likely it is, that the company will form an
audit committee in order to reduce agency costs. However, there are a number of
uncertainties linked to agents behavior (risk and moral hazard) (Raimbourg, 1997:
189). Moral hazard with hidden actions occurs when the agent can determine to a
degree the outcome of his or her action, and the principal can not directly observe the
agents effort, or perfectly infer it from the companys information system. Even
Romanian literature acknowledges the existence of agency relationships between
financial informations users. Decoupling control of property led to the increase of
agency problems. The relationships between managers and shareholders, as well as
the levers the latter has to control managers activity (by the means of audit), have
been frequently discussed by the researchers.
In theory, this paper can afford to go beyond the indirect approaches concerning the
assessment of audit quality and to propose, following the examples of authors like
Knapp (1991), Carcello et al. (1992), Pig (2003), Chemangui (2004), Manita (2008),
a direct analyze of audit process. The present study aims to emphasize the audit
quality indicators and also the way by which they could be influenced. For such a
research demarche I took into account the privileged role of the audit committees
members. However, when information transmitted to audit committee does not prove
useful, the committees role becomes a ceremonial one (Gendron et al, 2004). The
fact that the members of audit committee occupy the central place in the control
process helped me to better understand the indicators measuring audit quality. Despite
all these, audit quality is not uniform at all and, therefore, it has represented the
research theme for a lot of authors. When the researchers reveal bankruptcies
situations, a great attention would be paid to audit quality (Wooten, 2003). However,
it is very difficult for us to know the real number of audits proving a poor quality
because of the fact that not all of them have been published. To observe audit process
requires a sustainable effort; consequently, researchers studied audit quality by the
means of auditors quality (DeAngelo, 1981; Nichols & Smith, 1983; Kaplan, 1995;
Lennox, 1999). De Angelo (1981: 183) defined the audit quality as markets
assessment on the adjacent likelihood that an auditor would discover simultaneously a
significant anomaly or irregularity in the enterprises accounting system and that he
~25~
would make public this anomaly. In this regard, some authors conclude that an audit
report would be qualitative only if it is the result of a competent audit process and of
an independent one, technically speaking (Citron & Taffler, 1992). Research studies
of Nichols and Smith (1983), Knapp (1991), Kaplan (1995), Lennox (1999) retained
this demarche defining audit quality according to technique competence (the quality
to detect frauds and errors) and to auditors independence (the quality to reveal errors,
to make them known). The Big 8 CPA firms supply a higher level of audit quality
than do smaller CPA firms because the Big 8 possess technological advantages that
lead to the detection of more material errors in client financial statements (DeAngelo,
1981). Furthermore, Big 8 auditors are viewed as being more independent as they
have greater reputation at stake. Committees members could understand the
difference between the oversight function of the committee and the decision-making
function of management and must be willing to challenge management when
necessary (Blue Ribbon Commission Report, 1999). In other words, DeAngelo (1981)
argues that larger audit firms have a greater investment in the reputation capital. In
order to protect their investment, audit firms are likely to provide higher quality
audits. There is a lower incidence of litigation against Big Eight auditors than against
non-Big Eight ones (Palmrose, 1988) and also a positive relation between board size
and financial fraud (Beasley, 1996). A smaller board is more effective at fulfilling a
controlling function whereas larger boards are easier for the CEO to control. The
characteristics of audit committees influence negatively the significance when boards
characteristics are included (Carcello & Nagy, 2004). The reports of the
ineffectiveness in audit quality evaluation have driven both the professional and
academic world to rethink the current rules and mechanisms for audit quality
assessment and to debate this subject and its measurability.
From another perspective, Chemangui (2004) arrives to assess audit quality according
to auditors quality, the auditor being viewed as an individual or as a group of
individuals. By extending the approach area, other researchers have studied the
indicators of audit quality according to auditors fees (Malone & Roberts, 1996;
David et al., 2006) or to his reputation (McNair, 1991; Palmrose, 1988; Moizer,
1997). At the same time, audit quality could depend on organizational characteristics
of audit committee. The members of audit committee could have different motivations
for improving the quality of audit process (Power, 1995). The authors cite a number
of quality indicators such as: human resource (Wooten, 2003), quality control (Prat dit
Hauret, 2000; Malone & Roberts, 1996), expertise (Wooten, 2003), professional
negligence affecting audit quality (Malone & Roberts, 1996; McNair, 1991). Even
audit committees size has a significant impact on financial reporting (Felo et al.,
2003). Their results highlight the idea that there is a positive relation between the
audit committees size and the quality of financial reporting, although studies realized
by Abbott et al. (2004) as well as those of Bedard et al. (2004) infirmed the
affirmation above. On the other hand, a company could have problems connected to
its financial statements when there is not a frequency in meetings of audit committees
members (McMullen, 1996). Therefore, this paper sustains that the frequency of this
meetings could improve and intensify the control of financial reporting process.
The assessment of audit quality imposes some conceptual and empirical limits
influencing financial information credibility. Some limits are linked to the risk of
compliance with management (Fama & Jensen, 1983a; Craswell, 1988); others are
reported to the characteristics of identified indicators (very simplistic indicators or
~26~
indicators reducing audit quality), and also to their incapacity to determine the
solution for audit quality improvement (Sutton, 1993). In this sense, the last quoted
author tried to validate a number of key factors on which audit quality depends. He
identified 19 factors. Further, Manita (2008) developed a tool for assessing audit
quality which is composed of 49 quality indicators assigned to different stages of
auditing. The author shows clearly that audit process is a complex one which needs to
be understood and observed on several dimensions. Manitas study (2008) proves the
fact that the quality of audit process is not tributary only to technical aspects
characterizing auditors, but also to their quality characteristics (independence,
competence, expertise, ethics) as well as to organizational characteristics of audit
firms (audit team, organization of audit mission etc.). However, it is necessary to
specify the fact that the quoted study refers to a period prior to SOX introduction; this
event forced listed companies to establish audit committees. Manita has realized a
quantitative research using a sample of auditors which could not have had the same
education and perception on audit quality, as future audit committees members.
Cohen et al. (2002) interviewed 36 auditors in connection with corporate governance
influence on audit process, including the role of audit committees. After the
interviews, he concluded that auditors perceive management as the main header of
corporate governance. An important number of auditors interviewed considered audit
committees weak and ineffective. However, financial scandals and particularly the
failure of Arthur Andersen auditing firm, confirmed the insufficiency of this indirect
approach of audit assessment. Therefore, subsequent authors have addressed this
research question from a different perspective in order to make clear the way by
which this control system could be effective. They also intended to clarify audit
committees relevance for contributing to the reduction of audit failures. In this
respect, the paper draws attention to the need for studying an important aspect which
could influence the quality of financial information: that of communication and
collaboration between auditors and audit committees (Spira, 2003; Turley & Zaman,
2007). It seems that companies owners are very sensitive about the way in which
auditors communicate with audit committees members, about the identified risks and
the released results. On the other hand, this paper highlights the idea that audit
committees members prove respect to those auditors that take into account the risks
in question and the sensitive areas noticed during the audit process. This fact denotes,
in the eyes of audit committees members, the effectiveness and competence of
auditors.
This part of the present study concludes that companys integrity depends, to some
extent, on the independence and competence of audit committees members.
However, independence and competence are not the only criteria to be taken into
account in measuring the quality of audit process.
DISCUSSION AND CONCLUSIONS
By making a review of literature addressing audit committees theme, I arrived to
better understand the audit committees role but also to propose some solutions for
improving financial information quality. This paper also takes into account the
problem of increasing the accuracy, integrity and conformity of financial statements
transmitted to the users from all levels. Audit committee has preoccupied researchers
for a long time. However, by studying a large part of the published works on this
subject, I noticed almost the absence of clear solutions concerning the effective
~27~
intervention of audit committees in the increasing of financial information quality. For

this paper, I started from the unanimous need of capital markets to dispose of high
quality information. As a response to this need, regulators introduced the obligation
for listed companies to dispose of audit committees. The main role of these audit
committees consists in monitoring financial situations. Therefore, audit committees
should supervise the quality of the applied accounting principles and also the way by
which these principles affect financial situations. By the contribution of this paper, we
could appreciate that audit committee represents one of mechanisms controlling the
opportunistic behavior of managers, under the circumstances of the agency theory and
information asymmetry. From the empirical research studies, I found that the major
function of audit committees consists in reducing financial reporting risks.
The results of this fundamental research highlight some possible solutions by which
we could increase audit committee effectiveness in corporate governance and in
financial reporting. Audit committee effectiveness depends on the financial and extrafinancial expertise of the members. At the same time, the members of audit
committees should be champions in ethics and they must prove independence,
competence, morality and professional reasoning. Audit committees characteristics
are crucial for preventing frauds and accounting errors. However, the results of this
research paper indicate the fact that a fully independent audit committee is not able to
eliminate the entire fraudulent financial reporting. Generalizing, we could consider
that the intention of the Sarbanes-Oxley Act or of a Blue Ribbon Committee Report
seems insufficient for preventing fraudulent behavior manifested by companies
management. As a consequence, all the persons involved in corporate governance
should be more vigilant to the importance of financial informations quality. Unlike
the employee fraud, management fraud is more difficult to be detected because of
managers manipulation attempts and because of their opportunistic behavior. The
internal control systems can not be made entirely responsible for managerial frauds.
Therefore, we could appreciate that we need independent audit committees
monitoring the integrity of financial reporting and ceasing managers manipulations.
In order to achieve this goal, the present paper proposes to the audit committees
members to protect external auditors from the pressures exercised by managers. Audit
committees should possess real and sufficient information and should assume their
responsibility to fraud detection and prevention. However, this paper contains some
doubts linked to the ability of audit committees members to prevent all potential
frauds. This study sustains that the members of audit committees should cultivate
close relationships with the CEO and the CFO, with internal and external auditors in
order to solve the difficulties. In is imperative for the members to be informed of all
significant matters concerning financial reporting. Also, the frequency of audit
committees meetings could improve and intensify the control of financial reporting
process. Even the informal relations between the members of audit committees and
management could serve to maximize audit committee effectiveness. Agency problem
is and will be there as long as there are organizations based on corporate type. During
this study I observed that not only agency problem but also the failure of different
corporate governance instruments creates difficulties. An independent audit
committee is one of the most important mechanisms for minimizing these types of
problems. The establishment of an audit committee has a lot of value to different
types of users which could ensure the credibility of the financial information.
~28~
This study reflects my own opinion about the importance of audit committees. I
consider that a clarification of independence definition, could subsequently lead to a
manifestation of a truly audit committee independence. This positive consequence
will enhance its effectiveness and will improve the quality of financial information.
This paper gives me the possibility to affirm that it is necessary to find as soon as
possible real solutions concerning agency and corporate governance issues marking
the financial communication. The study provides the premises for identifying future
research perspectives extremely generous. In this sense, I propose to explore several
directions such as: the empirical studies on the information asymmetry phenomenon
or agency relations manifested on Romanian market at different levels; intercultural
studies concerning governance shortcomings within companies; empirical research
studies based on the corporate governance impact on audit process within Romanian
enterprises. Future studies could investigate the circumstances under which, by
changing audit committees characteristics, by increasing the meetings number of
audit committees members, by increasing also the number of financial experts within
audit committees or even that of women as members in those committees, we could
affect audit value and quality, including the quality of financial information
transmitted on the market.
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THE FINANCIAL AUDITORS RISK BEHAVIOUR

THE INFLUENCE OF AGE ON RISK BEHAVIOUR
IN A FINANCIAL AUDIT CONTEXT
Iancu Octavian IONESCU1& Eugeniu TURLEA
Bucharest Academy of Economic Studies, Romania
ABSTRACT
A main issue in the audit process is the risk faced by the decision makers in every aspect of an
audit process decision. The decision makers risk behaviour and their attitude towards risk is
considered to be central to the way business risk, in general, and audit risk, in particular, is
managed but no conclusive theory as to what influences the decision makers risk behaviour
is commonly accepted. Although previous studies have brought arguments in favour of
different factors considered to have an influence on the decision makers risk behaviour, what
is not known is whether age has an influence on risk behaviour. This article advances the
hypothesis that the auditors attitude towards risk is influenced by the auditors age, in a
financial audit context. The methodological approach used was the survey of a representative
sample using a carefully designed questionnaire and the use of statistical software to
investigate the responses. The analysis of data collected revealed that there is a strong
correlation between the financial auditors risk behaviour and the financial auditors age,
confirming the research hypothesis as well as setting a starting point for future research.
KEYWORDS: risk, age, financial audit, risk behaviour, correlation

INTRODUCTION
Throughout his work the financial auditor uses an element that is central to all audit
activities: risk assessment. The activity of risk assessment is closely linked to the
auditors risk behaviour and risk attitude, as well as professional judgement. The
validity and quality of the financial auditors professional judgement as well as his
risk behaviour are critically important elements which work together to strengthen the
reputation of the auditing profession. Generally, the academic literature related to
professional judgement, risk and decision making in audit showed that professional
judgement and decision making are inherent to any audit stage, that the risk
preferences and risk behaviour varies widely between auditors and that a wide
spectrum of factors influence professional judgement and risk behaviour. The
relationship between professional judgement and risk is a direct and constant one
because professional judgement in audit is exercised in a risk context. In exercising
professional judgement, the auditor makes initial risk assessments which are
consequently modified in the light of the new audit evidence gathered throughout the
audit process. Any risk assessment in audit implies professional judgement to some
extent. However, despite the fact that there are a significant number of empirical
studies on risk behaviour and decision making, these studies did not produce uniform
1
Correspondence address: Iancu Octavian IONESCU, Bucharest Academy of Economic Studies,

Romania; email: octavian.i.ionescu@gmail.com
findings. As the audit process is at the heart of the business world and while the audit
firm itself is a business, general characteristics of risk can be extrapolated to embrace
a more general business risk view. There are solid grounds to argue that the financial
auditor is a business decision maker. Moreover, while the audit process is basically a
team work led by the audit firms managers and partners, risk theory that applies to
business managers will certainly apply to the audit field as well. Risk is a concept
whose definition has not generated a consensus in the academic or business circles but
is generally accepted that it relates to issues of unpredictability, decision making and
potential loss. Risk is intrinsically linked with decision-making and every decision
made in business implies a certain degree of risk. According to March and Shapira
(1987), the importance of risk to decision making is attested by its position in decision
theory and by the high level of interest in risk assessment in audit. Kendrick (2004)
underlines the importance of understanding the personal attitudes to risk and considers
the attitude and behaviour dimension one of the key dimensions to understanding risk.
The rationale of the importance of understanding the decision makers risk behaviour
as underlined by Kendrick (2004), is that, to a certain extent, the strategies of an
organisation reflect the dispositions of their managers in terms of their background,
beliefs, attitudes and problem-solving styles. This behavioural aspect of risk taking in
decision making introduces the fundamental question about the determinants of risk
behaviour. What exactly determines or influences a decision makers risk behaviour
when making a decision? There are currently several views accepted. The most
popular are those articulated by Kogan and Wallach (1967): the dispositional view,
which considers the personal characteristics of a decision maker such as natural
predisposition towards taking or avoiding risk to be determinant of the type of
decision taken and the situational view, which considers the context in which the
decision is taken to be determinant of the decision makers risk behaviour,
irrespective of dispositional preferences. There are also integrative views accepted
which suggest that the dispositional risk propensity interacts with situational factors in
determining risk taking behaviour (Baird and Thomas, 1985; Sitkin and Pablo, 1992;
Das and Teng, 2001; Kendrick, 2004). This study follows the integrative lines and
proposes that age is a transcending factor which influences the decision makers risk
behaviour irrespective of dispositional or contextual factors. The purpose of this
article is to establish the relationship between the auditors age and the auditors risk
behaviour in a financial audit context, contributing to the understanding of risk
behaviour and adding to the literature on the relationship between age and risk. The
research question is whether the auditors age can influence his/her risk behaviour.
The research method is the hypothesis testing using questionnaires on a sample of
practising financial auditors, active members of The Romanian Chamber of Financial
Auditors (CAFR). The data will be analysed using the SPSS statistical software. The
main contribution of this work will be to complement the academic research on risk
and help to better understand the financial auditors risk behaviour in a financial audit
context.
1. LITERATURE REVIEW
In this chapter, theories and previous research in the field of risk behaviour is
explored. All the relevant theories and literature regarding risk and its relationship
with age will be discussed. The chapter begins with a discussion of the theories
regarding risk behaviour, followed by a discussion of the academic literature on the
~33~
relationship between age and risk. This approach will analyse the theories of risk from
different angles and will enable a multidimensional view on previous literature.
1.1. Theories on the determinants of risk behaviour
Academic theories which attempted to explain the risk behaviour of decision makers
date back as far as 1738 (Bernoulli, 1738) and there are a significant number of
empirical studies in the area of risk taking behaviour. However, these studies have not
produced uniform findings. The theories of risk taking behaviour are split into two
major competing paradigms: one which emphasizes the importance of individual
dispositional differences, which is called the dispositional view, and one which
emphasizes the importance of situational factors, called the situational view. The
dispositional view focuses on the individual differences in risk taking behaviour. For
this school of thought, the general traits and general dispositional tendencies of the
decision makers are believed to dictate their risk taking attitude. It argues that some
people have a natural predisposition to be more risk-seeking or more risk-averse than
others, irrespective of the situation or the context of the problem. In support of this
theory, a significant number of empirical studies have reported on individual
differences in risk taking behaviour. Alderfer and Bierman (Alderfer and Bierman,
1970) use two questions from Kogan and Wallachs (Kogan and Wallach, 1964)
Choice Dilemma Questionnaire relating to financial investment, alongside other types
of questions, to substantiate considerations regarding individual differences in
attitudes towards risk choice in financial investment. However, Alderfer and Bierman
(Alderfer and Bierman, 1970), among many other scholars (Bromiley and Curley,
1992; Weber, Blais and Betz, 2002), raise doubts as to the appropriateness of using
Kogan and Wallachs (Kogan and Wallach, 1964) Choice Dilemma Questionnaire to
extract generalities about any attitude behaviour relationship. It is interesting to
observe that by using the Kogan and Wallachs (1964) Choice Dilemma
Questionnaire and by being critical of it at the same time, Alderfer and Bierman
(Alderfer and Bierman, 1970) are actually raising doubts about the validity of their
own findings. In a study that directly examined the consistency of dispositional risk
taking behaviour in two groups, one risk-seeking and one risk-averse, Schneider and
Lopes (Schneider and Lopes, 1986) found that the risk-seeking group tended to prefer
riskier choice on a consistent base when compared with the risk-averse group.
Bromiley and Curley (Bromiley and Curley, 1992) observed that some people were
more tolerant towards risk than others and found that individuals tend to be consistent
in their attitudes towards risk. In an experiment in which the roles of risk attitude and
tolerance for ambiguity in predicting choice were jointly assessed, Ghosh and Ray
(Ghosh and Ray, 1997) found that both risk attitude and ambiguity intolerance
determined choice behaviour. Based on individual differences in risk taking as an
individual attribute, scholars have introduced the concept of risk propensity, defined
by Sitkin and Weingart (Sitkin and Weingart, 1995) as an individuals current
tendency to take or avoid risks (Sitkin and Weingart 1995, p.1575). Rowe (Rowe,
1977) and Fischhoff et al. (Fischhoff et al., 1981) have used the term risk propensity
with reference to a consistent individual trait towards taking or avoiding risks. Das
and Teng (Das and Teng, 2001) observe that Sitkin and Weingart (Sitkin and
Weingart, 1995) believe that even the critics of the dispositional approach to risk
have employed the traditional conception of risk propensity as a stable individual
attribute (Sitkin and Weingart 1995, p.1575). However, this view is questioned by
Weber, Blais and Betz (Weber et al., 2002). In their study, Weber, Blais and Betz
~34~
(Weber et al., 2002) present a psychometric scale that assesses risk taking in five
content domains financial decisions (separately for investing versus gambling),
health/safety, recreational, ethical and social decisions and find that the degree of
risk taking was highly domain specific, not consistently risk-averse or consistently
risk-seeking. The findings of Weber, Blais and Betz (Weber et al., 2002) are contrary
to those of Rowe (Rowe, 1977), Fischhoff et al. (Fischhoff et al., 1981), Schneider
and Lopes (Schneider and Lopes, 1986), Bromiley and Curley (Bromiley and Curley,
1992) and Sitkin and Weingart (Sitkin and Weingart, 1995), making it one of the
findings supporting the situational view. Many empirical studies suggest that
situational factors such as the framing of the problem and the context in which the
decision on risk is taken have a greater influence on risk taking behaviour. Slovic
(Slovic, 1972) argues that high correlations between risk-taking measures in
structurally different settings are highly unlikely, suggesting that different settings in
which decision on risk is made will have different decisional outcomes. March and
Shapira (March and Shapira, 1987) find that managers, as decision makers, make a
sharp distinction between taking risk and gambling, which implies that the context or
situation of the decision plays a major role in risk taking behaviour. In line with these
findings, a very strong argument in favour of the situational view of risk taking
behaviour comes from a seminal study conducted by Kahneman and Tversky
(Kahneman and Tversky, 1979) in which the authors advance an alternative theory of
choice under risk the prospect theory. Essentially, the prospect theory suggests that
individuals tend to interpret the outcomes of a risky decision according to a reference
point such as the status quo - which changes depending on whether the outcome is
framed as a gain or as a loss. In line with this view, March (March, 1988) introduces
the term adaptive aspirations as a complement to Kahneman and Tverskys
(Kahneman and Tversky, 1979) reference point. In the prospect theory, Kahneman
and Tversky (Kahneman and Tversky, 1979) and later Tversky and Kahnemann
(Tversky and Kahnemann, 1991) contradict the expected utility model (Bernoulli,
1738; von Neumann and Morgestern, 1947) and argue that, in evaluating risk, value is
assigned to gains and losses rather than to final assets, and probabilities are replaced
by decision weights. Kahneman and Tversky (Kahneman and Tversky, 1979) argue
that the carriers of value or utility are the actual changes of wealth rather than the final
asset positions that include current wealth. In particular, Kahneman and Tversky
(Kahneman and Tversky, 1979) observe that people under weigh outcomes that are
only probable in comparison with outcomes that are obtained with certainty and call
this the certainty effect. Consequently, Kahneman and Tversky (Kahneman and
Tversky, 1979) argue that the certainty effect contributes to decision makers being
risk averse in choices involving sure gains and risk seeking in choices involving sure
losses. There is evidence to support this view in a study by Highhouse and Yce
(Highhouse and Yce, 1996) who investigated the attempt to empirically separate
threat and opportunity perceptions from loss and gain perspectives. Highhouse and
Yce (Highhouse and Yce, 1996) found that when in the loss domain, most decision
makers perceived the risk alternative as an opportunity and when in the gain domain,
most decision makers perceived the risk alternative as a threat. However, it is
interesting to observe that Kahneman and Tverskys (Kahneman and Tversky, 1979)
prospect theory, although demonstrates several phenomena which violate the
principles of expected utility theory, it is based on responses of students and faculty to
hypothetical choice problems of the type that resembles a gambling situation and
therefore their arguments may be questionable in the light of the findings by Schubert
et al. (Schubert et al., 1999) which suggests that abstract gambling experiments might
~35~
not be adequate for the analysis of risk attitudes. The main conclusion of the risk
literature review is that since Kogan and Wallace (Kogan and Wallace, 1967) first
articulated the fundamental question about the determinants of risk behaviour in terms
of whether they are dispositional or situational, the issue remains unresolved.
1.2. Relationship between age and risk behaviour
While conventional wisdom suggests that individuals take fewer risks as they age, the
evidence from empirical studies yields contradictory results. In an early study on the
relationship between age and risk behaviour, Wallach and Kogan (1961) compared
risk-taking behaviour of college age and elderly men and women, and found that the
older subjects, both males and females, were significantly more conservative than the
college students. Recognizing the shortfalls of examining two extreme age groups,
Kogan and Wallach (1967) comment in a later review article on the need for further
exploration of age risktaking relationship using less extreme age groups. In an
attempt to satisfy this need, Vroom and Pahl (1971) investigate the age-risk behaviour
relationship on a sample of almost 1,500 managers with age ranging from 22 to 60
years. After plotting the data obtained using the Kogan and Wallach (1964) choice
dilemma questionnaire as a measure of risk propensity, Vroom and Pahl (1971) found
that the slope of the relationship between mean riskiness and age is greatest in the age
range 22 to 32 years, flattens out in the age range 33 to 48 years and increases again in
the age range 48 to 58 years. This means that for the managers used in Vroom and
Pahls (1971) study, the age group 22 to 32 years and 48 to 58 years appears to be
more risk seeking whereas the age group 33 to 48 appears to be more risk averse.
Vroom and Pahl (1971) also find evidence that the value people place on risk
decreases with age in a linear relationship. The results from Vroom and Pahl (1971)
study offer evidence that there is a significant relationship between age and measures
of both risk taking and of the value placed on risk. However, caution must be
exercised in interpreting the findings of Vroom and Pahl (1971) as the instrument
used to measure risk propensity Kogan and Wallachs (1964) choice dilemma
questionnaire has been subject to a number of criticisms (Cartwright, 1971;
MacCrimmon and Wehrung, 1984; Shaver and Scott, 1991; Kamalanabhan, Sunder
and Vasanthi, 2000). There is also the possibility that the sample used may have had
unique properties which might render the results artifactual. Despite these limitations,
the findings of Wallach and Kogan (1961) and Vroom and Pahl (1971) are supported
by those of Morin and Suarez (1983) who conclude that, on average, risk aversion
increases with age. However, these findings do not seem to hold unconditionally while on average and for those individuals with low levels of net worth risk aversion
increases with age, for those individuals with high levels of net worth risk aversion
decreases with age (Morin and Suarez, 1983). This is in line with Kahneman and
Tverskys (1979) prospect theory - in which age may be a factor that alters the
objective assessment of risk and which could represent an alternative theoretical
explanation for how age may affect financial decision making. The views presented
by Wallach and Kogan (1961), Vroom and Pahl (1971) and Morin and Suarez (1985)
that risk taking decreases with age, are challenged by the findings of Bellante and
Saba (1986), Wang and Hanna (1997) and Bellante and Green (2004) who argue that,
on the contrary, risk tolerance increases with age. It appears that, similarly to the risk
behaviour theory, the relationship between age and risk behaviour is not conclusive
and that additional variable factors must be taken into account.
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2. RESEARCH METHODOLOGY
The research philosophy of this study is based on the positivist deductive approach
embracing a critical realism epistemology. In the deductive approach of this study
there are several stages of the research: hypotheses are presented following the review
of the literature, the hypotheses are expressed in operational terms which propose a
relationship between two specific variables and, finally, testing the hypothesis and
examining the outcome of the test. If necessary, the theory is modified in the light of
the findings. The research in this explanatory study will be cross-sectional and the
quantitative mono method using questionnaires, together with analysis of quantitative
data, will be used to establish causal relationships between the variables contained in
the hypotheses.
2.1. Research hypothesis
Based on the literature review on age and risk behaviour while pursuing the research
objective, the following main hypothesis together with two deriving secondary
hypotheses is advanced:
Hypothesis 1. The financial auditors age influences his risk behaviour in a financial
audit context.
Hypothesis 1a. There is a significant correlation between the financial auditors age
and his risk behaviour, in a financial audit context.
Hypothesis 1b. The financial auditors risk tolerance is negatively correlated with his
age, in a financial audit context.
2.2. Research strategy
The objective of the present research is to answer the research question and identify
whether the auditors risk behaviour is influenced by his age. Due to time and
economic constraints, in answering the research question, the survey method is
selected for the purpose of this study in order to collect a sufficient amount of primary
data. The use of questionnaires is the most widely used data collection technique in a
survey and, in this study, a questionnaire containing 4 questions will be distributed to
a representative sample of 650 practising financial auditors, active members of The
Romanian Chamber of Financial Auditors (CAFR), for primary data collection. The
data collected will then be analysed using graphic representations and SPSS statistical
software and the results will be used to validate or invalidate the hypotheses. The
findings will be discussed and conclusions will be drawn. The design of the
questionnaire is essential for the reliability and validity of the data, hence great care
has been given to the framing and wording of questions. In this study, the
questionnaire which will be administered to the chosen sample will consist of 4
questions (see Appendix 1). Question 1 is a quantity type question to determine the
age of the respondent. Questions 2, 3 and 4 are rating type questions using a four
point Likert scale in which the respondent is asked how strongly he or she agrees or
disagrees with a statement. Four points were used for the Likert scale (strongly agree,
tend to agree, tend to disagree and strongly disagree) to eliminate the possibility that
the respondent will sit on the fence by ticking the middle not sure category which
will render the response ambiguous. We choose the four point Likert scale because we
wanted the respondent to express a clear opinion on the statements, which enabled us
~37~
to clearly determine whether the respondent is more or less risk seeker or more or less
risk averse in certain situations.
3. FINDINGS AND DISCUSSION
In August 2011 the questionnaires were distributed to 650 practising financial
auditors, active members of The Romanian Chamber of Financial Auditors (CAFR).
There were a total of 368 responses received which means a 56.6% actual response
rate. This actual response rate is above the expected 50% response rate for which we
have hoped at the design stage of the study. Out of a total of 368 actual responses, 16
responses had to be left aside because in these three cases the questionnaire has not
been filled in properly and responses to some of the questions were either missing or
incomplete. However, 352 responses were valid which means a total effective
response rate of 54.1%.
3.1. Data coding
The responses to the Questions 2, 3 and 4, which are rating type questions using a
four point Likert scale, were coded by assigning to each response option representing
a point on the Likert scale a number value from 1 to 4, with 1 representing the highest
preference towards risk and 4 representing the least preference towards risk. Risk will
be represented by the Total Risk Score variable arrived at by adding the
corresponding values for each respondents answer to questions 2, 3 and 4. Therefore,
the more preference for risk a person would show in his/her risk attitude or behaviour,
the lower the Total Risk Score would be. For a clearer picture of the coding
procedure, see Table 1 below.
Table 1. Illustration of the coding of responses for the questions using the four point
Likert scale
For Questions 2, 3 and 4:
Strongly Agree
Tend to
Agree
Tend to
Disagree
Strongly
Disagree
__________________________________________________________________
3.2. Hypotheses testing
Testing Hypothesis 1a. There is a significant correlation between the financial
auditors age and his risk behaviour, in a financial audit context.
In order to test Hypothesis 1a the respondents answers to Question 1, 2, 3 and 4,
which tests the risk propensities of the respondents in a specific financial audit
context, are investigated. Running a correlation test for the two variables of age and
~38~
risk behaviour using the SPSS statistical software will show the following results (see
Table 2).
Table 2. The sample correlation test for the two variables of age and risk behaviour
Pearson Correlation
Age
Total Risk Score
Age
Total Risk Score
.680**
Sig. (2-tailed)
.000
352
352
Pearson Correlation
.680**
Sig. (2-tailed)
.000
352
352
For the selected sample, the correlation coefficient between age and risk behaviour is
0,680 which indicates that the correlation is significant. The value of the correlation
coefficient (0,680) is not close to zero, so there is evidence of a linear relationship
between the two variables. It is positive, so the slope of the straight line resulting from
the linear relationship is also positive. That is, as total risk score increases, indicating
a more risk adverse person, age also increases. Finally, the value of the correlation
coefficient is close to 1 or -1 indicating that the relationship is a strong one. As a
consequence of the result of the test, there is evidence to retain Hypothesis 1a and
conclude that there is a significant correlation between the financial auditors age and
his risk behaviour, in a financial audit context.
Testing Hypothesis 1b. The financial auditors risk tolerance is negatively correlated
with his age, in a financial audit context.
In order to test Hypothesis 1b the respondents answers to Question 1, 2, 3 and 4,
which tests the risk propensities of the respondents in a specific financial audit
context, are investigated. This time, though, the data will be presented in a scatter
plot, with Total Risk Score plotted against age (see Figure 1).
From the scatter plot it appears that when age is high, total risk score is also high
which suggests that as age increases, total risk score may also increase. It is therefore
a positive correlation between Total Risk Score and age, a fact which is confirmed by
the positive value of the correlation coefficient (0,680) obtained in the statistic test
performed when testing Hypothesis 1a. However, bearing in mind that a high value of
Total Risk Score means a decreased risk tolerance, the higher the age, the more
decreased risk tolerance appears to be. In other words, risk tolerance tends to be
associated with lower age of the respondents and as age increases, risk tolerance
decreases. This is equivalent with the conclusion that there is a negative correlation
between risk tolerance and age. As a consequence of the result of the test, there is
evidence to retain Hypothesis 1b and conclude that the financial auditors risk
tolerance is negatively correlated with his age, in a financial audit context.
~39~
As both Hypothesis 1a and Hypothesis 1b are retained, there is evidence to support

the main Hypothesis 1, which is retained, and conclude that the financial auditors age
influences his risk behaviour in a financial audit context.
Figure 1. Scatter plot with Total Risk Score plotted against Age
CONCLUSION
This study investigated the relationship between financial auditors age and his risk
behaviour in a financial audit context. The study concentrated on the analysis of risk
behaviour and on the identification of a relationship between risk behaviour and the
age of the financial auditor. The responses of 352 practising financial auditors, active
members of The Romanian Chamber of Financial Auditors (CAFR), to the 4
questions contained in the questionnaires were analysed using a series of statistical
tests. The design of the questionnaire centred on carefully wording the questions
together with the data coding method represent the pivotal point of the study. The
responses analysis and findings provide significant evidence in favour of the main
research hypothesis. Consequently, the results of this study demonstrate that the
auditors risk behaviour is influenced by his/her age. However, one limitation of this
study is the relatively small sample size. Although statistically a sample number of
352 respondents is considered to be enough to draw conclusions about the population,
a larger number of participants would not only improve the validity and reliability of
the findings, but it might also indicate slightly different results, especially in the
borderline results. A second limitation refers to the way risk propensity was measured
by using a four point Likert scale. The four point Likert scale was chosen because it
translates the risk propensity showed by a respondent into different measurable and
analysable grades. The use of a Likert scale with more points would have resulted in a
more finely graded scale of measurement of risk propensity. Finally, the main
~40~
conclusion of this study, that age is a personal factor that influences the auditors risk
behaviour, could be used as a starting point for future research on the auditors
judgement and decision making process.
ACKNOWLEDGEMENTS
This article is a result of the project Doctoral Program and PhD Students in the
education research and innovation triangle. This project is co funded by European
Social Fund through The Sectorial Operational Programme for Human Resources
Development 2007-2013, coordinated by The Bucharest Academy of Economic
Studies.
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APPENDIX 1
The research questionnaire
You are asked a series of questions, some requiring you to make a decision in
hypothetical situations, others requiring you to express your view.
All the information you provide will be used for research purposes only and will be
treated in the strictest confidence. You will not be identified from the information you
provide.
I hope you find completing the questionnaire enjoyable and thank you for taking the
time to answer it. A summary of the findings will be emailed to you.
Question 1.
What is your age?
Question 2.
You are the recently appointed the auditor of ABC Ltd., about which you know that it
is a medium size developer with one shareholder that also represents the companys
management. You know that the company has invested a substantial sum of its
financial reserves in the development of a residential area which is now finalised. You
know that if the company manages to sell all the houses in the residential area in the
current financial year, there will be substantial success, not only financially but also in
market share. But if the company will not manage to sell all of its houses from its
residential area, it will be faced with serious liquidity and reputational problems. You
also know that there are 60% chances that the company will manage to sell all the
houses and 40% chances to be unable to sell all the houses.
Assuming that these are the only information available, please express your opinion
on the following statement:
The inherent risk at the ABC srl level is small.
Answer:
(please tick only one box)
Strongly agree
Tend to
Agree
Tend to
Disagree
Strongly disagree
Question 3.
A recent approach in financial audit is the one based on business risk. The business
risk audit approach is based on a companys objectives: a certain level of profitability,
obtaining a certain market share, maintaining a certain level of liquidity, brand
improvement etc. In essence, audit business risk approach is about the cost that a
company could incur if it doesnt meet its strategic objectives.
Considering the case of company ABC srl, presented in the previous question
(Question 2), please express your opinion on the following statement:
The business risk in the case of ABC srl (the risk that it will not meet its objectives) is
small.
Answer:
Strongly agree
Tend to
Agree
Tend to
Disagree
Strongly disagree
Question 4.
Assuming you are solvent and living in a comfortable lifestyle, in addition to
whatever you own you have been given 1,000 on condition that you choose one
option from the following two:
You may gamble the 1,000 - with a 50% chance of winning, in which case
you keep the whole 1,000, and a 50% chance of losing, in which case you lose
all the money
Or
You may keep 500 of the 1,000 without gambling
Please express your opinion on the following statement:
Gambling the 1,000 is a better choice.
Answer:
Strongly agree
Tend to
Agree
Tend to
Disagree
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Strongly disagree
THE INVESTIGATION OF ROMANIAN AUDITORS'

PERCEPTIONS OVER THE INTERNAL AUDIT
PRACTICES - AN ATTEMPT TO IDENTIFY THE BEST
PRACTICES IN THE CONTEXT OF CORPORATE
GOVERNANCE
Cristina BOTA-AVRAM1
Babes-Bolyai University, Romania
ABSTRACT
The main purpose of this study is to explore based on an empirical study, the Romanian
auditors perceptions over the internal audit practices that should be included into an
integrated framework of good audit practices in the context of corporate governance. It is
also aims to investigate the actual applicability of the proposed internal audit practices. The
research tool used was represented by the e-mail questionnaire, addressed to a sample of
members of Chambers of Financial Auditors of Romania. Even if the response rate was not
quite significant, the value of the paper is argued by the fact that these first results, combined
with other research tools (probably more effective) that could be used in the next research
activities, could represent a significant starting point in developing an integrated framework
of good internal audit practices in the context of corporate governance.
KEYWORDS: internal auditing, Romanian auditors, corporate governance, good practices,
auditors perception
INTRODUCTION
The events that characterise the end of 20th century and the beginning of 21st century
had been generated big pressures over the internal audits role and developments in
the context of latest developments of corporate governance concept. In the last years,
there are more and more specialists that all are agreed about the significance of
internal audit position in the context of corporate governance (Leung, 2003; Whitley;
Paape, 2007; Allen, 2008). Internal audits position is even more important as it is
strategically located at the meeting point of the interests of management, board of
directors and other stakeholders (Allen, 2008). Also, there are big pressures over the
chief internal auditor who should be in full knowledge of all the key elements of
corporate governance framework in order to be able to identify those areas where
internal audit could provide a real added value by enhancing the effectiveness of
corporate governance process (Leung, 2003).
In the context of latest developments of corporate governance process, it is more and
more highlighted the idea of internals audit approach as an integral part of the
1
Correspondence address: Cristina BOTA-AVRAM, Babe-Bolyai University, Romania; email:

botaavram@gmail.com
~45~
corporate governance framework, so internal audit should become more active,

playing a significant role as one of the key role players in the effectiveness of
managing businesses (Paape, 2003; Allen 2008). The expectations of management
and board of directors and not only from the chief internal auditor and his department
are strongly increasing. Its become absolutely necessary for the internal auditors to
develop a global vision over the key elements of corporate governance, looking for
solutions that could ensure the enhancing of their activities and their skills and
abilities for the assessment and monitoring of those key elements, in order to ensure
the effectiveness of corporate governance mechanisms.
Also, the global economic crisis that strongly affected the world economy starting
with 2008 was another reason that put the light over the real added value provided by
internal audit, especially in the context of corporate governance and risk management.
From the beginning of global economic crisis, there were many organisms and
organisations that tried to identify the major factors as being determinant in issuing
this economic crisis. A report realized by a group of seven supervisory agencies like
the French Banking Commission, the German Federal Financial Supervisory
Authority, the Swiss Federal Banking Commission, the U.K. Financial Services
Authority, and, in the United States, the Office of the Comptroller of the Currency,
the Securities and Exchange Commission, and the Federal Reserve Bank of New York
(Senior Supervisors Group, 2008) emphasized the weakness and shortcomings of risk
management and its failure in the in the process of identifying and effective
management of various groups of risks, due to an increasing complexity of services
offered and because of risky nature of business conducted as a relevant negative factor
that was determinant in issuing the present economic crisis.
The impact of such factors like weak management and inefficient corporate
governance was also underlined at the European Conference on Corporate
Governance (8th European Corporate Governance Conference), held in Stockholm in
December 2009, where it had been given important critics to the audit function about
its weakness and ineffectiveness in fighting against to a poor corporate governance
and against to a weak risk management process. In this context, the role of internal
audit should be to provide a reasonable assurance over the effectiveness of risk
management. But it is not internal audits responsibility to take some actions response
in order to face the negative risks identified. So, internal audit is not responsible to
implement the action response to prevent the identified risks, but its main
responsibility is to provide to management relevant reports over the assessment of key
risks and the effectiveness of all these categories of risks (Leech, 2008).
The above were presented only few factors that increased the pressures over internal
audit function to look for developing of a set of good audit practices, especially in the
context of corporate governance, so internal audit to be able to prove its quality of real
added value provider. The investigation over the auditors perception over the good
audit practices could provide a significant starting point in developing such a
framework that could integrate relevant internal audit practices, especially in the
context of the necessity to improve those audit practices within an emergent economy
like the Romanian one.
~46~
1. ROLE AND PRACTICES OF INTERNAL AUDIT IN CORPORATE

GOVERNANCE BACKGROUND LITERATURE
The International Standards for the Professional Practice of Internal Auditing
(Standards) issued by The Internal Auditing Standards Board of The Institute of
Internal Auditors (IIA) last version issued in October 2008 and revised in October
2010 states in the Glossary part that the value added provided by internal audit
activity is proved when it provides objective and relevant assurance, and contributes
to the effectiveness and efficiency of governance, risk management and control
processes (IIA, 2011). In fact, Standard 2110 - Governance emphasized more
exactly which must be the role of internal audit in the process of corporate
governance.
Figure 1. Role of internal audit in governance vision of IIA standards
(Source: adaptation after Standard 2110 Governance)
Also, the previous versions of IIA internal auditing standards were emphasizing the
role and contribution of internal audit in the context of ensuring good corporate
governance. Under these circumstances, in the international speciality literature there
could be identified a lot of relevant papers and articles with relevant findings in the
highlighting of internal audits contribution and good practices in the corporate
governance (Baker and Owsen, 2002; Vinten, 2002; Melville, 2003; Paape et al.,
2003; KPMG, 2003; Gramling et al., 2004; Yakhou and Dorweiller, 2005; Whitley,
2005; Sarrens and De Beelde, 2006; Gramling and Hermanson, 2006; Zain and
Subramaniam, 2007; Allen, 2008; Archambeault et al., 2008; Ray, 2009; Sarrens,
2009; Arena and Azzone, 2009; Sarrens et al., 2009; Sarrens and Abdolmohammadi,
2011). Next, our intention is to summarize the most significant internal audit practices
identified in the context of corporate governance from authors point of view, without
claiming that its a global and exhaustive synthesis.
Whitley (2005) highlights through his study the main steps that internal audit should
fulfil in order to provide its contribution to the corporate governance system, of which
the most important are:
Internal audit must assist the board in the self assessment of its governance;
~47~
Internal audit has to promote to the audit committee best ideas on good
practices for internal controls and risks management processes;
Internal audit has to include in its audit plan some major objectives like
information and transparency in the annual audit plan.
Internal audit should be preoccupied to review the ethical code and ethical
politics of the company in order to ensure there are correctly and delivered
timely to the employees of the company.
Internal audit should look for the solutions to enhance the effectiveness of
assurance activities focused on compliance, aiming to reduce the long terms
costs.
A valuable synthesis of the main good practices through internal audit could deliver
more added-value to the corporate governance it is also realised by Allen (2008). In
his vision, internal audit should be approached as a stronger player in the
governance team, and smart boards could obtain a highly valuable source of
expertise by assuring this position to the internal audit function (Allen, 2008). In the
context of new challenges that internal audit have to face it in the light of recently
economic turbulences, Allen (2008) highlights the main good internal audit practices
through the effectiveness of corporate governance could be really enhanced:
Internal auditors should occupy a strategic position where the interests of
management, boards and stakeholders intersect. In this way, internal auditors
could identify what could be done for companies to become more risk
intelligent.
Internal auditors could contribute to better governance by highlighting
significant connections between various parts of the organization and different
kinds of risks.
Internal auditors could serve as advocates for using non-financial metrics to
help manage risk and to help discover new value and develop competitive
advantage. In this direction, Allen (2008) points out the vital role that internal
audit could play by consulting with management on which nonfinancial
metrics may be more useful.
Also, internal audit could have a strong contribution for the enhancing of
entitys ethical conscience.
Analysing the internal audits role in modern corporate governance, KPMG developed
a relevant report through there are proposed some significant guidelines in the
developing of internal audit good practices in the context of modern corporate
governance. Most relevant internal audit good practices promoted by KPMGs report
(KPMG, 2003) are including:
The necessity to assure the independence guidelines for internal audit which
are referring at least at:
Internal audit function must be independent of the audited activities and
also must be independent from every day internal processes.
Internal audit must be able to exercise its mission on its own initiative in all
departments, establishments and functions of the entity.
Internal audit must be free to report and to disclose all its findings.
The head of internal audit department should have the authority to
communicate directly and on his initiative to the board, to the chairman of
the board and to the audit committee and its chairman.
~48~
Internal audit assist the board in fulfilling its corporate governance

responsibilities. In this direction, KPMGs report emphasizes the key roles of
internal audit in assisting the board and its audit committee in accomplishing
its governance responsibilities, these key roles assuming at least a deliverance
of next issues like:
An objective evaluation of the existing risk and internal control framework.
Systematic analysis of business processes and associated controls.
Reviews of the existence and value of assets.
A source of information on major frauds and irregularities.
Ad hoc reviews of other areas of concern, including unacceptable levels of
risk.
Reviews of the compliance framework and specific compliance issues.
Reviews of operational and financial performance.
Recommendations for more effective and efficient use of resources.
Assessments of the accomplishment of corporate goals and objectives.
Feedback on adherence to the organisations values and code of
conduct/code of ethics (KPMG, 2003).
Also, KPMGs report states that internal audit should have the ability to
transcend all departments without fear of limitation of scope.
The board/audit committee should have the ability to directly and critically
analyse and evaluate the internal audit function about its contribution to the
fulfilment of the boards responsibility for internal controls.
One of the most significant organizations at European level from internal audits point
of view European Confederation of Institutes of Internal Auditing (ECIIA)
developed a survey at European level over the role of internal audit in corporate
governance in Europe aiming to identify its current status, the necessary
improvements and future tasks that should be accomplished. Based on a survey
realised between all national institutes of internal auditing in Europe, ECIIA (2007)
report realised to develop a widespread picture of corporate governance activities and
internal audit developments in European context, in the same time looking for the
answers at some questions over the current involvement of internal audit in corporate
governance process, and finally to develop a set of proposals for good practices in
order to improve the role of internal audit in European corporate governance.
Its obviously the amplitude and the increasing number of researches dedicated to
the investigation of the role of internal audit in corporate governance at international
level. A strong preoccupation could be also identified at national level, even if it is
not as well debated as at international level. Through their papers, Romanian
researchers (Dobroteanu and Dobroteanu, 2006; Manolescu and Roman, 2007;
Stanciu and Eden, 2007; Weaver, 2008; Morariu et al., 2008; Zapodeanu et al.,
2009; Morariu et al., 2009; Sgardea et al., 2009; Manolescu et al., 2010; Dobroteanu
et al., 2011) aim to identify essential aspects of corporate governance according to
its latest evolutions at international level.
~49~
Figure 2. Proposals for enhancing the role and practices of internal audit in European
corporate governance
(Source: an adaption after ECIIA, 2007)
~50~
But there are only few papers that follow to identify the good internal audit practices
in the context of corporate governance. In this direction, a relevant contribution is
given by Stanciu and Eden (2007), which discussed in their paper the increasing role
of internal audit in corporate governance, but also the management expectations
related to the internal audits added value at corporate governance. Based on their
practical experience on internal audit activity and a strong background literature,
Stanciu and Eden (2007) deliver a lot of relevant suggestions for enhancing internal
audit activity, especially in national context, in order to ensure internal audit is
providing real added-value to risk management and corporate governance processes.
In the same direction, Morariu et al (2009) emphasizes the necessity of building a
strong partnership between internal auditor and management, as a premise for the
increasing real added-value delivered by internal audit, in the context of developing
the competencies supported by the implementing of a rational internal control
system.
From authors knowledge till that moment there arent developed papers over the
investigation of auditors perception regarding the good internal audit practices that
should be taken in consideration especially in Romanian context. From this point of
view, the authors opinion is that a research dedicated to the identifying of good
internal audit practices from corporate governances point of view deserves to pay a
lot of attention in research efforts, even if a research like the one developed within
this paper could be considered only a starting point due to the difficulty and
complexity of discussed subject.
2. RESEARCH METHODOLOGY DEVELOPMENT
2.1. Scientific approach
The present study is based on fundamental type of scientific research, under the
auspices of mainstream research, in the construction of research methodology being
included both quantitative and qualitative elements. Based on the relevant literature
that was reviewed with a focus on mainly research developments with significant
theoretical and practical implications for the internal audits role and practices in the
field of corporate governance it was develop a summary of main internal audit
practices that should be taken in consideration into an integrated framework of good
audit practices in the corporate governances area.
These internal audit practices were, then, tested based on empirical study developed in
order to highlight the Romanian auditors perception over the internal audit practices
in corporate governance area. For the internal audit practices tested through this
survey, there were tested two main criteria like:
Proposals for good practices - The agreement or disagreement of inclusion of
identified internal audit practices into a set of good practices from
respondents point of view
Applicability - The actual applicability of the proposed internal audit
practices.
~51~
2.2. The purpose and objectives of the empirical study

The purpose of this study was to develop a starting point in the process of identifying
the good internal audit practices in the context of corporate governance, without
claiming that there were identified the most relevant internal audit practices. More
specifically, the main objectives of the present study were:
To obtain a synthetic view from the Romanian auditors point of view regarding
the good internal audit practices that should be taken in consideration.
To test the real applicability of the proposed internal audit practices from the
respondents point of view
To try to obtain other proposals of good practices from respondents, that should
also be taken in consideration.
Based on literature review develop until this moment, it was made a selection of the
most significant and relevant audit practices, all these being included in questionnaire
used to develop this present study. In Table no.1 are summarised all these internal
audit practices over it was tested the auditors perception from their proposal but also
from their applicability point of view.
Table 1. The synthesis of internal audit practices proposed and tested
within this present study
No.
The internal audit practices proposed within this study
1.
Internal audit should be placed in the hierarchical structure of the entity in order to ensure the greatest
independence as possible.
2.
Internal audit should develop a strong partnership with external audit, based on mutual trust.
3.
Chief of internal audit department should have regular meetings with the chairman of the audit committee,
so that between them being developed a relationship based on mutual trust.
4.
Internal audit carries out its activities taking in consideration the strategic and operational risks identified at
the level of each major function within the entity.
5.
Internal audit communicate to the external auditor the risk categories identified at the level of financialaccounting function, the deficiencies discovered and also the recommendations issued.
6.
Internal audit should provide the support in the reviewing of ethical code and politics for ensuring there are
correctly and timely communicated to the employees.
7.
Internal audit should realise an analysis and systematically assessment of the main functions within the
entity, but also to the internal control procedures related to them.
Internal audit should be a relevant source of information on major fraud and irregularities.
The recommendations issued by internal audit should be focused firstly for more effective and efficient use
of resources.
8.
9.
10.
Internal audit should made an assessment of the accomplished of corporate goals and objectives.
11.
Internal audit assists board/audit committee in self-assessment of its corporate governance effectiveness.
12.
Internal audit should develop an internal audit charter complementary with the one of the audit committee.
13.
Internal audit should promote to the audit committee the best practices over the internal controls procedures
and risk management.
~52~
14.
Internal audit should discussed with the audit committee the internal audit plan, major findings that have
resulted from internal audit work activities, but also major information about the monitoring of follow-up of
audit findings.
15.
Internal audit should include in the internal audit plan, the objectives that are referring at the providing of
accurate and transparent information.
16.
Internal audit is preoccupied by the identification of relevant opportunities for the ensuring of assurance
activities from compliances point of view, aiming to reduce long term costs.
17.
Chief of internal audit department should communicate to the audit committee the illegal acts or
irregularities perpetuated or tolerated by management.
Internal audit should develop a balanced partnership with management, based on mutual trust.
18.
19.
Internal audit should have regular meetings with management in order to inform over the entity strategies,
the changes in risks profiles, but also over the major changes in entity policies and procedures.
20.
Internal audit is not responsible for implementing a good corporate governance, risk management or internal
control system, but it should provide a strong support for the increasing of their effectiveness.
21.
Internal audit is consulted about the choice/changing of external audit firm that would realise the external
audit.
Internal audit should monitor the follow-up of internal audit, but also external audit recommendations,
communicating the results to the audit committee.
22.
23.
Internal audit, with the audit committees approval might propose the internal audit reports publication for
the ensuring a greater transparency required by a good corporate governance.
(Source: a projection made by author based on relevant literature review)
2.3. The tools and sample used

This empirical study was based on a emailed questionnaire sent to members of
Chambers of Financial Auditors of Romania (CAFR) working in various positions:
external auditor or internal auditor. The questionnaire as research technique was used
in conjunction with the sample as a tool research. The sample used in this research
was determined starting from the members of professional body which coordinates the
audit activity (internal and external) at national level. Thus, our statistical population
included the active members of CAFR, whose email and contact details were
available on the CAFRs website. The period for developing this research was
February March 2011. In spite of its disadvantages, the option for using the e-mail
questionnaire was argued by the necessity of including in the sample a large number
of respondents, while an alternative direct approach would be quite difficult.
The questionnaire used was developed on next sections:
1. Part I General Information
2. Part II Perceptions over internal audits role and practices in corporate
governance
3. Part IV - Perceptions over external audits role and practices in corporate
governance
4. Part V - Perceptions over audit committees role and practices in corporate
governance
The specific objective of this paper is to analyse the results of Part I and Part II, more
exactly, the respondent perceptions over the internal audits contribution and good
practices in the context of corporate governance. It is necessary to mention that for
~53~
each section, the respondent had the possibility to propose another good audit
practices, beside the ones mentioned within the questionnaire, because as it was
mentioned before, this study claims to be only a starting point in the identifying the
best audit practices in the field of corporate governance. The sample used in this
survey is presented in Table no.2.
Table 2. Sample used and response rate obtain in the present study
Sample of members CAFR selected
Invalid email contacts
Valid contacts
Respondents with no audit experience
Final sample
Questionnaires received
First response rate
Invalid questionnaires
Final number of valid questionnaires
Final response rate
1
2
3=1-2
4
5=3-4
6
7= 6/5*100
8
9=6-8
10= 9/5*100
924
386
538
67
471
44
9,34%
20
24
5,10%
(Source: projection made by the author)
Unfortunately, from the first sample, a quite big numbers of selected contacts proved
to be invalid due to the failures messages received at the mail delivery. After the
questionnaire was sent there were some respondents that honestly admitted they have
the quality of member CAFR, but they dont have enough or not all audit experience
(67 respondents). From the total of 44 received questionnaires, a significant number
of 20 questionnaires were considered invalid due to some errors in proper fulfilling of
questionnaires. The first part was included general information about the respondents,
especially about their professional experience. In the final lot of valid questionnaires
there were not included the questionnaires completed by the respondents with no audit
experience, starting from their statement about their professional experience.
3. DISCUSSION OF RESULTS
3.1. The analysis of results
Even if the statistic literature admits as being reasonable a rate of response of at least
5 % (Rotariu and Ilut, 2006), our common sense cant afford us to accept the obtained
response rate (only 5,10%) as being a quite relevant one. But in spite of this great
disadvantage, that we have to admit we were aware from the very beginning when we
decided to use such a research tool, we still believe that the relevancy of our findings
are consistent in the manner they will be considered as a starting point in developing
more complexes researches by using also in conjunction with other research tools.
Shih and Fan (2009) develop an interesting meta-analysis of comparing response rates
in email and paper surveys. Their meta-analysis showed that e-mail survey mode
generally has considerably lower response rate than traditional mail survey mode
regardless of other survey characteristics (e.g. target population, use of reminders for
non-respondents, use of incentives). Also, another supposition of Shih and Fan (2009)
is that lower response rate in e-mail survey might partially be the result of prevalent
junk/spam e-mails nowadays, which may have caused many potential respondents to
ignore legitimate e-mail surveys. But in spite of these disadvantages, Shih and Fan
(2009) are agreed that this does not necessarily mean that e-mail survey should not
~54~
have its place in the repertoire of survey researchers. There shouldnt be ignored the
advantages of e-mail survey like:
a shorter response time,
considerably lower survey cost,
capability of reaching a large sample of respondents,
knowledge about whether an e-mail survey has been delivered to the correct email address, etc.
Shih and Fan (2009) sustain that these unique characteristics of e-mail survey make it
a significant tool for survey researchers in some research situations, in spite of its
inferiority in terms of survey response rate currently shown in the recent literature.
As could be noticed from Table no.3, from the total of our final sample of
respondents, 70,8% were represented by members of Chambers of Financial Auditors
of Romania (CAFR) working on internal auditor position, while 29,2% state they are
working as external auditor. From the final sample, there had been removed the
questionnaires completed by respondents working on other positions like manager,
due to the main objectives of this study the investigation of auditors perception
over the internal audits role and good practices.
Analysing their professional experience, as it is presented in Table no.3, over 70% of
our respondents state they have a professional experience on the audit activity over 5
years. We assume that this significant proportion of the respondents with relevant
professional experience could be considered as an important argument in considering
the findings of this survey as a good starting point in developing an integrated
framework of good practices in the context of corporate governance.
Table 3. The professional experience of respondents
Professional experience
The respondents position
under 2 years
Internal auditor
External auditor
Total
between 2 and 5
years
8,3%
8,3%
16,7%
12,5%
0.0%
12,5%
over 5 years
Total
50,0%
70,8%
20,8%
29,2%
70,8%
100,0%
(Source: a projection made by the author by using SPSS 16)
For all internal audit practices mentioned above in Table no.1, the purpose of this
study was to investigate the auditors perception from the point of view of:
Their proposal for inclusion into a set of good practices for internal audit
activity. Thus the respondents had the possibility to express their agreement or
disagreement about the proposals of internal audit practices by using Likert
Scale where:
(1) Strongly disagree;
(2) Disagree;
(3) Not sure;
(4) Agree;
(5) Strongly agree.
~55~
Their actual applicability was tested by using also Likert scale, where:
(1) Unknown;
(2) Known, but never applied;
(3) Known, but rarely applied;
(4) Known and often applied;
(5) Known and always applied.
Next, in Table no.4 and Table no.5 there are presented the frequencies obtained for
the tested internal audit practices from both point of view: their proposal and their
applicability.
Table 4 Proposals for internal audit practices
Response options
No.
Proposals for internal audit practices
Internal audit should be placed in the

hierarchical structure of the entity in
order
to
ensure
the
greatest
independence as possible.
Internal audit should develop a strong
partnership with external audit, based
on mutual trust.
Chief of internal audit department
should have regular meetings with the
chairman of the audit committee, so that
between them being developed a
relationship based on mutual trust.
Internal audit carries out its activities
taking in consideration the strategic and
operational risks identified at the level
of each major function within the entity.
Internal audit communicate to the
external auditor the risk categories
identified at the level of financialaccounting function, the deficiencies
discovered
and
also
the
recommendations issued.
Internal audit should provide the
support in the reviewing of ethical code
and politics for ensuring there are
correctly and timely communicated to
the employees.
Internal audit should realise an analysis
and systematically assessment of the
main functions within the entity, but
also to the internal control procedures
related to them.
Internal audit should be a source of
information on major fraud and
irregularities.
The recommendations issued by
internal audit should be focused firstly
for more effective and efficient use of
resources.
Internal audit should made an
assessment of the accomplished of
corporate goals and objectives.
2
3
8
9
10
Total
(1)
(2)
(3)
(4)
(5)
0%
0%
17%
13%
71%
100%
0%
0%
17%
17%
67%
100%
0%
8%
21%
13%
58%
100%
0%
0%
13%
17%
71%
100%
0%
0%
29%
17%
54%
100%
0%
4%
17%
29%
50%
100%
0%
0%
13%
17%
71%
100%
0%
0%
21%
13%
67%
100%
0%
0%
21%
25%
54%
100%
0%
8%
17%
25%
50%
100%
~56~
11
12
13
14
15
16
17
18
19
20
21
22
23
Internal audit assists board/audit

committee in self-assessment of its
corporate governance effectiveness.
Internal audit should develop an
internal audit charter complementary
with the one of the audit committee.
Internal audit should promote to the
audit committee the best practices over
the internal controls procedures and risk
management.
Internal audit should discussed with the
audit committee the internal audit plan,
major findings that have resulted from
internal audit work activities, but also
major information about the monitoring
of follow-up of audit findings.
Internal audit should include in the
internal audit plan, the objectives that
are referring at the providing of
Internal audit is preoccupied by the
identification of relevant opportunities
for the ensuring of assurance activities
from compliances point of view,
aiming to reduce long term costs.
Chief of internal audit department
should communicate to the audit
committee the illegal acts or
irregularities perpetuated or tolerated by
management.
Internal audit should develop a
balanced partnership with management,
based on mutual trust.
Internal audit should have regular
meetings with management in order to
inform over the entity strategies, the
changes in risks profiles, but also over
the major changes in entity policies
and procedures.
Internal audit is not responsible for
implementing a good corporate
governance, risk management or
internal control system, but it should
provide a strong support for the
increasing of their effectiveness.
Internal audit is consulted about the
choice/changing of external audit firm
that would realise the external audit.
Internal audit should monitor the
follow-up of internal audit, but also
external
audit
recommendations,
communicating the results to the audit
committee.
Internal audit, with the audit
committees approval might propose
the internal audit reports publication
for the ensuring a greater transparency
required by a good corporate
governance.
4%
13%
33%
13%
38%
100%
8%
13%
21%
25%
33%
100%
0%
8%
29%
8%
54%
100%
0%
4%
13%
13%
71%
100%
0%
8%
13%
33%
46%
100%
0%
4%
17%
33%
46%
100%
0%
0%
17%
8%
75%
100%
0%
4%
12%
29%
54%
100%
0%
4%
17%
29%
50%
100%
0%
0%
29%
17%
54%
100%
8%
13%
29%
25%
25%
100%
0%
0%
17%
25%
58%
100%
4%
8%
38%
17%
33%
100%
~57~
Table 5 Application of the proposed internal audit practices

Response options
No.
Actual application of internal audit practices

hierarchical structure of the entity in order to
ensure the greatest independence as possible.
2
3

partnership with external audit, based on
mutual trust.
Chief of internal audit department should have
regular meetings with the chairman of the audit
committee, so that between them being
developed a relationship based on mutual trust.
Internal audit carries out its activities taking in
consideration the strategic and operational risks
identified at the level of each major function
within the entity.
Internal audit communicate to the external
auditor the risk categories identified at the level
of
financial-accounting
function,
the
deficiencies discovered and also the
Internal audit should provide the support in the
reviewing of ethical code and politics for
ensuring there are correctly and timely
communicated to the employees.
Internal audit should realise an analysis and
systematically assessment of the main
functions within the entity, but also to the
internal control procedures related to them.
Internal audit should be a source of information

on major fraud and irregularities.
The recommendations issued by internal audit

should be focused firstly for more effective and
efficient use of resources.
Internal audit should made an assessment of the
accomplished of corporate goals and
objectives.
Internal audit assists board/audit committee in
self-assessment of its corporate governance
effectiveness.
Internal audit should develop an internal audit
charter complementary with the one of the
audit committee.
Internal audit should promote to the audit
committee the best practices over the internal
controls procedures and risk management.
Internal audit should discussed with the audit
committee the internal audit plan, major
findings that have resulted from internal audit
work activities, but also major information
about the monitoring of follow-up of audit
findings.
Internal audit should include in the internal
audit plan, the objectives that are referring at
the providing of accurate and transparent
information.
10
11
12
13
14
15
Total
(1)
(2)
(3)
(4)
(5)
0%
4%
37%
42%
17%
100%
0%
4%
50%
29%
17%
100%
8%
17%
38%
29%
8%
100%
0%
4%
38%
33%
25%
100%
0%
8%
42%
38%
13%
100%
13%
17%
33%
29%
8%
100%
4%
8%
33%
46%
8%
100%
4%
4%
42%
29%
21%
100%
0%
4%
42%
25%
29%
100%
8%
8%
54%
21%
8%
100%
17%
17%
42%
21%
4%
100%
21%
8%
46%
25%
0%
100%
8%
13%
38%
42%
0%
100%
8%
4%
17%
42%
29%
100%
13%
4%
38%
33%
13%
100%
~58~
16
17
18
19
20
21
22
23

identification of relevant opportunities for the
ensuring of assurance activities from
compliances point of view, aiming to reduce
long term costs.
Chief of internal audit department should
communicate to the audit committee the illegal
acts or irregularities perpetuated or tolerated by
management.
Internal audit should develop a balanced
partnership with management, based on mutual
trust.
Internal audit should have regular meetings
with management in order to inform over the
entity strategies, the changes in risks profiles,
but also over the major changes in entity
policies and procedures.
implementing a good corporate governance,
risk management or internal control system, but
it should provide a strong support for the
choice/changing of external audit firm that
would realise the external audit.
Internal audit should monitor the follow-up of
internal audit, but also external audit
recommendations, communicating the results
to the audit committee.
Internal audit, with the audit committees
approval might propose the internal audit
reports publication for the ensuring a greater
transparency required by a good corporate
governance.
8%
8%
50%
25%
8%
100%
8%
4%
21%
42%
25%
100%
0%
8%
42%
42%
8%
100%
0%
17%
46%
29%
8%
100%
0%
8%
46%
33%
13%
100%
8%
8%
50%
25%
8%
100%
4%
13%
25%
38%
21%
100%
21%
33%
38%
8%
0%
100%
Analysing the above tables, it could be noticed there are some internal audit practices
like the internal audit practice no.1 (Internal audit should be placed in the
hierarchical structure of the entity in order to ensure the greatest independence as
possible) for which 71% of respondent are strongly agree, but only 17% state they
are known and always applied, and 42% say that they are known and often applied.
The same situation is also available for other practices like practice no.2 (Internal
audit should develop a strong partnership with external audit, based on mutual
trust.) or practice no.17 (Chief of internal audit department should communicate to
the audit committee the illegal acts or irregularities perpetuated or tolerated by
management.). For many of those practices there seems to be significant differences
between the respondents perception over their proposals and their current
applicability at this moment. We consider it as a sign that its time to review our
current internal audit practices currently applied and see what changes are really
necessary, especially in this difficult and volatile economic context. Next, in table
no.6 and table no.7 for each internal audit practices it was calculated the basis
statistical parameters, for both table the display order being descending means.
~59~
Table.6 Statistical parameters for proposals of internal audit practices

Proposals of internal audit practices
Minimum
Maximum
Mean
Std.
Deviation

consideration the strategic and operational
risks identified at the level of each major
function within the entity.
24
3,00
5,00
4,5833
,71728

communicate to the audit committee the
illegal acts or irregularities perpetuated or
tolerated by management.
24
3,00
5,00
4,5833
,77553

systematically assessment of the main
functions within the entity, but also to the
internal control procedures related to them.
24
3,00
5,00
4,5833
,71728

hierarchical structure of the entity in order to
ensure the greatest independence as possible
24
3,00
5,00
4,5417
,77903

committee the internal audit plan, major
findings that have resulted from internal audit
work activities, but also major information
about the monitoring of follow-up of audit
findings.
24
2,00
5,00
4,5000
,88465

partnership with external audit, based on
mutual trust.
24
3,00
5,00
4,5000
,78019
Internal audit should be a relevant source of

information on major fraud and irregularities.
24
3,00
5,00
4,4583
,83297
Internal audit should monitor the follow-up of

internal audit, but also external audit
recommendations, communicating the results
to the audit committee.
24
3,00
5,00
4,4167
,77553
The recommendations issued by internal audit

should be focused firstly for more effective
and efficient use of resources.
24
3,00
5,00
4,3333
,81650
Internal audit should develop a balanced

partnership with management, based on
mutual trust.
24
2,00
5,00
4,3333
,86811
Internal audit should provide the support in

the reviewing of ethical code and politics for
ensuring there are correctly and timely
communicated to the employees.
24
2,00
5,00
4,2500
,89685
Internal audit communicate to the external

auditor the risk categories identified at the
level of financial-accounting function, the
deficiencies discovered and also the
24
3,00
5,00
4,2500
,89685

implementing a good corporate governance,
risk management or internal control system,
but it should provide a strong support for the
24
3,00
5,00
4,2500
,89685
Internal audit should have regular meetings

with management in order to inform over the
entity strategies, the changes in risks profiles,
but also over the major changes in entity
policies and procedures.
24
2,00
5,00
4,2500
,89685
~60~
Chief of internal audit department should have

regular meetings with the chairman of the
audit committee, so that between them being
developed a relationship based on mutual
trust.
24
2,00
5,00
4,2083
1,06237

identification of relevant opportunities for the
ensuring of assurance activities from
compliances point of view, aiming to reduce
long term costs.
24
2,00
5,00
4,2083
,88363
Internal audit should made an assessment of

the accomplished of corporate goals and
objectives.
24
2,00
5,00
4,1667
1,00722
Internal audit should include in the internal

audit plan, the objectives that are referring at
the providing of accurate and transparent
information.
24
2,00
5,00
4,1667
,96309
Internal audit should promote to the audit

committee the best practices over the internal
controls procedures and risk management.
24
2,00
5,00
4,0833
1,10007
Internal audit, with the audit committees

approval might propose the internal audit
reports publication for the ensuring a greater
transparency required by a good corporate
governance.
24
1,00
5,00
3,6667
1,16718
Internal audit assists board/audit committee in

self-assessment of its corporate governance
effectiveness
24
1,00
5,00
3,6667
1,23945
Internal audit should develop an internal audit

charter complementary with the audit
committees charter.
24
1,00
5,00
3,6250
1,31256

choice/changing of external audit firm that
24
1,00
5,00
3,4583
1,25036
Valid N (listwise)
24
Table 7 Statistical parameters for application of internal audit practices

Application of internal audit practices
Minimum
Maximum
Mean
Std.
Deviation

committee the internal audit plan, major findings that
have resulted from internal audit work activities, but
also major information about the monitoring of
follow-up of audit findings.
24
1,00
5,00
3,7917
1,17877
The recommendations issued by internal audit should

be focused firstly for more effective and efficient use
of resources.
24
2,00
5,00
3,7917
,93153

consideration the strategic and operational risks
identified at the level of each major function within
the entity.
24
2,00
5,00
3,7917
,88363
Internal audit should be placed in the hierarchical

structure of the entity in order to ensure the greatest
independence as possible
24
2,0
5,0
3,708
,8065

communicate to the audit committee the illegal acts or
irregularities perpetuated or tolerated by management.
24
1,00
5,00
3,7083
1,16018
~61~
Internal audit should develop a strong partnership

with external audit, based on mutual trust.
24
2,00
5,00
3,5833
,82970
Internal audit should monitor the follow-up of internal

audit, but also external audit recommendations,
communicating the results to the audit committee.
24
1,00
5,00
3,5833
1,10007
Internal audit should be a relevant source of

information on major fraud and irregularities.
24
1,00
5,00
3,5833
1,01795
Internal audit communicate to the external auditor the

risk categories identified at the level of financialaccounting function, the deficiencies discovered and
also the recommendations issued.
24
2,00
5,00
3,5417
,83297
Internal audit should develop a balanced partnership

with management, based on mutual trust.
24
2,00
5,00
3,5000
,78019
Internal audit is not responsible for implementing a

good corporate governance, risk management or
internal control system, but it should provide a strong
support for the increasing of their effectiveness.
24
2,00
5,00
3,5000
,83406

systematically assessment of the main functions
within the entity, but also to the internal control
procedures related to them.
24
1,00
5,00
3,4583
,93153
Internal audit should include in the internal audit plan,

the objectives that are referring at the providing of
24
1,00
5,00
3,2917
1,16018
Internal audit should have regular meetings with

management in order to inform over the entity
strategies, the changes in risks profiles, but also over
the major changes in entity policies and procedures.
24
2,00
5,00
3,2917
,85867
Internal audit is preoccupied by the identification of

relevant opportunities for the ensuring of assurance
activities from compliances point of view, aiming to
reduce long term costs.
24
1,00
5,00
3,1667
1,00722
Internal audit should made an assessment of the

accomplished of corporate goals and objectives.
24
1,00
5,00
3,1250
,99181
Chief of internal audit department should have regular

meetings with the chairman of the audit committee, so
that between them being developed a relationship
based on mutual trust.
24
1,00
5,00
3,1250
1,07592
Internal audit should promote to the audit committee

the best practices over the internal controls
procedures and risk management.
24
1,00
4,00
3,1250
,94696
Internal audit should provide the support in the

reviewing of ethical code and politics for ensuring
there are correctly and timely communicated to the
employees.
24
1,00
5,00
3,0417
1,16018
Internal audit assists board/audit committee in selfassessment of its corporate governance effectiveness
24
1,00
5,00
2,7917
1,10253
Internal audit should develop an internal audit charter

complementary with the audit committees charter.
24
1,00
4,00
2,7500
1,07339
Internal audit is consulted about the choice/changing

of external audit firm that would realise the external
audit.
24
1,00
5,00
2,4167
1,05981
Internal audit, with the audit committees approval

might propose the internal audit reports publication
for the ensuring a greater transparency required by a
good corporate governance.
24
1,00
4,00
2,3333
,91683
Valid N (listwise)
24
~62~
Based on the above tables, we propose to develop a ranking for the good practices
and uncertain practices, from both their proposal and their application, starting from
the display order by descending means (first 5 means and last 5 means).
From the point of view of their proposals, the good practices from the respondents
point of view are:
Internal audit carries out its activities taking in consideration the strategic and
operational risks identified at the level of each major function within the entity.
Chief of internal audit department should communicate to the audit committee
the illegal acts or irregularities perpetuated or tolerated by management.
Internal audit should realise an analysis and systematically assessment of the
main functions within the entity, but also to the internal control procedures
related to them.
Internal audit should be placed in the hierarchical structure of the entity in
order to ensure the greatest independence as possible.
Internal audit should discussed with the audit committee the internal audit plan,
major findings that have resulted from internal audit work activities, but also
major information about the monitoring of follow-up of audit findings.
Internal audit should develop a strong partnership with external audit, based
on mutual trust.
Internal audit should be a relevant source of information on major fraud and
irregularities.
Internal audit should monitor the follow-up of internal audit, but also external
audit recommendations, communicating the results to the audit committee.
From the point of view of their proposals, the uncertain practices from the
respondents point of view are (their mean is around 3,4-3,6 ):
Internal audit should include in the internal audit plan, the objectives that are
referring at the providing of accurate and transparent information.
Internal audit should promote to the audit committee the best practices over the
internal controls procedures and risk management.
Internal audit, with the audit committees approval might propose the internal
audit reports publication for the ensuring a greater transparency required by a
Internal audit assists board/audit committee in self-assessment of its corporate
governance effectiveness.
Internal audit should develop an internal audit charter complementary with the
audit committees charter.
Internal audit is consulted about the choice/changing of external audit firm that
From the point of view of their application, the good internal audit practices which
are more applied, taking in consideration their mean (around 3,5-3,7, which means
these practices are between rarely and often applied):
Internal audit should discussed with the audit committee the internal audit plan,
major findings that have resulted from internal audit work activities, but also
major information about the monitoring of follow-up of audit findings
The recommendations issued by internal audit should be focused firstly for
more effective and efficient use of resources.
~63~
Internal audit carries out its activities taking in consideration the strategic and
operational risks identified at the level of each major function within the entity..
Internal audit should be placed in the hierarchical structure of the entity in
order to ensure the greatest independence as possible
Chief of internal audit department should communicate to the audit committee
the illegal acts or irregularities perpetuated or tolerated by management.
Internal audit should develop a strong partnership with external audit, based
on mutual trust.
Internal audit should monitor the follow-up of internal audit, but also external
audit recommendations, communicating the results to the audit committee
Internal audit should be a relevant source of information on major fraud and
irregularities.
From the point of view of their application, the mostly unapplied internal audit
practices taking in consideration their mean (between 2,3-3 which means these
practices are never or quite rarely applied):
Internal audit should provide the support in the reviewing of ethical code and
politics for ensuring there are correctly and timely communicated to the
employees.
governance effectiveness.
Internal audit should develop an internal audit charter complementary with the
audit committees charter.
Internal audit is consulted about the choice/changing of external audit firm that
Internal audit, with the audit committees approval might propose the internal
audit reports publication for the ensuring a greater transparency required by a
Analysing the good means from both their proposal and their application, it could be
observe that, generally speaking, the mean obtain when speaking about their
application is lower than the mean when speaking about their proposal, which could
be understand as an agreement of the respondents for inclusion of those practices into
an integrated framework of good internal audit practices in corporate governance, in
spite of the fact that now there are only rarely or sometimes applied. The same
situation seems to be available for the practices that from their proposals point of
view are not so well agreed by the respondents, but in the same time they are never or
quite rarely applied, even if these are known for the respondents.
3.2. Limits of the developed study and suggestions for further research
A major disadvantage of this study is represented by the response rate, which even is
over 5% (as recommended in statistical literature), still our common sense couldnt
afford us to consider this response rate as being sufficient relevant. But, in spite of this
great disadvantage, we still believe the value of this paper is proved by creating the
necessary premises to develop a good starting point in the construction of an
integrated framework of good audit practices in corporate governance.
Also, another limit of our study is the short period for developing such a study,
because we are perfectly aware that through the extension of the period for obtaining
~64~
the answers and resending some follow-up mails to the respondents that didnt answer
at this questionnaire, it would be possible to obtain a greater response rate.
Because of the small number of respondents, it wasnt possible to develop a separate
analysis over two distinct subsamples: internal auditors and external auditors, all
having the quality of member of CAFR. But we are strongly convinced that such a
separate analysis but of course in case of greater number of respondents could provide
interesting results over the internal auditor but also external auditors perception over
good audit practices in the corporate governances area.
CONCLUSIONS
From the results obtained it can be noticed that Romanian auditors are not quite open
for the practices that could determine perhaps too much transparency necessary for a
good corporate governance. Quite clear examples in that direction is given by the
small mean obtain for the practice: Internal audit, with the audit committees
approval might propose the internal audit reports publication for the ensuring a
greater transparency required by good corporate governance that mostly of the
respondents were not sure about the utility of such a internal audit practice. If this
result would be correlated with the current applicability of this practice, the
conclusion would be the same, this practice obtaining the small mean from its
applications point of view.
Also, there are other practices of internal audit that were not very well received by the
respondents, neither from their proposal, nor from their application like the ones that
are referring at the specific role of internal audit in corporate governance (for example
governance effectiveness). The big question is: Romanian auditors arent perfectly
aware about their contribution to the corporate governance system or they dont want
to assume it? We hope that future researches dedicated to such a subject will provide
more clearly the perspectives that Romanian internal audit should follow for
developing the audit practices in the right direction identified also at international
level.
ACKNOWLEDGEMENTS
This paper was supported from the European Social Fund through Sectorial
Operational Programme Human Resources Development 2007-2013, research project
POSDRU/89/1.5/S/59184 Performance and excellence in postdoctoral research
within the field of economic sciences in Romania, Babe-Bolyai University, ClujNapoca being a partner within the project.
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~67~
PS2 Audit Public accounting

Chairperson
Rzvan MUSTA, Babes-Bolyai University, Romania
PUBLIC SECTOR PERFORMANCE

FROM THE PERSPECTIVE OF CORPORATE SOCIAL
RESPONSIBILITY A EUROPEAN AND NATIONAL
APPROACH
Eugeniu TURLEA, Aurelia STEFANESCU, Monica DUDIAN
Mihaela MOCANU, Adriana CALU
MANAGEMENT OF IRANS UNIVERSITIES IN

THELIGHT OF CONTINGENCY THEORY
Martin BROAD, Abbas ALIMORADI
THE ERA OF INTERNAL AUDIT IN THE PUBLIC

FINANCE SECTOR IN POLAND
Agnieszka SKOCZYLAS, Wojciech NOWAK

OF THE NATIONAL STRATEGY FOR THE FINANCIAL
REPORTING OF THE PRIVATE SECTOR ENTITIES
Ramona LAPTES, Adriana Florina POPA
PUBLIC SECTOR PERFORMANCE FROM THE

PERSPECTIVE OF CORPORATE SOCIAL
RESPONSIBILITY A EUROPEAN AND NATIONAL
APPROACH
Eugeniu URLEA1, Aurelia TEFNESCU, Mihaela MOCANU,
Monica DUDIAN & Adriana CALU
ABSTRACT
The analysis of the current state of the public sector reveals the dependence on political
changes, the interaction of a great number of actors, the gap between offer and demand, a
chronic deficit of financial resources and failure in the efforts to achieve performance. By
means of fundamental research, corporate social responsibility (CSR) is integrated into the
equation of performance of public sector entities. The research endeavour consists of a
synthesis of the literature in the field, as well as of the relevant regulations. The present paper
defines the CSR concept, identifies the characteristic features of the public sector as argument
for implementing CSR in this sector and proposes a CSR framework for the Romanian public
sector. Moreover, we point out how CSR issues are disclosed and perceived in the public
sector of the European Union countries, with reference to the particular case of the
healthcare system.
KEYWORDS: corporate social responsibility, public sector, performance, Romania,

European Union, public healthcare system
INTRODUCTION
The current environment dominated by repeated changes of governmental policies,
significant decrease of public resources, impairment of the public service quality, and
reduced capacity of the public sector to respond to the expectations of the community
require that the performance of public sector entities is approached from the
perspective of corporate social responsibility. Starting from the variety of
connotations of the corporate social responsibility present in the relevant literature,
from the characteristic features of the public sector of European Union countries, as
well as from the way corporate social responsibility is perceived in the public sector
of the Member States, we propose a general corporate social framework for the public
sector of Romania. We consider that such an approach strengthens the commitment of
public sector entities to the benefit of society, environment, and economic welfare and
contributes to improving public sector performance.
The research is interpretative in nature and consists of three dimensions: conceptual
clarifications of corporate social responsibility (CSR), characteristics of the public
1
Correspondence address: Eugeniu TURLEA, Bucharest Academy of Economic Studies, Romania;

email: eturlea@yahoo.com
~69~
sector and arguments for implementing corporate social responsibility, namely the
proposal of a CSR framework in Romanias public sector. Additional to approaching
CSR in the public sector, authors performed a qualitative analysis consisting in the
investigation of the websites of different relevant institutions from countries in the
European Union. The purpose of this analysis was to find to what extent these
organisms publish information on the social responsibility of the health system in that
country and the way they perceive social responsibility. The research endeavour
consists in a synthesis of the ideas published in the literature on this topic, as well as
of the regulations developed by the organisms in the field.
1. APPROACHES OF THE CONCEPT OF CORPORATE SOCIAL
RESPONSIBILITY. LITERATURE REVIEW
In the literature, the understanding of the concept of corporate social responsibility
is wide and translates into different labels. Since this concept is barely approached
from the perspective of the public sector, we will relate to the perspective of the
private sector. Gjlberg (2009), Walker & Parent (2010) and Vasilescu et al. (2010)
suggest related concepts such as corporate social responsiveness, sustainable
development, corporate sustainable development, corporate citizenship,
corporate philanthropy and corporate social rectitude, which hinder consensus on
the definition of CSR. Contrary to this statement, Siltaoja (2009) considers that
corporate social responsibility covers these and other related terms, thus serving as an
umbrella term.
Merali (2006) defines the concept of corporate social responsibility from a complex
perspective and considers that it includes a commitment to altruistic values for the
benefit of society in general. A different approach is that of Albareda et al. (2008),
who analyze corporate social responsibility in relationship to the role of government
in promoting this type of mentality. Starting from the assumption that businesses
operate beyond national boundaries and that their impact on society needs to be taken
more into account, authors claim that corporate social responsibility is a useful
framework, within which new ways of collaborating between corporations,
governments and civil society can be found, creating innovative mechanisms for
governance. A similar vision is supported by Sahlin-Andersson (2006), who
considers CSR a global trend that incorporates business corporations, states,
international organizations and civil society organizations. The author conveys the
following meanings to social responsibility:
A regulatory framework that places new demands on corporations, whereby
self-regulations as well as globally applicable standards represent a significant
proportion of this framework;
A mobilization of corporate actors to assist states and international
organizations, on the background that corporations become increasingly
important in the world and thus are co-opted by states in their efforts to build
global welfare.
A management trend that conveys to organisations an image of legitimacy,
modernity and attractiveness in the opinion of potential employees,
collaborators, customers and other factors.
treimikien & Puinait (2009) approach social responsibility from the perspective
of management, considering it a management strategy option. Authors think that by
~70~
integrating social responsibility in strategic planning, companies maintain or improve

their financial performance. An opposed opinion is that of Kakabadse & Rozuel
(2006), who claim that corporations perceive differently corporate social
responsibility, and when two corporations claim they are socially responsible, their
commitment is not comparable. Proponent of the existence of differences in the
perceptions of corporate social responsibility depending on the geographical area is
also the International Institute for Sustainable Development (2004).
The analysis of perceptions on corporate social responsibility in the Anglo-American
and in the European environment emphasizes the existence of differences. In favour
of the characteristic features of the Anglo-American area plead Carroll (1991) &
Gjlberg (2009). Carroll (1991) defines social responsibility with reference to the
economic, legal, ethical and philanthropic responsibilities of companies, while
Gjlberg (2009) considers that the US tradition of corporate philanthropy has
influenced the CSR discourse and practices. In the European area, as opposed to the
Anglo-American environment, corporations understand CSR as responsibility in all
their activities, as Porter (2003) states. By means of a bidimensional analysis,
Gjlberg (2009) considers that the European approach is focused on integrating CSR
into the management of core business operations. In this context, Juholin (2004)
brings the argument that Europe adopted the triple bottom line approach of Elkington
(1997), who distinguishes between people (social), the planet (environment) and
profit (economics).
Formulating a definition for the concept of corporate social responsibility proves to be
a difficult endeavour, even from an official perspective. By reference to the ideas
published by the entities involved in this direction, we present an official approach of
the concept of corporate social responsibility. For the European Commission, CSR is
a concept whereby companies integrate social and environmental concerns in their
business operations and in their interaction with their stakeholders on a voluntary
basis. In the view of the World Business Council for Sustainable Development,
corporate social responsibility is the continuing commitment by business to behave
ethically and contribute to economic development while improving the quality of life
of the workforce and their families as well as of the local community and society at
large. The International Institute for Sustainable Development represented by the
ISO Strategic Advisory Group (SAG) on Social Responsibility argues the difficulty of
defining social responsibility, considered a balanced approach for organizations to
address economic, social and environmental issues in a way that aims to benefit
people, communities and society. In particular, according to ISO 26000 (2010),
social responsibility is the responsibility of an organization regarding the impact of its
decisions and activities on the society and the environment, translated into an ethical
and transparent behaviour which contributes to sustainable development, to the health
and welfare of society, takes into account the expectations of stakeholders, follows the
laws in force and agrees to the international behaviour norms, is integrated within the
organization and implemented in its relationships.
In our opinion, the complexity of the CSR concept is also due to the principles of
accountability, transparency, ethical behaviour, following the interests of all
stakeholders, and obeying the laws, the international behavioural norms and the
human rights. The analysis of these principles emphasizes that CSR comprises not
only economic and legal aspects, but also ethical aspects. The economic aspect of
social responsibility refers to achieving a correct output regarding the quality-price
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ratio, while the legal aspect refers to following formal norms, both domestic and
international. The ethical component goes beyond the legal framework and consists in
respecting al socially recognized behavioural norms. In the view of Lantos (2001), the
ethical aspect means the organization makes what is right, just and fair. In order to
eliminate confusions between ethical and altruistic, Lantos (2001) excludes the
synonymy ethical-altruistic, because when an organization follows the social
responsibility principles, this leads to an increase in the social welfare, without the
welfare of the organizations owners being diminished.
The research of the connotations of the corporate social responsibility concept points
out its complexity and diversity. The absence of a consensus on the understanding of
this concept does not reveal the low interest of researchers, but the major concern to
identify new perspectives, in accordance with the development of society as a whole.
2. CHARACTERISTICS OF THE PUBLIC SECTOR VERSUS THE PRIVATE
SECTOR REGARDING SOCIAL RESPONSIBILITY
Identifying the boundaries between the public sector and the private sector proves to
be a difficult process, due to numerous overlaps, but at the same time a process which
is extensively dealt with in the relevant academic literature. Fryer et al. (2007)
explains the interest shown in this subject through the existence of blurred boundaries
between the public sector and the private sector, which in some areas overlap.
However, we consider that the features of the public sector can be derived based on a
comparative approach, namely by comparison with the private sector.
From the perspective of economic theory (Angelescu et al, 2001), the public sector is
the totality of public companies and public administrations. A similar endeavour in
defining the public sector based on the structure of the organizations is also
supported by Fryer et al. (2007). Accordingly, public organizations are organizations
that deliver governmental goods and services at local or national level. The traditional
assumption underlying the understanding of public organizations is that they deliver
services to the public and are publicly funded, owned and operated.
From another perspective, Broadbent & Guthrie (2008) argue that this assumption is
nowadays debatable, due to the phenomena of privatization and corporatization which
spread more and more in the public sectors worldwide. On one hand, privatization can
be defined as the process of selling state-owned assets, whereas management control
passes to private shareholders. On the other hand, corporatization consists in the
efforts to make public organizations function similar to how private firms function
when facing a competitive market or efficient regulation if they were monopolies.
In an approach that considers the type of decisions made, Dasclu et al. (1996) defines
the public sector as an entity consisting of institutions where collective or political
decisions are made (whereas these institutions are the central and local public
administrations with their subordinated public entities) or institutions which
accomplish objectives and tasks of public interest.
National regulations (Public Finance Law no. 500/2002) do not define in a
comprehensive manner the public sector. It is defined indirectly by referring to the
generic term of public institutions, which comprise the Parliament, the Presidential
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Administration, the Ministries, other bodies of public administrations, other public

authorities, autonomous public institutions, irrespective of their financing sources.
At international level, the International Public Sector Accounting Standards (IPSAS)
use the term of Government Business Enterprise. According to IPSAS 1 Presentation
of Financial Statements, Government Business Enterprise means an entity that has all
the following characteristics:
Is an entity with the power to contract in its own name;
Has been assigned the financial and operational authority to carry on a business;
Sells goods and services, in the normal course of its business, to other entities at
a profit or full cost recovery;
Is not reliant on continuing government funding to be a going concern (other
than purchases of outputs at arms length); and
Is controlled by a public sector entity.
With reference to the characteristics of the public sector, Fryer et al. (2007) considers
that their main feature is the absence of the goal of profit maximization, unlike private
organizations. In our view, this characteristic does not offer simplicity to the sector,
but complexity, taking into account that the public perceives the performance of the
public sector by reference to the quality of service. Based on the dual comparative
approach (public sector private sector), but in an exhaustive manner, Sundin &
Tillmar (2008) identify the following characteristics of the public sector entities:
Are guided by political and social objectives;
Their main source of funding is the taxes collected, which they allocate based
on equity principles;
The services delivered by them have a direct impact on the public, but also an
indirect impact on the community;
Are subject to public scrutiny, their decision making process must be as
transparent as possible and the consensus among interest groups must be
ensured.
In our opinion, involving the public in the control of public sector entities and
ensuring the transparency of the decisional process are characteristics in favour of the
need to ensure a general social responsibility framework in this sector.
From another perspective, Heracleous & Johnston (2009) define public organizations
through the association of two main dysfunctions: bureaucracy and inertia. Authors
consider that this prejudgment is so deeply rooted into the minds of the public
opinion, that businesses which develop bureaucracy and inertia are frequently
classified as businesses with an almost public sector mentality. Although the
balance between the invested value for each resource unit from the private sector, on
one hand, and from the public sector, on the other hand, inclines towards the private
sector, the public sector should go beyond this limit by assimilating the experience of
the private sector. Heracleous & Johnston (2009) highlight that the public sector is
constantly encouraged to adopt models and practices which proved successful in the
private sector, so that its performance can be improved. Strategic management
models, change management processes, quality management, performance
measurement are only some examples of such private sector practices.
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Fryer et al. (2007) completes the picture of the public sector characteristics with their
regional and temporal fluctuations, which they support through arguments. The
authors think that temporal fluctuations are due to the fact that public sector is subject
to the whims and fancies of government. Regional fluctuations is generated by
changes in administration, which lead to changes in the organization of at least one
area of the public sector, since each administration has its own approach, ideas,
interests and visions. The overly dependence on administration change results in
uncertainty, requires time for the acceptance and assimilation of the new visions and
reduces the quality of services, by increased time of response to public inquiries and
by the reduction of service offer. Although due to its nature, the private sector does
not face such challenges, this characteristic is important for it, too, since it is
indirectly impacted by the decisions of the administration.
An interesting approach of the public sector belongs to Talbot (2003). He postulated
that public services are three-dimensional: there is the policy, the managerial and the
professional domain. According to this approach, the employees of the public sector
are challenged to frequently switch between these often conflicting domains. For
instance, in a single day, it may happen that the manager of a public organization must
switch from the role as manager to the role of professional or policy-maker. Each of
these three domains differs through its own patterns and values, which are almost
always contradictory with each other. Thus, by comparison with the private sector,
where managers are almost exclusively dedicated to the managerial field, in the public
sector, employees in governing positions are challenged to accept the inherent
contradictions between these three domains, to get over the resulting conflicts and
uncertainties and to find a satisfactory balance.
A fundamental characteristic of public service is identified by Marobela (2008). In his
opinion, the boundary between the public sector and the private sector is drawn not
only by the objectives pursued but also by the manner in which the service is
delivered. Moreover, Parasuraman et al. (1985) quoted by Fryer et al. (2007)
approaches the characteristics of the public sector from the perspective of the quality
of the services in the public sector, namely intangibility, heterogeneity, and
inseparability, which he defines as following: intangibility means that no precise
definition and measurement of the services is possible; heterogeneity means that
services suffer from lack of consistency, since they depend on the interaction between
the individual service provider and the customer; inseparability refers to the
simultaneous occurrence of the delivery and the consumption of the service and the
potential influence of the customer on the outcome of the service provided
Fryer et al. (2007) identify the features of the public sector from the perspective of the
demand, by comparison with the private sector. Through the bidimensional analysis
(public sector private sector) of the number of customers, authors conclude that
unlike the public sector where in the absence of the profitability objective the increase
of the customers number means an increase of the efforts, in the private sector the
increased demand leads to profit maximization and therefore it is a major objective.
We think that in present times, characterized by the limitation of public resources and
the increase of the demand for services, this feature means that the public sector
should identify and adopt alternative measures in order to fulfil public expectations.
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The research points out that there are several approaches in the relevant literature with
regard to the characteristics of the public sector. By referring to the public sector in
Romania, we add to the above characteristics its complexity, which is generated by
the nature of the provided services and by the following actors which interact within
the system: entities with competences in the regulation, coordination, strategy and
oversight of public policies; financing entities; buyers; public service suppliers;
consumers (taxpayers, public). Moreover, we consider that a thorough analysis of the
characteristics of the public sector reflects the causes of the difficulties this sector
faces, by comparison with the private sector.
3. ARGUMENTS IN FAVOUR OF CORPORATE SOCIAL RESPONSIBILITY
IN THE PUBLIC SECTOR
CSR being approached only limitedly in the public sector, as well as the absence of
the goal of profit maximization are counterarguments for developing CSR in this
sector. But, if we consider that the goal of profit maximization, although belonging to
the private sector, is circumscribed to the performance goal (convergent with the
public sector), as well as that the objective of public sector entities is to fulfil the
expectations of the public (the citizens), we can state that social responsibility is
implicitly present in the public sector. Kakabadse & Rozuel (2006) feel that
approaching ethical, social and environmental issues is more appropriate in the public
sector than in any other sector, since by their very nature, public organizations are
expected to contribute to the citizens welfare and solve social problems.
For Siltaoja (2009), legitimacy and reputation represent pertinent arguments in favour
of corporate social responsibility in the public sector. The author considers that an
entity of the public sector becomes legitimate when it promotes corporate social
responsibility at the level of the entire entity. Walker& Parent (2010) give to CSR the
role to protect reputation, because it mitigates the attempts to discredit the public
organization.
Kakabadse and Rozuel (2006) argue the need for social responsibility in the public
sector from the perspective of the globalization of economies. Authors think that the
globalization of the activities of the entities from the private sector leads to the
prevalence of the economic over social interests. Consequently, limiting this impact is
a responsibility for both the private and the public sector, because governance should
get involved twofold: to develop a proper environment that enables private
organizations to act with social responsibility, namely to ensure that public service
entities are responsive to the needs of the community, show concern for the
environment and efficiently and effectively support economic growth.
Norway and Denmark are persuasive examples for the dual involvement of their
governments in the field of corporate social responsibility. Starting with 2008,
Norway has the first independent policy in the area of CSR, common for both the
entities of the private sector and the entities of the public sector, public funds (pension
fund) and public acquisitions. The main objectives of this policy are: clearly defining
the states expectations from the private sector and establishing the role of the
authorities and private entities, increasing the motivation and the ability of companies
for CSR, and the Norwegian state taking an international role in promoting and
implementing CSR. If we refer strictly to the corporate social responsibility of the
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state, the main aspects taken into consideration by the policy are: long-term
sustainable management of the resources of public entities, responsibility in managing
the pension fund, applying CSR principles in public acquisition, environmental
protection and ensuring that human rights are respected. For elaborating and adopting
the CSR model, the Norwegian government relates to the international norms and
experience, complemented by public consultations with social partners. In its action
plan for implementing CSR, Denmark defines similar goals as Norway and is based
on public consultations and international experience. The areas targeted for applying
CSR principles are as follows: public acquisitions, companies in which the state is
major shareholder (they must report on CSR compliance), public investments, public
funds, environment and climate changes.
In relationship to the characteristic features of the public sector, we consider that
another argument in favour of CSR is the intercorelation between the social
responsibility and the performance of public sector entities. In our opinion, CSR is a
driver for the financial and non-financial performance of the entities of the public
sector. For supporting this statement, we present the following aspects:
Social responsibility implies the voluntary agreement of the entity to be
assessed, to answer for its actions and to implement corrective measures for
eliminating the found deficiencies;
Transparency acts as an incentive mechanism against the potentially
opportunistic behaviour of management, promotes monitoring and eliminates
informational asymmetry between the public sector and the constituencies (the
public) with regard to the use of resources.
Ethical behaviour eliminates the conflicts of interests from the entity, which
could generate lack of trust regarding the manner in which public resources
are built and used;
Following the interests of all stakeholders implies the used of economic
resources as efficiently as possible, on the general background of sustainable
development;
The ethical, legal and environmental issues, as well as the issues regarding the
social context accompany all steps of the process of design and delivery of
public services/ products.
4. RESEARCH ON THE DISCLOSURE WITH RESPECT
TO CORPORATE SOCIAL RESPONSIBILITY
IN THE PUBLIC SECTOR OF THE EUROPEAN UNION COUNTRIES.
THE CASE OF THE HEALTH SYSTEM
The research endeavour takes into account the result of the empirical study
performed by tefnescu et al (2010) on identifying the extent to which the concept
of performance is used and quantified in the entities of the public healthcare system
of the European Union member states. Based on the research performed by
investigating the websites of the relevant institutions from the EU member states,
authors concluded that there are concerns on defining performance in the public
healthcare system, but the disclosures on performance, due to the fact that there are
no explicit and exhaustive requirements.
Starting from the assumption of the intercorrelation corporate social responsibility
performance, we continued the research in order to identify to what extent these
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bodies disclose information on the social responsibility within the health system of
that country and the way they perceive social responsibility. Moreover, the research
had in view to identify the information disclosed in the three areas of social
responsibility, namely society, environment and economy. For this purpose, we took
into consideration only the information disclosed in English. The extent to which
those countries offer such disclosure was diverse, an overall view of that situation
being presented in Appendix 1.
The performed research emphasizes that the relevant national bodies of the Member
States show concern for corporate social responsibility issues, but the disclosure of
such information is limited. We consider that an argument for this state of facts is
that this concept is relatively recent and, at international level, the public sector has
not shown great interest for disclosing information on social responsibility issues.
None of the investigated countries uses this phrase in the exact above-mentioned
form. The only country that uses a similar term is Ireland, designating it corporate
accountability. Moreover, some countries (Austria, Germany, Great Britain,
Denmark, Ireland, Lithuania, and Malta) use related terms: responsibility,
accountability, and sustainability.
Related to the social dimension of the corporate social responsibility concept, the
research points out that the entities involved in the public healthcare system are aware
of their responsibility towards the public and the time horizon over which they assume
this responsibility. Thus, Austria and the Nordic countries (especially Sweden) are
those most concerned for the short- and long-term responsibility towards the public.
As a sign of short-term responsibility towards the population we considered the
disclosure of information on the patient rights, on the importance given to their
individual needs and to the possibilities given to them to express their dissatisfaction
with the system. European countries that show such an orientation towards the
patients are: Austria, Belgium, Cyprus, Denmark, France, Ireland, Italy, Sweden and
the Czech Republic. As a sign of long-term responsibility towards the public in social
matters we took into consideration the measures taken for promoting a healthy
lifestyle and for preventing health problems. Numerous European countries have
stated their concern for health promotion and prevention: Austria, Belgium, Estonia,
Finland, Hungary, Malta, The Netherlands, Slovenia, Sweden and Romania. Germany
is the country that surprises by the fact it does not disclose information in English on
social responsibility. However, there are countries that demonstrate a wider vision on
the responsibility towards the public: Italy and Latvia. They both go beyond the
general discourse on the responsibility of public institutions and take into
consideration the responsibility of the employees in the system, whose part is critical
and complements the responsibility of policy-makers. By the use of the concept
Clinical Governance, Italy gives prominence to the role and the responsibility of the
employees of the healthcare system. Latvia guides the employees of the State Agency
of Medicines by publishing a Code of Ethics.
A particular case is the responsibility of the entities towards the environment.
Denmark is the only country in which the responsible bodies from the healthcare
system take responsibility towards the environment by reducing their energy
consumption and CO2 emission. The concern for the environment of other countries
(Spain, Estonia, Finland, and Hungary) is limited to the impact of the environment on
public health.
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The research of the economic dimension of social responsibility shows that Denmark,
Germany and Great Britain are the only countries with explicit concerns in this area.
Denmark has in view the affordability of the treatments, while Great Britain declares
that the provided services should be available to all, no matter the ability to pay of the
beneficiaries. In Germany, the importance of medicinal products and medical devices
as economic goods is also recognized, although the protection of public health is in
the foreground. An interesting initiative is that of Great Britain, which launched in
March 2011 The Public Health Responsibility Deal, with the purpose to involve the
business environment in achieving public health goals.
5. PROPOSAL OF A GENERAL CSR FRAMEWORK FOR THE ROMANIAN
PUBLIC SECTOR
The assumption underlying the proposal of a general CSR framework is based on its
limitation in the Romanian public sector, with impact on the performance of the
entities within this sector. From a structural point of view, the general framework
includes the following components: defining the CSR concept; internal and external
pressures on the public sector; external and internal stakeholder; responsibility areas;
the process of CSR implementation in the public sector and communication on CSR
matters.
The definition of corporate social responsibility in the public sector
Since public sector organizations differ from their private sector counterparts, it is
necessary to formulate a definition of corporate social responsibility that is welladapted to this kind of entities. For the purposes of this paper, the following definition
of CSR is considered to be most appropriate: CSR of public sector organizations is
their commitment to altruistic values for the benefit of people, environment and
economic welfare.
The external environment of the public sector
In the view of Nutt (2005), political considerations are an important part of the
external environment of the public sector. Changes in policy and the imposition of
short time-horizons on public managers are permanent challenges for public entities.
Short-time objectives are the consequence of political changes that constrains
politicians to achieve quick results in order to ensure success in the next round of
elections. From a political perspective, political issues become more important than
economic issues, and entities must adapt to the political environmental factors. Thus,
we feel that political pressures make the development of CSR in the public sector
necessary.
In addition to political pressures, the external environment of the public sector is
characterized by complexity, dynamism, munificence. Dynamism is generated by
knowledge development, technological innovations, as well as by the constant
changes of regulations within the public sector. The munificence is understood by
Kearney et al. (2009) as a multidimensional concept that includes dynamism, industry
growth, technological opportunities, and the demand for new products or services. We
consider that a munificent environment influences the public sector entities twofold.
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On one hand, it helps them to build slack resources and to access external resources in
difficult times, and on the other hand, it stimulates them to choose CSR practices,
because social, human and ecological issues are more pregnant than in stagnant
environments.
The internal environment of the public sector
Whereas the external environment influences the public sector organization and
implicitly its attitude towards CSR, the internal environment actively participates and
completes the integration of CSR within this sector. For Kearney et al. (2009),
internal environment consists of the following components: structure/formalization,
decision making process, control, and rewards/motivations. By referring to the
characteristic features of the Romanian public sector, we develop the components of
the internal environment, as follows:
Formalization refers to the existence of explicitly formulated and written
procedures that guides the activity of the entity, as well as the existence of
specific organization charts, job descriptions, strategic and operational plans.
Although a high degree of formalization has the disadvantage of a low
flexibility in the decision-making process, we consider that it favours the
implementation of corporate social responsibility due to the already existing
customized patterns.
The decision-making process is characterized by rigidity, because the
resources are mainly public, have the tendency to diminish and are limited
with regard to their allocation for investments that would significantly
contribute to enhancing the ability to respond to economic, social,
humanitarian and ecologic issues of the community. We consider that the
inflexibility of the decision-making process is the main impediment in
implementing CSR within the Romanian public sector;
The existence of adequate control systems facilitates the implementation of
CSR, because they can tightly monitor behaviour and resource utilization and
support a responsible attitude within the public sector entities;
Rewards are an obstacle for CSR success in the public sector. We support this
statement by the fact that the current ways of rewarding human capital within
the public sector are limited both financially and motivationally. Therefore,
the human resource does not have the motivation to get involved into CSRrelated activities. In our opinion, rewarding human capital should be
rethought, so that it takes into consideration the objectives, their level of
achievement and their usefulness.
Stakeholders
Due to its nature, in the public sector interact numerous actors who a stake in its
activity, namely: entities with responsibilities in the regulation, coordination, strategy
and oversight of public policy; financing entities; buyers; suppliers of public services;
consumers (taxpayers, public). The identification of stakeholders in establishing a
CSR framework in the public sector is necessary, although even in case of the
stakeholder concept, there is no consensus on its definition. Regarding the
classification of the stakeholders, Kakabadse & Rozuel (2006) suggest the
classification provided by Fottler et al. (1989), who identify three broad categories of
stakeholders: internal stakeholders, interface stakeholders, and external stakeholders.
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Internal stakeholders are those who belong to the entity and typically include
management, professional, and non-professional staff. Interface stakeholders are those
with double membership, they function both internally and externally to the
organization and include the taxpayers. External stakeholders can be divided into
three subgroups, as follows: those who provide inputs into the organization (e.g.
suppliers, service beneficiaries and funds providers), those who compete with the
public entity (e.g. other institutions or related organizations operating in the same
field as the public sector entity), and those who have a special interest in how the
organization functions (e.g. professional associations, government regulatory
agencies, labour unions, the media or the local community).
Responsibility areas
In a traditional sense, responsibility reflects the state or fact of being accountable or
to blame for something (http://www.dexonline.news20.ro). Thus, it is necessary to
identify the responsibility areas, so that appropriate processes and controls can be
implemented in each of them. Responsibility areas of the public sector entities differ
depending on the activity type, but also present overlapping areas that refer to:
environmental issues (mitigation of environmental damage; eliminating waste and
emissions; maximization of the efficiency and productivity of resources etc.), social
issues (contribution to arts, education and cultural matters, involvement in the
community, ensuring appropriate labour practices, respecting human rights etc. and
economic issues (maintaining economic efficiency; monitoring the impact on the
economic well-being of the stakeholders etc.).
Implementation process
Additional to the external and internal factors that affect the attitude of the public
sector organizations towards corporate social responsibility and the overlapping
responsibility areas of the entity (ecological, social and economic), this component of
the proposed CSR framework is the process of implementation itself. We think that
successfully implementing CSR requires a systematic approach that is in accordance
with the public organizations activity, culture, environment, risk profile and
operating conditions. The endeavour of designing a model for CSR implementation in
the public sector is based on the CSR implementation framework elaborated by
Hohnen (2007) for businesses, synthesized in Table. 1.
Table 1. Model for CSR implementation in the public sector
Steps
Plan
Assess CSR
Develop a CSR strategy
Do
Develop CSR commitments
Description
Define CSR
Identify external and internal influences
Identify stakeholders
Establish persons involved in strategy development
Research on existent CSR practices at other organizations
Prepare a list of CSR actions
Develop and support ideas for proceeding
Decide on direction, approach, boundaries and focus areas
Identify main potential CSR commitments
Discuss with major stakeholders
Prepare a draft of CSR commitments
Consult on the draft with the relevant stakeholders
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Steps
Implement CSR
commitments
Check
Improve
Cross-check
Description
Develop a CSR decision-making structure
Set performance targets
Engage persons to whom CSR commitments apply
Design and conduct CSR training
Communicate CSR commitments externally and internally
Measure performance
Report on performance
Identify opportunities for improvement
Improve
Return to plan and start the next cycle
(Source: own design after Hohnen, 2007)
Communication on CSR matters

Due to the role of corporate social responsibility practices in matters of legitimacy and
reputation of public sector organizations, the communication of how the entity
implements CSR is almost as important as the implemented practices themselves.
Therefore, the choice of the channels and forms of communication that are most
adequate to the specificity of a certain public sector entity is a critical part of the
proposed CSR framework. In reality, the interest of public managers is not to act
responsibly, by taking into consideration social, environmental and economic issues,
but to be perceived as acting in accordance with CSR practices. A similar idea is
supported by Owen (2008), who states that managers are more concerned over issues
related to image rather than true commitment to transparency and accountability. The
choice for a certain communication channel (booklets, trainings, electronic
communication, internal publications, staff meetings, verbal communication, policy
manual etc.) depends on the addressees of the CSR practices and the exact nature of
the public sector entity that decides to implement CSR practices.
CONCLUSIONS
The present research points out that defining the concept of corporate social
responsibility is difficult in the literature, due to its multiple facets. However, the
economic, environmental and social aspects are elements that overlap in most of the
meanings conveyed to the concept of corporate social responsibility. The limited
approach of this concept in the national and international public sector was the
starting point for identifying the characteristics of the public sector in order to argue
the opportunity of implementing CSR in this sector.
The complexity of the public healthcare system and the difficulties it faces were the
arguments that guided our research on the CSR disclosure and perception in the EU
states. Following the research carried out we found there are concerns for the social,
environmental and economic dimension of social responsibility. Denmark is the only
country that has a full vision on corporate social responsibility and discloses complete
information on its three dimensions. Austria and Germany show concern for the social
and economic side of CSR. Sweden, Belgium, Cyprus, France, Ireland, Italy and the
Czech Republic disclose information that shows only responsibility to the public and
the time-horizon for which they take responsibility, while Italy and Latvia also focus
on the responsibility of the employees of the public healthcare system. In Belgium,
Estonia, Finland, Hungary, Malta, Netherlands, Slovenia, Sweden and Romania,
concerns for corporate social responsibility are limited to health promotion and
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protection. At the opposite side, Germany and Great Britain disclose information on
the economic dimension of CSR (Great Britain supports the accessibility and
availability of healthcare services, irrespective of the ability to pay of the
beneficiaries, initiated a programme in order to involve the business environment in
fulfilling public health goals, while Germany recognizes the importance of medical
products and devices as economic goods).
In Romania, corporate social governance is not a major objective of the persons in
charge in the public sector. On this background, we consider that adopting a general
corporate social responsibility framework will respond socially, environmentally and
economically to the real needs of the community, will improve the performance of
public sector entities and will consolidate their orientation towards the public.
ACKNOWLEDGEMENTS
This work was supported by CNCSISUEFISCDI, project no.955/19.01.2009 PNII
IDEI, code ID_1827/2008, Panopticon on the performance connotations in the public
sector entities in Romania creation versus dissemination.
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~84~
ANNEX 1
Disclosures on social responsibility in the public healthcare system of the
European Union countries
Country
Name of
Institution
Site
Disclosure
language
Germany The Federal http://www.bmg.bund.de Ministry

of
Health
Federal
http://www.bfarm.de/cln Institute
for _103/EN/Home/home_no Drugs
and de.html
Medical
Devices
Information on social responsibility in the

healthcare system
German There is no information in English on social

English responsibility issues.
German Its mission statement shows a degree of concern

English for social and economic issues:
Their
(partially) responsibility is to protect human health, but they
also recognize the importance of medicinal
products and medical devices as economic goods.
However, there is no other information in English
on social responsibility issues.
Paul-Ehrlich- http://www.pei.de/EN/ho - German There is no explicit information in English on
Institut
me/nodeen.html?__nnn=t - English social responsibility issues.
rue
Austria Federal
http://www.bmg.gv.at/cm - German There is information about the Austrian Health
Ministry of s/site/thema.html?channe - English Care System. The Austrian state is aware of its
Health
l=CH0993
(partially) responsibility to provide the best possible health
care services to all citizens.
Orientation towards the patient: Quality,
transparency and orientation towards patients play
an important role. The opinions of the patient
advocacy groups matter in decision making. The
rights of the patients are legally defined and can
also be enforced by law.
Efficient use of resources: They recognize the
importance of efficiently using the available
resources in providing health care of high quality.
However, no explicit concern for the environment
is stated.
Health promotion and prevention are also
important issues. There are several free of charge
preventive services, such as the mother-child-pass
examination programme, which exists since 1974.
In October 2010, the report Assessing SocioEconomic Impacts of GMOs. Issues to Consider
for Policy Development was issued by the
Ministry. Additionally, annual reports on the Drug
Situation in Austria were issued.
Belgium Federal Public http://www.health.belgiu - Dutch
Information on various environmental issues.
Service (FPS) m.be/eportal
- French Useful information on health issues for the
Health, Food
- German population: risks and diseases, care, patient rights
Chain Safety
- English and intercultural mediation, healthy life, end of
and
life, social issues etc.
Environment
Bulgaria Bulgarian
http://www.bda.bg/index. - Bulgarian There is no information in English on social
Drug Agency php?lang=en
- English responsibility issues.
Ministry of
(partially)
Health
Cyprus Ministry of http://www.moh.gov.cy/ - Greek
The Mission of the Ministry is to continuously
Health
moh/moh.nsf/index_en/in - Turkish improve the health of the population through the
of the
dex_en
- English prevention of disease and the provision of high
Republic of
level health care.
Cyprus
Booklet on Patients Rights and Citizens Charter
not available in English.
There is no other information in English on social
responsibility issues.
Great
Department of http://www.dh.gov.uk/en/ - English The concern for accountability issues towards
Britain Health
index.htm
public health is evident.
The Department of Health published in July 2010
Country
Name of
Institution
Denmark Ministry of
the Interior
and Health
Danish
Medicines
Agency
Site
Disclosure
language
http://www.sundhedsmin isteriet.dk/English.aspx -
http://www.dkma.dk/1024visUKLSForside.asp?artikelID=728
Spain
The Ministry http://www.msps.es/en/h of Health and ome.htm

Consumer
Affairs Spain
-
Estonia
State Agency http://www.sam.ee/

of Medicines
The Ministry http://www.sm.ee/eng.ht of Social

ml
Affairs
-

healthcare system
a White Paper called Equity and Excellence:

Liberating the NHS. The core values are to
provide a comprehensive service, available to all,
free at the point of use, based on need, not ability
to pay. Regular reports of the Department of
Health on the progress in following the Structural
Reform Plan are published monthly. They promote
transparency
and
accountability
across
Government and allow people to check that the
department is meeting its commitment.
Moreover, in March 2011, the Department of
Health
launched
The
Public
Health
Responsibility Deal. The main idea behind it is
that businesses can contribute to public health
goals. Businesses are invited to sign up the pledges
in the Responsibility Deal and to fulfil the
monitoring and evaluation requirements for each
pledge.
Danish Brief information on patients rights in a
English publication regarding healthcare in Denmark,
(partially) issued in 2008.
Information on the reform programme Welfare
and Choice, launched in May 2002 by the Danish
Government. The programme aims at enhancing
the competition and quality of public-sector
services through choice. A great emphasis is
placed on the freedom of choice citizens have.
Danish The mission of the Danish Medicines Agency is to
English ensure the availability of effective and safe
(partially) healthcare products medicinal products, medical
devices and new therapies and to promote the
proper use of such products.
Clear concern for social responsibility issues,
revealed in the publication Perspectives and
challenges 2011-2016. They focus on the health
and welfare of people and animals, but also take
into consideration economic issues, such as
affordability of the treatments. They also recognize
their responsibility as public institution towards the
environment. For instance, they take measures for
reducing their energy consumption and CO2
emission.
Spanish There is no information in English on social
Catalan responsibility issues.
Basque However, there is information in Spanish on issues
Galician such as patient safety and environmental and
Valencia occupational health.
French
English
(partially)
Estonian The main responsibility of the Agency is the
English protection and promotion of public and animal
(partially) health, through the supervision of medicines for
human and veterinary use.
However, there is no information in English on
social responsibility issues.
Estonian Information on the Esthonian National Health Plan
Russian 2009-2020. Clear orientation towards social
English responsibility issues:
(partially) - the plan is meant to ensure that the people of
Estonia live longer, happier, healthier lives;
- overall objective: long life and quality of life;
- plans activities in five different fields: social
~86~
Country
Name of
Institution
Site
Disclosure
language
Finland
The Ministry http://www.stm.fi/en/fron of Social

tpage
Affairs and
Health
France
The Ministry http://www.santesports.g of Health and ouv.fr/

Sport
Greece
The National http://www.eof.gr/web/g Organization uest

for Medicines
(EOF)
Hungary The Ministry http://www.eum.hu/engli of Health of sh

the Republic
of Hungary
Ireland
The
http://www.dohc.ie/
Department
of Health and
Children

healthcare system
cohesion; childrens and young peoples health;

the environment; healthy lifestyles; and health
care.
Finnish Clear orientation towards social responsibility
English issues. Information in English on the client and
(partially) patient rights (including legislation on the topic).
Information in English on the promotion of
welfare. The Ministry supports the welfare of
people: by social and health services; by ensuring
income security; by increasing and maintaining
their social welfare, security and participation in
society, and by reducing poverty and social
exclusion; by using health promotion; by using
prevention work; by safeguarding a healthy living
environment and safe work environment.
French There is no information in English on social
responsibility issues.
However, there is information on the rights of the
patients, as well as a list of answers to frequently
asked questions.
Greek
No explicit information in English on social
English responsibility issues.
(partially) EOF is a public entity of the Ministry of Health.
EOF mission is to ensure public health and safety
with regard to several products, marketed in
Greece: medicinal products for human and
veterinary use; medicated animal foods and food
additives; foodstuffs intended for particular
nutritional uses and food supplements; biocides;
medical devices and cosmetics.
HungarianThe summary of the national public health
English programme from 2006 shows concern for the
(partially) lifestyle of the population (whereas nutrition,
smoking, HIV/AIDS, alcohol and drug prevention
are important issues), for health education and for
the environment. In 2004, Hungary was the host
country of the Fourth European Ministerial
Conference on Environment and Health.
Information on the international relations with
OECD, WHO and the Council of Europe.
Irish
The mission of the department is to improve the
English health and well-being of people in a manner that
promotes better health for everyone, fair access,
responsive and appropriate care delivery, and high
performance.
Customer-orientation: Principles of Quality
Customer Service, issued in July 2000 and given
effect by the Departments Quality Customer
Action Plan.
Concern for sustainability: The Minister
established the Expert Group on Resource
Allocation and Financing in the Health Sector in
April 2009. In July 2010, the group issued a report
on resource allocation, financing and
sustainability in health care.
A variety of other information: fact sheets,
publications, statistics, legislation, press releases
etc.
No explicit information in English on social
responsibility issues. However, the Statement of
Strategy 2008-2010 discusses the need for
commitment to people-centred services, and the
need to develop a modern, effective and transparent
~87~
Country
Name of
Institution
Site
The Irish
http://www.imb.ie/
Medicines
Board (IMB)
Disclosure
language
Italy
The Ministry http://www.salute.gov.it/ of Health

-
Latvia
The
State http://www.vza.gov.lv/
Agency
of
Medicines
Lithuania The
State http://www.vvkt.lt/
Medicines
Control
Agency
(SMCA)
Luxembou The Ministry http://www.ms.public.lu/ g

of Health
fr/index.html
Malta
The Ministry https://ehealth.gov.mt/He of

Health, althPortal/default.aspx
Elderly
and
Community
Care

healthcare system
framework of legislation, regulation and

accountability.
In 2007 the Commission on Patient Safety and
Quality Assurance was established. Its mission was
to develop proposals for a health service wide
(encompassing both the public and the private
sectors) system of governance based on corporate
accountability for the quality and safety of health
services.
Irish
The Framework for Public & Service User
English Involvement in Health and Social Care Regulation
in Ireland, issued in December 2009, emphasizes
the importance of involving service users and
members of the public in health and social care
services. This follows the recommendation of
OECD that the Irish Public Service place greater
focus on citizens and their expectations, and on
targeting delivery of services from their
perspective to achieve broader societal goals.
Italian
No information in English on explicit social
English responsibility issues. However, information in
(partially) English on clinical governance, quality and safety
in health care.
Clinical Governance is an integrated approach to
modernize the health system, placing at the centre
of programming and health management the
citizens needs. It also places importance on the
role and responsibility of healthcare workers thus
promoting healthcare quality.
Information on patient safety and risk
management, including information on stakeholder
involvement
in
safety
promotion
and
recommendations for healthcare workers.
Latvian Information on the objective of the Agency: to
English ensure availability of efficient, safe and qualitative
(partially) medicines to the Latvian population.
Code of Ethics for the purpose of guiding the
Agency employees.
Quarterly informative bulletin 2003-2010 in
Latvian.
Annual Report in English with no explicit
information on social responsibility issues.
LithuanianDeclared main responsibility is the protection of
English public health. Information on the policy of quality,
(partially) on its vision, mission and principles.
The motto is: To consumer only high quality, safe
and effective medicines.
Annual reports partly drafted in English for the
period 2003-2007 with no explicit reference to
social responsibility issues.
French No information in English on social responsibility
issues.
Information in French on the Governmental Health
Programme 2009.
Information, including regulatory initiatives, on
topics such as school medicine, promoting health
and preventing diseases, health when travelling and
immigrating, public health protection.
English General information: The stated mission is to
protect and promote the health of the people of the
Islands of Malta. The Health Division is committed
to assuring the accessibility, quality and
sustainability of the public health services and
~88~
Country
Name of
Institution
Site
Disclosure
language
The
The Ministry http://english.minvws.nl/ en/
Netherlandof Health,
s
Welfare and
Sport
Poland

healthcare system
resources.
Information on the structure and responsibilities of
the Strategy and Sustainability Division,
established in 2006.
Information on the mission statement, objectives
and services of the Elderly Care Department.
Information on the Health Promotion Unit, which,
among others, offers counselling and organizes
mass media campaigns on health issues. It
additionally organizes aerobic sessions, weight
management clinics and smoking cessation clinics.
Dutch
Information on different themes and if the case,
English information on the Ministrys policy and measures
regarding those themes: abortion, alcohol, blood,
disabled people, drugs, EU-Health Portal,
euthanasia, Exceptional Medical Expenses Act,
food and food safety, health insurance system, ICT
in healthcare, infectious diseases, long-term care,
medicines, mental health care, patient safety,
prevention, professionals in health care, senior
citizens, sexually transmitted infections, smoking,
social support, sports and youth.
Different documents, publicly available in English,
such as:
- the lecture In pursuit of sustainability, held in
2005 by a representative of the Ministry.
- the paper Health Care in an Ageing Society, a
Challenge for all European Countries, 2004
- parliamentary document on measures to be taken
to guarantee the sustainability of long-term care,
2008
Polish No information in English on social responsibility
English issues.
(partially)
The Ministry http://www.mz.gov.pl/w of Health

wwmzold/index?mr=m0 &ms=&ml=en&mi=535
&mx=6&ma=239
Portugal The Ministry http://www.min- PortugueseNo information in English on social responsibility
of Health
saude.pt/portal
issues.
Information in Portuguese on the national health
policy.
Slovakia The Ministry http://www.health.gov.sk - Slovak No information in English on social responsibility
of Health of /
issues.
the Slovak
Republic
Slovenia The Ministry http://www.mz.gov.si/en/ - Slovene Information on its activities, namely health
of Health
- English improvement and preventive activities. The basis
(partially) for these activities is the understanding of health as
something of value both to individuals and to
society as a whole, and as a precondition for the
successful economic and social development of the
country.
The national programme of food and nutrition
policy 2005-2010, describing the three pillars of
nutrition policy (food safety, healthy nutrition,
local sustainable supply), as well as the evaluation
of programmes and health indicators.
The plan for upgrading the health care system by
2020 (issued February 2011).
Sweden The Ministry http://www.sweden.gov.s - Swedish The Swedish Social Policy Model emphasizes the
of Health and e/sb/d/2061
- English role of the public sector in contributing to people's
Social Affairs
welfare, such as health and medical care. The
governmental support by means of social
insurance is provided in different phases of life.
Moreover, the support and service of the public
~89~
Country
Name of
Institution
Site
Disclosure
language

healthcare system
sector are based on individual needs.

Information on the results of an analysis
performed by the Ministry regarding possible
developments of the elderly population's needs for
health care and elderly care over the next forty
years.
Other policy areas that demonstrate social
responsibility: children rights, dental treatment,
disabilities, elderly care, sickness insurance and
public health.
Regarding public health, there are numerous
measures taken by the Government in order to
promote citizens ability to make healthy choices,
such as:
- a forum for dialogue on ways in which society
can contribute to healthy eating-habits and
physical activities;
- an advisory board to give advice on alcohol,
drugs, doping and tobacco policy, and a secretariat
to coordinate its work;
- Swedish Domains of public health objectives: participation;
The Swedish http://www.fhi.se/en/
National
- English economic and social prerequisites; conditions
Institute
of
during childhood and adolescence; health in
Public Health
working life; environments and products; healthpromoting health services;
Protection against communicable diseases;
sexuality and reproductive health;
physical
activity; eating habits and food; tobacco, alcohol,
illicit drugs, doping and gambling
National
http://www.socialstyrelse - Swedish Information on the role to co-ordinate, develop and
Board
of n.se/english/aboutus
- English follow up the communicable disease prevention
Health
and
and control in Sweden.
Welfare
Information on how to report malpractice or
dissatisfaction in Health Care or Social Services.
Czech
The Ministry http://www.mzcr.cz/En

of Health of
the
Czech
Republic
- Czech Main principles of the health service in the Czech

- English Republic: solidarity, high degree of selfadministration, multisource financing with major
share of public health insurance, equal availability
of health care for all insured persons and
obligatory vaccination against infectious diseases.
Information on the procedure for filing a
complaint and the authorities to which one can
complain.
Ethical code of patient rights including eleven
main points. A list of ten rights of children patients
as well as of foreigners as parents
Romania The Ministry http://www.ms.ro/
- RomanianGuide for Healthy Eating, 2006
No clear concern of the Ministry Strategic Plan
of Health
2008-2010 for social responsibility
No information on social responsibility issues
National
http://www.anm.ro/en/ho - Romanian Quarterly informative bulletins in Romanian from
Medicines
me.html
- English within the period 1999-2010
Agency
The informative bulletin 2/2010 states the strategic
objectives of the National Medicines Agency,
among which the protection of public health.
~90~
IMPROVEMENT IN ACCOUNTING SYSTEM

AND PERFORMANCE MANAGEMENT
OF IRANS UNIVERSITIES IN THE LIGHT
OF CONTINGENCY THEORY
Martin BROAD1 & Abbas ALIMORADI
University of Southampton, United Kingdom
ABSTRACT
Many external factors have affected Governmental Universities of Iran in the past six years.
Decentralization in terms of delegation of authority, financial pressure, and competitive
position for better quality and higher performance in teaching and research are the main
factors. This study investigates the effects of the aforementioned variables on the accounting
systems of Irans higher education institutions. According to Contingency Theory in
accounting, there is no identical management accounting system or control system to fulfil the
needs of all organizations in every situation (Chenhall, 2003, Otley, 1980). Based on the
Contingency Theory literature a theoretical model has been developed and empirically tested.
Data were collected from the Governmental Universities in Iran during the latter part of 2009
through a postal questionnaire. All 126 Governmental Universities in Iran were sent the
questionnaire and responses were obtained from Financial, Education, and Research
Departments in each university. Fully completed and usable questionnaires were collected
from 246 Departments (65.1 percent response rate) and Structural Equation Modelling
(SEM) was used to test the model. The preliminary results and analyses support the existing
literature in the most parts. Present study contributes in methodology and theory areas by
several points as well as proposing some suggestions for policy makers of Irans Higher
Education and Universities Management.
KEYWORDS: Accounting System, Performance Management, Contingency Theory,

Higher Education, Structural Equation Modelling, Developing Countries, Iran
INTRODUCTION
Iran has two big categories of universities namely Governmental and Nongovernmental Universities. Still the main load of higher education is on the
Governmental Universities which are funded by the Government for the majority of
their activities. Four basic reasons encouraged the researcher to undertake this study.
First, Irans Parliament passed the Forth Five-year Development Plan Act in 2004,
thereby proposed a reform for the universities and delegated them authority for
decision-making more than before. Second reason is the low performance of higher
education institutions in Iran in term of international ranking, as the best universities
in Iran are not ranked within the first 500 universities. Third, financial pressure and
competitive positions as other factors have been imposing on the universities during
1
Correspondence address: Martin BROAD, Director MSc Accounting and Finance, University of
Southampton, UK; email: aas1e08@soton.ac.uk
~91~
recent years. Finally, the researchers involvement as a lecturer and deputy-chancellor

of administrative and finance in a popular university was a key motivation for
undertaking this study. Many external factors have affected Irans universities in the
past six years. Decentralization in terms of delegation of authority, financial pressure
or budget constraint and competitive position for better quality and higher
performance in teaching and research are the main factors.
This study investigates the effects of aforementioned variables on the accounting
system and performance management of Irans higher education institutions by the aid
of Contingency Theory. The remainder of this paper consist of five sections. The next
section is about literature review and hypothesis development followed by the section
of variable measurement, and then the methodology section. The fourth section
presents the results of SEM analyses and hypotheses tests. In final section the
implications of the results are discussed and some conclusion and contribution is
explored.
1. RELATED LITERATURE AND HYPOTHESES DEVELOPMENT

According to Contingency Theory in accounting, there is no an identical management
accounting system or control system to accomplish the requirements of all
organizations in all situations (Otley, 1980). There are many studies having looked at
the effect of different external and contextual variables on design or change in
management accounting system or (in a wider area) management control system.
Most of these studies are in private sector organizations context. Chapman (1997),
Chenhall (2003), and Langfield-Smith (1997) have reviewed the contingency based
studies in accounting almost comprehensively. Looking at those reviews reveals that
there are many inconsistent findings and equivocal postulates concerning the effect of
contextual and environmental variables on design and use of management control
systems as well as organizational performance (Chenhall, 2003). In addition, in spite
of loads of contingency-based researches regarding the private companies context,
the field of public organization has not attracted sufficient attention in this matter
(Chapman, 1997). On the other hand, there are many differences between public and
private organizations so usefulness of contingency propositions which have been
confirmed in the context of private companies, needs further investigations and
evidence for public sector (Miah and Mia, 1996).
Based on the Contingency Theory and Performance Management literature, three
external variables namely competitive position, financial pressure and
decentralization and three aspects of accounting system including improvement,
budgetary participation, and emphasis on budget controls were chosen in order to
their effects on universities departmental performance be tested. In Performance
Management part, using some parts of the framework proposed by Otley (1999), the
interaction amongst those external variables, accounting system and two dimensions
of performance management, namely performance measures and reward system, are
investigated. Ten hypotheses are developed to assess the interactions between abovementioned variables and to support these hypotheses, some instances of evidence in
the literature are stated as below.
~92~
1.2. Improved accounting system (H1)

Decentralization has been considered as on of the prevalent causes for development in
management accounting systems. It is believed that broad scope and comprehensive
information with predictive characteristic could better serve organizations with
decentralized structures (Gordon and Narayanan, 1984). Level of sophistication in
management accounting system and decentralization are positively associated in UK
firms (Abdel-Kader and Luther, 2008). Budding (2008) conducting a research in
Dutch municipalities, found that decentralization is related to design and use of more
sophisticated management accounting system.
Competition is known as another motive for improvement in accounting systems.
Organizations which feel more intense competition would try to change their
management control system and adopt some new techniques to help them surviving
under competition pressure (Cooper, 1995). Khandwalla (1972) found that in the
circumstance of competition demand for control in organization would increase and
organizations are likely to spend more money on their control systems. He also
discovered that grater competition leads the companies to change their accounting
systems to more sophisticated ones and much more use of accounting information.
Cavalluzzo et al.s findings (1998) highlighted the importance of external competition
and its effect on governmental efficiency and accounting system design and use.
Financial pressure has also been considered as one of the causes of cost accounting
system development in hospitals (Orloff et al., 1992). Reid and Smith (2000) found
that most of the companies in their research sample had started to develop their
management accounting systems during the period of cashflow crisis, deficit of
finance, or innovation. The association between financial pressures and evolution in
one section of UK universities accounting systems former Polytechnic sector was
confirmed (Broad, 2001). Based on aforementioned studies and situation of Iranian
universities the hypothesis below is proposed:
H1. Universities which are (a) more decentralized and (b) facing more intense
competition and (c) higher financial pressure have more improved accounting
system.
1.3. Budget control and participative budgeting (H2 and H3)
Impact of decentralization on budgetary behaviour including participative budgeting
and more emphasis on budget control has been assessed in contingency-oriented
researches. It was confirmed that decentralized companies mostly are interested in
emphasis on formal management control systems (Burns and Waterhouse, 1975).
Miah and Mias (1996) collected data from governmental organizations in New
Zealand showed that in the case of delegating more responsibility and authority from
top managers to the lower managers, more control and financial activities evaluation
is needed. Kempkes and Pohl (2008) argue that universities autonomy not only is
related to the better research performance, but also it is associated with increase in the
efficiency of budget consumption in those institutions. On the other hand,
decentralization, in term of autonomy in decision-making, is considered as one of the
antecedents of participative budgeting (Modell et al., 2000). Several studies have been
looked at the relationship between these two variables. For example Merchant (1981)
~93~
found that for large, divers, and decentralized organizations stress on sophisticated
and participative budgets is of high importance. Gul et al. (1995) found some
confirming evidence regarding the association between decentralization and
participative budgeting in Hong Kong companies. The results of another study
confirmed also the facilitative role of decentralization to boost budgeting practices
such as participative budgeting in the public sector of a developing country (Awio and
Northcott, 2001).
Also environmental hostility has a significant relationship with putting more stress on
performing in the boundaries of budgets (Otley, 1978). Financial pressure might be
alleged as an external restriction and hostility from the Government on Iranian
universities. In more hostile environment resulted from resource limitations and
intense competitions, there will be much more reliance on formal control (Imoisili,
1989). No direct evidence could be found to confirm the negative association between
financial pressure and participative budgeting, however several papers have looked at
the effects of participative budgeting and budgetary slack (Young, 1985, Awasthi,
1988, Dunk, 1993a, Van der Stede, 2000, Davila and Wouters, 2005, Kren and Maiga,
2007). On the other side, it has been confirmed that rigid budget control could
negatively affect the slack in budgets (Merchant, 1985a, Dunk, 1993a). If
aforementioned relationships are true, it is expected that budget constraints would
hamper the participative budgeting practices. So it seems reasonable to propose
hypotheses 2 and 3 as below.
H2. Universities which are (a) more decentralized and (b) facing higher financial
pressure put more emphasis on budget control.
H3. Participative budgeting in Irans universities are (a) positively associated with
decentralization, but (b) negatively with financial pressure.
1.4. Effect of accounting and budgetary system on performance (H4 to H6)
It seems evident as well as has been claimed by many researchers that accessing to
more information would assist managers to make decision much more effectively (for
example see: Chenhall, 2003, Baines and Langfield-Smith, 2003). Cadez and
Guilding (2008) found that there is a positive association among the degree of usage
of strategic management accounting techniques and performance. Several researchers
have proposed that in an uncertain environment, the information provided by
management accounting system is much more useful (for example see: Gordon and
Narayanan, 1984). Competition has been identified as an index of uncertain
environment (Mia and Clarke, 1999). Simons (1990) doing a two year field study in
two competing companies, tried to investigate the extent and process of formal
management control system effects on strategy formulation to be assured that
competitive advantages would be saved. It is almost an accepted expectation of
accounting systems as a part of management control system to help organizations in
gaining competitive advantages (Bromwich, 1990). Then following hypothesis is
suggested:
H4. Universities departmental performance is (a) positively related to improved
accounting system (b) mediating by competitive advantage.
~94~
Shields and Shields (1998) have reviewed 47 published papers which had
investigated the effects of participative budgeting on several dependent variables.
Performance with 31 frequencies is the most frequent dependent variable in those
researches. Although organisational scholars such as Argyris (1952) and Becker and
Green (1962) have proposed positive relationship between participative budgeting
and performance (Kren, 1992), results of the studies in management accounting in this
regard are somehow equivocal (Chenhall, 1986). Therefore, many of the studies in
this field have looked at a mediating variable which may affect the relationship
between participation and performance. While the definition of budgets proposed by
King et al. (2010) can also be employed for public organizations, participative
budgeting in a public organization is not quite similar to a private organization, so it is
expected that its mediating variable may also vary. In public sector organizations, at
least in context of Iranian universities budgeting system is mainly about distribution
of funds between different departments and activities. Thus, it seems that if
participative budgeting could improve the Departments satisfaction with budgets it
might improve their performance, otherwise it may do not have any positive
consequence on performance or even negative, as it might create extra duty for each
department and employee. A significant association has been confirmed between
participative budgeting and both of job satisfaction and satisfaction with budgets
(Chenhall, 1986). So it can be expected to:
H5. Universities departmental performance is (a) positively related to
participative budgeting, (b) mediating by satisfaction with budgets.
Hopwood (1972) proposed three different styles of performance evaluation so called
Profit Conscious and Budget Constrained as well as Non- accounting Measures. He
concluded that use of Profit Conscious style is more related to the improved
organizational performance and less job-related tension amongst employees and their
supervisors, however Otley (1978) could not confirm this results in another company
and tried to justify the contradictory results by proposing the difference between main
activity centres in those companies. Many other studies in Finance Theory framework
found that budget control which is resulted from financial pressure in state-owned
enterprise which are production firms could have negative effects on employment,
pay rise, and sustainability in market, but a positive effect on productivity (Bertero
and Rondi, 2000, Nickell and Nicolitsas, 1999, Musso and Schiavo, 2008).
Nonetheless, it should be borne in mind that budget control in Iranian universities
mainly is about cash and fund, so it is somehow different with budget control in
private organizations. Shen (2003) found that budget constraint in US hospitals is
adversely related to the quality of their performance. In higher education field also
many studies have discussed consequences of budget constraint on their performance.
Reform in universities funding resulted in more budget control in Ghanas
universities could reduce their efficiency and create many problems for them (Brock,
1996), this is also the case for the universities in Sri Lanka (Chandrasiri, 2003).
Greenaway and Haynes (2003) argue that budget constraint in UK universities
resulted in poorer performance in at least four aspects of activities namely class size,
recruitment and remuneration, research, and social exclusion, although universities
have endeavoured to compensate this problem by increasing their productivity. So the
sixth hypothesis is proposed as below:
~95~
H6. Universities departmental performance is negatively associated with more

budget control.
Figure 1, concisely, illustrates hypothesis 1 to 6 in a schematic expression.
Figure 1 Effects of external variables on Iranian universities accounting system
and performance (proposal)
Competitive
position
Financial pressure
H1c
H1b
Improved
accounting system
H4b
H4a
Decentralization
H3a
H3b
H1a
H2a
Participative
budgeting system
H2b
More emphasis on
budget control
H5a
Competitive
advantage
H5b
Satisfaction with
budgets
H6
H5b
H4b
Universitys departmental
performance
1.5. Comprehensive performance measures (H7)

According to the balanced scorecard notion (Kaplan and Norton, 1993) it seems
evident that in a new situation such as competitive position organizations are more
likely to employ new and comprehensive measures to evaluate their performances.
Use of qualitative measures besides quantitative measures in the competitive positions
appears to be prevalent to lead organizations in a better point compared to their rivals
(Amir and Lev, 1996). As a result of another empirical study, it is claimed that there is
a positive and significant association among the magnitude of market competition and
use of multiple performance measures in manufacturing organizations (Hoque et al.,
2001). Recently this idea was confirmed in Taiwanese high-tech manufacturing firms
as well (Schulz et al., 2010). Although Kaplan (2001) giving several evidence, claims
that use of non-financial performance measures alongside with the traditional
measures is also useful in non-for-profit organizations, little empirical investigation
has been conducted in the context of public organizations. Thus, it seems interesting
to below hypothesis be tested in some public organizations:
H7. Use of comprehensive performance measures is more important for the
universities which are facing more intense competition.
~96~
Flamholtz (1983) argues that accounting and budgeting system could not be seen as a
complete control system and they should be linked with other parts of holistic
management control system, including an appropriate reward system, to be able to
meet their ultimate objectives. It was confirmed, empirically, that localization in
designing reward system could better benefit organizations (Thompson and Richter,
1998). Shelley (1999) argues that there is high level of autonomy for each university
in the UK to specify its own appraisal system, whereas it has not been the case for
Irans universities for many years. As it was mentioned earlier, following the new
legal reform it was supposed to universities be delegated more authority and
autonomy to change, legislate and administrate most of regulations that they think
should be corrected or there is ambiguity on them. So it may be claimed that:
H8. Improvement in the universities reward system is associated with their level
of decentralization.
1.6. Use of accounting in performance management (H9)
It is still hard to deny the importance and usefulness of accounting information to help
the management in performing their main tasks especially in decision-making and
control (Zimmerman, 1995).There are some evidence in the literature that support the
direct association among decentralization and usage extent of accounting information
(for example see: Miah and Mia, 1996, Budding, 2008) and indirect relationship
between competitive position and usage degree of accounting systems after changing
it to a more efficient system (for example see: Khandwalla, 1972, Simons, 1990).
Although Gordon and Narayanan (1984) could not find a significant association
among structure and usefulness of accounting information system, findings by
Chenhall and Morris (1986) confirmed the existence of such a relationship. Based on
this inconsistent results Miah and Mia (1996) endeavoured to test some propositions
in this regard at governmental organizations in New Zealand and found positive
association among them. Abernethy and Vagnoni (2004) performing an exploratory
study in two Italian teaching hospitals, found that decentralization in sense of
authority delegation directly affects the extent of usage of accounting systems in
decision-making and control aspects. On the other side, findings by Mia and Clarke
(1999) confirmed the association between intensified competition and increased use
of management accounting information. Therefore, proposition below is stated:
H9. The extent of use of accounting information in performance management by
the universities is related to (a) their level of decentralization and (b) intense of
competition.
1.7. Performance management and performance (H10)
In relation with the influence of two chosen aspect of performance management as
well as usage of accounting information in PM, on organizational performance several
confirming evidence could be found in the literature. Regarding the effect of
improved reward system, Ittner and Larcker (1995) tried to assess the association
amongst TQM practices, reward system, and level of performance. They found
supporting evidence for positive relationship between emphasis on non-traditional
information and reward system with performance just for the companies using TQM
practices less broadly. Gomez Mejia (1992) found positive association between
reward system, diversification, and performance. Bonner and Sprinkle (2002)
reviewed and proposed the relationship of monetary incentives, effort (direction,
~97~
duration, intensity, and strategy development) , and task performance. In a recent

study, it was also confirmed that performance-based payment would affect
employees effort which consequently improve organizational performance (Schulz et
al., 2010). However, no study could be found investigating the direct association
between improvement in reward system and organizational performance. In addition,
there are many empirical studies confirming positive relationship between
comprehensive performance measures and organizational performance (Kaplan
and Norton, 1993, Chenhall, 1997, Lee and Yang, 2010). Widener (2006) also found
some evidence supporting the positive association between importance of
performance measures and firms performance. Schulz et al. (2010) also found that
employing comprehensive performance measures would increase organizational
performance. Comprehensive performance measures is also crucial for governmental
organizations as it has been proved that behavioural aspects of performance
management practices are not less important than their financial aspects in public
organizations (Verbeeten, 2008).
Finally, it has been claimed by many researchers that accessing to more information
would assist managers to make decision much more effectively (for example: Miah
and Mia, 1996, Baines and Langfield-Smith, 2003, Chenhall and Langfield Smith,
2003). Mia and Clarkes (1999) findings showed that the improvement in
performance of business units is related to the extent of usage of information provided
by management accounting system in the competitive situations. Miah and Mia
(1996) also found positive relationship between grater usage of accounting
information and performance. So the final hypothesis is as below:
H10. Universities departmental performance is positively related to (a)
improvement in reward system, (b) importance of comprehensive performance
measures and (c) use of accounting information in performance management.
The schematic diagram below, Figure 2, summarizes the hypotheses 7 to 10 of this
research.
Figure 2 Interaction between external factors, accounting system and performance
management at Irans universities (proposal)
Competitive
positions
Decentralization
H9b
H9a
H7
Usage of accounting
information in PM
Comprehensive
performance
measures
Improvement in
reward system
H10c
H10b
H10a
Universitys departmental
performance
~98~
H8
2. VARIABLE MEASUREMENT
For variable measurement, it has been attempted to use and modify extant instruments
as far as possible. To measure the 12 main variables of this study, 66 indicators
(questions) were employed by use of a six-point Likert type scale questionnaire. To
measure Competitive Position the instrument of Khandwalla (1972) has been
adapted , so the extent of competition tension in education, research, and overall
issues has been asked. For measuring Financial Pressure 4 questions designed by
the researcher as no existing questionnaire could be found in this regard. The extent of
financial pressure, how often they need to postpone or ignore some expenditure due to
budget constraint, trend of budget growth, and their overall opinion regarding the
existence of financial pressure are the content of those 4 questions. There are several
kind of instrument for Decentralization measurement, however the instrument of
Inkson et al. (1970) has been modified in this study. The degree of authority for two
aspects of activities namely decision making and legislation in five areas of research,
education, financial, administrative, and recruitment have shaped the 6 questions
concerning the decentralization. Another question tried to gauge the effect of new
reform on delegating more authority to the universities.
To quantify Improvement in Accounting Systems a question with 11 section was
designed using the instruments of Khandwalla (1972), Chenhall and Morris (1986) ,
and Mart and Va (2007). The content of this question is about the changes in
accounting systems in some attributes of the system such as frequency, accuracy, and
qualification of accounting reports, speed of preparing accounting reports, demand for
different accounting reports, use of internal and independent auditing, use of nonfinancial information in accounting reports, use of new techniques of management
accounting, and computerising accounting practices, as well as automatic reporting.
Participative Budgeting was measured by 6 questions adapted from Milani (1975).
Involvement in finalizing their budgets, their influence on finalizing budgets, the
importance of participative budgeting for them to have reasonable budgets, the
frequency of their contacts with and from budgeting department, and the
convincement of reasoning by Budget Department after changing some parts of their
budgets are the content of those questions. As Budget Emphasis in public
organizations is somewhat different with private companies, no instrument could be
found for this variable as well. Therefore 3 questions were employed for this purpose
including the extent of budget emphasis, authority to transfer budget funds between
headings, and importance of compliance between actual performance and budget
figures.
To gauge Satisfaction with Budgets the respondents were asked to express their
satisfaction with completeness, fairness, and flexibility of budgets. In another question
their opinion about other staffs satisfaction with budgets were questioned.
Competitive Advantage was measured by employing Guilding (1999) instrument
and requesting the recipients about the extent of their use of accounting information in
competitors cost assessment and position monitoring, strategic costing, and offering
competitive price in proposals. To evaluate Use of Comprehensive Performance
Measures the instruments of Hopwood (1972) and Otley (1978) have been modified
and a combination of quantitative and qualitative common measures were asked. The
extent of effort put into their jobs, their concern with quality, the extent of students
satisfaction with them, their attitudes to their tasks and university, the punctuality and
~99~
length of their presence at their workplace, their task accomplishment on time, and
their concern with costs and budgets have been the indicators for this variable.
As reward system of faculty members and other staff are slightly different in Irans
universities, it has been endeavoured to measure Improvement in Reward System
separately in two questions. Proper relationship between amounts of salary, other
earning, and annual promotion with job performance were common in two questions.
The question regarding other staff has a fourth section to obtain their opinion about
proper link between staffs overtime payment and their job performance. Using the
formats and anchors employed by Cravens and Guilding (2001), Guilding (2002), and
Cadez and Guilding (2008) a four-section question was asked from all managers to
assess the extent of their Usage of Accounting Information for Performance
Management. The aspects of performance management were adapted to the Irans
circumstances based on the framework proposed by Otley (1999) including goal
definition and standard setting, performance measurement and comparing to the
targets, expenditure controlling and decision-making, and rewarding and
compensation.
For measuring Universities Departmental Performance the instrument of Merchant
(1981) which has been used by other researchers such as Brownell and Merchant
(1990) and Dunk (1995) was employed. To avoid from massive subjectivity bias, five
key performance indicators which are normally used by different departments in
Iranian universities were placed in the questionnaires. For Education Departments the
indicators are the rate of graduation during the planned period, quality of instructors
which can be measured based on combination of faculty members (more lecturers=1,
more full professor=6), graduates success in passing entrance exams to study in
upper levels, graduates success in finding jobs compared to other universities, and
quality of programmes and courses. Employed key performance indicators for
Research Departments include number of national publications, number of
international publications, number of applied research projects and contracts,
number of registered patents and inventions, and amount of research income. Key
performance indicators for Financial Departments are ability to pay for expenses and
liabilities on time, new investment in constructing or purchasing new buildings, new
investment in teaching, research, and experimental assets and facilities, growth in
other revenues other than governmental budgets, and percentage of saved budgets at
the end of each year. All of them were requested to rate their overall performance
compared to their counterparts in other universities as the sixth questions.
3. METHODOLOGY
The suitable philosophy and paradigm for this study seemed to be positivism and
functionalist and, as it was mentioned earlier, Contingency Theory was adopted as the
underlying theory for it. Choosing cross sectional survey as research strategy, data
were collected from the Governmental Universities in Iran during the latter part of
2009 through a postal questionnaire. Three main divisions of activity namely
Research Department, Education Department, and Financial Department of all 126
Governmental Universities in Iran were sent the questionnaire. Therefore, the
population of this study was 378 departments of Iranian State Universities.
~100~
To analyse the data, Structural Equation Modelling (SEM) technique has been
employed as the main tool, and it has been run by a computer programme called
Amos, version 17. SEM is a systematic approach that employed for test of models fit
by doing factor analysis and linear regression at the same time (Williams et al., 2009).
This technique could take the measures directly from questionnaire as indicators or
observed variables to estimate the relevant concepts or latent variables (Hoyle, 1995).
By using this technique combination of moderating and intervening models can also
be tested and some changes in initial model would be possible.
4. PRELIMINARY RESULTS
275 completed questionnaires were collected from the universities (72.8 percent
response rate), but only 262 of them were fully completed without any missing data,
as it is necessary for SEM, then the real response rate is 69.3 percent. Finally by
screening the data and in order to gain an acceptable level of normality of distribution
16 questionnaires were set aside as outliers, so final response rate is 65.1 percent. The
brief results of descriptive analysis have been shown in the table 1 as below.
Table 1 Descriptive statistic results of the data, using SPSS 17.
-.415
No. of
Items
3
Cronbachs
Alpha
.74
-.302
.094
.170
-.464
-.852
-.757
4
7
11
.77
.91
.87
0.94
.100
.291
.88
More emphasis on budget

2
6
4.45 0.83
control
Competitive advantage
1
5
2.25 0.96
Satisfaction with budgets
1
6
2.95 0.88
Comprehensive
1
6
4.38 0.87
performance measures
Appropriate
1
6
3.21 0.96
reward system
Usage of accounting
1
6
3.16 1.03
information in PM
Departmental performance
1
6
3.45 0.72
* Theoretical Min and Max are 1 and 6 respectively.
-.508
.141
.85
.455
.146
-.445
-.645
-.093
.208
4
4
7
.95
.87
.91
.477
.575
.88
.264
-.336
.91
.133
-.046
.76
Min*
Max*
Mean
Competitive position
4.21
Std.
Dev.
0.74
Financial pressure
Decentralization
Improved
accounting system
Participative budgeting
2
1
2
6
6
6
4.58
3.19
4.26
3.01
Variables
Skew.
Kurt.
-.200
0.64
0.84
0.75
To analyse the data by SEM, two phases should be performed , namely measurement
model and structural model (Williams et al., 2009). By running the first phase which
is actually a kind of confirmatory factor analysis the reliability of indicators has been
tested and confirmed, of course to gain a better model some of the indicators have
been dropped out of the model by the indication of the initial results (Shook et al.,
2004). After running the two proposed models by SEM, based on the outcomes of the
first phase, the indices of Model Fit showed that the collected data are fit to the
models.
~101~
4.1. Accounting System Model

According to the first models results (Figure 3) most of the indices of fit are good, for
instance CMIN/DF is 1.224, CFI equals .975, NFI is .881, and RMSEM is .030, so all
indices other than NFI which is slightly less than acceptable amount of .9, are at a
good status (higher than acceptable). Table 2 concisely illustrates the indices of fit for
the first model run by SEM.
Figure 3. Effects of external variables on Iranian universities accounting system and
performance (outcome)
Accounting.15System Model
e12
e11
DECENT1
.66
DECENT2
.82
.90
e10
DECENT3.77
.59
e9
DECENT4
FINPRE1
e7
e6
e5
PARBUD1
.91
.05
e3
.37
.75 .85
e19
PARBUD
PARBUD6
COMPOS2.50 e17
.71
.64
e21
IMPACC
.70
.65
BUDEMP2
.77
IMPACC9.72 e23
.85
IMPACC10 e24
.88
.49
BUDEMP3
.78
IMPACC11
.04
e32
e31
SATBUD
.31
e25
.73
.00 .85
.91
.13
-.06
e22
.88
.17
.56 .75
.75
SATBUD2.82
.67
IMPACC8
.18 .80
.81
e30
SATBUD1
.40
.08
BUDEMP
.41BUDEMP1
SATBUD4
COMPOS
.21
.82
.68
COMPOS1 e16
.64
.80
COMPOS3 e18
.44
e20
.18
.62
e1
.68
.08
.04
.12
-.22
PARBUD5.79
e2
.46
FINPRE
.70 .83
PARBUD3 .84
.63
.80
.72
SATBUD3
.52
.72
FINPRE4
DECENT
.56
e4
e15
.56
FINPRE2
.92
.81
.68
e8
e14
e13 .83
.84
COMADV
COMADV1
e26
COMADV2
e27
.82
.63
.79
.86
COMADV3 e28
.74
e33
e34
.33
COMADV4 e29
.07
.32
e35
DEPPER
.78
DEPPER1
e36
.70
DEPPER2
e37
.64
.81
.50
.61
.81
.66
DEPPER3
e38
.41
DEPPER4
e39
.66
DEPPER6
e40
By comparing the real values with acceptable figures of indices proposed in the
literature (Byrne, 2001) it can be concluded that the structural model is sufficiently
~102~
reliable. Of all indices in Table 2 just NFI is slightly less than acceptable range and it
is due to the complexity of the model (Kline, 2005), however for assessing the fitness
of a model reliance on the combination of indices (not just one index) has been
recommended (Byrne, 2001, Shook et al., 2004). Figure 3 indicates the graphic results
of the run of this model. In that Figure, rectangles represent observed variables and
ellipses show the latent variables. Factor loadings (between observed and latent
variables), common variances (as indicators of strength of relationship), and
regression coefficients (between latent variables or factors) can be found on figure
below in standardized form.
Table 2. Indices of fit for the Accounting System Model
The abbreviations that have been used in Figures 3 (previous page) and 4 and Tables 3
Index
Model
CMIN
DF
CMIN/DF
CFI
NFI
RMSEA
Real values
624
510
1.224
.975
.881
.030
Acceptable
values
N/A
N/A
Less than 3
More than .9
More than .9
Less than .05
and 5 mean as below:

DECENT = Decentralization
COMPOS = Competitive Position
FINPRE = Financial Pressure
IMPACC = Improved Accounting System
BUDEMP = More Budget Control
PARBUD = Participative Budgeting
SATBUD = Satisfaction with Budgets
REWSYS = Appropriateness of Reward System
USACPM = Use of Accounting in Performance Management
COMPME = Comprehensive Performance Measures
Based on the estimations resulted from SEM analysis (presented in Table 3) which are
mostly consistent with the literature, it can be claimed that improvement of
accounting system is related to competitive position (+.40); however this
relationship could not be confirmed with decentralization (+.04) and financial
pressure (+.08). On the other hand the association of participative budgeting with
decentralization (+.37) and financial pressure (-.22) was supported. Moreover, it
was confirmed that the universities with higher financial pressure and more
decentralization (more delegated authority) put more emphasis on budget
controls, though the association with financial pressure (+.44) was found stronger
than decentralization (+.12). In addition, the positive effect of improved
accounting system (+.13) and participative budgeting (+.31) on universities
performance was confirmed, nevertheless the negative effect of budget control was
not found so significant (-.06). Furthermore, competitive advantage does not seem
to mediate the relationship between improved accounting system and universities
performance (+.003), but partial mediation of satisfaction with budgets on
association between participative budgeting and performance was found
significant (+.14).
~103~
Table 3. Regression coefficients based on Maximum Likelihood (ML) for Accounting

System Model
Variables
DECENT ->IMPACC
COMPOS->IMPACC
FINPRE ->IMPACC
DECENT->PARBUD
FINPRE ->PARBUD
FINPRE ->BUDEMP
DECENT->BUDEMP
PARBUD->SATBUD
IMPACC->COMADV
SATBUD->DEPPER
PARBUD->DEPPER
BUDEMP->DEPPER
COMADV->DEPPER
IMPACC->DEPPER
Estimate
S.E.
C.R.
.055
.723
.116
.323
-.219
.489
.114
.412
.033
.270
.259
-.047
.049
.078
.082
.143
.092
.059
.066
.080
.066
.073
.057
.064
.062
.048
.045
.037
.673
5.053
1.259
5.464
-3.313
6.094
1.721
5.638
.578
4.240
4.175
-.984
1.100
2.132
.501
.000
.208
.000
.000
.000
.085
.000
.563
.000
.000
.325
.271
.033
4.2. Performance Management Model

In relation to the outcomes of second model (Figure 4) the indices are approximately
the same as the previous model. CMIN/DF is 1.285, CFI is .974, NFI is .894, and
RMSEM equals .034, so for this model also all indices except NFI are higher than
acceptable level. As it can be discovered from the comparison between NFI indices of
these two models, NFI for this model (.894) is slightly better than NFI for the
previous model (.881). This point supports this idea that NFI is quite sensitive to the
complexity of the model (Kline, 2005), as the later model is slightly simpler than the
previous one. Indices of fit for this model can be seen in Table 4.
Table 4. Indices of fit for the Performance Management Model
Index
Model
CMIN
DF
CMIN/DF
CFI
NFI
RMSEA
Real values
367
287
1.285
.974
.894
.034
Acceptable
values
N/A
N/A
Less than 3
More than .9
More than .9
Less than .05
Having had a fit model; it might be reasonable to trust on the results of the structural
relationships between latent variables. Regression coefficients resulted from SEM
analysis regarding the Performance Management Model (Table 5) show the
association between proposed latent variables.
~104~
Figure 4. Effects of external variables on Iranian universities Performance

Management and Performance (outcome)
Performance Management Model
.16
.84
e10
e9
.45
DECENT1
.66
DECENT2
.91
.77
DECENT3
e7
DECENT4
.67
.81
COMPOS
DECENT
e5
REW SYS3
.49
e13
COMPOS3
.32
.12
e14
.47
REW SYS2
e12
COMPOS2
.70
.59
e6
e11
.66
.81
.82
.91
e8
COMPOS1
e15
.30
.69
.74 .86
.29
.65
.10
.49
FREW SYS
.80
e16
REW SYS6
e17
.82
.91
SREW SYS
.14
REW SYS5
.37 .63
.40
REW SYS7 e18
.74
e4
.75
USACPM1
.65
e3
USACPM2
e2
USACPM3.79
e1
USACPM4
.86
.81
.66
.81
.12
.14
.04
USACPM
.04
COMPME
.62
e23
e24
.27
.87
.94
COMPME1
e19
COMPME2
e20
.88
.36
.60
.55COMPME3
.31
e21
COMPME4
e22
.32
.20
e25
DEPPER
.78
.70
DEPPER1
DEPPER2
e26
e27
.65
.82
.48
.60
.81
.67
DEPPER3
e28
.42
DEPPER4
e29
.66
DEPPER6
e30
Table 5. Regression coefficients based on Maximum Likelihood (ML) for

Performance Management Model
Variables
Estimate
S.E.
C.R.
DECENT ->FREWSYS
DECENT ->SREWSYS
DECENT->USACPM
COMPOS ->COMPME
COMPOS->USACPM
FREWSYS -> DEPPER
SREWSYS -> DEPPER
COMPME->DEPPER
USACPM->DEPPER
.145
.330
.278
.621
.201
.033
.023
.202
.199
.085
.073
.067
.130
.105
.052
.059
.045
.053
1.700
4.490
4.145
4.781
1.909
.635
.391
4.538
3.782
.089
.000
.000
.000
.056
.526
.696
.000
.000
Therefore, it can be asserted that based on this model which is fit with the collected
data there is a significant association between competitive position and employing a
comprehensive set of performance measures (+.81), but not so strong association
with the usage of accounting information for performance management (+.14). On
the other side, although the effect of decentralization on more usage of accounting
information in performance management was explored significant, its effect on better
reward system appears to be different for faculty members (+.12) and other staff
(+32). It seems vital to be mentioned here that based on the exploratory and
~105~
confirmatory factor analysis, it seemed inevitable to distinct between reward system

for faculty members and other staff and treat them as two separate variables in the
model. Finally, consistent with main stream of Balanced Scorecard researches,
association between use of comprehensive performance measures and
performance was supported (+.32), nevertheless the relationship among better
reward system and higher performance neither for faculty members (+.06) nor for
other staff (+.03) could be proved. Nevertheless, the association among usage of
accounting information in performance management and performance appears to
be significant (+.27). Figure 4 shows the results of this model in more details
schematically.
Table 6 and 7 below, summarise the results of test of proposed hypotheses including a
brief description of hypotheses contents, confirmation or rejection, and the level of
significance for supported hypotheses.
Table 6. Results of hypotheses testing, Accounting System Model
H no.
H1
H2
H3
H4
H5
H6
Content of hypothesis
Association between improved accounting system and:
a. decentralization
b. competitive position
c. financial pressure
Association between emphasis on budget control and:
a. decentralization
b. financial pressure
Association between participative budgeting and:
a. decentralization (positively)
b. financial pressure (negatively)
Association between departmental performance and:
a. participative budgeting, directly
b. participative budgeting via satisfaction with budgets
a. improved accounting system, directly
b. improved accounting system via competitive advantage
Association between departmental performance and emphasis on budget controls
Result of test
Rejected
Confirmed***
Rejected
Confirmed***
Confirmed***
Confirmed*
Confirmed***
Confirmed***
Confirmed***
Confirmed**
Rejected
Rejected
*** = .01, ** = .05, and * = .10 level of significance
Table 7. Results of hypotheses testing, Performance Managements Model

H no.
H7
Content of hypothesis
Association between importance of comprehensive performance measures and
competitive position
H8
Association between decentralization and improvement in reward system of:

a. faculty members
b. other staff
H9
H10
Association between usage of accounting reports in PM and:

a. decentralization
b. competitive position
a. improved reward system
b. comprehensive performance measures
c. usage of accounting reports in PM
*** = .01, ** = .05, and * = .10 level of significance
~106~
Result of test
Confirmed***
Confirmed*
Confirmed***
Confirmed***
Confirmed*
Rejected
Confirmed***
Confirmed***
DISCUSSION AND CONCLUSION

By looking at the new situations such as delegation of authority from the Government
to the Universities in Iran, competitive positions and financial limitations which the
universities in Iran are facing with, it seemed that Contingency Theory can explain
and predict some changes in their accounting system and performance management.
Although the vast majority of the contingency-based studies have been done in private
sector, the results of this study showed that most of the contingency postulates are
somehow true in public organizations such as the state universities even in a
developing country like Iran.
As the results of hypotheses testing indicate (Tables 6 and 7) just one hypothesis out
of ten was fully rejected and three more were partly refused. It means that the findings
of this research mostly confirm the existing literature; however in some parts they are
not consistent with the expectations stem from the literature. Firstly, according to this
results, of three proposed factors which could cause improvement in accounting
systems of Iran universities only competitive positions found to be influential, but not
decentralization and financial pressure. So in relation to decentralization, the result
supports Baines and Langfield-Smith (2003), but contradicts some others (Miah and
Mia, 1996, Budding, 2008). It might be due to the deletion of some of the observed
variables underlying improved accounting system by the SEM. This removal left
just those variables that emphasis on the technical aspects of improvement in
accounting systems. Contradiction with the literature regarding the effect of financial
pressure is more justifiable because those evidence are mostly about cashflow crises
as proxy of financial pressure (Reid and Smith, 2000) or improvement just in costing
system (Orloff et al., 1992) whereas the case in Iran universities is about budget
constraint and its effect on improvement of overall accounting system not just
costing system.
Secondly, not only no indirect association could be found between improved
accounting system and universities performance via creating competitive
advantage for them (in contrary with the findings of Bromwich, 1990, Simons, 1990,
Hoque et al., 2001), but also the direct effect is not as strong as the effect of
participative budgeting on universities performance. This might imply two points
at least. First, the nature and objectives of use of accounting system in public
organizations is different with private companies (Miah and Mia, 1996, Jackson and
Lapsley, 2003) as they may use that information mainly for control purposes
(Abernethy and Vagnoni, 2004). In addition, it supports this notion that in public
organization still budgeting aspects of accounting system is more important than
other aspects such as technical improvements in those systems (Goddard, 2005,
Ramadhan, 2009).
Thirdly, test of the sixth hypothesis showed that there is, unexpectedly, no significant
negative relationship between more budget emphasis and universities
performance. Although it was against the proposed hypothesis, however there are
many contradictory findings in the literature around this matter (Hopwood, 1972,
Otley, 1978, Hirst, 1981, Lau and Tan, 1998). Studies in the area of Finance Theory
suggest that more budget control could increase the productivity of organizations,
although it may negatively affect their employment, pay rise, and sustainability in
market (Bertero and Rondi, 2000, Nickell and Nicolitsas, 1999, Musso and Schiavo,
~107~
2008). On the other hand, it is argued that in organizations with domination of

professionals (Abernethy and Stoelwinder, 1995, Broadbent, 2007), sever stress on
budget controls could be considered as an obstacle of performance improvement
while another study showed that more budget control in US hospitals is adversely
related to the quality of their performance (Shen, 2003). So it seems that several
variables are acting in the area of that relationship that they may counteract and offset
the effect of one another.
Finally, as expected and consistent with previous studies, the positive association are
confirmed amongst two proposed contingent variables (decentralization and
competitive position) with two aspects of performance management (improvement in
reward system and use of comprehensive performance measures), respectively
(Kaplan and Norton, 1996a, Chenhall, 1997, Perera et al., 1997, Schulz et al., 2010,
Shelley, 1999). Also relationship between aforementioned external variables and
extent of usage of accounting information in performance management is supported
as so did implicitly other researches (Simons, 1990, Miah and Mia, 1996, Ballantine
et al., 1998, Budding, 2008). On the other hand the effect of those changes in
performance management practices, except for improved reward system, on
universities performance proved to be remarkable based on this study and supports
the literature (Kaplan, 2001, Karathanos and Karathanos, 2005, Widener, 2006, Cadez
and Guilding, 2008, Schulz et al., 2010).
However, some explanations could be provided for not finding significant positive
association between improved reward system and universities performance.
First, most of the studies which found positive association between reward system and
performance, have been conducted in private organizations where there are more
objective criteria of performance to be linked with employees rewards (Modell et al.,
2000). Second, it is argued that there is no perfect linkage between individuals
performance evaluation and organizational performance evaluation, so improving
reward system by better linking with individuals performance does not necessarily
mean it would improve organizational performance (Metawie and Gilman, 2005). In
addition, some studies suggest that connecting performance measures to the reward
system could create some side effects such as gaming, task negligence, tunnel vision,
and short-termism (Ittner et al., 1997, Goddard et al., 2000, Ittner et al., 2003) which
they may hamper the organizational performance. Moreover, it has been claimed that
incentive-based reward system could boost quantitative performance, but not
qualitative performance (Verbeeten, 2008), whereas in public organizations especially
in universities quality of performance seems to be more important. Finally, many of
studies which found positive association among reward system and performance have
inserted some kind of intervening variables such as efforts (Bonner and Sprinkle,
2002), and strategy diversification (Gomez Mejia, 1992), therefore devising a
mediating variable such as motivation or job satisfaction might have better been
explained the association between reward system and universities performance.
This study contributes to the literature in several ways including methodological,
theoretical, and practical contributions. Design, adapt, and test of an instrument with
high degree of reliability and validity regarding the accounting system and
performance management of universities, conducting a nation-wide and large scale
survey in the area of performance management of public organizations whiles prior
studies in this regard are mostly qualitative and case-based (Verbeeten, 2008), and use
~108~
of SEM as the main data analysing procedure to overcome some previous statistical
problems in this kind of researches as well as opening a new avenue for Iranian
researchers (as this technique is not well-known in Iran) are the main methodological
contributions of this study. In term of theoretical, this research contributes by several
points such as investigating about dissemination of knowledge concerning
management accounting and performance management in developing countries
(Hopper et al., 2008), extending and testing the contingency postulates in public
sector organizations particularly in Higher Education of a developing country
(Chenhall, 2003), acting as one of the rare studies that broadened contingency notions
from the accounting area to the performance management realm (Cuganesan and
Donovan, 2011), and explicitly proposing and testing financial pressure in term of
budget constraint as a new contingent variable (Chenhall, 2003, Abdel-Kader and
Luther, 2008) as well as proposing it as a hindering antecedents for participative
budgeting (Shields and Shields, 1998).
Finally, policymakers in Irans Higher Education can use the outcome of this research
to understand the extent of success in implementation of new reform in Iran Higher
Education and justify the priority of decentralization to the centralized decisionmaking concerning the universities activities as well as the consequences of
participative budgeting on the performance of universities. In addition, universities
management also may learn some lessons from this study such as implementing
participative budgeting at least at internal level, doing more amendments in their
reward system, and design and use of broader range of performance measures for
evaluating the performance of their employees rather than relying just on traditional
measures such as punctuality or length of presence at the workplace.
Care should be taken for use of the results of this study due to some limitations such
as the problems related to questionnaire-based studies, relatively small sample size (as
SEM needs larger sample size), not including all variables affecting universities
performance such as strategy and political environment, and ignorance of students
perspective. In the future, many replications could be undertaken in this matter in Iran
or other developing countrys context. Moreover undertaking a qualitative research
methodology could increase the understandings around the result of this study and
may add to the robustness of these findings. In this research just three department of
the universities, namely Education, Research, and Financial Divisions were
investigated, future studies could take into the account the Students Affair Division
and look at the students perspective too.
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THE ERA OF INTERNAL AUDIT IN THE PUBLIC

FINANCE SECTOR IN POLAND
Agnieszka SKOCZYLAS1 & Wojciech A. NOWAK
University of Lodz, Poland
ABSTRACT
The modern internal audit was introduced to the Polish Public Finance Sector in 2002. From
this moment the evolution of internal auditing in Poland is progressing from the
implementation of strict financial functions through the assessment of compliance of public
sector entities, until the assessment of the effectiveness and efficiency of the institution. The
aim of this paper is to present the development of internal audit in the Polish Sector of Public
Finance. In this study the following are presented: Polish legislation in the internal audit, the
scope of its operation in the public finance sector, as well as the direction of its changes.
KEYWORDS: internal audit, countries in transition, public finance sector, management

control, internal audit development and evolution, internal audit regulation, EU accession
INTRODUCTION
Statehood in Poland has a thousand-year old tradition, after all, intermittent periods of
its absence. Modern, independent Polish state was reborn in 1918, as a result of
processes of surmounting the First World War. It covered the lands, which for over
120 years were under the rule of Russia, Prussia and Austro-Hungarian Empire. Its
first task was to merge into one state organism the systems of government and local
government which derived from nineteenth-century tradition, respectively: Russian,
Prussian and Austro-Hungarian. This tumultuous process took more than 20 years,
until the outbreak of World War II in September 1939. The already mentioned process
comprised adoption of the Polish Constitution (in 1921) as well as its extensive
change (in 1935), and building (in 1933) the legal foundations of a uniform system of
local government functioning under the supervision of state authorities.
Within the central as well as local government of the reborn state certain control and
inspection functions in the financial and economic affairs were to be fulfilled. On the
national level, their implementation was assigned to the heads of state offices and the
Supreme Chamber of Control while on the level of local government the role was
performed by the management of local government units, revision committees of
representative councils, the inspection union of local government and national
supervisory authorities. Control and inspection functions fulfilled by the heads of state
and local government boards were focused on issues relevant to contemporary internal
audit in financial and operational affairs (aspects). This situation was maintained
except for the period of World War II - without substantial changes to the early 2000s,
until the beginning of preparations for accession to the European Union, except that in
1
Correspondence address: Agnieszka SKOCZYLAS, Accounting Department, University of Lodz,

Matejki 22/26, 91-360 Lodz, Poland, email: agnieszka.skoczylas@uni.lodz.pl, wanowak@uni.lodz.pl
~114~
a centrally planned economy era and at the beginning of the period of the last political
transition (to 1992) revision of local government associations did not work and their
functions were performed by the local government units.
Pattern of existence and mechanism of control and inspection functions in the
government sector were governed by the law in the rank of Acts and Directives, while
approaches and procedures of control and inspection functions were not standardized.
Internal audit activity was not so much advanced as in other highly developed
countries. Therefore, one of the first tasks to be undertaken in preparation for Polish
entry to the European Union was the introduction of modern internal audit in the
public finance sector. The most significance in this process was given to ensuring
consistency in polish system of control and inspection with the internal audit system
in the European Union. The article is presents an analysis of its development since its
introduction in 2002 to the present day.
1. ADJUSTMENT OF THE INTERNAL AUDIT IN THE POLISH PUBLIC
FINANCE SECTOR
As a result of integration with the European Union and to ensure the proper
functioning of the public finance sector, Poland was obliged to build a system that
would guarantee the accuracy and efficiency of the collection and disbursement of
public funds and management of the property, known as the public internal financial
control (PIFC) (Robert de Koning, 2007) In accordance with European guidelines
(Agenda 2000, 1997), one of the major components of the system of public internal
financial control is "an independent internal audit functioning in all required by law
public institutions responsible for the creation of audit on the basis of international
standards for internal audit, as well as the central body responsible for harmonizing
and coordinating system auditorium in the country" (Chojna-Duch E., 2002, p. 59).
Adaptation to EU requirements made it necessary to regulate the issue of internal
financial control and internal audit in order to improve efficiency, transparency and
openness of public administration and better use of public funds (Chojna-Duch E.,
2002, pp. 58-59).
The internal audit was introduced to the Polish law in 2002. The universally binding
legal instrument in this respect was, and still is, the Public Finance Act (Law Gazette
No. 155, item. 1014). It regulates not only the definition and rationale of the internal
audit, but also introduces the principles of organization and coordination of internal
audit, as well as eligibility requirements which must be met by internal auditors. The
Public Finance Act is accompanied by other acts which complement the provisions of
the Act, so-called executory provisions. These include:
directives concerning the detailed method and procedures for conducting
internal audit,
announcements of the Internal Audit Standards, the Code of Ethics and
Internal Audit Charter in the public finance sector.
The Directives apply to the conduct of internal audit, depending on the nature of the
services provided, and also indicates the most important documents that should be
created as a consequence of audit. Announcements, in turn, provide a set of
constructions and guidelines relating to the functioning of the audit and the activities
of internal auditors.
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Each of the existing documents is subject to continuous evolution. List of legislation

on internal audit activity in the public finance sector since its inception to the present
time is presented in Table 1.
Table 1. List of legislative acts in force in the Polish sector of public finances
in the years 2002-2009
Year
2002
2003
2004
Acts
Act of 26 November 1998 on
public finance (Law Gazette
No. 155, item. 1014).
Directives
Directive of the Minister of
Finance of 5 July 2002 on the
detailed method and procedures
for internal audit (Law Gazette
No. 111, item. 973).
2005
Act of 30 June 2005 on public

finance ( Law Gazette
No. 249, item. 2104)
Announcements
Announcement No. 2 Minister of
Finance dated 30 January 2003
concerning the announcement of
"Standards for Internal Audit in the
public finance sector" ( Official
Journal MF No. 3, item. 14)
Announcement No. 6 of the

Minister of Finance dated 28 April
2004 on the announcement of "Code
of Ethics of the internal auditor in
the public finance sector, " and the
"Charter of internal audit units of
public finance" ( Official Journal
MF No 6, item. 28)
Directives of the Minister of
Finance dated 24 June 2006 on
the detailed method and
procedures for internal audit
(Law Gazette No. 112, item.
765).
2006
2007
2008
2009
2010
Act of 27 August 2009 on

public finance ( Law Gazette
No. 157, item. 1240)
Announcement No. 11 of the

Minister of Finance dated 26 June
2006 on internal audit standards in
the public finance sector ( Official

Finance dated 10 April 2008 on
the detailed method and
procedures for internal audit (
Law Gazette No. 66, item. 406).

Finance on 1 February 2010 on
the conduct and documentation
of internal audit (Law Gazette
No. 21, item. 108).
Announcement No. 8 Ministry of

Finance dated 20 April 2010 on the
standards of internal audit in the
public finance sector. (Official
(Source: Authors' research)
The most important changes in individual acts in force in respect of internal audit
were related to the modification of the perception of its role in the organization and
the nature of the services provided by it. The breakthrough came at the time of
introduction in the Polish public finance sector the International Standards for the
Professional Practice of Internal Auditing developed by the Institute of Internal
Auditors in the United States (The Institute of Internal Auditors). These standards are
considered the most important guidelines for the functioning of the internal audit and
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are used and respected by the majority of public and private institutions in the world.
In Poland, from 26 June 2006, the standards were introduced as mandatory for use by
public sector institutions. This resulted in a change in existing law. The key change
was introduced, however, in 2009. It was associated with a significant extension of
services provided by the internal auditors, as well as a new perspective on the role and
place of audit in public sector organizations.
2. RIGHT INTERNAL AUDIT APPROACH - DEFINITION AND SCOPE
OF SERVICES PROVIDED BY IT
The internal audit was introduced to the public finance sector units for the first time in
the amended Public Finance Act of 26 November 1998. Given the need to fulfil the
provisions in providing pre-public system of internal financial control, basic
definitions, principles, and also organization and coordination of internal audit have
been included alongside those relating to the functioning of financial control in
Chapter 5 of the Public Finance Act of 1998, "Control of financial and internal audit
in the public finance sector". This Act defined the internal audit as "all activities
through which a manager of a unit receives an objective and independent assessment
of functioning in the field of finance in terms of legality, economic prudence,
efficacy, reliability, and transparency and openness".
The statutory duties of the main tasks of the internal auditor were:
examination of accounting documents and records in the accounts,
evaluation system for the collection of public funds and their availability as
well as management of the property,
assessment of efficiency and economy of financial management.
The internal audit activity in its initial phase of development was equated with
financial control. The audit was at that time seen as a mechanism for checking the
functioning of transactions and financial procedures. It included the verification of the
accounting operations and aimed at reviewing and highlighting errors, as well as
evaluation of internal regulations in this regard. This resulted in an audit that was seen
as a kind of financial control, which resulted from the tasks assigned to it.
In 2005, the Public Finance Act was changed, which resulted in the change of the
definition of internal audit. During this period the internal audit was a collective term
comprising "all activities, such as:
an independent assessment of the management and control systems within a
unit including the financial control procedures, which aim at providing the
manager with an objective and unbiased evaluation of the adequacy, efficiency
and effectiveness of these systems,
consulting services, including the submission of proposals aimed at improving
the functioning of the organization".
The principle activity of the audit remained within the financial area. However, the
auditor was entitled to perform certain additional services related to the provision of
consulting activities, as well as proposals for improving the functioning of the
organization. Thus, the catalogue of the activities within which the auditor could
perform their duties was extended. Its tasks were to assess:
business compliance with the law and the applicable procedures in the unit,
~117~
efficiency and economy of activities undertaken in the field of management

and control systems,
reliability of financial statements and reports on budget implementation.
The last, very significant substitution in the functioning of the internal audit took
place in 2009. Not only did the Public Finance Act published in 2009 introduce a new
concept of internal audit, much closer to the international auditing standards, but it
also replaced the concept of financial control and management control. According to
the above mentioned Act "Internal auditing is an independent and objective activity
designed to add value and improve organizations. Internal audit assists the unit in
carrying out its activity through a systematic assessment of the management control
and operations consultancy" (Act of 27 August 2009).
Based on the above definition, the role of modern internal audit in the Polish public
finance sector is the management control assessment, which according to the current
law on public finance means the whole of the action taken to ensure that the
objectives and tasks are consistent with the law, efficient, cost-effective and timely
(Act of 27 August 2009, art. 68.). The most important aspects, according to the Polish
legislature, which should be included in management control, are (Act of 27 August
2009, art. 68.):
business compliance with laws and internal procedures,
effectiveness and efficiency of operations,
the reliability of financial statements,
protection of resources,
upholding and promoting the principles of ethical conduct,
effectiveness and efficiency of information flow,
risk management.
The concept of management control is associated with the implementation of relevant
activities by the managing of the institution through which the organization achieves
its goals. These activities should proceed in a timely manner, in accordance with the
law and procedures, and thus contribute to obtaining the greatest possible advantage,
while making the most economical use of outlay. The legislature, therefore, did not
resign from the current tasks assigned to internal audit, namely financial control,
which is much narrower than the term management control, and it is a part of it. In the
current Public Finance Act financial control was left at the discretion of heads of
units, by keeping the record of director's responsibilities for financial management of
the institutions. This does not mean, however, that managers were exempt from the
implementation of the remaining tasks of the exercise of financial control. On the
contrary, the scope of the management of public organization has a significant
extension, through the introduction of management control, which covers all types of
activities and all areas and processes operating in the unit, including financial one as
well. We can say that the management control absorbed the financial control
and proper financial control became one of the elements of management control
(Figure 1).
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Figure 1. Management control and financial control

concerns the processes of collecting and distributing
public funds and management of property.
Financial
control
Management
control
means all actions taken to ensure that the objectives
and tasks are accomplished in a manner consistent
with the law, efficient, cost-effective and timely.
Management control in relation to the functioning of Polish public sector, refers to the
concept of internal control, which was defined by international organizations such as
COSO (The Committee of Sponsoring Organizations Treadway Commission) or
INTOSAI (International Organization of Supreme Audit Institutions by The
International Standards of Supreme Audit Institutions - ISSAI). According to them,
internal control is a tool or a management process used to obtain reasonable assurance
that management objectives have been achieved. It is performed by a board of
institutions, management and other employees of the organization (Risk Management
- Integrated Framework, COSO, 2004). Internal control, from the standpoint of
international organizations is perceived in a much broader way than internal control,
which was formed in the culture of the Polish public organizations. So far, the internal
control functioning in polish units meant comparing the actual state with the required
one and was performed by a specially established organizational units (so-called
institutional control).
A guideline to implementation and evaluation of management control in the public
finance sector are the management control standards established by the Minister of
Finance (Journal of Law MF No. 15, item. 84). It is "an ordered set of guidelines that
those responsible for the operation of management control should use to create,
evaluate and improve management control system" (Journal of Law MF No. 15, item.
84). Their purpose is to promote the implementation of a coherent and uniform model
of management control in public finance sector, in accordance with international
standards, taking into account the specific tasks of the implementing institution.
The standards include five elements that correspond to each management control
tasks, which is presented in Figure 2.
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Figure 2. Elements of management control according to the Standards

of management control in the Polish Public Finance Sector
Compliance
Operations
Financial
Strategic
INFORMATION AND COMMUNICATION

CONTROL MECHANISMS
OBJECTIVES AND RISK MANAGEMENT
PUBLIC SECTOR ENTITY
MONITORING AND EVALUATION
INTERNAL CONTROL
Taking into consideration the international guidelines on internal control, as well as

American literature in this field, one should emphasise that the definition of
management control which is presented in the Polish Public Finance Act is not
significantly different from the recognition of internal control by international
organizations. Its role and scope of activities are important elements in terms of public
sector institutions. The exercising of management control in terms proposed by the
legislator can contribute not only to improvement of the quality of the management of
these bodies, but also to the entire system of public finance.
The correctness of functioning of the management control system in the public
finance sector, in accordance with the current law, should be supervised by the
internal audit. It is its duty to assess the adequacy, efficiency and effectiveness of its
functioning. From the standpoint of the Polish law there are new tasks for internal
auditors. Analysing this issue with reference to international guidelines, it should be
said that the internal audit functioning in the Polish sector of public finances has
finally come closer to a global perspective on the role of internal audit in the
management of the organization. The evolution of internal audit is shown in Table 2.
Apart from the range of the internal audit services in public sector entities, which
were required by the legislature, auditors are required to apply some general
principles in their operations. They are carrying out their tasks on the basis of an
annual audit plan, which has to be prepared by the auditor by the end of the calendar
year. The auditor is also required to prepare a report presenting the realisation of
audit activities. For 8 years of audit activity, the model of audit plan and audit report
were prepared by the Minister of Finance. In 2010, the idea of common model was
abandoned and a list of positions required in both the plan and the report was
published. Planning of the internal audit is based on documented risk analysis. In
determining the scope of areas to be surveyed in a given year the internal auditor is
obliged to take into account the results of risk analysis, managers attentions, the
priorities of the audit committee, the number and qualifications of auditors working in
auditing, as well as the time needed for implementation of planned activities.
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Table 2. The evolution of the definition and scope of internal audit units of the Polish
public finance sector
Years
2002-2005
Definition of Internal Audit

Internal audit is all activities through which
manager of a unit receives an objective and
independent assessment of functioning in the
field of finance in terms of legality, economic
prudence, efficacy, reliability, and transparency
and openness.
Scope of services
The statutory duty of the main tasks of the
internal auditor was:
examination of accounting documents and
records in the accounts,
evaluation system for the collection of public
funds and their availability as well as
management of the property,
assessment of efficiency and economy of
financial management.
2006-2009
Internal audit is all activities, such as:

an independent assessment of the
management and control systems within a
unit including
the financial control
procedures, which aims at providing the
manager with an objective and unbiased
evaluation of the adequacy, efficiency and
effectiveness of these systems,
consulting
services,
including
the
submission of proposals aimed at improving
the functioning of the organization.
Internal auditing is an independent and objective
activity designed to add value and improve
organizations. Internal audit assists the unit in
carrying out its activity through a systematic
assessment of the management control and
operations consultancy.
Internal audit task was to assess:

business compliance with the law and the
applicable procedures in the unit,
efficiency and economy of activities
undertaken in the field of management and
control systems,
reliability of financial statements and reports
on budget implementation.
From 2010
The correctness of functioning of the

management control system in the public units,
in accordance with the current law, should be
supervised by the internal audit. It is its duty to
assess the adequacy, efficiency and effectiveness
of its functioning.
(Source: Authors' calculations based on the Public Finance Act in Poland between the years
2002-2009)
The internal audit units of the Polish sector of public finance provide various services.
Until 2005 in the first phase of its development the auditors were able to accomplish
the tasks included in the annual audit plan and audit commission (assigned task). The
people to delegate tasks were the head of the unit in which auditor was employed and
the responsible minister. Since 2005, the internal auditor can also carry out
consultancy services. To achieve this aim auditors, while are preparing the annual
plan, have to assign sufficient amount of time to complete it.
In 2009, according to International Standards of IIA, a provision that the internal
auditor performs assurance and consulting services was introduced. Assurance
services are meant by a group of activities undertaken to provide an independent and
objective assessment of the functioning of management control. Consulting services
comprise all activities aiming at improving the institution's activities. Despite the
adoption of International Standards and their nomenclature, interpretation of Polish
legislature is not entirely consistent with them.
Internal auditors can perform their tasks providing they receive a personal
authorization issued by the head of the public organization. Assurance services
provided by the auditor should be based on risk analysis and an audit programme. The
audit programme must include a subjective and objective study, which define who and
what will be subject to assessment. Completion of the activities finishes with
preparation of the audit report, which is subject to appeal. As far as consulting
services are concerned auditors have the right to prepare different audit documents,
~121~
depending on type and nature of services provided. It should be emphasize that the
methodology of implementation of audit assignments adopted in Poland in accordance
with the national legislation does not differ significantly from the techniques
presented in the International Internal Audit Standards.
3. THE ORGANIZATION OF INTERNAL AUDIT SECTION IN PUBLIC
FINANCE SECTOR UNITS
Organization of Internal Audit in the Polish public finance sector is diverse
(Kaczurak-Kozak, M., 2006, p. 97). It can be perceived in two ways:
depending on the environment in which the institution employing an internal
auditor is functioning,
the place of the internal audit unit within the organizational structure.
In the first point internal auditing in public finance sector operates on three levels:
central, local government and public unit, which is presented in Figure 3.
Figure 3. Organization of Internal Audit in the Polish public finance sector
Public finance sector
Level of local government
Central level
(government administration)
Level of public finance units
Since the beginning of internal audit in the public finance sector, the coordinating
body on the level of government (central) is the Minister of Finance. Initially,
between 2002-2005, the Ministry of Finance performed his/ her tasks with the
assistance of Chief Internal Auditor, working in the Ministry of Finance and his/her
subordinate organizational unit. The Minister's tasks included the setting of standards
of audit and financial control, cooperation with foreign institutions, collecting
information on the performance of audit and financial controls as well as improving
the functioning of these areas. At the end of 2006 the position of Chief Internal
Auditor was defuncted, and by mid-2009, the Minister of Finance performed the tasks
associated with coordinating the audit, only with the assistance of an organizational
unit in the form of the Audit Department of the Public Sector. Since September 2009,
individual ministers have been obliged to appoint an audit committee in all the
ministries supervised by them. The Committees' responsibility is to advise the
Minister in the area of internal audit and management control in public bodies
subordinate to him/her. The committee must consist of at least three members,
including a person appointed by the responsible minister, having the rank of secretary
or undersecretary, who will perform the function of a chairman and at least two
independent members who are not employees of the ministry, or its subordinate units.
In accordance with International Standards for the Professional Practice of Internal
Auditing IIA committees should operate in each unit having an internal audit. In
~122~
Poland, a different solution has been introduced, which means the committees operate
on the level of ministries, not the local units.
On the level of local government the internal audit organization and coordination is
the responsibility of the borough leader, mayor, or the city president. It should be
noted that as far as these institutions are concerned, a certain degree of freedom was
given by the Minister of Finance, which results in a variety of internal auditor
activities in the whole public finance sector. This is due to decentralization, and
consequently the ability of the management to take decision on certain issues in a
manner independent of the government.
The third level of internal audit organization in the public sector consist of, listed in
the Act, public sector entities and local government units which accumulate
substantial public funding or carry out significant public expenditure. Conducting
internal audit in those institutions is a requirement imposed by the legislature. The
coordinating body of their activities are individual ministers and appointed by them
audit committees.
Another important issue in the functioning of internal auditing in public finance sector
is the position of internal auditor and internal audit unit within the organizational
structure (Winiarska K., 2006, p. 261). According to the Public Finance Act,
institutions of this sector were obliged to ensure that the internal audit unit has
organizational autonomy through direct subordination to the head of the organization
in which this unit operates. Internal audit activities, in accordance with the Public
Finance Act, are coordinated by an internal auditor employed by the head of the
institution (Art. 277, 280). Subordination of business in this area is shown in Figure 4.
Figure 4. Organizational subordination of internal audit in public sector
organizations
Head of organization
Internal Audit
Unit
The chief audit executive
Tasks of the Audit Coordinator

other people called
Assistants Internal Audit
Internal auditors
The organizational structure presented in the figure should operate in any public
sector institution. In fact, the organization and place of internal audit and the internal
auditor in the organizational structure of units is varied. This mainly concerns the
subordination of the internal audit unit and the subordination of the internal auditor.
An analysis of data collected in Poland by the Audit Department of Public Finance
Sector, Ministry of Finance shows that (Kubik A., 2005, No. 1, p. 35):
single positions of internal auditor is mostly created,
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there are cases of mergers of units or positions of the internal audit with
internal control unit or another (the overwhelming trend in this area is in units
of local government).
IIA Standards raise questions related to the organization of internal audit, as well as
the tasks performed by internal auditors. According to them, the internal audit unit,
precisely the chief audit executive should be on the level of the organization which
will give him/her the organizational and functional independence in performing their
audit activity (Kubik A., 2005, p. 6). According to the Institute of IIA the chief audit
executive should report directly to a functional internal audit committee or its board.
For administrative purposes, however, the chief audit executive should report directly
to the President or the Director of the organization (Gleim I.N., 2004, p. 38). IIA
Institute in its Standards emphasizes a need to establish the committee and council
audit which they believe should be composed of people independent of the
management unit and whose responsibility is to assist internal auditors in carrying out
their duties independently and objectively. Standards indicate the position of the chief
audit executive in the organizational structure but do not designate the place for other
internal auditors. As a result of above mentioned managers are given the freedom to
shape the function of the audit. One should be remember though that each institution
is different, has its own regulations and organizational structure. The Standards are
meant to provide guidance and assistance in the era of internal audit organization but
do not impose a ready and unambiguous solution.
Another important issue is the number of internal auditors working in institutions of
the public finance sector. Some organizations employ from 1 to 5 or even 20 auditors
and other auditors work half or quarter-time. There are no guidelines to regulate this
issue. On the other hand, if such guidelines were to occur, it is worth considering their
content. According to E.J. Saunders, there are no established standards for the
construction, organization of internal audit and the number of people that should be
employed in it. This decision may be taken based on the assessment of the
organization, its structure and specificity of function. Number of employed internal
auditors should reflect the needs and development of an institution. The above cited
author recommends that their number in the unit should account for 2% of the
employees in the organization (Saunders E.J., 2003, p. 47). However, the quality of
the human factor should be considered there because, as K. Czerwinski points out,
employing even a large number of internal auditors in the organization will not
compensate for the lack of experienced people in the field of internal auditing, which
may lead to limiting the scope of audit work (Czerwinski K., 2004, p. 32). It should be
also noted that each institution operates in a changing environment and, therefore, an
internal audit of the unit must keep pace with these changes, and even overtake them
(See E.J. Saunders, p. 47).
Without questioning any of the listed solutions for the internal audit organization it
should be emphasized that while creating the internal audit unit one should take into
account the needs resulting from the necessity to ensure the supervision and control
over the functioning of the institution. This unit should be adjusted to the size,
structure and needs of individuals and consist of highly qualified people to ensure a
variety of performed tasks (Czerwinski K., 2004, p. 24). The main objective
underlying the introduction of internal audit in any institution should be to strive for
high quality of its operations by streamlining management processes, to stimulate
~124~
continuous quality improvement by supporting the activities of the management,

including increased efficiency of the internal control system, reducing operating costs
and the elimination of waste of financial resources (Chojna-Duch E., p. 61).
4. AUDIT STILL INTERNAL OR ALREADY EXTERNAL
ORGANIZATIONS OF PUBLIC FINANCE SECTOR OBLIGED
AND EMPOWERED TO CONDUCT INTERNAL AUDIT
The obligation to conduct an internal audit from the moment of its existence in the
Polish sector of public finances concerned most of the institutions belonging to this
sector. These included in particular: the ministries, central offices, regional offices,
customs offices, tax offices, earmarked funds, health insurance. Other organization
obliged to conduct internal audit were public sector organizations that gather
substantial public money or make a considerable expense. On this basis, the Minister
of Finance defined the amounts of revenue and expenditure which, if exceeded during
the year, shall be subject to internal audit (This amount was 40 000 000). In 2005,
when the Public Finance Act was amended, the list of public organizations obliged to
conduct an internal audit was extended and included: Treasury of the Chamber,
Chamber of Customs, prosecution, or regional audit chambers. The number of entities
obliged to conduct audit increased from year to year, as shown in Table 3.
Table 3. The number of public sector entities obligated to conduct internal audit
and internal auditor jobs
Number of public sector
entities, including:
- number of units of a
central government
- number of units of local

government
Year
The obligation to conduct

internal auditor
Obligation to employ
an internal auditor
2002
2003
2004
2005
2006
2007
2008
2009
2006
2007
2008
2009
2006
2007
2008
2009
1600
1600
2200
2200
2400
2557
2643
2751
1300
1936
1959
1975
1100
621
684
776
No information
No information
No information
No information
No information
1269
1358
1455
577
648
674
690
No information
621
684
776
(Source: Authors' research based on reports of the Ministry of Finance, Internal Audit in the
public sector in 2006-2009)
In 2009 the legislature modified the list of public sector entities obliged to conduct
internal audit and their number decreased. Currently, they are such units as: the Prime
Minister's Office, ministries, provincial offices, chambers of Customs and Revenue,
Department of Social Insurance, the Agricultural Social Insurance and National
Health Fund. Individuals (art. 272, Act of 27 August 2009), such as: state budgetary
units, public universities, independent public health care, executive agencies, state-
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appropriated funds and local government units are required to conduct an internal
audit when a certain amount of income or expenditure is exceeded. In the remaining
institutions internal audit can be conducted if the head of this organization has the
will, or when it is imposed by the responsible minister.
According to the European guidelines (Agenda 2000), mentioned at the beginning of
the article, the concept of public internal financial control is associated with the
provision of "an independent internal audit, acting in all the public institutions by
law". It should therefore be considered whether the legislative requirement should
differentiate internal audit units in the Polish public sector due to the amount of
revenues or expenditures made. So should the financial aspect be the factor
determining the proper and effective functioning of public institutions? On the one
hand, internal auditing in Poland is developing through the implementation of
international standards and change of policies, on the other hand it always remains in
the area of financial control, by limiting the directory of units required to conduct the
audit using a single criterion - the amount of revenue or expenditure.
Another key issue in the field of auditing in public finance sector organizations is the
obligation to employ an internal auditor. Until 2009, each public sector entity obliged
to conduct an internal audit was required to hire an internal auditor. According to
current legislation some institutions are given the choice between the internal audit
being conducted by an employed internal auditor or by an auditor working for several
organization. This alternative results in public organizations using external audit.
External service provider may be either a natural or legal person who must meet
certain requirements imposed by law on public finance. These include in particular:
the need to meet eligibility requirements governing the profession of internal
auditor in the public finance sector,
the obligation to conduct an audit under the provisions of the Public Finance
Act and its implementing legislation.
When an organization decides to use the services of an external audit it is required to
sign a contract for at least a year. The possibility of using external service is accepted
by the responsible minister. The local government organizations can use external
audit services only if the amount of income and the amount of revenues and expenses
and expenditures is less than 100 000 000.
From an organizational point of view of internal audit, one should also mention the
protection of people employed as auditors in the public finance sector. In 2002-2005,
the body authorised to terminate the contract with an internal auditor or to change
conditions of contract was the Chief Inspector of Internal Audit. After the liquidation
of the position of Chief Internal Auditor the responsibilities were taken over by
Minister of Finance. In 2009, the amended Finance Act retained the entry defining
employment and change of working conditions of the internal auditor, but limited the
circle of auditors, only to chiefs audit executives.
5. LICENCE TO PRACTICE AS AN INTERNAL AUDITOR
Since 2002, namely the emergence of internal audit in the Polish law, the internal
auditor could be anyone who (Art. 35k, Act of 26 November 1998):
has the Polish citizenship (January 2006),
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has full legal capacity and makes full use of public rights,
has not been penalized,
has a higher education,
passed the test organized by the Examination Commission.
These conditions gave, on the one hand, the possibility of applying for internal
auditing to a large numbers of Polish citizens, on the other hand imposed an
obligation to pass a state exam. The legislature, taking into account the impossibility
of finding suitably qualified auditors, in the first phase of the internal audit activity in
Poland, introduced a so-called transitional period. The period meant that anyone who
wanted could be employed in the internal audit but the guarantee of employment was
obtain only after passing the state exam by the end of 2004 year.
The examination was held by a specially appointed Examination Committee, which
began functioning to 2003 and finished its activity in 2006. It consisted of two parts,
written and spoken and its requirements were clearly defined by law. As a result of it
the right to work in internal audit in the public finance sector was gained by 2,181
people. It is noted that the period between 2003-2006 was the moment when
significant financial resources, including the EU, were involved, internal Audit in the
Polish public sector developed and qualification of auditor were substantially
improved.
In 2006 numerous changes in access to the profession of public sector auditor were
introduced. The idea of state exam was abandoned but people who previously passed
the state exam preserved their rights. Promotion, however, was given to people who
(art. 58 Act of 30 June 2005):
completed controller application and passed an exam conducted by the

Examining Board appointed by the President of the Supreme Chamber of
Control,
passed an exam qualifying for the post of inspector of fiscal control,
were certified accounting auditors.

These alterations resulted in changing number of auditors employed in the public
finance sector, which is presented in Table 4.
Table 4. Number of auditors working in the public finance sector required
to maintain an internal audit
Year
2004
2005
2006
2007
2008
2009
Audited units (approximately)

2200
2200
2400
2550
2640
2751
Number of people employed in Internal Auditing

Total
Internal auditors
Auxiliary
663
415
118
709
537
137
1054
859
107
980
742
67
972
821
123
918
800
118
(Source: Authors' research based on reports of the Ministry of Finance, Internal Audit in the
public sector in 2006-2009)
The results presented in the table show a significant increase in the number of internal
auditors by the end of 2006, an average of more than 200 people a year. Since 2007
the decreasing trend can be observed, while the number of staff employed in the
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sections of the internal audit units of public sector finance increased at fairly rapid
pace.
Finally, in 2009, another modification in acquiring audit rights was introduced. As a
result, the Supreme Chamber of Control controllers and fiscal control inspectors were
deprived of the right to work as internal auditors and the right to work in this
profession was given to whose who have obtained a post-graduate diploma in internal
auditing and have a two-year practice. The legislator defined the practice in internal
audit as: conducting audit, performing control activity in the area of UE funds by tax
inspectors and supervising and performing inspection activities by the auditors of the
Supreme Chamber of Control. The legislator did not, however, define the scope of
law which should be included in the programme of postgraduate studies in this area,
but pointed out that units entitled to issue diplomas were the ones with the right to
award the degree Ph.D. in economics or law.
It is difficult to assess the impact of these changes on the profession of internal
auditor, and the functioning of public sector entities. There is currently no available
data on the number of auditors employed in these institutions, or providing services to
them in 2010. However, taking into account the provisions and requirements of laws,
and thus the possibility of resigning from audit given to selected units, one can expect
a further decline in these numbers. However, taking into consideration changes in the
qualifications for the job of internal auditor - post-graduate studies in the field of
internal auditing, you can count on a significant increase in the number of people
interested in gaining permission to perform the profession. But will the public sector
respond to this interest with proper supply, will there be the managers of public
entities who will want to hire an auditor, or use such services.
6. EVALUATION AS A DETERMINANT OF THE DIRECTION
OF INTERNAL AUDIT DEVELOPMENT IN POLISH PUBLIC FINANCE
SECTOR
Changes in the economy necessitate the continued improvement of public
organizations and more efficient management of public funds. Depending on the
modification of rules for the functioning of public sector entities and the activities of
these organizations the nature and extent of services provided by auditors is also
subject to transformation. In order to assess the activities undertaken by public
organizations, thereby improving their performance evaluation process is used. It
involves a systematic examination of the value or characteristics of a particular
program, project, activity, subject to the usual criteria, the purpose of its improvement
and development (A. Haber, M. Szalaj, 2009).
The amended Public Finance Act of 2009 contains a number of conditions designed to
be introduce to the Polish public sector evaluation (A. Haber, M. Szalaj, 2009). One
of them is to modify the tasks assigned to internal audit. As mentioned earlier, the role
of internal audit since 2009, has been to assess the adequacy, efficiency and
effectiveness of management control in the public finance sector. These tasks are
associated with the implementation of a series of steps intended to measure the effects
of these institutions. They are defined in the literature as efficiency audit (called also
value for money audit). Its primary purpose is to focus on efficiency, effectiveness
and economy of operation of Polish public organizations. It uses a series of indicators
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and metrics to measure efficiency. From the perspective of the scope of internal audit
work in Poland it is certainly a significant progress. Internal audit, since its
introduction in the public finance sector, focused primarily on assessing the
compatibility of the organization with the applicable rules, guidelines, particularly
with regard to the financial area. Now its task is to verify the effectiveness and
efficiency of all processes in the organization. Taking into account the development
trends of internal audit in Poland, we can define its various forms, which have
appeared in Poland since its introduction to public finance sector. They are presented
in Table 5.
Table 5. Formation of various types of audits in the Polish public finances
Year
2002
Type of audit
Financial audit
2005
Compliance audit
2006
Operational audit
2009
Efficiency audit
Value for money audit
Description
Internal audit checks the functioning of transactions and financial
procedures. It included the verification of the accounting operations and
aimed at reviewing and highlighting errors, as well as evaluation of internal
regulations in this regard.
Internal audit assess that the organization activity is adhering to law,
regulations and control standards and other guidelines
This type of audit falls within the category of services to facilitate the
management unit by evaluating four management functions: planning,
organizing, controlling and monitoring. The purpose of its conduct is to
answer the question why the problem exists and what is its cause.
Internal audit assess the adequacy, efficiency and effectiveness of
functioning of the public organizations.
Using various types of audits by the internal auditors of the Polish sector of public
finances was dictated by the changes which occurred in the organization of this sector.
The public sector since the 80's of the last century has undergone a metamorphosis,
from the bureaucratic form defined by Weber in the direction of effective, efficient
and pro-quality systems. Following these changes, transformations are also subject to
internal audit role. The emergence of performance-audit related to the implementation
of performance budgeting in the public finance sector, whose idea is to improve
expenditure management in the public sector (More, Lubiska T., 2007, pp. 32-45). In
the implementation of performance budgeting, it is necessary to appoint suitably
defined and hierarchical objectives for the collection and disbursement of public funds
and the identification of specific outcomes and indicators for their verification.
Budgeting allows you to determine which tasks are most important for achieving the
specific targets and using indicators shows the extent to which they were completed
(Bombik P.K., 2006, No. 437, p. 476). Similar basis governs the methodology used in
the implementation of the efficiency audit. Due to the constant changes taking place in
public finance sector, you can expect that the tasks and role of internal audit will be
subject to further change, so as to provide reasonable assurance on the functioning of
the institutions of this sector.
CONCLUSION
Internal Audit in the Polish sector of public finances appeared in the twenty-first
century, in the world it has a centuries-old tradition (Peemller V.H., Kunowski S.,
1997, nr 27, Fach 28, s. 1264). It has gone a long way in shaping its position on the
international area. The evolution of internal audit in Poland and the world is presented
in Table 6.
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Table 6. Development of Internal Audit in the Polish sector of public finances

and the world
The development of internal audit in the world
1950
1960
Development of Internal Audit in the Polish public

finances
Control of the accounting records

Control of the accounting records and
compliance with the basic operation
procedures
1970
Analysis of existing procedures
1980
Evaluation of existing procedures

concerning introduction of additional
control
2000
Evaluation of internal control and

reporting on its state managers.
2001
Evaluation of risk management
2002
Reducing risks and improving risk
management system
2002
2003
2006/2007
Add value
2005
???
2009/2010
Examination of accounting documents and

records
in
their
accounts.
Evaluation system for the collection of
public funds and their availability and
management of the property.
Assessment of compliance with applicable
procedures.
Evaluation of the effectiveness and
economy of activities undertaken in the
field of management and control systems
and the reliability of financial statements.
Improving the functioning of the
organization.
Add value.
Evaluation of the adequacy, efficiency and
effectiveness of management control
system.
(Source: Authors' research based on the K.H. Spencer Pickett, The Internal Auditor at Work:
A Practical Guide to Everyday Challenges, John Wiley & Sons, Inc.., Hoboken, New Jersey,
2004, p. 11, Winiarska K., 2008, p. 7).
Based on the information provided, we can conclude that the evolution of internal
auditing in Poland is progressing from the implementation of strict financial
functions, to evaluation of operations of the institutions, which assist managers in
managing the unit. This progress is reflected in the public sector very clearly, where
the definition of internal audit and the scope of services provided by it has changed
over 8 years in a significant way, starting from the evaluation of financial operations
through the assessment of compliance of public sector entities, until the assessment of
the effectiveness and efficiency of the institution. The evolution of internal auditing in
Poland took place in a similar way as in the world, however, started much later and
proceeded faster. The experience which the Polish sector of public finances has drawn
from the development trend of the audit in the world had significant impact.
~130~
Currently, internal audit is becoming an increasingly useful tool for the Polish sector
of the public finances units, it is not only used to gather information, but it evolves
towards the provision of ready-made applications and management arrangements,
which may result in increased efficiency of the organization. Given this rapid process
of change which is subjected to public entities in Poland, as well as having a
progressive pace of change in the world it is difficult to indicate what will be the next
stage of development of internal audit, both in Poland and abroad.
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~132~

OF THE NATIONAL STRATEGY FOR THE FINANCIAL
REPORTING OF THE PRIVATE SECTOR ENTITIES
Ramona LAPTES1
Transylvania University of Brasov, Romania
Adriana Florina POPA

ABSTRACT
In the early 2000, the Romanian accounting entered in a new stage of reform, built in
connection to the international realities. In 2004, in Romania, the authorities have initiated a
national strategy to improve the financial reporting, considered to be a true catalyst for
developing a sustainable economy. The present demonstrates that the national strategy for
improving the financial reporting of the private economic entities, mostly based on the
elaboration of the individual annual financial statements of the public entities according to
the IFRS referential, has encountered some difficulties in the complex process of
implementation. The identification and the analysis of the difficulties, but also the highlight of
the progress of implementing the national strategy for improving the financial reporting of
the private sector entities, are the main objectives of this study.
KEYWORDS: accounting, financial reporting, Romania, national strategy, IFRS,

conformity
INTRODUCTION
It is a currently known fact that the world economy is shifting from a model built on
interdependent national economies to a model represented by a network of
multinational companies that operate globally. This economic climate imposed
reconsiderations and reorientations in the accounting area. In the late '90s, the general
trend in the accounting field was to reach the goal of standardization and
harmonization of the national accounting systems. The harmonization process didnt
have the expected outcome and, in the recent years, internationally, there is a retreat
towards the national convergence (Lapte, 2007).
The accounting evolved nowadays to another level of knowledge, a process caused by
the profound changes that took place in the economic field, under the inertia of the
globalization and the internationalization of the economies. The accounting experts
called the recent dynamic of the accounting as accounting postmodernism.
In Romania, the accounting postmodernism was described by professor Ionacu and
several meanings are reserved to it (Ionacu, 2003):
1
Correspondence address: Ramona LAPTE, Transylvania University of Brasov,

Faculty of Economic Sciences and Business Administration, Romania; email address:
ramonalaptes@hotmail.com
~133~
The accounting theoreticians attempt to find answers to the current phenomena

(the globalization of the economies, the continuous deregulations of the markets,
the steady development of the consumer society and of the information society),
which raises issues in the business administration;
The postmodernist society is seen in a continuous transformation that requires a
multidisciplinary approach to the economic management of the entity, a mix of
economics, sociology, philosophy and law;
The accounting postmodernist researches, started in UK after 1980, and taken
over by the French specialists, are, in the vision of professor Ionascu, those
considered to be post constructivist, the interpretative ones and the critical
radical current.
The accounting research oriented towards postmodernism show interest primarily in
the accounting language and the accounting information meaning, as a way of social
communication.
In this context, in 2002, IASB and FASB signed a memorandum and agreed to
complete a project named The International Short Term Convergence, with the
main goal of eliminating a series of differences between the IAS and the US GAAP
referentials, until the end of 2005. After that date, a second step was set, reflected in a
common project called Draft of Common Checking of the International
Convergence (Ristea et al., 2006).
Contrary to the normalization efforts of the two bodies, the convergence of the US
GAAP / IAS is not a simple process, primarily due to the disagreement regarding the
sphere of the influence between the two accounting referentials. If the US GAAP are
required to the companies seeking for funding from the U.S. capital markets, the IFRS
accounting referential is recommended to the companies seeking to be listed on the
international capital markets. Therefore, the IAS/IFRS referential is intended to cover
a larger area and it refers to companies with different structures (Lapte, 2007).
Fully aware of this advantage of the IFRS referential, on 17th of November 2007, the
SEC publicly announced that it recognizes, starting from the financial year 2007, the
financial statements of the foreign entities in accordance with the IFRS without prior
reconciliation to the U.S. GAAP. In this regard, Sarah Johnson made the following
affirmation in 2008: Goodbye GAAP - It's time to start preparing for the arrival of
the international accounting standards (Dumitrana et al., 2010).
At the European Union level, the process of the IAS/IFRS referential implementation
started on the 1st of January 2004, when two periods were identified (Ristea et al.,
2006):
the interval between the 1st of January 2004 and the 31st of December 2004
represented the transition period, the period of the restatement of the financial
statements or the comparative period;
the interval between the 1st of January 2005and the 31st of December 2005
represented the period of actual appliance or the period of the elaboration of the
first financial statements according to the IFRS referential.
Basically, at the European level, according to the Regulation 1606/2002 on the
application of the international accounting standards, known as the IAS Regulation,
starting the 1st of January 2005, all the companies listed on EU capital markets,
~134~
including the credit institutions and the insurance companies, were required to publish
the consolidated financial statements under the IFRS. This approach led to the
development of two accounting systems in the European Union countries,
simultaneously applicable: an accounting system based on the IFRS and another one
based on the national GAAP. The member states chose the conformity with the IFRS,
both for the individual financial statements of the listed companies and for the
consolidated and individual financial statements of the unlisted companies. Therefore,
starting on the 1st of January 2005, 7000 listed European groups gave up the national
accounting regulations in favor of the appliance of the international financial reporting
standards (Ristea et al., 2010).
FEE (Federation of European Accountants) believes that countries and markets are
best served by high quality financial information and that this is best delivered by a
single independent global standard setter for accounting and corporate reporting. In
April 2009, the G20 (the Group of Twenty) called on the worlds accounting standard
setters to continue to work towards a single set of high-quality global financial
reporting standards. FFE believes that the G20 should urge the IASB to use all
existing high quality accounting standard setting expertise from around the world,
including those within FASB and EFRAG (the European Financial Reporting
Advisory Group), to work together on new global solutions in those areas that really
matter to investors (FEE, 2009).
Inside the European Union, the discrepancies signaled between the accounting
directives and the IFRS referential led to the necessity to adopt the Modernization
Directive 51/2003. This directive offered to the companies that organize their
accounting according to the European directives the possibility of appealing to the
IAS/IFRS accounting options. The directive amended the European directives
regarding the content of the annual statements, the balance sheet and the income
statement disclosure, the valuation rules, the issue of the provisions, the structure of
the audit report, the content of the annual report and others (Ristea et al., 2006).
Which is, though, the situation of the implementation of the IFRS referential in
Romania?
In Romania, the state authorities believe that the improvement of the financial
reporting in our country in the next period should have its pillars on the extension of
the IFRS referential. Therefore, in 2004, by the adoption of the Government Decision
no. 2170/2004, the Romanian Government approved the National Strategy Action
Plan in order to improve the financial reporting in Romania. This country action plan
includes the objectives regarding the development of the business environment,
arising from the program of measures agreed by the Romanian Government and the
International Bank for Reconstruction and Development, underlying the Loan
Agreement for programmatic adjustment (PAL), signed at Bucharest on 27th of
September 2004.
The monitoring of the implementation of the Country Action Plan in order to improve
the Romanian financial reporting was initially the attribution of the Accounting
Advisory Board, which was organized and operated under the Government Decision
no. 1449/2002.
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The Accounting Advisory Board, by the Ministry of Finance, informed the Romanian
Government on a quarterly basis about the progress made in achieving the objectives
of the Country Action Plan. In 2005, by Government Decision no 401/2005, the
Accounting Advisory Board was reorganized into the Accounting and Financial
Reporting Council (CCRF), an independent supervisory body, with attributions in the
insurance of the convergence of the national regulations and practices in the financial
accounting and auditing with the European Union regulations.
The Romanian Accounting Group (GRC), consisting of experts on accounting issues,
was set up inside the CCRF, in order to provide support, consulting, training and
informing services, in order to ensure the implementation of effective and efficient
processes used in the translation of the IFRS and the related materials, and to provide
a source for the development and the timely implementation of the IFRS in Romania.
The increase in the quality of the financial reports is considered a key component of
the sustainable economic development in Romania. This requirement has become, in
the last decades, the main priority for many countries and it presently represents the
subject of significant reforms in the field.
The quality of the financial reports, directly involving the accounting and auditing
standards, as a legal and institutional framework for implementing them, is an end in
itself. The ultimate goal is to bring added value to the financial reporting system in
order to support the stability of the financial system and the economic growth in the
private sector.
As part of the reform, from the end of 2002 until February 2003, the World Bank
experts conducted an assessment of the existing standards and practices related to the
accounting and the financial audit of the financial statements, in order to identify the
necessary reforms for improving the financial reporting by the private sector. The
recommendations from this evaluation were included in the Report on the Observance
of Standards and Codes (ROSC) adopted on the 9th of May 2003.
The present shows that the initiative of bringing the national accounting regulations as
close as possible to the international financial reporting standards had no success. The
Order no. 907/2003 (amended by the Order no. 2001/2006) on the application of the
International Financial Reporting Standards require that the economic entities, listed
on a regulated market, which elaborate consolidated financial statements, have to
apply the international financial reporting standards starting 2007. The other
economic entities, considered of public interest, can apply the international financial
reporting standards in the elaboration of the individual or the consolidated financial
statements for their own information needs. However, in the relation with the state, all
the entities, including those applying the international financial reporting standards,
have to prepare the annual financial statements in accordance with the European
directives (Jianu et al., 2009).
In the recent years, in Romania, the accounting of the economic entities has been
frequently reconsidered and submitted to a comprehensive reform process, initiated in
the early 2000. In 2004, the Romanian Government approved the National Strategy
for the Action Plan implementation, in order to improve the financial reporting.
~136~
What are the coordinates of this national strategy? What is present stage of the
National Strategy for improving the financial reporting in Romania? What are the
limits of applying the international financial reporting standards by the Romanian
economic entities? These are several questions that we intend to answer to in this
paper. In order to achieve this goal, we conducted a normative type of research, which
allowed us to identify and analyze the key issues of the National Strategy for
improving the financial reporting of the economic entities operating in the private
sector.
2. BOUNDARIES OF THE NATIONAL STRATEGY FOR IMPROVING
THE FINANCIAL REPORTING
The accession process to the European Union provided to the Romanian Government
a conceptual framework for the reform of the accounting, the financial auditing and
the financial reporting, represented by the community acquis. The acquis includes:
primary legislation (treaties), secondary legislation (directives, regulations, decisions,
recommendations, etc) and case studies.
The Accounting Advisory Board (CCC), which operated under the Ministry of
Finance and brought together representatives of the government, the regulatory
authorities, the accounting and auditing professions, the business environment and the
academics who showed interest in the financial reporting issues, was appointed to
develop a country action plan in order to improve the financial reporting in Romania.
The Council's activity aimed to increase the confidence of the users of accounting
information in the financial reporting and the corporate governance.
According to the GD no. 2170/2004, the country action plan to improve the financial
reporting in Romania is a detailed document which sets out the specific actions to be
completed in order to achieve the reform objectives.
This plan is a dynamic document, because it is based on the community acquis, which
is constantly evolving, and because Romania will change its ability to adopt and carry
out the reform as the objectives will be achieved.
In April 2004, the Accounting Advisory Board, with the World Banks assistance,
started to develop the Country Action Plan with the strategic goal The fulfillment of
the major accounting and auditing obligations, arising from the community acquis
prior to 2007 - the accession date.
Several alternative policies were identified in the Country Action Plan, including:
establishing a program to introduce the International Financial Reporting
Standards (IFRS), according to the implementation capacity;
a detailed definition of the public interest of the entities;
selecting the most appropriate model for setting up an independent oversight
body of the audit and the accounting field, as a whole;
the development of the professional training and the higher economic
education integration in the training programs reform.
~137~
After the first stage of implementing the Country Action Plan, which ended in
September 2005, the Financial Reporting Council has concluded that the areas of
interest are:
the insurance of the accounting and auditing Romanian legislation compliance
with the community acquis;
the implementation of the IFRS and the International Standards of Audit (ISA)
at the public interest entities, for the financial year ended at 31st of December
2006;
the improvement of the operational capacity of regulatory bodies;
the improvement of the oversight of the accounting and auditing professions,
the corporate governance and the public transparency, as outlined in the
community acquis, both at legislative level, as well as at the best practices in
the European Union level.
The implementation of the Country Action Plan implies a mix of short and medium
term projects.
According to the GD no. 2170/2004, the short-term objectives are:
setting up the Steering Committee for the implementation of the Country
Action Plan;
the amendment of the primary and secondary legislation;
improving the organization of the Accounting Advisory Board and the
operational capacity of regulatory institutions: MFP (Ministry of Finances),
BNR (National Romanian Bank), CNVM (Romanian National Securities
Commission) and CSA (Insurance Supervisory Commission);
the continuous improvement of the professional training;
the assessment of the ways to enhance the quality and the credibility of the
financial audit.
The long-term objectives are:
the compliance of the Romanian legislation with the accounting law based on
the IFRS and the European directives;
the completion of the secondary legislation for the capital market;
launching the implementation process to ensure an improved public
transparency of the financial statements of the listed companies and other
public interest entities;
improving the organization and the development of the best practices for the
professional bodies in the accounting and financial audit field.
The IFRS adoption determines a major change in the accounting language for the
public interest entities, as well as for the accounting consultants, the auditors and the
analysts in the financial accounting field. Moreover, this approach, which is a major
national one, will determine additional responsibilities for all the regulatory bodies.
The transition to the IFRS is not exclusively regarding the accounting field, but it has
much wider implications - from the basic activity planning to the strategic
management of the business entities. The adoption of IFRS requires the following
(CSA, 2006):
a new performance appraisal system;
~138~
improving the quality of information for management in order to adopt the

most appropriate decision;
increasing the competitiveness;
changing the whole basis of reporting.
For the investors, the implementation of the IFRS referential will lead to the increase
of the credibility of the information submitted by the companies, a better
understanding of the risks and benefits and to the comparability of the results
achieved by the companies activating in the same domain.
In the transition to the IFRS, Romania joined the pilot group of countries that carry
out the ROSC program for accounting and auditing. The ROSC program and its
component for accounting and audit are a part of the initiative to strengthen the
international financial architecture. The current international economic context, under
the sign of the global economic crisis, demonstrates the understatement of the
importance of the pillar represented by the accounting and auditing standards.
For Romania, the World Bank experts have made an initial assessment of the existing
regulations and practices in the accounting and financial audit, in 2003, and the
findings were presented in the ROSC report on accounting and auditing, published in
May 2003. At that time, Romania's progress in accounting in the recent years was
highlighted and a number of basic policy recommendations were formulated,
including: the harmonization of the laws and standards; the financial reporting of the
credit institutions, the insurance companies and the pension funds; the consolidated
financial statements disclosure; the accounting and auditing surveillance; the Chamber
of Financial Auditors of Romania (CAFR) independence; a twinning agreement for
CAFR to help the transfer of knowledge, education and professional training (World
Bank, 2003).
In 2003, the strategic objective of the Country Action Plan for improving the financial
reporting in Romania was the "Fulfillment of the major accounting and auditing
obligations, arising from the community acquis before 2007 - the accession date". In
order to achieve this goal, five basic objectives were formulated in the action plan, as
follows:
the compliance of the Romanian legislation in the field of accounting and
auditing with the community acquis;
the implementation of the IFRS and ISA for the public interest entities (PIE)
from the 1st of January 2006;
the improvement of the operational capacity of the insurance regulatory body
(CSA);
improving the operational capacity of the regulatory body of the capital market
(CNVM);
the improvement of the surveillance, the corporate governance and the public
transparency.
Although, in the recent years, Romania has made significant progresses in increasing
the quality of the financial reporting by implementing the National strategy for
improving the financial reporting of the private economic entities, in the ROSC report
on accounting and auditing, published by the World Bank experts in December 2008,
some issues to be corrected in the future were identified.
~139~
3. CURRENT PROBLEMS OF THE NATIONAL STRATEGY

FOR IMPROVING THE FINANCIAL REPORTING OF THE PRIVATE
SECTOR ENTITIES
As noted, one of the goals of the National Strategy for improving the financial
reporting refers to the compliance of the Romanian accounting with the applicable
European Union regulations.
At the EU level, by the Regulation no. 1606/2002 (the so-called IFRS Regulation), the
mandatory IFRS application for the elaboration of the consolidated financial
statements by the listed companies was agreed only for those IFRS approved at the
Community level, by the European Commission's regulations, starting the 1st of
January 2005. The Member States had the option of extending the scope of
application of the IFRS for other categories of companies, and for the individual
financial statements.
In what follows, we intend to present the sticking points, actual and potential, of the
National Strategy for improving the financial reporting of the private economic
entities, as identified by the representatives of the World Bank and the International
Monetary Fund in the ROSC report on accounting and auditing, published in
December 2008 (World Bank, 2008):
the process of setting the accounting regulations in Romania is supervised by the
Ministry of Finances, which issues the accounting regulations for the Romanian
trade sector. The main accounting rules are discussed in the Accounting and
Financial Reporting Council (CCRF), which brings together the key monitoring
bodies and the stakeholders interested in the Romanian financial and regulating
system. CCRF is chaired by the Ministry of Finances and includes
representatives from: BNR, CNVM, CSA, CSSPP (Private Pension System
Supervisory Commission), the Ministry of Justice, CAFR, CECCAR (The Body
of Expert and Licensed Accountants of Romania), academics and professional
associations for the commercial sector. However, CCRF doesnt bring together
representatives of the banking and insurance sector, any of those who elaborate
or use the financial statements or the technical staff of the member firms of the
international audit networks;
compared to the Ministry Order no. 94/2001, Accounting regulations
harmonized with the European directives and the International Accounting
Standards, the explicit reference to the IFRS referential was removed from the
Ministry Order no. 3055/2009, Accounting regulations in accordance with the
EU directives. The absence of an explicit reference to the IFRS, when the
Romanian Accounting Regulations dont provide detailed guidance, is seen by
the accounting and auditing professions and by those who prepare the financial
statements as a problem. According to the Ministry Order no. 94/2001, the
IAS/IFRS referential was applied when no other specific treatment was
indicated. In the content of the Ministry Order no 3055/2009, there is no explicit
reference to the IFRS.
if the banks and the listed companies prepare consolidated financial statements
according the IFRS approved by the European Commission, the banks and the
listed companies without subsidiaries are not required to prepare financial
statements in accordance with the approved IFRS. This reality leads to a
potential lack of comparability between the listed entities and the banks: while
~140~
the parent companies prepare the consolidated financial statements according to

the IFRS, other banks and listed companies without subsidiaries prepare the
financial statements according to the Romanian accounting regulations;
according to the Accounting law no 82/1991, the insurance companies prepare
the consolidated financial statements using either the approved IFRS or the
Romanian accounting regulations in the insurance sector, which is a
transposition of the Insurance Accounts Directive. For 2006, the Romanian
insurance companies didnt prepare the consolidated financial statements in
accordance with the IFRS. The CSA should require all the insurance companies
to publish their financial statements prepared in accordance with the approved
IFRS, because they are public interest entities. Moreover, the CSA should allow
the insurance companies to supplement the provisions of the IFRS 4 Insurance
Contracts with other accounting standards. Currently, the IFRS 4 Insurance
Contracts is incomplete and some insurance companies include provisions of
U.S. GAAP in their accounting policies, to the extent they are consistent with
the IFRS 4;
the Emergency Ordinance no. 90/2008 on the statutory audit introduced a
system of public oversight by the establishment of the Public Oversight Board
of the Statutory Audit Activity (CSPAAS), which will have to undertake
external quality assurance for the statutory auditors and the audit firms that audit
public interest entities;
although the CECCAR and CAFR professional bodies have changed in the
recent years the governing principles, the agreements and the governance
practices, they are not fully understood or known. Therefore, an independent
person should conduct a review of the governance arrangements of both
professional bodies;
particular attention should be paid to the program of quality assurance and
review, initiated by CAFR in 2003: the department of monitoring and
professional competence activates with 7 hired persons (5 inspectors and 2
assistant inspectors) under the responsibility of an authorized inspector. The
inspectors were intensively trained on the IFRS and ISA issues by experts from
the Institute of Chartered Accountants of Scotland (ICAS). However, the work
quality reviews take, on average, only one or two days and are conducted by
inspectors who dont have significant experience in auditing. Two of the
inspectors are students of ACCA (Association of Chartered Certified
Accountants) and the other five are qualified financial auditors. Although the
inspectors from the CAFR monitoring department have received adequate
training, their minimal professional experience as auditors, is a shortcoming that
cant be neglected. The lack of practical experience in auditing could affect their
ability to review the audit working papers, especially when reviewing the audit
working papers for banks or insurance companies. One solution would be to
include auditors with experience in these areas in the monitoring teams, on an ad
hoc basis. Furthermore, the average time allocated to the review and quality
assurance activities in the field of the financial audit varies from one to two
days. The period of time for the individual controls must be extended
significantly for a better quality review of the audit work performed by the
auditors. In the coming years, CAFR could consider limiting the frequency of
checking the work of auditors who are not involved in the public interest
entities, to only once every six years, in favor of improving the quality of
reviewing the work of the auditors inside the public interest entities. According
~141~
to the 8th Directive, as amended, the auditors of public interest entities should
be checked at least once at every three years;
the small number of specialists in accounting and financial audit, as required by
IFRS, is doubled by a lack of skilled graduates in accounting. Traditionally, the
audit firms staff rotation is very high and it often happens that a graduate, who
has only two years of experience within a member firm from an international
network of audit firms, to be offered a manager position in the financial or
accounting department. Therefore, there is a clear need for the Romanian
universities to demonstrate their ability to produce graduates able to meet new
market requirements;
the consultation process for issuing the accounting and auditing regulations
could be improved. In Romania, there is a lack in terms of implementing an
effective process of consultation with those who prepare the financial
statements, the auditors and the users of financial statements. It is possible that
the consultation process is not efficient as long as the entities feel that their
opinion does not influence the body that regulates and supervises their activity;
in Romania, both the CAFR and CECCAR independently translated all the ISA
and the IFAC Code of Ethics in the relative context of their own activities. A
single quality translation of the ISA and the IFAC Code of Ethics for Romania
would reduce the confusion about the source and availability of the applicable
standards and would eliminate the differences of terminology that may exist in
the multiple translations. The multiple translations are a waste of resources and
are a good example for the lack of cooperation between the two professional
bodies. In the following period, a real cooperation between CAFR and
CECCAR is needed in order to avoid the multiple translations and to agree on
the terminology used;
although the auditors are the subject to some civil, disciplinary, administrative
and criminal sanctions, in Romania legal actions against auditors were not
initiated;
in general, the surveillance bodies focus more on monitoring the prudential
criteria than on the financial reporting, as follows:
the focus of the monitoring department of the CSA appears to be more on
the prudential requirements than on the financial reporting. No case of
infringement of the financial reporting requirements was communicated or
published;
the monitoring unit of the CNVM, which reviews the financial statements of
listed companies, include six people who were prepared, particularly on
IFRS, under a project funded by the European Union, in particular IFRS
(Phare 2005 "The strengthening of the institutional capacity of CNVM).
The monitoring unit began its activity in May 2008 and, among other duties,
it reviews the consolidated financial statements of the listed companies
prepared according to the approved IFRS. The quick implementation of the
knowledge acquired in the EU project, to ensure an effective review of the
financial statements in accordance with the IFRS, challenged to the newly
established unit. Although the penalties stipulated by the securities law
include the civil liability of those who prepare the financial statements, the
directors and the auditors, no action has been reported in court till now. The
Bucharest Stock Exchange reviews the financial statements of the listed
companies to see if they have the complete documentation, but in the
absence of an overall review of the annual reporting, including the financial
~142~
statements and the audit report, it doesnt assess the quality of the
information provided by them. Furthermore, the CNVM is required to
monitor and implement the financial reporting of the listed companies. The
CNVM has never asked about the restatement of the financial statements and
has limited only to setting fines for their late filing;
the Romanian Accounting Regulations provides little or no information about
the matters covered by the following IFRS: IFRS 2, Share-based payment;
IFRS 6, Exploration for and evaluation of mineral resources; IFRS 8, Operating
Segments; IAS 40, Investment Property and IAS 41, Agriculture.
Although Romania has implemented the relevant accounting directives, the absence of
many necessary elements for supporting the infrastructure, combined with the
Romanian tradition of the rules-based accounting, is challenging in terms of ensuring
that the principles set out in EU legislation are applied in a such a manner that the
quality the financial reporting is ensured.
The International Financial Reporting Standards are based on concepts and not on
rules, calling for the professional reasoning of the accountants and the auditors. At the
same time, in obtaining financial information, the emphasis is placed on the
evaluation before the accounting recognition of a transaction, but also on the principle
of materiality and on the cost-benefit ratio. All these requirements were new
approaches to the Romanian accounting since the passage to the international
financial reporting standards, even if a partial one, involved not merely a change in
the accounting rules but a whole process of change at the companys level (Jianu et
al., 2009).
Studies that have been conducted in Romania in the recent years on the opening of the
economic entities to the accounting based on IFRS show the reluctance of the
majority towards the reform of the financial reporting system in this direction, the
main justification being related to charging the companies with additional costs (costs
of audit, staff training costs, software costs etc).
A study conducted in 2009, shows the reluctance of most professional accountants
involved in the research to the reform of the financial reporting, based on the
philosophy of IFRS: 84.8% of the respondents considered that the harmonization of
the Romanian accounting regulations the IFRS for the large firms during 2000-2005,
was purely dictated by political decision. Only 12.1% of the respondents saw in the
process of harmonization of the Romanian accounting regulations with the IFRS
referential a necessity imposed by the development and the globalization of the capital
markets (Lapte and Popa, 2009). Regarding the delimitation of an area of application
of the IFRS referential in the Romanian accounting, we find, from the same study, the
following (Lapte and Popa, 2009):
45,4% of the respondents considered that the IFRS referential should be adopted
by all the economic entities;
only by the listed companies, both for the consolidated and the individual
financial statements;
only by the big companies by the public interest entities;
~143~
only by the entities that want choose so;
The other respondents consider IFRS referential is useful for the economic
entities that are interested in financing their activity from the international
market.
Another study, done in 2009, in the companies providing accounting and audit
services, referring to the opportunity of the IFRS referential implementation in
relation to the professional accountants level of training in this area, demonstrates that
at the implementation date most of the Romanian accounting professionals didnt
know this referential, the awareness degree being an alarming one, less than 20%.
Nowadays, 75% of the respondents who were the object of the research consider that
the accounting professionals master the IFRS referential, but the other respondents,
25%, believe that the Romanian accounting professionals are not ready to apply the
IFRS referential (Jianu et al., 2009).
The training of the staff involved in the IFRS application is a long-term goal. The
public interest entities must train their own experts, because, presently, there arent
enough experts on the IFRS application. On the other hand, the IFRS are in a
continuous development process which involves a continuous training of the
professional accountants.
In Romania, although there were some progresses compared to 2003, the quality
assurance system and the enforcement mechanisms for the general purpose financial
statements and the audit requirements are still insufficient. For example, the system
adopted by the CAFR in order to ensure the quality is operational, but the monitoring
team, which includes five professional auditors, lacks the experience and the
professional skills in auditing, especially in the financial sector. The Chamber of
Financial Auditors Romania needs to significantly improve the monitoring team and
the quality assurance system in order to achieve the objectives set by the 8th Directive
(World Bank, 2008).
In this respect, in Romania, a Strategy for the public oversight of statutory audit work
was developed in 2010, being initiated by the Public Oversight Board of the Statutory
Audit Activity (CSPAAS), an organization founded in 2008 by the transposition of
the Directive 2006/43 / EC. The key strategic objective of the CSPAAS is to promote
and to follow the increase in the public confidence in the statutory auditing of the
annual financial statements and the consolidated financial statements (CSPAAS,
2010).
If the Romanian National Bank monitors and adopts the financial reporting
requirements applicable to the banks and the non-banking financial institutions, the
insurance supervisory bodies havent published any example of application of the
financial reporting requirements. In this context, the effectiveness of the Insurance
Supervisory Commission (CSA) in monitoring the quality of the general purpose
financial statements issued by the insurance companies becomes questionable.
~144~
The Insurance Supervisory Commission (CSA) welcomed the following approach to

the national strategy for the transition to the IFRS implementation by the insurance
companies (CSA, 2006):
starting from the financial year 2007, the insurance companies listed on a
regulated market or being prepared for listing at the balance sheet date, and
which elaborate consolidated financial statements, had to elaborate such
financial statements according to the IFRS;
for the financial years of 2008 and 2009, the insurance companies had to prepare
annual and consolidated financial statements according to the IFRS, as the
second set of financial statements for the information needs of the CSA, the
market and other categories of users;
based on the assessments made referring to the IFRS application in the
individual financial statements, a decision was going to be adopted regarding the
possibility of elaborating the financial statements of insurance companies
according to the IFRS, as a single set, since 2010.
For the economic entities in the insurance sector, the IASB decided to implement a
specific standard for this activity, which will be gradually applied over two-stages. In
the first stage, this specific standard was not used, the applicable principles being
those provided by: IAS 32, Financial Instruments: Disclosure and Presentation, IAS
39, Financial Instruments: Recognition and Measurement and the IFRS 4, Insurance
Contracts. The second phase ended in the late 2010 with the adoption of the specific
standard to the insurance domain (CSA, 2006).
On the other hand, the unit responsible for monitoring the listed companies, set up
inside CNVM, began its activities in May 2008 and is challenged to review the
consolidated financial statements prepared in accordance with the International
Financial Reporting Standards.
Moreover, the Romanian National Bank, by the BNR Order no. 9/2010 on the
application of the International Financial Reporting Standards by the credit
institutions, as a basis of accounting, decided the elaboration of the annual individual
financial statements in accordance with the IFRS starting from the fiscal year 2012.
In conclusion, in Romania, the national strategy for improving the financial reporting
of the private economic entities is mostly based on the elaboration of the individual
annual financial statements of the public entities under the IFRS referential, but the
experience of the recent years demonstrates unequivocally that in our country, there
are some difficulties in implementing the IFRS, as follows (Toma, 2010):
the misinterpretation of the IFRS or the terminology problems, sometimes
generated by the translation errors or the multiple translations;
the confusion that occurs between the standards and the regulations; wrongly,
we come to equate the two concepts, even if they are different issues: the
standards have a recommendation character, they arent mandatory and are
issued by non governmental bodies, while the regulations are mandatory and are
issued by government institutions;
the IFRS nature is another issue for the Romanian accounting professionals:
when reading an International Financial Reporting Standard, the Romanian
accounting specialists are particularly concerned about the accounting
~145~
investigation, rather than the elements regarding the accounting information

disclosure in the financial statements;
the financial reporting refers to the general financial statements, the same way
the IFRS treat this subject, while the accounting regulations in Romania
laconically question the general financial reporting;
the confusion connected to the applicability of the IFRS: the international
financial reporting standards are issued in order to be applied by the economic
entities and cant be brought to a governmental level in order to consolidate a
nationally centralized accounting;
the relationship between taxation and accounting, which is not settled at the
European level, because two issues can be identified in this area: first, issues of
cost, generated by drawing two sets of financial statements, second, drawbacks
related to the reliability (when information from balance sheets prepared
according to different accounting referentials are read, it's hard to believe that no
question was raised: what are the actual results?);
internationally and nationally no clear import pattern of the IFRS emerged:
taking over the IFRS, adopting some national standards of financial reporting or
setting up of national standards based on the IFRS principles?;
difficulties in applying the IFRS for the small and medium enterprises,
considering that in the Romanian law these entities are not clearly defined small
and medium enterprises;
issues related to IFRS implementation costs, while the Romanian state is facing
difficulties in applying the international financial reporting standards in the
public sector system;
in the context of implementing the IFRS, the human factor, that is the
accounting professional, should not be neglected, considering that at his level,
possible training, ethical and professional reasoning issues can be identified, due
to his universally recognized subordination to the taxation.

The accounting professionals have repeated on various occasions that, nowadays, the
accounting community is driven by the strong desire of standardization and
harmonization of the international accounting practices and, more recently, of
convergence in the accounting field, in order to increase the comparability and the
credibility of the information disclosed in the financial statements.
In order to achieve these aims, the national standard setters must give their input into
draft IFRS pronouncements in order to ensure that IFRS meet the needs of the
stakeholders in their countries and to contribute to the thought process as to how to
develop the best accounting and financial reporting solutions (FEE, 2009).
Since 1990, the Romanian accounting theory and practice is in a constant search for
an identity. Since then we have witnessed the "import" of accounting solutions that
have been transformed into genuine referentials that helped us to react in every
moment of change.
Year 2000 was for the Romanian accounting the beginning of a large process of
reconstruction, especially in the conceptual field. Furthermore, as the accounting
~146~
reform went ahead the economy reform, the supply of accounting information did not
follow, but anticipated the demand.
Since 2001, with the adoption of the Ministry Order no. 94/2001, Romania
experiences the implementation of the IFRS referential and, presently, a national
Strategy of improving the financial reporting of the economic entities is now outlined.
It remains to be seen whether, contrary to all the difficulties, the path that we intend to
follow, will lead to the increase of the quality and the reliability of the financial
reporting of the economic entities. Certainly, an important role in achieving this goal
belongs to the accounting professional, whose difficult mission is to keep up with the
frequent reconsiderations of the accounting rules, largely decided at the international
level.
This is another step taken in achieving a final goal of developing a functional model
for optimizing the national strategy regarding the financial reporting of the Romanian
private entities.
ACKNOWLEDGEMENTS
This research was financed through the research contract in partnership CNMP 92085/2008, Development of a functional model for optimizing the national strategy
regarding the financial reporting of the Romanian private entities.
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in order to improve the financial reporting in Romania and some measures for the
organization of the Accounting Advisory Board
GD 401/2005 for setting up the Accounting and Financial Reporting Council by the
reorganization of the Accounting Advisory Board
Regulation no. 1606/2002 of the European Parliament and the Council on the 19th of July
2002 regarding the application of the international accounting standards
Directives, Regulations and other official acts available on-line at http://ec.europa.eu/
internal_market/accounting/officialdocs_en.htm, accessed on March 28, 2011
~148~
PS3 Financial analysis I

Chairperson
Petru OPRIS, West University of Timioara, Romania
FINANCIAL RATIOS AND MARKET VALUATION ON

EMERGENT MARKETS: THE ROMANIAN CASE
Bogdan DIMA, Petru OPRIS
A HYBRID DEVICE OF SELF ORGANIZING MAPS

(SOM) AND MULTIVARIATE ADAPTIVE REGRESSION
SPLINES (MARS) FOR THE FORECASTING OF FIRMS
BANKRUPTCY
Javier de ANDRES, Fernando SNCHEZ-LASHERAS,
Pedro LORCA, Francisco Javier DE COS-JUEZ
THE RELEVANCE OF COMPANY EVALUATION

METHODS IN CONDITIONS OF ECONOMIC
INSTABILITY. EMPIRICAL STUDY
ON THE COMPANIES QUOTED IN THE BUCHAREST
STOCK EXCHANGE
Marilena MIRONIUC, Mihai CARP, Ioan-Bogdan ROBU
FINANCIAL RISK ANALYSIS AT THE STOCK

EXCHANGE LISTED COMPANIES IN THE
PASSENGER ROAD TRANSPORTATION INDUSTRY
Vlad IORDACHE, Vasile ROBU, Costin CIORA
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FINANCIAL RATIOS AND MARKET VALUATION ON

EMERGENT MARKETS: THE ROMANIAN CASE
Bogdan DIMA1 & Petru OPRIS
West University of Timioara, Romania
ABSTRACT
We are investigating the predictive relevance of the issuers financial ratios for the financial
instruments market prices. Using a sample of Romanian companies listed at Bucharest Stock
Exchange we are finding in a GMM- System framework that even in short run (5 years) there
is some room for considering such relevance. This result suggests that the standard finding in
literature according to which financial ratios usually displays weak predictive power in short
horizons and some predictive power in long horizons should be more clearly analyzed in the
context of the recent economic and financial instability..
KEYWORDS: Financial ratios; Returns predictability; Fundamentals; Market value;

GMM-System estimators
INTRODUCTION
We are testing the relevance of the financial ratios for the formation of stocks prices
on an emergent capital market such the Romanian one. Are these prices connected
with the fundamental variables linked to the issuers financial situation? Is there a
transmission process between the changes in this situation and prices adjustments? Is
this relevant for the valuation literature?
The key point is that both accounting data and share prices have as purpose to reflect
value (capital) and change in value (profit). Thus, one important issue arises when
questioning about the existence of relationship between these two and timing (lags
due to need for finishing reporting period).
The current stage of the research in this field is resumed by Cochrane (2001:388) as:
Returns are predictable. In particular, (a) Variables including the dividend/price ratio
and term premium can in fact predict substantial amounts of stock return variation.
This phenomenon occurs over business cycle and longer horizons. Daily, weekly, and
monthly stock returns are still close to unpredictable .
However, this conclusion is criticized from several directions. For instance, it was
observed that in testing the connections between the descriptors of the issuers
financial architecture and the evolutions of prices the statistical inference is
problematic since the highly persistent set of financial ratios displays frequently near-
Correspondence address: Bogdan DIMA, West University of Timioara, Romania;

email: bogdan.dima@feaa.uvt.ro, http://www.feaa.uvt.ro
~150~
to-unit root properties. Thus, there can appear uninformative inferences on predictive
relations (Valkanov, 2003; Lewellen, 2004).
Another observation underlines the fact that the process by which the
contemporaneous stock price reflects value relevant information (both accounting and
non-accounting) remains unchanged over time. In our opinion, this is a critical
hypothesis, since it is equivalent with the absence of any learning process in the
investors decisions, process that would be able to guide the adjustments in the
construction and management of financial assets portfolios. If this is presumed, then
it is possible to take into account more sophisticated inter-linkages between the
evolution of stocks and the financial performance of their issuers. A direct testable
consequence for such inter-linkages could be the manifestation of non-linear
connections between prices dynamics and the content of the financial statements. In
this sense, there are recent empirical evidence showing convexity in the relationship
between prices and accounting information. Empirical tests, although exploratory,
provide further evidence of a nonlinear relation between stock price and accounting
measures of earnings and book value (see, for instance, Riffe and Thompson, 1998).
In the mean time, it is not completely clear how much predictive power can be
attributed to financial ratios.
Summers (1986), Fama and French (1988), and Campbell and Shiller (1989, 2005)
suggest a simple theory of slow mean reversion to explain the predictive power. That
is, stock prices cannot drift too far from their fundamentals (e.g., dividend, earnings,
and book value) in the long run. The theory of slow mean reversion requires financial
ratios to be stationary.
As Chang et al. (2008) notes The phenomenon of the mean-reversion discussed from
the literature explore whether the stock price followed random walk. If the stock
prices violate the trend of random walk, one possibility is the stock prices followed
mean-reversion process. If the stock prices followed mean reversion in the long-run,
the price movements should be predictable from the movements in firm fundamental
values. In this sense, determining whether stock prices are mean-reversion is a very
important issue for investors. Consequently, to analysis equity fundamentals, what is
important is to verify whether the stock price moves with its firms fundamental.
Lamont (1998) argues that fundamentals predict returns in the short run, while prices
predict returns in the long run. Supplementary, the prediction relation between returns
and financial ratios appears to suffer from structural instability over time. Especially,
in the late 1990s, the prediction relation seems not robust (see, Goyal and Welch,
2003; Paye and Timmermann, 2006; Lettau and Van Nieuwerburgh, 2008).
Also, it should be considered the argument advanced by Lettau and Van
Nieuwerburgh (2008) who are suggesting that the puzzling empirical patterns in
return prediction are caused by the changes in the steady-state mean of financial ratios
and are estimating regime-switching models for the steady-state mean of financial
ratios.
Guan (2010) noticed that firm financial ratios can help identify stocks that outperform
other stocks during recessions, even after controlling for firm characteristics such as
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size, book-to-market ratio and past returns. Using a parsimonious composite score
based on the unadjusted and industry-adjusted financial ratios, firms with high scores
earn 1.29% per month more than firms with low scores during recessions. The return
differences are smaller but significantly negative during expansions. The strong
predicting power of financial ratios is not due to its ability to predict the beta (since
the high score firms and low score firms have similar betas). The findings suggest that
financial ratios provide valuable incremental information about stock systematic risk
at the business cycle frequency besides the size, book-to-market, momentum
characteristics and betas.
However, the emergent capital markets are characterized by lower levels of financial
instruments liquidity, imperfect transaction mechanisms, frequent situations of
information asymmetry and fragile institutional framework.
In this context, the objective of this study is to seek for some empirical evidences if or
if not there is an even limited predictive capacity of the issuers financial status
descriptors on emerging markets by examining a set of data for some companies
which are quoted on Bucharest Stock Exchange in order to identify if the financial
ratios are significant and positively correlated with the evolution of market values.
The paper is organized as follows: Section 2 describes the methodology. Section 3
reports on the data used for the empirical tests and on the results of these tests. Some
conclusions are formulated and some future research analytical directions are
indicated in Section 4.
1. METHODOLOGICAL FRAMEWORK
An initial step of our methodological approach consists in testing the relevance of the
financial ratios for the market values of the companies. If these ratios appears to be
connected to the dynamic of market values, then it can be argued that there
information content is relevant for the decisions of investors to incorporate the
financial instrument issued by the considered companies in their portfolio. In such
case, the market value is performance-driven and reflects some relevant fundamental
determinants of issuers financial situations.
Thus, we run preliminary regressions as:
C lo se i , t = 0 + i X i , t + t + i + i , t
(1 )
Here, the dependent variation of market daily close prices (CLOSE) is linked to
individual X financial ratios. i is the unobserved time-invariant specific effects; t
captures a common deterministic trend; it is a random disturbance assumed to be
normal, and identical distributed (IID) with E (it)=0; Var (it) =2 >0 .
In order to estimate the involved parameters, we apply the so-called GMM-System
estimation. The GMM-System methodology as proposed by Arellano and Bover
(1995), Blundell and Bond (1998, 2000) and Windmeijer (2005) - is involved because
estimators like fixed and random effects, IV or standard GMM may yield to biased
results. Also, since a small panel sample may produce downward bias of the
estimated asymptotic standard errors in the two-step procedure (Baltagi, 2008: 154),
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we use the Windmeijer correction for the estimated standard errors. More exactly,
Windmeijer (2000, 2005) observes that part of downward bias which can appear for
the standard errors in small samples is due to extra variation caused by the initial
weight matrix estimation being itself based on consistent estimates of the equation
parameters. In order to correct this bias, it is possible to calculate bias-corrected
standard error estimates which take into account the variation of the initial parameter
estimates. We employ a version of this correction applicable for GMM models
estimated using an iterate-to-convergence procedure.
There are several advantages of the GMM-SYS over other static or dynamic panel
estimation methods. Among these: static panel estimates, as the OLS models, are
subjected to the problem of dynamic panel bias (Bond, 2002); in our database, we
have 12 companies (N) analyzed over a short time span of 5 years (T) and the
literature includes several arguments for dynamic panel model being specially
designed for a situation where T is smaller than N in order to control for dynamic
panel bias (Bond 2002; Baltagi 2008); the problem of the potential endogeneity can be
easier addressed in dynamic panel models than in static and OLS models, since all
variables from the regression which are not correlated with the error term (including
lagged and differenced variables) can be potentially used as valid instrumental
variables; the dynamic panel model is able to identify short and long-run involved
effects (Baltagi 2008). Also, the GMM-System exploits the stationarity restrictions,
while the first-differenced GMM estimator can behave poorly when the time series
are persistent.
The GMM-System tries to simultaneous estimate the Equation 1 together with a respecification designed to eliminate the company-specific effects by using first
differences of the involved variables as:
C lo se i , t = i X i , t + t + i + Z i , t + i , t
(2 )
Z is a set of instruments for the dependent and explanatory variables. The systemGMM approach estimates equations (1) and (2) simultaneously, by using lagged
levels and lagged differences as instruments. The presence of both lagged levels and
differences is justified by Arellano and Bover (1995) and Blundell and Bond (1998)
which showed that lagged levels can be poor instruments for first-differenced
variables, particularly if the variables are persistent. For comparison purposes, we
are reporting the results of a dynamic GMM (Arellano and Bond, 1991).
Further, the financial ratios that individually appear to be relevant for the formation of
market prices can be aggregated in a single indicator of issuers financial conditions
for instance by using the Principal Components Analysis applied on these ratios.
This procedure models the variance structure of a set of observed variables using
linear combinations of the variables. These linear combinations (components) may be
used in subsequent analysis, and the combination coefficients (loadings) can be used
for a subsequent interpretation of the components. The global indicator is constructed
by weighting the individual disclosure dummies with these loadings. Details on the
procedure are provided in Appendix. We are involving such approach since: (a) this is
a procedure of reducing the number of observed variables to a smaller number of
principal components which account for most of the variance of the observed
~153~
variables; (b) we are expecting the financial ratios to be highly correlated; (c)
component scores are a linear combination of the observed variables weighted by
eigenvectors and thus allows for considering the relative importance of individual
variables. Such global indicator is designed to be use for an overall assessment of the
impact exercised by the financial ratios on market values.
2. DATA AND EMPIRICAL RESULTS
2.1. Romanian capital market data
Our dataset consists in 12 companies from the first tier of the Bucharest Stock
Exchange over a time span between 2005 and 2009. These stocks have a maximal
degree of liquidity and are forming a significant fraction of the market. The variables
reflect the annual close prices, the business turnover, two liquidity ratios, the net
treasury ratio and the dividends per share. In our opinion, such financial ratios are
susceptible to capture in a synthetic manner the financial situations of the issuers as
well as the returns obtained by the investors. Consequently, these ratios are
presumably relevant for investment decisions even on an imperfect market such as the
Romanian one with slow prices adjustment mechanisms and their effects on longer
market cycles.
The data are provided by Bucharest Stock Exchange and represents the (log) last close
of the year indexes as dependent variable and a set of financial ratios computed based
on the financial statements of the issuers as explicative variables.
Table 1 reports on the main statistic characteristics of the data. The data displays nonnormal distributions with significant fat-tails effects. The values of the dispersion as
well as the parameters of the distribution suggest the possibility of some significant
outliers in for the observation period.
Table 1. Main statistic characteristics of data (yearly values; variation, %)
Close prices Current liquidity ratioQuick ratio Net treasury ratio Dividends per share
Mean
62.65
96.37
119.06
24.44
-1.37
Median
30.00
-2.60
2.46
-0.23
0.00
Maximum
2145.22
2843.53
2430.21
1673.31
270.59
Minimum
-94.05
-99.00
-99.07
-627.93
-100.00
Std. Dev.
287.44
421.74
468.11
275.25
63.07
Skewness
6.59
5.49
4.16
3.49
1.77
Kurtosis
48.35
33.97
19.23
23.63
9.00
Jarque-Bera
5482.73
2653.52
818.20
1165.79
119.37
Number of observations
60
60
60
60
60
Such potential heterogeneity requires an adequate methodology for dealing with the
induced bias in data and can be viewed as a supplementary argument for the involving
of the GMM-System approach.
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2.2. Results
Our preliminary evaluation reported in Table 2 indicates that all the considered
financial ratios are significant and positively correlated with the evolution of market
values.
Table 2. Market value of shares and financial ratios of issuers
Explanatory
Current liquidity ratio =
Total current assets /
Total current liabilities
1.03*** (0.28)
Quick ratio =
(Cash and short term investments+
Total receivable, net) /
0.99***(0.27)
0.25* (0.14)
Net treasury ratio =

Treasury, net / Total Assets
Dividends per share
M1
M2
Sargan
Observations (balanced)
0.98***(0.33)
-2.42[0.02]
1.49[0.14]
[0.74]
(Df=14)
48
-1.90[0.06]
1.23[0.22]
[0.77]
(Df=14)
48
-2.14[0.03]
0.42[0.68]
[0.64]
(Df=14)
48
-1.65[0.10]
-0.52[0.68]
[0.61]
(Df=14)
48
Standard errors (heteroskedasticity corrected) are in round brackets. The null that each
coefficient is equal to zero is tested using the second-step robust standard
errors.***/**/*- statistically significant, respectively at the 1%, 5%, and 10% level.
M1 and M2 are tests for first-order and second-order serial correlation in the firstdifferenced residuals, asymptotically distributed as N(0,1) under the null hypothesis
of no serial correlation (based on robust two-steps GMM estimators). Sargan is a test
of the over-identifying restrictions, asymptotically distributed as 2, under the null of
instruments validity (two-steps estimators).
Thus, the considered financial ratios can be viewed as providing for the investors a
synthetic description of the issuers performances and financial health as well as the
dividend policies. Based on their informational content, the investors can evaluate the
financial risks associated with holding and trading the stocks and, in caeteris paribus
conditions, the associated returns.
Consequently, Table 3 displays the results of a Principal Components Analysis on the
individual ratios in order to provide such a synthetic descriptor of the issuers
financial status.
The first section of Table 3 summarizes the eigenvalues, showing the values, the
forward difference in the eigenvalues and the proportion of total variance explained.
Since we are performing principal components on a correlation matrix, the sum of the
scaled variances for the four ratios is equal to 4. The first principal component
accounts for 55% of the total variance while the second accounts for 28% of the total.
The first two components account for over 83% of the variation.
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The second section describes the linear combination coefficients. One can notice that
the first principal component (labeled PC1) is a linear combination of all four ratios.
Thus, it might reasonably be interpreted as a global financial situation indicator. The
second principal component (labeled PC2) has negative loadings for the dividends
per share and it appears to represent an indicator of financial architecture descriptors
(without the investors remuneration component).
Table 3. Principal Components Analysis for financial ratios
Number
Value
Difference
Proportion
Cumulative
value
Cumulative
proportion
1.00
2.20
1.08
0.55
2.20
0.55
2.00
1.12
0.52
0.28
3.31
0.83
3.00
0.60
0.51
0.15
3.91
0.98
4.00
0.09
---
0.02
4.00
1.00
PC 1
PC 2
PC 3
PC 4
Eigenvectors (loadings):
Variable
Current liquidity ratio =
Total current assets /
0.64
0.00
-0.27
-0.72
Quick ratio =
(Cash and short term
investments+ Total receivable, net) /
0.64
0.00
-0.33
0.70
Net treasury ratio =

Treasury, net / Total Assets
0.29
0.71
0.63
0.03
Dividends per share
0.30
-0.70
0.65
0.03
Included observations: 59; balanced sample (listwise missing value deletion);

computed using: Spearman rank-order correlations; extracting 4 of 4 possible
components
For an evaluation of the first principal component in its hypostasis of overall indicator
of issuers financial situations and dividends policies, we run separate testing
regressions with the indicator against close prices as well as against business
turnovers (Table 4 and 5).
Table 4. Market value of shares and financial situation indicator
Explanatory
Close prices(t-1)
Financial situation of issuers
M1
M2
Sargan
GMM-DIF
-0.12*** (0.04)
39.40*** (4.07)
[0.30]
(Df=12)
35
GMM-SYS
-0.20** (0.09)
42.71*** (11.75)
-1.87 [0.06]
1.23[0.22]
[0.82]
(Df=14)
48
~156~
instruments validity (two-steps estimators). White period instrument weighting
matrix and White period standard errors & covariance (no degree of freedom
correction) are used for dynamic GMM. Transformation of the data in GMM-System:
Orthogonal deviations method.
Table 5. Business turnover and financial situation indicator
Explanatory
Business turnover(t-1)
Financial situation of issuers
GMM-DIF
-0.28*** (0.06)
9.50*** (1.47)
M1
M2
Sargan
[0.33]
(Df=12)
35
GMM-SYS
0.13(0.66)
14.16*** (3.88)
-2.16 [0.03]
-0.48[0.63]
[0.49]
(Df=10)
48
instruments validity (two-steps estimators). White period instrument weighting
matrix and White period standard errors & covariance (no degree of freedom
correction) are used for dynamic GMM. Transformation of the data in GMM-System:
Orthogonal deviations method.
The results of such regressions suggest that the financial status of the issuers matters
both for the formation of stocks prices as well as for the business dynamic of the
issuers. This outcome remains robust to the change in estimation methodology as well
as to the inclusion as control variables of the lagged values of dependent ones.
However, our empirical model does not incorporate a formal description of the
implied transmission channels and does not examine the possible implications for a
more accurate description of such channels of the dual impact on financial ratios on
prices and turnovers. Thus, a broader analysis should consider these issues and should
extend the set of explanatory variables.
The objective of the study is to seek for some empirical evidences if or if not there is
an even limited predictive capacity of the issuers financial status descriptors on
emerging markets by examining a set of data for some companies which are quoted
on Bucharest Stock Exchange in order to identify if the financial ratios are significant
and positively correlated with the evolution of market values.
~157~
Of course, there are some clear limits of the proposed analysis. Among them:
The limited number of issuers / financial ratios considered;
The heterogeneous structure of the data sample;
The short data span;
The possible disturbances induced by the nonlinear interactions among the
explanatory variables etc.
Further research directions should minimally: 1) considering an underlying
mechanism for the potential impact in the changes in financial status and policies
dividends at issuers level for both the market values and business turnovers; 2)
integrating a larger set of explanatory variables especially from the descriptors of
financial equilibrium and performances; 3) providing more conceptual explanations
for the signaling effects of the financial ratios and for their impact on investors
decisions.
Despite such caveats, it can be argued that even such a limited study can highlight the
existence of some signaling mechanisms through which the informational variables
describing the issuers financial status can affect the prices even in a case of an
emergent market with significant informational imperfections such as the Romanian
one.
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Goyal A., Welch I., (2003) Predicting the Equity Premium with Dividend Ratios,
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~159~
APPENDIX
Principal Component Analysis
Principal components analysis is a variable reduction procedure. Thus it is similar in
many respects to exploratory factor analysis but there are significant conceptual
differences between the two procedures. Perhaps the most important of these
differences deals with the assumption of an underlying causal structure: factor
analysis assumes that the co-variation in the observed variables is due to the presence
of one or more latent variables (factors) that exert causal influence on these observed
variables. In contrast, principal component analysis makes no such special
assumptions about an underlying causal model and allows for analysis of more
various empirical situations. Its central idea is to reduce the dimensionality of a set of
interrelated variables, while retaining as much as possible from the variation which is
present in dataset. The procedure is currently widely applied from climatology to
economics, genetics, psychology or quality control (see for details Jolliffe 2002).
This type of analysis models the variance structure of a set of observed variables by
using linear combinations of the variables. These linear combinations, or components,
may be used in subsequent analysis, and the combination coefficients, or loadings,
may be used in interpreting the components.
The principal components of a set of variables are obtained by computing the
eigenvalue decomposition of the observed variance matrix. The first principal
component is the unit-length linear combination of the original variables with
maximum variance. Subsequent principal components maximize variance among
unit-length linear combinations that are orthogonal to the previous components.
From the singular value decomposition, a (nxp) data matrix Y of rank r could be
represented as:
Y = UDV '
( a.1.)
U and V are orthonormal matrices of the left and right singular vectors, and D is a
diagonal matrix containing the singular values.
More generally, one could write:
( a.2.)
Y = AB '
A is an (nxr), and B is a (pxr) matrix, both of rank r, and
A = n 2 UD1
B=
n 2 VD
( a.3.)
Thus 0 1 is a factor which adjusts the relative weighting of the left

(observations) and right (variables) singular vectors, and the terms involving are
scaling factors where {0, } .
The basic options in computing the scores A and the corresponding loadings B involve
the choice of (loading) weight parameter and (observation) scaling parameter .
In the principal components context, let be the cross-product moment (dispersion)
matrix of Y, and let perform the eigenvalue decomposition:
= LL'
( a.4.)
Here L is the pxp matrix of eigenvectors and is the diagonal matrix with
eigenvalues on the diagonal. The eigenvectors, which are given by the columns of L,
are identified up to the choice of sign. It could be observed the facts that since the
eigenvectors are by construction orthogonal, L' L = LL' = I m .
1
There could be done some settings as U = YLD 1 ,V = L , D = (n ) 2 , so that:
A = n 2 YLD
B = n 2 LD
( a.5.)
A can be interpreted as the weighted principal components scores, and B as the
weighted principal components loadings.
Others detail of this procedure concerns an appropriate choice of the weight parameter
and the scaling parameter through which different scores and loadings with
various properties could be constructed.
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A HYBRID DEVICE OF SELF ORGANIZING MAPS

(SOM) AND MULTIVARIATE ADAPTIVE REGRESSION
SPLINES (MARS) FOR THE FORECASTING OF FIRMS
BANKRUPTCY
Javier de ANDRS1, Fernando SNCHEZ-LASHERAS,
Pedro LORCA & Francisco Javier de COS JUEZ
University of Oviedo, Spain
ABSTRACT
This paper proposes a new approach to the forecasting of firms bankruptcy. Our proposal is
a hybrid method in which sound companies are divided in clusters according to their
financial similarities and then each cluster is replaced by a director vector which summarizes
all of them. In order to do this, we use Self Organizing Maps (SOM). Once the companies in
clusters have been replaced by director vectors, we estimate a classification model through
Multivariate Adaptive Regression Splines (MARS). For the test of the model we considered a
real setting of Spanish enterprises from the construction sector because of the importance of
this branch of activity in the Spanish economy. It is also remarkable that in our dataset the
proportion of distressed firms is very close to that which is derived from Economic statistics.
With this procedure we intend to overcome the sampling-bias problems that matched-pairs
models often suffer.
KEYWORDS: Bankruptcy, Self Organized Maps (SOM), Multivariate Adaptive Regression

Splines (MARS), Construction firms
INTRODUCTION
During the last years the importance of bankruptcy forecasting models is very high
due to the current financial crisis, which demands an even more careful management
of financial resources. Furthermore, under Basel II Accord recommendations (Bank
for International Settlements, 2006), banks which choose to develop their own
empirical model to quantify required capital for credit risk (Internal Rating-Based
Approach) are required to maintain less capital than those using the Standardized
Approach.
According to Sueyoshi and Goto (2009a), research on bankruptcy-based performance
assessment can be classified into three broad categories. First, those studies centered
on a particular model, which test how such model performs in comparison with
others. Second, research focused on the selection of an appropriate set of variables to
implement a particular model. The third category comprises papers which investigate
the bankruptcy process.
1
Correspondence address: Javier de ANDRS, University of Oviedo, Faculty of Economy

and Business, Department of Accounting, Avda.del Cristo s/n, Oviedo 33006, Spain;
email: jdandres@uniovi.es
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Among these categories, the first is the one which has received most attention by
researchers. The tested models are mainly statistical methodologies (for a review of
the most outstanding studies see Keasey and Watson, 1991; Balcaen and Ooghe,
2006, among others) and Artificial Intelligence techniques (for a review see, e.g., Aziz
and Dar, 2006; Ravi Kumar and Ravi, 2007).
Ravi Kumar and Ravi (2007) discuss the models which have been most frequently
used in studies focused in insolvency prediction via intelligent systems. These models
are Fuzzy Logic (FL), Neural Networks (NN), Genetic Algorithms (GA), Case-Based
Reasoning Systems (CBR), Rough Sets (RS), Support Vector Machines (SVM),
Decision trees (DT), Data Envelopment Analysis (DEA) and Hybrid Systems (HS).
Among these, HS are the most promising. These combine two or more intelligent
techniques in several forms to derive the advantages of all of them. HS have received
considerable attention from researchers as they amplify the advantages of the
intelligent techniques while simultaneously nullifying their disadvantages. Most HS
require a considerable amount of data to reach to accurate estimations. This is not a
problem nowadays, as there exist publicly available databases containing financial
information of listed and unlisted firms.
However, studies using HS for bankruptcy prediction suffer from a drawback which is
that the majority of them estimate the model upon the basis of a sample in which nonfailed companies are underrepresented. In most cases a matched-pairs design is used.
The selection of non-failed firms is arbitrary, which makes the model to achieve a
high in-sample percentage of correct classifications but it is likely to be inaccurate for
failure prediction in new cases drawn from a real population.
Another strategy is to consider a real population as the sample. That is, to consider
all the companies for which we have financial information available. However, as
only a very small percentage of firms enter into financial distress in a normal
economic situation, such samples are very unbalanced. This causes coefficient
instability and leads to poor performance ability of the models.
As an alternative to both strategies we propose a HS model where, upon the basis of a
real population of firms, data are preprocessed to summarize the information of
healthy firms. So, the initial unbalanced sample is transformed into a balanced one
which retains the main features of the healthy firms. Self Organized Maps (SOM) is
used in this stage. Then a classification device is developed upon the transformed
sample, for which we use the Multivariate Adaptive Regression Splines (MARS)
approach. The results are compared with benchmarks which are popular in bankruptcy
prediction literature. As an important application of the combined approach, this paper
applies it to the solvency assessment of Spanish construction firms.
The remainder of the paper is structured as follows. Section 1 revises prior studies on
bankruptcy prediction using HS. Section 2 is devoted to build the database. Section 3
describes the algorithm and the analytical procedures we used. Section 4 comments on
the main results, including the benchmark techniques applied. Finally, section 5 is
devoted to the summary and main conclusions, including also some further research
avenues.
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1. PRIOR BANKRUPTCY RESEARCH USING HYBRID SYSTEMS

Basically, there are four types of HS which have been applied to financial distress
prediction:
Hybrid Algorithms (HA), where two or more intelligent algorithms are tightly
integrated to form a new classification device (i.e., GA-trained NN, neurofuzzy systems).
Ensemble Classifiers (EC), which consist of multiple single classifiers whose
decision is combined to form that of the combined system, usually by applying
a voting scheme.
Feature Selectors (FS). In these systems, an algorithm is used for the selection
of the predictors of failure among a list of feasible variables and another model
is used to predict the bankruptcy status using the selected indicators.
Clustering and Classificatory devices (CC). These HSs preprocess the financial
information on the failed and non-failed firms and identify groups based on
similarities. The grouping information is used in the subsequent estimation of a
classification model.
Tables 1, 2, 3 and 4 contain a summary of a selection of the most outstanding studies
on financial failure prediction using each type of HSs.
Table 1. Studies on bankruptcy prediction using the HA approach
Authors
Tseng and Lin
(2005)
Main tested method

Fuzzy sets integrated into a
logit model.
Wang et al.
(2005)
Hybrid algorithm of fuzzy

sets and SVM.
Ahn and Kim

(2009)
Instance selection for CBR

using GA.
Sample composition
904 companies, 353 of
them either failed or
acquired.
Dataset 1: 30 failed and 30
nonfailed firms.
Dataset 2: 653 data, with
357 cases granted and 296
cases refused.
Dataset 3: 1225 credit
applicants, of which 323
are observed bad creditors.
1335 solvent companies
and 1335 failed.
Chuang and Lin

(2009)
Hybrid model of MARS, NN

and CBR.
1000 credit applications,

300 of them bad.
Li and Sun
(2009)
Hybrid model of CBR and

ELECTRE outranking
method.
Hybrid model of DEA, RS
and SVM.
81 healthy companies and

81 companies in distress.
Yeh et al. (2010)
76 healthy firms and 38

distressed.
Main results
The proposed model provides
more information than
conventional models.
The results are not conclusive
as they depend on the
characteristics of the datasets.
the prediction accuracy of the

proposed model is higher than
the best performance of
different NNs.
The hybrid model outperforms
single models and a hybrid
model of MARS and NN.
The hybrid model outperforms
other comparative CBR
models.
The proposed model performs
better than NNs.
Table 2. Studies on bankruptcy prediction using the FS approach

Authors
Huang et al.
(2007)
Main tested method

Hybridization of F-score,
genetic algorithms (feature
selection) and SVM.
Sample composition
Dataset 1: 307
creditworthy applicants
and 383 not creditworthy.
Dataset 2: 700
creditworthy and 300 notcreditworthy.
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Main results
With a small feature subset, a
hybrid SVM-GA system
obtains a good classification
performance.
Authors
Chen et al.
(2009)
Main tested method

MARS for feature selection
and SVM for classification.
Sample composition
1130 good and 870 bad
credit applications.
Tsai (2009)
t-statistic analysis for feature

selection and NNs for
classification.
Chaudhuri and
De (2010)
Fuzzy clustering for feature

selection and SVM for
classification.
DTs for feature selection and
CBR for classification.
GA and statistical methods
for feature selection, CBR
for classification.
Five datasets: 3 approx.

balanced, 1 with a 2/1 ratio
of good to bad cases and 1
resembles a real
population.
50 bankrupt firms matched
with 50 non-bankrupt.
Cho et al. (2010)

Li et al. (2010)
Ravisankar and
Ravi (2010)
t-statistic analysis and Group

Method of Data Handling
(GMDH) (A SOM model)
for feature selection. GMDH
for classification.
500 healthy and 500

bankrupt firms.
135 healthy companies and
135 distressed ones.
Dataset 1: 29 healthy banks
and 37 bankrupt.
and 18 bankrupt.
and 65 bankrupt.
and 30 bankrupt.
Main results
The hybrid system
outperforms both several
individual approaches (CART,
SVM and MARS) and a
hybrid system which combines
SVM and CART.
The proposed model
outperforms benchmarking
systems.
The rating estimation done by
the model does not depend on
heuristics.
The proposed models
outperform Logit and NNs.
If a true optimal feature subset
is not used CBR could
possibly produce lower
performance.
The proposed models
outperform other neural
architectures.
Table 3. Studies on bankruptcy prediction using the EC approach

Authors
Alfaro et al.
(2008)
Kim and Cho
(2008)
Tsai and Wu
(2008)
Main tested method

Adaptive boosting (adaboost)
of CT.
Ensemble of NN using
evolutionary computation
techniques.
Ensemble of several NN.
Yu et al. (2008)
Bootstrap aggregating
(bagging) of NN.
Hung and Chen

(2009)
Stacking of algorithms based

on bankruptcy probabilities.
Karthik Chandra
et al. (2009).
Boosting of multi layer

perceptron NN, CART,
RandomForests, SVM and
logistic regression.
Random subspaces, class
switching and rotation
forests.
Ensemble of SVM devices.
Nanni and
Lumnini (2009)
Yu et al. (2010)
Sample composition
590 failed and 590 nonfailed firms.
307 instances of
creditworthy applications
and 383 where it is not.
Dataset 1:307 creditworthy
applications and 383 not
creditworthy.
Dataset 2: 700 good and
300 bad credits.
383 bad credits.
Dataset 1: 357 good credit
cases and 296 refused.
Dataset 2: 30 failed and 30
non-failed firms.
56 bankrupt companies and
64 non-bankrupt
companies.
120 failed and 120 healthy
companies.
Same as in Tsai and Wu
(2008).
902 good loans and 323
bad cases.
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Main results
Adaboost outperforms NN.
The model outperforms nonevolutionary ensembles of
NN.
Multiple NN classifiers do not
outperform a single best
neural network classifier in
many cases.
The proposed model

consistently outperforms
single models and other EC.
The ensemble performs better
than other ensembles which
use the weighting or voting
strategy.
Boosting yields results
superior to those reported in
previous studies on the same
data set
Random subspaces perform
better than the other EC.
The proposed ensemble
consistently outperforms other
ensemble models and five
single systems.
Table 4. Studies on bankruptcy prediction using the CC approach

Authors
Alam et al.
(2000)
Main tested method

Fuzzy clustering and SOM.
Sample composition
8 failed banks and 248
non-failed-banks.
Foglia et al.
(2001)
Logit model for the

estimation of bank borrowers
default probabilities and
cluster analysis to assign
borrowers to credit scoring
grades.
Clustering algorithms for
identifying unrepresentative
subsamples and NN using the
remainder of their samples.
3343 firms divided in

several credit scoring
grades.
Hsieh (2005)
Defu et al. (2008)
Same as Hsieh (2005) but

using also classification
trees.
Hu and Wang
(2008)
Identification of clusters
prior to the training of a NN.
Dataset 1: 700
creditworthy applications
and 300 not-creditworthy.
Dataset 2: 368 accepted
credits and 222 that were
denied.
383 bad credits.
300 bad credits.
300 piece of data divided
into 3 credit conditions.
Abdou (2009)
Genetic programming and

SOM.
851 good loans and 411

bad loans.
Boyacioglu et al.
(2009)
k-means clustering and

SOM.
21 failed banks and 46

non-failed banks.
De Andrs et al.
(2011)
Fuzzy clustering and then a

MARS model is estimated on
the clusterized data.
59336 healthy and 138

failed firms.
Main results
The estimated model provides
an ordinal rating of the data set
in terms of failing likelihood
possibility.
The ultimate choice in
defining a bank's internal
grading system relies on
empirical ground.
The model is efficient in
comparison with benchmark
methods.
GA and K-means algorithm

can effectively improve the
classification accuracy of a
credit scoring model.
The model offers a good rate
of correct classifications
although it lacks some
generalization power.
The best model depends on the
choice of misclassification
costs.
Neither methods can
outperform multilayer
perceptron NN.
The proposed model
outperform single
classification devices (NN,
LDA, MARS).
It must be pointed out that if the bankruptcy prediction models are eventually to be
used in a predictive context, the estimation samples of failing and non-failing firms
should be representative of the whole population of firms (Ooghe and Joos, 1990).
Nevertheless, in the great majority of the hybrid prediction models revised in tables 1
to 4, the samples are not representative of the whole population. Most studies
oversample failing companies because of the low frequency rate of failing firms in the
economy. A common strategy is the use of matched pairs samples (on the basis of
size, sector, and/or age). This can lead to biased parameter estimates especially if the
sample is made up of failed firms and very sound companies. In that case the model
will achieve a high percentage of correct classifications but it is likely to be inaccurate
for failure prediction in new cases drawn from a real population.
An alternate sampling strategy is to consider a real population. As Foglia et al. (2001)
point out, this procedure increases the variance of the estimates of coefficients due to
the data imbalance between sound and unsound firms. An additional drawback is that,
having into account that in a normal economy most companies are non-bankrupt, to
classify all the firms as not-bankrupt would let the model reach a high percentage of
correct classifications. To avoid this, the algorithm can be designed to consider the
different misclassification costs (the costs of classifying as insolvent a company
which is solvent are much lower than those of the opposite error). Such a model will
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pay more attention to accurately classifying the failing companies at the expense of
more misclassifications of non-failing firms.
However, the estimation of the different misclassification costs is not straightforward
as it depends on the financial decision to be taken. Furthermore, such estimation is a
subjective task as it also depends on the risk profile of the agent who makes the
decision.
As an alternative to both approaches, we propose a method which enables the
formation of a sample which is representative of the main features of the population
but retains the balanced design and the stability of the coefficients.
Our proposal is a hybrid method in which sound companies are divided in clusters
according to their financial similarities and then each cluster is replaced by a director
vector which summarizes all of them. The clustering process is made by means of a
SOM procedure. The most relevant reasons for choosing SOM among the different
methods for clustering are the following two: first, this technique was specifically
designed for multidimensional datasets, and is able to take advantage of their
complexity and second, unlike other methods for data-reduction and clustering, this
family of algorithms is characterized by a learning process that is constantly updated
as it takes more information from the input data, improving the output dynamically
over the training stage and therefore producing more reliable results.
Prior to the calculation of clusters, sound companies are divided into two groups:
1. Companies which are actually sound but whose financial features have a certain
degree of similarity with those of failed ones. These are called borderline
companies.
2. Companies which are sound and whose financial features are clearly different
from those of bankrupt companies.
The clustering process is carried out separately for each group of firms. Although the
idea of considering a grey zone or group of doubtful firms has been previously
introduced by other researchers (see, i.e., Ooghe et al., 1992; Alam, et al., 2000;
Tseng and Lin, 2005), we made the discrimination between sound and doubtful firms
on a multivariate basis by using a non-euclidean distance measure (the Mahalanobis
distance).
Once the companies in clusters have been replaced by director vectors, we estimate a
classification model through MARS. The reason for choosing MARS as the second
part of the hybrid system lies in the fact that this technique is a flexible procedure,
which models relationships that are nearly additive or involve interactions with fewer
variables (Hastie and Tibshirani, 1990). MARS builds flexible models by fitting
piecewise linear regressions; that is, the nonlinearity of a model is approximated
through the use of separate regression slopes in a limited number of intervals of the
variable space. This is made by using a procedure which is inspired by the recursive
partitioning technique governing Classification And Regression Trees (CART)
algorithm (Breiman et al., 1984). Such features make it especially suitable for the
bankruptcy prediction problem, as the variety of indicators that can be computed upon
the financial statements of a firm can be considered as manifestations of a small
number of financial features (i.e. profitability, solvency, etc.). So, a small number of
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indicators can represent most of the information contained in the annual accounts
(Yli-Olli and Virtanen, 1989). Consequently, some studies (see, i.e., Lee et al., 2006;
Chen et al., 2006) found evidence that MARS performs better than other approaches
when applied to financial classification purposes. As benchmarks for our hybrid
system we estimated a simple MARS model (whithout the SOM-preprocessing stage)
and a multilayer BP-trained NN.
2. THE DATABASE
In the present research we consider failing and nonfailing firms from the construction
sector in Spain. The recent credit crisis and economic downturn have had some
serious implications for the Spanish construction sector. As the economic situation
changed, along with the increase in unemployment and the rise of the interest rates,
the expectations of house prices' evolution that sustained demand and encouraged new
developments disappeared. Consequently, firms in the real estate and construction
sectors are facing difficulties and challenges which affect their future viability.
2.1. Enterprises in the sample
In Spain, bankruptcy is regulated by the Bankruptcy Act 22/2003, of 9th July. This Act
contemplates a unique proceeding, which is called bankruptcy (concurso de
acreedores). This procedure can conclude either with the approval of the settlement of
creditors or with the liquidation of the company. Filing for bankruptcy does not
necessarily means that the firm is insolvent. However, the recovery rate (understood
as cents on the euro recouped by creditors through the regulated procedures) in Spain
is lower than in many developed countries, i.e. Belgium, Denmark, Finland, Iceland,
Ireland, Norway, Netherlands, Sweden, United Kingdom, Canada, United States,
Hong Kong, Japan, Korea, Singapore, Taiwan, New Zealand, or Australia (IFC,
2010). So, in practice bankruptcy procedure can be understood as insolvency.
Many papers on bankruptcy prediction have focused on the manufacturing sector (i.e.
Altman, 1968; Begley et al., 1996; Zhang, Hu, Patuwo, and Indro, 1999; Becchetti
and Sierra, 2003). Nevertheless, there are several papers examining the bankruptcy in
sectors other than manufacturing. For example, telecommunications industry
(Foreman, 2003); restaurant industry (Gu, 2002; Kim and Gu, 2006; Young and Gu,
2010); air carriers (Davalos et al., 1999); nursing facility industry (Knox et al., 2009);
oil companies (Sena and Williams, 1998); retail sector (Bhargava et al., 1998);
construction industry (Sueyoshi and Goto, 2009b).
Therefore, a database with Spanish construction firms was drawn up. As bankrupt
companies we considered those whose judicial declaration took place in 2008. In
accordance with Spanish legislation, limited liability companies are required to
deposit their annual accounts in the Registro Mercantil. This information is gathered
and provided by Bureau van Dijk and Informa for Spanish firms in the SABI
database, one of Europes leading publishers of electronic business information.
Bureau Van Dijk is also the provider of the Wharton Research Data Service. We
deleted from the sample companies that did not provide full information about all the
variables from the year prior to bankruptcy. To avoid the distortions caused by defects
in the preparation of financial information of small enterprises, whose annual
accounts are generally unaudited, we also deleted from the database those firms
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whose total assets were below 100K . Once these filters were applied, we obtained a
final data set that was made up of 63.107 firms. Of these, a total of 256 companies
went bankrupt in 2008.
Although there has been a significant reduction in the number of construction firms,
only a limited number of Spanish construction companies fell into insolvency during
2008 (0.40%).
2.2. The financial ratios for predicting bankruptcy
In this paper we used the five variables proposed by E.I. Altman in his seminal paper
on the usefulness of linear discriminant analysis (Altman, 1968). The reasons for this
choice were the following: i) they are variables that are readily available for any
company. It must be borne in mind that increasing the number of variables has the
undesirable effect of reducing the number of companies in the dataset, since not all
companies provide equal levels of information; ii) several papers used this same set of
variables to test the effectiveness of statistical techniques and/or other models for
bankruptcy prediction (i.e., Odom and Sharda, 1993, for neural networks or Lizarraga
Dallo, 1998 for the logit model); iii) it should be noted that some authors (i.e., Begley
et al., 1996; Lizrraga Dallo, 1997, and Grice and Ingram, 2001) have studied the
validity of the Altman function when applied in other geographical settings and time
spans. They concluded that with a proper reassessment of the coefficients, the model
proposed by Altman in 1968 remains as a valid approximation for the issue of
predicting insolvency.
Therefore, the five variables used in this paper are the following:
X1 = working capital/total assets
X2 = retained earnings/total assets
X3 = earnings before interest and taxes (EBIT)/total assets
X4 = market value of equity/book value of total debt
X5 = sales/total assets
Regarding the fourth of the variables, it should be noted that its calculation is difficult
in environments where only a small percentage of companies are quoted. Therefore,
in subsequent sectoral applications of this model to predict insolvency, the author
replaced, in the numerator of this variable, the market value of equity by the book
value of equity (Altman, 1993). In this research we considered such a definition.
Tables 5 and 6 show some descriptive statistics for the variables.
Table 5. Descriptive statistics (bankruptcy companies).
Variable
X1
X2
X3
X4
X5
Q1
-0.138
-0.123
-0.170
-0.092
0.786
Median
0.006
0.015
0.013
0.031
1.407
Q3
0.157
0.069
0.052
0.103
2.229
Mean
-0.024
-0.122
-0.109
0.008
1.602
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StdDev
0.450
0.412
0.310
0.304
1.101
Asymmet.
-1.692
-2.838
-2.277
4.028
0.905
Kurtosis
7.848
10.725
5.742
41.531
0.682
Table 6. Descriptive statistics (healthy companies)

Variable
X1
X2
X3
X4
X5
Q1
-0.016
0.025
0.019
0.062
0.802
Median
0.136
0.126
0.051
0.217
1.400
Q3
0.367
0.310
0.104
0.607
2.130
Mean
0.160
0.163
0.060
1.237
1.596
StdDev
0.352
0.321
0.173
51.701
1.212
Asymmet.
-2.560
-8.391
-5.728
239.962
3.077
Kurtosis
69.241
456.771
234.588
59307.861
48.180
From a first examination of the information contained in Tables 5 and 6 it is clear that
the statistical distribution of the considered variables is asymmetric and extremely
leptokurtic. This corroborates previous results on the statistical distribution of the
financial indicators (Lau et al., 1995; Martikainen et al., 1995, among others) and
advises against the use of parametrical models.
3. ALGORITHM AND ANALYTICAL PROCEDURE
3.1. The proposed hybrid model
The model proposed in the present research combines the use of MARS models with a
clustering technique which is SOM mapping in order to obtain a MARS model which
uses as training information only those companies considered as representative of
each cluster. A more detailed explanation of the steps of the algorithm is presented
below.
Step 1: Study of the similarities of the bankrupt companies by means of Mahalanobis
distances. The Mahalanobis distance of all the bankrupt companies was calculated.
Step 2:Those bankrupted companies that were more dissimilar to the rest of the
sample were signalled as outliers and removed from the data set to be employed for
step 3 although they were taken into account for the training and validation of the
model. The determination of the bankrupted companies considered as outliers was
done by means of the robust estimation of the parameters in the Mahalanobis distance
(Rousseeuw and Van Zomeren, 1990) and the comparison with a critical value of the
Chi-square distribution (in our case the 95% quantile).
Step 3: The Mahalanobis distance of each one of the non-bankrupt companies versus
the set of all the bankrupted companies not considered as outliers was calculated.
Step 4: A new category of companies was created, which was called borderline.
The companies that were not considered as outliers when compared with the sample
of bankrupt companies are supposed to be more likely to go bankrupt than the rest of
non-bankrupted companies. Therefore they were included in this new category.
Step 5: Companies belonging to non-bankrupted and borderline populations were
classified in clusters using the self-organizing maps algorithm (Kohonen, 1995).
Several clusters of different dimensions were defined and trained with the nonbankrupted and borderline sets. This step is performed in order to obtain a more
balanced set of data for the training of the models in the next steps.
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Step 6: An algorithm based on multivariate adaptive regression splines (MARS)

(Friedman, 1991) was then used to implement a different model for each set of
clusters. These models are estimated in order to determine the number of clusters that
best represents the initial set of data. Every MARS model was then applied to the
initial set of bankrupt and non-bankrupt companies and the performance of each one
was evaluated by means of their specificity and sensibility (more details on this point
are provided below).
Step 7: The last step of the algorithm consisted in the training and validation of a
MARS model using the number of clusters with the best performance in step 6.
3.2. The Mahalanobis distance
The Mahalanobis distance is a non-euclidean distance measure (Mahalanobis, 1936)
based on correlations between variables by means of which different patterns can be
identified and analyzed. It is a useful way of determining the similarity of an unknown
sample set to a known one. It differs from Euclidean distance in that it takes into
account the correlations in the data set and is scale-invariant, i.e. not dependent on the
scale of measurements.
Given the vectors that represents the set of variables of two companies x1 and
x2 n , their Mahalanobis distance can be calculated as follows:
n
d A ( x1 , x2 ) = ( x1 x2 )T A ( x1 x2 )
(1)
nxn
Where A
is positively semi-definite and represents the inverse of the
covariance matrix of class {I } . The Mahalanobis distance is therefore a weighted
Euclidean distance where the weighting is determined by the range of variability of
the sample point; expressed by the covariance matrix (Avishekand Maiti, 2010).
T
Using the eigenvalue decomposition, A can be decomposed into A = W W . Thus, it
is also feasible to learn the matrix W . Then, we have
d A ( x1 , x2 ) = ( x1 x2 )T (W W T ) ( x1 x2 )
(2)
3.3. Self-organized Maps neural networks

The name Self-Organizing Map (SOM) represents a class of neural-network
algorithms in the unsupervised-learning category. The SOM is an algorithm used to
visualize and interpret large high-dimensional data sets.
The SOM map (Jeong et al., 2010) consists of a regular grid of processing units,
"neurons". A model of some multidimensional observation, eventually a vector
consisting of features, is associated with each unit. The map attempts to represent all
the available observations with optimal accuracy using a restricted set of models. At
the same time the models become ordered on the grid so that similar models are close
to each other and dissimilar models far from each other.
n
Let N be the dimension of the n sample vectors X (t ) , t = 1,2,..n , where each
sample vector is identified by a label. The two-dimensional output layer contains a
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k = 1,..., xdim y dim

W
rectangular mesh of
nodes, each serving as codebook vector k of
dimension N . The training of the weight (codebook) vectors of the maps nodes is
realized by the following algorithm (Kohonen, 1995):
For a given number of iterations do:
1. Pick up randomly one sample vector X (t )
2. Find the nearest weight vector Wc : X Wc = min j X W j
3. Update the weights Wi according to the rule:
Wi (t + 1) = Wi (t ) + hci (t )[X (t ) Wi (t )]
(3)
h (t )
Where ci is the neighbour function that is usually of the gaussian type:
hci (t ) = (t ) exp( Wc Wi / 2 2 (t ))
or of a local bubble type (Kohonen, 1995).
h (t )
Weights of neurons laying in the neighbourhood ci
of the winning neuron are
X
(t
)
(
t
)
[
0
,
1
]
moved closer to
. The learning rate
decreases monotonically with
(t
)
time,
determining that the radius of the neighbourhood also decreases
monotonically. After many iterations and a slow reduction of (t ) and (t ) , the

neighbourhood covers only a single node and the map is formed: neurons with
weights that are close in the parameter space W are also close on the mesh and can be
labelled with names (classes) of input clusters. A graphical interpretation of the
Mahalanobis distance can be found in the research of Maesschalck et al. (2000).
3.4. Multivariate adaptive regression splines (MARS) model
As stated earlier, MARS is a multivariate nonparametric regression technique
developed by Friedman (1991). Its main purpose is to predict the values of a
r
continuous dependent variable, y (n 1) , from a set of independent explanatory
v
variables, X (n p) . The MARS model can be represented as:
( )
r r
r
y = f X +e
(4)
r
where e is an error vector of dimension (n 1) .
MARS can be considered as a generalisation of classification and regression trees

(CART) (Hastie et al., 2003), and is able to overcome some of its limitations. MARS
does not require any a priori assumptions about the underlying functional relationship
between dependent and independent variables. Instead, this relation is covered from a
set of coefficients and piecewise polynomials of degree q (basis functions) that are
r r
X
entirely driven from the regression data , y . The MARS regression model is
constructed by fitting basis functions to distinct intervals of the independent variables.

Generally, piecewise polynomials, also called splines, have pieces smoothly
connected together. In MARS terminology, the joining points of the polynomials are
~172~
called knots, nodes or breakdown points. These will be denoted by the small letter t.
For a spline of degree q each segment is a polynomial function. MARS uses two-sided
truncated power functions as spline basis functions. These are described by the
following equations (Sekulic and Kowalski, 1992):
q
[ (x t )]q+ = (t x )
[+ (x t )]q+
0
(t x )q
=
0
if x < t
(5)
otherwise
if x t
(6)
otherwise
where q ( 0 ) is the power to which the splines are raised and which determines the
degree of smoothness of the resultant function estimate.
r
y
The MARS model of a dependent variable with M basis functions (terms) can be
written as follows (Friedman and Roosen, 1995):
(7)
M
r
r
r
y = fM (x ) = c0 + c m Bm ( x )
m =1
r
c
where y is the dependent variable predicted by the MARS model, 0 is a constant,
r
Bm ( x ) is the m-th basis function, which may be a single spline basis function,
c
and m is the coefficient of the m-th basis function.
Both the variables to be introduced into the model and the knot positions for each
r
individual variable have to be optimized. For a data set X containing n objects and p
explanatory variables, there are N = n p pairs of spline basis functions, given by
equations (5) and (6), with knot locations
xij i = 1, 2,..., n; j = 1, 2,..., p

(
).
A two-step procedure is followed to construct the final model. First, in order to select
the consecutive pairs of basis functions of the model, a two-at-a-time forward
stepwise procedure is implemented (Friedman and Roosen, 1995). This forward
stepwise selection process leads to a very complex and overfitted model. Such a
model, although adequately fitting the estimation data, has poor predictive abilities for
new objects. To improve the prediction, the redundant basis functions are removed
one at a time using a backward stepwise procedure. To determine which basis
functions should be included in the model, MARS utilizes the generalized crossvalidation (GVC) criterion (Sekulic and Kowalski, 1992). GVC is the mean squared
residual error divided by a penalty which is dependent on model complexity. Then,
GVC is defined in the following way:
r 2
1 n
y i fM ( xi )
n
GVC (M ) = i =1
(1 C (M ) / n )2
(8)
~173~
where C (M ) is a complexity penalty that increases with the number of basis functions
in the model and which is defined as:
C (M ) = (M + 1) + d M
(9)
where M is the number of basis functions in equation 7, and the parameter d is a

penalty for each basis function included into the model. d can be also regarded as a
smoothing parameter. In the present research, d equals 2. This value can be chosen by
model user but it must be remarked that a smaller d generates a larger model with
more basis functions; a larger d creates a smaller model with less basis functions
(Kriner, 2007). Further details about the selection of the d parameter can be seen in
Friedman (1991).
The maximum interaction level of the spline basis functions is restricted to 10 as the
application of the MARS model to the studied data set confirmed that the maximum
*
interaction level (optimal model size M ) was 2.
The main steps of the MARS algorithm as applied in this research can be summarized
as follows (Sekulic and Kowalski, 1992):
1. Select the maximum allowed complexity for the model and define the d
parameter.
2. Forward stepwise selection:
3. Start with the simplest model, i.e. with the constant coefficient only.
4. Explore the space of the basis functions for each explanatory variable.
5. Determine the number of basis functions ( M ) that minimizes the prediction
error and include them into the model.
6. Go to step 2 until a model with a predetermined complexity is derived.
7. Backward stepwise selection:
8. Search the entire set of basis functions (excluding the constant) and delete
from the model the one that contributes least to the overall goodness of fit
using the GCV criterion.
9. Repeat 5 until GCV reaches its maximum.
The predetermined complexity of MARS model in step 3 should be considerably
larger than the optimal (minimal GCV) model size M , so choosing 2 M as the
minimum predetermined complexity for the model is enough in general (Friedman
and Roosen, 1995).
The predictive ability of the MARS model can be evaluated in terms of the root mean
squared error of cross-validation (RMSECV) and the squared leave-one-out
2
correlation coefficient ( q ). To compute RMSECV, one object is left out from the
data set and the model is constructed for the remaining n 1 objects. Then the model
is used to predict the value for the object which is left out. When all objects have been
left out once, RMSECV is given by the following expression (Friedman and Roosen,
1995):
~174~
(y
RMSECV =
i =1
y i )
(10)
y
y
where i is the value of the dependent variable of the i-th object and i is the
predicted value of the dependent variable of the i-th object with the model built
without the i-th object.
2
The value of q is given as:
n
q2 = 1
(y
i =1
n
2
y i )
(y
i =1
(11)
y)
where y is the mean value of the dependent variable for all n objects.
Finally, we must comment on the procedure used to assess the performance of the
model. The first measure is accuracy, which is the global percentage of correct
classifications. We also computed the sensitivity, which is the percentage of bankrupt
companies which were correctly classified. The last measure is specificity, which is
the proportion of healthy companies correctly identified.
4. RESULTS
In this section we detail the results of the algorithm, as well as those of the benchmark
techniques.
4.1. The algorithm
First, table 7 details the number of clusters for each model. All companies belonging
to non-bankrupt and borderline populations were classified in clusters using SOM.
The clusters were obtained as the output of step 5 of the algorithm. As can be
observed, the minimum number of clusters used for the models is 144. This means
that the original SOM was of (12 12) neurons. Please note that each cluster is
represented by a director vector. A director vector (Perner, 2008) can be described as
the expected value for each one of the independent variables for all the companies that
belong to a certain cluster. Models with less neurons were tested but not included in
the present research due to their lower performance. As it was already mentioned
before, this step was performed in order to obtain a more balanced set of data for the
training of the models in the following steps in which each cluster was represented by
a director vector that aims to summarize the information of all the individuals
contained in each subset. Table 7 shows the number of clusters that were used and in
which model they were employed. Please note that all the models were trained using
the 204 bankrupted companies.
~175~
Table 7. Number of clusters used for each model

Number of director vectors (clusters)
Model name
Non-bankrupt companies
Borderline companies
M1
144
144
M2
169
169
M3
196
196
M4
225
225
M5
M6
M7
M8
M9
256
289
324
361
400
256
289
324
361
400
An algorithm based on MARS models (step 6) was afterwards used in order to

implement a different model for each set of clusters. The intention of these models is
to determine the number of clusters that best represents the initial set of data. In order
to reach this aim, all the models were trained using a set which comprises (a) all the
bankrupted companies, (b) the director vectors corresponding to non-bankrupt nonborderline companies and (c) the director vectors corresponding to borderline
companies. The validation was made by calculating the confusion matrix using the
information of the original database. Table 8 shows the average percentage of
correctly classified companies in the five runs of each model. The last column of the
mentioned table represents the total percentage of companies of the database that were
correctly classified by the model. This is the most important parameter as it gives us
an outlook of the global performance of the model. It is noticeable that although no
maximum degree value was imposed to the MARS models all the models from M1 to
M9 were of degree 3.
Table 8. Average percentage of companies that are correctly classified in their
corresponding category
Model name
% of companies correctly classified
M1
Bankrupt
88.10
Non-bankrupt
57.50
Borderline
89.70
Non-bankrupt + Borderline
82.51
Total
79.16
M2
88.30
58.30
90.70
83.46
79.94
M3
88.90
59.80
91.20
84.19
81.18
M4
88.90
60.30
91.30
84.38
81.96
M5
88.70
60.40
91.60
84.63
84.29
M6
88.50
60.60
92.30
85.22
85.22
M7
87.90
62.80
91.50
85.09
85.09
M8
87.30
61.30
87.20
81.42
81.43
M9
85.40
58.80
83.20
77.75
77.78
According to the results of Table 8, the model with the highest performance was M6
although their results were very close to M7 and that was the reason why in the last
step of the algorithm two MARS models were validated and trained using as input
information the numbers of clusters defined by both M6 and M7. Finally, step 7
consisted in the training and validation of M6 and M7. We used as input information
~176~
the whole database and performed five runs in which 80% of the information was
used for training and the other 20% for validation.
Table 9 contains a confusion matrix in which the mean values obtained in the
validation of the results of the five different M6 MARS models are shown. Please
note that the results of model M7 are not presented as they were slightly worst than
those obtained for M6.
Table 9. Confusion matrix: average values of the validation results of 5 different M6
MARS models trained
Real category
Predicted
category
Non-bankrupt
Bankrupt
Non-bankrupt
11,513
Bankrupt
1,339
46
In addition, according to the information contained in Table 8 it must be remarked

that the specificity of the model is 89.58%, that is, it is able to detect 89.58% of the
companies that did not go bankrupt. It also detects 88.46% of all those companies that
went bankrupt (sensitivity). Finally, we must also underline that the global accuracy
of the model is 89.58%.
4.2. Benchmark techniques
As indicated above, the benchmark techniques used to compare with the results
obtained by the algorithm proposed in the present paper were two: back propagation
NN and MARS. The model has 5 neurons in the input layer and 7 in the intermediate.
The MARS model obtained was of degree 2 although no maximum degree condition
was imposed.
For the estimation of the accuracy of NN and MARS, we followed a procedure similar
to that proposed to test the accuracy of the proposed algorithm. NN and the MARS
model were applied to five random selected training data bases (80% of the data
chosen at random) and tested over their corresponding validation subsets (the
remaining 20% of the database).
For the case of the NN model, the results obtained in the five runs yielded an average
specificity of 99.95 %, an average sensitivity of 21.00 % and an average global
accuracy of 99.01%. Although the specificity the NN-based device is higher than that
of our proposal, it is inefficient for the detection of bankrupt companies, due to its low
sensitivity. This makes this model useless for decision-aid purposes because the costs
of the error consisting in considering a bankrupt company as non-bankrupt are very
much higher than that of the opposite error.
The results obtained for the MARS model were as follows: average specificity of
99.79 %, average sensitivity of 3.85 % and average global accuracy of 99.78%. These
results are even worse than those of NN, so it can be concluded that the MARS model
is also useless for practical purposes.
~177~
5. SUMMARY, CONCLUDING REMARKS AND FURTHER RESEARCH

This paper proposes a new approach to the forecasting of firms bankruptcy. Our
proposal is a hybrid method in which sound companies are divided in clusters
according to their financial similarities and then each cluster is replaced by a director
vector which summarizes all of them. In order to do this, we use SOM mapping. Once
the companies in clusters have been replaced by director vectors, we estimate a
classification model through MARS.
For the test of the model we considered a real setting of Spanish enterprises from the
construction sector because of the importance of this branch of activity in the Spanish
economy. It is also remarkable that in our dataset the proportion of distressed firms is
very close to that which is derived from Economic statistics. With this procedure we
intend to overcome the sampling-bias problems that matched-pairs models often
suffer.
We also used two benchmark techniques to compare with the results obtained by the
algorithm proposed in the present paper: a back propagation neural network and a
MARS model.
Our results show that the proposed hybrid approach is much more accurate than the
benchmark techniques for the identification of the companies that go bankrupt. As
future research efforts we can mention the application of the procedure proposed in
the present research to other related tasks in the field of financial statements analysis
(i.e. prediction of takeovers, analysis of bond ratings etc.).
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THE RELEVANCE OF COMPANY EVALUATION

METHODS IN CONDITIONS OF ECONOMIC
INSTABILITY. EMPIRICAL STUDY
ON THE COMPANIES QUOTED IN THE BUCHAREST
STOCK EXCHANGE
Marilena MIRONIUC1, Mihai CARP & Bogdan ROBU-IOAN
Alexandru Ioan Cuza University of Iasi, Romania
ABSTRACT
In the context of the economic-financial instability that characterizes the current business
environment, knowing the value dimension of companies is an essential requirement for a
correct support of strategic decisions. The objectivity of the value obtained depends on the
relevance of the evaluation methods, determined by the ability to failthfully notice the
influence of all the factors that characterize the economic environment. This study aims at
establishing a hierarchy of the three major evaluation approaches (patrimonial, comparative,
and based on the present value of the flows), according the mentioned criterium. Starting
from a sample of 40 companies quoted in the Bucharest Stock Exchange, we have determined
the ability of each method to provide a faithful and credible value, through the indication of
potential risks. This study has allowed the identification of the profile of the insolvency risk
according to the three suggested evaluation methods, obtaining the classification functions of
the companies into risk groups, as well as the probabilities to determine insolvency. The
results were obtained using the factorial analysis of multiple correspondencies, the
discriminant analysis, and the logistic regression analysis, and the data were processed using
the SPSS 19.0 statistic software.
KEYWORDS: evaluation methods, relevance, insolvency risk, factorial analysis,

discriminant analysis, logistic regression analysis
INTRODUCTION
The evolution of the worlds economy, marked by the globalization of the economic
phenomenon, both at a geographical level and in what concerns the free circulation of
capital, has imposed the need to quantify businesses according to their value, as a
significant benchmark that supports the investment decision of the owners of available
financial resources.
The evolution of the company aims to provide a value dimension of the entity rather
than setting a price at which they can sell. If price is an objective measure, resulted
from the confrontation of the demand with the offer, value is identified as a subjective
notion depending on the influence of a large number of factors that mark the destiny
of a company.
1
Correspondence address: Marilena MIRONIUC, Alexandru Ioan Cuza University of Iai,

Romania; email: marilena@uaic.ro
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The value of an economic entity may differ from its price in response to the pressure
applied by: the objectives followed in the transaction (continuity of activity,
dissolution, strategy modifications), the existence of a company brand, the raise of the
market quota, the consolidation of the business with new activity segments, the value
of the human capital, social or emotional reasons, etc. All these factors reflect a
shadow of relativity upon the notion of value, which they eventually reduce to an
estimation unconditionally subject to change. The volatitity of the concept can be
related both to the time perspective, as the value amount established is practicalyy
valid only at the moment of the evaluation, and to the spatial, geographical, political
instability, social, or natural factors perspective, the last one having a significant
weight in the quantification process.
This gives birth to a series of questions that have not yet found an answer: Is the value
of the company composed of the value of its net assets (the sum of the composing
parts), or is it determind by the companys ability to generate future benefits for the
interest owners? What is the value of a company that, although it has a balanced
asset structure and has generated substantial benefits for the shareholders in the past,
activates on a collapsed market? Does it really have no monetary equivalent? Here
we refer to the famous one-dollar takeovers. If the answers to these questions are
searched for in a period of economic-financial crisis, the difficulty of finding them
raises with the multiplication of the factors that exert pressures on the economic
entities (lack of outlets, lack of financial resources, social pressures, legal
inconsistencies, etc.).
The need to establish the value of companies reveals its importance in various
moments of their development, marking thus their destinies. The provision of a value
level is required in cases of property transfers to other shareholders, since it is known
that the interests of the parties involved in the trasaction are divergent. The quotation
of the companies on the capital market is another moment that requires a value
support of the companys dimension, since the investors are interested in a correctly
estimated share price, which would give them the possibility to obtain future earnings.
Within restructuring operations, establishing the companys value is the basic element
that conditions the success of the performed action, a process aimed to capitalize on
the competitive advantages that can be offered by a different form of organization. As
Thauvron (2007) notices, evaluation is a company management instrument that
managers use to guide the operations performed in order to meet the fundamental
objective of maximizing the entitys value. Under these circumstances, the doctrine of
the economic-financial analysis is called upon to offer solutions for supporting the
investment process to the purpose of performing it in an objective manner, providing
useful benchmarks for the health of the economic environment in general.
The diversity of the solutions used to establish the value of the companies is included
into major approaches based on: the present value of the cash flows, the evaluation of
the equity, or comparisons between market values. Each of these approaches is
supported by significant data generated by the presence of the company in the
economic environment and attempts to provide pertinent value solutions.
These evaluation methods are mainly supported by the influence of quantitative
factors. Only the extent to which these determiners also include the effects of
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qualitative data, present in the competition area, provides a faithful image of the value
of the companies. The usefullnss of these estimations lies therefore in their ability to
provide a value determined by the influence of most factors that affect the economic
environment.
In periods marked by economic instability, the pecuniary measurement approach of
the company becomes a difficult process, receiving special importance. In this sense,
in the present study, we aim at identifying, through a mainly quantitative analysis, the
extent to which evaluation methods provide appropriate information on the value of
the companies, stressing, for the companies quoted in the Bucharest Stock Exchange,
the relevance of each approach in supporting financial decisions.
1. APPROACHES AND VIEWPOINTS ON THE EVALUATION METHODS
OF THE COMPANY
The evaluation of economic entities is a complex activity that requires the use of
inter-disciplinary information benchmarks such as accounting, finance, management,
law, or taxation, as well as an important connection with the practice, thus coagulating
the three major approaches of the field.
1.1. The method of the discounted cash flow
Based, according to financial theory, on the ability of the entity to generate future
cash flows, this method is considered to have higher information valences than the
other approaches.
The value of the company is equal to the sum of the future cash flows it will generate,
made present at a rate that reflects the cost of the resources employed to achieve them
(Thauvron, 2007). The definitions of the used flows are extremely varied. Usually, the
free cash-flows after tax, the net benefit, the current result, or the gross operational
excess are retained (de La Bruslerie, 2006). Used with precedence, free cash flows are
generated by the operating activity, without quantifying the effect of debts, which are
computed after tax (Fernandez, 2010).
The method of discounted cash flows, also known as DCF, is at the center of the
concerns of estimating the value of the company from the investors perspective, from
that of the companys capital owners (the shareholders), and of bonds owners (Berk,
et al., 2008).
Ceddaha (2010) notices the use of the weighted average cost of capital WACC to
the purpose of discounting the mentioned flows, a measure that must encompass the
payment requirements of capital providers. It is necessary to make a distinction
between the cost of borrowed resources and the cost of the own capital. Sander et al.
(2007), Ingram et al. (2010) and Fama et al. (2004) stated that, in the case of listed
companies, the cost of equity is calculated, especially, through the CAPM model
(Capital Assets Pricing Model) and other models based on the market equilibrium are
used alternative. Shareholders always wish to be paid a higher quantum than the debt
cost because the creditors are not affected in the same manner by the risk of
bankruptcy of the company. For this reason, WACC is computed as a weighted
average of the risks taken by the two categories of financial resource providers.
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Taken from the analyses performed by Keynes, according to which the value of a
company corresponds to the present dimension of future income flows generated by
its capital possessions (Walter, et al., 2008), this method resorts to uncertain inputs
forecast on different time horizons, thus attracting a subjective dimension. The
subjectivity of this method comes from the difficulty of making relevant forecasts,
since the general economic environment is characterized by intense and frequent
modifications. The limits of the method have been extensively studied, trying to
provide solutions for their removal. Thus, Baroni et al. (2006), Atherton et al. (2008)
and Young (2007) note in their work, the difficulty of obtaining reliable sizes on the
discount rate, on the future revenues and expenses, and the size of the final value, as
variables that determine the relevance of the evaluation method. Mallinson et al.
(2000) and French (2006) state that the subjectivity of the method is due to the
influence of the factors such as: the lack of comparable information regarding the
sales and the assets value, the significant dynamics of the market that determines large
variations of the transfer pricing (very difficult to forecast), the dependence method of
comparable size and the number of transactions existing in the market.
1.2. The patrimony evaluation method
This approach can be characterized, according to Walter and Brian (2008), through
the statement that the company is worth what it owns. This approach consists in
establishing the value of the company based on the information provided by the
financial statements published by the entity. More specifically, this means the
estimation of the dimension of the assets that remain at the shareholders disposal
after its reduction by the total debts of the company.
If the evaluation process is applied on companies whose activity predictably continues
incessantly, as well as a time benchmark, as the financial statements achievement date
approaches, the value of the company is given by the volume of the equity value
(EV). The pertinence of this evaluation is supported by the application of accounting
laws that impose an annual correction of the balance structures with the differences
generated by the economic reality, to the purpose of reflecting a faithful image of the
financial position and performances of the entity. When the activity of quantifying the
companys value does not coincide with the moment when the annual statements are
drawn, it is necessary to correct the EV by the extent of the influences generated by
the value deviations identified after the re-evaluation and alteration of each balance
post.
De La Bruslerie (2006) notices the difference that should be preserved in connection
with the financial dimension of the evaluated assets, as an operational value estimated
from the perspective of the continuity of the activity antagonistic with the liquidity
value of each separate patrimony element.
Thauvron (2007) considers that value, supported by this method, reflects a static
vision on reality, which does not take into account the future profitability of the
company. Moreover, this method does not include the influence of other factors that
affect value, such as: the current state of the activity field in which the company
operates, human resources, contracts, etc., elements that are not reflected in the
accounting statements (Fernandez, 2010).
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Although financial theory criticizes the patrimonial approaches used in company

evaluations, characterizing them as limiting, they are a practical solution, often used,
and has a low degree of uncertainty.
1.3. The comparative method
According to this approach, value is computed through the relation with the
dimension of certain indicators provided by the companies in the same activity field
as the subject company. This is a simple, practical, fast, and objective method because
it avoids using discount rates whose estimation is always delicate (Thauvron, 2007).
However, for the efficient application of this method, the pertinence of the sample of
comparable economic agents is particularly important.
Also called the multiples method, it is based on computing ratios (multiples) at the
level of the selected companies. This calculus uses measures such as the own capital,
the sales figure, the net result, the free cash flows, the current result, etc. The model
uses the average of the multiplication at the sample level in order to correct the
measure identified for establishing the value of the economic entity.
The development of the evaluation process can be synthesized in the following stages:
defining the sample, selecting and calculating the multiples, and applying the ratios on
the selected indicator.
The diversity of the methods, as well as their various degrees of relevance in
establishing appropriate values for the economic entities, have generatd intense
debates reflected in numerous studies.
As a result, Gollier and Weitzman (2010) wonder over what period financial
predictions can be made, when the discount rate used is a subjective measure. They
answer by stating that we have to admit the non-existence of a well-supported
principle that allows us to extrapolate a ratio in the past on the future benefits, over a
long period of time. It is also possible to discuss the extent to which the discount rate
objectively reflects the cost of the invested capitals according to the computing
method. One of the most important equations in monetary theory and practice is that
of the weighted average cost of capital (WACC), from which results the cash flows
discount rate. Miller (2006) notices the relativity of the computing method of the
mentioned rate, presenting an improved version, which, in the authors opinion,
generates significantly higher results. The funding of investment projects determines,
according to accounting norms, a capitalization of the interests. This process does not
generate, at the same moment, a decrease of the taxes, which affects the relevance of
the result provided by the calculus of the weighted average cost of capital after tax
(Pierru and Babusiaux, 2010).
In the same tendecy to explain and increase the reliability of the field, Booth (2007)
suggests a method for computing the discount rate specific to each evaluation method.
Richardson and Tinaikar (2004) notice the tight connection between accounting and
the company evaluation models, stressing the interrelations between them, both at a
procedural level and at that of the basic objective of providing users with reliable
information. We can say that the evaluation methods are models for the accounting of
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the future and that the efficiency of these techniques derives from the way that
accounting principles are implemented (Penman, 2010).
Beiner et al. (2006) and Klein (2002) state that between the value of the company and
the quality of corporate governance there is a direct and positive connection. They
support their opinion with a study performed on quoted Swiss companies, reflecting at
the end the correlations established between the two phenomena. In the same
direction, we can notice that the connection between the value of the company and the
compensations obtained by managers has a significant impact on their decisions to get
involved in the governance of the entity. Shareholders prefer the managers
compensation to be tightly connected with the value of the company, because this
connection provides management with the motivation to create wealth for the owners
(Lee and Chen, 2011).
The purpose of this study is to stress the informational usefulness of evaluation
methods, their ability to objectively reflect, in conditions of economic insability, the
value tendencies of the company. Used by managers in the control process through
the value of the economic entities, the techniques for establishing the monetary
equivalent of the business must provide an appropriate financial dimension, able to
support the strategic decisions that have to be taken. In this sense, the dynamic
analysis of these values can provide clues on the potential risks, especially on the
insolvency risk, the relevance of the method having in this case a major importance.
Knowing that the results obtained from the usage of evaluation methods are directly
related and tightly connected to the financial state and performance of the company,
based on a deductive-inductive approach, we aim to create a hierarchy of these
methods (patrimonial equity value, based on the net present cash flows, based on
market comparisons), starting from the analysis of a sample of companies quoted in
the Bucharest Stock Exchange (BSE). The comparability criterion used to classify
evaluation methods will be the number of cases correctly included into one of the two
categories (solvent and insolvent companies).
This approach, based on a positivist process, implies validating the formulated work
hypotheses, through empiric results obtained after the analysis of the data collected
from the studied sample (Smith, 2003).
2.1. Formulating the work hypotheses
Considering the computing method of the value of a company based on the three
evaluation methods previously mentioned, we aim to test the following formulated
work hypotheses:
Hypothesis 1: It is identified a profile of the insolvency risk based on the association
of the increase/decrease indexes of the values estimated following the application of
the three evaluation methods, in the analyzed sample.
Hypothesis 2: There is a score function obtained on the basis of the increase/decrease
indexes of the value of the studied entities, which classify them into two groups of
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risk (one characterized by the insolvency risk and the other with no insolvency risk) in
order to identify the degree of objectivity of the evaluation methods regarding the
exposal of the entities to the insolvency risk.
Hypothesis 3: There is a model for determining the degree of relevance of evaluation
methods, based on estimating the probability of insolvency risk, which uses the values
of the related increase/decrease indexes.
2.2. Analyzed variables
In order to meet the objectives of the research, in the present study we have
considered the variables synthesized in the following table.
Table 1. Analyzed variables
Symbol
IEV
IMC
EVvariation index
MC variation index
Meaning
Index computing method

(EVi-EVi-1)/EV1
(MCi-MCi-1)/MCi
IVFCF
VFCF variation index
(VFCFi-VFCFi-1)/VFCFi
The value of the company obtained using each evaluation method has taken into
consideration the following initial determinations:
EV = At Dt, where:
- EV = the companys own capital equity value (net accounting asset);
- At - total company assets at the end of the fiscal year;
- Dt - total company debts at the end of the fiscal year.
MC = NrIS * VS = NrIS * EPS * PERmedium = Rnet * PERmediu where:
- MC corrected stock exchange capitalization;
- VS share value;
- EPS - earnings per share;
- PERmedium the average price earnings ratio per activity branch;
- NrIS - number of issued shares;
- Rnet net result of the fiscal year.
VFCF = [FCFi+1/ (1+WACC)1] + [FCFi+2/ (1+WACC)2] +[FCFi+3/ (1+WACC)3]
+[FCFi+4/ (1+WACC)4] + [FCFi+5/ (1+WACC)5], where:
- VFCF net present value of the free cash flows;
- FCFi the free cahs flows at the reference moment i;
- WACC the weighted average cost of capital at the reference moment i,
discount rate.
The current value is obtained by discounting the future annual cash flows or by
multiplying them by a discount factor (Mironiuc, 2009). In order to forecast future
cash flows (i+1,, i+5), we have applied the CFPV evaluation method, as follows:
1. An average raise index of the turnover (TO) has been computed as the general
average between the raise indexes for each fiscal year, from 2005 until 2009;
2. Based on this raise index, the TO values corresponding to the fiscal years:
2010, , 2014 have been forecast;
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3. FCF was computed for each fiscal year as the difference between the net cash
(NC) at the end and at the beginning of the analyzed period.
4. NC is expressed as the computed difference between the cash assets and the
cash liabilities.
5. The average weight of the FCF value in the total SF has been established,
computed for the weights specific to each fiscal year, from 2005 until 2009;
6. Based on the average weight of the FCF value in the total TO, FCF was
predicted for the fiscal years 2010,..., 2014, as the product between the TO
predicted for these years (2010,, 2014) and the average weight obtained;
7. WACC was computed for the fiscal years 2008 and 2009 based on the
relation: WACC = [EV/ (EV+Dt] * ROCE + [Dt/ (EV+Dt] * Rd, and ROCE =
Rnet/EV, Rd = RNOA + (RNOA ROCE) * EV/Dt, RNOA = Rop/At, where
(Mironiuc, 2006) :
- ROCE - return on common shareholders equity;
- Rnet - net result;
- Rop - operational result;
- RNOA - return on net operating assets;
- Rd interest rate corresponding to the debts.
The category variables used to identify the profile of the insolvency risk were
obtained by discretizing the three indexes (IEV, IMC, IVFCF), using the SPSS 19.0
statistic software (Jaba, 2004). In order to determine the intervals corresponding to the
discretized variables categories, we have taken into account the average (m) and the
square deviation () for each of the three indexes. Therefore, the selected intervals
include index values as follows: (-; m-/2) for a low index, [m-/2; m+/2) for a
medium index, and [m-/2; +) for a high index. The newly resulted variables are
synthesized in Table 2.
Table 2. Analyzed category variables
Symbol
Ctg_IEV
Ctg_IMC
Ctg_IFCF
Meaning
The category variable corresponding
to the index of the EV value increase
to the index of the MC value increase
to the index of the VFCF value
increase
Interval relation
(-;-0.665) low IEV; [-0.665; -0.035) - medium
IEV; [-0.035; +) - high IEV
(-; -0.315) low IMC; [-0.315;1.195) - medium
IMC; [1.195;+) - high IMC
(-;-1.3) low IVFCF; [-1.3;0.94) - medium IVFCF;
[0.94;+) - high IVFCF
The analyzed category variables will be used to identify the profile of the insolvency
risk, by pointing out the associations between these variables and the state of the
analyzed company (be it insolvent or not).
2.3. Data and sample
The target population studied is composed of the companies quoted in the Bucharest
Stock Exchange (BSE). From this population, we have randomly extracted a sample
of 40 quoted companies (BSE), as follows: 20 insolvent companies whose bankruptcy
procedure started in 2010 and 20 companies whose shares can still be sold and that
have a profitable economic-financial activity. Their list is provided in Table 3.
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Table 3. List of the companies in the extracted sample

BSE Symbols
ADCA
AVIM
CEBI
CEIB
COAR
Insolvency risk
COGL
IASO
CRMC
ICER
EEOB
INLA
GETR
MUIL
HIRY
PANX
PRON
ROMJ
SEPE
TCCP
VILC
ADMET
ARCO
ARCV
ARMT
BAZV
No insolvency risk
BBGA
BRNA
BEZA
BUCV
BIBU
BUTU
BEUC
CABZ
BRCR
CACU
CAOR
CERB
CFED
CFOR
CLEL
(The symbols have been taken from www.bvb.ro)
From the studied sample, of the total insolvent companies, 75% operate in the
industrial field, 5% in commerce, and 20% in services, and in the case of companies
with no insolvency risk, 60% of them operate in industry, 15% in commerce, and 25%
in services. The structure of the sample according to the activity field of the quoted
companies is given in Figure 1.
Figure 1. Structure of the extracted sample according to the activity field
of the companies
The data was collected from the financial statements of the companies quoted in BSE,
for the fiscal years 2004-2009, presented on the Web sites: http://bvb.ro,
http://www.doingbusiness.ro and http://recom.onrc.ro.
2.4. Data analysis methods
In order to meet the objectives of the research and to validate the work hypotheses, a
series of data analysis methods are necessary. The methods used in the study are the
factorial analysis of multiple correspondencies, the discriminant analysis, and the
logistic regression analysis.
The factorial analysis of multiple correspondencies (FAMC) is a multi-varied
analysis method, developed for the first time by Benzcri in 1969, for the study of the
associations between three or more nominal (category) variables, and is a generalized
version of the factorial analysis of correspondencies (Lebart at al., 2006). Therefore,
for a sample of n individuals, we have values recorded for a series of m associated
variables, based on which we can obtain the profile of an individual in a certain group,
after studying the associations between the analyzed variables. This method
synthesizes the initial information by studying the associations between the variables
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stressed through a dispersion diagram built on a system of factorial axes organized

downwards, according to their importance in explaining the total variance of the
cloud.
The discriminant analysis (DA) is a multi-varied classification method, initially
suggested by Fisher in 1936, in order to differentate between individuals belonging to
the same species, according to a series of specific characteristics. The method aims to
classify a population into predefined groups, based on certain score functions (Z),
which express the relations between the independent variables, Xi, and the categories
of classification variables. The relation between the category dependent variable
(dichotomous or multi-chotomous) and the linear combinations of several metric
independent variables is of the form: Z = 0 + 1X1 + 2X2 + ... + nXn. In this
relation, Z is the computed score; Xi with (i=1,...,n) are the independent variables; i
are the coefficients of the model (unkown). Each company can be associated to a
score computed based on the individual values of the Xi variables. According to the
value of the obtained score, a company can be included in one class or another of the
category variable. In DA, the methodological approach implies: obtaining the
discriminant functions (as a linear combination of Xi), identifying the independent
variables that contribute the most to explaining the differences between the groups,
classifying the individuals for predictive purposes by allocating them to a specific
group according to the score obtained, starting from the specified values of the Xi
variables and evaluating the accuracy of the classification (Lebart at al., 2006).
The logistic regression analysis (LRA) is applied in order to determine the probability
of occurrence of the insolvency risk and uses the regression models with dependent
alternative variables, of the form: Y = 0 + iXi + , where Y = 0 in case there is no
insolvency risk and Y = 1 in case the insolvency risk exists, and Xi represents the
independent variables (factors), i the coefficients of the logistic regression model,
and is the error component. Moreover, since Y is a Bernoulli variable (Gujarati,
2004), it associates to the values one and zero the following probabilities of
occurrence: p for Y = 1 and q for Y = 0. LRA starts from the idea that the conditioned
average, M(Yi/Xi) = pi, is based on a logistic distribution: M(Yi/Xi) = pi = 1/[1+e^(0+iXi)] = 1/(1+e^-zi). After applying the reverse function, there will result that zi =
ln[pi/(1-pi)], and the logistic model will be defined by the relation Li = ln[pi/(1-pi)] =
0+iXi+i (Gujarati, 2004).
The identification of the profile of the insolvency risk (based on the three evaluation
methods), obtaining the coefficients of the disciminant function, as well as those of
the logistic regression model, have been achieved using the SPSS 19.0 statistic
software.
3. RESEARCH RESULTS AND DISCUSSIONS
After applying the FAMC method on the data in the studied sample, we have obtained
the diagram in Figure 2. This diagram presents the associations between The state of
the company and The index classes corresponding to the three evaluation methods:
based on the EV (own capital), on the MC, and on the VFCF. This method was
applied only after the discretization of the expression variables of the companys
value (corresponding to the three methods), and for three classes have been built for
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each of the three variables: 1 low index (-; m-/2); 2- medium index [m-/2;
m+/2) and 3- high index [m-/2; +).
Figure 2. The profile of the risk of insolvency according to the three evaluation
methods
According to the diagram in Figure 2, we can see that for the period 2008-2009, the
association between the characteristic indexes of the three evaluation methods
significantly differs in what concerns the state of the company, by representing the
variables categories in the system of two factorial axes, characterized by the
dimensions: Dimension 1 and Dimension 2. The two dimensions are obtained based
on a linear combination of the analyzed variables (frequency of occurrence will be
considered in each variable category). Cumulative, dimensions explain at least 50% of
the degree of association between the analyzed variables. Therefore, for the analyzed
sample, we can notice that bankrupt companies have a low variation index of the EV
and MC value, but record a high variation index of VFCF. Unlike them, solvable
companies have a medium and respectively high index indice of the EV value and a
medium variation index for the values computed using the MC and VFCF methods.
We can see thus that in the case of insolvent companies there is a reverse correlation
between their values obtained based on free cash flows and patrimony and
comparative methods (corrected stock exchange capital). From an optimistic
perspective, the value of the company, obtained by discounting the future cash flows,
is not supported by the current economic reality, but the value of the entity can be
correctly evaluated through patrimony methods and by the correct stock echange
capitalization.
We can conclude that in crisis conditions the EV as well as the MC faithfully indicate
the state of a company at a certain moment, in comparison with the VFCF-based
evaluation, which provides a distorted (overestimated) image of the position and
financial performance of the company. Insolvent companies will attempt to improve
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the image provided by the decreasing values recorded by EV and MC, by stressing
oversized future cash flows, not correlated with the financial realities (the companys
position and performance). Moreover, after data analysis in SPSS, for the analyzed
sample, 40.2% of the variation corresponding to the state of the company (its being
insolvent or not) is determined by IEV, a rather high value compared to the 23.7%
determined by IMC and the 29.3% determined by IVFCF, which explains the importance
of using the net accounting asset in presenting the faithful image of the company. As
a result, the patrimony method can be considered the main method that can serve to
present the real state of a company and implicitly to indicate the insolvency risk, in an
unstable economic environment.
Applying DA on the data in the analyzed sample, respectively the analysis of the
indexes punctually recorded for each individual company, based on the three
suggested evaluation methods, we have obtained in SPSS a series of descriptive
statistics synthesized in Table 4. Based on them, the intervals corresponding to each
category variable in Table 2 have also been determined.
Table 4. Descriptive statistics at the sample level
State of the
Company
Insolvent
companies
Solvent
companies
Total
Variable
IEV
IMC
IVFCF
IEV
IMC
IVFCF
IEV
IMC
IVFCF
Mean
-2.73
0.29
1.68
-0.14
0.60
-0.60
-1.43
0.45
0.54
Standard
deviation
9.56
1.50
6.55
0.27
1.50
2.30
6.80
1.49
4.98
The descriptive statistics presented in Table 4 point out a series of differences at the
sample level, in what concerns the state of the company (solvent or insolvent),
according to the values of the indexes of the three evaluation methods. We can see
that a bankrupt company records a very small average value of IEV and a high average
value of IVFCF, a situation opposed to the state recorded for solvent companies, the
difference between the values of the indexes corresponding to the used methods being
rather low. We can draw the conclusion that obtaining a value in an optimistic
manner, through the method based on the present cash flows, can be realistically
evaluated using the patrimony method, which seems much more prudent and which
takes into account the economic realities, the position and financial performance of
the company. At the IMC level, the difference between the average values of the
indexes for solvent and insolvent companies is insignificant (0.31), compared to the
differences resulted after applying the other methods (2.59 for EV and 1.08 for
VFCF). This indicates that the method based on the corrected stock exchange capital
(corrected market capitalization) market cannot signal any significant difference
between the value of a solvent company and that of an insolvent company, as its
usage does not allow the identification of the insolvency risk.
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Table 4. Coefficients of the classification functions and the structure matrix

Variables
IEV
IMC
IVFCF
Constant
Standardized
function
0.695
0.190
-0.797
-
Structure matrix
0.566
0.308
-0.687
-
State of the company

Insolvent
Solvent
-0.075
-0.005
0.180
0.266
0.093
-0.017
-0.899
-0.779
In what concerns the impact of each method, we will take into consideration the
values of the specific indexes of the three evaluation techniques, the results being
synthesized in Table 4, in the Structure matrix column. The coefficients
corresponding to each index indicate the degree of correlation between the index and
the standardized classification function, obtained by aggregating the products between
the coefficients and the associated indexes. High values (over 0.5) of the coefficients
in the Structure matrix signal a strong correlation between the associated index and
the classification function, as well as in what concerns influence. We can notice that
in the case of IMC the value of the correlation coefficient is insignificant (0.308),
which demonstrates that the MC method does not significantly contribute to stressing
the differences between the two states of the companies (insolvent/ solvent).
In the case of VFCF, high values of IVFCF indicate the presence of insolvency risk
because of the strong negative correlation (-0.687) between the index and the
Standardized function. The score of the Standardized function, obtained for an
analyzed company, will be significantly diminshed by high values of IVFCF and will
lead to classifying the company in the insolvent group. In contrast with IVFCF, IEV is
strongly and positively correlated (0.566) with the Standardized function, and high
values of this index will determine a high classification score and implicitly including
the analyzed company in the solvent group. The standardized function is the
mathematical model that leads to classifying an analyzed company into the two
categories (solvent/insolvent), based on the belonging of the value of the obtained
score to the classification intervals. This has the form: Score = 0,695IEV + 0,190IMC 0,797IVFCF, and low values of the scores are associated with insolvent companies,
while high values of the scores are associated with solvent companies. A score close
to -0.337 indicates the presence of the insolvency risk, and a score close to the
average value 0.337 indicates the absence of this risk (these values represent the
averages of the scores corresponding to the two classification groups). Moreover, the
values of the coefficients associated to the indexes of the standardized function also
indicate the importance of the method in obtaining the classification score and
implicitly indicating the state of the company.
Based on these results, we can conclude that the cash flow discount method allows
obtaining distorted results concerning the value of the companies. Insolvent
companies will attempt to hide their unfavorable financial state (their position and
performance) expressed through low values of EV. Solvent companies have a high IEV,
recording low values of IVFCF, thus revealing the usefulness of applying the prudence
principle with the purpose of obtaining a faithful image. In this case we can also state
that the evaluation method based on EV best indicates the position and financial
performance of a company at a given moment, unlike the other two methods.
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The main advantage of DA is obtaining classification functions, which will allow the
subsequent inclusion of the companies that are not part of the analyzed sample, in
predictive purposes. The coefficients associated with the indexes of the evaluation
methods are presented in Table 4, and the classification functions obtained have the
form: ScoreInsolvent = -0.899 -0.075IEV + 0.180IMC +0.093IVFCF and ScoreSolvent = 0.005IEV + 0.266IMC -0.017IVFCF. By replacing the two variable functions with the
data presented by a company that will have to be classified into one of the two
categories, two score values will be obtained (a value for ScoreInsolvent and a value for
ScoreSolvent). These values will be compared, and the highest value will also determine
the companys belonging to one of the two categories.
In what concerns the LRA method, the main results obtained in SPSS concern the
functions for determining the probability of occurrence of the insolvency risk for a
comoany, after the application of each evaluation method. For an analyzed company,
the three probabilities of occurrence of the insolvency risk will be compared,
according to the used method, with the purpose of their classification. Moreover,
based on the probability computing functions, LRA allows a series of comparisons in
what concerns the correct classification of the analyzed companies into the insolvent/
solvent groups. This way, the method used to obtain a classification function that has
the fewest wrongly classified cases will be the method that best indicates the absence
of the insolvency risk and implicitly a faithful image. The obtained results are
synthesized in Table 5, and for the interpretation of the function coefficients, their
exponential value (exp) will be used.
Table 5. Results obtained through LRA
Variables
IEV
IMC
IVFCF
Constant
Exponential coefficients of the

probability
EV
0.183
0.557
MC
0.862
1.067
VFCF
1.243
0.975
Correctly forecast cases

Solvent
Insolvent
75%
40%
60%
-
55%
80%
50%
-
(*Sig < 0.5)
Starting from the results obtained in SPSS, based on the coefficients associated to the
variation indexes of the evaluation methods, it is possible to obtain the functions for
determining the probabilities of occurrence of the insolvency risk. Therefore, for each
method, a probabilistic model of the insolvency risk will be obtained, having the
form:
EV: [pinsolvent/(1-pinsolvent)] = 0.557(0.183)ÎEV;
MC: [pinsolvent/(1-pinsolvent)] = 1.067(0.862)ÎMC;
VFCF: [pinsolvent/(1-pinsolvent)] = 0.975(1.243)ÎVFCF;
Therefore, for IEV = 0 (the company has not recorded any modifications of EV), the
probability for a company to be bankrupt and not solvent is 0.557 (the ratio between
the probabilities for the two states), and an increase of the index by one unit (IEV = 1,
double EV) will amplify this risk by 0.183, eventually generating an insolvency risk
of 0.102 (0.5570.183). The EV method successfully indicates 75% of the solvent
companies (error 25%) and 55% of the insolvent companies (error 45%), resulting in
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a total error for the case when this method does not indicate correctly the solvent and
insolvent companies of 11.25% (25%45%). We can conclude that the prioritary usage
of this method will indicate companies with no insolvency risk.
For IMC = 0 (the company has not recorded any modifications of MC), the probability
for a company to be bankrupt and not solvent is 1.067 (the ratio between the
probabilities for the two states), and an increase of the index by one unit (IMC = 1,
double MC from one period to another) will amplify this risk by 0.862, eventually
generating an insolvency risk of 0.920 = 1.0670.862 (the ratio between the
probabilities for the two states). The MC method successfully indicates 40% of the
solvent companies (error 60%) and 80% of the insolvent companies (error 20%),
resulting in a total error for the case when this method does not indicate correctly the
solvent and insolvent companies of 12% (60%20%). We mention that this method
can be considered ideal for recognizing companies with an insolvency risk, in the
conditions in which the capital market is sensitive enough to any element that may
indicate the presence of this risk.
For IVFCF = 0 (the company has not recorded any modifications of VFCF), the
probability for a company to be bankrupt and not solvent is 0.975 (the ratio between
the probabilities for the two states), and an increase of the index by one unit (IVFCF =
1, double VFCF from one period to another) will amplify this risk by 1.243,
eventually generating an insolvency risk of 1.212 = 0.9751.243 (the ratio between the
probabilities for the two states). The VFCF method successfully indicates 60% of the
solvent companies (error 40%) and 50% of the insolvent companies (error 50%),
resulting in a total error for the case when this method does not indicate correctly the
solvent and insolvent companies of 20% (40%50%). Since there is the risk not to
provide the best clues on the presence of the insolvency risk (error risk = 20%), we
consider that the VFCF-based method is not appropriate for signaling the insolvency
risk.
Following the analysis of the LRA evaluation method, we consider it appropriate to
use the EV method, which can successfully indicate the presence of the insolvency
risk in the company, having the lowest error risk (11.25%).
CONCLUSIONS
This study brings a series of contributions concerning the relevance of the evaluation
methods in presenting the actual state of the companies and their real value, in
conditions of economic instability.
An essential point in this study is the identification of the usefulness and of the degree
of objectivity of each evaluation method, as well as of the opportunities to signal
insolvency risks, extremely useful in the managers approaches to govern companies
by reporting the decisions to the value of the business; here we refer to the concept of
governance through value. The patrimony methods, although currently challenged
for their inability to encapsulate in the value of the company anything but what is
recorded in the accounting statements, provide a prudent value image, appropriate in
conditions of economic instability, favoring the long-term preservation of the business
stability. The methods based on the discounted cash flows, although highly valued,
provide, in our opinion, a distorted image on reality because of their relativity and
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uncertainty triggered by the forecast process, implied by their application. As an

essential element for supporting these statements, a question mark is raised
concerning the usage of measures related to the past in order to quantify what can
happen in the future.
In what concerns the MC-based method, we can state that the volatility of the stock
flow, influenced by the tilte demand and offer on the capital market, as well as by
other factors concerning the degree of market development, the investors trust, the
applicable legislation, as well as by many other external factors, cannot faithfully
indicate the value of the company at a certain moment. This method can be combined
with the others in order to accentuate the trust in a potential value obtained based on a
certain method.
In what concerns the data analysis methods, the application of FAMC has the
importance of identifying a profile of the insolvency risk, based on value variation
indexes (starting from obtaining the value of the company according to the three
methods considered). DA supports obtaining company classification functions
according to the insolvency risk (usefulness of the method), and through the values of
the coefficients associated to the indexes in the classification functions, it allows
evaluating the degree to which a method significantly contributes to identifying the
considered risk. This is how a first hierarchy of the methods is achieved, using the
explicitation criterion of the variance of the passage from one state to another
(solvency-insolvency) based on the variation indexes of the value computed according
to the analyzed methods. A higher weight of the variation of the state (the insolvency
risk) attributed to an index corresponding to a method, will indicate a higher
importance of this method. From the performed analysis, we could see that both the
value computed using EV and that using VFCF significantly contribute to the
classification of the companies into solvent and insolvent.
Another significant element of this study is the identification of the probabilities of
occurrence/identification of the insolvency risk based on the evaluation methods.
Moreover, their hierarchy has been achieved according to the number of correctly
classified cases, in this case EV clearly detaching itself from the other evaluation
methods.
By validating the three work hypotheses suggested in the study, after meeting the
objectives of the research, we can state that in conditions of economic instability
(financial crises), the value of the company estimated using EV can be considered
relevant in presenting a faithful image of the company. Simple and easy to apply, this
method does not expose the shareholders to the potential risks of the capital market, to
the problems and limitations of the forecasts, nor to the subjectivity and relativity of
the other evaluation methods.
The limitations of this study are generated by its exclusive focus on BSE and by the
size of the sample, being mainly caused by the limited access to the causality and
specialized information necessary to develop our research. Future research directions
will aim at surpassing these limitations by suggesting extended and in-depth studies
on other capital markets, by including other methods, as well as by a better
identification of the factors that condition obtaining objective and appropriate
company values, as an essential support for investment and management decisions.
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ACKNOWLEDGEMENTS
This work was supported by the the European Social Fund in Romania, under the
responsibility of the Managing Authority for the Sectoral Operational Programme for
Human Resources Development 2007-2013 [grant POSDRU/CPP 107/DMI
1.5/S/78342]
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FINANCIAL RISK ANALYSIS AT THE STOCK

EXCHANGE LISTED COMPANIES IN THE
PASSENGER ROAD TRANSPORTATION INDUSTRY
Vlad IORDACHE1, Vasile ROBU& Costin CIORA
ABSTRACT
We are tempted to say that business activity is usually influenced by the emergence of
operational risk, but we should not overlook the impact that the structure of funding sources
can have on the outcome of the enterprise. Financial risk appears when funding from
borrowed sources involving charges for payment of debts (interest) which affect the
profitability of the enterprise. The purpose of this paper is to show the level of financial risk
present at a number of five listed companies in the passenger road transportation industry.
The analysis was based on interpretation of risk level using the results obtained by
calculating the coefficient of financial leverage for a period of five years; the purpose was to
demonstrate that using this tool managers can make decisions in a short time so that decision
making process will not be long standing.
KEYWORDS: financial leverage, financial risk, methods, profitability, risk

INTRODUCTION
The beginning of our era has been characterized both by risk and uncertainty, and this
prompted us to turn our attention towards measuring the degree of risk present in our
activity, why? Because the rules of the game had to be changed during it, because the
need to adapt to new economic conditions have requested it.
Risk and uncertainty have been and still are problems that have concerned both
scholars and practitioners since ancient times.
We are tempted to say that a business activity is usually influenced by the emergence
of operational risk, but we should not overlook the impact that the structure of funding
sources may have on the outcome of the enterprise.
Future business decisions or actions are often influenced by financial risk, so that
financial risk analysis is an important information both by value and correlation with
the findings of operational risk analysis, for a globally risk assessment.
The capital of a company consists of two components: equity and borrowed capital.
The two components raise different costs of capital. Thus the cost of borrowed capital
Correspondence address: Vlad IORDACHE, Bucharest Academy of Economic Studies, Romania;

email: vlad.jordache@yahoo.com
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includes the value related to financial expenses with the interest that the company
must constantly bear from the moment it used the credit lines.
So, borrowing involves a change in the results, thus leading to changes in financial
risk. Financial risk arises from the presence of financial expenditure that remunerates
borrowed capital (interest on loans).
Financial risk or capital risk looks over financial structure and depends on the
financing of the activity: if it is financed solely by equity, financial risk is not present.
Financial risk appears when funding from borrowed sources involving charges for
payment of debts (interest) which affect the profitability of the enterprise.
The crisis has manifested itself in full effect in 2008-2009 affecting capital market
development both nationally and internationally. This led to declines in most listed
companies stock quotes. For investors it is important to pursue all necessary
information concerning the development or liquidation of their portfolio, market
development being a crucial factor. Investors have watched the evolution of capital
market crisis even before the event took place, observing also the evolution of the
financial risk of companies on which they had assets, correlated with the development
of stock market indicators.
The issue of financial leverage is represented initially in the theories presented by
Modigliani and Miller. They tried to identify an optimal value of financial leverage to
enable an increase in company value, concluding ultimately that the two independent
variables have no relationship.
In 1958 Modigliani and Mill have theorized that firm value is independent of capital
structure. Later, Myers and Majluf (1984), Fama and French (2002) showed the
impact of taxation on capital structure and the value of the company, promoting the
idea of asymmetric information and agent costs. (Triandafil, C, 2007)
The financial leverage impact on investors` perception on a specific company caused
contradictions between theories issued by various theorists. Thus it was found out that
leverage is a positive sign for investors, especially in light of the fact that only one
company with good financial results will be able to attract external financial
resources. (Ross, S, 1977)
Other theorists have noted that the lever can have a negative impact on potential
investors because by indebtement the company tends to become riskier. Another point
of view was that when the firm used external financing resources, operational cash
flow was not sufficient to cover financial obligations. (Miller, M. and Rock, K., 1985)
2. THE IMPORTANCE OF DETERMINING THE LEVEL OF FINANCIAL
RISK IN PASSENGER ROAD TRANSPORTATION
Financial risk analysis in the area of passenger transport is and will remain of great
importance, because there will always be the need of individuals to move in the
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society we live in. Additionally, risk is a part of all existing activities in the context of
todays economy, even more when the need for funding is increasing.
Transportation is an important sector of the economy both in terms of its direct
contribution to the GDP and of its role in the movement of goods and persons
involved in the creation of gross value added of other industries. It is still an evolving
industry that promises positive developments
Passenger transportation is following an ascending trend, and this is mainly due to the
increased contribution of intercity and international road transport. Transport holds a
share of about 7% of gross domestic product, representing the second category of
services, after trade, as importance in the tertiary sector; at the same time it is an
activity with a contribution equivalent to growth of agriculture. In contrast, shipments
are constantly changing, with high annual growth rates. Passenger road transportation
covers 70% of travel need.
In conclusion, having this current economic climate we felt that the study on the
development of the level of financial risk is interesting for any investor who wants to
develop a portfolio and wants an easy tool that shows him the financial risk level of
the company he is wishing to invest into.
3. FINANCIAL RISK ASSESSMENT THROUGH THE ANALYSIS
OF FINANCIAL LEVERAGE RATIO EVOLUTION
Financial risk assessment can be made using position indicator to overall break even
point. In addition, for assessing is also used the sensitivity analysis of return on equity
that falls under the funding policy. It can be said that the sensitivity analysis is a risk
measurement method in direct correlation with the performance of a system.
Sensitivity analysis can be regarded as a risk quantification tool for influencing
economic activities and management, as financial analysis and diagnosis method used
in the study of financial equilibrium and, therefore, as a basis for technical and
financial evaluation of the decision. In terms of the financial balance diagnosis,
sensitivity analysis shows the exact action of the two axes that give the sense of
equilibrium concept, namely: profitability and risk. The model used to study the
sensitivity is financial leverage effect.
In terms of the financial risk, this is the additional risk of the activity, a risk over the
economic risk, given that the company is self-financing the activity whilst is also
borrowing money.
The financial risk depends on the following factors:
The financing way, reflected by capital structure
Cost of equity and borrowed capitals
The existence of an accurate assessment of financial risk level is of interest for both
creditors and shareholders. The basis of a decision regarding the financing activity is
supported if the proposed solution offers low risk and if the expected benefits justify
the committed effort.
The creditor or the shareholder will study in this regard, particularly the status of
liquidity, beeing less interested in working capital analysis. The decision making
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concerning investment, composition of circulating asset and short-term commitments

have a greater importance than the information about the values of assets and longterm commitments. A potential investor interest is particularly directed to the
company's ability to generate profit.
The analysis and assessment of financial risk can be based on financial leverage ratio
(CLF). This ratio expresses the sensitivity of the exercise net result to the changes in
operating result:
Rnet / Rnet
CLF =
(1)
Re xer / Re xer
where: Rnet net result
Rexer operating result
Financial leverage ratio expresses the percentage change in response to changes in net
operating result by a percentage of operating result and its size is directly proportional
to the degree of financial risk.
For a factorial point of view the financial leverage ratio used to assess financial risk is
determined based on the profit and loss account, in which net result is obtained after
deducting income tax from the gross result:
Rnet = Rbrut (1 i)
Rnet = [ Re xer Chfin + (Vfin + Re xtr )] (1 i)
where: Rbrut - the gross result
Chfin - financial charges
Vfin - financial income
Rextr extraordinary result
i - tax rate
(2)
But the financial income and the extraordinary result are not related to the activity that
the enterprise currently has in progress, so the calculation relationship of financial
leverage ratio becomes:
Re xer
CLF =
(3)
Re xer Chfin
To prevent financial risk firms should calculate and ensure a break even point, set up
as a confidence interval and not as a predetermined reference value. The limits of this
range are determined by the level of uncertainty the company is evolving in. When it
tends to zero, we will certainly be talking about a punctual profitability and not about
an interval in which profitability is attained with a satisfactory profitability. And,
when uncertainty is high, the confidence interval has such high level that it becomes
unusable in decision making.
4. THE EVOLUTION OF THE FINANCIAL LEVERAGE RATIO
To analyze the financial risk we performed a comparative study of the evolution of
the financial leverage ratio value over a period of five years in a number of five
companies, all listed on the Bucharest Stock Exchange. This should be noted because
of the fact that when traded companies needing funding and not wanting to use the
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loans of the banking system, they may decide to resort to financing instruments from
the capital market.
The determination of the financial leverage ratio lies in the need for investors to
assess financial risk in making investment decision.
To start the analysis we considered necessary to review the progress of the BET index
in the five years under study to observe the evolution of the annual value of
transactions volume on the capital market.
Graph 1. BET evolution during 2005-2009
(Source: Information taken from www.bvb.ro)
As it can be seen from the chart concerning the BET index evolution calculated on the
basis of traded volume during 2005 - 2009 we find that the level of 51% of BET index
in 2005 recorded a downward trend for the period 2006-2007, culminating in a
negative level of about - 70% in 2008. This can be justified by the concerns that were
on the market in 2008, considering that this was a maximum period of the crisis we
are still going through.
The negative trend from 2008 was stopped and in 2009 we can find that the anti-crisis
effects at economic level began to make their presence felt, so it led to a positive
evolution of the BET index, a sign that the stock market evolutions have registered a
recovery.
Next, we proceed to the analysis of results evolution achieved by the financial
leverage ratio. We conducted a comparative analysis of this indicator on a period of
five years for a total of five companies that are listed on the stock market. This study
was conducted to determine the level of financial risk, using a method easy to use for
its quantification.
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Table 1. Financial leverage ratio calculation

Year
2005
2006
2007
2008
2009
Company
Operating
Results
Financial
expenses
Financial leverage
ratio
135,954
106,098
4.55
340,480
12,965
1.04
42,462
1.00
259,340
92,433
1.55
152,315
2,256
1.02
A
B
C
D
E
148,039
-217,481
100,234
191,170
90,419
20,220
44,344
57,360
2.57
0.91
1.79
1.43
-224,138
1.00
122,680
134,543
-10.34
-1,074,561
33,900
0.97
87,778
54,681
2.65
157,521
71,935
1.84
104,597
155,946
-2.04
A
B
C
D
E
203,248
-4,173,555
52,278
379,252
232,993
994,840
43,783
163,053
-6.83
0.81
6.15
1.75
104,597
155,946
-2.04
474,635
439,066
13.34
-2,912,626
1,485,391
0.66
-214,284
19,722
0.92
513,750
253,856
1.98
324,285
118,090
1.57
(Source: Personal calculations based on data taken from the annual financial statements of
companies listed on BSE)
Company A S.C. EXPRESS TRANSPORT S.A., Trgu Jiu

Company B S.C. MONDOTRANS S.A., Trgovite
Company C S.C. TRANSALBA S.A., Alba Iulia
Company D S.C. TRANSBUZ S.A., Slatina
Company E S.C. VALEA PRAHOVEI S.A., Cmpina
The calculations made on the basis of such information is summarized in the chart
below where we realized an annual comparison of the evolution of financial leverage
ratio to highlight the evolution of the financial risk of each company within the five
years of analysis.
~206~
Graph 1. CLF evolutions during 2005-2009
(Source: Personal calculations based on data taken from annual financial statements of
companies listed on BSE)
The results for 2005 by calculating the financial leverage ratio for the five companies
allow us to affirm the following:
For the company A there is a very high level of financial risk greater than the
average of the other companies, which can translate into a level of financial
expenditure greater than the income level of the year, following the possible
situation that the company resorted to using sources of loan whose
reimbursement is accompanied by a high level of risk
The results for the other companies are within 1 to 1.5, which means that the
financial risk recorded by the four companies can be classified as minor.
We can say that financial risk value obtained based on the leverage ratio in
2005 is correlated with the BET index, which registered a growth of trading
and hence a higher volume, so the capital flows were directed towards
investment in the purchase of new portfolios.
In terms of the leverage ratio level evolution for 2006 is registered an overall negative
trend, because the values recorded by this indicator show a very high level of financial
risk.
The companies B and E have registered values that can make us conclude that the
their financial risk is a minor, CLF values being very close to the value 1, a situation
possible because the share of financial expenditures was very low in the year 2006.
For 2007, the CLF values recorded for the five companies have reflected evolutions
different than the previous year. So if the previous year was reflected a bad general
situation featuring a maximum financial risk for most analyzed companies, the
situation in 2007 is balanced with a low risk degree.
The negative situation that has emerged from the analysis of the company E financial
burden is the result of much higher financial expenditure than the income of the year.
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The high value of financial expenditure levels may be the result of very high interest
costs. It must therefore be followed the evolution of the risk in the future, to see if the
degree of indebtment continues to be very high.
The year 2008 brings significant changes in the level of the financial risk for the five
companies analyzed. These relatively favorable evolutions of the previous years for
the companies have developed negatively this year, aspect that must be correlated
with the evolution of the banking institutions. It is known that 2008 was a year
marked by adverse evolutions of the credit institutions level because they wanted to
minimize such risks and thus the financing instruments became more expensive.
Therefore, the negative values recorded by the companies A and B were determined
by high levels of financial expenditure, which can be the result of the credit cost rise
by increasing interests that at the company level had the effect of increasing the share
of interest expenditures in total financial expenses and thus caused a negative
financial leverage ratio.
The companies B and D present a tolerable level of financial risk, a minor risk,
succeeding in managing costs to maintain the same levels of the previous years and so
for them the crisis was not that strong.
The C Company recorded a very high financial risk, which results in a high level of
uncertainty with respect to the consequences of the financial situation of the company
and so the financial situation will be followed for a longer period also by using
analytical methods that include more precise and accurate assessment tools.
CLF levels recorded in 2008 were normal for this period of uncertainty in which the
rumors characterized mainly the capital market evolutions.
The year 2009 is characterized by some stability, because the leverage ratio levels for
the five companies have been in amounts similar to the previous year. The situation
has stabilized, a high level of financial risk registering only at company A, where it
was recorded a very high level of financial risk.
The other companies have stabilized their situation and demonstrated lower levels of
values of financial risk with financial leverage ratio in the range of 0.7 to 1.5. The
situation in 2009 is the result of relative reduction in the amount of financial expenses
as a result of enterprise management guidance to reduce the share of interest expense
on one hand and a return to their funding sources, on the other hand.
CONCLUSIONS
In conclusion, the importance of financial leverage ratio of current financial
management and forecasting comes from the fact that the net result is sensitive to
indebtedness and it conditions the size of benefit and dividend per share, of great
interest to shareholders and self-financing business, which enhances equity.
A more precise estimation of the level of financial leverage ratio comes to meet both
businesses and potential investors demands as an easy way to assess the degree of
companies risk exposure.
~208~
The times we are living require the existence of early and effective means for
estimating the likely benefits and losses so that decisions are taken in a short time and
at a level of risk as low as possible. The results should be correlated with the
evolution for the year 2010 when the economic crisis effects have diminished and
creditors tried to relax the credit market.
To prevent the financial risk firms should calculate and ensure a break even point, set
up as a confidence interval and not as a predetermined baseline value. The range is
determined at this time by the level of uncertainty the enterprise is deploying its
activity in. When it tends to zero, it will certainly be a punctual return and not an
interval in which profitability is achieved with satisfactory probability. And, when
uncertainty is high, the confidence interval has a size so large that it becomes
unusable in decision making. (Prunea 2003)
AKNOWLEDGEMENT
Studies.
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Cimau, I. D., (2003), Riscul-element n fundamentarea deciziei. Concept, metode, aplicaii,
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Fama, E.F. and M.C. Jensen, (1983), Separation of ownership and control, Journal of Law
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Marszalek, J., Sekula, P., (2010), Financial leverage the investors perspective, 6th
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Myers, S.C., (1977), Determinants of corporate borrowing, Journal of Financial Economics
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Petrescu, S. (2005), Performan i risc n analiza financiar, Analele tinifice ale
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Prunea, P., (2003), Riscul n activitatea economic. Ipostaze. Factori. Modaliti de reducere,
Ross, S. (1977) The determination of financial structure: the incentive-signalling approach
Stancu, D., Stancu, Ion., (2006), Asimetria informaional, creterea sustenabil, riscurile de
exploatare i de ndatorare, a IV-a ediie a Risk Management Forum 2006,
IBR Bucureti, accesat la http://store.ectap.ro/articole/163.pdf, la data de 20.03.2010
erban, C., (2003), Tez de Doctorat: Strategii de prevenire a riscurilor din activitatea
economico-financiara a intreprinderilor
Triandafil, C. M., Brezeanu, P., Huidumac, C., (2007), Levierul financiar la interferena
dintre clasic i modern: studiu de caz asupra ntreprinderilor cota te la BVB, sectiunea
echipamente
~209~
PS4 IFRS I
Chairperson
David ALEXANDER, University of Birmingham, UK
BENEFITS AND COSTS OF PREPARING IFRS

STATEMENTS BY NON-LISTED COMPANIES:
EVIDENCE FROM THE CZECH REPUBLIC
David PROCHZKA
~210~
BENEFITS AND COSTS OF PREPARING IFRS

STATEMENTS BY NON-LISTED COMPANIES:
EVIDENCE FROM THE CZECH REPUBLIC
David PROCHZKA1
University of Economics, Prague, Czech Republic
ABSTRACT
EU Regulation No. 1606/2002 obliges companies listed on the EU stock exchanges to prepare
consolidated financial statements in compliance with IFRS. Many Czech companies are under
control of foreign companies (listed on EU capital markets). As the voluntary application of
IFRS was not allowed until 2010, Czech companies prepared financial statements according
to Czech legislative for statutory purposes. However, for consolidation purposes, they had to
provide parent companies with financial statements prepared in compliance with IFRS.
The paper deals with three basic approaches to the conversion of financial statements. The
first method uses conversion on the financial statements level. The second method applies the
conversion on the trial balance level. Finally, some companies prefer to implement
specialised accounting software, which enables to record all accounting transactions
parallelly under CAS and IFRS. Each method is shortly described and its main cost-benefits
are analysed. Theoretical conclusions are shortly evidenced by empirical data on example of
the Czech non-listed companies.
KEYWORDS: Conversion of Financial Statements; IFRS; Czech Accounting Standards;

Dual (Financial) Accounting System.
INTRODUCTION
The adoption of the International Financial Reporting Standards has caused a radical
change in financial reporting, esp. in countries with the code-law tradition of
accounting regulation. The research evidences an increased usefulness of financial
statements prepared in accordance with the IFRS worldwide. The benefits of
accounting harmonisation are well known. However, the implementation of the IFRS
into national legislation elicits costs for many subjects involved in the process. E.g.
many national legislations decree entities to prepare the IFRS statements for European
stock exchanges and simultaneously to prepare the financial statements based on
national accounting standards for statutory and/or tax purposes. As a consequence,
entities have to maintain two different sets of accounting data. The conversion of
financial statements from one set to another is a complex and costly process. The
papers main aim is to analyse advantages and disadvantages of various methods used
for the conversion of financial statements and to evaluate current practice in the Czech
Republic as far as non-listed companies concern.
Correspondence address: David Prochzka, University of Economics, Prague;

email: prochazd@vse.cz
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1. BACKGROUND
1.1. Literature overview
The International Accounting Standard Committee was set up in 1973 as the reaction
of accounting profession to a steady shift from the stewardship function of financial
accounting (oriented mainly on the past course) to the forward-looking orientation and
the need of reliable and comparable information useful in decision-making regarding
the allocation of scarce resources not only on a national level, but also in the
worldwide context. After some 30 years, the IFRS are leading principles (at least for
listed companies) in many countries.
Recent researches have demonstrated the usefulness of accounting information
contained in financial statements prepared according to the IFRS. The IFRS adoption
has increased the quality of disclosed information comparing to national GAAP
(Barth et al., 2008, p. 496). Moreover, the IFRS adoption in Europe has not only
contributed to the enhancement of financial reporting, but has also assisted in
improving the comparability between countries Macas (2008, p. 8.). This
improvement in quality is significant across Europe as shown by Aubert and
Grudnitski (2009) and esp. in countries with code law (Morais and Curto, 2007a),
where accounting was and still is more closely linked to taxation systems. The same
authors (Morais and Curto, 2007b) proved that this tendency is accompanied with less
smooth earnings since financial reporting in accordance with the IFRS is not closely
related to the taxation as local accounting standards are. Inwinkl and Aussenegg
(2009) support this view and add that lower level of earnings management under the
IFRS is more substantial factor in the Central and Eastern European countries as the
IFRS allow less discretion than national tax-oriented accounting standards.
The IFRS have had a material impact on firms financial information in some
countries. The increase in value relevance is demonstrated esp. in countries with
significant level of discretion in financial reporting, such as Italy (Paglietti and
Conversano, 2007; Cordazzo, 2008) or Spain (Pardo et al. 2009; Ferrer et al., 2009).
The positive influence of the IFRS adoption is also evidenced in transitional countries,
e.g. in Romania (Mustata et al., 2009) Poland (Jaruga et al., 2007) or Russia
(Bagaeva, 2009). The evidence confirming the value relevance of the IFRS is also
available for countries, which traditionally focus on supplying the high quality
information for external users, such as United Kingdom (Christensen et al., 2009;
Ferrer et al., 2009).
To conclude a short literature overview on usefulness of the IFRS, it may be stressed
that the adoption process helps in solving problems both on microeconomic and
macroeconomic level. Firstly, IFRS statements reduce informational asymmetry
between providers and recipients of capital (Dumontier and Maghraoui, 2007); thus
lowering the costs of monitoring management behaviour. As a consequence, the costs
of capital are predominantly cut down (Lee et al. 2008). Transparency and
interconnectivity of capital markets together with the intensification of foreign direct
investments flows (Marquez-Ramos, 2009) are typical examples of positive
macroeconomic side-effects of the IFRS worldwide application.
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1.2. Papers aim and contribution

As the previous summary of literature shows, the benefits of IFRS adoption are
significant and can be traced in many areas of economy. On the other hand, not
negligible costs are induced by the harmonisation process. Entities are obliged to
prepare financial statements, which may be more complex than under local GAAP;
investors have to recustomise models computing intrinsic values of corporate
securities, creditors need to adjust their risk assessment models, state authorities solve
the problem how to ensure control of tax duty fulfilment under new accounting
regime, etc. Not all costs of the IFRS implementation are borne by those who take
advantage of more useful and comparable financial statements. A comprehensive
cost-benefit analysis of the IFRS implementation is difficult because it is unfeasible to
compare benefits of one group involved with costs of another group.
The paper focuses on firms preparing financial statements in compliance with the
IFRS. More specifically, advantages, disadvantages and costs of various methods used
for the preparing of IFRS financial statements will be scrutinised. The problem seems
to be very trivial at the first sight. The method used and cost incurred should be very
similar as under any else reporting system. However, we should have on mind that
financial reporting is a subject of state regulation in many countries. Besides IFRS
statements for stock exchanges, entities may also be bound to prepare financial
statements according to national accounting standards for statutory and/or tax
purposes. As a consequence, entities face a problem how to ensure the preparation of
two sets of financial statements, usually substantially different, in order to meet all
legal requirements under restriction of minimal costs. This issue will be referred as
conversion of financial statements further in the text.
Advantages and disadvantages of various approaches to the conversion of financial
statements will be evaluated (Chapter 2). Further, a short description of regulatory
framework for financial reporting within the European Union together with the
analysis of accounting regulation in the Czech Republic will be performed (Chapter
3.1). Finally, empirical evidence will be presented to support the theoretical findings
on conversion of financial statements process and its specifics in the Czech Republic
(Chapter 3.2-3.3).
General findings of the paper on possible methods of financial statements conversion
may be utilised by all entities around the world that are in charge of preparing two
sets of financial statements. The benefit-cost analysis of those methods are valid
regardless whether two or more set of statements are prepared by listed or non-listed
companies, obligatory or voluntarily. Moreover, national regulators of accounting
may be influenced by the analysis to undertake certain steps reducing the cost burden
for companies and/or enhancing benefits from the IFRS adoption for national
economy as a whole.
The paper also contains a short analysis on an example of non-listed companies
domiciled in the Czech Republic. The Czech Republic as a case country has been
chosen for two reasons. The conversion of financial statements is an accounting issue
of great importance because about 40% of Czech companies prepare two sets of
financial statements. Secondly, accounting profession has been striving to persuade
the regulator of accounting in the Czech Republic (i.e. the Ministry of Finance) to
~213~
undertaken certain measures and thus to improve rather unsatisfactory situation. After
many years, the Ministry of Finance reflected the effort of accounting profession and
amended the Act on accounting by enabling selected entities to apply the IFRS on a
voluntary basis. The historical development in the Czech Republic can serve as an
inspiration for the regulators of financial reporting in other countries, both in positive
and negative sense. It can be assumed that countries, whose accounting regulation is
based on the code law approach and whose accounting is tightly subordinated to tax
system requirements, may face a similar problem.
2.
CONVERSION OF FINANCIAL STATEMENTS
The conversion of financial statements can be defined as a process when an entity

prepares two or more sets of financial statements, each in compliance with distinct
financial reporting standards. Financial statements different from statutory accounts
for bank credit purposes; financial statements based on national legislation for tax
purposes by listed companies; financial statements according to foreign GAAP for the
purpose of consolidation by parent company domiciled abroad or financial statements
in accordance with generally accepted principles instead of local GAAP for stock
exchanges are most common examples of financial statements conversion.
There are three dimension of financial statements conversion:
preparation of the first individual financial statements (opening balance sheet
respectively) prepared in compliance with an alternative set of financial
reporting standards;
reporting of individual financial statements and other figures needed for
consolidation or other purposes in regular intervals;
consolidation of individual financial statements.
The number of particular steps in each mentioned phase may differ depending on the
purpose of conversion. Whether a company makes conversion on its own or whether
it uses a template (e.g. prepared by parent company) is another factor influencing the
process of conversion.
Further in the paper, the case of national financial statements conversion into IFRS
financial statements for the purpose of consolidation by foreign parent company will
be assumed. E.g. a company based in the Czech Republic, and reporting under Czech
Accounting Standards for statutory purposes, is owned e.g. by a German parent
company listed on a Frankfurt Stock Exchange. For the consolidation purposes, the
Czech company has to prepare additional set of financial statements in compliance
with the IFRS. Despite this narrow specification, general applicability of the papers
conclusions should not be impaired.
2.1. Phase 1: Preparation of the first financial statements according to the IFRS
There are several steps, which shall be undertaken in this phase:
The preparation for the first time adoption of IFRS:
establishing of general road map for the conversion (expected costs,
deadlines, responsible persons, methods, controls);
~214~
introduction of basic principles on which IFRS are based to all people in

charge with the adoption (not only companys accountants and
management, but also IT specialists, tax specialists, etc.);
overview of current accounting software and other information systems.
The analysis of local GAAP:
identification of general differences between national GAAP and the IFRS;
identification of differences between entitys accounting politics under
national GAAP and the IFRS;
list of all differences, which will be subject of conversion, structured in
following groups: applied under both systems, but applying different
accounting methods; applied only in local GAAP, but not under IFRS;
applied only in the IFRS, but not under local GAAP.
The accounting choices:
measurement bases used in IFRS statements;
accounting politics, incl. useful lives for non-current assets, level of
significance, etc.;
usually defined by the parent company in order to hold uniform
consolidation politics.
The formulation of data needed for the conversion:
design of a conversion bridge, which will be used for the conversion
(usually usage of spreadsheets);
definition of outputs from current accounting SW needed for the conversion
(e.g. accounts receivable datasets with amounts and due dates);
definition of external inputs (e.g. interest rates for discounting of long-term
receivables and payables, etc.).
The creation of a conversion bridge:
reclassification of items (usually between non-current and current);
remeasurement of accounting elements, when different measurement bases
are applied under local GAAP and the IFRS;
elimination of items recognised only under local GAAP (e.g. certain kinds
of provisions, capitalised establishment costs, etc.);
recognition of items required by the IFRS and not applied under local
GAAP (e.g. finance leases assets and liabilities);
recognition of items required by IFRS 3 if a subsidiary was acquired within
business combination;
calculation of all amounts relating to the conversion incl. deferred tax.
The preparation of financial statements and other information:
usually according to the template designed by a parent company.
The implementation of opening balance into accounting SW or other IS:
relevant only if dual accounting system will be used for keeping accounts
(more details in next subchapter).
The implementation of outputs and figures calculated within the conversion of

financial statements is a process, which requires a lot of time. If an entity does not
possess accounting software enabling parallel (dual) keeping of accounts under
different set of accounting standards, implementation of a new information system or
reengineering of the current software is needed. This is a timely and costly issue.
Therefore many entities select other technical solutions, which will be used for the
conversion of financial statements in subsequent periods.
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2.2. Phase 2: Periodic financial statements conversion technical solutions

The advantages and disadvantages of various methods of financial statements
conversion are relevant especially in case of regular (e.g. monthly) reporting. No
general advice, which solution to adopt, exists. Each entity should have take into
account its specific conditions and chose an approach mixing benefits and cost in the
most favourable manner.
There are three basic approaches how to transform financial statements from one set
of accounting standards to another set of financial statements (Mejzlk, 2006):
conversion on financial statements level;
conversion on trial balance level;
dual accounting system (separate module for each set).
The choice of conversion method appropriate for an entity depends on many factors,
at least labour and ICT costs, number and nature of differences, frequency of and
deadlines for reporting should be taken into consideration.
Conversion on financial statements level
This method uses only the reclassification of items presented in statutory financial
statements. The main advantages of the method are:
easy and quick to implement;
no specialised ICT is needed;
low cost and labour burden;
easy to check the correctness of adjustments.
The disadvantages are:
applicable only if the number of differences is very low (no measurement,
recognition, accounting policies issues);
workable only for those cases when classification is the only one difference.
Conversion on trial balance level
In this case, the list of accounts (trial balance) based on local GAAP is exported from
an accounting software and then adjustments are made in spreadsheets (like Excel).
The following pros can be identified:
no specialised ICT is needed (data spreadsheets are sufficient),
applicable even if the number of differences is higher.
The cons of this method are:
applicable only for differences in recognition of items (provisions, IFRS 3
recognised assets); however not operational for different measurement issues
(work-in progress) and dissimilar accounting policies (depreciation);
additional accounting expert for the IFRS should be employed => higher
salary expenses;
conversion system is designed by the expert => his/her substitution in case of
illness or termination of the job is questionable and sometimes even excluded
without additional significant costs;
testing of the correctness and conclusiveness of the conversion bridge is
complicated and causes additional problems esp. for auditors;
~216~
the consistency of adjustments within periods and data relationships (e.g.

retained earnings) are hard to hold;
the way of archiving of underlying documents relating to the conversion,
which is made outside the accounting system, is an open issue.
Moreover, this method is indecisive as far as meeting reporting deadlines concerns.
After all transactions according to local GAAP are recorded, no additional
transactions need to be recorded into the accounting system. However, afterwards the
whole conversion process has to be carried out.
Timely and error-free data recording is a limiting factor of this method. Most delays
are caused because deadlines for recording of transactions are not held, e.g. missing
transactions are accounted for additionally due to delay of underlying documentation
and the whole conversion must be run once again. Predefined tables, macros and other
automatic calculations may mitigate the negative consequences of those delays,
although not in all cases.
Dual accounting system
The accounting system is set up so as it enables entities to record all transactions
twice regarding on the different requirements of the both financial reporting
standards. There are following plusses of this method:
all types of differences could be included;
conclusiveness and objectivity is secured as all adjustments are incurred
directly in SW modules;
customisation of accounting SW is possible and more outputs for management
are available;
the only viable solution if number of difference is very high;
possible integration of accounting software with consolidation reporting
systems and other ICT systems.
This method has following minuses:
implementation of a new or an upgrade of current SW is needed => additional
costs and changes in processes;
more transactions are recorded (more workload => additional employees =>
higher labour costs);
question is how to record the transactions (all transaction to record twice in
each module or to make special module for different transactions only);
way of archiving of the documents is not clear-cut (shall be documents
numbered, ordered and stored according to local GAAP or IFRS or in a
combined manner?).
This method of conversion of financial statements brings uncertain results regarding
the reporting deadlines. More transactions need to be recorded into accounting
software. However, if all is recorded, additional adjustments are not needed, as both
sets of financial statements can be exported directly from accounting software.
Moreover, recording of additional transactions do not cause any serious delays,
because updated IFRS statements can be retrieved from accounting software
immediately.
~217~
2.3. Phase 3: Consolidation of individual financial statements technical

solutions
After individual statements are converted for consolidation purposes, the
consolidation can be processed. The way of submission of individual statements to
parent company is a general problem of consolidation independent on the conversion
of financial statements process. The phenomenon exists even if all consolidated
entities use the same financial reporting standards in their statutory accounts.
However, the technical solution of this issue is often interconnected with a method
used for the conversion. Particular design of consolidation or reporting system
depends on:
the size of consolidation group;
the informational needs for managing the concern;
costs of each solution.
There are several possible ways how group entities can submit their financial
statements to parent companies.
Separate spreadsheet tables without any links:
consolidation is made by hand or data are entered into a relatively simple
system;
can be applied only if the structure of a consolidation group is relatively
simple (two or three companies, low number of intragroup transactions,
etc.);
a method requiring low costs.
Integrated spreadsheet file with links:
consolidation is made by the merging predefined spreadsheets files filled-in
by all companies;
applicable if consolidation group is not to big (several companies usually
not more than eight);
if there are a lot of links among files and many intragroup transactions to be
eliminated, Random Access Memory may not be able to process the
calculations and computer systems may fall down;
a low cost method; hard to hold consistency between periods; problematic
for auditors to check interconnections between individual and consolidated
statements.
Special consolidation software:
developed directly by a parent company or purchased solution customised
according to requirements of a consolidating company;
some types of consolidation software is based on spreadsheets (usually
break-down systems from the top to the bottom) software typically
developed internally by consolidation group, e.g. by programming new
functions in spreadsheet software and then integrated with data warehouse;
other types of software work with databases (usually sum-up systems
from the bottom to the top) typically stand-alone software purchased from
external IT company;
relatively expensive; conclusive; easy to check by auditors.
Integrated accounting/consolidation SW:
the highest level of integration of accounting and consolidation software;
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all-in-one solution, when entities keep their accounts in accounting

software and parent company retrieve data directly from accounting module
into consolidation module;
relatively expensive solution; all advantages of keeping accounts within
one integrated system.
3. EVALUATION OF THE FINANCIAL REPORTING DEVELOPMENT
IN THE CZECH REPUBLIC
3.1 Regulation of financial reporting in the Czech Republic
As a member state of the EU, regulation of accounting in the Czech Republic shall
conform to the EU legislation. The chief source of the EU guidance comes from the
following documents.
Fourth Council Directive 78/660/EEC of 25 July 1978 based on Article 54 (3)
(g) of the Treaty on annual accounts of certain types of companies (incl.
subsequent amendments);
Seventh Council Directive 83/349/EEC of 13 June 1983 based on the Article
54 (3) (g) of the Treaty on consolidated accounts;
Regulation (EC) 1606/2002 of the European Parliament and of the Council of
19 July 2002 on the application of international accounting standards.
Regulation on International Accounting Standards ordains a duty to prepare
consolidated financial statements by publicly traded companies. Member states may
broaden the scope of entities, which are obliged/allowed to apply the IFRS (e.g. in
individual financial statements of listed companies or in individual/consolidated
financial statements of non-listed companies).
The main means of Czech national accounting regulation is the code law. The Czech
accounting and financial reporting is regulated by:
Act No. 513/1991 Coll., Commercial code;
Act No. 563/1991 Coll., on accounting;
Decree of Ministry of Finance No. 500/2002 Coll., amending some enactments
of Act No. 563/1991 Coll., on accounting, in the financial statements of
business enterprises;
Czech Accounting Standards (further CAS) for business enterprises subject
to Decree of Ministry of Finance No. 500/2002 Coll.
Act on accounting until 2010
Despite the fact that EU regulations are generally binding in their entirety and are
directly applicable in all member states of the EU without any further implementation
in national legislations, the provisions of Regulation (EC) 1606/2002 were
incorporated directly in the Act No. 563/1991 Coll., on accounting. The obligation to
prepare consolidated financial statements accoutring to the International Accounting
Standards as adopted by the EU by companies listed on the EU capital markets is
included in 23a, article 1. However, the Czech regulator of accounting went one step
further and set up a duty for listed companies to prepare also their individual financial
statements according to the IFRS. Pursuant to 19, article 9 entities, which are
business companies and which are the issuers of securities publicly traded on a
regulated market in the member states of the European Union, shall apply the
~219~
International Accounting Standards as adopted by the EU for keeping their accounts

and for preparation of financial statements.
In addition, the IFRS can be applied in consolidated financial statements of non-listed
companies voluntarily (23a, article 2).
No other entities were allowed to choose the IFRS on voluntary basis.
Act on accounting from 2011
After several years of effort by academics and practitioners, the Ministry of Finance
proposed an amendment of Act on accounting, which was approved by the Parliament
in 2010. Starting from 2011, companies specified by the Act are allowed to select the
IFRS as the basis for preparation of individual financial statements, which are
accepted for statutory purposes. Pursuant to the new 19a, articles 7 and 8, following
three groups of entities may opt to use the IFRS in their individual financial
statements:
parent companies preparing consolidated financial statements in compliance
with the IFRS voluntarily pursuant to 23a, article 2;
subsidiaries belonging to a consolidation group for which the consolidating
company prepares IFRS consolidated statements;
joint ventures belonging to a consolidation group for which the consolidating
company prepares IFRS consolidated statements.
The amendment of the Act has changed the features of companies covered by
Category II (see their description further in the text). From 2011, the Category II
entities can opt whether to prepare two sets of financial statements (both CAS and
IFRS) or whether to prepare only one set of financial statements (just IFRS).
3.2 Issues regarding the implementation of Regulation (EC) 1606/2002
The adoption of IFRS in the EU has elicited new practical problems for companies
affected. Member states of the EU follow different paths when implementing
Regulation 1606/2002. Some countries have enacted only minimal requirements set
up by the Regulation, i.e. only the obligation to prepare consolidated financial
statements in compliance with the IFRS by listed companies; other countries have
broadened the scope to their individual statements. Compulsory or voluntary
application of the IFRS by non-listed companies is also possible in some countries.
Following approaches are preferred in selected countries:
Compulsory IFRS application in consolidated statements of listed companies
(pursuant to EU Regulation) and simultaneously
compulsory IFRS application in individual statements (e.g. Italy, Iceland,
Cyprus, Malta, Greece, Slovakia, the Czech Republic);
compulsory application of local GAAP in individual statements (e.g.
Austria, Belgium);
right of choice between local GAAP and IFRS in individual statements (e.g.
the Netherlands, Denmark, Ireland, Hungary).
Compulsory IFRS application in consolidated statements of non-listed
companies and simultaneously
compulsory IFRS application in individual statements (e.g. Cyprus, Malta).
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Voluntary application of the IFRS in consolidated statements of non-listed

companies and simultaneously
compulsory application of local GAAP in individual statements (e.g. the
Czech Republic before 2010);
right of choice between local GAAP and IFRS in individual statements (e.g.
the Netherlands, the Czech Republic after 2011).
Compulsory/voluntary application of the IFRS in individual statements of nonlisted companies (e.g. Denmark, Estonia, Finland, Ireland, the Netherlands,
Poland, etc.).
As far as financial reporting concerns, three groups of Czech companies can be
recognised. To summarise, provisions of the Czech Act on Accounting distinguished
following groups of companies until 2010:
Category I (very heterogeneous bulk of Czech companies that are publicly
traded on stock exchanges in the EU markets IFRS reporting only):
These entities have both to account for their transactions and to prepare their financial
statements (both individual and consolidated) using the IFRS. These companies are
not required to prepare their financial statements according to the Czech Accounting
Standards (further CAS) as financial statements prepared in accordance with the
IFRS are also accepted for the statutory purposes.
Category II (majority of big companies, small and medium-sized enterprises
both CAS and IFRS reporting):
This category covers a diverse group of companies, for which the common feature is
that companies in question are not a direct issuer of publicly traded securities.
Nevertheless, their owners are such issuers. Therefore, the companies belonging to
this category shall prepare their individual financial statements in accordance with the
CAS for statutory purposes. In addition, they are supposed to provide their parent
companies with financial statements and other information needed for consolidation
in compliance with the IFRS. Act on accounting until 2010 did not permit any
voluntary application of the IFRS instead of the CAS by this kind of entities.
Companies preparing consolidated financial statements voluntarily pursuant to 23a,
article 2 may be also subsided in this group.
Category III (Small and medium-sized enterprises only CAS reporting):
Category III covers family owned companies and other companies that are neither
direct, nor indirect issuer of publicly traded securities. They shall account for and
report in accordance with the CAS (again without possibility to apply the IFRS
voluntary).
Provisions of Act on accounting required mandatory application of the IFRS not only
in consolidated financial statements of listed companies (pursuant to Regulation
1606/2002), but also mandatory application of the IFRS in their individual statements.
Individual financial statements are accepted for statutory purposes levied by the
Commercial Code and are submitted to Business Register. That means that listed
companies (Category I companies) are not engaged in the process of financial
statements conversion, as both individual and consolidated financial statements are
prepared according to the IFRS and no additional set of financial statements prepared
in accordance with the Czech Accounting Standards (CAS) is necessary.
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The conversion of financial statements was an important issue for companies covered
by Category II. The majority of Czech companies are not directly listed on stock
exchanges (there are only 60 issuers listed on Prague Stock Exchange). According to
Act on accounting, all non-listed companies had to keep their accounts and prepare
their individual financial statements in accordance with the Czech accounting
legislation. However, about 40% of Czech companies are under control of foreign
owners. A lot of them are domiciled in Germany, Netherlands, Austria and other EU
member states and they are often listed on stock exchanges. For the consolidation
purposes, Czech companies must provide their parent companies with IFRS financial
statements.
As a voluntary application of the IFRS in individual financial statements had not been
allowed till the end of 2010, affected companies faced a problem of financial
statements conversion. Statutory accounts were held in compliance with the CAS; and
consequently statutory statements had to be converted into IFRS statements.
The conversion is not a trivial issue as a huge number of differences between CAS
and IFRS exist. The crucial conceptual weak points of financial reporting under the
CAS are:
no identification of users of financial statements and of their needs (it is not
explicitly expressed, but state and its authorities are considered to be the
primal user of financial statements);
absent specification of objectives of financial reporting;
vague requirements on qualitative characteristics that determine critically
usefulness of information in financial statements;
absent definitions of fundamental accounting elements;
misinterpreted notion of true and fair view;
unsound and/or missing accounting principles for many accounting spheres.
The situation becomes worse, when we deal with accounting treatment of certain
items. PricewaterhouseCooper (2009) published a comprehensive analysis, which
comprises differences between IFRS and CAS on 80 pages. Therefore, the decision,
which method of conversion to use, needs a deeper analysis by an entitys
management. All relevant advantages, disadvantages, possible benefits and cost
restrains should be taken into account.
With reference to a general analysis carried out earlier, the first method of conversion
(on financial statements level) is not appropriate for the vast of Czech companies, as
differences between CAS and IFRS are not insignificant. Remaining two approaches
are therefore favoured by Czech companies. The second method of financial
statements conversions (on trial balance level with usage of spreadsheet applications
like Excel, OpenOffice, etc.) represents golden middle way, as benefits and costs
are balanced for the majority of Czech companies reporting both under CAS and
IFRS. Low level of conclusiveness and dependence on the only one accounting expert
responsible for the conversion is offset by significant ICT cost savings, because no
specialised software is used under this approach. The last method (dual accounting
system) is applied by those Czech companies belonging to consolidation groups
which use the same accounting and reporting system for all group companies.
Sometimes hardware and software is placed in another location (e.g. at a group
central) and companies keep their accounts via remote access. Higher ICT (ERP or
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other sophisticated systems are used) and labour (more bookkeepers are needed for
recording each transaction virtually twice) costs are counterbalanced by two dataset of
information. Moreover, the conclusiveness and consistency of accounting records is a
valuable asset of this method.
3.3. Readiness of Czech non-listed companies for the switch to IFRS
It is obvious that impossibility to apply the IFRS voluntary produces high social costs
regardless, which method of conversion is chosen by entities. Scarce economic
resources have to be employed in non-productive use. Academics and accounting
profession tried therefore persistently to persuade the Ministry of Finance to amend
the Act on accounting by enabling voluntary application of the IFRS in individual
financial statements by Category II companies. The Ministry of Finance finally
recognised this proposal to be justified. Starting from 2011, Czech companies, which
are consolidated companies in the context of Regulation 1606/2002, can chose to
prepare their individual financial statement in accordance with the IFRS. In case of
optional application of the IFRS, financial statements conversion is not an issue
anymore. However, companies may decide to maintain current status quo and to
prepare their individual statements further under CAS principles.
New provisions of the Act were enacted in December 2010. How many entities will
utilise amendments of the Act is still uncertain. As the implementation of new
accounting software is a quite complicated project, it is highly improbable that any
companies have switched to the IFRS already from January 2011. First empirical
evidence will not be available sooner than next year. Author of the paper carried out a
quick empirical pre-research to evaluate the readiness of companies, external
accounting firms, auditors and accounting software developing firms for the IFRS
transition. A questionnaire containing two sets of questions was answered by ten
accounting or auditing firms. The first group of questions relates to the possible extent
of differences between the IFRS and CAS among various types of companies,
namely:
How significant are differences between the IFRS and CAS among
manufacturing companies?
How significant are differences between the IFRS and CAS among merchants?
How significant are differences between the IFRS and CAS among companies
providing services (without financial sector)?
Table 1. Differences between IFRS and CAS financial statements
Insignificant
Manufacturers
Merchants
Services
0%
80%
0%
Rather
insignificant
0%
20%
50%
Rather significant
Significant
60%
0%
40%
40%
0%
10%
The second group of questions focuses on evaluation of readiness for the IFRS
adoption by various subjects, namely:
How do you evaluate readiness of companies for voluntary application of the
IFRS?
How do you evaluate readiness of external accounting firms for voluntary
application of the IFRS?
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How do you evaluate readiness of auditors for voluntary application of the IFRS?
How do you evaluate readiness of accounting software developing firms for
voluntary application of the IFRS?
Table 2. Readiness for voluntary application of IFRS by non-listed companies
Entities
Accounting firms
Auditors
Software firms
Certainly not
0%
10%
0%
10%
Rather not
10%
30%
50%
80%
Rather yes
40%
50%
50%
10%
Certainly yes
50%
10%
0%
0%
Despite the fact, that the research is not fully representational because of restricted
size of the sample, certain tendencies can be derived from the respondents answers.
The reactions to the first set of questions affirm a general conclusion about high
number of differences between the IFRS and CAS. According to professional
accountants and auditors, this issue is relevant esp. for manufacturing companies
(which create a significant part of Czech gross domestic product). In addition, entities
providing services usually struggle with revenue recognition as there is no guidance
on this issue (neither general, nor for the construction contracts) in CAS and revenue
recognition is mainly influenced by legal and tax matters.
As far as readiness for voluntary application of the IFRS concerns, companies are on
the top of the list. Companies, currently preparing both sets of financial statements,
should have relatively smaller difficulties when shifting from CAS statutory accounts
to the IFRS. On the other side, it is believed that Czech software firms are not ready
for the transition, which could bring problems for companies considering voluntary
IFRS adoption. ICT solutions for keeping accounts according to the IFRS are offered
by foreign software developers (such SAP, etc.). However, costs of this solution can
be prohibitive for affected companies, esp. for medium sized enterprises.
The possible advantages from a voluntary shift to IFRS in statutory accounting may
be evaluated with reference to experience of Czech listed companies, which have to
apply IFRS obligatory both in consolidated and individual financial statements. There
are about 60 issuers on Prague Stock Exchange, from which were excluded some
issuers such as public sector institutions (Ministry of Finance, City of Prague, City of
Liberec), financial institutions and issuers with domicile located abroad.
Representatives of 23 companies remaining in the sample were asked for filling-up a
questionnaire scrutinizing benefits and costs from the IFRS implementation in their
companies. The benefits mentioned by already-adopters may serve as a useful source
of reference for those companies, who are contemplating about utilising of a new
provision of Act on accounting allowing voluntary IFRS adoption in individual
financial statements by designated entities. The answers of eleven respondents on
benefits are summarized in Table 3.
Table 3. Benefits from IFRS implementation on companies level
Easier access to financing by share capital

Easier access to financing by bonds
Easier access to financing by bank credits
Certainly
yes
73%
9%
0%
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Rather yes
Rather not
27%
55%
45%
0%
27%
36%
Certainly
not
0%
9%
18%
Easier reporting within consolidation group

Increased relevance of data for management
Increased credibility for our trade partners
Increased reputation for general public
Certainly
yes
64%
0%
0%
0%
Rather yes
Rather not
36%
27%
64%
45%
0%
55%
27%
55%
Certainly
not
0%
18%
9%
0%
Once again, presented table cannot be supposed to represent generally valid

inferences due to a restricted sample. However, it can be said that results are not
surprising for the most of answers and they correspond to expectations. As IFRS are
compulsory for listed companies, the connection between IFRS implementation and
the possibility to raise share capital financing is very close. A successful issuance of
bonds is also supported by the IFRS adoption, as capital markets are the only source
of available debt funds even in such an undeveloped capital market like in the Czech
Republic. Banks possess more tools for evaluating financial health of applicants for
bank credits, therefore IFRS adopters do not perceive the shift to IFRS to be really
relevant for this purposes. Based on personal talks with some representatives, IFRS
statements play no role in banks assessment whether to grant a company with
requested credit or not. Nevertheless, IFRS statements are said to reduce costs of
preparing applications forms and other documentation required by bank significantly.
The IFRS implementation is not supposed to enhance data relevance for management
purposes. It is a quite interesting outcome, when taking into account relatively low
relevance and usefulness of accounting principles set up by Czech national accounting
legislation. There are at least two possible explanations to this phenomenon. Firstly,
managers are accustomed to former Czech accounting standards, which they used for
years, and their do not understand and/or do not believe in data based on the IFRS.
Secondly, due to weakness of the CAS companies were forced to developed highquality management accounting systems removing those weak points and supplying
relevant data for decision-making. Therefore, a shift to IFRS has not produced any
significant increase in data relevance from managers point of view. This finding
needs further attention and scrutiny.
Representatives are indecisive regarding the influence of IFRS statements and annual
reports on company reputation in the eyes of general public. On the other side, IFRS
statements are supposed to be welcomed by trade partners. They are usually applied
for credit scoring of customers and other risk management procedures. Finally, the
IFRS implementation brought substantial advantages in the process of preparing
consolidated financial statements. Representatives of all listed companies assert that
the IFRS adoption has eased reporting within consolidation group. This may be the
crucial supporting element for those Czech non-listed companies when evaluating
whether to adopt IFRS voluntarily in individual financial statements as it is allowed
by Act on accounting starting from 2011.
CONCLUSIONS
The IFRS implementation into the Czech legislation has brought new quality to
financial reporting due to their usefulness in comparison with the CAS. On the other
side, if the IFRS are not allowed to be applied voluntarily in individual financial
statements of listed companies or in individual statements of non-listed companies
belonging to a group consolidated in compliance with the IFRS, the necessity of
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financial statements conversion occurs. The second case is a common practice in the
Czech Republic because Act on accounting did not enable non-listed entities to use
the IFRS on a optional basis until 2010. The financial statements conversion is
therefore an issue for almost 40% of Czech companies. To keep accounts according to
two sets of relatively difference accounting standards in single accounting software is
very costly matter. Therefore, most entities have chosen to make the conversion
through Excel and similar data spreadsheets on trial balance level.
Such an approach reduces costs significantly; however accuracy and transparency of
the conversion process heavily rest on the abilities of a single expert who are in
charge of the conversion. The conclusiveness of such conversions is not high in
general. The author of paper has experience from a significant number of companies,
of which financial statements converted from CAS to IFRS using trial balance method
of conversion are not in compliance with all provisions of IFRS. Spreadsheets are not
constructed to cope with all nuances of double-entry accounting. With rising number
of differences between CAS and IFRS, omissions and computing mistakes are
common feature of this method of financial statement conversion. Mistakes and
omissions remain even after being checked by auditors. As a consequence, the quality
of consolidated financial statements presented by parent companies may be severely
impaired, because a lot of Czech companies create a significant part of consolidated
figures. In my opinion, this is an issue of a fundamental importance not only for the
Czech Republic, but worldwide. Nevertheless, this issue are not really addressed by
either current practice or research.
In the context of previous doubts, the amendment of Act on accounting by the end of
2010, which enables selected companies to apply the IFRS voluntarily, shall be
welcomed. By allowing companies to apply the IFRS in their individual statements,
the Czech Republic follows pattern of financial reporting used e.g. in the Netherlands,
Denmark, Ireland, etc. The amendment should lead to presenting accounting
information, which is more useful for public. The second favourable effect would be
the reducing cost connected with recording transactions and preparing financial
statements under two different set of accounting standards. Finally, the risk of errors
contained in consolidated financial statements would substantially decrease, because
voluntary IFRS adoption in individual financial statement means that all records are
kept within accounting software and not outside in spreadsheets.
Claims to prepare individual statements compulsory according to national accounting
legislation (e.g. for tax purposes) levy high costs on companies and have other
negative economic consequences. National regulator of accounting should enable
affected companies to prepare their individual statements on alternative basis, mostly
in compliance with the IFRS. The development in the Czech Republic can serve as a
source of inspiration for all those countries solving the relationship of financial
reporting standards applied for consolidated and individual financial statements.
However, more robust empirical evidence will be available earliest in 2013, as first
companies will probably switch to the IFRS from year 2012.
There are some restrictions impairing inferences of this study. Firstly, not all
companies are allowed to apply the IFRS voluntarily. Only entities, which are subject
of a full consolidation under IFRS principles, are allowed to take advantage of the
option offered by the amendment of Act on accounting. As a consequence, companies
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classified as investments in associate and consolidated by equity method are excluded

from this option.
The crucial problem is, although, that Czech accounting is closely linked with the
taxation system. For the computation of current income tax, only net income
according to the CAS is relevant. Therefore, all companies regardless whether they
prepare individual financial statements according to the IFRS compulsory or
voluntarily have to keep evidence of taxable income based on the CAS. Without
releasing financial accounting from the income tax law, the conversion of financial
statements will remain a common practice for Czech companies. Author of the paper
is a member of a researcher team that is currently working on a study evaluating
various approaches how tax system can be separated from the financial reporting. The
future conclusions of this study can be valid for all countries, in which state regulator
carries out the regulation of financial reporting mainly for the tax purposes.
ACKNOWLEDGEMENT
The paper is processed as an output of a research project Auxiliary Computer
Applications Support for the IFRS Implementation in Business Practice supported
by the Internal Science Foundation of the University of Economics, Prague
(registration number F1/3/2010).
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International Financial Reporting Standards in Europe, Tampere, 32nd Annual
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forward, Brussels, CEC, 13.06.2000.
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2009 bound volume. London: IASB, 2009. ISBN 978-1-905590-90-2.
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Accounting Standards of European Public Firms, Tampere, 32nd Annual Congress of
the European Accounting Association, 12. 5. 2009 15. 5. 2009.
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Jaruga, A., Fijalkowska, J., Frendzel, M., Jaruga-Baranowska, M. (2007) The Impact of
IAS/IFRS on the Accounting Regulations and Practical Implementation in Poland,
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PS5 Fair value

Chairperson
Mihaela DUMITRANA, Bucharest Academy of Economic
Studies, Romania
THE IMPACT OF THE ED/2009/5 FAIR VALUE

MEASUREMENT ON THE PROFESSIONALS
Mirela PAUNESCU, Mirela NICHITA
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THE IMPACT OF THE ED/2009/5 FAIR VALUE

MEASUREMENT ON THE PROFESSIONALS
Mirela PUNESCU1 & Mirela NICHITA
ABSTRACT
The main objective of this research is to find out the reaction that the Exposure Draft issued
by IASB on Fair value measurement had on different types of respondents. The main data
comes from the IASB web site and consists in the comment letters the responded submitted
on IASBs request. As we will see, the vast majority of the respondents were in favour of the
project, even if they (almost) all had something to comment on specific issues. The main
objections of the respondents and their main suggestion were revealed as a result of this piece
of research. Our study contributes to the accounting literature by examining the users
opinions on the Exposure Draft issued by IASB in the first stage. When new standard will be
published, we intend to trace the modification and deviation from the ED in the new standard
based on the users comments.
KEYWORDS: Fair value measurement, exposure draft, comment letters, SFAS 157
INTRODUCTION
The fair value measurement model over the past years is a requirement or an
alternative offered to entities among several IFRSs. In some case, the use of fair value
is mandatory (such as for financial instruments, for investment property and so on), in
other it is the companys option (such as for measuring fixed assets). But the
definition of fair value and the requirements related to disclosure is to be found in
several IFRSs. Until nowadays, many IFRSs provide disparate, inconsistent and
sometimes limited, guidance on how to measure or to disclose information about the
fair value. This is why in September 2005 the Board added to its agenda a project to
clarify the meaning of fair value and to provide guidance for its application in IFRSs.
As a result, in November 2006 IASB published a discussion paper on Fair Value
Measurements. In line with the past and as a reflection of the need for increased
convergence with US generally accepted accounting principles (US GAAP), the
papers starting point was the Statement of Financial Accounting Standards No. 157
Fair Value Measurements (SFAS 157). The paper issued by IASB and SFAS 157 are
almost identical in all respects. As the Americans moved faster, IASB took advantage
of the fact that their standard was already published and applicable. But the draft
discussion is only the starting point as IASB published 13 questions for which it
requested responses. The number of received comment letters exceeds 150.
Correspondence address: Mirela PUNESCU, Bucharest Academy of Economic Studies, Romania;

email: mirela.paunescu@gmail.com
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1. BACKGROUND
The main objective of our research is to find out the reaction the Exposure Draft
issued by IASB on Fair value measurement had on different types of respondents
(more precisely on big accounting companies, professional bodies, banks and banks
regulators, universities, and so on). The main data comes from the IASB web site and
consists in the comment letters the responded submitted on IASBs request.
As we will see, the vast majority of the respondents were in favour of the project,
even if they (almost) all had something to comment on specific issues. The main
objections of the respondents and their main suggestion were revealed as a result of
this piece of research.
We will not approach in this piece of research the subject of the validity of the fair
value model, its pros and cons, nor even the reaction of professional toward the fair
value model as a result of the financial crisis.
Our study contributes to the accounting literature by examining the users opinions on
the Exposure Draft issued by IASB in the first stage.
1.1. A short history of the ED on Fair Value Measurement
IASBs intention is to provide a framework for measuring fair value and disclosure
about fair value. This ED does not introduce new fair value measurements, nor is
intended to change the rule neither of measuring the fair value nor for choosing a
model based on the fair value. IASB planed only to specify how entities should
measure fair value and disclose fair value information and not when entities should
measure assets and liabilities at fair value. The new coming Standard will only apply
when other IFRSs require or permit fair value measurements or disclosures and not to
measurements that are only similar to fair value in some respects.
Following the above mentioned discussion draft paper, in March 2008 the Board
published a discussion paper named Reducing Complexity in Reporting Financial
Instruments aiming to consider how to simplify the reporting of financial instruments,
including when fair value is an appropriate measurement basis for financial
instruments.
In March 2009 the Board issued Improving Disclosures about Financial Instruments.
That document aims to enhance disclosures about fair value measurements of
financial instruments.
1.2. Literature review
From our knowledge, there is no similar study conducted on this issue. On the other
hand, IASB by itself published a short letter with its own interpretation on the
respondents views and answer on the questionnaire. In order to be as objective as
possible, we did not read this material before conducting our study. We have
researched by our own the answers, and in the end we have made a comparison with
the findings of IASB. Our findings may be a little different from IASBs and the
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difference is normal and justified by the subjective factor coming from interpretation
of descriptive answers.
1.3. The main requirements of the exposure draft
As we have mentioned before, IASBs intention is to provide a framework for
measuring fair value and disclosure about fair value. Probably the most important
aspect of the ED is the definition of the fair value (par. 1 ED):
The amount for which an asset could be exchanged, a liability settled, or an equity
instrument granted could be exchanged, between knowledgeable, willing parties in an
arms length transaction.
In order to appraise the fair value, the entity must identify the reference market and
the market participants. The market to be used is the most advantageous market to
which the entity has access. The most advantageous market is the market that
maximizes the amount that would be received to sell the asset after considering
transaction costs and transport costs, and it is in most of the cases the principal market
of the entity, meaning the market with the greatest volume and level of activity for the
asset.
As for the market participants, even if the entity should not identify them specifically,
it should consider their characteristics and the fact that they must be independent of
each other; knowledgeable, able and willing to enter into a transaction for the asset.
Also very interesting is the assumption on which the pricing of the fair value is based,
namely the highest and the best use. More precisely, when there is no actual
transaction in order to freely observe the price, in order to asses the price that market
participants would use for the asset the entity must assume that the market participant
will use the asset in its highest and best use (HBU) that is physically possible, legally
permissible and financially feasible at the measurement date, and, accordingly will
maximise the value of the asset or the group of assets.
The highest and best use of the asset may be in use or in exchange. HBU is in
use if the asset would provide maximum value to market participants mainly through
its use, on a stand alone base or in combination with other assets. If the highest and
best use of the asset is in use, the fair value of the asset shall be measured using an inuse valuation premise. HBU is in exchange if the asset would provide maximum
value to market participants principally on a stand-alone basis. If the highest and best
use of the asset is in exchange, the fair value of the asset shall be measured using an
in-exchange valuation premise.
A change from the previous rules is set by the EDs requirement regarding the
treatment of the fair value at initial recognition of the item. According to par. 34 if an
IFRS requires or permits an entity to measure an asset or liability initially at fair value
and the transaction price differs from fair value, the entity recognizes the resulting
gain or loss in profit or loss unless the IFRS requires otherwise.
In order to estimate the price at which an orderly transaction would take place
between market participants, the entity must use valuation techniques. Those
techniques may relate the market approach, income approach or cost approach. The
market approach uses prices and other relevant information generated by market
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transactions involving identical or comparable assets or liabilities (including a

business). The income approach uses valuation techniques to convert future amounts,
such as cash flows or income to a single present (discounted) amount. The cost
approach reflects the amount that would currently be required to replace the service
capacity of an asset and it is often referred to as current replacement cost.
The assumptions that market participants would use when pricing the asset or liability,
are named by the ED inputs to the valuation technique. Such inputs may be:
(a) Observable inputs that are developed on the basis of available market data and
reflect the assumptions that market participants would use when pricing the item.
(b) Unobservable inputs inputs for which market data are not available and that are
developed on the basis of the best information available about the assumptions that
market participants would use when pricing the item.
Perhaps one of the most important step forward made by IASB was the attempt to
standardized the computation of fair value by prioritizing the inputs in 3 levels (part
of the fair value hierarchy). Actually, the entity must used first all the level 1 inputs
available ( they are given the highest priority), than level 2 and if there is no other
choice available, level 3 inputs may be used ( they are given the lowest priority).
According to IASBs view, level 1, inputs are unadjusted quoted prices in active
markets for identical assets or liabilities that the entity can access at the measurement
date.
Level 2 inputs are inputs (other than quoted prices included within Level 1) that are
observable for the asset or liability, either directly (for example prices) or indirectly
(i.e. derived from prices) for substantially the full term of the asset or liability.
Included in Level 2 inputs are the following:
(a) Quoted prices for similar assets or liabilities in active markets;
(b) Quoted prices for identical or similar assets or liabilities in markets that are
not active (paragraph B5 provides examples of factors that may indicate that a market
is not active)
(c) Inputs other than quoted prices that are observable for the asset or liability
(e.g. interest rates and yield curves observable at commonly quoted intervals,
volatilities, prepayment speeds, loss severities, credit risks and default rates)
(d) Inputs that are derived principally from or corroborated by observable
market data by correlation or other means (market-corroborated inputs).
As we can see the inputs in the second level require adjustments in order to be used.
Level 3 inputs, according to par 53, are inputs for the asset or liability that are not
based on observable market data (unobservable inputs). Unobservable inputs shall be
used to measure fair value only when relevant observable inputs are not available,
meaning when there is little or no market activity for the asset or liability at the
measurement date. But, as the fair value measurement objective remains the same
(which is an exit price from the perspective of a market participant that holds the asset
or owes the liability), unobservable inputs still shall reflect the assumptions that
market participants would use when pricing the asset or liability, including
assumptions about risk.
As for disclosure requirements, the entity shall disclose information that enables users
of its financial statements to assess the methods and inputs used to develop those
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measurements and, for fair value measurements using significant unobservable inputs
(Level 3), the effect of the measurements on profit or loss or other comprehensive
income for the period.
2. HYPOTHESIS DEVELOPMENT
2.1. Research Design
The main objective of the research is the analysis of the extent to which new adopted
accounting values, and especially the fair value, answer to the need of informational
for users that do not only want to know what were the results for the previous
financial period, but theyd like to be able to anticipate future trends based on
information released by the financial statements. Alternatively, we analyzed and tried
to group and summarize the main criticisms or proposals developed by the IASB
improvements project and we tried to determine whether the responses analyzed in
homogeneous classes of respondents are consistent. Our assumptions were that
respondents (by category) will identify the same problems and propose the same
changes, but these assumptions have been contradicted in some respects by the
research conducted. We have also tried to draw a conclusion with regards of how fair
value will be accepted after IFRS publishes a standard for measuring it, and to
consider "maturity" as its concept.
2.2. Sample selection
In order to infer the results found after analyzing letters of comments received by
IASB, we used typical methods of descriptive statistics. The population was made up
of letters of comments received by IASB as a result of the questions published by
IASB on its own site (www.ifrs.org or www.iasb.org). Comments came from a
questionnaire containing 13 questions and any interested person could have expressed
their views. Number of individuals in the population (in our case the number of letters
published) was 160. The research was conducted on a sample basis, the number of
individuals in the sample was 100 (i.e. 62.5% of total population) and by that we
made sure that we have selected a sufficient number of responses from all categories
we have previously identified. Thanks to the high population we believe that the
sample is representative for the population and so we can draw conclusions relevant to
this level.
We usually avoided the letters from individuals, noting from past experience that they
do not have full capacity to respond to all issues in the questionnaire (which in
principle we wanted) or they generally tend to agree or disagree with the IASB project
without, however, bringing qualitative arguments for their opinion. In contrast, with
exceptions, are entities famous or at least well known in their category (such as
regulatory bodies, banks and universities) that have been able to justify their
arguments for a response, pro or contrary to the belief of IASB.
Sampling was done by using a stratification method. The population was then divided
into layers and from those layers either all individuals were chosen or we have applied
a controlled selection for that layer. The reasons for choosing this method were as
follows: the investigator knew the population (the letters were numbered and
respondents were identified by name and / or institution, the country they came from
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and the representative body which they have represented), those who responded to
questions were not uniform (different backgrounds, with different interests), we aimed
to capture the views of each significant category identified, in some layers / categories
there was a significant number of individuals while in others (significant categories
for the research) there was a very small number (for example in Other groups or
Regulatory institutions / bodies individuals were numerous, while in Large
accounting companies or Universities the number of individuals who answered the
questions was small) and the last reason is that that some groups have had the
resources of all kinds so they have answered to all ( or almost ) all of the to questions,
while others had not and such they either did not give a relevant response or did not
answered for more than one or two questions (e.g. letters of response from the large
accounting firms have a high qualitative value, the respondents argued their views,
even contrary to those of the IASB, with well-grounded arguments, while individuals
who responded personally were either simply approving or not, but they did not
presented any arguments to contradict or to agree with the 13 questions in the
questionnaire).
Out of the 13 questions we have chosen 8 questions for which we have processed the
answers. Selection criteria was based on the questions relevance for the research
questions, the type of response that the question demanded and the importance we
granted to the question with reference to our research.
The number of those who answered a straight yes or no for the questions was
very low. In fact, from all the responses received, we had to decide whether the
answer is rather agree or disagree with what the ED requested. We have found a
significant number of responses: "Yes we agree but we think that ..."and the
disagreements or the proposed improvements to be more significant than the issues
agreed upon. Responses like "partially agree were treated, depending on the
question, as YES or NO answers, meaning that if the number of proposed
observations (and not disagreements) was insignificant and the question did not
require consent without any reservation, we consider the answer to be YES I agree.
If the person answering rather disapproved or wished-for a change or an alteration in a
number of issues, we have treated the answer as NO.
After classification of responses in four categories (Yes, No, Partial Agreement and
N / A - no response) we have considered the responses of "Mostly agree" as
disapproval, and we have calculated the main statistical indicators based on responses
reinterpreted and reclassified into three categories (answer YES, NO and N / A - not
answered). The categories identified by us are listed below:
Table 1. Category of respondents
Nr.
1
2
3
4
5
6
7
8
Abbreviation
A
B
C
E
F
I
S
U
Category
Others
Banks
Professional bodies (accounting and auditing)
Evaluation Regulatory bodies
Larger accounting companies (Big 4 and others)
Assurance companies and actuaries
Stock exchange markets and similar entities
Universities
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We have added together Assurance companies and actuaries because there were too
few letters to make two classes separate. Also, in Professional bodies (accounting
and auditing) we have included accounting professions.
2.3. Questions selected
Definition of fair value and related guidance
Question 1
The exposure draft proposes defining fair value as the price that would be received to
sell an asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date (an exit price) (see paragraph 1 of the draft
IFRS and paragraphs BC15BC18 of the Basis for Conclusions). This definition is
relevant only when fair value is used in IFRSs. Is this definition appropriate? Why or
why not? If not, what would be a better definition and why?
The transaction
Question 3
The exposure draft proposes that a fair value measurement assumes that the
transaction to sell the asset or transfer the liability takes place in the most
advantageous market to which the entity has access (see paragraphs 812 of the draft
IFRS and paragraphs BC37BC41 of the Basis for Conclusions). Is this approach
appropriate? Why or why not?
Question 4
The exposure draft proposes that an entity should determine fair value using the
assumptions that market participants would use in pricing the asset or liability (see
paragraphs 13 and 14 of the draft IFRS and paragraphs BC42BC45 of the Basis for
Conclusions). Is the description of market participants adequately described in the
context of the definition? Why or why not?
Application to assets: highest and best use and valuation premise
Question 6
When an entity uses an asset together with other assets in a way that differs from the
highest and best use of the asset, the exposure draft proposes that the entity should
separate the fair value of the asset group into two components: (a) the value of the
assets assuming their current use and (b) the amount by which that value differs from
the fair value of the assets (ie their incremental value). The entity should recognise the
incremental value together with the asset to which it relates (see paragraphs 20 and 21
of the draft IFRS and paragraphs BC54 and BC55 of the Basis for Conclusions). Is the
proposed guidance sufficient and appropriate? If not, why?
Fair value at initial recognition
Question 9
The exposure draft lists four cases in which the fair value of an asset or liability at
initial recognition might differ from the transaction price. An entity would recognise
any resulting gain or loss unless the relevant IFRS for the asset or liability requires
otherwise. For example, as already required by IAS 39, on initial recognition of a
financial instrument, an entity would recognize the difference between the transaction
price and the fair value as a gain or loss only if that fair value is evidenced by
observable market prices or, when using a valuation technique, solely by observable
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market data (see paragraphs 36 and 37 of the draft IFRS, paragraphs D27 and D32 of
Appendix D and paragraphs BC76BC79 of the Basis for Conclusions). Is this
proposal appropriate? In which situation(s) would it not be appropriate and why?
Valuation techniques
Question 10
The exposure draft proposes guidance on valuation techniques, including specific
guidance on markets that are no longer active (see paragraphs 3855 of the draft
IFRS, paragraphs B5B18 of Appendix B, paragraphs BC80BC97 of the Basis for
Conclusions and paragraphs IE10IE21 and IE28IE38 of the draft illustrative
examples). Is this proposed guidance appropriate and sufficient? Why or why not?
Disclosures
Question 11
The exposure draft proposes disclosure requirements to enable users of financial
statements to assess the methods and inputs used to develop fair value measurements
and, for fair value measurements using significant unobservable inputs (Level 3), the
effect of the measurements on profit or loss or other comprehensive income for the
period (see paragraphs 5661 of the draft IFRS and paragraphs BC98BC106 of the
Basis for Conclusions). Are these proposals appropriate? Why or why not?
Convergence with US GAAP
Question 12
The exposure draft differs from Statement of Financial Accounting Standards No. 157
Fair Value Measurements (SFAS 157) in some respects (see paragraph BC110 of the
Basis for Conclusions). The Board believes that these differences result in
improvements over SFAS 157. Do you agree that the approach that the exposure draft
proposes for those issues is more appropriate than the approach in SFAS 157? Why or
why not? Are there other differences that have not been identified and could result in
significant differences in practice?
3. ANSWERS FOR THE SELECTED QUESTIONS
As a general remark, the overwhelming majority responded favourably to the IASBs
project, whether they agreed with the IASBs view or not on particular aspects.
We also noticed that the large majority of respondents disagree with the exposure
draft in at least one or two aspects, the number of unfavourable responses being more
numerous than the positive ones.
Question 1
The exposure draft proposes defining fair value as the price that would be received to
sell an asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date (an exit price) (see paragraph 1 of the draft
IFRS and paragraphs BC15BC18 of the Basis for Conclusions). This definition is
relevant only when fair value is used in IFRSs.
In the IASBs view (paragraph 1 of the draft IFRS) fair value is the price that would
be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.
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As we have noticed, the fair value is mainly based on an exit value (price received to
sell an asset). From the illustrative examples and the guidance given by ED it results
that even when the company does not intend to sell the asset or an active market is not
available, the estimated price is still to be used.
The first question relates to the definition of fair value and related guidance and is
about how do respondents consider that definition, appropriate or not? Arguments
were requested regardless of the answer. Also, in case the respondent disagreed, a
better definition in his view was requested together with the reason in its favour.
For the first question, approximately 66% from the respondents answered that they do
not agree with the definition proposed by IFRS for the fair value, and they have
considered that the value defined by the ED is not feasible for every reporting entities,
nor that it may cover all the questions and particular situation that may appear in the
real life. The main objection for the fair values definition is that it should not be
based on an exit price (or an exit value), regardless of the situation in which it might
appear, but also on an entry price or on another value, depending on the particular
situation. The vast majority of those that disagreed underline the fact that especially
for liabilities a notion such as settlement is not appropriate, but it rather should be
considered in exchange a transfer: of the liability and more than that, as an active
market for liabilities is, if not impossible, than it is very hard to find, an exit value is
not at all appropriate for them.
An other significant part of respondents emphasized that the definition given by ED to
the fair value is not consistent with the examples also presented by IFRS in a separate
document and they made reference to more than one example that relied on the in
use value although the fair value is to be based on the exit price.
On the other hand an insignificant number of letters strongly recommended IASB to
give up the definition based on (restricted on) the exit price and to allow entities to
determine the fair value based on the intention the company has with regard to that
asset (to sell or to use the asset) or based on the business model of the company
(meaning that if the company doesnt have any intention to sell the asset but it rather
intends to use it, the fair value should be computed completely based on the in use
value, and not on an selling price, as long as this price it is not relevant for the entity
with regard to that specific asset).
Interesting and to be expected was the reaction of evaluators and actuaries: they have
criticized that there are to many definitions for the fair value, basically the same (at
least supposed to lead to the same result), but which may lead to misunderstandings.
They recommended IASB to use the same definition given in their own standards.
The transaction
Question 3
The exposure draft proposes that a fair value measurement assumes that the asset or
liability is exchanged in an orderly transaction between market participants to sell the
asset or transfer the liability at the measurement date (paragraphs 812 of the draft
IFRS). An orderly transaction implies exposure to the market for a period before the
measurement date, it is not a forced transaction and takes place in the most
advantageous market to which the entity has access.
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The most advantageous market is the market that maximizes the amount that would be
received to sell the asset or minimizes the amount that would be paid to transfer the
liability, after considering transaction costs and transport costs.
IASB intends to find out with the third question if the approach for the most
advantageous market is appropriate or not, and the respondents were also asked to
present arguments supporting their answer.
As for the second question regarding the definition of the market in order to determine
the fair value (definition which includes the term most advantageous market) a little
bit more than 50% from the comment letters (to be more accurate : 58% from the data
we have searched) have disagreed with IASBs approach. However we may assume
that the answers were evenly divided between those agreeing and those disagreeing
with the IASBs vision about the perfect market.
Those who disagreed with the definition proposed by the ED suggested that it is better
to use the main market on which the entity usually sales (very probably the market on
which the company record the highest level of sales).
Some letters disapproved strongly the choice of the most advantageous market,
recommending, in the name of prudence and with consideration with what happed as
a result of the financial crisis, the use of the smallest price available on the markets
(especially for banks which evaluate their financial assets using the fair value model).
Question 4
In order to estimate the fair value, according to the exposure draft (see paragraphs 13
and 14 of the draft IFRS) entities should determine fair value using the assumptions
that market participants would use in pricing the asset or liability. Market participants
should be independent of each other, knowledgeable, able to enter into a transaction
and willing to enter into a transaction. More guidance is given by IASB in the Basis of
Conclusion and Illustrative examples. For example, the entity should not specifically
identify market participants, but should reasonably use the most probable assumptions
of market participants, taking into consideration the asset or liability, the most
advantageous market and characteristics that distinguish market participants.
The fourth question from the questionnaire and third in our research was about the
respondents view about the description given by IASB for market participants. On this
question most letters were favourable projects are recognized definition of exposure
(56.41%) but those who are approved almost equal to the number disapproved. Those
who responded negatively tied the rule of how to define fair value (Q1 as the answer
was negative and therefore felt unable to agree with Q3). Those disagreeing with the
definition of market participants underlined the difficulties probable to be encountered
by the entities in assuming the other partys information. More than that, some
information are not available to persons from outside the entity. Many of the letters
also stress the subjectivity of such an assumption.
Question 6
The next question focuses on what do respondents believe about using the highest and
best use assumption when measuring the fair value. The exposure draft assumes that
market participants are able to generate economic benefit by using the asset in its
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highest and best use. Highest and best use refers to the use of an asset by market
participants that would maximise the value of the asset or the group of assets and
liabilities considering uses of the asset that are physically possible, legally permissible
and financially feasible at the measurement date. A physically possible premise takes
into account the physical characteristics of the asset to be considered when pricing the
asset, such as the location or size of a property. A legally permissible hypothesis takes
into account any legal restrictions on the use of the asset such as the zoning
regulations applicable to a property. A financially feasible premise takes into account
whether a use of the asset that is physically possible and legally permissible generates
adequate income or cash flows to produce an investment return normally required
from an investment in that asset put to that use.
The fourth question (Q 6) was designed in order to see the respondents views on the
requirement for the entity to split the fair value of group assets into two components:
(a) the value of the assets and assuming its current use (b) the amount by which this
value varies fair value of assets (i.e. incremental value).
This question have arisen live disputes, and the vast majority of respondents saw the
provision as being irrelevant and as having a lot of disadvantages among which we
quote: irrelevant, leading to confusion, unnecessarily increases the complexity of
evaluation and reporting, and so on. Most of the respondents suggested that this
recognition of the value of the asset value must be made incremental (global) and not
separately.
Question 5
Fair value at initial recognition
When an asset is acquired in an exchange transaction for that asset or liability, the
transaction price is the entry price, meaning the price paid to acquire the asset. Even if
conceptually entry prices and exit prices are different, in many cases they will be
equal. In such cases, the fair value of an asset or liability at initial recognition equals
the entry (transaction) price. There are many factors enumerated by IFRS to be taken
into consideration in order to determine if the entry price is the same as the exit price.
However, when an entity uses an asset together with other assets in a way that differs
from the highest and best use of the asset the exposure draft proposes that the entity
should separate the fair value of the asset group into two components: (a) the value of
the assets assuming their current use and (b) the amount by which that value differs
from the fair value of the assets (ie their incremental value). The entity should
recognise the incremental value together with the asset to which it relates (see
paragraphs 20 and 21 of the draft IFRS). Moreover, if an IFRS requires or permits an
entity to measure an asset or liability initially at fair value and the transaction price
differs from fair value, the entity recognizes the resulting gain or loss in profit or loss
unless the IFRS requires otherwise.
The fifth question (Q 9) was aiming to find the opinion on how to initially recognize
the value of a possible difference between the fair value and the value of entry (entry
price). The majority of respondents have not agreed to such recognition of difference
in the income statement claiming that lead to its volatility and found that such a
provision allows manipulation of financial statements (59%). However the exposure
draft provides that such recognition is possible only when relevant IFRSs require or
permit the use of those elements of fair value for initial recognition.
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Question 10
With the sixth question in our research (Q 10), IASB wanted to know if the way the
assessment techniques are described in the absence of active markets and illustrative
examples included in the annex to the project are sufficient and relevant. The majority
of respondents (57%) disapproved, accusing them mainly because there is not enough
information, and making reference to the Guidelines already published by the IASB in
October 2008: Measurement and disclosure of financial instruments that no longer
exists an active market.
Question 11
For the seventh question (Q 11), which was meant to cover additional disclosure, the
majority of respondents agreed with the requirements to increase transparency of
financial statements that are derived from the presentation of information about how
to determine the fair value hierarchy and the assumptions used, only that, on the other
hand, the IASB approach was found inappropriate (70.13% - among the highest rates
of disapproval). Most often raised issue was the very high cost required to submit
information requested by the exposure draft. On the other hand, the request for
additional information deriving from the ED did not seem as feasible as would have
been the specific demands from each reporting standard (basically, in their opinion,
the requirement for specific disclosure should come from the standards addressing
those elements, for example, intangible assets, tangible or so). A significant number
of questionnaires participants expressed the view that further submissions costs will
be far exceed the benefits generated by these presentations.
Also a significant number of letters disapproved with the IASBs view with regards of
certain information that should have been present according to the ED. Those
information seemed to the above mentioned to be too numerous and tricky (such as
those in the interim report under IAS 34).
Question 12
For the last question (Q 12) on the differences between the American standard on fair
value and the Exposure Draft, the majority of respondents (more than 50%) believed
that the difference in requirements between exposure draft and SFAS 157 is actually
an improvement proposed by the ED over the SFAS, and therefore agreed to the
difference. Yet, the overwhelming majority of those who understand and were willing
to accept the difference between the American and the International standard (in draft)
have recommended the IASB and FASB to meet and agree upon uniform
requirements.
There were a significant number of participants who said that although the difference
is relatively identifiable and measurable, they do not agree with the difference
between the two rules and that it would be more beneficial a consistent view or a
common development based on a dedicated standard value fair.
Only an insignificant number (disagreeing with the differences) have said that they
would recommend the American Standard in the name of convergence. However,
most of the letters were from professional bodies or entities that came from countries
"friendly" with the U.S., countries which have a reporting system based on US GAAP
rather than on IFRS (e.g. Canada). The only argument those entities used (although
most of them did not present any arguments) was that US FAS is older and has
already been published by the FASB.
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4. THE IASBS COMMENTS ON THE SURVEY

According to the IASBs opinion, nearly all respondents were in favour of the ED.
Overall, the following themes deriving from the comment letters were identified by
IASB among others:
1. Having a single source of guidance will reduce complexity and improve
consistency in application of fair value measurements;
2. The IASB and FASB should work together to develop fully-converged
guidance for fair value measurements in IFRSs and US GAAP;
3. An exit price notion is not relevant for assets when an entity does not intend
to sell the asset (i.e. when it is being used in the operations of the business or
it is a financial asset not held for trading);
4. Some of the guidance for measuring fair value in inactive markets in the
Expert Advisory Panels report should be added to the final IFRS on fair
value measurement guidance.
As for specific issues, relating to the definition of the fair value, IASB found that there
were some respondents that thought the proposal to define fair value as an exit price is
appropriate because it retains the exchange notion in the current definition, provides a
clear measurement objective, also removes the complexity caused by the diverse
guidance in IFRSs, and it increases convergence with US GAAP.
On the other hand, some respondents were reported to be on the opinion that it is
inappropriate to define fair value exclusively as an exit price, but it rather should
reflects an entry price in some circumstances (e.g. business combinations) and an exit
price in others (e.g. financial instruments), in order to provide useful information and
to be more relevant.
Other respondents were reported to think that fair value should not be market-based,
but should instead reflect the value to the business taking into account an entitys
ability to generate future cash flows by using the asset or liability within the business.
IASB recognizes that many respondents believed that the exit price notion is not
appropriate for liabilities because, in most cases, an entity cannot transfer its liabilities
and therefore there is no exit price but rather a settlement of a liability.
As for the transaction, according to IASB comments, some of the respondents agreed
with the proposal to base a fair value measurement on the price in the most
advantageous market for the asset or liability and thought that there is no significant
difference in fair values whether they are measured using the most advantageous
market or the principal market. Other was reported to be confused about the two
notions.
IASB also reported that some respondents were concerned that using the most
advantageous market introduces an upward bias into the measurement while the
thought that the exposure draft does not provide sufficient guidance on what to do
where there is no observable.
With regards of the market participants, IASB informed that generally, respondents
agreed with the market participant notion even than some commented that the
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proposed guidance does not sufficiently address how to apply the market participant
notion when there is no observable market.
IASB also notified that a part of the respondents considered that fair value should
instead be measured from the entitys perspective, especially when Level 3 inputs are
involved.
As for the highest and best use and valuation premise, many respondents were
reported to agree with the proposal that fair value reflects the highest and best use of
an asset while other thought inappropriate for a fair value measurement to consider
the highest and best use of an asset. They believe that fair value should better reflect
an entitys current use of the asset in order not to over-inflate the value and to avoid
inconsistencies between the cash flows generated from using the asset (in the
statement of financial performance) and the value of the asset (in the statement of
financial position).
Even if that subject was one of the most disagreed upon, in our opinion, IASB noticed
in its comments on incremental value, when highest and best use differs from current
use, that several respondents had concerns about the proposal to require an entity to
separate the fair value of an asset group when one or more of the assets is used in a
way that differs from its highest and best use as this is inconsistent with the valuation
premise, which states that all assets within a group must be measured on the same
basis (i.e. either in use or in exchange). Moreover, the opinion was that it will be
costly to measure the value of an asset or an asset group on two different bases (one
being the current use and the other being the highest and best use), particularly since
they think it is costly enough to analyse whether an assets current use is its highest
and best use to comply with the proposed requirements.
As for the valuation premise, IASB also did not express in figure the percentage of
those disagreeing, but presented the main concerns as being the lack of relevance of
the highest and best use concept and also confusion by the clarification in the
exposure draft that the in-use valuation premise assumes that the asset is sold
individually, not as part of the sale of an asset group.
With respect to fair value at initial recognition in IASBs view respondents generally
agreed that the four situations listed in the ED might lead to a difference between
entry and exit prices at initial recognition but disagreed with keeping the prohibition
in IAS 39 to defer day 1 gains and losses if the fair value is not based solely on
observable inputs while other thought there should be a clear principle and the type of
asset or liability should not influence the recognition of gains or losses.
IASB considers many respondents agreed with the descriptions of valuation
techniques in the exposure draft and find them helpful, while other respondents,
mainly in the valuation community, believed that an IFRS on fair value measurement
should not contain information about valuation techniques, but valuation standards
and practice guidance should (and already do) address this. The opinion that the
replacement cost approach as a valuation technique is inconsistent with the exit price
notion was also mentioned.
With respect to disclosures requirements, both our findings and IASBs comments are
in line with each other. Both the agreement with the proposed disclosures in order to
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provide meaningful information to users about the relative subjectivity about fair
value measurements and the concern that it will be too onerous and probable for the
benefit to outweigh the cost, especially for the Level 3 disclosures were reported. Also
the volume of disclosures and the risk of overwhelming users with information were
brought up by IASB.
ASB also mentions some respondents thought that disclosures should be addressed in
each standard and that they might be different depending on the asset or liability being
measured.
CONCLUSION
The responses in their rough form, unclassified on the type of respondents and
depending on the answer, and are presented in the following table:
Table 2. Unclassified answers
Yes
No
N/A
Partially agree
Answers
Q1
30
55
12
3
Q3
33
43
21
3
Q4
44
32
22
2
100
100
100
Q6
Q9
Q10
15
52
33
0
30
41
27
2
33
42
23
2
Q11
23
52
23
2
100
100
100
100
Q12
31
27
38
4
100
The next step was to classify the answer on the respondents type and to give up the
last category (Partially agree) and to combine it with the Yes or No category,
accordingly.
Table 3. Yes NO classification answers
%
Yes
No
Total %
Q1
Q3
34,09
65,91
100
Q4
41,77
58,23
100
Q6
56,41
43,59
100
Q9
22,39
77,61
100
41,10
58,90
100
Q10
42,86
57,14
100
Q11
29,87
70,13
100
Q12
50,00
50,00
100
As we may see, the most disapproved with questions were Q 6 and Q 11. Question 6
refers to the recognition of the increment value up to the fair value for the group to
which the asset belongs, where the use of the asset intended by the entity is different
than its higher and best use. Question 11 addresses the requirement of supplementary
information about how the fair value was measured, and it was expected to be a
challenging question, with regards of high costs required and the cost benefit
relationship.
~244~
Figure 1. Yes NO classification answers

Answers
100,00
80,00
60,00
Yes
40,00
No
20,00
0,00
Q1
Q3
Q4
Q6
Q9
Q10
Q11
Q12
Questions
More than that, responses were heterogeneous among classes of respondents which
shows that the problems related to the fair value model still remains open, unresolved.
We anticipated at least for certain questions to receive homogeneous (uniform)
answers among classes; this assumption, however, was proved wrong by the
responses.
Some results, however, could have been anticipated and are confirmed by values
obtained, such as:
1. Banks and insurers (we have analyzed 20 letters coming from such
respondents) were especially against further disclosure as required by IASB.
The number of letters disagreeing ( 13 out of 16 responses for that question)
was twice higher than the average;
2. Insurance companies have largely frowned upon the definition of fair value (
even more than banks had), coming probably as a result of the fact that they
are more affected in terms of provisions and reserves to be measured than
banks are ( 9 answers against the definition from 11 as compared to 12
answers against from 18 valid answers coming from banks);
3. Accounting firms have also largely disapproved the supplementary
information required to be presented. They were in majority against the IASB
proposal with regards to Q 9, Q 10 and Q 11;
4. Both stock exchange markets and universities have welcomed and approved
the requirements for submission of additional information (with very high
values as compared with the average);
5. Evaluators have unanimously condemned the new definition of fair value and
illustrative examples of computing present value techniques, which is only
logic as they have their own rules for determining the market value and
methods used to compute present value of assets (such as methods based on
the income or cash flow);
6. Both large accounting firms and universities have strongly resisted to the
proposal for recognition of gains from the first day, gains resulting from the
difference between original cost and fair value of the transaction.
We have also tried to see if there is any correlation between the answers and found
out that even if they are correlated, the coefficients of correlation are very small
~245~
(below 0.4) with the exception of Q 3 Q 4 for which we have computed a 0.5634
value (the highest correlation value).
If we codify the negative answers with -1 and positives ones with 1, than we obtain
the following values:
Table 4. Average on classes of respondents and questions
Question
Q1
Q3
Q4
Q6
Q9
Q10
Q11
Q12
A
0,00
-0,60
0,00
-0,33
0,00
0,50
-0,60
0,50
B
-0,33
-0,11
0,11
-0,54
-0,11
-0,29
-0,53
-0,63
C
-0,45
-0,13
0,10
-0,80
-0,03
0,16
-0,38
0,38
E
-1,00
0,00
0,00
-1,010
0,00
-1,00
-1,00
0,00
F
0,50
0,14
0,25
-0,14
-0,71
-0,50
-0,71
0,00
I
-0,64
-0,43
-0,43
-0,67
-0,20
-0,43
-0,43
-0,50
S
0,50
0,00
1,00
1,00
-0,50
0,00
0,50
0,33
U
-0,60
-0,50
0,50
-0,33
-1,00
-1,00
1,00
-1,00
Legend
Abbreviation
A
B
C
E
F
I
S
U
Category
Others
Banks
Professional bodies ( accounting and auditing)
Evaluation Regulatory bodies
Larger accounting companies ( Big 4 and others)
Assurance companies and actuaries
Stock exchange markets and similar entities
Universities
If we look in Table 4 we note that the average for the question is mostly negative
(indicating that the respondents gave a negative answer to the question) except for
questions 4 and 12, for which most respondents (but not an overwhelmingly
percentage) agreed. Question 4 concerns the definition of market participants, and
question 12 concerns the convergence with U.S. standards of reporting.
The same table shows that most disapproved questions were Q 6 and Q 11. Question 6
refers to the recognition of fair value increment for the group to which the asset
belongs, where he makes use of the asset is different than HBU entity (use of
optimal). Question 11 addresses the disclosure of information about how to measure
fair value, and it was expected to be challenged, most respondents referring to the
high costs required by supplementary information and the cost - benefit.
As a general remark, the majority of respondents agreed with the idea of the exposure
draft but disagreed with the exposure draft on most of the features, the number of
unfavourable responses being more numerous than the positive ones. Thus, we note
that the average for the question is mostly negative (indicating that the respondents
gave a negative answer to the question) except for questions 4 and 12, for which most
(but not an overwhelming majority) agreed. Question 4 is concerned with the
definition of market participants, and question 12 with the convergence with U.S.
standards.
As a final conclusion we may draw from the piece of research conducted, is the
observation that the dispute is far from coming to its end. If IASB takes into account
~246~
the criticisms and suggestions, then it would issue a totally different standard of
current exposure draft, or it would allow multiple methods of presentation and
techniques for calculating fair value.
Also as a general remark, the majority of respondents agreed with the idea of the
exposure draft but disagreed with the exposure draft on most of the features, the
number of unfavourable responses being more numerous than the positive ones. Thus,
we note that the average for the question is mostly negative (indicating that the
respondents gave a negative answer to the question) except for questions 4 and 12, for
which most (but not an overwhelming majority) agreed. Question 4 is concerned with
the definition of market participants, and question 12 with the convergence with U.S.
standards.
The most disapproved with questions were Q 6 and Q 11. Question 6 refers to the
recognition of the increment value up to the fair value for the group to which the asset
belongs, where the use of the asset intended by the entity is different than its higher
and best use. Question 11 addresses the requirement of supplementary information
about how the fair value was measured, and it was expected to be a challenging
question, with regards of high costs required and the cost benefit relationship.
REFERENCES
IASB meeting, Comment letter summary, Agenda reference 2 A, October 2009,
www.iasb.org , accessed April 2011
Exposure Draft ED/2009/5, Fair Value Measurement, http://www.ifrs.org/Current+Projects/
IASB+Projects/Fair+Value+Measurement/ED/ED.htm , accessed April 2011
Basis for Conclusions Exposure Draft Fair Value Measurement, http://www.ifrs.org/
Current+Projects/IASB+Projects/Fair+Value+Measurement/ED/ED.htm, accessed April
2011
Comment letters for ED 5, http://www.ifrs.org/Current+Projects/IASB+Projects/Fair+Value
+Measurement/ED/ED.htm , accessed April 2011
Tufcea (Punescu) Mirela (2010), Evoluie i dezvoltare privind evaluarea n contabilitate,
Tez de doctorat
Ronnen, J., (2008), To Fair Value or Not to Fair Value: A Broader Perspective, Abacus, vol. 44,
no. 2, 2008, http://pages.stern.nyu.edu/~jronen/articles/Fair_Values.pdf
***
Ernst
&
Young
(2005),
How
fair
is
fair
value?,
London,
http://www.anc.gouv.fr/sections/la_recherche_a_l_anc/1ers_etats_generaux/a_wilson_h
ow_fair_is/downloadFile/file/A_WILSON_How_Fair_is_Fair_Value.pdf?nocache=129
2609799.42, accessed April 2011
~247~
PS6 Management information systems I

Chairperson
Pavel NASTASE, Bucharest Academy of Economic Studies,
Romania
AN ENTERPRISE ONTOLOGICAL APPROACH

FOR SEMANTIC WEB
Adrian COZGAREA, Gabriel COZGAREA, Delia BABEANU

NON-TECHNICAL CHALLENGES IN ADOPTING

ENTERPRISE 2.0
CRITICAL SUCCESS FACTORS FOR THE ORACLE

DATABASE AUDIT
Simona Felicia UNCHIASU, Pavel NASTASE
~248~
AN ENTERPRISE ONTOLOGICAL APPROACH

FOR SEMANTIC WEB
Adrian COZGAREA1, Gabriel COZGAREA & Delia BABEANU
ABSTRACT
Considered part of artificial intelligence, ontologies became a technique over and over used
in the analysis of informational systems from different domains. Because it enables
description of structural characteristics and semantic in simple relative terms, and in WEB
semantic conditions, facilitates the knowledge sharing between the different users. Ontologies
bring a plus of knowledge in relation with "traditional" formalisms (Entity-Relationship
model, Object-Oriented model, etc.). This article presents the formals specific to ontologies
and proposes a relative ontology of the enterprise through the light of users' information on
WEB.
KEYWORDS: Informational systems, knowledge designing and management, ontologies,

semantic WEB
INTRODUCTION
In the present conditions, when the informational organizations area is subjected to
outstanding dynamics, analysis and modeling of informational systems invoke the
existence of advanced techniques and methodologies, to allow as much of related
activities are carried out automatically by means of appropriate software tools. To
achieve such an aim the applications software or computers in general, to become able
to "understand" all of the data or information exchanged, so that the analyst to be
discharged from routine activities or irrelevant.
The adoption of Internet specific technologies by most organizations has led to the
increasing interdependence of their reason for modeling and designing information
systems, a conceptual framework of the current ad (possibly standardized) common,
reusable and sufficiently flexible. Such an objective can be achieved only through
abstract universal formalisms, and completely independent of implementation
techniques.
The two objectives mentioned above, have become the artificial intelligence object
study, more precisely of the knowledge representation systems, which offers a
technique focused on the ontology term, a concept taken from the philosophy by
which it is assigned to the branch of philosophy what is studying the traits of
existence (Romanian Academy, Institute of Linguistics "Iorgu Iordan", 1998). In
1 Correspondence address: Adrian COZGAREA, Academy of Economic Studies, Bucharest;
email: acozgarea@gmail.com
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computer science, the term was introduced by Thomas R. Gruber, in 1993, to appoint
"an explicit specification of a conceptualization (Gruber, T., 1993: 199).
Meant any ontology consist in disseminating them, so that the knowledge described to
be shared between many researchers have more scope to be analyzed. For this reason,
the real power of ontologies is offer by the semantic WEB, an extension of the current
WEB in which the organization and access to public data are secured according to
their semantics. The term "semantic WEB" was introduced by Tim Berners-Lee
(inventor of the World Wide Web) with the following meaning: "a web of data that
can be processed directly and indirectly by machines" (Berners-Lee, T. et al., 2001).
In this article, there are presented the main concepts, techniques and methodologies to
specific ontologies and semantic WEB, and then to be described a proposed ontology
for enterprises that want to benefit from the advantages offered by the two
technologies.
1. ONTOLOGIES AND SEMANTIC WEB IN LITERATURE REVIEW
1.1.Ontologies
The reference in the field of ontologies represents "A translation approach to portable
ontologies" (Gruber, T., 1993: 199), which describes the formal framework for the
design and use of ontologies in order of representation of knowledge. Thus, ontology
(in computer sense) represents, in fact, a conceptual model of knowledge related to a
particular domain, as described by a set of terms: classes restrained with essential
properties, relationships, objects, and the restrictions applied to them. Classes describe
the essential concepts of interest domain, and relationships most often mentioned are
those of type "is-a", for taxonomies description. Once conceived, ontology can be
populated with specific data: each class will correspond to a collection of objects
(individuals) who have specific values for attributes.
Similarities ontologies with conceptual schema of relational databases, or even with
the oriented-object model is evident, only as an ontology aims not only to the data and
relationships between them, but also the knowledge obtained on the basis of the rules
of inference. In addition, it must not be forgotten the reason of any ontology -the
availability to all researchers interested in - that is not valid in the case of classical
models reminded before.
Depending on the scope, ontologies may be designed for a general domain (such as
space, time, etc.), for a specific domain (medical, economic, technical, etc.) or for a
certain application (sales management of a firm, employees records of a company,
etc.). Because these latter are not available or public, they are actually pseudoontologies (Fensel, D. et al., 2008).
The purpose of the description of ontologies has been proposed in several languages:
Resource Description Framework (RDF), Knowledge Interchange Format (KIF), Web
Ontology Language (OWL), etc. A detailed presentation on this topic is made in
(Fensel D. et al., 2008). There are attempts (some very successful) representation of
the ontologies in UML or even in the Entity-Relationship formalism. The best known
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example, in this sense, constitutes REA ontology (Resources-Events-Agents) proposed

by McCarthy in 1982 for the accounting field and described by an E-R diagram.
In our study, we have focused on particular OWL language created for the ontologies
development for the WEB. Available in version 2 (2009), the OWL represents a
declarative expression of the ontologies.
1.2.
Web Ontology Language (OWL)
Web Ontology Language is developed by W3C (World Wide Web Consortium), an

international community. Specific OWL is the consideration of open worlds, i.e.
description of knowledge is not limited to a file or to a specific context. For example,
a class defined in ontology can be refined or extended in other ontologies. OWL
offers more syntax that can be used in various purposes: Functional-Style syntax,
RDF/XML syntax, RDF Turtle Syntax etc. Of these, in practice, the most used syntax
is RDF/XML which is based on the expressions defined in RDF (rdf:), RDFS (RDF
Schema - rdfs:) and XML Schema (xsd:).
The different concepts used OWL formalism in three categories: entities, expressions,
and axioms. Entities that constitute the foundation of structural ontologies are
represented by individuals, classes and properties. The elementary axioms are
statements relative to entities, and the expressions are built on the basis of complex
phrases entities. Individuals are concrete objects (instances), classes of domain
studied represent collections of individuals, and the attributes signify properties
(characteristics) of objects.
In OWL, a class can be defined in several ways: by specifying explicit its contents as
a subclass of existing classes (subClassOf), by applying logical operators
(intersectionOf, unionOf, complementOf, oneOf, etc.) on existing or undertake classes
by defining certain restrictions on properties of another class. Also, OWL offers two
predefined classes, Thing(T) and Nothing(); the first stand at the basis of any
hierarchy, and the second can be designated as a subclass without instances for any
class in the hierarchy. The applied classes describe the axioms actually links between
these and may concern: a relationship of sub classing (subClassOf), a relationship in
which two classes have the same individuals (equivalentClass) or a relationship
through which individuals of a different classes are another class of individuals
(disjointWith).
Individuals are clearly defining the target dealing with classes that they belong to.
Axioms applied to individuals are sameIndividualAs (two individuals covered by the
same concept) and differentFrom (previous deny).
Properties in OWL can be of type object (ObjectProperty), stating that correlate
individuals of two classes or type of date (DataTypeProperty), involving elementary
values (integer, string, etc). Regardless of their type, the properties may be
characterized by a set of axioms: subPropertyOf (property is a specialization of
another), InverseOf (the two properties are additional/opposite), functionalProperty
(describes a property mono-value), and transitiveProperty (if property P has connects
the object A to B and B to C, then P tie on A and C) etc.
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1.3. Using ontologies

As we've seen, any ontology is designed for the purpose of representation and
network shares knowledge in a format accessible to both human, and especially
software. As the basis of the Semantic WEB, ontologies are used for the purpose of
the description of the WEB documents semantics in a language based on logic (e.g.
OWL) that can be understood by WEB applications or intelligent agencies. By using
the ontologies "... tomorrow's applications can be intelligent, in the sense that they
can more accurately work at the human conceptual level" (W3C, 2004).
By processing the automatic ontologies (through an inference engine called reasoner)
can provide knowledge and services for the applications in the field of artificial
intelligence: semantics search engines, software agents, intelligent databases,
knowledge management applications or for assisting decisions etc.
In order to design and use of ontologies were developed several software tools that
provide both their editing and processing of knowledge described. For our study, we
used Protg open-source application, developed on a Java platform by the Stanford
Center for Biomedical Informatics Research. By inference modules (reasoners)
incorporated (e.g. FaCT ++, Pellet etc.), Protg can automatically generate a
hierarchy of classes (infer hierarchy) on the basis of specifications to ensure logical
consistence verification for ontology.
2. DESIGN METHODOLOGIES FOR ONTOLOGIES
The review literature offers a wide enough range of methodologies for ontologies
design, some of them dedicated to even the economic or business domain. In the
paperwork (Paredes-Moreno A. et al., 2010), is described a methodology for
development of the business ontologies in 6 stages:
Requirements analysis;
The collection of metadata (schemas, restrictions, management rules etc.);
Construction: presume description of the hierarchy of classes and ontology
populating with queries of classes (class queries);
Ontology refine;
Test by comparing the ontology with the other relevant ontologies;
Feedback: collection of learning and the selection of the best practices of
integration.
An example of a general methodology is the one proposed in respect of (Noy N.F. &
McGuinness D. L., 2001), that the necessary development stages of ontologies are:
Determining the scope and purpose of the ontology, during which must answer
some basic questions: what is the area covered by the ontology?, in what
purpose will be used ontology? Who will use and will maintain ontology? etc.
Possibility to reuse existing ontologies. In this stage recommend consulting the
libraries of ontologies published on the WEB, and in case that is an ontology
of the image area is intended to be created, then it will be necessary to import
them;
Identification and enumeration of main terms in the ontology;
the definition of classes and class hierarchy;
~252~
Setting properties for each class;

Define the characteristics associated with the properties (type, scope and co
domain, the axioms, if any, etc.);
The creation of instance, which supposedly define individuals for classes, as
well as updating the property with the appropriate values.
A general methodology, in 6 steps, it is proposed in (Peffers K. et al., 2007):

Identification of the problem and motivation (solution justification);
Definition of the objectives of a solutions derived from the definition of the
problem;
Ontology design and development;
Demonstration of utility items obtained previously in solving of one or more
instances of the problem;
Evaluation of solution in relation to the problem;
The communication.
Of these methodologies, we choose on the proposed (Noy N.F. & McGuinness D. L.,
2001), because is much closed to information systems modeling and design
methodologies and, additionally, is a methodology that is mapped very well on
Protg logic tool used in our research.
3. THE PROPOSED ONTOLOGY FOR ENTERPRISES REPRESENTING
ON THE WEB
The steps followed for development of the enterprise's own ontologies are, according
to the general guide for the ontologies preparation (Noy N.F. & McGuinness D. L.,
2001), the following:
3.1. Domain and scope determination for the ontology
Proposed ontology aims description of an enterprise in the light of information and
knowledge traced by potential users-beneficiaries: products and services supplied,
jobs offer, as well as indicators that can provide a picture of the economic-financial
condition of the enterprise. As potential users, we have in mind traders interested in
finding a vendor for a particular product or service, investors on financial market and
the people who watch finding a job.
3.2. The re-use of the existing ontologies in the field
The best known ontologies for enterprise are published only in the stage of conceptual
models, they are not implemented and in a language (such as OWL) to allow their
import by anonymous users. We have in mind here: TOronto Virtual Enterprise
(TOVE), ontology developed by a group of researchers at the Toronto University,
Resources-Events-Agents (REA) proposed by McCarthy, Business Model Ontology
(BMO) developed by Osterwalder and Pigneur (Osterwalder A. & Pigneur Y., 2002)
etc. By shared ontologies, most are either too complex or contain irrelevant our
objective elements (are focusing only on certain activities sales, supply chain
management, etc. or approaches the enterprise only in terms of organizational). In
conclusion, the proposed new ontology does not contain any item imported from
another formal existence on the WEB.
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3.3. Used terms in ontology

In our vision, any enterprise (producing goods and/or services) can be described by
the following concepts:
Enterprise such as (name, location, etc.);
The offer of goods and services provided by enterprise;
Jobs offer;
Economic indicators for production activity (turnover, production obtained);
Indicators of return (profit, return rate);
Indicators of liquidity (current ration, quick ratio);
Economic and financial indicators of profitability (profit margin, return on assets,
return on equity);
Economic-financial indicators for risk evaluation (debt coverage ratio, debt to
equity).
3.4. The hierarchy of classes
From the terms presented in the previous step, we believe that our ontology may be
based on the following classes as are represented by the Protg in the Figure 1. After
defining the classes we have resorted to define axioms attaching thereto. For example,
individuals may not belong to the class Enterprise classes State or Offer, the converse
is obviously valid. For example, the class declaration Enterprise in OWL (after the
syntax of RDF/XML) is the following:
<owl:Class rdf:about="http://EO#Enterprise">
<rdfs:label>Enterprise</rdfs:label>
<rdfs:subClassOf rdf:resource="&owl;Thing"/>
<owl:disjointWith rdf:resource="http://EO#Offer"/>
<owl:disjointWith rdf:resource="http://EO#State"/>
</owl:Class>
Figure 1. The ontology proposed to be developed for an enterprise
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3.5. Defining properties for classes (including its characteristics)

Since a subclass inherits all super class properties, we insisted on defining properties
at the level of base classes. In a first phase, we defined the properties of the object
type, i.e. those serving in the correlation of individuals come through different classes.
So, for example, Enterprise class is correlated of Offer and States classes through the
properties hasOffer and hasState. To allow inference and in the opposite direction, we
proceeded to define inverse properties (inverseOf) those declared previously, i.e.
offerOf and stateOf. Graphically, links are represented by Protg as in the Figure 2.
In OWL, disclaimers second inverse properties (for example, hasOffer and offerOf)
are presented below:
<owl:ObjectProperty rdf:about="http://EO#hasOffer">
<rdfs:label>hasOffer</rdfs:label>
<rdfs:domain rdf:resource="http://EO#Enterprise"/>
<rdfs:range rdf:resource="http://EO#Offer"/>
</owl:ObjectProperty>
<owl:ObjectProperty rdf:about="http://EO#offerOf">
<rdfs:label>offerOf</rdfs:label>
<rdfs:range rdf:resource="http://EO#Enterprise"/>
<rdfs:domain rdf:resource="http://EO#Offer"/>
<owl:inverseOf rdf:resource="http://EO#hasOffer"/>
</owl:ObjectProperty>
Figure 2. Links between classes
Of course, for each class we defined and the main properties of date type: eName,
eAddress (with sub property uri), eCity, eCountry for Enterprise, oName and date
for Offer. And, limit to only one example, we provide the code for the property OWL
eAddress (destined for address postal record) and eUri (WEB address) of the
Enterprise class:
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<owl:DatatypeProperty rdf:about="http://EO#eAddress">
<rdf:type rdf:resource="&owl;FunctionalProperty"/>
<rdfs:label>eAddress</rdfs:label>
<rdfs:range rdf:resource="&xsd;string"/>
</owl:DatatypeProperty>
<owl:DatatypeProperty rdf:about="http://EO#eUri">
<rdfs:label>eUri</rdfs:label>
<rdfs:range rdf:resource="&xsd;anyURI"/>
<rdfs:subPropertyOf rdf:resource="&owl;topDataProperty"/>
</owl:DatatypeProperty>
3.6. Ontology populate with individuals
To verify the proposed ontologies, we defined two enterprises: Alpha (Bucharest,
Romania), Beta (London, England), the first with an offer to the format of a product
(AlphaProd) and a service (AlphaServ), and the second with an offer-product
(BetaProd).
With the scope of verifying the ontology, we performed the following tests using
Protg:
Verifying logical consistence (with Pelllet and FaCT++) both reasoners
have validated the ontology
Applying logical queries, in order to knowledge verification:
o Which are enterprises that provide services (Enterprise and hasOffer some
Service)?
o Which are enterprises in London that provide products (Enterprise and
eCity value "London" and hasOffer some Product)?
CONCLUSIONS
Nevertheless, public ontologies may lead getting the new information and to enriching
existing knowledge bases. Analysis of an enterprise by proposed ontology provides
general information about its activity and to what it can offer the partners: goods,
services, etc. For this reason, we consider that the development of ontology should
target primarily her usefulness both for ordinary users, and domain for the researchers
involved. And if the structure of ontology can be read and processed by the existing
software tools, it may be regarded as it has achieved the goal: to share knowledge of
all those interested.
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Fensel D., Kerrigan M., Zaremba M. (2008), Implementing Semantic Web Services, Springer
Gruber, T. (1993), A translation approach to portable ontologies, Knowledge Acquisition
vol. 5, no.2:199-220
~256~
McCarthy W.E. (1982), The REA accounting model: A generalized framework for
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First Ontology', Stanford Knowledge Systems Laboratory Technical Report KSL-0105, available on-line at, http://protege.stanford.edu/publications/ontology_development/
ontology101.pdf
Osterwalder A., Pigneur Y. (2002), An e-Business Model Ontology for Modeling e-Business,
15th Bled Electronic Commerce Conference, Bled, Slovenia, June 17 - 19, 2002,
available on-line at, http://129.3.20.41/eps/io/papers/0202/0202004.pdf
Paredes-Moreno A., Martinez-Lopez F.J., Schwartz D.G. (2010), A methodology for the
semi-automatic creation of data-driven detailed business ontologies, Information
Systems, vol. 35:758-773
Peffers K.,Tuunanen T., Rothenberger M.A.,Chatterjee S. (2007), A design science research
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Stanford University School of Medicine (2010), Protg, available on-line at,
http://protege.stanford.edu
University of Toronto, TOVE Ontology Project (1992), available on-line at,
http://www.eil.utoronto.ca/enterprise-modelling/tove/
W3C,
OWL
(Web
Ontology
Language)
(2009),
available
on-line
at,
http://www.w3.org/TR/2009/REC-owl2-overview-20091027/
W3C, OWL Web Ontology Language - Use Cases and Requirements (2004), available on-line
at, http://www.w3.org/TR/webont-req/
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Drago Marian MANGIUC1
ABSTRACT
Enterprise 2.0 family technologies have growing popularity, the cloud computing market is
growing rapidly and, as a consequence, companies of all sizes start to evaluate the potential
fit. The use of Software as a Service, Platform as a Service and Infrastructure as a
Service has been evolving during the past years and has become increasingly popular. As its
computing viability and benefits are legitimized, the adoption rate is rapidly increasing. The
most popular business model in the abovementioned family is by far Software as a Service
(also called SaaS), which is a software distribution model assuming the software applications
are hosted and maintained by the vendor or the distributor, and user access is granted
exclusively by means of the Internet. Based on both literature review and action research, the
paper at hand is a synthesis for the results of an empirical study performed during the last
two years among Romanian and foreign companies, in order to outline and provide an
objective and unbiased answer to the question: Is the market ready for these technologies or
did they come too soon?. The paper is a part of a larger research performed by the author in
the field of Enterprise 2.0 technologies.
KEYWORDS: Enterprise 2.0, Software as a Service, Platform as a Service, Infrastructure

as a Service, Empirical study
INTRODUCTION
As the Enterprise 2.0 family of technologies is evolving and facing ever-growing
adoption, we can also observe the development of some next-generation business
models for the purchase and use of business software applications, business platform
and business infrastructure components. The flagship of these new models is, by
far, Software as a Service, usually abbreviated SaaS, which has evolved to be a
quite common practice for Enterprise 2.0 specific software distribution (Menken,
2008). As semantic technologies penetrate and consolidate the modern organizations
business processes, the traditional sales of business IT architectural layers
(software, platform, infrastructure) give up in front of the new business models, as the
consumers become aware of the simplicity and the efficiency of this new practice
(Fan et. al., 2009). Based on a recent empirical study performed by the author, the
paper at hand is an attempt to figure out whether this movement towards cloud
computing is the advent of a new era in business IT, or just a fragile wave of
interest for a novelty.
Correspondence address: Drago Marian MANGIUC, Bucharest Academy of Economic Studies,

Romania; email: mangiuc@gmail.com
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This attempt is part of a larger research performed by the author in the field of
organizational memory and Enterprise 2.0 technologies, and also continues a previous
doctoral research in the field of computer-assisted financial audit tools and
techniques, whose final results were publicly defended in order to be validated by
both the scientific and academic community. The main goal of the aforementioned
research was the identification of some new areas of applicability for the modern
knowledge-based information technologies in the field of financial audit.
When possible, a direct identification of the practitioners expectations was attempted
by means of direct interviews and also by means of the empirical study questionnaire.
The questions for the empirical study were carefully designed so as to get unbiased,
objective answers. The members of the target group were encouraged to add their own
observations regarding the questionnaire. Validation of the research conclusions was
performed by means of an informal discussion with some real life practitioners,
members of some companies which performed or are in the process of performing the
shift to Enterprise 2.0. In case some other authors opinion was enclosed in the paper,
whether in exact quotation or synthetic form, a complete mention of the source
identification information was made. Some of the data in the paper is based on the
results of some previous market research studies that were credited accordingly.
The author has over seven years of previous experience in the research area, and also
a series of previous research results (published articles, conference attendances and
doctoral research). By defending the research results at the proceedings of such a
prominent scientific conference, attended by both scholars and practitioners bearing
some interest in the research area, the author attempts to get further validation of his
opinions, both confirmation and rejection of the aforementioned opinions scientific
and practical importance being welcome.
2. OLD vs. NEW IN GETTING BUSINESS SOFTWARE
Traditionally, software applications are regarded as products, or as assets, both for the
producer and the consumer. They are usually bought by the consumer, which may be
considered the owner of a copy of the program (Cusumano, 2004). The customer pays
a license fee which renders him the right to install and use the software application in
a certain hardware configuration and for a certain number of users. In most of the
cases, the software may be used for an unlimited time period, but on a single machine.
The consumer might also pay a periodic fee, usually 5 to 25% of the initial price for
update, maintenance and technical support services. From the accounting point of
view, software applications are capitalized, which means they are to be presented as
an asset in the buyers financial statements (Iod, 2002), and suffer depreciation based
on their acquisition value and presumed lifespan.
The standard model of software as a product has been adopted mainly due to the
tremendous success of some software producing companies like Microsoft, Oracle or
SAP, which were proud to report the huge profits obtained. But aside from the
success stories, the situation is very similar to the music industry, being almost
exclusively based on hits or breakthroughs, which are extremely advertised
software applications being of great interest for the large public (Haines, 2008).
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However, the software products which are not regarded as hits by the market and
the general public usually get much smaller profits, and their producers are almost
always on a narrow line between profit and loss. Moreover, the top software
producers almost never adopt the open standards which allow for free data transfer
among applications. Sealing the applications, limiting the users choice to a few
proprietary formats and avoiding any possibility of converting documents to the
formats of the direct competitors were always features of the top software
producers, despite the major drawback they represent for the consumers and the final
users. Once a company has become a customer, its possibilities to migrate to a
cheaper or better product were drastically reduced (Gannod et. al., 2005).
Even if the aforementioned analysis reveals a series of important benefits, using
software as a product is also marked by a set of major issues. In most cases, the
software application is downloaded from the vendors website, and installation and
setup are the exclusive task of the customer. As a consequence, the software
application has to be prepared to run in heterogeneous, unstable or unforeseen
environments (Pohl et. al., 2005). The software application is usually installed across
the customers network, on hardware configurations and operating systems installed
and configured by the customer. At least in theory, the software application has to be
able to face any challenge in terms of configuration and operate in any environment,
with any set of parameters. According to the authors, reaching this goal is extremely
expensive for the applications developer.
The second major drawback software developers have to face is the cross-platform
support for their software, or the support for multiple operating systems. When a
software developer intends to get a significant market share for its product, it has to
develop a few separate versions of the software, one for each major operating system
(Windows, Linux, MacOs, Unix). The more than significant differences among the
aforementioned operating systems render just a small part of the application source
code usable in all the versions, the development of four or five almost different
applications (one for each operating system) being required in most of the cases. The
negative impact on the software developer is obvious in this situation. A large
quantity of time and human resources, which otherwise might be used for adding new
features to the application, is used instead to test the software on different operating
systems, on different operating systems versions, or on different hardware
configurations (Haines, 2008).
The drawbacks often affect the consumer, too. In most cases the cost of installation,
setup and configuration for the purchased software applications are significantly
larger than the purchase cost per se. Each organization has its own network, having
many features and idiosyncrasies and, by consequence, aspects as the network
topology or hardware incompatibilities have to be foreseen, taken into account and
dealt with. Even for the most popular applications, which usually are thoroughly
tested and adequately documented, the system or the network administrators take
major risks for each setup and update of the software.
As a result of the aforementioned drawbacks, both software application developers
and their customers are eager to adopt a new model for the development and the
distribution of such applications, usually known as Software as a Service and
abbreviated SaaS. Even if the model is around for a few years, being far from a total
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novelty, the difference resides in its recent success registered as a consequence of the
high compatibility with the Enterprise 2.0 family of technologies (Blokdijk, 2008).
The SaaS success during last few years is tightly interconnected with the advent and
the rise of the Web 2.0 technologies. As network connection and Internet access are
ubiquitous, the business model behind the new approach may be accessible for the
vast majority of software consumers. Web applications have reached a maturity level
allowing on-line users to get the same experience and facilities as from traditional,
off-line applications (Heydarnoori et. al., 2006). In the authors opinion, a comparison
of the Web-based e-mail management suites (like Gmail) with traditional e-mail client
applications as Microsoft Outlook, or a comparison of the traditional Microsoft Office
suite with the Google Docs on-line suite may be enlightening.
Cloud computing applications are faster, simpler and cheaper to use, as there is no
involvement of capital requirement for servers or storage and operational expenses for
running a large data center (Buyya et. al., 2011). Cloud industry is growing quickly
and vendors are investing significant amounts of money to develop solutions-as-aservice, suggesting they believe in the success of this technology as an alternative to
traditional IT solutions. A very large scale study, performed by Gartner Inc.
(Krautheim, 2009), the worlds leading information technology research and advisory
company, revealed that for the 2008-2013 time interval, an impressive growth of the
Enterprise 2.0 and cloud computing market is predicted, from 9.1 to 26.6 billion $. In
order to get a better view of the facts, the Compound Annual Growth Rate (or CAGR)
was chosen to be computed. The compound annual growth rate is calculated by taking
the nth root of the total percentage growth rate, where n is the number of years in the
period being considered. Taking into account that the estimated growth is not
considered to be linear (or constant), the CAGR allows for results comparison, both
intra-industry and cross-industry. The following formula was applied (Formula 1):
Formula 1. The Compound Annual Growth Rate
Ending Value Nr. of years
CAGR =
1
Begining Value
(Source: Grundfest, 1990:350)
A value of 24% is computed for the CAGR, based on the aforementioned formula. In
the authors opinion, the growth rate has a definitely large value, which renders the
Enterprise 2.0 as a mature, settled set of technologies. A ten billion dollar market,
having almost 25% growth per year does not appear based on an experiment or a
single pioneer company. A company moving from SaaP to SaaS becomes more and
more a trend follower than a trend setter.
According to the author, the general support or interest for SaaS, which is clearly
observed for the majority of the corporate software consumers resides in the rapid
adoption of the SaaS business model by the small companies in the fields or industries
requiring many complex (and often overwhelmingly complex) software applications.
Using software as a service was mostly attractive because it allowed to small
companies having a minimal IT department (or having no IT department at all) to use
software application otherwise out of reach due to installation, configuration and
maintenance issues not manageable in the absence of a well-staffed IT department.
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A large multinational company almost always affords to assemble a team of

professionals in order to properly install, configure and manage networks or largescale software applications, but a small company almost never can afford such costs.
In our opinion, the second major benefit of software as a service is that the customer
is allowed to pay only for what he really needs. The vast majority of corporate
business software applications come with a fixed minimal cost of the hardware,
installation and configuration efforts involved, usually computed for a large-scale
department. Even if the department dimensions are significantly smaller, the cost is
much less elastic and does not fall back accordingly. As a result, small companies are
often forced to support cost levels similar to the ones of the large companies. Using
SaaS allows the customers to significantly reduce the aforementioned costs, as they
usually are charged based on the amount of time, storage space or application
resources used. Even if the advantages are obvious, it is not to expect that all
companies will unconditionally (or blindly) move to the new technology, without a
shadow of a doubt. Thus, one question of main importance, included in the aforesaid
empirical study, requested the members of the target group to state their key buying
(or not buying) criteria. Four main criteria were provided (cost, scalability, expertise
and operational stability), and the respondents were encouraged to provide their own
criteria, if not in the list. The weight of each main criterion in the answers received is
stated in Table 1:
Table 1. The weight of each main criterion
CRITERION
Cost
Operational stability
Scalability
Expertise
WEIGHT
80.2%
74.6%
32.9%
25.8%
In the authors opinion, the results may be explained as follows:

Cost the size of the expense implied by moving to Enterprise 2.0 is still the
most important of the criteria. As the switch to SaaS is mainly taken into
account by small or medium sized organizations, unable to afford large IT
departments, this kind of companies was the main target of the questionnaire.
Even if moving from SaaP to SaaS is attractive due to the small IT costs on
the long term, the immediate costs of the process are still an important concern
for the potential customers. In a previous paper (Mangiuc, 2010), the author
provided a model and a set of results in the field of computing ROI (Return on
Investment) for an Enterprise 2.0 implementation.
Operational stability most of the managers are concerned about the impact
of the movement on the organizations current activity. Small companies
usually fight a lot for their market share and, due to the fierce competition; a
temporary shutdown of their services is usually out of question. In this case, it
is the duty of the cloud mover, or the service provider to develop and
present a strategy allowing the customers transition to Enterprise 2.0 without
compromising its operational stability. And with a 74.6% rate of concern,
building such strategy will be no easy task.
Scalability most of the respondents do not regard scalability as an important
concern, and this is mainly due to the aggressive advertising campaign of the
cloud movers, which claim that adopting software as a service usually
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comes with unlimited scalability at almost no cost. Even if this is mostly true,
the collateral scalability costs have to be taken into account. For example, if a
new branch office of the company is opened, the cost of the extra software
access required by the software provider is usually small, but the costs of the
underlying hardware and network communications infrastructure may not be
as small as the amount paid to access the software applications from within the
new location.
Expertise the lack of expertise in migrating to the cloud seems not to be an
important concern for the customers, as they regard this kind of expertise
mostly as an additional service provided by the migration assistant or by the
Enterprise 2.0 services provider. In most customers opinion, the migration
expertise is to be bought from the provider, not gathered by the customer itself
(Buyya and Bubendorfer, 2009).
In addition to the four aforesaid criteria, the respondents also provided the following
additional buying criteria (presented in the reverse order, by number of occurrences):
Security-related services (81%) according to the survey results, security
seems to be a top priority for the potential customers, and usually, the first
questions asked by a company before moving to cloud are all about security
issues. Even if customers who admit that their own information systems have
serious security issues are quite hard to convince about the secured
environment of the cloud-based services. In the authors opinion, this behavior
is mainly due to the fear of the unknown, and if improperly handled, it may
become a real deal breaker, even more important than cost. The provider of the
Enterprise 2.0 services usually has to explain in great detail the security
measures related to the following procedures:
Protection of data during transit and in storage (obfuscation, cloud-specific
storage etc.);
Encryption and decryption algorithms (strength, implementation);
Disaster recovery policies (backup systems, disaster recovery plans etc.);
Restricted access, intrusion protection and firewall services;
Security documentation and certifications;
Data security procedures related to the termination of service.
Tightly related to the security issues are the legal issues of the cloud-based
business model. Most of the potential customers are very interested in the legal
jurisdiction and framework applicable for each potential contract they will
agree on, as well as the legal authority that is able to decide in case of
litigation.
Service and support (73%) most customers look at moving to cloud and
using Enterprise 2.0 as a milestone of their business activity and are very
concerned about the support they will get to successfully accomplish the
process. As most providers claim 24/7 availability for their services, most
customers also expect 24/7 technical support, at least in the first stages of the
transition. Most of the respondents required full time support for their
employees, as the final users of the service, not particularly for the IT
department and staff. In the authors opinion, most of the potential customers
feel like their business processes will be somehow outsourced, or look at
moving to cloud computing as a leap of faith (Walsh, 2009), so as full time
service and support are fundamental prerequisites for the success of the
migration.
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Flexibility (73%) a large part of the respondents were concerned about the
ability of the provider to integrate and manage hybrid environments, which
will allow the customer company to leverage their cloud services while also
augmenting their internal IT capabilities. Large heterogeneous environments
are frequently due to a large number of legacy systems, to previous evolution
attempts, or to previous failed or successful cost-cutting attempts. However,
Enterprise 2.0 services providers always advertise the universality of the
cloud computing, as well as the full availability of the provided applications
and services, for computers which have only a Web browser installed. As a
result, most customers expect almost unlimited flexibility, and also assume
their entire IT infrastructure will be fully functional in the cloud.
Performance (72%) since the advent of Web applications and Internet-based
computing, some voices complained about the performance gap between
desktop applications and their on-line counterparts (Youseff et. al., 2008). For
almost a decade, Web applications were regarded as a palliative, incomplete
way of replacing traditional desktop applications. Even if broadband Internet
and the huge technological advances made the border between desktop and
Web more and more hollow, some traditionalist customers still fear about a
performance decrease when moving from traditional to cloud-specific
computing techniques. When analyzing the current offer of cloud computing
solutions, we may discover that the fear is not completely ill-founded. Most
potential customers should assess the cloud providers capabilities at the subsegment level (i.e. CRM, SCM, and ERP) due to large differences in the subsegments maturity and performance.
Availability (72%) most cloud services providers show off a lot about the
24/7 availability of their services and, consequently, even a minor stop of the
service (a few minutes) is regarded as a small disaster. For example, if Google
document management or e-mail services become unavailable, even for a few
seconds, the media makes a lot of hype on the subject. If this happens for a
provider whose services are mostly free of charge, it is obvious that
unavailability of a paid service will be very harshly sanctioned by the
customers. Some of the respondents even asked about the existence of
contractual clauses and compensations for the service unavailability periods.
Issue resolution (68%) some of the potential customers feel that the general
phone-based or Internet-based support is not enough for such an important
choice like migration to the cloud and, consequently, ask for direct assistance
in issue resolution. On the other hand, most of the Enterprise 2.0 services
providers are quite reluctant to provide direct support, especially when it
implies sending own employees to the customers location. Moreover, the
location of the provider may be in a different country, or even on a different
continent than the location of the customer. In order to fill this gap, a new kind
of business raised during the last years, offering cloud moving services.
Having a strong contractual basis with both the service provider and the
customer, the cloud mover company offers to assist the customer as an
external consultant, compensating for the providers lack of ability to provide
direct support.
The billing model (67%) migrating to cloud-based services implies, for most
companies, a re-design of their perspective of IT costs. Switching from local
to cloud usually leads to important savings on server hardware, software
licensing, infrastructure maintenance and administration labor costs. Even if
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the main reason to embrace Enterprise 2.0 is a significant decrease of the ITrelated costs, some customers may be suspicious at first when facing the
cloud-specific billing models. One main advantage of the cloud is the ability
of the customer to pay only for usage. This model applies for all the layers of
Enterprise 2.0 (SaaS, IaaS, PaaS). Even if the information that customers
will only pay for what they use is ubiquitous, there is no uniform unit yet.
The service provider may charge based on the Internet bandwidth used, the
storage space employed, or the instance-hour for each provided service (the
service provided for one hour to one computer of the customer).
Years of experience and customer portfolio (66%) even if the cloud is still
very young among the IT-specific approaches, some of the main players on
the market (like Google, Oracle or Microsoft) may already claim to have
significant experience with moving customers from local to cloud-based
services. A large number of respondents admitted that in case of an eventual
migration, they would more likely choose a big name in the field (like the
three abovementioned companies), than a newcomer, even if the latter has a
much better offer in terms of costs and support policy. Some of the
respondents even admitted that having the leaders of their industry or branch
in his customer portfolio may be the best reference an Enterprise 2.0 services
provider can get.
Quality of the applications hosted in the cloud (42%) the cloud computing is
new, but still old enough to be prone to competition. As presented in figure 1,
there are multiple offerings for each family and sub-segment of the cloudbased set of services.
Picture 1. Cloud computing families and sub-segments
CLOUD
KEY ACTORS
Software-as-a Service (SaaS)
Salesforce
Google Apps
Oracle
Facebook
Netsuite
CRM
CCC
Platform-as-a Service (PaaS)
Force
Caspio
Google App Engine
Microsoft Azure
DCC
ERP
SCM
Infrastructure-as-a Service (IaaS)
Rightscale
Amazon Web Services
Eucalyptus
GoGrid
Integration
as a Service
Compute Private
Services Cloud
Integration as a Service
When analyzing the potential cloud computing solutions, companies should assess
each cloud providers capabilities at the sub-segment level (i.e. CRM, SCM, ERP),
due to large differences in the sub-segments maturity. For each sub-segment, a set of
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representative players have to be selected based on their offer, individual maturity,

and the role they play within their sub-segment. The current landscape of the cloud
services offer is a mix of new and recent niche players competing with more
established software and hardware vendors. The providers have to be compared based
on the following criteria (at least):
Domain of activity;
Date of first cloud release;
Year-on-year growth (for example, 2009 to 2010);
Key differentiators;
A sample of key clients;
A sample of key partnerships;
Business process services (23%) in some cases, migration to cloud
computing may have a greater effect than usual on the structure and dynamic
of a company business processes. Consequently, the potential customer may
consider that the re-engineering of the affected business processes is a part of
the Enterprise 2.0 implementation process, leaving this task for the cloud
service provider. The provider, on the other hand, has seldom enough
knowledge of the customers position and business model details to provide
valid advice in re-modeling the business process. In the authors opinion, this
is another situation where the expertise of a cloud mover or a consultant
company would make a significant difference.
The exit plan (11%) due to business consciousness (or just distrust), a small
group of respondents considered that a valid exit plan should be part of the
deal. Most of the expressed concerns were about data security after the cloudbased service use is discontinued, and also about a proper service cancelation
procedure in case of a switch to a new provider, which should be able to
access and copy business data from the old one. The question also applies for
the situation of a return to the software and business model that the customer
had before moving to the cloud. Another issue brought into discussion was the
providers treatment of sensible business data in the case of a late or overdue
payment for the service.
The analysis of the aforementioned criteria reveals that even if most of the potential
customers are rather interested in a migration to the cloud, they would agree to take
this step only after getting reasonable assurance about the safety and the sustainability
of the approach. As a result, the author considers that the main players on the
Enterprise 2.0 market need a change of tone in their advertising campaigns, with
less emphasis on marketing promises and more answers to the key fears of the
potential customer.
Despite all the aforesaid advantages, we consider the SaaS model not to be a universal
solution for all the corporate business software issues. According to some of the
quoted authors (Heydarnoori et. al., 2006; Blokdijk, 2008), the new model will never
replace the traditional model entirely, but will provide an increasingly better
alternative to the software as a product. We also consider there are a set of major
issues and a set of business areas where SaaS has less of a chance to succeed.
According to the author, most of the issues originate from the fact that the customer is
required to have extremely strong confidence in the software service provider. In
some situations, granting such confidence to an outsider may be considered as a proof
of irresponsibility and may even compromise business continuity. For example:
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A large multinational company producing candy and chocolate products

should never let a software provider store and manage the secret
manufacturing recipes for the products.
A government agency processing secret or confidential information should
never let an external service supplier manage its data sets.
A healthcare institution taking the confidentiality of their patients medical
history very seriously, should not hand the management of the medical history
data to an outside service provider.
A bank should never let a service provider manage all the customers financial
information and even perform transactions on behalf of the customers.
Some other aspects here are open for interpretation. For example, the issue of the
legal framework applicable in such contexts: to what extent has a Romanian company
using applications hosted on Cayman Islands servers to comply with the local and the
remote legal framework (Hall and Frey, 2007).
All the aforesaid issues diminish as the distributors of such applications provide
solutions for the privacy, security and trust-related problems. Even though, the list of
questionable practices remains open. For example, the SaaS model does not provide
the means for the service consumer to locally store his own data. The customers data
are stored in the application providers data center, placing the Internet between the
customer and the provider. Consequently, any malfunction of the application
providers system or the customers Internet Service Provider (ISP) renders the
application unusable for the customer. Moreover, a malfunction of the application
providers system renders the application unusable for all its customers, which may be
hundreds, thousands or millions of people or companies. The advantage of a
centralized application management is the significant cost decrease, but the dark
side of the matter is that any malfunction affects everybody. In the authors opinion,
a SaaS offer can easily become the victim of its own success if inadequately managed.
A rapid increase in the number of customers not followed by the necessary increases
in bandwidth, security systems, backup systems and staff may throw into chaos an
otherwise successful project. Obviously, the software as a product model is also
prone to disasters, but the malfunction only affects a customer or a small group of
customers, not everybody in the same time. Even if the customers IT team is able to
get involved swiftly in case of a malfunction, its expertise level in debugging the
application is significantly lower than the application developers.
As a SaaS application provider, the merely existence of the company and business
process depends on the provided applications availability. The large providers of
SaaS (like Google) are always bragging about the 24/7 availability of their
applications and, by consequence, any malfunction, even a partial or limited one, is
severely penalized by the media and also by the customers. The above is true even for
the free applications, but in the case of commercial ones, a serious malfunction may
irreversibly damage the image of the provider. On the other hand, investing in security
and backup may be somehow appealing for a SaaS provider, as the benefits of the
investment are simultaneously delivered to all its customers.
The landscape of the Software-as-a-Service market is divided today into a few main
sub-segments:
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3.
Customer Relationship Management (CRM) The on demand CRM market

is one of the most mature sub-segments in the SaaS market. The first players
arrived on the market in early 2000 and, since then, the market has grown
towards maturity. According to analysts (Walters and Newton, 2010), the
CRM on demand market will generate more than 2 billion USD in 2011 and
will represent more than 20% of the entire CRM market.
Enterprise Resource Planning (ERP) ERP defines a broad area of subcategories, from human resources to financial management. Today, most of
the SaaS ERP customers are midsized companies. Large corporations are still
confronted with limitations due to the complexity of their needs preventing
them from entirely embracing cloud ERP solutions.
Supply Chain Management (SCM) Supply chain management applications
are those that allow companies to improve externally oriented processes, to
manage selected portions of their supply chains, and to control their supplier
base.
Content, Communication and Collaboration (CCC) The content,
communication and collaboration market varies in the maturity of its subsegments. Adoption rates range from a high use of SaaS (where 60% of all elearning solutions are SaaS-based) to medium (10% of e-mail) and low
adoption (only 2% of enterprise content management systems run on SaaS).
Digital Content Creation (DCC) SaaS currently represents a small part of
the digital content creation market. This market relies, more than others, on
customer decisions; consequently, as the consumers appetite for digital video
(Youtube, MySpace...) shows tremendous growth and online image editing
software versions (e.g. Adobe Photoshop Online, Picasa, etc.) are appearing,
many evolution directions are ahead for digital imaging and video.
FURTHER DEVELOPMENT OF THE SAAS MODEL

INFRASTRUCTURE AND PLATFORM AS A SERVICE
The interest for cloud computing in the infrastructure market has grown substantially
during the last five years, and so have the investments (Ashta and Patel, 2010).
Several infrastructure services have been re-labeled and this causes confusion
between the various offerings. From outsourcing, the market has already moved to
infrastructure utility and, as cloud computing grows, infrastructure utility is becoming
Infrastructure-as-a-Service (IaaS). Today, public cloud infrastructure is not yet able
to provide a complete offering to companies and therefore the market is growing
slowly, being still based on the early hybrid cloud models. The main areas of interest
for this market are considered to be:
Backup & storage services In the online backup and storage services market,
price competition is high, forcing providers to keep costs low to maintain
profitability. Consequently, the providers are looking to gain their benefits
from economies of scale.
Compute services The key added value offered by compute providers is
elastic computing power, which can transparently cater to the organizations
fluctuating needs. Currently, on demand compute services is at an early stage.
Private cloud computing A private cloud environment is a solution that
enables companies to centralize their IT resources instead of working with
separate environments. The advantages for companies include the ability to
access a pool of resources that offers the flexibility and scalability to handle
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fluctuating demands, and cost savings through on demand provisioning of

virtualized resources.
As a result, the idea of providing technology by request is no longer limited to
software applications, but is also extending to some other areas, as the infrastructure
or the hardware system. The term Infrastructure as a Service (or IaaS) is used far
less than SaaS, but is becoming a more and more important component of the
Enterprise 2.0 family of technologies. For example, the Amazon company, worldwide
renowned for its virtual store and generally considered the largest book seller in the
world, started to provide IaaS services, the most successful one being S3 (short for
Simple Storage Service). The service allows companies to rent data storage capacity,
paying only for the occupied space. Even if the service, in its essence, is a very simple
one, it allowed for the development of a whole suite of third-party applications aimed
at access and data management, the very low prices asked forcing to a general
decrease in the price of the Internet-based data storage services (AWS, 2009). The S3
service may be used as a back-end for any software application (traditional or Webbased), its major strong points being scalability and extreme flexibility. A consumer
of the S3 service in need of a significant and immediate increase of the S3 storage
space does not have to do anything to get it, but use as many data storage space is
needed, a subsequent payment being performed, depending on the subscription terms.
There is no need a to add and configure new drives or storage units, and there is no
need to contact Amazon in order to ask for a supplement, the whole process being
implicit, when the new files of the customer are saved on the providers storage
servers. So, the customer gets instantaneous and smooth scalability for the
infrastructure provided as a service.
A second member of the same family of services, is EC2 (short for Elastic Computing
Cloud), consisting in a set of virtual machines which may be rented by the customers.
The virtual machines are usually based on open-source software (Linux, Apache,
MySQL, PHP) and are able to instantaneously scale up or down, depending on the
customers needs for the server. This service also had a price so low, that a general
decrease in the price of the hosting services occurred. As the customers only pay for
what they use, there is no minimum price (AWS, 2009).
Although having generated considerable interest, Platform as a Service is still an
early-stage market. The software development platform providers have broadened
their scope to enable multi-tenant development and by leveraging their presence in the
SaaS market, are bringing these platforms to the market as PaaS solutions.
Another technology having a solid contribution for the success of the SaaS model is
virtualization, which is the abstraction and the re-partitioning of the existing hardware
resources (Battle & Benson, 2008). The procedure provides an increased application
independence of the hardware configuration, allowing processes or operating systems
to execute in total isolation. A virtual machine is a guest operating system which
executes over a host operating system, and the technique releases the guest
operating system from dealing directly with the hardware components. According to
the author, the main advantages of virtualization are:
Server consolidation more physical servers are concentrated in a much
more powerful virtual server, with a significant decrease in the cost of the
processing unit.
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Server partitioning with resource limitation allows for a physical server to

be broken in a set of virtual servers, and also for a very detailed limitation of
the resources each virtual server (or partition) is allowed to use.
Application sandboxing provides a security and isolation mechanism for an
application or operating system, allowing it to execute completely separate
from the other applications and operating systems sharing the same physical
resources.
Management of the development and testing platforms allows for the easy
simulation of the different execution environments, a useful tool for software
applications development and testing.
Rollout, rollback and patching allows simplifying the application update
process, by means of the update rollout and updating rollback, both at the
application and the operating system level.
The use of the virtual machines significantly increased the efficiency of server
resources management, allowing for a significant decrease in the total amount of
hardware that needs to be deployed, installed, configured and maintained. Some
Internet Service Providers (ISPs) employed virtualization in order to simultaneously
execute different operating system instances on the same physical machine. The
instances are then offered to the customers as Virtual Private Servers (or VPS). Five
years ago, the ISP had to buy, install and configure a physical server for each
customer in need of a server hosting, rendering the server hosting process very
expensive, even prohibitive for the small companies which did not need the whole
power of a physical server.
Platform-as-a-Service (or PaaS) is a set of web-based services that provide all the
facilities required to support the complete life cycle of building and delivering web
applications and services, where the user is typically within the software developing
organization. Most PaaS systems are hosted, Web-based application-development
platforms, providing end-to-end or, in some cases, partial environments for
developing full applicative programs online. They handle tasks from editing code to
debugging, deployment, runtime, and management. In PaaS, the system's provider
makes most of the choices that determine how the application infrastructure operates,
such as the type of operating system used, the APIs, the programming language, and
the management capabilities. Users build their applications with the provider's ondemand tools and collaborative development environment. Despite its high
technological interest, PaaS adoption is slow to take off because the PaaS solutions
are relatively new and still lack standards.
PaaS remains an early-stage market with revenue of around 50 million USD, which
represents approximately 1.5% of the total application development market. Despite
the massive investments vendors such as Microsoft, Google and Salesforce performed
in PaaS technologies, the PaaS market remains immature and most vendors still have
proprietary and differing programming standards. As a result of its high technological
interest, and also because SaaS is growing sharply, the PaaS market will experience a
high growth in the coming five years (estimated to be around 50% of the present
value) and reach 400 million USD in 2013 (10% of the total application development
market) (Lawton, 2008). In the next years the confidence in the PaaS model is
expected to grow, so more organizations will build their applications in PaaS
environments. Organizations will be encouraged to experiment the PaaS
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development, taking advantage of the familiarity and previous experience they have
with their SaaS solutions.
4.
MAIN RISKS IN ADOPTING ENTERPRISE 2.0
Another key set of questions included in the aforesaid empirical study tried to identify
the main risks that members of the target group consider to assume in the eventuality
of an Enterprise 2.0 implementation. As the question was open-ended, a lot of
different answers were received, so the author re-arranged the answers by grouping
them into fewer categories (based on similarity or resemblance). In the descending
order of occurrence, the main risks in adopting cloud-related technologies were stated
as follows:
The loss of governance moving to the cloud forces the customer to accept
the control of the service provider on a quite large number of important issues
and areas of the own business process. This loss of control is widely perceived
as a very large potential security breach and it may be the main reason
customers tend to choose service providers having a frontrunner position on
the market, or, at least, a very good and well established reputation.
The lock-in most potential customers feel there is currently little on offer in
the way of tools, procedures or standard data formats or services interfaces
that could guarantee data, application and service portability. This can make it
difficult for the customer to migrate from one provider to another or to migrate
data and services back to an in-house IT environment.
Compliance risks some of the respondents stated that part of their investment
in achieving certification (e.g. to an industry standard or to a set of regulatory
requirements) may be put at risk by migration to the cloud. In most cases, the
compliance test process will require the cloud-based services providers to
produce evidence of their own compliance with the relevant requirements,
and, in some cases, even to permit audit by the cloud customer. In a few
situations, even the use of a public cloud-based infrastructure implies that
certain kinds of compliance cannot be achieved.
Data protection as previously stated, cloud computing poses several data
protection risks for both cloud customers and providers. In some cases, it may
be difficult for the cloud customer to effectively check the data handling
practices of the cloud services provider. On the other hand, some cloud
providers do offer exhaustive information on their data handling practices.
Some also offer certification summaries on their data processing and data
security activities, and fully describe the data controls they have in place.
Management interface compromise the customer-usable management
interfaces of a public cloud services provider are accessible through the
Internet and, consequently, mediate access to larger sets of resources (than
traditional hosting providers), posing an increased risk, especially when
combined with remote access and Web browser vulnerabilities.
Insecure or incomplete data deletion when a request to delete a cloud
resource is made, as with most operating systems, this may not result in true
wiping of the data. Associated with the use of multiple tenancies, and the reuse
of hardware resources, this may represent a higher risk to the customer than
using dedicated hardware.
Malicious insider while usually less likely, the damage which may be caused
by malicious insiders is often far greater. Cloud architectures necessitate
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certain roles which are extremely high-risk. Examples include the cloud
services providers system administrators and managed security service
providers.
Isolation failure multi-tenancy and shared resources are defining
characteristics of cloud computing. This risk category covers the failure of
mechanisms separating storage, memory, routing, and even reputation between
different tenants.
In the authors opinion, most of the aforementioned risks are basically security
concerns due to the migration from one business model to another. Most of the risks
also have counterparts in the traditional, software-as-a-product model and are far from
being cloud-specific. It is obvious that potential customers need in-detail knowledge
of the security system that the cloud-services provider offers, but they also need to reassess the own security systems, in order to perform a fair comparison.
The Enterprise 2.0 technologies have led to the advent and development of new
business models for the IT-specific needs of an organization. Software-as-a-Service
(SaaS), Infrastructure-as-a-Service (IaaS) and Platform-as-a-Service (PaaS) are just
the first wave of such models facilitating the access of small and medium
organizations to advanced IT-management tools traditionally reserved for the very
large companies. Based on the results of an empirical study, the paper is an attempt to
identify the general attitude of the potential customers towards moving to cloud
computing, and also, the key orientation criteria for the aforementioned group. As
revealed by the results of the survey, most of the potential customers are generally
eager to implement cloud-based technologies in their organizations, but only as a
result of a well-thought and detailed migration strategy. The initial key buying criteria
provided in the survey were completed with a few more by the respondents,
demonstrating a precautious and mature attitude towards going through a process
which small companies usually cannot afford to fail. Employing SaaS implies a series
of major changes in the way software applications are licensed and used. Many
challenges arise, both for the software services providers and for the software
consumers, but SaaS is able to provide both sides the benefits of a new and efficient
software distribution model. The main benefits for the consumers usually reside in the
decrease of the infrastructure expenses and immediate access to the latest version of
the software applications they use. As for the software developers, they are able to get
improved feed-back from the users of their applications, leading to a general decrease
in the development costs and, as a result, an increase in the profit margin of their
product. Moreover, the SaaS model is not the only successful initiative of this kind.
Due to the almost unlimited possibilities offered by the virtualization process,
infrastructure also becomes a service, significantly decreasing installation and
maintenance costs for the hardware systems and the network (infrastructure
management costs). The SaaS market is the most successful segment of the Enterprise
2.0 family, and its success leverages the growth of the IaaS and PaaS markets, which
are still in early stages, but with tremendous potential for the next five years. The
respondents identified a set of major risks in adopting cloud-based technologies, and
the identified risks may be regarded as key improvement areas for the cloud-based
services providers.
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The adoption of the new software distribution model will not happen overnight, but
will become a gradual process, having a variable growth rate, but, according to the
author, the first companies to discover the benefits of the new model, and the
companies willing to adapt in order to get the benefits, will gather significant
competitive advantages from the adoption of the model.
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NON-TECHNICAL CHALLENGES
IN ADOPTING ENTERPRISE 2.0
Drago Marian MANGIUC1
ABSTRACT
As the family of Enterprise 2.0 technologies is developing and gaining market share, and
migration to cloud-based computing becomes more of a natural choice for many small or
medium-sized organizations, a growing number of companies start to look interested in the
new wave of technologies. Even if the adoption rate of cloud-based services is rapidly
increasing, the migration process is far from being smooth, or even standardized. Thus, the
potential beneficiary of an Enterprise 2.0 implementation faces a wide range of challenges on
many levels: operational, software, platform, infrastructure, security etc. Based on both
literature review and action research, the paper at hand is a synthesis for the results of an
empirical study (a survey) performed during the last two years among Romanian and foreign
small and medium-sized companies, in order to pinpoint the most important non-technical
challenges that an executive has to face when looking at a migration to the cloud. The paper
is a part of a larger research performed by the author in the field of Enterprise 2.0
technologies.
KEYWORDS: Enterprise 2.0, Cloud computing, Migration, Challenges, Empirical study

INTRODUCTION
The traditional setup of IT management for an organization implies that the
aforesaid organization has total control and ubiquitous visibility over the owned
infrastructure and the employed services. All the components are fully accessible and,
also, precisely measurable by means of an organization-level defined set of metrics
and indicators. No matter how complex it is, each component of the IT infrastructure
is taken into account for the computation of a performance indicator and, as a result, it
may be tuned so as to reach its optimal performance level. Adopting Enterprise 2.0
technologies and migrating to cloud services may significantly diminish the visibility
and control levels that the organization has over the employed components and
services. The immediate effect of this fact is the lack of some important guarantees
regarding the quality and the good operation of services. Moreover, the adoption of
Software as a Service (SaaS) brings further limitations of the beneficiarys visibility
over the cloud infrastructure and its operation parameters (Walters, 2009). Such
parameters may enclose vital information (transaction ID, instance ID, application
type, security level, location, DNS information etc.). However, as long as this kind of
information is not standardized, the comprehension of its contents, meaning and use
may be a challenging process for the organization benefiting from the service. As the
1
Correspondence address: Drago Marian MANGIUC, Bucharest Academy of Economic Studies,

Romania; email: mangiuc@gmail.com
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range of cloud-based services is expanding, the beneficiary may face the need to
monitor hundreds of instances and thousands of indicators. As a result, the author
thinks that a conceptual framework for the management of cloud-based business
processes becomes more and more of a necessity.
During the last years, a lot of IT companies migrated from the centralized model of
running applications on prohibitively priced mainframes to the distributed model,
Internet-oriented and having a service-based architecture. It is usually considered that
applications and IT resources designed by the guidelines of the Service Oriented
Architecture (SOA) provide a solid foundation for the adoption and integration of the
cloud domain conceptual frameworks (Shan, 2010). Building their IT development on
such conceptual framework, enterprises are able to re-scale swiftly in order to satisfy
the needs of their customers. There is also the advantage of splitting the applications
themselves from the physical resources they require, as well as the possibility to
instantly gather additional resources of software, platform and infrastructure in order
to successfully face some activity peaks. However, as the performed survey reveals,
not all enterprises are prepared or eager to take this chance in order to fundamentally
change the way they benefit from IT. The reasons for this behavior seem to be very
different from one company to another. In many cases, the drawbacks are due to
business constraints, for example, when the business processes and the underlying
data set are extremely tightly coupled, with a set of very weakly defined integration
points. In some other cases, the migration is not possible due to a very strong
dependence on the existing and legacy information systems which are bound by
proprietary, legally protected data formats or whose further development is no more
feasible because of efficiency reasons. In such cases, the adoption of Enterprise 2.0
technologies is excessively costly to remain an attractive choice.
In the authors opinion, the cloud-based technologies may become an important part
of a modern approach, able to design and create a dynamic, flexible and adaptable
organization, as the applications and services they support are no longer dependent on
a single, fixed infrastructure. As virtualization and the SOA approach infiltrate the
enterprise, a set of weakly coupled services, executing on an agile and scalable
architecture, may transform any organization into a node of the cloud. By gaining
these new abilities, organizations may be able to rapidly adapt to change. As any of
the previous IT revolutions, the cloud-based approach is both the result of a
technological evolution and the result of a business processes re-engineering
demarche.
The author performed an analysis of the main factors governing the evolution of
Enterprise 2.0 technologies, and concluded that the many different factors may be
synthesized in a number of seven main elements leading to an increase in value from
three main perspectives: economic, architectural and strategic (Figure 1). The gain of
economic value is mainly due to the pay-as-you-go or pay-as-you-grow models
which allow the extension of the IT architecture without requiring the traditional
capital expenses. The gain of architectural value is due to the existence of a unique
and abstract environment for IT development. The gain of strategic value is due to the
fact that the enterprise is able to focus on its business core, leaving the IT
management tasks to external actors. A literature review in the field (Kittlaus and
Clough, 2009) leads to the conclusion that the factors influencing the success of an
organizations adaptation to Enterprise 2.0 may be synthesized as follows:
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The virtualization techniques and the extremely rapid development of the

market.
The rapid development of the hardware components (mostly processors and
network equipment).
The quick development of broadband networks.
The accelerated increase of the IT infrastructure requests for an organization.
The fast evolution and the significant decrease of the time-to-market indicator
for Internet-based applications.
The waves of economic crisis which impose continuous cost cuts for the
enterprises.
Figure 1. The Seven Elements of Cloud Service Value
The adoption of Enterprise 2.0 requests the organizations to appeal to a set of

technologies which are still during the development phase, along with a significant reengineering of the business models (Ristola, 2010). The authors survey revealed that
a large number of organizations and IT departments try to keep risk at an manageable
level by identifying the gaps in technology or process and trying to provide acceptable
solutions for the identified issues. The main issues faced when implementing
Enterprise 2.0, as revealed by the survey, are presented in Figure 2. The authors
survey may be compared with a similar research performed during the same period by
CIO Research (Golden, 2009) amongst the cloud services providers. The results of
this study are synthesized in Table 1. The comparative analysis of the two studies
reveals as obvious that security, performance and integration are the main concerns
for both the Enterprise 2.0 services providers and their actual and potential customers.
Even if the perspectives of providers and customers do not match 100%, in the
authors opinion this is mainly due to the different evaluation techniques employed by
each group. While the service providers use the Quality of Service (QoS) indicator, or
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the way it was defined by the contractual agreements (Service Level Agreements
SLA) as a fundamental landmark, the customers mostly value the service experience
itself. The following table (Table 2) presents the opinions of cloud services providers
and customers, side by side.
Figure 2. The main concerns of the Enterprise 2.0 services beneficiaries
Table 1. The main concerns of the Enterprise 2.0 services providers

CONCERN
Security
Integration with existing systems
Loss of control over data
Availability concerns
Performance issues
IT Governance issues
Regulatory/compliance concerns
Dissatisfaction with vendor pricing/offer
Ability to bring systems back in-house
Lack of customization opportunities
Measuring ROI
Not sure
Other
RESPONDENTS
45%
26%
26%
25%
24%
19%
19%
12%
11%
11%
11%
7%
6%
In many cases, the IT departments over focus on the infrastructure level

functionalities, losing sight of the operational and managerial perspective. The IT staff
ignorance in the field of business practices or in the field of organizational financial
policy may render more damage to the organization than the technical solution is able
to fix. Consequently, it is mandatory to also analyze the non-technical factors of
influence for the success or the failure of a cloud migration process. Without claiming
to have built an exhaustive model, the author reasons that organizations should always
go through the following five steps before taking the final decision about choosing an
Enterprise 2.0 solution:
1. The mandatory identification of the real reasons for the adoption of the cloud
model, from the business, the value and the cultural perspectives. The process
implies to identify the data, process and service elements which are fully
compatible with the new paradigm. The risk level assessment and the
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2.
3.
4.
5.
identification of compliance requests are also recommended in order to

understand how the organization internal systems will be affected.
The development of a risk assessment and management system associated to
the various risk levels. The mechanism should be integrated in the future
information and IT systems lifecycle. The assessment has to include all the
datasets, services and business processes pending for migration in the cloud.
The development of a governance strategy and a security strategy. The
candidate services have to be connected with the associated data and business
processes. After that, the service, data and processes have to be relocated
together, so as to comply with the organizational business strategy and
business objectives.
The implementation of security and governance measures, as well as the
system and operational requests.
An assessment of the risk management practices for the main potential cloud
services providers. Based on their own requests, the managers of the migration
process may assess the risk of each potential offer, deciding whether it is good
or bad for the organization.
Table 2. Providers vs. customers perspective
CUSTOMERS
Data security
Do not trust the cloud.
Regulatory reasons exist for data to be locally retained
Service latency
The cloud can be many milliseconds away.
The cloud is not suitable for real-time applications.
Application availability
Cannot switch from existing legacy applications.
Equivalent cloud applications do not exist.
PROVIDERS
What if something goes wrong?

What is the true cost of providing Service
Level Agreements (SLAs) as described by
the contract?
SaaS/PaaS models are challenging.
Much lower upfront revenue.
Customers want open standards/APIs.

Need to continuously add value.
The understanding of the Enterprise 2.0 implementation processes and technologies in

their most intimate details, along with a reasonable internal maturity level of the
organization, will definitely help management to determine the time and the manner
cloud based services may be employed in order to support the own business processes
(both the core and the auxiliary level). While most of the technical issues prove to be
highly quantifiable (at least on a superficial level), it is compulsory that non-technical
issues are identified and dealt with. The most significant non-technical issues that a
cloud migration may impose for a large-scale organization may be considered as
belonging to three main groups: financial, operational and organizational.
This attempt is part of a larger research performed by the author in the field of
organizational memory and Enterprise 2.0 technologies, and also continues a previous
doctoral research in the field of computer-assisted financial audit tools and
techniques, the final results of which were publicly defended in order to be validated
by both the scientific and academic community. The main goal of the aforementioned
research was the identification of some new areas of applicability for the modern
knowledge-based information technologies in the field of financial audit.
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When possible, a direct identification of the practitioners expectations was attempted

by means of direct interviews and also by means of the empirical study questionnaire
(a survey). The questions for the empirical study were carefully designed so as to get
unbiased, objective answers. The members of the target group were encouraged to add
their own observations regarding the questionnaire. Validation of the research
conclusions was performed by means of an informal discussion with some real life
practitioners, members of some companies which performed or are in the process of
performing the shift to Enterprise 2.0. In case some other authors opinion was
enclosed in the paper, whether in exact quotation or synthetic form, a complete
mention of the source identification information was made. Some of the data in the
paper is based on the results of some previous market research studies that were
credited accordingly.
The author has over seven years of previous experience in the research area, and also
a series of previous research results (published articles, conference attendances and
doctoral research). By defending the research results at the proceedings of such a
prominent scientific conference, attended by both scholars and practitioners bearing
some interest in the research area, the author attempts to get further validation of his
opinions, both confirmation and rejection of the aforementioned opinions scientific
and practical importance being welcome.
6. FINANCIAL CHALLENGES
The traditional business processes for the IT-centered companies usually require
constant relationships with both customers and service providers on multiple levels:
data, control and management. The first efforts for a migration to the cloud may seem
twice as costly as developing an in-house solution, as the IT department will have to
manage both the legacy and the newly arisen relationships. Even a quick analysis,
(that the survey proved to be true) leads to the conclusion that the migration process is
way more appealing for the small and medium size companies, than for the large-size
multinational companies. In the authors opinion, the whole range of the Enterprise
2.0 services looks more attractive for small-sized companies, which are more sensitive
to the flexibility and cost savings of such a solution. The performed survey proved
that most of the cloud-based services beneficiaries are small-sized companies.
7.
ENTERPRISE SCALABILITY CHALLENGES
Taking into account that using cloud-based services is not always less expensive than
the traditional version, enterprises should estimate the benefits of the investment
during its whole lifespan, not only on the immediate level. The return on investment
(ROI), for which a cloud investment-specific evaluation model was previously built
and presented (Mangiuc, 2010), is extremely useful, but still unable to provide a
complete view by itself. For a better insight, it is advisable to also look for and
account the hidden costs of storage systems, employee training, network equipment
etc., as each one has its own financial implications. All these aspects have to be taken
into account before deciding for or against the migration to the cloud.
Cost variability is an important aspect of cloud-based technologies implementation. If
cost variability, transparence and scalability are taken into account, the migration to
the cloud may be regarded as an opportunity and also as a challenge. In the life of any
IT-oriented organization there are times when the IT infrastructure becomes
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overloaded. In such situations, instead of a long and painful cloud migration process,
it is possible to see the cloud as an extension of the internal datacenter. In some other
cases a cloud-based alternative may be regarded as a very efficient back-up solution,
supporting real-time update and immediate activation if the internal infrastructure
collapses. Even though, it may happen that the fees paid to a cloud service provider
for a few tears do not look so small when compared against the immediate costs of an
internal infrastructure (hardware acquisitions, deployment, configuration etc.). As a
consequence, the organization management has to look at the financial figures from
multiple perspectives in order to state whether an Enterprise 2.0 implementation
stands. In the authors opinion, answers should be provided to a few important
questions:
Which are the tradeoffs of each option?
Which kind of benefits is more important for the organization?
Will the organization take real advantage from the fact that the IT department
will only focus on cloud-level applications instead of the traditional processes?
Which are the real business and financial implications of letting go all the
specialists who are currently designing, deploying and maintaining servers?
As most of the business processes will move on-line, has the organization
enough know-how to choose wisely?
The new business opportunities will take advantage of the cloud-based
services, or will the potential customers become scared or confused?
Moreover, some important voices claim the cloud platform to be a reliable and
inexpensive environment to test the new ideas and enterprise applications (Gonalves,
2009). The new enterprise applications may be rapidly scaled to the dimension of the
markets they are aimed at, even as prototypes. However, the benefits are significantly
higher in the case of a large number of small-sized applications than for a single largesized application. This observation raises a legitimate question: how could one define
the optimal size of a cloud-based application, so as the efficiency for the enterprise to
reach its maximum value? The implementation of an Enterprise 2.0 application is still
too complex to answer this question in exact terms.
On the other hand, from the cloud-based services provider point of view, even if
international bodies open standards which allow and encourage interoperability
between cloud implementations, the personalization of some functionality will
always be required in order to address specific customer requests. And, of course, the
huge amounts of money that cloud providers invest in their own data centers
(including the employment of highly qualified personnel) will not lead to any profit if
the customers cancel their subscriptions prematurely. As a consequence, it is very
likely that a large part of the providers investment to be quite aggressively transferred
to the migration costs of its first customers.
To sum up, it is possible to state that the cloud-based services migration process and,
even more, a possible in-house return process imply a too high level of costs to be
decided without an extremely thorough and coherent financial analysis.
8.
SOFTWARE LICENSING
License management and virtualization are important issues for the large-sized
organizations. The management of package-based software applications is not as easy
as for a personal computer, mostly when the many computers and sub-networks of the
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organization use different software packages. The integration of the packages and the
evaluation of the total licensing cost are one of the major challenges of a large scale
organization financial management.
Contemporary IT departments have network administrators which have to ensure the
compliance with the contractual agreements of the different types of acquired
software licenses, and to monitor the use of the acquired tools and services in order to
maintain optimum efficiency. It is not uncommon to find that most members of an
organization constantly use application that the IT department had no knowledge of,
or that some licenses are constantly paid for, without being used once. A migration to
the cloud should automatically eliminate all the aforementioned issues, as the use of
the service is controlled and measured by the provider. Even though, the future
savings may be difficult to foresee, mostly when the service providers employ
licensing models that are too traditional, or somehow incompatible with the cloud
paradigm. In the authors opinion, among the few licensing models employed
nowadays, the least adequate are:
The model based on the number of processors in most cases, the hardware
resources needed to execute a cloud-based application fluctuate massively.
Due to the nature of Enterprise 2.0 services, neither the IT department, nor the
final users are able to know exactly how many processing units are employed
at a certain time. Moreover, if the running application needs some extra
computing power, the cloud service, by its nature, will perform an automatic
acquisition of the needed resources, without asking the final users permission.
Such flexibility may lead to a significant fluctuation of the service fees,
frustrating or confusing the final users.
The model based on the number of instances using virtualization as a
horizontal scalability assurance solution may become awkward when some of
the acquired virtual instances need to expand over more physical units in order
to successfully handle all the processing requests. From a theoretical point of
view, each organization should acquire more licenses than it currently needs,
with the sole purpose of covering the eventual increases from the future.
Recent surveys (Shalom, 2008) disclose that the licensing costs volume has an
about 20% increase when the migration to a virtualized architecture is
performed.
The model based on the number of users in some cases, licensing fees are
computed based on the number of users accessing the application
simultaneously. A large number of cloud-based applications employ this
model, allowing the provider a strict control of usage based on the number of
licensed users. However, an essential advantage of an elastic environment, like
the cloud, has to be the immediate possibility of scaling the application, based
to the business needs of a certain moment. In the absence of this capability, the
customer will probably have to buy more licenses than the organization
actually needs, licenses dedicated to some potential users that the customer
might as well never have.
In the authors opinion, such obsolete models based on the number of processors, the
number of instances or the number of users, are not able to perform in a satisfactory
manner any more, when applied to an extremely elastic environment as the
Enterprise 2.0. Using provisions is not a viable solution, but a very costly
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alternative, able to significantly reduce or even cancel the benefits of decreasing

capital and operation expenses in the cloud.
9.
BUSINESS OPERATIONS CHALLENGES
Business operations cover aspects related to consumption and the non-technical

management of the IT services. These include, but are not limited to, the way
organizations deal with security measures and procedures, transaction processing etc.
Using Enterprise 2.0 services, an organization may deploy an Internet-based business
process inside its own information system, may add virtual resources when necessary,
and then may drop the resources when no longer needed. This kind of elasticity allows
for the adoption of some new business models, including the pay-as-you-go system,
employed for the use of infrastructure and IT management resources, with the obvious
result of immediate upsize or downsize scalability, as requested by the current
operational needs. Even if benefits are obvious, organizations should evaluate their
cloud-based services provider the same way they evaluate their own IT resources
(datacenter, infrastructure, bandwidth etc.). This way the organization will be able to
properly decide about a possible migration to the cloud, in order to avoid the collapse
of the own business processes. In the authors opinion, the evaluation of the options
and the adoption of the final decision have to take into account the following
elements:
The migration to the cloud has to provide strategic value, not just cost
decreases The initial success of the cloud-based offers was due almost
exclusively to the extremely low prices (as compared to the traditional
solutions). Even so, to face the competition, the cloud-based services providers
have to offer more than low prices. This will allow organizations to position
their IT strategy from the wider perspective of the own business processes.
Migration of the core business processes to the cloud even if a large number
of companies claimed the migration of their own business processes to the
cloud, the actual way to get competitive advantages in the process is quite
vague. It is still open for debate whether cloud-based services are able to
provide reliable support for critical processes, on the same level with the
traditional approach (Gu and Cheung, 2009). Moreover, when the companys
main competitors use the same services provider, the competitive advantages
become vaguer and harder to describe or measure.
The complex issues of business integration have to be solved The complexity
of an application execution framework increases when the employed
technologies evolve for a significant period. The direct consequence is that the
migration to the cloud will be significantly more difficult when the
organization has complex and tightly integrated applications, or previously
developed in-house applications, enclosing specific functionalities, security or
performance elements. As the cloud-based range of solutions is extending, the
demand for integration tools and services will substantially increase.
A very good match of the employee skills has to be performed an important
dimension of the enterprise migration plan has to be the acquirement of the
necessary competences to manage the new cloud-based technologies, along
with the continuation of the existing business processes. Developing the
competences of all the involved employees to a level where they are able to
manage advanced cloud computing elements, especially the implementation,
deployment and documentation of the internal business processes raises a set
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of additional constraints over the existing organizational cloud migration plan.

It may prove to be extremely difficult to update all the involved personnel due
to the complex nature of architectural, implementation and operational aspects.
On the other hand, it may be quite difficult to recruit third-party experts able to
assist or drive the organization through the migration process. This is mainly
because the eventual external experts have to become very familiar with the
existent business models and processes. Both alternatives involve taking major
risks, being highly dependent on the employees openness to the new
organization model, as well as their ability to see and document the
operational details which control the migration process.
10. ORGANIZATIONAL CHALLENGES
Each enterprise dealing with the idea of a migration to the cloud needs a full and deep
understanding of the organizational implications of the two main alternatives: the
management of an own IT investment or the acquisition of IT as a service from
external providers. The IT managers and all the stakeholders of the business process
have to analyze the short-term costs and the long-term benefits of the migration
process. The level of service that each potential provider is able to offer is a critical
piece of information, and also the foundation to analyze the quality of services (QoS)
based on the service uptime, service response and service performance, which have to
be compared against the current or the reference values. In the authors opinion, even
if it represents a costly process, it is advisable that the enterprise implements a pilot
business process based on the new technologies, regarded as a prototype. Such
process will allow the organization accommodation to the new approach and its key
specific elements. This exercise should take into account some extremely important
elements, like:
Solving conflicts regarding the services distribution channels an evergrowing number of Enterprise 2.0 services providers aggressively enlarged the
range of provided services, in order to get as much market share as possible.
Consequently, the conflicts between the providers technical staff and the
technical staff of its business partners are more and more recurrent
(Rochwerger et al., 2009). Such conflicts may explode anytime, affecting
not only the cloud services provider, but also its customers. Such aspects are
extremely harmful for the customers perception and trust, inducing the idea
that the services supply chain is not too well defined.
Distribution of service on multiple levels organizations that have already
invested in own storage and security systems no longer have a solid appetite
for a migration to the cloud environment. Moreover, trans-organizational
software applications may prove difficult to switch to Enterprise 2.0, if their
development process was not based on a set of open and convertible standards.
As a result, many of the potential customers may become interested only in a
partial adoption of the cloud model, or in a hybrid adoption formula (like
private cloud).
Solving the security and reliability issues of the business processes the
enterprises care for their own data is already common knowledge. Most of the
enterprises take ample measures so as their data does not get lost or stolen.
Also, most enterprises consider the cloud environment as a serious security
threat, and, as a result, the surveys reveal security concerns as the most
important concerns for a potential cloud customer, surpassing the performance
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or reliability issues. As the cloud-based services gain popularity and wide

public acceptance, they will become a more important target for hackers.
Consequently, the essential challenge for a cloud services provider will be to
protect organizational data both from external attacks (from outside the
firewall) and from internal attacks (from applications which execute in
different virtual machines, but on the same physical machine). Some of the
aforementioned issues are not limited to the IT solution and cannot be
addressed only on a technical level. This is why cloud services providers have
to cooperate with their customers so as the implemented security practices get
official certification from industry-specific independent bodies.
Even if the Enterprise 2.0 set of technologies and the migration to the cloud offer
significant values and opportunities for the IT-based organizations, the traditional
concerns in the field of security, integration, service availability are still applicable.
However, many issues arise due to the specific nature of these services which imply
that information belonging to multiple organizations is stored and processed on the
same hardware platform (multi-tenancy). Moreover, there are further suspicions raised
by the fact that not only the corporate data, but a large part of the corporate business
processes takes place outside the corporate datacenter. Based on a previous survey,
the paper at hand is an attempt to identify and debate the main non-technical issues an
organization may face when designing or executing a migration from the traditional
IT model to the cloud-based IT model. The research led to the idea that the
assessment and evaluation of the cloud-based systems risks has to become a
continuous process, not only a step in the migration plan. This is mainly due to the
rapid development of the domain, which may render todays assertion obsolete in a
few months or a year. Consequently, the author tried to find the generally applicable
facts and solutions, without detailing the case of a certain cloud-based services
provider on the market today.
Most of the observed issues and drawbacks were discussed by their operational and
managerial implications. One of the key issues at a managerial level proves to be the
lack of standards applicable for the cloud-based companies adopting Enterprise 2.0.
The existing standards only assure the cloud services interoperability, so as the tools,
applications, virtual images and other informational assets of an organization may be
shared in different cloud environments. The portability standards, able to allow the
transfer of a companys applications and business processes from a service provider to
another are still to be expected. The paper also supports the idea that both the external
services providers and the organizations developing in-house solutions have to
implement operational interfaces for their services, able to allow user account
management, user rights management, service execution modifications, data back-up,
resources management and secure application partitioning. Moreover, a coherent and
robust security policies system has to be implemented, in order to separate the final
users perspective from the underlying infrastructure and execution platform, and to
respect the multi-tier architecture definition and IT governance principles. Nowadays,
a lot of normative bodies and organizations try to collect the best practices in the field
and elaborate standards and conceptual frameworks (like the TM Forum, ITIL, and
Microsoft Operations Framework).
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The decision to migrate to cloud-based services has a tremendous impact over both
technical and non-technical aspects of an organization. The business owners have to
be convinced that the return on investment (ROI) may be achieved at the predicted
level. The technical staff (enterprise architects, developers, operational and IT
management teams) must have a complete and proper understanding of the risks
attached to placing the enterprise business processes in the cloud. When the
organization is missing the proper human capital, or the migration design and
execution teams are not motivated enough, the final results may be far from the
predicted ones, and frustration may take the place of the competitive advantage.
REFERENCES
Golden, B. (2009) The case against Cloud Computing, Part: II., CIO White Papers,
available on-line at http://www.cio.com/article/478419/
Gonalves, Vnia (2009) Adding Value to the Network: Exploring the Software as a Service
and Platform as a Service Models for Mobile Operators, Mobile Wireless Middleware,
Operating Systems, and Applications Workshops, Lecture Notes of the Institute for
Computer Sciences, Social Informatics and Telecommunications Engineering, vol. 12:
13-22
Gu, Lin, Cheung, Shing-Chi (2009) Constructing and testing privacy-aware services in a
cloud computing environment: challenges and opportunities, Proceeding Internetware
'09, Proceedings of the First Asia-Pacific Symposium on Internetware, ISBN: 978-160558-872-8
Kittlaus, Hans-Bernd, Clough, Peter N. (2009) Software Product Management and Pricing:
Key Success Factors for Software Organizations, Springer Publishing, ISBN: 978-3540-76986-6
Mangiuc Drago (2010) Enterprise 2.0 Implementation Success Evaluation Model, AMIS
2010 - Proceedings of the 5th International Conference, Accounting and Management
Information Systems, vol.1: 1023-1039
Ristola, Jaakko (2010) Information Technology Service Management for Cloud
Computing, Ph.D. thesis, Aalto University School of Science and Technology,
available on-line at http://lib.tkk.fi/Dipl/2010/urn100243.pdf
Rochwerger, B., Breitgand, D., Levy, E., Galis, A., Nagin, K., Llorente, I. M., Montero, R.,
Wolfsthal, Y., Elmroth, E., Caceres, J., Ben-Yehuda, M., Emmerich, W., Galan, F.
(2009) The Reservoir Model and Architecture for Open Federated Cloud Computing,
IBM Journal of Research and Development, vol.53, no.4:1-11
Shalom, Nati (2008) Space-Based Architecture and The End of Tier-based Computing,
GigaSpace Technologies Whitepapers, available on-line at http://www.gigaspaces.com
/files/main/Presentations/ByCustomers/white_papers/The_End_of_Tier.pdf
Shan, Tony (2010) SOA and Cloud Computing: Synergy, Interlock and Transition,
proceedings of the IEEE 3rd International Conference on Cloud Computing (CLOUD
2010), available on-line at http://www.thecloudcomputing.org/2010/
Walters, Tim (2009) SaaS - The Benefits and Challenges of Implementing an Enterprise
Scale SAS Warehouse and Business Intelligence Shared Service, SAS Global Forum
2009, available on-line at http://support.sas.com/resources/papers/proceedings09/2612009.pdf
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CRITICAL SUCCESS FACTORS FOR THE ORACLE

DATABASE AUDIT
Simona Felicia UNCHIASU1 & Pavel NASTASE
ABSTRACT
The increased use of Internet, portable devices, mobile and wireless technologies has
enhanced and eased the access to information and expanded the risk of unauthorized
disclosure of confidential personal, customers and business related information. All the
aforementioned factors have facilitated the corporate espionage, privacy breach, data
leakage and terrorism, therefore the information security topic was brought in the forefront of
information technology concerns for many organizations. Expectations in terms of
confidentiality, integrity and availability of the information are high, since shareholders,
employees, customers and business partners demand a real-time access and accurate data.
Risks associated with such information systems need to be addressed. An effective approach
must consider the risks introduced by all components of an information system, like
application, operating system, network and telecommunication, databases, interfaces with
other legacy systems and by the physical environment. In the past, many IT audits were
performed just at the application or at the network level and quite frequently the database
was overlooked, even though it is the repository for critical data and therefore a key
component of any information system. Loosing data confidentiality, integrity and availability
can cost a company not only in terms of sales but in reputation and litigation costs also.
Currently, the interest in auditing databases has increased due to the growing legal and
regulatory frameworks as well. Having this in our mind, we tried to propose in this article an
audit plan that best covers the ORACLE databases vulnerabilities and hardening issues. The
audit plan is based on literature review, COBIT framework and our own practical
experiences with databases. We analyzed the COBIT framework and we selected the
processes and the relevant control objectives that are critical for the database control and we
translated them into audit steps.
KEYWORDS: IT Governance, COBIT, Data breach, Database vulnerabilities, Database

audit program
INTRODUCTION
The increased use of Internet, portable computer devices, mobile and wireless
technologies has enhanced and eased the access to information and expanded the risk
of unauthorized disclosure of confidential personal, customers and business related
information. All the aforementioned factors have facilitated the corporate espionage,
privacy breach and terrorism, therefore the information security topic was brought in
the forefront of information technology concerns for many organizations. The new
technological developments have provided new opportunities for the occurrence of
information systems related problems such as data leakage, identity theft, malicious
1
Correspondence address: Simona Felicia UNCHIASU, CISA, CRISC, Ph.D. student, Bucharest
Academy of Economic Studies, Romania; email: simonaunchiasu@yahoo.com
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attacks using viruses, denial of service attacks, systems unavailability, and the list
could go on.
Nowadays, companies face the challenge of protecting the sensitive data stored in
their information systems. Data protection, also known as information security, means
to prevent the outside and inside attempts to access data, to monitor and review the
users activities, so as to detect and prevent unauthorized system access, use,
disclosure, disruption and possibly fraudulent activities.
A large number of financial, ERPs (Enterprise Resource Planning) and CRMs
(Customer Relationship Management) information systems reside on Oracle
databases; therefore the IT and financial auditors together with security officers
should be aware of the auditing techniques and of the audit related capabilities that
database offers. Organizations that do not make efforts on protecting their information
assets are exposed to significant operational, including fraud, reputational and
compliance risks, without to mention the threats faced in accomplishing their goals
and objectives. Expectations in terms of confidentiality, integrity and availability of
the information are high, since shareholders, employees, customers and business
partners demand a real-time access and accurate data.
Risks associated with such information systems need to be addressed. An effective
approach must consider the risks introduced by all components of an information
system, like application, operating system, network and telecommunication,
databases, interfaces with other legacy systems and by the physical environment. In
the past, many IT audits were performed just at the application or at the network level
and quite frequently the database was overlooked, even though it is the repository for
critical data and therefore a key component of any information system. Loosing data
confidentiality, integrity and availability can cost a company not only in terms of sales
but in reputation and litigation costs also. Currently, the interest in auditing databases
has increased due to the growing legal and regulatory frameworks as well.
Having this in our mind, we tried to propose in this article an audit plan that best
covers the ORACLE databases vulnerabilities and hardening issues. The audit plan is
based on literature review, COBIT framework and our own practical experiences with
databases. We analyzed the COBIT framework and we selected the processes and the
relevant control objectives that are critical for the database control and we translated
them into audit steps.
1. TODAYS THREAT LANDSCAPE
Todays threat landscape has shifted from widespread and unfocussed Internet worms
to targeted attacks aimed at specific companies. Over the years, two fundamental
issues have been constant. Firstly, the threat landscape continues to evolve and gain in
complexity. Secondly, attackers will always be a step ahead of the defenders in
exploiting vulnerabilities across people, process and technologies. What has changed
today is the motivation, the methods and tools employed by these attacks: nowadays
we are no longer fighting an individual hacker, but a highly organized, well-funded
crime syndicate.
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Data breaches is in the forefront of the threat landscape and usually, it occurs in all
types of organizations but today, the targeting of financial services is quite shocking.
Stealing digital money and, perhaps more important, large volumes of sensitive
customer data became a priority for the cyber criminals. According to the study 2010
Data Breach Investigations Report conducted by Verizon Risk Team in cooperation
with the United States Secret Service, a growing percentage of cases and an
astounding 94% of all compromised records in 2009 were in financial services
industry. Moreover, it was estimated that more than 900 million records were
compromised over the last five years, with a peak in 2008. Payment card data,
personal information and bank accounts data were the most compromised data types.
It is very difficult to point out the geographic origin of these attach especially when it
relies mainly on source IP addresses. Figure 1 shows the regional origin of the
external attacks, having on the top the breaches originated from East European
countries.
Figure 1. Origin of external attacks
21%
Europe - East (incl. Russia)
19%
America - North
18%
Asia - East
10%
Europe - West
5%
Middle East
Africa
2%
Asia - South/Southeast
2%
Oceania
2%
31%
Unknown
(Source: 2010 Data Breach Investigation report, Verizon, 2010: 16)
An astonishing 94% of the records were stolen using hacking techniques. The top
three types of hacking are formed by the use of stolen login credentials, exploitation
of backdoor or command/control channel and SQL injection. It is worth mentioning
that in the data breach scenarios, SQL injection has three main uses, like:
query data from the database;
modify data within the database;
distribute malware to the systems.
The aforementioned study brings into discussion the assets from which data were
stolen, and as expected, servers and applications are on the top. Figure 2 shows a
statistic of the types of compromised assets.
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Figure 2. Types of compromised assets

Type
Category
% of Breaches
% of Records
Database server
Servers & Applications
25%
92%
Desktop computer
End-User Devices
21%
1%
Web app/server
19%
13%
Payment card
Offline Data
18%
<1%
POS server (store controller)
11%
<1%
Laptop computer
End-User Devices
7%
<1%
Documents
Offline Data
7%
<1%
POS terminal
End-User Devices
6%
<1%
File server
4%
81%
Automated Teller Machine(ATM)
End-User Devices
4%
<1%
FTP server
2%
3%
Mail server
2%
4%
Customer (B2C)
People
2%
<1%
Regular employee/end-user
People
2%
<1%
(Source: 2010 Data Breach Investigation report, Verizon, 2010: 39)
The study concluded that only 4% of the breaches would have required expensive and
difficult preventive measures. It was noted that changes of the default configuration
and altering of the existing practices often solve problems much easier than redesign
of processes and new purchases. Furthermore, the attacks are easier to prevent then is
to deal with their consequences.
Conclusions and recommendations of the study can be translated into audit steps that
are listed below and that will be re-examined deeper in chapter 4, during the proposed
database audit program:
assess the implementation of a role based access process;
assess the implementation of segregation of duties principles;
assess the incident reporting, monitoring and response processes;
check if measures for preventing credentials stealing are implemented;
check if a security awareness program was implemented within the organization;
assess the monitoring and filtering process of the network traffic;
assess the log gathering and analysis process;
check the implementation of a knowledge sharing process.
2. IT GOVERNANCE, RISK MANAGEMENT AND CONTROL
FRAMEWORK
IT governance, risk management and control objectives are critical in the performance
of any audit process. The governance of the IT processes is evaluated mainly as part
of the policies, procedures and management oversight controls. Risk plays an
important role for both auditors and auditees. Firstly, risk is the key factor in
designing the audit plan, hence in evaluating what to audit and secondly, it has a
significant role in evaluating how management manages risks. Implemented controls
are the primary evaluation point in the audit process.
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Enterprise Governance is a relatively new term that refers to the way an organization
is managed. Enterprise Governance constitutes the entire accountability framework
of the organizations. There are two dimensions of enterprise governance
conformance and performance that need to be in balance. This statement captures the
essence of enterprise governance as described by the International Federation of
Accountants (IFAC) in the report Enterprise Governance Getting the Balance
Right.
IT governance is an integral part of enterprise governance, a combined business and
IT issue which requires a business driven approach. According to ISACA, IT
governance has been defined as the responsibility of the board of directors and
executive management, and consists of the leadership and organizational structures
and processes that ensure that the organizations IT sustains and extends the
organizations strategies and objectives. (ISACA, Board Briefing on IT Governance,
2nd Edition, USA 2003) Furthermore, the implementation of IT governance ensures
that the IT function adds value to the company while balancing risks versus return.
IT governance is a comprehensive term that encompasses IT processes, IT resources,
information, business and legal issues, and all concerns stakeholders, senior
management, process owners, users, auditors and suppliers. A critical path to the
success of IT governance is an effective communication among all parties involved,
based on a common language, constructive relationship and commitment in
addressing the issues. Basically, the IT governance is made of two issues: IT delivers
value to the business and IT risks are mitigated to an acceptable level, which means
the strategic alignment of IT with the business and the establishment of accountability
within the enterprise.
IT governance integrates and institutionalizes best practices and is an enabler for the
company in taking full advantage of its information, thus maximizing benefits,
gaining competitive advantage and exploiting successfully the opportunities.
Business must deal with risks. Risk is an inherent part of business, brought to our
attention as a result of major events occurred over the past years: fraud incidents,
major credit failure, information technology exploits and information flows. In order
to put risk in the proper business context, the Committee of Sponsoring Organization
of the Tradeway Commission (COSO) issued in 2004 the Enterprise Risk
Management Integrated Framework, known as COSO ERM Framework, which
defines risk as follows: Risk is the possibility that an event will occur and adversely
affect the achievement of an objective.
According to COSO ERM Framework, the above mentioned process is defined as
follows: enterprise risk management is a process, effected by an entitys board of
directors, management, and other personnel, applied in strategy setting and across the
enterprise, designed to identify potential events that may affect the entity and manage
risk to be within its risk appetite, to provide reasonable assurance regarding the
achievement of entity objectives.
Risk management is not something new to the business world. Several industries,
among them being the financial services, insurance services and the energy
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companies, have developed and tested risk management techniques in order to

mitigate the key risks associated to those industries.
Companies have traditionally focused on the financial risks, but recently, increased
attention was paid to the operational risk and systemic risk mainly due to the
regulators concerns. The technology and information security risks are a significant
part of the aforementioned risks. Today economy brings a new spectrum of IT related
risks, such as disclosure of confidential data, non-availability of services negotiated
due to systems downtime, or missed business opportunities caused by a rigid IT
infrastructure. Basically, risk management addresses the IT risks, defined as the
business risk associated with the use, ownership, operation, involvement, influence
and adoption of IT within an enterprise. IT risks consist of IT related events that could
potentially impact the business. (ISACA, Implementing and Continually Improving
IT Governance, 2009)
Risk management is a continuous process with two components, identification and
control. It begins with a clear understanding of the companys appetite for risk, which
drives all the risk mitigation efforts and influences future investments in technology.
Afterwards, it continues with the identification of risks and their impact on assets.
Once identified, risks must be controlled and mitigated by countermeasures to an
acceptable level. Consideration should be given to the residual risk, as well. The
performance of risk mitigation process should be measured and monitored on a
continuous basis.
Control Objectives for Information and related Technology COBIT is an IT
governance framework which provides a structure for developing control objectives.
The framework is strongly focused on controls and less on execution and support. It
allows managers to overpass the gap between control requirements, technical issues
and business risks, by providing clear policies and good practices for IT controls from
a business perspective. COBIT provides a framework to ensure that IT is aligned with
the business, acts as an enabler for business and its usage maximizes benefits, IT
resources are used responsibly and IT risks are managed appropriately. Furthermore,
it covers security topic in addition to other risks that can occur while using
information systems.
COBIT has been aligned and harmonized with other IT standards and best practices
like COSO ERM Framework, ITIL, ISO/IEC 17799 and SEI Capability Maturity
Model. COBIT is positioned at a high level and acts as an integrator of the different
guidance materials. The framework is focused on what is required to achieve,
meaning adequate management and control of IT, while the more detailed IT
standards and best practices are at a lower level of detail describing how to manage
and control specific IT topics.
COBIT framework map IT activities in a generic process model divided in four
domains which are:
Plan and Organise
Acquire and Implement
Deliver and Support
Monitor and Evaluate
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These four domains are interrelated; while Plan and Organise provides direction to
solution delivery and service delivery, Acquire and Implement provides the
solutions and passes them to be transformed into services, Deliver and support
receives the solutions and makes them usable for the end users and Monitor and
Evaluate monitors all processes to ensure that the direction provided is followed.
Across the four domains, 34 processes are identified, each one having a number of
control objectives.
The principle that COBIT framework relies on, depicted in Figure 3, is that IT
resources are managed by IT processes in order to achieve IT goals that respond to the
business requirements.
Figure 3: The COBIT Cube
(Source: COBIT 4.1 Excerpt, IT Governance Institute, 2007: 25)
It is worth mentioning that the level of security and controls implemented for the
information systems should be correlated with the risk the respective system poses to
the overall organization, therefore controls may vary depending on the level of risk
identified for that particular system.
3. RESEARCH APPROACH AND METHODOLOGY FOR THE ORACLE
DATABASE AUDIT
In the following pages we tried to propose an audit plan that best covers the databases
vulnerabilities and hardening issues. The audit plan is based on literature review,
COBIT framework and on our own practical experiences with databases. We analyzed
the COBIT framework and we selected the processes and the relevant control
objectives that are critical for the database control and we translated them into audit
steps.
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3.1 Planning and scoping of the audit

The key starting point in performing the database audit is to understand the business
risk that lies in the system of which the respective database is a component. It is
important for the auditors to understand how the system is used, what is the criticality
of the transactions processed by the system and the confidentiality and availability
requirements for the data stored in its database.
The second step is to obtain an understanding of the IT environment and to see how
the database fits into the overall system architecture. A clear picture of the IT
architecture will help the auditor to identify and assess the risks created by each
component of the information system, e.g. application, interfaces, network topology,
operating system that may potentially influence the database security. In this respect,
the auditor should:
interview the application / system administrator;
interview the business owners of the systems;
review an inventory of IT infrastructure (servers, databases, applications, etc);
review network topology;
perform a general review of the IT policies and procedures in place to observe
how the internal control system is.
Based on the review, the risk category is identified for each component of the
information system.
A lack of a clear understanding of the business risks and of the IT environment may
result in an audit report that is not capturing the risks that the information system
really poses to the organization and the findings and recommendation could be
unrealistic and could not mitigate the existing risks.
Following the thorough understanding of the risks involved and the IT environment,
the subsequent steps are performed:
Define the audit scope and objectives. These should be aligned with the Annual
Audit Plan and Audit Charter and should consider the budget and time
limitations.
Define the audit limitations and constraints, if any.
Review the previous database audit reports. Reports issued by both internal and
external auditors and the regulatory bodies should be considered. Determine
whether the issues previously identified have been corrected, taking into
account the following:
the efficiency and the response time of the corrective measures;
addressing of the root cause problem (if possible) and not only of the
consequences.
The auditor should assess the overall risk level employed by the remaining
findings and recommendations, left unsolved.
Based on the assessment of the previous audit reports, changes in the scope and
objectives of the audit should be performed, if it is the case.
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3.2 Oracle database audit steps

Three phases were identified when performing the audit fieldwork: data gathering, the
actual hands-on activities for testing the security and the database internal controls
and the report writing.
Data gathering
During data gathering stage, the auditor must gain a through understanding of the
Oracle database environment. In this respect the following information should be
obtained and assessed:
Organizational chart and job descriptions of the staff involved in database
related activities;
Policies and procedures governing the day-to-day database activities;
List of outsourcers and contractors;
IT Risk assessment document;
The internal and external Service Level Agreements - SLAs;
A list with the projects related to databases planed for current year and the
projects performed during the last year;
High - level system architecture;
Database servers architecture;
Network diagram;
List with Oracle database servers, their locations and the applications they
support with the corresponding licenses;
Version and release of the Oracle database and related tools implemented, like
Oracle Enterprise Manager, Oracle Advanced Security Option;
The operating system on which the database resides;
Number of the database instances;
Utility software used to log on and manage the database, like TOAD;
Relevant information security requirements related to the databases;
Incident management procedure and a list with the incidents reported at the
database level for a period covering the last year;
Business Continuity Plans BCP and Disaster Recovery Plans DRP related
to databases;
Record retention policy.
The auditor will conduct interviews with the DBAs administrators and security
administrator to determine their awareness level related to their daily tasks, corporate
policies and procedures employed, their professional skills and the current processes
and tools used to administer and maintain security of the database.
Operating system audit tests
During the second phase of the fieldwork, the auditor will test the internal controls
and the security of the database. The operating system security, hereinafter called OS,
is the foundation for securing Oracle databases. Insecurely configured operating
systems are the primary target of both internal and external attackers. If an attacker
gains access to an operating system account like the Oracle account, he/she can
potentially do the following:
compromise the database by accessing all the data;
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delete and modify all files, including database files and binaries;
modify start-up parameters;
shut down the system.
The operating system on which the database resides must be adequately protected;
therefore the critical controls and audit test to be performed at the OS level are
described below:
Oracle permissions
Inadequate files and directory permissions increase the database risk level. The
file permissions should be checked in $ORACLE_HOME/bin and
$ORACLE_HOME and should all be owned by Oracle accounts and by root
administrator.
Secure or remove default accounts
During database creation, Oracle creates several default database users and
schemas. The default accounts name and their default passwords should be
changed. For example, the default DBSNMP account is used by Oracle Intelligent
Agent to login to each Oracle System ID that it manages.
Membership of OSOPER and OSDBA roles
The OSOPER and OSDBA roles are created at the operating system level when
Oracle is installed. They cannot be granted. Membership of OSOPER and
OSDBA roles should be checked.
Permissions of the data files (.dbf)
The data files need to be adequately protected, therefore permission to the .dbf
files need to be checked.
Raw device permissions
Oracle raw devices should have minimum permissions, thus only Oracle can use
them.
Secure network communications
The TNS is Oracles networking architecture. TNS sends a lot of information in
clear such as the version number of the database. An advanced attacker can sniff
traffic and gain valuable information; therefore the auditor should assess the
security controls implemented.
Scripts that contains usernames and passwords in clear text
The auditor should look for scripts containing usernames and passwords stored in
clear text. It may be the case that an automated script with a password inside is
required; consequently encryption techniques for the password should be used.
ALTER privileges.
The auditor should ensure that no user has ALTER SESSION and ALTER
SYSTEM privileges.
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Export files
The auditor should check for the existence of the export file. Attackers might
either export the databases data including users passwords or be able to read a
legitimate export which could facilitate the database attack.
Archive log files
The data usually archived in the log files are precious and should be protected.
The auditor should locate the archive log files and check that no user except the
legitimate ones can read them.
Access to native PL/SQL compiler in production environment
The access to native PL/SQL compilation in production should be removed. The
access to this functionality would allow the execution of other binary files and to
wrap existing packages with the attackers own code.
Vulnerability scan
The auditor should review the OS vulnerabilities scan report.
Oracle database audit tests
During the fieldwork, the auditor will test the database implemented controls. Listed
below are the critical audit tests that should be performed:
Oracle database support
The auditor should check if the database version running on the servers is
currently supported by the vendor and if not, to look for additional agreements
between organization and vendor.
Patch management process
The auditor should assess the process for reviewing and applying databases and
operating system patches. The entire patch management process and the respective
procedures should be checked. Evidence must be provided related to a sample of
patches chosen by the auditor.
Promotion to production process
All promotions to production (patches, updates, new functionalities, bug fixes)
should be thoroughly tested before bringing them into production environment. A
severe control process must be in place for promotion to production activities.
Database change control process
The auditor should review the change control process to ensure that all database
changes are performed in a controlled manner. Evidence for a sample of recent
database changes should be obtained and analysed.
Incident management process
The auditor should review the incident management process. All incidents must be
recorded in a history log and reports on the respective incidents must exist. In a
later stage of the organizations maturity level, all the solutions used for solving
incidents could be gathered to organize a knowledge database. A sample of
database incidents should be reviewed.
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Database monitoring process

A regular process for monitoring key-database functions and security related
events should be implemented. The auditor should obtain any reports or queries
that are used for monitoring the system.
Procedures for monitoring sensitive accounts and privileges, system level
privileges and database objects are recommended to be in place. The output of the
following queries should be reviewed to determine whether:
the updates made by the database administrator accounts are monitored:
SELECT *FROM
DBA_STMT_AUDIT_OPTS;
auditing is in place for all system level privileges:
SELECT *FROM
DBA_PRIV_AUDIT_OPTS;
auditing is in place for database objects:
SELECT *FROM
DBA_OBJ_AUDIT_OPTS;
Furthermore, the auditor should review the process for monitoring:
errors in the alert log and the creation of trace files;
unexpected database start-ups and shut-downs.
Audit trail mechanisms
The auditor should assess the adequacy of the level of auditing set for the users
actions. The setting for the AUDIT_TRAIL parameter in the init<SID>.ora file
should be check to determine if auditing is enabled.
Retention policy
The auditor should review the data retention policy and assess if the location
where are stored is secured from tampering. Attention should be paid to audit
trails and logs retention procedures.
Scrambled data on the test databases
Significant efforts are done and a lot of money is spent to preserve data
confidentiality, but sometimes all the efforts are compromised by minor details.
Test environment must be fed with data, and it is commonly used to take the test
data from the production environment. Usually, test environments are less
protected then the production one, therefore before promoting the data into test
environment, these should be scrambled. The auditor should look for the
scrambling mechanisms.
User management process
The auditor should review the user management procedures. In addition to the
usual process of creation and deletion of users, special attention should be paid to
the procedures used for reviewing inactive profiles, users that never logged on and
accounts inactive for more than 30 days or the maximum required by the
organization security policy.
The auditor should obtain from the Human Resources Department a list of
terminated employees and compare it with the list of the users, to ensure that
accounts were revoked in a timely manner.
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Access and authorization

All users and their activities in the system should be uniquely identifiable. In this
respect, the following aspects must be reviewed:
procedures used to log on to the system. Each database administrator should
use a unique account to log on and to administer the database. The user
sharing practice, if exists, should be immediately discontinued.
obtain a list of users to ensure that default accounts and generic accounts, like
test or guest, are not used;
the users profiles should be linked with job description and respect the
segregation principles;
the process for granting and revoking temporary accounts, like vendor and
consultants account;
users should not have access to the DBA_SOURCE view. The query to be run
is:
SELECT * FROM DBA_TAB_PRIVS
WHERE TABLE_NAME=ALL_SOURCE;
roles and user accounts that have INSERT, UPDATE or DELETE privileges;
roles created with the WITH ADMIN OPTIONS;
privileges assigned with GRANT option;
privileges assigned to PUBLIC account;
SYS or SYSTEM should own all objects in the SYSTEM table;
security over access to the Data Dictionary;
Procedures should be in place for obtaining emergency access to the database. The
emergency access should be revoked after the business issue is solved. Procedure
should exist for remote connection to the database. The auditor should assess the
adequacy of the aforementioned processes based on a sample review.
Password features
The auditor should review the following:
the process for establishing the initial password;
generic password and passwords that can be easily guessed should not be
used;
password attributes like: change password at first log on, frequency of change,
password length, use of special characters, password history log, etc.
password attributes should be aligned with the organization security policy.
Encryption
Encryption mechanisms should be used to protect confidential information where
appropriate.
Trusted relationship
Trusted relationship should be restricted and protected.
Disaster recovery and back-up arrangements
A disaster recovery strategy and back-up procedures should exist and should be
tested on a regular basis.
The auditor should review the following:
the strategy for back-up and recovery of the database;
the process for securing and storing tape backups;
how the damaged and obsolete equipments are disposed;
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business continuity plan;

testing plans and results of the last disaster recovery test.
Physical security
Physical access to database systems should be restricted to authorised personnel
only. The auditor should visit the data centre to ensure that database systems are
stored in secured environments, like equipments are connected to an alternative
power source, there are smoke detectors, fire extinguishers, there are no pipes
crossing the data room, etc and that password-protected screen savers are in place.
Once all of the aforementioned audit steps will be covered, the results will be captured
in the audit report.
CONCLUSIONS
Todays threat landscape has evolved toward targeted attacks aimed at specific
companies, specially the financial services ones. Stealing digital money, payment card
information, personal data and customers databases became the top priority for
attackers. And all these data are stored in the databases.
Oracle is used worldwide to house business database applications. If not well
protected, the databases become a very attractive target for the attackers. Oracle has
enhanced the security features of the database but if not properly configured, is almost
useless. Hardening measures that are at no cost and easy to implement should be
known by all database administrators and IT auditors. It was proven that 64% of the
breaches could be easily prevented by the implementation of simple and cheap
controls. Clearly there is a strong need for improving and enforcing the accountability
management. The simple goal is to ensure that users do not have more privileges than
they need and all access is monitored. The practices of using generic accounts and
username sharing should be discontinued. Even if everybody agrees that it shouldnt
be there, there are still active default accounts or default passwords.
The audit of the databases has become a critical challenge for organizations. Any
deficiency in the database security can nullify all the controls that have been
implemented at the application level. Moreover, the regulatory environment has
increased over the last years, international and national regulations have evolved in
detailed frameworks covering the internal control system and special data aspects, like
preserving confidentiality, integrity and availability. All these regulatory constraints
have been translated into the activation of audit trails mechanisms within the
information systems and into the growth of the storage capacity, all this having a
serious impact on the performance of the information systems. Nowadays, the IT
management faces a new challenge that is to find the right balance between the risk
level introduced by the information systems and the mitigating controls with a direct
impact on the systems performance.
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REFERENCES
Al Marcella (2006) IT Audit Practices, ISACA Training Week - Budapest, Training support
materials
Bill Bruck (2003) Taming the Information Tsunami 2nd edition, Microsoft Press
Charles Le Grand and Dan Sarel (2008) Database Security, Compliance and Audit,
Information Systems Control Journal, vol. 5: 27-31
Christopher Reed (2010) Achieving Data Warehouse Nirvana The Critical Role of
Information Control, Information Systems Control Journal, vol. 4: 31-34
Information Systems Audit and Control Association (2006) CISA Review Manual, USA,
IT Governance Institute (2007) COBIT 4.1, USA
Information Systems Audit and Control Associations (2009) Security, Audit and Control
Features Oracle Database 3rd Edition, USA,
Jeffrey T. Hare (2008) Monitoring Privileged Application Users in Oracle Applications
Environment, Information Systems Control Journal, vol. 6: 46-50
John H. White (2006) Important, But Often Dismissed: Internal Control in a Microsoft
Access Database, Information Systems Control Journal, vol. 6: 30-34
Mike Pinch (2009) Database Activity Monitoring: An Emerging Technology for Audit and
Compliance, Information Systems Control Journal, vol. 1: 44-47
Mukul Pareek (2006) Living with Risk, Information Systems Control Journal, vol. 6: 35-38
Nancy Bagranoff, Mark Simkin, Carolyn Norman (2008) Core Concepts of Accounting
Information Systems, John Wiley & Sons, INC, USA
Nastase Pavel, Lunceanu - Unchiasu Simona Felicia (2010) IT Governance Maturity level
for the Romanian companies, 11th World Congress of Accounting Educators and
Researchers Conference volume, Singapore
Nastase Pavel and etc. (2007) Auditul si Controlul Sistemelor Informationale, Editura
Economica
Paul J. Sobel (2007) Auditors Risk Management Guide: Integrating Auditing and ERM, CCH
Learning Center, USA
Ponemon Institute (2010) 2009 US Cost of a Data Breach Study, available on-line at
www.encryptionreports.com
Robert Dollinger, Luciana Andron (2005) Baze de date si gestiunea tranzactiilor, Editura
Albastra
S. Anantha Sayana (2003) Auditing OS and Database Controls, Information Systems
Control Journal, Vol. 3, available on-line at www.isaca.org
Steve Rimell (2007) Advanced IT Audit School, IT Audit School training material, Athens
Verizon Risk Team (2010) 2010 Data Breach Investigation Report, available on-line at
www.verizonbusiness.com
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PS7 Financial instruments

Chairperson
Florin VASVARI, London Business School, UK
USE OF FINANCIAL SECURITIES IN THE CZECH

REPUBLIC: SOME EVIDENCE FROM SMES
Ji STROUHAL, Marie PASEKOV,
Eva HRUBOOV, Carmen Giorgiana BONACI
THE FINANCIAL INNOVATION

AND THE DYNAMIC CAPITAL MARKET
Flavia Mirela BARNA, Miruna Lucia NACHESCU
A SELECTION FUZZY MODEL INVOLVING ASSETS

AND PROJECTS
Adrian Victor BDESCU, Radu Nicolae CRISTEA,
Dana-Maria BOLDEANU
THE ROLE OF FINANCIAL DESCRIPTORS

IN THE OPTIMAL PORTFOLIO SELECTION
Bogdan DIMA, Flavia BARNA, Horatiu REGEP
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USE OF FINANCIAL SECURITIES IN THE CZECH

REPUBLIC: SOME EVIDENCE FROM SMES
Ji STROUHAL1 & Marie PASEKOV
University of Economics Prague, Czech Republic
Eva HRUBOOV
Tomas Bata University in Zlin, Czech Republic

ABSTRACT
The international accounting harmonization process and recent developments in international
financial reporting standards determined a shift in accounting paradigms from historical cost
accounting towards fair value accounting. Our paper analyzes how this shift impacted upon
Czech accounting by particularly focusing on reporting for securities. Extending the objective
of our paper, we assess the current status in terms of securities being used by small and
medium-sized entities and entities ability to measure these financial instruments. The
developed analysis relies on information being collected through the use of a questionnaire
based survey. Finally we conclude through a comparative approach of Czech accounting
regulations and International Financial Reporting Standards in the area of financial
instruments.
KEYWORDS: financial securities, financial reporting, measurement, SMEs, financial

derivatives, Czech Republic.
INTRODUCTION
Searching for the solutions of measurement issues represents one of the key problems
analyzed within current research. There may be seen a conflict between the
requirements for relevance and timeliness of measurement on one side and the
reliability and conclusive evidence on the other side. However, it shall be stated that
the important problem of measurement issues is the possibility of subjective
manipulation with values, which is possible when using certain measurement bases.
Actual economic environment strongly affects the requirements for measurement
requested from users.
When considering an economic boom there can be seen higher optimism of investors
which leads towards requirement of measurement of all accounting items at fair
values, which mainly represent current market prices of assets. Using this concept
means the turn from the prudence principle and conservative historical costs concept
in financial accounting. Moreover fair value concept in financial accounting leads to
higher tendency of revaluation assets or liabilities affecting profit or loss of the
company.
1
Correspondence address: Ji STROUHAL, University of Economics Prague, Czech Republic;

email: jiri.strouhal@vse.cv
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Meanwhile, upon economic recession users revaluate their views on accounting

methods, especially the measurement bases. Economic recession evokes the
renaissance of conservative approaches in measurement, especially the applicability
of prudence principle. Confidence in financial market upon recession is thrilled; there
can be seen strong price swings. Swings in market prices of financial instruments or
breakdown of real estate market may also evoke valid doubts whether the fair value
concept (and market price is the most reliable evidence) is really the most objective
and most reliable approach suitable for wide spectrum of users of accounting
information.
We think that the tendency of fair value measurement results from the investors
pressure: the main objective for investors was capital spillover and maximization of
short-term profit. It is impossible to ignore the fact that all these requirements were
strongly connected with economic boom conditions. A rather too optimistic
approach applied upon economic boom is based on fair value approach. The high
value of assets which is given by active market or it is based on the estimates in case
that active market does not exist, leads towards rising equity as well as balance sheet
sum and in case of revaluation through profit or loss also towards fictive profits which
can be distributed to owners. It shall be also stated that the estimates of fair values
used to have low level of reliability because of subjective estimates of valuator or
based on mathematical models which are connected with restrictive assumptions.
On the other hand the approach based on accounting conservatism and prudence
principle in recession periods may (jointly with inflation) lead towards erosion of
companys substance and deepen and prolong the recession. Our paper focuses on
measurement issues in the particular field of financial securities. Another particularity
of the study relies on presenting small and medium-sized entities (SMEs)
perspective. Problems arising while reporting for financial securities are being
discussed. Since some of Czech entities report under Czech accounting regulations
while others under IFRSs, it is interesting to observe the impact of this mixed
accounting regulation environment upon accounting practices. A questionnaire based
survey was conducted in order to capture the current state of facts in reporting for
financial securities at national level.
The remainder of our paper is structured as follows: section 2 develops a literature
review analysis on financial reporting and the use of derivatives in emerging
economies; sections 3 discusses securities measurement and the corresponding
valuation process; section 4 develops the analysis of information obtained through the
questionnaire based survey and interprets the obtained results from our sample of
Czech SMEs; and section 5 concludes upon the developed research with reference to
IFRSs and Czech accounting regulations in the filed of financial instruments.
Before the IFRS standards were adopted in the EU, it was stock exchanges in
particular which required that listed entities submit financial statements in compliance
with the IFRS or US GAAP. Previous researches dealing with the degree of disclosure
(Cooke, 1992; Meek et al., 1995), or the probability of using multinational standards
(El-Gazzar et al., 1999; Murphy, 1999; Leuz, 2003) indicate a positive correlation
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between the listing of accounting units on foreign markets and the degree of
disclosure and use of multinational standards as the basis for financial reporting.
In 2002, the European Union Commission adopted Regulation 1606/2002 which
established an obligation for companies being listed on European stock exchanges to
prepare their consolidated financial statements under IFRS, no later than 2005.
Whittington (2005) emphasizes the fact that previous to this decision, each EU
country required a different national reporting approach for listed companies. Among
the benefits of having a single set of financial reporting standards applied by
companies we must mention: easier access to foreign capital markets, increased
confidence of foreign companies in domestic capital markets, worldwide
comparability of accounting information, increased transparency, increased clarity
through the "common accounting language", simplifying the regulation process of
capital markets and lower susceptibility of accounting standards by political pressures.
Of course that all these benefits are first derived at a theoretical level and have also
already been tested within research accounting literature with what we might call
mixed results. The application of international financial reporting standards within
emerging economies has also raised the interest of accounting research. Concerns
being raised mainly relate to the lack of qualified accountants and auditors and to the
low markets efficiency (Eccher and Healy, 2000; Sucher and Alexander, 2002). It is
these circumstances that also led to some of the Czech companies to apply IFRSs,
while others still applying national accounting regulations, therefore creating an
interesting setting to be analyzed.
One of the problems being raised by companies in terms of risk management is
related to hedge activities actually being hindered through the requirements of hedge
accounting, which are mostly found to be far from the economic truth. Therefore it
becomes difficult for entities engaging in hedging activities to qualify for hedge
accounting even though as Trombley (2003) underlines entities want to apply hedge
accounting.
Numerous studies in our professional practice have dealt with the bond between the
economic and the accounting concept of hedging. Melumad et al. (1999), for instance,
indicates that the application of hedge accounting in compliance with the US standard
SFAS 133 leads to deviations from optimum hedging in the economic sense.
However, Barnes (2001) draws attention to the fact that these deviations from
economic hedging are the very consequence of the set hedge accounting model,
pointing out that hedge accounting may motivate poorly performing companies to
speculate and influence their economic results on a short-term basis.
Several studies have dealt with the information and control effects of hedge
accounting (e.g. Jorgensen, 1997; Hughes et al., 2002). The most interesting finding
lies in the fact that the voluntary application of hedge accounting leads to a deviation
from the optimum hedging strategy (as opposed to the exclusive application of
economic hedging without the application of the principles of hedge accounting).
Beyond hedging activities, our analysis extends to the use of derivatives. A series of
other studies in accounting research literature analyze derivatives trading and
derivatives markets role within emerging economies. The development of capital
markets has the ability to enhance economic development through its influence on
efficiency, solvability and competition within the financial sector, by mobilizing
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financial savings, efficiency of investments allocation, entities solvability,

decentralization of property and distribution of wealth, as well as by new and
developing entities access to share based financing (Stoica et al., 2006, p. 30).
Capital represents a different type of commodity, but one that is essential for
emerging countries economic development, capital accumulation, be it by internal
development, direct foreign investments and/or help being received from outside,
being necessary in order to bring economic ratios to the level that is required through
development plans. In order to reach these objectives a series of institutional settings
must be considered so that they also enhance capital accumulation. By this we refer to
commercial and savings banks, investment banks and other financial institutions,
insurance companies, pension funds and not least the securities market (Enthoven,
1973, p. 196). The development of the capital market within developed economies
still represents a crucial element when it comes to stimulating capital formation
(Riahi-Belkaoui, 2002, p. 26), having the ability to generate a part of the capital that is
necessary for local or foreign entities and end encouraging investments.
Furthermore, trade literature documents those markets for derivatives trading play an
important role when it comes to the development of a countrys financial structure by
creating some connections between cash markets, hedgers and speculators. The
increase in the use of derivatives offers alternatives for risk management and
facilitates cash flows towards emerging economies, while also creating the context to
enhance systematic risk and negative effects during financial crisis periods (Lien and
Zhang, 2008). We therefore consider it important to acknowledge the fact that
derivatives can play both positive and negative roles. A series of studies (such as
Kregel, 1998, Dodd, 2000, IMF, 2002) demonstrate the importance of derivatives
when it comes to hedging and risk management, but also the related possibility to
increase risk within financial systems by generating an unforeseeable dynamic in
crisis development, while also offering channels for crisis propagation.
Derivatives dissociate risks being associated with classic trading instruments beyond
countries boundaries, regardless if it is market risk, credit risk, liquidity risk, interest
rate risk or currency risk. More precisely, derivatives should transfer these risks from
investors who do not want them towards those with a better capacity to manage them
(Lien and Zhang, 2008, p. 40). Therefore, handling investments at international level
becomes more attractive by generating opportunities to develop cash flows as well as
to diversify investment portfolio. Still, we consider that risk enhancement, using
derivatives with the purpose of avoiding prudential regulations and manipulating
capital adequacy requirements should not only be looked at as simple side effects. We
can even asses that inadequate use of derivatives creates the fundament that might
lead to financial crisis unleashing. This is due to the fact that derivatives accelerate
cash outflows during crises and therefore increase cash flows volatility at international
level, further amplifying the crisis by making its evolution unforeseeable.
The generally accepted main function of derivatives market is that of facilitating risk
transfer between economic agents (Lien and Zhang, 2008, p. 48), the diverse shapes
being taken by derivative financial instruments offering packages with certain
payment patterns, redistributing and reallocating the risk associated with future cash
flows between market participants. By contracting a certain position on the futures
market that is actually opposed to the one on the spot market, compensating losses
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within the latter becomes possible based on the gains within the first. The
standardized, organized and centralized nature of futures markets makes it possible
for risks to be carried by other parties, such as speculators, who naturally benefit from
a premium that matches the undertaken risk.
A study being developed by the International Monetary Fund in 2002 (IFM, 2002)
was offering examples of derivatives use with the purpose of redistributing risk and
facilitating cash flows from outside the countries towards emerging economies.
Among these examples we must mention currency derivatives being used in order to
hedge for unexpected changes of the exchange rate and the impact that might have
upon investments, and interest rate swaps that allow corporation and banks to exploit
the comparative advantage of borrowing at a fixed rate versus a variable one within
different markets.
Another aspect which we consider relevant is the fact that trading futures and options
involves lowers costs when compared with trading within the spot market (Lien and
Zhang, 2008, p. 52). When trading derivatives an increase of informational flows
within the market is also expected, therefore generating the potential for the
development of a price forecast function within derivatives market. We must also not
forget that futures prices contain information regarding the anticipated demand which
could be used within the decision making process. A detailed analysis on the price
forecast function in derivatives markets id developed by Mayhew (2000).
Futures markets are considered to have a role in stabilizing prices based on the
following reasoning: by offering protection against losses related to price risk, future
markets encourage goods storing, this representing a mechanism being used in order
to stabilize prices within the spot market. It is therefore assumed that futures markets
have the ability to reduce volatility within spot markets. On the other hand, Mayhew
(2000) documents that if the market is not perfect from the competitiveness point of
view introducing futures contracts might determine many of the producers to
manipulate prices within the spot market through the production process and the
storing decisions, therefore actually increasing volatility within the spot market.
Despite the increase in derivatives use within emerging economies, their trading level
can not be compared with trading in more mature markets. The study being developed
by the International Monetary Fund (2002) shows that among the most common
problems that determine decreases of derivatives trading volumes within emergent
economies we find the week and inadequate infrastructure of the legal system and of
the markets, restrictions regarding derivatives use as well as the assembly of markets
that are relatively little developed within the considered economies. The effects of
derivatives markets, both the positive and negative ones, depend on the fiscal and
financial fundament of emerging economies within which they are being developed
(Lien and Zhang, 2008, p. 56). In other words, as Khor (2001) documented, when
analyzing derivatives trading we must not only focus on derivatives use per se, but we
should also consider the weaknesses at the root of national financial systems, as well
as some shortcomings in microeconomic policies. Morales (2001) analyzes the
benefits and risks of central banks using currency and interest rate derivatives outside
the country when considering both calm periods and turbulent times. The obtained
results document that the effect derivatives trading can have on an emerging
economys capacity to handle risk and to attract intermediate capital actually depends
on the internal financial systems capacity to adapt to changes taking place in
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financial risk, including links with liquidity and changes taking place in market
conditions.
When discussing the role of derivatives trading within emergent economies we must
also consider the place where trading can take place, namely within organized
exchanges or within Over the Counter (OTC) markets. This is due to the fact that the
structure of the trading environment has been documented to represent a significant
factor in the development of derivatives market (Lien and Zhang, 2008, p. 60).
Merton and Bodie (1995) correlated at a conceptual level the functions of the financial
system and organizational structures within which these functions are fulfilled,
assessing that financial intermediaries differ from one country to another and that the
structure of the financial system changes in time. Therefore if the basic functions of
derivatives markets stay the same within all markets they could be facilitated through
the different institutional structures which are required to be tailored after the above
mentioned functions.
Considering all these aspects, we may say that issuing the right prudential regulations
within emergent economies represents a real challenge for the authorized regulatory
bodies. Lien and Zhang (2008) document that these regulations should create
incentives for market participants to use derivatives in an adequate manner and to
facilitate the development of cash flows without increasing capital risk levels. In this
regard a series of aspects should be considered such as updating accounting
regulations, developing clear foresights for risk management and related to financial
institutions capital, and more transparent reporting regarding the transactions taking
place within derivatives markets (Dodd, 2000).
Another study being developed by the International Monetary Fund in 2003 (quoted
by Lien and Zhang, 2008) documents that regulatory bodies must find a the middle
way between allowing for more efficient risk management and the risk of increased
exposure to potential vulnerabilities in the markets development process. It is
therefore expected for financial institutions to prove high quality risk management
abilities and continuous updating of regulatory bodies capacity to measure risk.
2. FINANCIAL SECURITIES MEASUREMENT
We will further synthesize some main aspects related to financial securities
measurement practices before proceeding with analyzing the responses being received
from the analyzed entities in relation to these practices. Selected portfolios of shares
shall be revaluated at fair value. Fair value can be determined as a market price of
shares or could be based on valuation models. Especially at less transparent markets
shall be used these models. As common methods shall be stated:
net asset value model,
Price/Earnings ratio model,
dividend discount model.
The net asset value model is based on book values, and the fair value is determined
from the net asset value of the issuer. As a major limitation of this model shall be
considered the absolute inconsistency of measurement bases where is applied both
cost model as well as fair value approach. From the mathematical point of view it is
the ratio of equity to number of issued shares.
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Price/Earnings ratio model is a very popular method how to determine the fair value
of shares. It is a product of earnings per share ratio and price/earnings ratio.
According to IFRSs it is required to present EPS ratio within the statement of
comprehensive income. However there shall be stated following limitation of this
model: (i) in certain markets it is not easy to find out P/E ratio value, and (ii) this
model is not applicable in case that the valuated company reaches loss.
Finally we have to mention Gordons dividend discount model. In this case the fair
value is calculated as a ratio between the estimated amount of dividends to required
rate of return less growth rate of dividends. As a major disadvantage of this model
shall be stated the fact it cannot be applicable for those share issuers reaching loss and
those who do not pay dividends.
The main objective of this research was to determine, whether SMEs use financial
instruments, whether the entities are able to calculate their fair value, and finally
whether companies use hedging instruments as a tools of risk management. A
questionnaire based survey was conducted in order to obtain the necessary
information. The questionnaires were distributed in printed and electronic form.
3. DEVELOPING THE ANALYSIS AND INTERPRETING RESULTS
Our analysis is based on responses being obtained from a total of 111 companies with
annual turnover exceeding CZK 5 billion. Respondents were asked to characterize
their business based on the main area of their activity. They could select one or more
of the following categories: production, trade, services, finance and insurance. None
of the respondents belonged to the insurance sector. The structure of our sample in
accordance to the area of activity respondents declared to belong to is presented in
Figure 1. We must mention the fact that some of the companies reported more than
one branch of activity.
Figure 1. Samples structure based on companies area of activity
50%
45,9%
45%
40%
33,3%
35%
30%
25%
20,7%
20%
15%
10%
5%
2,7%
0%
Production (51)
Trade (23)
Services (37)
(Source: authors projection)
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Finance (3)
The overview of investments being made in securities by the companies in our sample
is presented in Figure 2. The obtained results show that the analyzed companies
mainly invest in shares, bills of exchange and checks. Investments in stock warrants,
interim certificates, warrants, inward bills, dock warrants and agriculture warrants
proved to be less common within our sample.
Figure 2. The relative number of references to the types of securities in which
companies invest
40%
30%
20%
10%
Fina
Agriculture warrant
All
Dock warrant
Inward bill
Warrant
Check
Bill of exchange
Trade
Bond
Participation
Interim certificate
Share
Stock warrant
0%
The structure of the securities being used by Czech entities corresponds with the
economic developments within each considered period. During the crisis, there was a
strong distrust in the financial system all over the world. This impacted upon
investments in the stock market. During the past two years shares lost 10% of their
value and have been trading far below their intrinsic value. Bonds were considered to
contribute in making investment less attractive to investors. This can be explained by
having state and municipal bonds presenting a relatively low yield which is closely
linked to low interest rates in the Czech Republic and abroad, and also by not
recording high nominal values for these types of securities. The results being obtained
through the questionnaire also reflect SMEs not being able to invest in bonds in six
digit numbers. A paradoxical phenomenon is revealed through the fact that riskier
types of bonds, such as bonds being issued by corporations, were found do be more
attractive. This indicates the fact that investors tend to rather trust corporations than
the state. As a consequence, in 2010 huge investor interest was documented in bonds
issued by Microsoft, while US government bonds were not found to be so attractive.
~310~
Bills of exchange and checks represent traditional securities being used by entities to
pay their debts and liabilities. Due to the fact that Czech national regulations have
been covering these types of securities for more than sixty years now, entities can rely
on clear rules and good law enforcement. This also explains why they represent the
most commonly used securities in Czech Republic.
Figure 3 offers an overview on our sample entities investments in derivative
contracts. Foreign currency derivatives are most commonly used, in the shape of
currency forwards, currency swaps, currency options and currency futures, which
together constitute 37.8% of references.
Other types of derivatives are referred to only in 12.6% of the references. Analyzed
businesses but do not actually use commodity derivatives. Another interesting fact
being observed is that most of the references to the use of derivatives come from the
manufacturing companies.
Figure 3. The relative number of references to the types of derivatives being used by
sample companies
FX f orward
FRA
Equity f orward
Commodity f orward
FX f utures
Interest rate f utures
Equity f utures
Commodity f utures
FX swap
Interest rate swap
Cross-currency swap
Equity swap
Commodity swap
FX option
Interest rate option
Equity option
Commodity option
20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
Services
All
Derivatives represent a highly debated topic nowadays. When trying to explain the
interest for derivatives we find several reasons. Among them there is also derivatives
contribution in the context of the 2007 financial crisis. It was this point in time that
once again attracted the use of the term toxic assets as equivalent for derivative
financial instruments. SMEs are expected to use derivatives for risk management
purposes rather than for speculation. As it was also shown in Figure 3, most of the
entities have to deal with currency risk or/and interest rate risk.
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Once again we documented the reputation of some contracts, such as forwards and
swaps, which have proven themselves to investors by some years now. Both bankers
and entrepreneurs themselves already have experience with such contracts in the
Czech financial market. The characteristics making these contracts attractive are their
particular clarity and low complexity of the contract. The following chart 1 and chart
2 document that it represents a well grounded judgment to hedge for exchange rate
risk or interest rate risk. The trend in developments of CZK against the EUR, USD
and GBP, as well as developments in interest rates over the last decade make a good
point in showing why it is so important to develop hedge activities.
Chart 1. Currency rate developments - CZK / EUR, USD and GBP
for the 1999-2010 periods
(Source: www.cnb.cz, authors processing)
Chart 2. PRIBOR 3M and 3M EURIBOR for the 1999-2010 periods
(Source: www.cnb.cz; www.euribor-rates.eu, authors processing)
~312~
Pirchegger (2006) is concerned with the fact that accounting units tend to note
primarily the high level of disclosure obligations in relation to hedge accounting and
the costs related thereto. On the other hand, the primary goal of the standard-issuing
authority is the incontestable effort to provide investors with highly relevant
information. The fact that the information on hedge accounting should form an
indivisible part of the financial statements is motivated by the effort to assure
investors that the criteria applicable to the field of hedge accounting were applied
correctly rather than by the fact that the information on hedge accounting causes
considerable additional costs to accounting units. The following figure provides
evidence on the use of hedge activities by tested companies.
All
Production
Trade
Services
Finance
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
not applied
f air value hedge
cash f low hedge
Finance
hedge of net f oreign operation
All
The obtained results document that the analyzed entities remain conservative with
regard to hedge activities which appear as new or little known in the Czech Republic.
The reason behind these results might be due to these types of contracts being
considered as risky. Furthermore when considering the Czech analyzed entities
portfolios we mainly find shares and debt securities, bills of exchange and checks.
Meanwhile derivatives were mainly used within the manufacturing industry with
entities preferring the standard form of currency forwards, currency swaps, currency
options and currency futures.
FINAL DISCUSSION AND CONCLUSIONS
The most significant differences when comparing IFRSs with Czech accounting
regulations are related to the relatively low requirements on disclosure. Guidance
being offered in the area of reporting for financial instruments under IFRSs is mainly
considered to be solution focused. This is done by associated with the real issues, or
more precisely through the current market value of these instruments. This is due to
standard setters endeavor to provide investors with the latest available information
when preparing financial statements. This information is wanted to include all recent
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developments in the assets prices as reflected within the market. Though the
assumption is certainly noble, the cornerstone of its applicability relies on the
existence of a highly functional and transparent market. And unfortunately, for the
time being, it seems like the Czech market is not. Fair value measurement is one of
the measurement bases being accepted in the Czech Republic, but it is usually
determined based on valuation models, rather than by using the market price.
When comparing the measurement bases comprised within the IFRSs and Czech
regulations, we must also underline the fact that under Czech law it is impossible to
measure long-term assets and liabilities at present-value (amortized cost extension),
the same as current assets and liabilities and those with a maturity of one year in the
Czech environment. Therefore, entities follow the applicable regulations requiring the
assessment and presentation of their nominal values. Absolute ignorance of the time
value of money can and do significantly influence (in full compliance with statutory
requirements) financial statements and probably provide investors with information
that drives bad investment decisions.
The financial reporting of non-listed companies in the field of financial instruments is
to a certain extent affected by requirements compliant with the IFRS. In the field of
equity securities, there are identical requirements for the initial recognition;
nevertheless, the subsequent revaluations are carried out in a different manner,
depending on the comparability of the assignment of the individual tools to the
respective portfolios. The adoption of portfolios applicable in international standards
(HFT, AFS) and the subsequent application of identical requirements to them would
be beneficial in the field of investments in equity securities in the Czech Republic.
In the field of bonds reporting, the level of compatibility between the IFRS
requirements and Czech regulations is not significant due to the different approach to
discount/premium amortization. That is why the introduction of the HTM portfolio
would be beneficial in the Czech Republic on condition that the tax consequences are
resolved at the same time, i.e. that the premium amortization is fully allowable for tax
purposes from the viewpoint of the investor purchasing a bond.
Derivative contracts are recorded in the accounting system in compliance with the
IFRS requirements. In this respect, a relatively significant problem lies in the fact that
companies negotiating derivative contracts lack the appropriate information and
knowledge, as well as in the fact that the amount of disclosed information on such
contracts is insufficient. Hedge accounting has become more popular in the Czech
Republic lately. Primarily, such efforts are motivated by tax aspects, with the Income
Tax Act establishing that the costs of derivatives negotiated for the purpose of
hedging are fully allowable for tax purposes. Long debates in this field were evoked
by the fact that it was unclear whether the provision of the law concerned meant the
economic or the accounting concept of hedging. Thanks to that provision in particular,
companies introduced the application of the concept of hedge accounting. The future
of hedge accounting in the Czech Republic is connected to a great extent with the
possibility of a wide application of the fair-value option.
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ACKNOWLEDGEMENTS
This paper is one of the research outputs of the projects P403/11/0002 and
GA402/09/0225 registered in the Czech Science Foundation (GACR) and project
number POSDRU/89/1.5/S/59184 Performance and excellence in postdoctoral
research within the field of economic sciences in Romania, Babe-Bolyai University,
Cluj-Napoca being a partner within the project.
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*** www.cnb.cz (Czech National Bank website)
*** www.euribor-rates.eu (EURIBOR rates online)
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THE FINANCIAL INNOVATION

AND THE DYNAMIC CAPITAL MARKET
Flavia Mirela BARNA & Miruna Lucia NACHESCU1
West University of Timisoara, Romania
ABSTRACT
The financial innovation is not a new process. All instruments, techniques, services and
capital markets that exist now have been financial innovations at the moment when they came
into being. The amplitude of innovation and structural development was without precedent:
new financial instruments appeared, new negotiation markets came into being and new
regulations were issued, the rapid succession finding the necessary support in the bigbang; weve passed from regulated activity in the financial field to the deregulated activity
and then to the re-regulated activity while auto-regulations were always present.
The financial globalization generated the changing of the contemporary financial
environment, represented by the increased interdependence of the national financial spaces,
remarkable mobility of capital flows, concentration of financial activities in favorable areas
and the creation of important international financial centers, expansion of the financial
operations volume as well as the creation of new financial instruments. In the context of the
financial globalization, the speed of innovating in the financial field was highly increased.
KEYWORDS: financial innovation, risk, ETFs, financial derivatives

INTRODUCTION
The objective of this paper is presenting the financial innovation, both from the
theoretical and applied point of view. During the last decades, we have been witnesses
of the never before seen development of new financial instruments that justify the
description of the world economy, used by James Tobin the paper economy.
The amplitude of the innovation process and of the structural changes of the
developed financial markets is bigger than ever: new structures, new negotiation
markets, new techniques and financial instruments, new rules and regulations.
According to Jack Marshall, The financial engineering is not an instrument; it is a
profession that uses instruments. The derivative financial instruments came into
being from speculative reasons and from the normal desire of protection against the
commercial and financial risks. The increased volume of the international market and
of the derivative instruments lead to a continuous diversification of the instruments
and support assets.
Correspondence address: Miruna Lucia, Nachescu, West University of Timisoara,

Faculty of Economics and Business Administration; email: mnachescu@oxygencomputers.ro
~317~
1. THE COMPLEX PROCESS OF FINANCIAL INOVATION

Innovate is defined in Websters Collegiate Dictionary as to introduce as or as if
new, with the root of the word deriving from the Latin word novus or new.
Economists use the word innovation in an expansive fashion to describe shocks to
the economy (e.g., monetary policy innovations) as well as the responses to these
shocks (e.g., Euro deposits).
The innovations are sometimes divided into product or process innovation, with
product innovations exemplified by new derivative contracts, new corporate securities
or new forms of pooled investment products, and process improvements typified by
new means of distributing securities, processing transactions, or pricing transactions.
Financial innovation, process innovation as well as product innovation (representing
the diversification and modernization of the financial products already existing on the
capital markets) is vectors of the financial liberalization. The expected results of the
financial innovation usually regard the economic growth. Their efficiency can be
estimated in direct causal relation, by measuring the changes of those growth ratios.
Financial innovation is in fact a way of diversifying the investment possibilities for
the financial resources existing in the real economic world. In this context, financial
globalization can be regarded as a filter placed either before the results (when we have
an amplifying effect) or after them, making the efficiency judgments regarding the
financial innovation used very difficult (dilution effect).
The innovations in the financial field do not imply obligatory new products or
services, being also associated to the changes that are done to the existing products
and services, in order to make them more suitable to the demands of a continuously
changes of the market. As a consequence, the financial innovation is a continuous
process, the financial institutions being both interested and stimulated to improve their
products and services in order to fulfill the clients needs and increase their profits.
Merton (1992) invented the concept of spiral financial innovation to describe how
such new financial products satisfy the demand existing on a certain market,
generating new financial products and new markets where these financial products are
being sold and bought. The new financial instruments allow the new investors to
diversify their portfolios and to control the risk through an advanced management that
implies the use of derivatives financial instruments. Another innovation refers to the
coming into being of structured finance (complex financial instruments) that has
stimulated the growth of the capital markets. The new financial instruments allow the
investors to diversify the risk associated to investments. A significant innovation was
the transformation of illiquid actives, especially mortgage and consumption credits,
into liquid exchange securities that are being exchanged on the capital markets.
One sub-branch of the literature on financial innovation has created lists or
taxonomies of innovations. For example, Finnerty (1988, 1992, 2001) has created a
list of over 60 securities innovations, organized by broad type of instrument (debt,
preferred stock, convertible securities, and common equities) and by the function
served (reallocating risk, increasing liquidity, reducing agency costs, reducing
transactions costs, reducing taxes or circumventing regulatory constraints.)
~318~
The financial engineering represents the process of creating financial innovative

instruments with the purpose of solving certain financial problems. A new financial
instrument is truly innovative only if it helps the capital markets to function more
efficient, making them less incomplete. [***, Security Innovation in Corporate
Bond Markets, f.a:1].
The financial engineering came as a necessity, in the context of profound
transformation of the financial markets in the 60s [Eales, B., 2000: 1], determined by
the giving up of the fixed exchange rates, political instability, inflation, price
instability on the financial markets. The increasing incertitude made most of the
participants on the financial markets to look for protection through new financial
products. The concept of financial engineering started to be used after the model
Black-Scholes of evaluating the options price came into being, at the beginning of the
70s. The financial innovation can be seen mainly in the field of interests (especially
on short terms), in the currencies field and that of shares and bonds: from the classic
derivatives (options, futures), to the exotic options, futures rate agreements (FRA),
interest swaps, to the hybrid or synthetic products, but also in the case of the
securization process that fits the same category, as well as the investment funds in
monetary actives.
In the process of financial innovation, the institutional investors have a very important
role: they are the promoters of new financial products, that they need in order to
protect themselves against certain risks or to obtain the wanted results and they are the
first users of these new products. The brokerage on a large scale of holding financial
assets is welcomed now, when the sophistication of the financial products is bigger
each day, when information is so important, when looking after a certain portfolio
implies more and more time and energy and when the management of risks by using
modern methods implies advanced knowledge or the use of professionals.
2. THE CHALANGE OF THE FINANCIAL INOVATION
Being conscious of the dangers of globalization and those generated by the increased
usage of financial innovation, the national supervision authorities for the financial
markets, have included in their major concerns the updating of their national
regulations in the field but also the increasing of the international cooperation (at least
in the regulatory field).
By settlement (regulation) we mean the supervision and control exercised by the
government over the activities of private companies, having as objectives the
efficiency, correctitude and safety [Bannock, G.; Manser, W., 1990: 172]. Starting
from the observation that excessive settlement can act as an obstacle at entry on the
capital market and therefore reduces concurrence, the trend of de-regulation appeared,
more visible in the case of stock exchanges.
The process of deregulation means the elimination of controls imposed by the
government on the market operations (in general), taking into account that some of
them are not good for the economy [Bannock, G.; Manser, W., 1990:112]. The main
purpose of the deregulation of the capital market was to stimulate the concurrence in
the field and between intermediaries, in favor of the investors. Deregulation has been
a visible trend for some years now (since the 80s) in the economic and financial
~319~
policy of developed countries. It was determined by the internationalization of

markets generated an increased competition in the financial system and a bigger
fluidity on the capital markets.
Augusto de la Tore and Sergio L. Schmukler (2007: 120) have established a relation
between the stock market internationalization and the stock market liberalization.
They have shown that before the moment of stock market liberalization, the average
market capitalization of international firms/GDP was of 1.8%, after this moment, the
average increased to 7.7%.
The concept of de-regulation does not imply giving up rules and regulations (at least
not in totality). The capital markets stay regulated, being organized markets. A clear,
precise, complete and stable set of laws is a necessary premise to ensure the future
development of the capital markets. De-regulation has stimulated the financial
innovation, but sometimes, excessive rules were the starting point for creating new
financial products; in some cases, the battle between the financial intermediaries and
the regulating authorities of the financial markets lead to a process of re-regulating.
Important technological progress assisted the financial innovations in the process of
developing the capital markets. The development of the communication system
increased and made the speed of transmission of the financial information in the world
much higher. The lack of information was reduced and the geographical distances
became less significant for the investors. The technological innovation also influenced
the transaction methods, the online brokerage services, the real time payment systems
and many other systems and services.
All these innovations lead to the reduction of the transaction costs and to the
improved liquidity of the capital markets.
Augusto de la Tore and Sergio L. Schmukler (2007: 121) have also analyzed the
relation between stock market internationalization and reforms and have shown that
the market capitalization of international firms/GDP has increased after the
introduction of the electronic trading platform from an average of only 3.1% to an
average of 14.4%.
3. THE IMPACT OF FINANCIAL INOVATION ON THE DYNAMICS
OF MARKETS
The financial innovation made it possible for the investors to manage better their
portfolios in a very volatile environment. On the other hand, beside the obvious
advantages, the new financial products, the new financial markets brought with them
new risks for the investors and new challenges for the regulating and supervising
authorities.
At this moment, we consider that the main characteristic of the new financial
instruments is given by the fact that they allow the separation of characteristics and
risks and their combination in very new and diverse ways. This gives the investors
and the ones demanding loans the possibility to keep the wanted characteristics and to
give rid of the ones they do not want. Therefore it is possible to have a much
diversified lot of instruments that include all possible combinations of the
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characteristics: form (capital market versus banks), due time (short term versus long
term), interest rate (fixed versus floating), liquidity (there is or isnt a secondary
market for that particular element).
In this context, we can distinguish between what would be called innovation of
instruments and ex post innovation. In the first case, a new instrument is created with
a certain set of characteristics, while in the second case, the same effect can be
obtained through a technique that allows the characteristics of a certain active or
passive element to be changed after the event took place, not by exchanging the
instruments characteristics but by a sort of exchange of obligations. A simple
example is a swap operation where two parties exchange obligations of paying the
interests that were set at fixed or floating interest rates. In fact, this kind of operations
allows different users to use their comparative advantages on different markets and to
sell them to others.
3.1. The case of ETFs
Due to the financial innovation, the last few decades were characterized by an
increased number of financial instruments used on the capital market, the ETFs being
regarded as a revolutionary instrument that has an unexpected impact on the global
investment environment. The unprecedented dynamics of the international capital
markets lead to the increased competition between the financial instruments, adapted
to the different risk, investment or speculative management needs, the ETS gaining a
more and more important place in the preferred investment alternatives both of
institutional investors as well as individual investors.
Considered as the result of serendipity (Gary L.Gastineau, 2010: p.1), ETFs are a
special category of investment fund, structured in a similar way as the traditional
funds but listed and sold/bought on the market as usual shares. Richard Ferri defines
them as: baskets of titles bought and sold as individual shares through a brokerage
company on a certain exchange market (Richard Ferri, 2009: p. xvii). The hybrid form
of mutual funds, the ETFs, invest in a certain shares or bonds portfolio that imitate the
structure of an index or reference point, with the purpose of reproducing the
performance of that index or reference point.
The ETFs offer great flexibility and are well adapted to answer to the investors needs.
They have lots of applications in the chosen investment strategy. They can be used
with very good results in different models of assets allocation (Strategic Asset
Allocation, Tactical Asset Allocation, Dynamic Asset Allocation, Integrated Asset
Allocation, Constant-Weighting Asset Allocation, Insured Asset Allocation), in
sophisticated hedging strategies and cash-flow management strategies, being the
optimum solution for more fluid investments in times of portfolio transition
(transition management).
Between the frequently associated to ETF strategies we have those of the type coresatellite. The ETFs can be used as the core of the portfolio, following the best
diversification possible on different classes of assets and an expected profitability
close to the average market one. In the same time, concentrated investments can be
done, in a certain sector or country, creating a satellite independent portfolio, that
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involves smaller capital allocations than in the case of a core portfolio that has a
higher risk but also a superior profitability than the markets profitability.
The correlation between the profitability and risk of financial instruments, the
estimation of future trends, the costs and benefits associated to the holding of certain
assets but also the distinctive characteristics of each particular instrument are the
object of interest of all entities on the capital market.
A comparative analyze of the ETFs and main derivatives instruments that are the main
competitors (Futures on index, swaps on index and options on index) becomes
pertinent. The main differences between these regard explicit costs (commissions and
other taxes), implicit costs (harder to measure impact of the market, opportunity
costs, expected tracking error), liquidity, operational complexity (documenting,
supervision etc), the risk of counterparty but also the regulated constraints (limitation
of the exposure on certain assets). Also, in choosing the optimum instrument, we have
to take into account the transaction period, the strategy applied by the portfolio
manager as well as the conditions imposed by the client.
Even if they are competitors, the financial innovation phenomenon allowed the
diversification of financial products and gave birth to some very attractive and
complex combinations like the ETFs on futures or the futures on ETFs, having as a
result the harmonization of the used instruments characteristics.
Another rival product is the swap on index that, as the ETFs, is attractive for the
portfolio managers and the institutional investors as it offers the possibility of
diversifying the portfolios. The swap on indexes is a contractual financial agreement
that generates a transaction between two parts, where at least one of them is willing to
pay the other a rate of profitability based on stock exchange indexes, at a future
moment, until the end of the contract. The other part is going to make payments based
on a fix or variable interest applied on the same percentage of the capital value that is
at the basis of the swap. Similar to the ETFs and futures contracts, swaps are used in
strategies of asset allocation, their number increasing significantly between 20062008, from 475 billion $ to 1,475 trillions $ in 2008, before Lehman Brothers went
bankrupt. Unlike the ETFs, swaps (agreements between the parts implicated in the
transaction to exchange between themselves the financial advantages they have on
different markets) are not negotiated on a regulated stock exchange market, being
transactions between dealers. Beside the absence of a secondary market, another
disadvantage is the lack of a centralized discounting system, the obligation of a
thorough documentation and of an administrative support and implicates the
possibility of counterparty risk as there is no warranty that the parts are going to fulfill
their obligations.
Another instrument that offers exposure either on the entire market or on specific
segments through a single transaction is the option contract on indexes. This is a
standardized engagement that ensures the right of the buyer, but not the obligation, to
buy or sell a specified quantity of a support asset, at an established price, in exchange
of the payment of a bonus paid to the seller of the option through a compensation
house.
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Compared with the ETFs, the options on indexes have the advantage of investing in
the first place a small capital, limited to the bonus paid and also having an ex-ante
determined risk. The buyer cannot lose more than the price of the option or of the
bonus paid if the stock exchange index is not evolving accordingly to the expectation.
It has to be mentioned that the options on the indexes S&P 500 are among the most
popular ones, along with those on Dow Jones Industrial Average Index Options or
Nasdaq 100 Index Options.
The apparition of ETFs made it possible for combined products as the options on
ETFs to come into being. The differences between the options on indexes and those
on ETFs are numerous. The most important is that while the options on ETFs are
finalized with the delivery of ETF units, the options on indexes are liquidated through
compensation, namely through the payment in cash of the differences between the
price of the contract and the price of the support asset at due time. Also, by being of
America style, the options on ETFs can be exercised at any given moment before due
time, while the options on indexes (European style) can be exercised only at due time.
One of the reasons of an accelerated growth of the ETFs in respect to other
instruments refers to the fact that while the futures, swaps or options contracts are
classified as derivatives, the ETFs are instruments that are more secure (fully funded).
In a period where the cautions attitude of investors and the increased wish for
protection against risk dominate the market, the ETFs have gained an important place
especially among the middle size and conservative investors. Still, in the case of ETFs
the costs are known ex-ante while in the case of futures the spreads are not known
until the moment when they occur. The simplicity of ETFs transactions is not
comparable to the management of the margin or the documentation of the swap,
making the investors accept a higher cost for the ETFs.
Even if they are preferred many times over other investment alternatives, as in the
case of any other financial instrument, the investors in ETFs must take into account
also the potential risks. Beside the market risk, the counterparty risk and the liquidity
risk that we can find also in the case of other investment funds, the ETFs present a
specific risk as there are cases when their performance doesnt follow the
performance of the index. In this case, the difference between the performance of the
ETF and that of the index it follows is named tracking error.
According to a study performed by Morgan Stanley, the tracking-error associated to
the ETFs registered an important increase in 2009, factors as the markets volatility,
diversification demands, the optimization strategies and the capital fluctuations in the
companies with reduced capitalization contributed at the ETFs failure to reach the
performance of the benchmark. If in 2008 the tracking error associated to the ETFs
listed on the American markets was of only 0.52%, in 2009 it reached 1.25%. For
example, iShares MSCI Emerging Markets Index obtained in 2009 a profitability of
71.8% while the reference index registered 6.7% more, namely 78.5%. We must
accept that some funds of the American market, such as style ETFs, have registered
surprisingly performances, while the sector ones, on merchandise and with fixed
income are left behind in respect to the benchmark.
Even if holding ETFs is not risk free, the institutional investors, especially the
European ones where the retail sector is still developing, use these products more and
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more often as they can be a real solution for investments in the times of crises and
incertitude that we are going through. Despite the international investing environment
characterized by risk and incertitude, when investors become more and more selective
and pay more attention to their investment alternatives, to choosing those classes of
assets and investment strategies that could protect them, the use of ETFs became more
popular and the volume of transactions with ETFs increased. Even more, while the net
sales of the mutual funds have decreased as a result of the financial crises, the sales of
the ETFs have grown. So, we can consider that the financial crisis was more of an
opportunity than a threat for the ETFs ecosystem.
A closer look at the statistic data regarding the ETFs market comes to the support of
what weve said earlier. So, in 2008, the administrated assets of the ETFs listed in
Europe grown with up to 11% while in USA they decreased with 14.39%. Inevitable,
the question why this difference between the two markets? Beside the fact that USA
was the scene of the first signs of the crises, we can notice the volatility of the market
shown in the fluctuations of the market indexes, the S&P 500 registering for example
daily fluctuations of over 5%, 18 times in 2008 (this only happened 17 times in the
last 53 years). The decrease of assets held by the American ETFs becomes
explainable, while in the case of the European markets, where the instability was felt
only later through the contagion effect, they continued to grow.
Another reason is that in USA, the ETFs are mostly used by the individual investors
that in the context of a turbulent market have preferred to use bank deposits end to
avoid the exposure associated to ETFs. In Europe on the other hand, the ETFs market
is usually used by institutional investors that have withdrawn the investments in
certificates, swap contracts and other structured products and have directed these
resources towards ETFs, considering they were safer.
Even if the administrated assets of the European ETFs have increased, they represent
less than a third of the total administrated assets of the American market that classifies
at the first according to this criteria, with over 800 billion $. The USA market can be
characterized by a much higher homogeneity and liquidity than the European one
where we are faced with a certain degree of fragmenting even if we have a joint
regulatory frame (UCITS IV); also, in the USA, hedging funds are the main category
of ETFs users while in Europe users only recently started to use this kind of products,
being normally more interested in derivatives products of the over-the-counter market.
The biggest transaction volumes on the European market are those on the stock
exchanged of Germany and UK, but we have to say that many of the ETFs
transactions are done on the OTC market.
Back on the global level, the assets administrated by the ETFs have seen a fall of
10.74% in 2008, followed by a spectacular growth in 2009, from 711.1 billion of $ in
2008 to 1,036 billion $ in 2009 and to 1,239 billion $ in October 2010 (graph 1).
As to the numeric evolution of ETFs, the increasing trend was kept during the crises,
both in Europe and USA, as the graph below shows. We can notice that in 2008, the
number of funds existing on the market grew with 36.09% in respect to 2007, in
October 2010 the number of these being of 2409, with over 200% more than in 2007.
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Graph 1. The evolution of ETFs at global level in respect to the administrated assets
Active administrate (mld.$)
1400
1300
1200
1100
1000
900
800
700
600
500
400
300
200
100
0
Active adm. (mld.$)
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
0,8
1,1
2,3
5,3
8,2
17,6
39,6
74,3
104,8 141,6
212
2004
2005
2006
2007
2008
2009
2010
309,8 412,1 565,6 796,7 711,1 1.036 1.239
(Source: processed after Blackrock, Oct. 2010)
Looking back, it is interesting to mention that the annual compound ratio of growth of
the number of ETFs from the moment when they were introduced in 1993 and until
the end of 2007 was of 53% in comparison with the annual compound ratio of growth
of the number of mutual fund that reached only 4%.
Numar de ETF-uri
Graph 2. The numeric evolution of ETFs at global level
2600
2400
2200
2000
1800
1600
1400
1200
1000
800
600
400
200
0
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Numar
21
21
31
33
92
202
280
282
336
461
714 1.1721.595 1.9452.409
(Source: processed after BlackRock, Oct. 2010)
If we refer to the dynamics of the ETFs market on regions, we can reflect the
situation at the end of October 2010 in the table below. We can observe that Europe is
again ahead of USA, with a growth rate of the European ETFs bigger than that
registered in America. The constant growth of the European ETFs can be due to a
complex of factors that influence the decision of fund managers regarding the
localization of ETFs: the existence of specialized personnel in the field, the favorable
fiscal rules, the regulations and formalities regarding the new products. For example,
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as a consequence of the favorable fiscal regime, Ireland became an important player

on the European market, with a share market of over 28% of the European ETFs.
Also, we notice the numerical increase of ETFs in Asia-Pacific, where, even if the
ETFs industry is of only 188 such funds, the growth potential is extremely high,
almost one third of the Asian financial institutions using already ETFs in their
investment strategies. The statistic data reveals the fact that at the end of November
2010, the top of Asian ETFs (except Japan) in respect to the administrated assets is
dominated by iShares FTSE A50 China Index ETF, Tracker Fund of Hong Kong and
Hang Seng Index ETF, all of them being listed on the stock exchange of Hong Kong.
Graph 3. The numeric evolution of ETFs in the last year, on regions
1200
1000
Nr ETF-uri
800
600
400
200
0
2009
2010
Crestere
SUA
772
887
14,90%
Europa
832
1048
26%
Asia-Pacific
128
188
46,90%
(Source: processed after BlackRock, Oct. 2010)
The next graph reflects in a concise manner the analyzed market shares. In the rest of
the world category we have included Latin America with only 26 ETFs, Africa and
Middle East with 29 such funds.
Graph 4. The market share in respect to the number of ETFs
11,88%
7,80%
36,82%
SUA
Europa
Asia-Pacific
Restul lumii
43,50%
(Source: processing after BlackRock, Oct. 2010)
If we were to make a comparison in respect to the volume of net capitals invested in

the ETF, according to the statistic data for the first 10 months of 2010, the level for
USA was of 85.9 billions $, more than the double of investments in Europe. To what
concerns the net capital invested in Asian ETFs (except Japan) this was of 9.5 billion
$. In Japan, the investments in ETFs, registered for the same analysis horizon, were of
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5.5 billion $, the most important fund regarded from the administrated assets respect
being TOPIX ETF issued by Nomura Asset Management the main supplier of ETFs
on the Japanese market with a market share of 53.7 % at the end of November.
Graph 5. Net capital invested in ETFs during the first 10 months of 2010
(Source: processed after BlackRock, Nov.2010)
Continuing with the analyze of the ETFs market, we are going to present the most
used ETFs in the world, the first positions being held by ETF SPDR Trust Series 1
(symbol SPY), ETF Russell 1000 Index (symbol IWD) and ETF PowerShares QQQ
Trust Index (symbol QQQQ), as statistic data from the end of October 2010 showed.
Table 1. Most sold/bought ETFs at global level
ETF
SPDR S&P 500

iShares Russell 2000 Index Fund
PowerShares QQQ Trust
iShares MSCI Emg.Mkts.Ind. Fund
iShares MSCI Brazil Index Fund
iShares MSCI EAFE Index Fund
Financial Select Sector SPDR Fund
ProShares UltraShort S&P 500
iShares Barclays 20+ Yr. T Bond Fund
Energy Select Sector SPDR Fund
Average daily
transactional
volume (billions $)
20.513,7
3.726,1
3.287,9
2.084,1
1.193,3
1.005,4
969,8
891,0
858,4
759,0
Administrated
actives
(billions $)
78.243,9
13.185,5
22.249,5
44.906,1
10.512,5
35.123,5
5.255,8
3.433,4
2.987,9
6.583,3
(Source: processing after BlackRock, Oct. 2010)
The SPDR Trust Series 1 ETF (symbol SPY) follows the performance of the S&P 500
index that include American companies with high stock exchange capitalization, such
as Exxon, Procter &Gamble, Microsoft, JP Morgan etc. On the second place we can
find Russell 1000 Index ETF (symbol IWD) based on the Russell 3000 index that
measures the performance of the top 3000 companies of USA from the stock
exchange capitalization point of view. The index is updated annually in respect to the
free-float and the companies must fulfill certain criteria in order to be kept or to be
included in the index. Among these companies we can find Procter &Gamble, JP
Morgan, Johnson &Johnson etc. Then, we have PowerShares QQQ Trust Index ETF
(symbol QQQQ) that regards the Nasdaq 100 index with the biggest and most present
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on the market 100 non-financial companies listed on Nasdaq Stock Market. This
offers the possibility of long term investments in companies of the technology
industry such as Apple, Microsoft, Google, Cisco, Oracle etc.
The presented aspects allow us to say that the ETFs represent one of the most
important financial innovations of the last decades, given their spreading and the
investors interest in selecting the ETFs as priority investment alternative. The simple
way of diversifying the portfolio and of dividing risks as well as the harmonizing the
aspects regarding profitability and risk are added to the main reason for which
investors prefer ETFs, namely that they combine the advantages of a mutual fund with
those of a share.
3.2. The case of the financial derivatives
Derivatives in general, came into being as a reaction to the existing risk, but their use
can be risky in some cases. They represent one of the most invocated examples of
what financial innovation means, as an answer to the market needs.
Through the protection they offer against risks, the types of derivative products are
very diversified. The financial risks regard mainly the risk of exchange rate and that
of the interest rate, have made the object of interest starting from the 70s (passing
from the fixed rate to the floating system) and mainly after the 80s (inflation, dollars
instability, high increase of the interest rate), and also the risk of the exchange
security variation (named the market risk or risk of financial assets quotation).
The global derivatives market is a main pillar of the international financial system and
economy. As an indispensable tool for risk management and investment purposes,
derivatives are used by more than 94 percent of the worlds largest companies. They
contribute to improving operational, information, price, valuation and allocation
efficiency, thus substantially increasing the efficiency of financial and commodity
markets. Derivatives help lower the cost of capital and enable firms to effectively
invest and channel their resources. These factors are an important driver of economic
growth.14) Europe as the most important region in the global derivatives market
stands to benefit immensely from the positive impact of derivatives.
The derivatives market can be dividend in two parts: Exchange Traded Derivatives
(ETD) and OTC Derivatives (OTCD), interdependent components of a single global
risk transfer mechanism. The increased risk associated with the OTCD market along
with the growth in the last one (see the graph) represents one of the crises
determinants. Additional details are essential to understanding ETD and OTCD: (i)
Notional or face value of the underlying transactions only tell part of the story and
imply excessive levels of leverage and risk in OTCD markets. (ii) OTCDs and ETDs
are a subset of a broader mechanism to transfer risk among a diverse spectrum of
participants and for a wide array of needs. (iii) By other measures such as notional
turnover the ETD market is occasionally the larger sibling of the two.
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Figure 1. Mainstream View of Global Financial Markets
(Source: Rowady, P., 2010)
On the OTC market, as we have already shown, more and more complex derivatives
are used. In the next example we try to show the classification of such complex
derivatives at the end of the first semester of 2010.
Figure 2. The most usual derivatives products of the global OTC market
(Source: Triennial and semiannual surveys, Positions in global over the counter (OTC)
derivatives markets at end-June 2010, 2010:8)
In contrast to the decline in notional amounts outstanding of OTC contracts, gross

market values for existing OTC contracts rose by 15% to 25 trillion $ at end-June on
the back of sharp asset price movements. Gross credit exposures, after netting
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agreements, which had dropped slightly in the half-year up to end - 2009 (6%)
increased by 2% to 3.6 trillion $. Overall, nominal growth in amounts outstanding was
subdued or negative in all risk categories, with a 7% drop in credit derivatives leading
in percentage terms.
We can easily notice that the most used instruments on this market are the derivatives
on interest rates. The second place is held by the Credit Default Swaps, these being
the most used category of derivatives on the OTC market and not only. In our opinion,
the degree of information and education regarding the derivatives financial
instruments used influences the degree of exposure to the associated risks.
Figure 3. The structure of derivatives products on the global OTC market
(Source: Triennial and semiannual surveys, Positions in global over the counter (OTC)
derivatives markets at end-June 2010, 2010:9)
Notional amounts outstanding of OTC interest rate derivatives remained stable at 452
trillion $ in the first half of 2010, after increasing by 3% in the previous six months.
Positions between reporting dealer fell by 5%, while business with non-financial
customers grew by 6%, mainly in short maturities. Market values were buoyant, rising
by 25% in aggregate in the half-year up to June 2010, with the value of contracts on
US dollar interest rates increasing by 42%.
Notional amounts outstanding of credit default swaps declined for the fifth
consecutive period, largely due to terminations of existing contracts. The structure of
the market continued to change. Positions in the generally more liquid multi-name
contracts increased by 10%, while those in single-name contracts continued to
decline, with a decrease of 16%. Gross market values for single-name contracts
dropped by 20%, while those for multi-name contracts increased by 21%.
In our opinion, the credit default swap contracts market, estimated at 55 trillions $,
but unregulated and lacking transparence, could generate the next crises of the
financial system. While the fear of a new crises on the credit default swap contracts
market is accentuated in the financial system, the apparently imminent intervention of
the authorities (in order to regulate these contracts and make them more transparent)
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seams to intensify the pessimism of the markets, as the immediate effects of certain
measures cannot be predicted.
As they are contracts and not titles or insurance policies, the credit default swap
contracts can be closed very quickly, a simple phone call or message being enough.
This is one of the reasons that make them so interesting. The majority of technical
aspects were standardized by the International Association for Derivatives and Swap
Contracts.
In addition, as long as there is a seller ready to answer to the wishes of a creditor (to
transfer risks), a credit default swap can cover almost any transaction. So, after almost
a decade of exponential growth, the market of credit default swaps is close to the first
major decline, due also to the contemporary financial crises, liquid assets being scarce
on the capital market.
In particular, special purpose vehicles (SPVs) and hedge funds are singled out for the
first time. In the past, this breakdown had been used only by a subset of reporters in
the past, so that data for these sub-categories in June 2010 are not directly comparable
with those of previous periods. In the current period, CDS contracts with hedge funds
and SPVs account for about 5% and 4% respectively of total notional amounts
outstanding with other financial institutions.
In this context, a product created as a hedging instrument became a possibility for the
investors that want to bet on almost any transaction on the credit market. The hedging
funds have invaded the credit market, in search of rapid profits.
The financial crisis has brought to light several deficiencies in the derivatives market
specifically in those segments lacking standardization and centralized clearing.
Consequently, the once strong market growth coupled with blind spots in regulation
and supervision have given way to a substantial build-up of systemic risk, in the OTC
segment.
Deficiencies of the market include:
Excessive build-up of bilateral exposures and insufficient collateralization,
resulting in a dramatic increase in counterparty risks;
Insufficient risk valuation and risk management capabilities;
Interconnectedness and complexity;
Lack of transparency in selected areas of the market, hindering market
participants and supervisors from recognizing existing risks;
Operational inefficiencies and limited legal certainty.
A substantial share of derivatives trading activity is concentrated in the hands of a few
international banks (so-called broker-dealers). Accordingly, their exposures from
derivatives are high. For example, the four largest US derivatives players hold
derivatives positions resulting in credit exposures of more than 900 billion, an
amount more than twice their equity capital.
As revealed by the current crisis, OTC derivatives markets have yet another
fundamental weakness: they lack sufficient capabilities for comprehensive risk
assessment and management. For complex derivatives, the problem is twofold. First,
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many market participants lack the ability to adequately price and value derivatives
and, in some cases, independent valuations by a third party are not available to
support them. Second, after having exposed themselves to risks, many do not have
sufficient capabilities to monitor and mitigate these risks effectively.
During the last decades we have experienced the rapid development and
sophistication of the financial systems leading to diversified and complex financial
activities and instruments. In this process, the evolution of the financial sector plays a
more and more important role in the appearance and amplification of the
macroeconomic fluctuations. The negative effects of this financial instability
underline the necessity of adopting measurements in the prudential regulation field, in
accounting, in risk measurement, in monetary policy etc, for fortifying the financial
system and ensuring the macroeconomic stability.
The amplitude of the derivatives markets and of certain new financial instruments is
due to the volatility of the global financial environment but also, they are a factor of
instability due to the advantage they offer to the speculators.
The aspects presented in the present paper allow us to say that the financial innovation
contributed and still contributes to the increasing financial integration, the new
products being created in such a way as not to depend on borders or geographic zones.
Still, these financial innovations can become a brake for the deregulation process, as
the emergence of new micro and macroeconomic risks makes it important to establish
new prudential regulations.
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***, Security Innovation in Corporate Bond Markets, University of Toronto
*** The Global Derivatives Market. An Introduction (2008)
*** Triennial Central Bank Survey BIS (2010) Foreign Exchange and derivatives
market activity in 2010
~333~
A SELECTION FUZZY MODEL INVOLVING ASSETS

AND PROJECTS
Adrian Victor BDESCU1,
Radu Nicolae CRISTEA & Dana-Maria BOLDEANU
ABSTRACT
The last decade has brought on an increase and dynamic diversification of the investments,
most of them focused on traditional securities, with an alert orientation towards alternative
means of investment, like private shares, private debt and real estate investments. By
diversifying various types of assets, the overall risk of the portfolio can be reduced, while the
medium and long term potential benefits may increase. If we consider the transaction costs as
being proportional, we shall use the expected net return and standard deviation as objective
functions. We propose a bi-objective programming model for solving the mixed assets
portfolio selection problem within developed research, by resorting to a series of remarkable
results of the fuzzy theory.
KEYWORDS: Fuzzy model, securities portfolio, expected net return, investment decision
INTRODUCTION
The fuzzy approaches are used frequently for describing and treating uncertain and
imprecise elements from a decision problem. Similarly, fuzzy theory facilitates the
uncertainty analysis of systems in which it is caused by elements of unclear origin,
rather than its random nature, and may be applied in order to mathematically quantify
imprecise observation values, linguistically data or verbal decisions. The group
membership function, a central model of any fuzzy model, is thought as being the
strongest landmark of fuzzy set theory (Munda et al., 1992). In practical applications
concerning set theory, the construction of membership functions is usually
accomplished thru iterations (McNeil and Freiberger, 1994), (Bardossy and
Duckstein, 1995), (Klir and Yuan, 1996).
Together with fuzzy theory and probability analysis, the existing approach methods
for uncertainty and imprecision also include another version, based on using interval
mathematics. In many cases, using intervals for expressing the variation of certain
coefficients may serve the purpose of research to a greater extent. (Alefeld and Mayer,
1996)
It has been frequently suggested that the origin of modern mathematical models in
finances resides in Louis Bacheliers dissertation over speculation theory. However
true that may be, there is no doubt that Markowitzs research regarding portfolio
1
Correspondence address: Adrian Victor BDESCU, Bucharest Academy of Economic Studies,

Romania; email: badescuadi@gmail.com
~334~
selection had the strongest impact over modern financial mathematics. Hence,
Markowitzs theory over portfolio management analyses individual agents of the
financial markets. This theory combines concepts of probability theory and
optimizations in order to model the agents behaviour during various times of
evolution in economy. The theory assumes that agents are searching for a balance
between maximizing income and minimizing investment risks. Income is calculated
with medium efficiency, and the risk is a variance of the assets that form the portfolio.
Such mathematical representations of income and risk have allowed the
implementation of optimization techniques in studies concerning portfolio
management. The two objectives of the investors maximizing profits and
minimizing risks are oriented so that they maximize the incomes expected value
and minimize the variance of the portfolios value. The solution will hence be a
function of the risk level to the resulted income. Although recent models present new
and varied perspectives of the mathematical definitions of risk and economic agents
income (investors, in this case), the relationship between income and risk has always
been one of the problems that the financial theories have tried to resolve.
Although the fact that the analysis of the problems described by the portfolio
selection, related to the model efficiency mean-variance can be resolved in a
polynomial time interval, historically speaking, many efforts have been made in order
to reduce the effective computation time. Sharpes model (1963) represents one of the
main successes in this field. The model reduces the estimation of the number of the
variance-covariance coefficients to a much smaller total value. Considering the
hypothesis according to which investors decisions are influenced only by the income
risk (which is smaller than the income mean), the Mean-Semivariance (M-S) method
was suggested, in order to develop the model known today as Markowitz-MaoSwalm. In this case, the definition of semivariance is the expected value of the square
of the deviation from the mean or, more generally speaking, the value selected as
critical by the decision taker.
In order to solve the problem of large-size portfolio optimization models, Konno and
Yamazaki (Konno and Yamazaki, 1991) have analysed the efficiency mean-absolute
deviation type approach for investment risk measurement. Using the data supplied
by the Tokyo stock market, Konno and Yamazaki have compared the performance
resulted from the efficiency mean-variance model, with respect to the efficiency
mean-absolute deviation model, and discovered that the efficiency levels of the two
were extremely close. Feinstein and Thapa (Feinstein and Thapa, 1993) have
rephrased the above-mentioned model, equivalent to the one developed by Konno
(Konno et al., 1993) and that simultaneously halves the restrictions on the number of
non-zero assets of the optimal portfolio. Also, while Konno demonstrated that the
efficiency mean-absolute deviation does not need a covariance matrix, Simaan
(Simaan, 1997) discovers that this should lead to a much higher estimated risk and
exceed the benefits.
1. THE BI-OBJECTIVE MODEL FOR MIXED ASSETS PORTFOLIO
SELECTION
In order to illustrate our method, we assume that an investor assigns his wealth in
projects and traditional assets. Therefore, regarding the mixed assets portfolio
selection, the available assets for investments are divided in two types. The first class
~335~
of assets resides in traditional titles. The second resides in projects. The main
difference between the two types of investments is that decisional variables for
projects are binary, while the ones for securities are continuous. There is an available
budget for each project, and the budgets can be quantified by investors or experts. We
assume that the total cost of a project is the same as the budget needed to start the
project. Also, the project investments cannot be reallocated in any moment of time,
unlike title investments.
We consider the structure of securities from the mixed assets as having n risky titles
S i , i = 1 , 2 ,..., n , that offer random earning rates, as well as m projects, P j , j = 1, 2,..., m . We
assume that the investor starts with a portfolio that includes only securities titles, and
then decides to rebuild the new mixed securities portfolio, including titles and
projects.
To formalize the problem we introduce the following notations:
~
ri : random variable, which represents rate of return on securities without transactional
costs S i , i = 1, 2 ,..., n , ;
ri : expected net return for securities without transactional costs S i , i = 1, 2 ,..., n , ;
~
R j : random variable representing random net earnings of a project P j , j = 1,2,..., m ;
Rj :
project expected net return after cost deduction
P j , j = 1,2,..., m ;
M: total value of securities owned by an investor;

X i : total value of investment on risky securities S i , i = 1, 2 ,..., n ,
x i : rate of total investment in risky assets S i , i = 1, 2 ,..., n ,
X i0 : total value of risky securities investment from the existing portfolio S i , i = 1, 2 ,..., n , ;
x i0 : rate of total value of risky securities investment in existing portfolio S i , i = 1, 2 ,..., n , ;
k i : rate of transactional costs for risky securities S i , i = 1, 2 ,..., n , and non risky asset Sn+1;
zj :
binary variable which indicates if the project is a selected asset or not

z
P j , j = 1,2,..., m
1, if Pj project is selected for investments

j=
0, if not
We assume that the vector of random variables
~
~
~
~
~ ~
r 1 , r 2 ,..., r n , R 1 , R 2 ,..., R m
is distributed
on a given space {(r1t ,..., rnt , R1t ,..., R mt ), t = 1, 2 ,..., T } with known probabilities:
~
~
~
~
~ ~
p t = Pr r 1 , r 2 ,..., r n , R 1 , R 2 ,..., R m = (r1t ,..., rnt , R1t ,..., R mt ), t = 1, 2,..., T
Then, expected net return
ri
of risky securities
S i , i = 1, 2 ,..., n ,
is given by the relation: ri = pt rit , i = 1,2,..., n, where
rit
without transactional costs
can be predicted. Expected net
t =1
return
Rj
of
P j , j = 1,2,..., m
project, is given by: R j = pt R jt , j = 1,2,...., m , where
R jt
can
t =1
be generated through predicted data.

Having a securities mixed portfolio (x1 , x 2 ,..., x n , z1 , z 2 ,..., z m ) , the expected return of the
portfolio without transactional costs can be expressed by:
~336~
n +1
n +1 T
i =1
j =1
i =1 t =1
j =1 t =1
ri X i + R j z j = pt rit X i + pt R jt z j
where
X i = Mx i , i = 1, 2,..., n + 1
rn +1,t = rn +1 , t = 1, 2 ,..., T
We are using a V form function for expressing transactional costs. The transactional
costs of securities S i , i = 1,2,..., n, n + 1 will be given the relation: C i ( X i ) = k i X i X i0 .
Consequently, total transaction costs of mixed securities portfolio are expressed as
such:
n +1
n +1
C i (X i ) =
i =1
i =1
X i X i0
Considering x = (x 1 ,..., x n + 1 ), z = (z 1 ,..., z m ) and X = ( X 1 ,..., X n + 1 ) , then the net expected return
of the mixed securities portfolio after the payment of transactional costs is given by
the relation:
n +1
n +1
j =1
i =1
f ( X , z ) = ri X i + R j z j Ci ( X i ) =
i =1
n +1 T
n +1
i =1 t =1
j =1 t =1
= pt rit X i + pt R jt z j k i X i X i0
If
we
i =1
consider
the
following
notations
for
x1 ,..., x n , x10 ,..., x n0 , x n0+1
0
0
0
X 1 ,..., X n , X n +1 , X 1 ,..., X n , X n +1 , then the net expected return of the mixed securities
portfolio after the payment of transactional costs is given by:
n +1 T
i =1 t =1
j =1 t =1
n +1
f ( x, z ) = pt rit xi M + pt R jt z j k i M xi xi0
i =1
Maximizing the expected net return f (x , z ) of the mixed securities portfolio with
respect to the payment of transactional costs can be considered a prime objective of
the selection problem of this portfolio.
In selecting the traditional titles portfolio, Markowitz used variance to measure the
portfolio risk, the first risk quantity measure. Since then, different risk assessment
methods have been suggested within specialized literature concerning financial
portfolio selection [3]. These methods include semivariance, absolute deviation, semiabsolute deviation and so on. Considering that the semi-absolute deviation is more
appropriate for portfolio risk measurement, we shall use the semi-absolute deviation
function in the mixed title portfolio selection model.
The semi-absolute deviation of a mixed title portfolio return of states
be represented by:
m
Wt ( X , z ) =
p (r
i
ti
zj
ri )2 X i +
i =1
~337~
(R
tj
j =1
Rj
)2 pi
t = 1, 2 ,..., T
can
In this approach, we can use the function w (x , z ) to measure the portfolio risk.
Minimizing the mixed title portfolio risk can be considered as the second objective of
the selection problem for the mixed title portfolio.
When it comes to the mixed securities portfolio (which includes titles and projects), a
number of restrictions must be taken into consideration.
We introduce the following notations:
B j : the projects capital budget P j , j = 1,2,..., m , for instance, the cost paid by the investor
once the project is chosen and started;
B : the maximum invested sum assigned to the project components out of the mixed
securities portfolio;
Y j : total investment value for the P j project for instance Y j = B j z j , j = 1,2,...,m
S:
the investments maximum value for components of the titles which form the
mixed securities portfolio.
With the following restrictions:
Budgetary restriction of the project component:
m
j =1
j =1
Y j = B j z j B
Budgetary restriction of the title component:

n +1
x M
i =1
Budgetary restriction of the capital:

n +1
j =1
n +1
Y + x M = B
i =1
j =1
z j + xi M M
i =1
Non-zero restriction:
x i 0 , i = 1, 2 ,..., n + 1
By implementing these restrictions, the bi-objective problem (BOP) of the mixed

securities portfolio selection can be expressed as:
Figure 1. Expression of the bi-objective problem (BOP) for mixed securities portfolio
n +1
max f ( x , z ) =
p t rit x i M +
i =1 t =1
n +1
pt R
jt
j =1 t =1
k
i =1
min w ( x , z ) =
z
p i (rti ri )2 X
i =1
j =1
n +1
xM
i =1
m
j =1
n +1
Bjz
xM
i
i =1
x i 0 , i = 1, 2 ,..., n + 1
z
= {0 ,1}, j = 1, 2 ,..., m .
~338~
iM
(R
tj
j =1
)2 p i
x i x i0
2. FUZZY MIXED SECURITIES PORTFOLIO SELECTION MODEL

We are going to describe the management method for the decision takers
expectations, by highlighting the interpretation of his rational behaviours (Albrecht,
2003; Bdescu et al, 2005). Thus, because investments are generally influenced by
changes in social and economical factors, an approach towards optimization is not
always the best solution. In many cases, a satisfactory approach from the investors
perspective is preferred, rather than an approach towards optimization. An investor
always has different levels of aspiration for the anticipated profit and risk. In the real
world of financial management, the experts knowledge and expertise are very
important with taking decisions.
Relying on the experts knowledge, an investor can decide his level of aspiration for
the portfolios anticipated profit and risk. Watada (2001) proposed a logistic function,
a sigmoid membership function, for expressing the levels of aspiration of an
individual, concerning the anticipated profit and risk. The sigmoid membership
1
function is f ( x ) =
1 + exp( x ) .
We consider that it is more appropriate to use the logistic function in order to reveal a
vague/fuzzy level of the objective which an investor can consider (Bellman et al.,
1970; Konno et al., 1993). According to the maximization principle and using the
variance to measure the portfolio risk, Watada (2001) proposed a fuzzy portfolio
selection model which extends Markowitzs Mean-variance model for the fuzzy case.
Regarding the suggested portfolio rebalancing model, the two objectives are taken
into consideration (profit and risk), as well as the limitations of the portfolios
liquidity. Since the anticipated profile, risk and liquidity are vague and uncertain, we
use the sigmoid membership function introduced by Watada (2001) to express the
aspiration level of the anticipated profile, risk and portfolio liquidity. Using the risk
function of the semi-absolute deviation to measure the portfolio risk, we suggest a
rebalancing model for the fuzzy portfolio, which is based on the Bellman-Zadeh
maximization principle (Bellman et al., 1970).
The membership functions for the objective for anticipated profile, risk and liquidities
are given as follows:
a) The membership function for the objective the portfolios anticipated profit:
r ( x) =
1
1 + exp( r ( E ( r ( x )) rM ))
where rM is the inflexion point where the membership function takes the value 0.5 and
r can be given by the investor, according to its own degrees of satisfaction for the
anticipated profile. rM represents the central aspiration level for the anticipated profile
returned by the portfolio. Figure 2 shows the membership function for the established
profit objective.
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Figure 2. The membership function for the established portfolios anticipated profit
b) The membership function of the objective the portfolios risk:

w ( x) =
1
1 + exp( w ( w ( x ) w M ))
where w M is the inflexion point where the membership function takes the value 0.5
and r can be given by the investor, according to its own degrees of satisfaction for
the anticipated profile. rM represents the central aspiration level for the anticipated
profile returned by the portfolio. Figure 3 shows the membership function for the
established risk objective.
Figure 3. The membership function for the established risk portfolio
c) The membership function of the objective the portfolios liquidities:

1
l ( x) =
1 + exp( ( E (l( x)) l ))
l
where l M is the inflexion point where the membership function takes the value 0.5 and
r can be given by the investor, according to its own degrees of satisfaction for the
anticipated profile. rM represents the central aspiration level for the anticipated profile
returned by the portfolio. Figure 4 shows the membership function for the established
liquidity objective.
~340~
Figure 4. The membership function for the established liquidity objective
Observation 1:
and
respectively, w ( x , z ) ,where
f
and
w ,
determine the shape of the functions family

f >0
and
w > 0 .
f ( x, z)
and,
The greater the value of the parameters
the lower the vague dimension.
According to the priciple of Bellman and Zadeh (Bellman et al., 1970), we can define
the following expression:
= min { f ( x , z ), w ( x , z ) }
.
The fuzzy mixed securities portfolio selection problem can be defined as:
max
f ( x, z )
w (x, z )
and all (PBO) restrictions.

Considering = log
1
1
, then =
1
.
1 + exp ( )
The logistic function is monotonic and increasing, so maximizing leads to

maximizing . So, this problem can be transformed into an equivalent one, as follows:
max
f ( f ( x, z) f M ) 0
w (w(x, z ) M ) + 0
Figure 5. Expression of the linear programming problem (PPL)

and all (PBO) restrictions, where
and
are the parameters that can be given by the
investor, based on his level of satisfaction regarding the expected return and risk.
Note that (PPL) is a classical linear programming problem, and can be solved using
one of the linear programming algorithms, for instance the simplex method.
~341~
Also, the family of S-shaped nonlinear functions of the two factors can modify its
shape with respect to the parameters f and w . By selecting the values of these
parameters, the aspiration levels of the two factors can be precisely described. On the
other hand, different parameter values can reflect different levels of aspiration of the
investors. As follows, it is convenient for them to elaborate investment strategies by
using the suggested model for the mixed assets portfolio selection.
2. INVESTMENT DECISION ON A ASSETS PORTFOLIO BASED
ON A FUZZY ALTERNATIVE
In order to illustrate this sections suggested approach, lets consider the case of an
investor who analyses the possibility of reconstructing a portfolio made out of shares
from four assets Microsoft, Google, Apple, Yahoo:
Table 1. Initial Portfolio assets
MICROSOFT
GOOGLE
APPLE
YAHOO
20%
40%
30%
10%
The reconstruction process requires the decision taker to consider introducing

securities in his shares package.
The utilized data have been observed during October 2009 September 2010 and
registered with weekly frequency. The data was extracted using Google Finance and
processed thru a set of procedures which imply: determining the rates of return,
eliminating the aberrant values within risk formation, regrouping the data in four
week modules (which describe a period) and estimating the accomplishment
probability of the respective rates of return.
We assume that the total worth of the actives M owned by the investor is of 350.000$.
Until now, the investor had bought only risk-free assets (bonds) but, because they
have a smaller return than risk assets, the investor wants to increase the value of the
portfolios dividends. So, in order to reach its objective, the investor reallocates the
available funds between the four risk assets and two projects.
The rates of return for the four risky assets and their accomplishment probabilities are
given in the following table:
Table 2. Rates of return and probabilities for the risky assets
0.36
MICROSOFT
(M)
0.000305779
GOOGLE
(G)
0.0296
APPLE
(A)
0.08938
YAHOO
(Y)
0.005416
0.28
0.026493352
0.00285
0.02558
0.03937
0.22
0.008808809
0.002234
0.01394
0.03433
0.14
0.069485842
0.03369
0.031953
0.04019
PROBABILITY
We assume that the maximum value of the investment S assigned to the actions is of
260.000$, and the maximum value B assigned to immovable projects is of 90.000$.
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We already have the values of f M and w M to 0.04 and, respectively, 0.375. The
possible values for the two projects are listed in the next table by their budgets:
Table 3. Budgets and probabilities for 2 projects
PROBABILITY
P1
P2
0.36
50000$
30000$
0.28
45000$
35000$
0.22
25000$
32000$
0.14
5000$
12000$
For the data in the above tables, we have calculated the risk matrix (as standard
deviation):
Table 4. Risk matrix for assets and projects
MICROSOFT
0.008875
0.022008
0.00295
0.031648
GOOGLE
0.013423
0.002317
0.002343
0.015311
APPLE
0.037774
0.027516
0.01893
0.002069
YAHOO
0.010102
0.032607
0.026541
0.023363
P1
7920
4339.032
5534.691
11898.47
P2
408
3005.573
1257.031
6480.551
Also, using Excel 2010 processor, we have estimated the rates of return on the assets,
and obtained the following values:
Table 5. Rates of return on assets and projects
MICROSOFT
GOOGLE
0.015098
0.007229
APPLE
YAHOO
0.026423
0.022253
P1
P2
0.105143
0.083771
Because the projects are expressed in absolute values and not return rates, the values
needed to be normalized by dividing thru M.
Using data resulted before we have determined satisfactory investments strategies
solving the optimisation problem, which has the following format:
max
f(
n +1 T
t it i
i =1 t =1
j =1
jt z j
j =1 t =1
k M x
i
xi0 f M ) 0
i =1
p (r
i
ti
zj
ri )2 X i +
(Rtj R j )2 pi
j =1
n +1
B j z j B;
i =1
n +1
xi M S ;
i =1
n +1
p r x M + p R
j =1
Bjz j +
x M M
x i 0, i = 1,2,..., n; z j = {0,1}, j = 1,2,..., m.
~343~
i =1
+ 0
We used a fuzzy alternative both to avoid solving a bi-objective model and mostly to
highlight the decision takers expected satisfaction. In other words, because a
nonlinear membership function may change its shape according to the parameter
values, the function could better reflect the investors logic and expectations from this
portfolio.
Figure 6. Nonlinear membership function of the portfolio
Table 6. Rate of return and involved risk on the selected portfolio
30
37
52.5
600
500
400
800
1000
1200
PORTFOLIO RATE
OF RETURN
0.09
0.115
0.215
INVOLVED
RISK
0.00000002
0.00000001
0.000000014
We consider that the first alternative is preferred by the investor, because it generates
the highest degree of satisfaction after mathematically illustrating its logic regarding
the investment decision. So, in order to find the portfolio structure in this case, we
elaborate the following function with the aid of Wolfram Mathematica software:
Figure 7. Mathematical expression of the portfolio structure
We obtain the following optimal portfolio structure for maximizing the decision
takers satisfaction:
Table 7. Optimal portfolio structure
MICROSOFT
(M)
7%
GOOGLE
(G)
34%
APPLE
(A)
37%
YAHOO
(Y)
22%
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P1
P2
Yes
No
CONCLUSIONS
We can conclude by showing that, in todays extremely dynamic and unpredictable
business environment, the decision takers invest in various categories of assets in
order to maintain a competitive advantage. Certain securities and projects may be
integrated a mixed assets portfolio. Thus, the mixed assets portfolio amplifies the
investors opportunities. Regarding the expected efficiency and risk, the two objective
functions have been implemented as a bi-objective programming model than can
reflect the investors hopes and expectation once the mixed assets portfolio has been
determined, by means of a selection problem with transactional costs.
Moreover, the investors vaguely expressed expectations regarding the efficiency and
risk levels are considered to be fuzzy numbers in order to be formally illustrated in a
way that allows them to determine the optimal portfolio structure, by means of
specialized algorithms. The experimental results show that the suggested model can
successfully generate a portfolio strategy, depending on the degree of satisfaction
expected by the investor.
ACKNOWLEDGEMENT
This work was supported by CNCSIS UEFISCSU, project number PNII IDEI
_1805/2008.
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~346~
THE ROLE OF FINANCIAL DESCRIPTORS

IN THE OPTIMAL PORTFOLIO SELECTION
Bogdan DIMA1, Flavia BARNA & Horatiu REGEP
ABSTRACT
The central point of this paper is the selection of an optimal portfolio of financial instruments
based on financial descriptors. In the first phase has been proposed and tested a statistical
model aimed at the connections between the financial statements descriptors of issuers and
the market values return of stocks issued by them. Thus, we identified those descriptors which
in the period under review (2006-2009), had a direct impact on the dynamics of stock prices
traded on the capital market in Europe. In the second stage it was used a selection model of a
set of optimal portfolios based on those financial descriptors considered relevant. The main
results support the idea that we can have a set of optimal portfolios that generate returns
expected by investors by using exclusively financial descriptors.
KEYWORDS: financial descriptors, optimal portfolio, selection criteria, market values

return.
INTRODUCTION
The complexity of the investment process derives from the size and market liquidity,
investor attitudes towards risk, the complexity of endogenous and exogenous factors
analyzed by each investor at the moment of the elaboration of the strategy of portfolio
selection.
The identification of the opportunities to invest, the choice of an economic sector, the
evaluation of the financial descriptors of issuers and their role in the random evolution
of the financial instruments are aspects that need to be considered by any investor.
One of the most difficult aspects of investing in the stock market is selecting the best
performing stocks. The success of quantitative strategies stock selection is well
documented in developed markets.
For example, whereas Claessens, Dasgupta and Glen (1998) find the premium for
large companies and growth stocks, Fama and French (1998), Patel (1998) and
Rouwenhorst (1999) report a premium for value stocks and small companies.
Claessens et al. (1998) also document the premium for beta and turnover.
This article has as main objective the analysis of the connections between the
descriptors of the financial statements of issuers and the market values return of
stocks issued by them. In this context, we propose to identify the financial indicators
1
Correspondence address: Bogdan DIMA, The Faculty of Economics and Business Administration,
West University of Timisoara, Romania; email: bogdan.dima@feaa.uvt.ro
~347~
which in a reference time span between 2006 and 2009 had a direct impact on the
dynamics of stock prices traded on the capital market in Europe as well as to use such
base for the selection of an optimal set of portfolios.
1. MODEL USED TO IDENTIFY AND ANALYZE THE CONNECTIONS
BETWEEN FINANCIAL DESCRIPTORS RETURN OF FINANCIAL
INSTRUMENTS IN ORDER TO SELECT AN OPTIMAL PORTFOLIO
A first step in initiating an analytical approach aiming at the impact of financial
descriptors on the market values return of financial instruments traded on developed
European capital markets is to identify a formal model that highlights these
interconnections:
returnit = xit + t + i + it (1)
x vector of explanatory variables (financial descriptors)
independent variable coefficient
returnt = ln(
Closeit
) * 100 (2)
Closeit 1
i overlooked effects
t common deterministic trend
it random disturbance assumed to be normally and identically distributed
where E(it) = 0; Var (it) = 2 > 0 (3)
In our opinion, from the manifold financial descriptors, we performed a selection of
nine indicators that characterize liquidity, leverage, effectiveness and profitability of
an issuer:
Current liquidity (LC) reflect the possibility of current patrimony elements

to be converted into liquidities within a short period of time in order to pay off
current debt. If the total amount of current liabilities is higher than the total
value of current assets then this indicator is sub-unit and this could indicate
that the short-term financing was used to purchase "long-term assets which is
normally considered dangerous, although there are sectors where a sub-unit
value is considered acceptable:
LC =
Ac
*100 (4)
Dts
Ac current assets
Dts current short-term debt
Quick liquidity (LR) - reflects the possibility of current assets that are
materialized in outstanding debts and treasury to cover current liabilities; we
subtract the stocks because these have the lowest characteristic of liquidity of
current assets:
Ac S
*100 (5)
LR =
Dts
S stocks
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Leverage (GI) - reflect the total liabilities to total assets and follows the
company's ability to cover with the available resources all uses and how
resources are distributed for use:
DT
*100 (6)
AT
G =
DT total liabilities
AT total assets
Earnings per share (EPS) - reflects the profit for each owned share and is
calculated as the ratio between net profit and the weighted average of number
of common shares outstanding during that year. The dynamics of this indicator
presents to the investors a picture of the performance of the issuer:
EPS =
net
*100 (7)
WNac
net net profit

WNac balanced average of number of common shares outstanding during that year
Diluted earnings per share (diluted EPS) - to determine this rate, the
corresponding net profits to common shareholders and the balanced average of
shares are adjusted with the influences of all dilutive potential common shares.
Dilutive potential common shares are considered to be converted into common
shares at the beginning of the period or at the issue date of the potential
common shares.
Dividend rate (DR) - reflects the profits which returns to shareholders for each
share owned, and is calculated as the ratio of dividends paid to shareholders
and the balanced average of number of common shares during that year. The
dynamics of this rate shows the issuing company's management vision on the
dynamics of stock prices:
D
*100
WNac
(8)
RD =
D dividends paid to shareholders
Return on assets (ROA) - one of the leading indicators of profitability of a

company from the point of view of profits made, which measures the
efficiency of asset utilization in order to obtain profit:
ROA =
net
*100 (9)
AT
Return on equity (ROE) - can be considered the most important indicator that
measures the performance of companies, because this actually shows the
contribution of the shareholders to finance the company:
net
*100
ROE = Cpr
(10)
Cpr equity
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Financial leverage (FL) - indicates that the issuer finances his activity through
loans. Thus, we can have volatility in the revenue due to the rise of interest
expenses:
LF =
DT
* 100 (11)
Cpr
In the second step we select a set of investment portfolios that meet the investment
requirements starting from the identification and financial analysis of those financial
descriptors that have a correlation with the dynamics of the market price of stocks of
the issuing companies.
The proposed model assumes that any investor will try to invest his capital in optimal
conditions in terms of financial statements of the issuing companies taken under
consideration. In this context, we will follow the next steps:
Selection of potential financial assets that the investor takes into account in
structuring its portfolio;
Estimating the connections between the financial statements descriptor of
issuers and the dynamics of historical prices;
An estimation based on the results obtained in the previous step of a possible
evolution of the return market values for a forecasting perspective according to
the period in which a portfolio will be constituted. In our case, we took into
account the results from the period 2006-2008 and we determined an estimation
of a possible return that an investor can expect for 2009. The estimation for
2009 follows the identification of possible positive and negative returns on
which investors can decide on the type of transaction (long or short) Thus, in
case of returns higher than zero investors will trade long, and in case of a return
lower than zero then the investor will trade short;
The selection of a method of allocating the available financial resources among
the various classes and individual assets taken into consideration. The chosen
method for the selection of the set of portfolios will be the inversely
proportional allocation with the historical volatility of returns. In this regard, the
premise is that all investors have a medium / high risk aversion and therefore
they pursue the setting up of "defensive" portfolios with a structure that will be
preserved for longer temporary perspectives of holding financial assets:
Wi =
(12)
i2
n
i =1
2
i
Wi percentage of a financial asset in an investment portfolio

i2 historical volatility of returns of financial asset
Portfolio establishment and management and the evaluation of ex-post returns
and their subsequent risk. Evaluation will be done using the Sharpe and Sortino
ratio.
Sharpe Ratio (ShR) - It is useful in comparing two portfolios or stocks in terms of
risk-adjusted return. The higher the Sharpe Ratio, the more sufficient are returns for
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each unit of risk. It is calculated by first subtracting the estimate return from the return
of the portfolio, then dividing by the standard deviation of the portfolio.
_
ShR =
R ER
(13)
R portfolio return
ER estimated return for a period of time
P portfolio standard deviation
Sortino Ratio (SR) - is similar to the Sharpe ratio, except it uses downside deviation
for the denominator instead of standard deviation, the use of which doesn't
discriminate between up and down volatility.
SR =
R ER
(14)
R return over a period of time

2 downside risk standard deviation of negative returns
2. THE IMPLEMENTATION OF MODELS AND THE INTERPRETATION
OF RESULTS
The models will be tested empirically on a set of 137 companies listed on European
capital markets. The issuing companies that were selected for fundamental analysis are
included in the structure of some important indexes from the European capital market:
CAC40 (France), Ibex 35 (Spain), S & P MIB (Italy), DAX (Germany), FTSE 100
(UK) BUX (Hungary), PX (Czech Republic) and WIG 20 (Poland).
The perspective of analysis considered for analyzing financial descriptors is
2006-2008, and for the year 2009 we accomplished a forecast of possible returns that
an issuer can record based on the results obtained from the analysis of the financial
rates.
For an easier implementation of the model, the selected issuing companies were
grouped according to sectors in which they operate (see Annex 1-5):
basic materials sector - 18 companies;
industrial sector - 24 companies;
technology, telecommunications and media sector - 19 companies;
energy sector - 29 companies;
consumer and health sector - 47 companies.
The used methodology implies recourse to a "Panel Generalized Method of
Movements."
There are several advantages of the GMM-SYS over other static or dynamic panel
estimation methods. Among these: static panel estimates, as the OLS models, are
subjected to the problem of dynamic panel bias (Bond, 2002); in our database, we
have 127 companies (N) analyzed over a short time span of 3 years (T) and the
literature includes several arguments for dynamic panel model being specially
designed for a situation where T is smaller than N in order to control for dynamic
panel bias (Bond 2002; Baltagi 2008); the problem of the potential endogeneity can be
easier addressed in dynamic panel models than in static and OLS models, since all
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variables from the regression which are not correlated with the error term (including
lagged and differenced variables) can be potentially used as valid instrumental
variables; the dynamic panel model is able to identify short and long-run involved
effects (Baltagi 2008). Also, the GMM-System exploits the stationarity restrictions,
while the first-differenced GMM estimator can behave poorly when the time series
are persistent.
The obtained empirical results are presented in the following table:
Table 1 Statistic model results
Dependent Variable: Market returns
Method: Panel Generalized Method of Moments
Transformation: First Differences
White period instrument weighting matrix
White period standard errors & covariance (d.f. corrected)
Instrument specification: Lagged values of returns (from 1 to 3), EPS and ROA (from 1
To 2)
Constant added to instrument list

A) Basic materials (18 companies)
Variable
Coefficient
Std. Error
t-Statistic
Prob.
Returns(-1)
EPS(-1)
ROA(-1)
ROE(-1)
-1.243457
0.091567
-18.69844
8.809040
0.092652
0.022418
2.601485
2.473420
-13.42078
4.084497
-7.187601
3.561482
0.0000
0.0011
0.0000
0.0031
B) Industrial (24 companies)

Variable
Coefficient
Std. Error
t-Statistic
Prob.
Returns(-1)
Diluted EPS(-1)
Effective interest rate(-1)
-0.963363
-17.34071
-26.85258
0.083750
10.35401
7.338023
-11.50283
-1.674782
-3.659376
0.0000
0.1095
0.0016
C) Technology, telecommunications, media (19 companies)

Variable
Coefficient
Std. Error
t-Statistic
Prob.
Returns(-1)
EPS(-1)
-1.037504
1.349303
0.139906
0.201852
-7.415721
6.684601
0.0000
0.0000
D) Energy (29 companies)

Variable
Coefficient
Std. Error
t-Statistic
Prob.
Returns(-1)
EPS(-1)
-1.001197
-1.940791
0.085291
0.557147
-11.73854
-3.483446
0.0000
0.0017
E) Consumer, health (47 companies)

Variable
Coefficient
Std. Error
t-Statistic
Prob.
Returns(-1)
Current liquidity(-1)
Quick ratio(-1)
EPS(-1)
0.887278
7.336577
-15.90176
0.506861
0.897732
1.439564
3.375288
0.090912
0.988355
5.096389
-4.711231
5.575270
0.3286
0.0000
0.0000
0.0000
(Source: Developed by the author based on datas supplied by Teletrader Software AG)
~352~
Analyzing these results shows that for the basic materials sector:
The variable with maximum potential explanatory is ROA followed by EPS and
ROE. The profitableness estimator calculated by reference to the total on net
assets appears to be negatively correlated with the dynamic of the stocks return.
A possible explanation for this result is that the invested resources return is
estimated before the allocation of the net results of the issuer. Consequently, it
reflects the efficiency of the resource, but does not indicate the way the results
achieved due to the global activity of the company are used. In the same time
the sectors and / or issuers which register a growing rhythm higher than the
market average associate higher levels of ownership and trading risk. These
risks are offset by the existence of a higher level of results that can be
distributed to potential investors so that the risk premium required by them and
incorporated into the prices decreases once with the increase of ROA providing
one of the channels through which the positive dynamics of this rate attenuates
price volatility;
In the same time, an increase of the return obtained by investors quantified by
ROE determines an increase of the relative preference for holding their shares
with a higher level of that rate. Consequently, the growth of ROE determine the
increases of demand translated in conditions of higher elasticity of price in their
dynamics;
Similar effects are exercised by the increase of EPS, variable which is
consistent and systematic associated with the dynamics of prices for all
considered sectors.
In the industrial sector case the results presented in table 1 indicate the followings:
The variable with maximum potential explanatory is the effective interest rate
followed by diluted EPS. The dynamics of effective interest rates is negatively
correlated with the dynamics of stocks return. The dynamics of this rate can
generate a volatility of revenues as a result of increasing the weight of borrowed
capital in total debts. In the same time, in the industrial sector are accepted
higher levels of borrowed capital necessary to conduct and / or develop the
issuing company's business;
The dynamics of the diluted EPS indicator is similar to the EPS indicator
dynamics, thus systematically associated to price dynamics of the sector.
The only variable which has a maximum explanatory potential in the technology,
telecommunication and media and energy sector is EPS.
In the last sector case - consumer, health - according to the obtained results the
following can be mentioned:
The variable with maximum potential explanatory is EPS followed by current
and quick liquidity. EPS dynamics is a direct factor of influence of the
dynamics of stock prices of issuers because it expresses the share of profit for
each share owned;
Similar effects are exercised also by the dynamics of liquidity rates which
shows the capacity of an issuing company to cover their current liabilities with
current assets.
Based on the results obtained from the analysis of the financial statements descriptors
using statistical model there were identified the interconnections between these
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descriptors and the stock market value return. So, in the following table it is presented
the importance of financial indicators in relation to the dynamics of the price on the
stock market.
Table 2. The importance of financial descriptors in relation to the dynamics
of stock market price
Sector
Ins
Ins
Ins
Ins
Ins
Ins
Ins
Ins
Ins
S
Ins
S
EPS
diluted
Ins
S
Ins
Ins
S
Ins
S
Ins
Ins
S
S
Ins
Ins
LC
Basic Materials
Industrial
Technology,
Telecommunication,
Media
Energy
Consumer, Health
LR
EPS
RD
ROA
ROE
LF
Ins
Ins
Ins
S
Ins
Ins
S
Ins
Ins
Ins
S
Ins
Ins
Ins
Ins
Ins
Ins
Ins
Ins
Ins
(Source: Developed by the author based on the results generated by the statistical model)
Legend:
Ins = insignificant
S = significant
Starting from these premises, it was implemented a selection model of an optimal
portfolio for each analyzed sector. We also determined the potential returns in the year
2009 which varies depending on the portfolio type; long or short (see Figure 1.).
Figure 1. Potential returns of investment portfolios in the year 2009
Returns obtained by the investment portfolios
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
-10.00%
-20.00%
Basic
Materials
Industrial
Teh, Tec,
Media
Energy
Consumer,
Health
Long Portfolio
49.20%
34.05%
4.37%
3.25%
24.25%
Short Portfolio
-4.52%
-5.45%
11.74%
-9.95%
-17.14%
Sectors
Long Portfolio
Short Portfolio
(Source: Developed by the author based on the selection model of an optimal portfolio based
on financial descriptors)
From the analysis of the optimal portfolios on sectors it can be observed that all the
long portfolios are recording positive returns, the highest returns being within the
basic materials sector (49.2%) and in the industrial sector (34, 05%).
~354~
In the short portfolios case only the technology, telecommunications and media sector
register positive returns of only 11.73%.
The returns of the selected portfolios are directly influenced by the allocation of
stocks in the portfolio and the number of issuers taken into account. So, for the basic
material sector were taken into account 18 issuers, 24 in the industrial sectors, 19 in
the technology, telecommunications, media sector, 29 and in the energy sector and 47
in the consumer and health sector.
In the long portfolio structure were taken into account only those companies for which
the estimates of the potential returns, based on the financial descriptors for the period
2006-2008, were positive. In the situation when the estimated returns are negative,
those companies have entered the short portfolio composition. (See Annexes 6-15).
An important issue for an investor is also the ex-post evaluation of the returns and
their subsequent risks for the set of the optimal portfolios. A comparative analysis of
the Sharpe and Sortino ratios highlights the fact that for all sectors the Sharpe ratio is
lower than the Sortino ratio.
Table 3. Portfolios types and performances
Sector
Basic Materials
Consumer, Health
Energy
Industrial
Tec, Tel, Media
Portfolio Type
long
short
long
short
long
short
long
short
long
short
Return 2009
Sharpe
Sortino
No. Instruments
49.20%
-4.52%
24.25%
-17.14%
3.25%
-9.95%
34.05%
-5.45%
4.37%
-11.74%
-0.645
0.1518
0.4007
-0.148
-0.4998
-0.7758
-0.603
-1.6289
-0.3442
-0.9381
0.3792
2.5638
0.5311
1.6868
-0.2704
-0.2969
0.6424
1.9725
0.4591
0.7431
16
2
18
29
23
6
2
22
3
16
(Source: Developed by author)
Using the Sharpe ratios to compare and select among investment alternatives can be
difficult because the measure of risk, portfolio standard deviation, penalizes portfolios
for positive upside returns as much as the undesirable downside returns.
CONCLUSIONS
The selection of an optimal portfolio must have an investment strategy based on
investment objective, risk aversion of the investor, the type and characteristics of
investment instruments.
The diversity of the investment objectives, the behavioral changes of an investor, and
the enrichment of the overall investments spectrum for the holders of capital led to the
development of techniques and selection models and portfolio investments
management models.
~355~
Following the presented results it can be mentioned that we can create a set of optimal
equities portfolios in order to generate returns above the returns obtained by the
instruments that are considered risk-free only by using financial descriptors. Because
in the structure of portfolios are included only stocks traded in developed capital
markets, it can be said in the first instance that the developed portfolios are destined to
investors with a low aversion to risk.
However, by applying the selection criteria based on financial descriptors we
followed the development of some "defensive" portfolios whose structure to be
preserved for longer time horizons for holding financial assets. Thus, by applying this
method it can be said that these portfolios can also be selected by investors with an
average risk aversions.
REFERENCES
Baltagi B.H., (2008) Econometric Analysis of Panel Data, Chichester: John Wiley & Sons
Ltd, 4th edition.
Blackburn, K., Hung, V., T., Y. (1998), A Theory of Growth, Financial Development, and
Trade Economica Vol. 65, No. 257.
Bond S., Dynamic Panel Models: A Guide to Micro Data Methods and Practice, Institute for
Fiscal Studies, Department of Economics, UCL, CEMMAP (Centre for Microdata
Methods and practice) Working Paper CWPO9/02, 2002. Available online:
http://cemmap.ifs.org.uk/wps/cwp0209.pdf.
Claessens, S., Dasgupta, S. and Glen J. (1998), The cross section of stock returns: Evidence
from emerging markets, Emerging Markets Quarterly 2, 413
Fama, E., French, K. (1996), Multifactor explanations of asset pricing anomalies, Journal
of Finance 51, 5584
Fama, E, French, K. (1998), Value versus growth: the international evidence, Journal of
Finance 53
Greenwood, J., Jovanovic, B., (1990) Financial Development, Growth, and the Distribution
of Income, Journal of Political Economy, Vol. 98, Nr. 1
Reilly, B, (2000) Investment Analysis and Portfolio Management, Harcourt College
Publishres
Patel, S., (1998), Cross-sectional variation in emerging markets equity returns, January
1988-March 1997, Emerging Markets Quarterly 2, 5770
Rouwenhorst, G., (1998), International momentum strategies, Journal of Finance 53,
267284
Rouwenhorst, G., (1999), Local return factors and turnover in emerging stock markets,
Journal of Finance 54, 14391464
Sharpe, W.,(1963) A simplifield model of portfolio analysis, Management Science, Vol 9,
Nr. 1
Sharpe, W.,(1964) Capital Assets Prices A theory of market equilibrium under conditions
of risk, Journal of Finance, Vol. 19, Nr. 3
Sharpe,W., (1970) Portfolio theory and capital markets, Mc Graw-Hill Book, 1970;
~356~
APPENDIX 1
Issuing companies from the consumer and health sector
No.
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
Issuing Symbol
Issuing Name
AsB
Bai
BAT
Car
Com
Dia
ITG
Ico
Kin
MaS
Mor
Nex
SAB
Jsa
Unl
Whi
Associated British Food Plc

British Airways Plc
British American Tobacco Plc
Carnival Corporation & Plc
Compass Group Plc
Diageo Plc
Imperial Tobacco Group Plc
InterContinental
Kingfisher Plc
Marks & Spencer Group Plc
Morrison Supermarkets Plc
Next Plc
SABMiller Plc
J Sainsbury Plc
Unilever Plc
Whitbread Plc
Wol
Wolseley Plc
Ast
Astra Zeneca Plc
Gla
GlaxoSmithKline Plc
SmN
Aco
Crr
Dan
Lor
LVM
Mic
PeR
Peu
PiP
Smith & Nephew Plc

Accor
Carrefour SA
Danone
L'Oreal SA
LVMH
Michelin
Pernod-Ricard
Peugeot
Pinault Printemps Redoute SA
Ren
Renault
Ess
Essilor International
San
Adi
Dai
Dpo
Hen
Luf
Sanofi-Aventis
Adidas AG
Daimler AG
Deutsche Post AG
Henkel KGaA
Lufthansa AG
Met
Metro AG
FrM
Fresenius Medical Care AG
Mer
Aug
Bul
Geo
Lot
Lux
Merck KGaA
Autogrill SpA
Bulgari SpA
Geox Spa
Lottomatica SpA
Luxottica Group SpA
EgP
GeR
Egis Pharmaceuticals Ltd

Gedeon Richter Plc.
Country in which is traded
Great Britanie
France
Germany
Italy
Hungary
APPENDIX 2
Issuing companies from the basic material sector
No.
Issuing Symbol
Issuing Name
Ang
Anglo American Plc
Ant
Antofagasta Plc
BHP
BHP Billiton Plc
Bun
Bunzl Plc
JoM
Johnson Matthey Plc
Kaz
Kazakhmys Plc
Lon
Lonmin Plc
Rti
Rio Tinto Plc
Vre
Vedanta Resources Plcs
10
Xst
Xstrata Plc
11
Air
Air Liquide SA
12
Arc
Arcelor Mittal SA
13
BAS
BASF SE
14
Bay
Bayer AG
15
Lin
Linde AG
16
Ace
Acerinox SA
17
TVK
TVK Nyrt.
18
KGH
KGHM Polska Miedz SA
Great Britanie
France
Germany
Spain
Hungary
Poland
APPENDIX 3
Issuing companies from the energy sector
No.
Issuing Symbol
Issuing Name
BGG
BG Group
BPl
BP Plc
Cen
Centrica Plc
InP
International Power Plc
Nat
National Grid Plc
Rod
Royal Dutch Shell Plc
ScS
Scottish & Southern Energy
Sev
Sever Trent Plc
UUG
10
Ele
11
GDF
GDF Suez
12
Sce
Schneider Electric
13
Teh
Technip
14
Tot
Total
15
Veo
Veolia Environnement
16
EON
EON AG
17
RWE
RWE AG
18
Ene
Enel Spa
Great Britanie
United Utilities Group

Electricite de France
19
Eni
Eni SpA
20
Sam
Saipem SpA
21
SnR
Snam Rete Gas SpA
22
Ten
Tenaris SA
23
Ter
Terna SpA
24
Ena
Enagas SA
25
Ibe
Iberdrola SA
26
Red
Red Electrica Corporacion SA
27
Rep
Repsol YPF SA
28
CEZ
29
PGo
CEZ a.s.
Polskie Gornictwo Naftowe I
Gazownictwo SA
France
Germany
Italy
Spain
Czech Republic
Poland
APPENDIX 4
Issuing companies from the industrial sector
No.
Issuing Symbol
Aam
Issuing Name
Amec Plc
BAE
BAE Systems Plc
Cap
Capita Group Plc
Cob
Cobham Plc
GfS
G4S Plc
Rex
Rexam Plc
Smi
Smiths Group Plc
Als
Alstrom RGPT
Bou
Bouygues
10
Eur
European Aeronautic
11
Laf
Lafarge
12
Sai
Saint Gobain SA
13
Val
Vallourec
14
Atl
Atlantia SpA
15
Buz
Buzzi Unicem SpA
16
Fin
Finmeccanica SpA
17
Ita
Italcementi SpA
18
Pir
Pirelli & C SpA
19
Abn
Abertis Infraestructuras SA
20
Acc
21
AdC
22
FCC
Acciona SA
Actividades de Construccion y
Servicios SA
Fomento de Construcciones y
Contratas SA
23
Sac
Sacyr Vallehermoso SA
24
Pol
Polimex Mostostal SA
Great Britanie
France
APPENDIX 5
Issuing companies from the technology, telecommunication and media sector
No.
Issuing Symbol
Pea
Issuing Name
Pearson Plc
ReE
Reed Elsevier Plc
Sag
Sage Group Plc
BTG
BT Group Plc
Vod
Vodafone Group Plc
Alc
Alcatel - Lucent
Cap Gemini
CaG
Lag
Lagardere
Viv
Vivendi
10
STM
STMicroelectronics
11
12
FTe
Med
Mediaset SpA
13
SAP
SAP AG
14
Sie
Siemens AG
15
DTe
Deutsche Telekom AG
16
Mte
Magyar Telekom Plc.
17
18
AsP
TVN
TVN
19
TeP
Telekomunikacja Polska SA
Great Britanie
France
France Telecom
Italy
Germany
Hungary
Asseco Poland SA
Poland
APPENDIX 6
Long Portfolio Basic Materials
Long Portfolio Basic Materials
Reverse of the historical
volatility
Percentage in
portfolio
Return 2009
Sharpe
Sortino
ANG
0.022185148
6.29%
3.53%
-0.5107
0.6867
ANT
0.0231364
6.56%
5.55%
-0.1887
2.1034
BHP
0.029353603
8.32%
3.60%
-0.7597
-0.2039
BUN
0.06543166
18.54%
2.50%
-0.8002
-0.0482
JOM
0.024097184
6.83%
2.29%
-0.6970
0.0782
KAZ
0.010039867
2.84%
4.98%
-0.2262
1.5248
RTI
0.010292587
2.92%
2.40%
-0.6643
0.1426
VRE
0.011601309
3.29%
4.77%
-0.2974
1.2052
XST
0.00978431
2.77%
1.55%
-0.3701
0.5649
AIR
0.035380491
10.02%
2.39%
-0.4005
0.6994
ARC
0.012170432
3.45%
2.20%
-0.5752
0.3197
BAS
0.012613244
3.57%
1.61%
-0.8454
-0.2851
BAY
0.023833625
6.75%
2.01%
-1.2470
-0.7276
LIN
0.035860521
10.16%
3.46%
-0.3887
0.8148
TVK
0.013800255
3.91%
1.35%
-1.8041
-1.0818
KGH
0.013351281
3.78%
5.02%
-0.2951
1.4172
49.20%
-0.6450
0.3792
Issuers
Portfolio total results
APPENDIX 7
Short Portfolio Basic Materials
Short Portfolio Basic Materials
volatility
Percentage in
portfolio
Return 2009
Sharpe
Sortino
LON
0.016005694
5.85%
-4.48%
-0.1103
1.4202
ACE
0.257460102
94.15%
-0.04%
0.1680
2.6349
-4.52%
0.1518
2.5638
Issuers
APPENDIX 8
Long Portfolio Industrial
Long Portfolio Industrial
volatility
Percentage in
portfolio
Return 2009
Sharpe
Sortino
PIR
0.019066141
46.28%
21.81%
-0.3093
0.9483
SAC
0.022134656
53.72%
12.24%
-0.8560
0.3790
34.05%
-0.6030
0.6424
Issuers
APPENDIX 9
Short Portfolio Industrial
Short Portfolio Industrial
volatility
Percentage in
portfolio
Return 2009
Sharpe
Sortino
AAM
0.016401409
0.92%
-0.44%
0.4170
1.9396
BAE
0.045896192
2.58%
0.12%
-0.2434
-0.2772
CAP
0.238192812
13.39%
-0.23%
1.5493
COB
0.215857306
12.13%
-2.45%
0.9961
25.6738
GFS
0.045349148
2.55%
-0.61%
0.5493
2.9011
REX
0.386229871
21.71%
4.10%
-8.5042
-8.1120
SMI
0.127765798
7.18%
-0.98%
0.2329
2.4259
ALS
0.021769595
1.22%
-0.19%
0.2197
0.9757
BOU
0.025188283
1.42%
-0.27%
0.0711
1.0378
Issuers
EUR
0.04793502
2.69%
-0.43%
-0.5139
0.8213
LAF
0.017322387
0.97%
-0.28%
-0.0329
0.9870
SAI
0.030057442
1.69%
-0.21%
-0.2276
0.7103
VAL
0.03063795
1.72%
-0.78%
0.6771
2.5315
ATL
0.023656664
1.33%
-0.44%
-0.0358
1.1800
BUZ
0.056713145
3.19%
0.10%
-0.8674
0.0760
FIN
0.025986729
1.46%
-0.03%
-0.4805
0.1693
ITA
0.190676246
10.72%
-0.68%
-1.0642
0.3729
ABN
0.037139801
2.09%
-0.46%
-0.2671
0.9622
ACC
0.015147998
0.85%
-0.02%
0.3524
0.8646
ADC
0.117841337
6.62%
-0.42%
0.5630
1.9142
FCC
0.052200676
2.93%
-0.68%
-0.5527
0.9953
POL
0.010841156
0.61%
-0.16%
-0.9332
0.2320
-5.45%
-1.6289
1.9725
APPENDIX 10
Long Portfolio Technology, Telecommunication, Media
Long Portfolio Technology, Telecommunication, Media
volatility
Percentage in
portfolio
Return 2009
Sharpe
Sortino
ALC
0.051982532
40.87%
2.12%
-0.7364
0.9034
VOD
0.034247661
26.93%
0.92%
0.0206
0.2328
REE
0.040955308
32.20%
1.32%
-0.1514
0.0844
4.37%
-0.3442
0.4591
Issuers
APPENDIX 11
Short Portfolio Technology, Telecommunication, Media
Short Portfolio Technology, Telecommunication, Media
Issuers
SAG

volatility
Percentage in
portfolio
Return 2009
Sharpe
Sortino
0.144674503
10.96%
-2.82%
-0.2905
2.0891
CAG
0.057731314
4.37%
-0.66%
-0.5298
0.7998
STM
0.056135725
4.25%
-1.25%
-0.6233
1.0065
SAP
0.092180188
6.98%
-1.87%
-0.2570
1.9074
SIE
0.018239249
1.38%
-0.27%
-0.0992
0.5921
ASP
0.018812126
1.42%
-0.40%
-0.7449
0.4595
BTG
0.033245451
2.52%
0.00%
-0.8644
-0.0038
FTE
0.053872152
4.08%
0.55%
-0.3715
-1.5403
DTE
0.048042671
3.64%
0.16%
-0.5656
-0.2934
MTE
0.056392702
4.27%
-1.32%
-0.1533
1.7651
TEP
0.276635976
20.95%
3.99%
-3.3167
-4.3541
PEA
0.24939242
18.89%
-6.22%
0.2399
6.0395
LAG
0.050400443
3.82%
0.08%
-1.0828
-0.0720
VIV
0.055944963
4.24%
0.47%
-0.7945
-0.8909
MED
0.076738867
5.81%
-2.02%
-0.4055
1.6147
TVN
0.032094408
2.43%
-0.15%
-0.5988
0.2078
-11.74%
-0.9381
0.7431
APPENDIX 12
Long Portfolio Energy
Long Portfolio Energy
Issuers
BGG

volatility
Percentage in
portfolio
Return 2009
Sharpe
Sortino
0.028977064
2.44%
0.39%
0.0544
0.1592
BPL
0.084494223
7.12%
0.94%
-0.0181
1.5035
CEN
0.064298989
5.42%
0.30%
-0.5196
0.3585
INP
0.024766436
2.09%
0.53%
-0.2968
0.6791
NAT
0.062127045
5.23%
-0.04%
-0.4448
-0.4228
ROD
0.057752406
4.87%
0.24%
-0.2315
0.1202
SCS
0.057186825
4.82%
-0.23%
-0.7489
-0.4609
SEV
0.07158607
6.03%
-0.59%
-0.9685
-1.0838
ELE
0.018795954
1.58%
0.00%
-0.4586
-0.3317
GDF
0.076343655
6.43%
-0.99%
-0.6179
-2.8227
SCE
0.030487483
2.57%
1.11%
-0.0504
1.6029
TOT
0.047834164
4.03%
0.59%
-0.3014
0.7947
VEO
0.018159955
1.53%
0.06%
-0.6428
0.0408
EON
0.022675592
1.91%
0.05%
-0.4437
-0.3141
RWE
0.036385786
3.07%
0.20%
-0.4045
0.1806
ENE
0.031336693
2.64%
-0.25%
-0.8351
-0.4057
SAM
0.017183152
1.45%
1.01%
-0.0396
1.5498
SNR
0.194584446
16.39%
-2.30%
-1.1743
-2.4805
TER
0.088590574
7.46%
1.83%
0.1961
3.0341
ENA
0.05308896
4.47%
-0.04%
-0.5037
-0.3673
IBE
0.028908774
2.44%
0.05%
-0.4743
-0.2045
RED
0.042636587
3.59%
0.27%
-0.0975
-0.0242
PGO
0.02871033
2.42%
0.12%
-0.2968
-0.2839
3.25%
-0.4998
-0.2704
APPENDIX 13
Short Portfolio Energy
Short Portfolio Energy
volatility
Percentage in
portfolio
Return 2009
Sharpe
Sortino
UUG
0.12768126
41.37%
9.69%
-1.5899
-2.5465
TEH
0.020772981
6.73%
-5.50%
-0.0176
1.9044
ENI
0.050903745
16.49%
-1.20%
-0.5192
0.4389
TEN
0.037933675
12.29%
-8.84%
-0.0196
2.5236
REP
0.049131346
15.92%
-3.43%
-0.3040
1.1412
CEZ
0.022196159
7.19%
-0.67%
0.2715
0.8921
-9.95%
-0.7758
-0.2969
Issuers
APPENDIX 14
Long Portfolio Consumer and Health
Long Portfolio Consumer and Health
volatility
Percentage in
portfolio
Return 2009
Sharpe
Sortino
BAT
0.04923405
4.45%
0.50%
-0.0296
-0.0743
COM
0.424818819
38.36%
9.89%
1.5250
ITG
0.029323261
2.65%
0.15%
-0.5072
-0.3945
MOR
0.053458756
4.83%
-0.05%
-0.2925
-1.3345
SAB
0.052164709
4.71%
2.12%
0.4155
4.4693
JSA
0.06213955
5.61%
-0.09%
-0.5199
-0.1406
UNL
0.043470034
3.92%
0.92%
0.1967
1.9200
CRR
0.024714297
2.23%
0.44%
-0.3468
0.5346
DAN
0.047687406
4.31%
-0.04%
-1.2497
-0.7596
LOR
0.028242658
2.55%
0.57%
0.0088
1.0237
PEU
0.013482852
1.22%
0.81%
-1.1551
-0.1214
ADI
0.029582532
2.67%
0.88%
-0.1433
1.1744
DAI
0.015824574
1.43%
0.47%
-0.3648
0.4486
HEN
0.035402205
3.20%
1.53%
-0.1021
1.7094
MET
0.022949306
2.07%
0.83%
-0.1731
1.0906
SMN
0.054918656
4.96%
1.87%
-0.3960
1.3506
ESS
0.060231098
5.44%
1.19%
-0.0943
1.5414
GER
0.059948977
5.41%
2.23%
-0.6908
1.1382
24.25%
0.4007
0.5311
Issuers
APPENDIX 15
Short Portfolio Consumer and Health
Short Portfolio Consumer and Health
Issuers

volatility
Percentage in
portfolio
Return 2009
Sharpe
Sortino
ASB
0.067878453
1.81%
-0.21%
0.2781
1.6364
BAI
1.65379711
44.10%
-1.73%
-0.3703
1.1198
CAR
0.08628845
2.30%
-0.80%
0.1049
2.7965
DIA
0.104599189
2.79%
-0.34%
0.5418
2.7262
ICO
0.20627226
5.50%
-2.55%
0.1863
3.3631
KIN
0.047856299
1.28%
-0.67%
0.7964
3.7658
MAS
0.028116616
0.75%
-0.47%
-0.0344
1.9630
NEX
0.0657654
1.75%
-1.15%
0.2173
4.0763
WHI
0.082041483
2.19%
-0.94%
0.0634
2.9462
WOL
0.132581657
3.54%
-4.16%
0.4147
5.3919
ACO
0.053647824
1.43%
-0.12%
-0.2343
0.8441
LVM
0.034355041
0.92%
-0.45%
0.1120
2.1253
MIC
0.02449765
0.65%
-0.23%
-0.0960
1.1839
PER
0.041080512
1.10%
-0.13%
-0.1264
0.8294
PIP
0.024090464
0.64%
-0.38%
-0.0809
1.5868
REN
0.011639419
0.31%
-0.21%
-0.2972
0.8763
DPO
0.028210338
0.75%
-0.09%
-0.3306
0.5660
LUF
0.056710993
1.51%
-0.07%
-0.3812
0.7549
AUG
0.033813984
0.90%
-0.44%
-0.0906
1.8048
BUL
0.030128833
0.80%
-0.22%
-0.2144
1.0467
GEO
0.01555927
0.41%
-0.04%
-0.4831
0.1890
LOT
0.151319161
4.04%
0.92%
-1.8141
-1.1365
LUX
0.044147036
1.18%
-0.41%
0.2477
2.1071
AST
0.040191611
1.07%
-0.04%
1.1744
2.2830
GLA
0.371314234
9.90%
-0.27%
-0.1769
1.1701
SAN
0.089951668
2.40%
-0.46%
0.6762
2.7014
FRM
0.109384875
2.92%
-0.30%
1.0265
3.6298
MER
0.046398123
1.24%
-0.01%
0.3080
0.8698
EGP
0.06827401
1.82%
-1.15%
-0.1901
2.4934
-17.14%
-0.1480
1.6868
PS8 Intellectual Capital

Chairperson
Niculae FELEAGA, Bucharest Academy of Economic Studies,
Romania
INTELLECTUAL CAPITAL DISCLOSURE:

EUROPEAN EVIDENCE
Liliana FELEAGA, Niculae FELEAGA,
Voicu Dan DRAGOMIR, Luciana Maria RABU
INTELLECTUAL CAPITAL:
THE ANNUAL REPORTING PRACTICES
Nicoleta Maria IENCIU, Dumitru MATI
DETERMINANTS OF INTELLECTUAL CAPITAL

DISCLOSURE IN THE CASE OF ROMANIAN
COMPANIES
Maria Cristina MORARIU
~368~
INTELLECTUAL CAPITAL DISCLOSURE:

EUROPEAN EVIDENCE
Liliana FELEAGA1, Niculae FELEAGA,
Voicu Dan DRAGOMIR & Luciana Maria RABU
ABSTRACT
The aim of this research is to examine the degree to which different categories of intellectual
capital are disclosed in the annual reports of a sample of large European companies. The
sample comprises 18 companies included in the STOXX Europe TMI Software & Computer
Services Index, from 6 countries. Keeping with the previous literature, the present study has
analyzed the disclosed items of intellectual capital outside the financial reports of these
entities; this methodological choice assumes that disclosure outside the requirements of
accounting standards shows the true commitment of managers in the creation and
development of intellectual capital. For the content analysis of intellectual capital disclosures
we have used relevant methodologies from the prior literature. The elements disclosed in
narrative form were coded as binary variables on an index scale, and several frequencies and
charts are included in the discussion section.
KEYWORDS: Intellectual capital, software companies, European firms, research methods

for intellectual capital assessment
INTRODUCTION
The expansion of information technologies and cost-effective communication services
has profoundly transformed industrial activities. Productive systems have gone
through massive mutations, which are relying on the emergence of a new economic
logic. Dematerialized production, the exponential growth of information services and
the integration of data flows into readily accessible databases have led to the
configuration of a post-industrial economy, whose qualitative attributes of flexibility
and reactivity are an essential part of this highly adaptive system. In other words,
tangible investments are progressively giving place to intangible elements, such as
knowledge management systems. Global markets do no longer exclusively deal with
goods and services; knowledge has also become a highly valued commodity, which is
transferred by itself or in association with traditional material goods. Therefore,
companies and nations seek to gain a competitive advantage on any global market, by
supplying increasing amounts of knowledge or intellectual capital, which
incorporate impressive material, monetary and human resources. Quite many studies
point to the fact that between 75% and 90% of international market capitalization is
attributable to intangible assets (Hand & Lev, 2005; Baklouti et al., 2007; Zyla, 2010).
In other words, intellectual capital has become the major component of growth and
success for companies of any size. The advent of these changes has provided strong
1
Correspondence address: Liliana FELEAG, The Bucharest Academy of Economic Studies, Piata
Romana nr. 6, sector 1, Bucuresti, cod 010374, e-mail: liliana_malciu @yahoo.com
~369~
incentives for managers to include intellectual capital disclosures into the annual
reports, in order to acknowledge and demonstrate the effectiveness of intangibles
management (Brennan & Connell, 2000). This type of information is required by
investors with the clear aim to narrow the information gap (Wong & Gardner, 2005).
Consequently, the management, measurement, and disclosure of intellectual capital
have gained relevance as a major research topic (Petty and Guthrie, 1999).
The present paper investigates the reporting practices of companies included in the
STOXX Europe TMI Software & Computer Services index. We believe it to be the
first study in this field targeting the intellectual capital disclosures of firms in the IT
sector, therefore significantly contributing to the intellectual capital disclosure
literature. The results are useful for all those interested in the extent of voluntary
disclosures of intellectual capital, while professional bodies and regulators may also
benefit from the application of relevant methodologies in the creation of guidelines
and accounting policies for those components of intellectual capital which are not yet
formally recognized as assets in the corporate financial statements.
The present study is also testing and thoroughly discussing the methodology of
Guthrie et al. (1999), whose intellectual capital framework involves 24 variables
across three intellectual capital categories. This contribution to the literature is timely
and relevant, since we propose that the aforementioned methodology should be
incorporated into the mainstream corporate disclosure framework, by shaping it to
meet the needs of all stakeholders.
The remainder of the paper is structured as follows. First, several definitions of
intellectual capital and some of its components are provided. In the following, the
paper describes the research method and presents the results. In the final section, the
conclusions are accompanied by a description of tentative avenues of research.
1. THE DEFINITION OF INTELLECTUAL CAPITAL
The global expansion of intangible investments is a major incentive for academic
research. Thinkers from a multitude of fields have attempted to discover the criteria
for the recognition and measurement of this type of corporate investments, which are
by no means similar to acquiring property, plant and equipment. However, the main
obstacle is establishing the perimeter of analysis, since there is no universally
acceptable definition of intangible investment. The heterogeneity and the vastness
of the conceptual implications arise also from the usual confusion between such terms
as intangible, dematerialized or intellectual (Feleag et al., 2010). Moreover,
the term investment itself is subject to controversy. For these reasons, we prefer to
use the notion of intellectual capital.
The concept of intellectual capital has been introduced in the context of academic
research conducted at the beginning of the 1990s on North American and
Scandinavian companies (Dow Chemical, Canadian Imperial Bank of Commerce, and
Skandia, respectively). The results of these investigations are to be found in two
fundamental contributions of Edvinsson & Malone (1997) and Stewart (1997). Thus,
the former consider intellectual capital to be equivalent to having corporate control
over knowledge, management techniques, market relationships and professional skills,
the synergy of which would offer a competitive advantage to the respective firm.
~370~
Similarly, Stewart (1997) considers intellectual capital to consist of intellectual

material knowledge, information, intellectual property, experience that can be put
to use to create wealth.
Generally, the literature has identified three sub-phenomena that constitute the
concept of intellectual capital: human capital, structural (internal) capital, and
customer (external) capital.
Human capital is the set of collective knowledge, creativity, management skills and
entrepreneurship abilities observable at the employees of an entity. These resources
can be grouped in three categories (Edvinsson & Malone, 1997): competencies
(talents, experience, capacities), attitudes (motivation, managerial abilities), and
intellectual agility (the capacity to innovate and to establish new patterns of
knowledge). The authors insist on the fact that, as employees leave the company, their
human capital may no longer be available to the entity. Thus, human capital is much
more volatile than structural capital, but crucial to the development and survival of
any organization. Entities should not refrain from investing in human capital simply
because of its high degree of volatility.
Other researchers have analyzed human capital from a different perspective,
describing the enterprise as a dynamic mixture of specific organizational capacities,
not as an inventory of resources with a potential for interaction (Bounfour, 2000). In
this vision, human capital could be reduced to the ensemble of implicit knowledge
and routines stored in the brains of the employees. This knowledge can be broken
down into: information, quality of working teams, collective capacities, organizational
competences and culture. Human capital is an essential component of any entity, since
organizations can exist only when they benefit from the presence of humans and their
creativity (Bounfour, 2000).
According to Stewart, human capital develops when an enterprise is intensively using
the knowledge of its employees, or when a large number of individuals acquire useful
knowledge for their work within the enterprise. In other words, in order to develop
their competitive edge, companies are forced to accumulate, preserve and use their
human capital in the most efficient way possible. Human capital also comes as
a surprise gift to the company: the employer knows its worth (the opportunity cost
of education) and its returns (higher earnings for the firm), but no one knows the
actual content of this capital. That is, the manager does not know for sure which of the
abilities developed through education are useful for the economic activity (Hartog,
1999).
Structural (internal) capital is the protective environment for human capital,
allowing the employment of the latter for value creating purposes (Stewart, 1997).
Between these two forms of capital there is a fundamental difference (UNI P&MS,
2000): Structural capital can be owned by the organization whereas human capital is
volatile. People can walk away, they might fall ill or die, or they might be enticed
away by a competitor. They cannot be owned. Structural capital relates to a firms
databases, procedures, systems, distribution networks and anything that has higher
value to the company than material value (cost).
~371~
Customer (external) capital relates to the knowledge that is embedded in the

relationships external to the firm (Bontis, 1998). This consists of marketing channels,
relationships with customers and suppliers, brand names and reputation. Some of
these can be considered to be proprietary, but only in a temporal sense and, even then,
not with any degree of confidence. For instance, a company has some influence over
the value of its customer relationships; however, reputation and relationships can
change over time and a company cannot control the behavior of customers or
suppliers if they are not compliant (Guthrie & Petty, 2000).
The three components of intellectual capital should not be seen in isolation. They are
complementary and in permanent interaction between each other and with other
external factors (Edvinsson and Malone, 1997).
2. METHODOLOGICAL ASPECTS: SAMPLE SELECTION AND RESULTS
The purpose of our research is to examine the extent to which different categories of
intellectual capital are disclosed in the annual reports of large European companies.
The preliminary sample includes 21 companies listed in the STOXX Europe TMI
Software & Computer Services index. In accordance with the Classification
Benchmark (ICB) provided by Stoxx ltd., the Software & Computer Services Sector
contains: (i) companies that provide consulting services to other businesses relating to
information technology, (ii) companies providing Internet-related services, such as
Internet access providers and search engines and providers of Web site design, Web
hosting, domain-name registration and e-mail services; and (iii) publishers and
distributors of computer software for home or corporate use. One company was
eliminated because it did not include any information related to intellectual capital in
its annual reports, and another two because they did not have their reports available on
the website until 30 September 2010. The final sample was comprised of 18
companies from 6 countries, and is presented in Table 1.
The majority of research contributions in the field of intellectual capital reporting
have focused on the content analysis of annual reports (Subbarao & Zeghal, 1997;
Guthrie & Petty, 2000; Brennan, 2001; Olsson, 2001; Williams, 2001, Wong and
Gardner, 2005; Morariu, 2010). Annual reports are a highly useful source of data,
because managers of companies commonly signal what is important through the
reporting mechanism (Guthrie & Petty, 2000; Goh & Lim, 2004). They are also a
good proxy for measuring the comparative position and trends of intellectual capital
between firms, industries and countries (Abeysekera & Guthrie, 2005).
Table 1. Sample companies
COMPANIES
Atos Origin
Autonomy Corporation
Aveva Group
Cap Gemini
Dassault Systems
Dimension Data
Fidessa Group
Indra Sistemas
Invensys
COUNTRY
FR
GB
GB
FR
FR
GB
GB
ES
GB
COMPANIES
Kudelski
Logica
Micro Focus International
Misys
Sage Group
SAP
Temenos Group
Tieto
United Internet
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COUNTRY
CH
GB
GB
GB
GB
DE
CH
FI
DE
In a manner similar to prior research, the collection procedure in our study has
ignored the elements which are already included as part of the financial statements.
Since all the companies in our sample are in compliance with the International
Financial Reporting Standards (IFRS), the mandatory disclosures on the face of the
financial statements and in the notes to the accounts are not indicative of the
managers propensity to disclose intellectual capital elements in the Management
discussion section of the annual report (Guthrie & Petty, 2000; Brennan, 2001; Ax &
Marton, 2008).
For the content analysis for annual reports, the methodology developed by Guthrie et
al. (1999) was considered relevant, since it proposes a framework which classifies
intellectual capital into three components: internal capital, external capital and
employee competence. The components of each dimension are listed in Table 2.
Table 2. Intellectual capital elements used in the coding instrument
INTERNAL CAPITAL
(ORGANIZATION CAPITAL)
Patents
Copyrights
Trademarks
Management philosophy
Corporate culture
Management processes
Information systems
Networking systems
Financial relations
EXTERNAL CAPITAL
(CUSTOMER/RELATIONAL
CAPITAL)
Brands
Customers
Customer loyalty
Company names
Distribution channels
Business collaborations
Licensing agreements
Favorable contracts
Franchising agreements
EMPLOYEE COMPETENCE
(HUMAN CAPITAL)
Know-how
Education
Vocational qualification
Work-related knowledge
Work-related competencies
Entrepreneurial spirit
The prior research (Guthrie et al., 1999) has employed a coding scale to measure the
quantity of disclosure concerning the component elements of intellectual capital. This
four-point scale is presented as follows:
0 the element is not present in the annual report;
1 the element can be found in a narrative;
2 the element takes a numerical form (counts, frequencies, trends);
3 the element is presented in monetary terms.
However, the preliminary results of a pilot test and the consultation of related
literature have shown that the components of intellectual capital are mainly presented
in narrative form (Guthrie et al., 1999; Goh & Lim, 2004; Bukh et. al, 2005, Ax &
Marton 2008). This implies that companies are more interested in simply pointing out
where the added value lies rather than assigning currency value to it (Petty & Guthrie,
2000; Wong & Gardner, 2005). For this reason, our investigation does not consider
the four-point scale as relevant, and uses instead a binary coding system (present/not
present).
We collected the cross-sectional raw data from the annual reports of the selected
companies, for one fiscal year. Depending on the accounting period of each company,
year-end dates varied between the 31st December 2009 and the 30th September 2010.
The first stage of the content analysis procedure was performed by a junior researcher,
who extracted data related to intellectual capital from the annual reports onto a coding
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sheet with several variables. Another researcher independently confirmed the coding
for each element and filled in a spreadsheet on the basis of the information reported
on the coding sheets. This gives a high degree of confidence in the overall result.
Table 3 shows the frequencies found in the content analysis of the annual reports of
the 18 listed companies in the sample. The results are presented in nominal terms and
also proportional terms with regards to our particular sample size. In parallel, the
results reported by Guthrie et al. (1999) are shown for comparative purposes.
Table 3. The frequencies of disclosures concerning intellectual capital elements, side
by side with the results of Guthrie et al. (1999)
COMPANY
Internal Capital (organization capital)

Patents
Copyrights
Trademarks
Corporate culture
Information systems
Networking systems
Financial relations
External Capital (customer/relational capital)
Brands
Customers
Customer loyalty
Company names
Business collaborations
Licensing agreements
Favorable contracts
Franchising agreements
Employee competence (Human Capital)
Know-how
Education
Vocational qualification
CURRENT STUDY
Sample: 18
100%
GUTHRIE ET AL.
(1999)
Sample: 20
100%
8
5
6
14
8
14
13
9
8
44%
28%
33%
78%
44%
78%
72%
50%
44%
3
1
2
12
6
15
10
3
1
15%
5%
10%
60%
30%
75%
50%
15%
5%
6
18
12
3
4
15
6
5
0
33%
100%
77%
17%
22%
83%
33%
28%
0%
9
16
7
5
10
13
8
1
1
45%
80%
35%
20%
50%
65%
40%
5%
5%
6
6
3
14
15
4
33%
33%
17%
78%
83%
22%
6
6
1
12
9
19
30%
30%
5%
60%
45%
95%
Frequencies found compare poorly with those of Guthrie et al. (1999). This result was
to be expected, given that the current sample is significantly different from that
employed by the latter researchers. The firms included in the STOXX Europe TMI
Software & Computer Services index are significantly larger than those listed on the
Australian Stock Exchange, as indicated by Guthrie et al. (1999). Larger firms are
more likely to disclose more information (Guthrie and Mathews, 1985) and to possess
more intellectual capital because they are more visible and have more resources at
their disposal to sponsor new initiatives (Abeysekera & Guthrie, 2005). Secondly, the
sample of Guthrie et al. included companies from six industries, whereas the present
study is focused on only one intangibles-oriented industry. The companies belonging
to the Software & Computer Services Sector are more likely to design, develop, sell
or exploit resources of an intellectual nature, thus being able to disclose more
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information related to their intangible capital (Wong & Gardner, 2005). Thirdly, the
timing of this research can also be a cause of the differences between the presented
results. Our study has been conducted more than a decade after that of Guthrie et al.
(2009). The passage of time is expected to have lead to a refinement of the
companies policies regarding the disclosure of intellectual capital.
When assessing the Intellectual Capital disclosures under the three components of IC:
internal capital, external capital and human capital (Figure 1), Internal Capital has the
largest reporting rate of 42% of the IC attributes disclosed (85 elements out of 202).
Items of External Capital are the second most reported elements, in the proportion of
34% (69 elements out of 202), while Employee Competence class comprise the most
neglected elements, with 24% of the total disclosures (48 items out of 202).
As shown in Table 3, only one of the 24 elements of IC scored 100% disclosure rate
across sample companies: information related to customers was disclosed by all 18
companies. At the opposite pole, no information on franchising agreements is
disclosed whatsoever.
The internal capital is the structural capital that is contained inside the firm, and
includes intellectual property (patent, copyright, and trademarks) and intangible
infrastructure assets (management philosophy, corporate culture, management
processes, information systems, networking systems and financial relations). The
company that showed the highest number of internal IC attributes was SAP, which
disclosed quantitative and qualitative information on all nine components of internal
capital. The next ranked company displaying high internal IC attributes was Atos
Origin, which presented information on all aspects of internal capital except
copyrights. The company that showed the lowest number of internal IC attributes was
Temenos Groups, which included data only about information systems.
Figure 1. Intellectual Capital Disclosures with a breakdown on the three main classes
Regarding Internal Capital, the disclosures related to management philosophy and

management processes are the most common, each with 14 elements out of 85.
Considering the total sample of 18 companies, the proportion of companies which
disclosed such information is of 77%. Disclosures regarding corporate information
systems are the second most common, with 13 items out of 85, being relevant for 72%
of the sample companies. Out of the 9 attributes of the internal capital, the ones with
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the lowest disclosure frequency were: copyrights (disclosed by five companies) and
trademarks (disclosed by six companies). These results are consistent to those
reported by Bozzolan et al (2003) who found large amounts of disclosure in
management processes and information technology, while intellectual property was
the most rarely disclosed. For the current study, the other internal IC attributes
proportions are shown in the figure below (Figure 2).
Figure 2. Internal IC disclosures, with a breakdown on the nine components
The external perspective of IC is relevant for the relationships and sources of value
from outside the firm. Guthrie & Petty (2000) explained the large proportion of
external capital disclosures through the increased emphasis in recent years on
rationalizing distribution channels, reconfiguring a firms value chain and reassessing
customer value. In the present study, none of the companies exhibited full disclosure
on the nine components of external capital. The companies that showed the highest
number of external IC attributes (5 out of 9) were: Cap Gemini, Indra Sistemas,
Logica, SAP and Temenos Group. On the other side, the poorest disclosures are to be
found at Tieto and United Internet, which provided information on only two relevant
components of external capital.
Figure 3. External IC disclosures, with a breakdown on the nine components
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As shown in Figure 3, within external capital reporting, the two most popular
elements were related to customers (100% disclosure rate) and business collaborations
(with data to be found in 15 out of 18 reports). The emergence of customer disclosure
is not surprising as the emphasis on customers within the management accounting
literature is very relevant for companies irrespective of industry (Foster, Gupta, and
Sjoblom, 1996), while the high rate of disclosure relative to collaborations with other
businesses can be explained by the international exposure of companies from our
sample.
The final aspect under consideration is the human perspective, which takes into
account the contributions of the employees and includes areas such as training,
education and entrepreneurial spirit. The company that demonstrated the highest
human intellectual capital disclosure was SAP, which presented qualitative and
quantitative information on all six components of human capital. In contrast to SAP,
three other companies reported on only one component of human capital: Aveva
Group (on work-related competencies), Kudelski (on know-how) and United Internet
(on education).
The most popular type of human IC disclosure is about work-related competencies
(present in 15 annual reports). Work-related knowledge is the second most popular
choice in the human capital disclosures, while vocational qualification was an item
that received very little attention (6.25%). These results are comparable to those
reported by Bozzolan et al (2003) and by Wong & Gardner (2005). Overall, the
disclosure proportions for the current study are shown in the Figure 4, which also
includes the other types of disclosures that were displayed by companies.
Figure 4. Employee competence (Human Capital) disclosures, with a breakdown on
the six components
CONCLUSIONS
Thomas Stewart (1991) formulated the following hypothesis: Intellectual capital is
becoming corporate Americas most valuable asset and can be its sharpest competitive
weapon. The challenge is to find what you have, and use it. However, a major
obstacle in achieving competitiveness is tracing the epistemological perimeter of the
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concept of intellectual capital. To illustrate this difficulty, in the first section of the
present article, a literature review was constructed around the proposed definitions for
the concept of intellectual capital, along with a description of its components. The
strategic importance of organizational knowledge is a strong incentive for researchers
to propose definitions, perspectives and methods for the recognition and valuation of
intellectual capital.
In the second section, the present study was set out to apply content analysis
rigorously and to examine the nature and extent of intellectual capital disclosure for
the companies included in the STOXX Europe TMI Software & Computer Services
index. The results indicate that the reports issued by these companies emphasized the
importance of intellectual capital and covered a wide range of intellectual capital
items. In a similar note with other related studies, empirical evidence shows that,
although firms talk of human capital as the most important asset, in practice the most
reported category is internal capital with 42% (which was divided into intellectual
property 9.4% and infrastructure assets 32.6%), followed by external capital with 34%
and employee competence with 24%.
Secondly, evidence shows that very limited disclosure was made on patent, copyright,
trademark, company names, distribution channels, brands, franchising agreement,
know-how, entrepreneurial spirit and vocational qualification. This implies that
standard-setters are welcomed to develop an accounting framework that would allow
the recognition and measurement of such IC elements for which there are no
applicable accounting standards.
There is much scope for further research in this area. More data on companies in the
Software & Computer Services sector could be gathered in a longitudinal design,
which would provide more insight and would provide empirical evidence not only in
the extent of disclosure, but also on the time variations in IC reporting. Moreover, the
sample could be extended to include companies from other sectors, which would
serve to estimate a statistical model with a sector control variable. Finally, a more
developed research design could explore the complex motivations behind the
disclosure of IC, at a managerial level and from a market perspective.
ACKNOWLEDGEMENTS
This work was supported by CNCSIS UEFISCSU, project number PNII IDEI code
1859/2008, contract no. 837/2009.
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INTELLECTUAL CAPITAL:
THE ANNUAL REPORTING PRACTICES
Nicoleta Maria IENCIU1 & Dumitru MATI
ABSTRACT
The objective of this study is to examine voluntary intellectual capital disclosure provided by
listed Romanian entities in annual reports from the year 2009. In order to achieve such
objective we have undergone an applicative, quantitative research, using as method of
research the content analysis of the annual statements from Romanian entities listed at the
Bucharest Stock Exchange on information supplied on intellectual capital.
KEYWORDS: Intellectual Capital, Annual Reports, Romanian Listed Entities, Voluntary

disclosure
INTRODUCTION
Researchers of economics have lately manifested a great interest in studying and
informing potential investors regarding the true "fortune" of entities, because they
believe that people are ignored to a large extent, the resignation of a key employee is
not registered in the financial documents, hence the statement that individuals have an
important power within a company, due to their knowledge.
The switch to an economy based on knowledge had a major impact on the accounting
profession. Information is power and accountants had access to data understood by
very few or which were not within reach for just anyone. The technological
developments made information available at a large scale, and the routine activities,
such as processing and analysis, are now left to be taken care of by the IT team. As far
as accounting competences are concerned, a recent publication from FMAC (The
Financial Management and Accounting Committee within the International
Accounting Federation) states that: Local knowledge and technical competency will
become insufficient; instead, emphasis will be placed on contributions which bring
value in the accounting. In order to obtain an input in value, the accounting
profession will have to combine knowledge with understanding the traditional
financial information with more sophisticated interpretation techniques. This means
developing an accountant vigilance, which includes creating relations with other
departments and appreciating how their role contributes to the company's strategic
direction. Accountants must consider themselves not as crushing numbers, but also
as strategic advisers that can help entities to understand and evaluate their financial
and competitive position. The need to cross to a new level, to a rebirth of accounting
emerged from this, considering all non-tangible elements, even intellectual capital.
Nevertheless, many researchers hesitate in defining intellectual capital, but feel that
1
Correspondence address: Nicoleta Maria IENCIU, Babe-Bolyai University, Faculty of Economics

and Business Administration,Cluj-Napoca, Romania; email: nicoleta.ienciu@econ.ubbcluj.ro
~380~
this capital, which contains non-financial and related information, is the basic value
for a company (Amir & Lev, 1996; Edvinsson & Malone, 1997; Stewart, 1997;
Bontis, 1999, 2001, Ittner, 2008). They claim that intellectual capital supports entities
in creating value and offers competitive advantages. Therefore, intellectual capital can
be considered as one of the most valuable assets and the most competitive weapon in
business.
Consequently, the fundamental objective of this paper is to create an accurate image

of what intellectual capital represents from the angle of accounting researches. In
order to achieve this objective, we perform a content analysis of the annual reports
from entities listed on the Romanian capital market.
1. PRIOR RESEARCH AND BACKGROUND
The annual reports prepared and published by the entities listed on the capital market
have been used to investigate the practice of reporting information on intellectual
capital (Brennan, 2001; Guthrie et al., 1999, 2006) and the content analysis of the
annual statements having been used by various researchers, because it represents a
good instrument for a comparative assessment of positions and trends used in
preparing the statements.
Australian researchers have been amongst the first to adopt the content analysis as a
means to examine the practices used by entities to manage and prepare the statements
on intellectual capital. Guthrie and Petty (2000), by referring to the Australian annual
reporting practices, focus on intellectual capital utilized by the largest 19 entities, on
market capitalization. They use the method of content analysis and a modified version
of Sveibys model in order to classify information on intellectual capital. The three
dimensions of the intellectual capital conceptual framework (internal capital, external
capital and human capital) together with the related subcategories (nine for the internal
capital framework, nine for the external capital and six for the human capital) are encoded
with the value 0 when the variable is not included in the annual statement, 1 if the value is
presented in a discursive fashion, 2 when the information is approached from a
quantitative point of view and 3 when the information is assessed monetarily. The results
from Australian researches are far from being systematic, despite the attention and
significance granted to intellectual capital. Australian entities do not have an agreed
framework for preparing reports concerning the intellectual capital, moreover, it appears
the notion of assessing and reporting intellectual capital is enclosed into a rhetorical
framework lacking in content (Guthrie & Petty, 2000, p. 246). This is also supported by
the statement according to which almost every aspect related to intellectual capital has
been presented in a discursive fashion and not under monetary terms (Guthrie & Petty,
2000, p. 247).
Brennan (2001) conducted a similar study with relation to Irish entities, analyzing
annual statements from 21 entities listed on the stocks market. The author used an
identical scheme as Guthrie & Petty (2000) in order to encode data in the content
analysis of annual reports and has identified similar results to the Australian study.
Results obtained indicated that the Irish context was similar to the Australian one
because there is no reporting frame for intellectual capital; hence the entities assess
their intellectual capital by using the qualitative method and less the quantitative one.
Just as Guthrie & Petty (2000) have noticed, these results emphasize the difficulties
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encountered by entities in the administrative process for assessment and reporting of

intellectual capital.
A study conducted by Olsson (2001) examined the annual statements of the 18 most
important entities listed at the Swedish Stock Exchange, selected based on their
turnover, drafting a list of five elements in order to evaluate the level of human capital
reporting. The study pointed out that neither company granted more than 7% space,
as part of their annual statements, for presenting information on human resources, as
the information found in the statements had both quantitative and qualitative
deficiencies.
In their study on Malaysian entities, by using the questionnaire on intellectual capital
Bontis (2000) have found evidence linking corporate performance to the relevance
granted to human, structural and relational capital. A similar study has also been
conducted in Ireland (OReagan et al. 2001), coming to the result that intellectual
capital becomes a key element for the value of entities and national economic
performance. Even more so, it has been indicated that the usefulness of annual
statements is more and more challenged as they do not include intellectual capital
elements.
Therefore, based on the ideas presented above, we have conducted a study of our own,
using the content analysis method with regards to the annual reports of entities listed on
the Romanian capital market, intending to analyze the relevance of the ideas that have
been studied until now by transferring them into the chosen sample of entities.
The present paper contains a study performed on 68 entities listed on the Bucharest
Stock Exchange (BSE), Main Market (starting on December 31st, 2009). The
participant entities are from high technology industries such as: manufacturing,
mining and quarrying, constructions, financial services, transport, wholesale and retail
trade, tourism (see Appendix 1). In the study we took into account all the entities listed
on the BSE Market. Thus, from a total of 100 entities, we analyzed 68 entities (considered
the most traded), 6 of them being suspended and 26 non-listed. The sample was chosen
based on the fact that listed entities are obligated to publish their annual statements,
open to the public and, at the same time, deemed to be renowned entities heavily
impacting on the economy of a country. The entities included in the study is
represented by entities listed at the). The sources used for extracting information on
intellectual capital were the annual statements for the fiscal year 2009, because we consider
them the most important sources of information made available by the entities to the
external users and in particular to the shareholders.
We have made a content analysis, included in the study, for the annual statements of entities
listed on the Bucharest Stock Exchanges, wherein we have monitored the three dimensions
of the intellectual capital conceptual framework (internal capital, external capital and human
capital) together with the related subcategories (for the purpose of classifying information,
we have used a modified version of Sveibys model) which we have grouped as follows:
two subcategories for the framework of internal capital (the intellectual property patents,
copyrights, registered trademark; the infrastructure assets corporate culture, management
of processes, IT system, networks systems, research projects, financial relations), five for
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external capital (the customers companys customers, the loyalty of customers, customer
relations, customer involvement, attracting new customers; the reputation / image of the
company; the supply and distribution channels relations with suppliers and competitors;
the cooperation in business, research, concluded contracts; concluded agreements
franchises, licenses) and four for the human capital (education; employees; work-related
knowledge and work-related competencies).
3. THE ANALYSIS OF OBTAINED RESULTS
Starting from the classification of the intellectual capital elements by means of a
modified version of the Sveibys model (Bozzolan et al., 2003), we have performed a
content analysis of the annual statements of the entities listed on the Bucharest Stock
Exchange (Table 1) during which we have monitored the three dimensions of the
intellectual capital conceptual framework (internal, external and human capital) together
with the related subcategories we have grouped according to Table 2.
Aerostar
Alro
Altur
Alumil Rom Industry
Amonil
Antibiotice
Armatura
Azomures
Banca Comerciala
Carpatica
Banca Transilvania
Bermas
Biofarm
Boromir Prod
Banca Romana de
Dezvoltare
CNTEE Electrica
Table 1. The scoring system of information regarding intellectual capital within

Romanian listed entities in 2009
(panel A)
0,3
0,3
0,3
0,3
0,3
0,5
0,5
0,3
0,3
0,3
0,3
0,3
0,3
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
Relational/ External
Capital
0,4
0,5
0,2
0,7
0,4
0,5
0,4
0,6
0,5
0,3
0,4
0,5
0,6
Customers
(companys customers,
the loyalty of
customers, customer
relations, customer
involvement, attracting
new customers)
0,5
0,5
0,5
0,5
0,5
0,5
The image of the

company
0,5
0,5
0,5
0,5
0,5
Supply and distribution

channels (relations with
suppliers and
competitors)
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
Structural/ Internal
Capital
Intellectual property
(patents, copyrights,
registered trademark)
Infrastructure assets
(corporate culture,
management of
processes, IT system,
networks systems,
research projects,
financial relations)
~383~
Aerostar
Alro
Altur
Alumil Rom Industry
Amonil
Antibiotice
Armatura
Azomures
Banca Comerciala
Carpatica
Banca Transilvania
Bermas
Biofarm
Boromir Prod
Banca Romana de
Dezvoltare
CNTEE Electrica
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
Human Capital
0,5
0,6
0,5
0,3
0,1
0,3
0,6
0,3
0,1
0,1
0,1
0,5
0,6
0,3
Education
0,5
0,5
0,5
Employees
0,5
0,5
0,5
0,5
0,5
Work-related
knowledge
0,5
Work-related
competencies
0,5
0,5
0,5
0,5
Cooperation
(in business, research,
concluded contracts)
Concluded agreements
(franchises, licenses)
Cemacon
Comcm
Comelf
Compa
Compania
Energopetrol
Condmag
Contor Grup
Dafora
Electroaparataj
Electroputere
Farmaceutica
Remedia
Grupul Industrial
Electrocontact
Impact Developer
Constructor
registered
trademark)
(corporate culture,
management of
processes, IT
system, networks
systems, research
projects, financial
relations)
Capital
Customers
(companys
customers, the
loyalty of
customers, customer
relations, customer
involvement,
attracting new
customers)
Casa de Bucovina
Capital
Carbochim

(panel B)
0,3
0,3
0,3
0,3
0,3
0,5
0,3
0,3
0,3
0,3
0,3
0,5
0,3
0,3
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,1
0,3
0,3
0,4
0,3
0,3
0,4
0,4
0,3
0,5
0,4
0,3
0,6
0,2
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
~384~
Carbochim
Casa de Bucovina
Cemacon
Comcm
Comelf
Compa
Compania
Energopetrol
Condmag
Contor Grup
Dafora
Electroaparataj
Electroputere
Farmaceutica
Remedia
Grupul Industrial
Electrocontact
Impact Developer
Constructor
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
Human Capital
0,3
0,6
0,5
0,3
0,4
0,4
0,6
0,4
0,5
0,3
0,5
0,6
Education
0,5
0,5
0,5
0,5
Employees
Work-related
knowledge
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
The image of the

company
Supply and
distribution channels
(relations with
suppliers and
competitors)
Cooperation
(in business,
research, concluded
contracts)
Concluded
agreements
Work-related
competencies
Mefin
Mj Maillis Romania
Oil Terminal
Oltchim
OMV Petrom
Petrolexportimport
Prodplast
Romcarbon
Rompetrol Rafinare
Rompetrol Well
Services
SNTGN Transgaz
SSIF Broker
Santierul Naval
Orsova
Intellectual
property
(patents,
copyrights,
registered
trademark)
(corporate culture,
management of
processes, IT
system, networks
systems, research
projects, financial
relations)
Relational/
External Capital
Mechel Targoviste
Capital
Mecanica Ceahlau

(panel C)
0,5
0,3
0,3
0,5
0,5
0,5
0,5
0,5
0,3
0,3
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,6
0,4
0,6
0,4
0,5
0,6
0,8
0,4
0,6
0,6
0,7
0,7
0,7
0,3
0,3
~385~
Mecanica Ceahlau
Mechel Targoviste
Mefin
Mj Maillis Romania
Oil Terminal
Oltchim
OMV Petrom
Petrolexportimport
Prodplast
Romcarbon
Rompetrol Rafinare
Rompetrol Well
Services
SNTGN Transgaz
SSIF Broker
Santierul Naval
Orsova
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
Human Capital
0,5
0,5
0,5
0,4
0,4
0,1
0,5
0,3
0,4
0,4
0,6
0,6
0,6
0,1
0,3
Education
0,5
0,5
0,5
0,5
0,5
0,5
0,5
Employees
Work-related
knowledge
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
Customers
(companys
customers, the
loyalty of
customers,
customer relations,
customer
involvement,
attracting new
customers)
The image of the
company
Supply and
distribution
channels (relations
with suppliers and
competitors)
Cooperation
(in business,
research, concluded
contracts)
Concluded
agreements
(franchises,
licenses)
Work-related
competencies
Transilvania Constructii
SIF Banat Crisana
SIF Moldova
SIF Muntenia
SIF Oltenia
SIF Transilvania
Sinteza
Siretul Pascani
SOCEP
TMK Artrom
Teraplast
Titan
Turbomecanica
Turism Felix
Turism Hoteluri Marea
Neagra

(panel D)
Capital
0,3
0,3
0,3
0,3
0,3
0,5
0,3
0,3
0,3
0,5
0,8
0,3
registered
trademark)
0,5
~386~
SIF Banat Crisana
SIF Moldova
SIF Muntenia
SIF Oltenia
SIF Transilvania
Sinteza
Siretul Pascani
SOCEP
TMK Artrom
Teraplast
Titan
Turbomecanica
Turism Felix
Turism Hoteluri Marea
Neagra
(corporate culture,
management of
processes, IT
system, networks
systems, research
projects, financial
relations)
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
Capital
0,5
0,8
0,5
0,1
0,1
0,4
0,4
0,5
0,7
0,5
0,4
0,5
0,3
Customers
(companys
customers, the
loyalty of customers,
customer relations,
customer
involvement,
attracting new
customers)
0,5
0,5
0,5
0,5
The image of the

company
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
Human Capital
0,1
0,1
0,6
0,3
0,4
0,5
0,4
0,6
0,3
0,1
0,6
0,3
0,5
0,3
0,3
Education
0,5
0,5
0,5
0,5
0,5
0,5
Employees
0,5
0,5
0,5
0,5
0,5
Work-related
knowledge
0,5
0,5
0,5
0,5
0,5
0,5
Work-related
competencies
0,5
0,5
0,5
0,5
0,5
Supply and
distribution channels
(relations with
suppliers and
competitors)
Cooperation
(in business,
research, concluded
contracts)
Concluded
agreements
~387~
Structural/ Internal Capital
TOTAL
Zimtub
Zentiva
Vrancart
Ves
Vae Apcarom
UZTEL
UCM Resita
UAMT

(panel E)
0,3
0,8
0,3
0,8
0,3
0,3
0,2
0,1
0,5
0,5
0,5
0,5
0,5
0,5
0,3
Relational/ External Capital
0,5
0,7
0,6
0,4
0,4
0,3
0,4
0,2
0,4
Customers
(companys customers, the
loyalty of customers, customer
relations, customer involvement,
attracting new customers)
0,5
0,5
0,5
0,5
0,8
The image of the company
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,8
0,5
0,5
0,5
0,5
0,5
0,2
(patents, copyrights, registered
trademark)
(corporate culture, management
of processes, IT system,
networks systems, research
projects, financial relations)
Supply and distribution

channels (relations with
suppliers and competitors)
Cooperation
(in business, research,
concluded contracts)
Concluded agreements
Human Capital
Education
Employees
0,5
0,5
0,1
0,5
0,5
0,5
0,5
0,4
0
1
0
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,5
0,4
0
0,5
0,5
0,4
0
0,5
0,5
0,1
0
0,5
0
0
0
0
0
0,3
0
0,9
0,1
0,5
0,5
0,5
0,5
0,5
0,5
0,1
0 = the entities do not provide any information; 0.5 the entities provide qualitative information; 1 the entities provide
quantitative information
(Source: accomplished by authors)
These variables have been encoded with the score (value) 0 when the variable is not
included in the annual statement, 0,5 when the information is approached from a
qualitative point of view, 1 when the information is approached quantitatively. In the end,
we have calculated an average of scores and we have obtained a final scoring granted to
entities for information supplied in the annual statements on intellectual capital according
to Table 1.
~388~
Table 2. The analyzed elements of intellectual capital

1. Internal capital
2. External capital
3. Human capital
1.1. Patents
1.2. Copyrights
1.3. Trade-marks
1.4. Corporate culture
1.5. Management processes
1.6. Information systems
1.7. Networking systems
1.8. Research projects
1.9. Financial Contacts
Customers
2.1. Customers
2.2. Customer loyalty
2.3. Business collaboration
2.4. Customer involvement
2.5. Attracting new customers
Entity reputation
Supply and distribution channels
2.6. Relationships with suppliers
2.7. Relationships with competitors
Collaborations
2.8. Business collaboration
2.9. Research collaborations
2.10. Contracts
Agreements
2.11. Franchising agreements
2.12. Licensing agreements
Education
Employees
Work-related competence
(Source: adapted from Bozzolan et al., 2003)
We can notice the low interest manifested by Romanian entities in reporting

intellectual capital. Scorings obtained by the reports on elements within internal,
external and human capital have been 0,21; 0,38, and 0,27, relatively small scorings,
which signifies that most entities report insignificant information with regards to
intellectual capital, information which are mostly qualitative, non-financial and nonmonetary, related to the components elements of intellectual capital. The scorings
presented above were calculated using the following formulas:
i =1
ScoringIC
i =1
j =1
m1
m2
ECDj
j =1
m2
n
i =1
ScoringHC
ICDj
ScoringEC
m1
(1)
(2)
HCDj
j =1
m3
(3)
n
m3
~389~
Where:
ICDj/ECDj/HCDj = Internal Capital/External Capital/Human Capital dimensions
(components considered for our research)
m1 = Internal Capital dimension (2 analyzed components)
m2 = External Capital dimension (5 analyzed components)
m3 = Human Capital dimension (4 analyzed components)
n = the analyzed population (68 analyzed entities)
The scores obtained, using the prior formulas and according with Table 1 are
presented in Table 3.
Table 3. The obtained scores regarding the intellectual capital reporting
Intellectual capital components
Scoring
Internal capital
0,21
External capital
0,38
Human capital
0,27
We can observe from the scores obtained and presented above that the information
regarding internal capital, external capital and human capital provided by the Romanian
listed entities are qualitative information.
Hence the question we have asked: Is there a lack of interest for intellectual capitals
components within Romanian listed entities, or more likely a lack for a reporting and
evaluation framework for the intellectual capital which makes this information be
considered irrelevant for the company? At the same time, the small percentage
represented by reporting information on intellectual capital can be also explained by
the fact that although management would like to provide more relevant and useful
information to the public, they cannot act in such a way, because the danger of
competitors espionage persists. As underlined by Williams (2001) as well, such
reporting can catch attention from undesired parts as well. Therefore, although there
are sufficient arguments to convince management that reporting information on
intellectual capital is a necessity, they would not act because such reporting could
affect the company in a negative way, in particular for the case where the intellectual
capital groundwork is a poor one. On the other hand, the annual statement can
indicate that one priority for the company consists in investing financial resources in
the internal production or the purchase of new assets. Or, to the contrary, a report
from a company disposing of little intellectual capital might have a negative impact
on the companys reputation on the stock market, because this way it can be
considered unsuccessful.
If we were to perform an analysis of information reported for the three groups of
components related to intellectual capital, we should mention that:
according to expectations, aspects reported with regards to the internal structure
were part of the field of research projects. Information related to intellectual
property have not been reported, except on rare occasions, as they are irrelevant;
information regarding the external structure referred to four elements in
particular: customers, companys reputation, distribution chains, cooperation
and licenses;
~390~
as for the human capital, four of the Romanian participating entities offered no
information whatsoever for this topic. The most frequently reported element
and the closest to human resource was the one regarding the number of
employees, while the rest of annual reports were divided between the
knowledge of human capital, competences thereof and the employees training.
CONCLUSIONS
In this paper we aimed to achieve the proposed objective, to present an accurate image
of what intellectual capital represents for Romanian listed entities. In order to achieve
the purpose of our study, we have made a content analysis, of annual reports of
entities listed on the Bucharest Stock Exchanges, wherein we have monitored the
three dimensions of the intellectual capital conceptual framework (internal capital,
external capital and human capital) together with the related subcategories, using a
modified version of Sveibys model.
As a result of the study, we draw the conclusion that the treatment for intellectual
capital framework in Romania is in an initial stage. Most Romanian entities handle
this matter with indifference, reporting only certain information in connection to this
subject, yet without creating an individual framework of reporting.
Results obtained indicated that the national context is similar to the international
context because there is no reporting framework for intellectual capital. Romanian
listed entities do not have an agreed framework for preparing reports concerning the
intellectual capital; most information related to intellectual capital has been presented in a
discursive mode and not under monetary terms.
During future research, we will consider the analysis of annual reports for a longer
period of time, with a larger sample of listed entities on the national capital market or
international capital market. For the time being, the limitation of the study is given by
the relatively small population of entities participating to the analysis. Also, during
future research we will have in view more elements of intellectual capital for the
purpose of increasing the relevance of study.
ACKNOWLEDGEMENTS
This work was supported by CNMP, project number 92-085/2008. The project is entitled
Developing a functional model for optimizing the national strategy regarding financial
reporting within Romanian private sector entities.
REFERENCES
Amir, E. & Lev, B. (1996) Value-relevance of non-financial information: the wireless
communications industry, Journal of Accounting and Economics, August-December: 3-30
Bozzolan, S., Favotto, F. & Ricceri, F. (2003) Italian annual intellectual capital disclosure: an
empirical analysis, Journal of Intellectual Capital, vol. 4, no. 4: 543-558
Bontis, N. (2001) "Assessing knowledge assets: A review of the models used to measure intellectual
capital", International Journal of Management Reviews, vol. 3, no.1: 41-60
~391~
Bontis, N. (1999) "Managing organizational knowledge by diagnosing intellectual capital: Framing

and advancing the state of the field", International Journal of Technology Management,
vol. 18, no.5-8: 433-62
Edvinsson, L. & Malone, M.S. (1997) Intellectual Capital: Realizing Your Companys True Value
by Finding Its Hidden Brainpower, HarperCollins, New York, NY
Guthrie, J. & Petty, R. (2000) Intellectual capital: Australian annual reporting practices, Journal of
Intellectual Capital, vol. 1, no. 3: 241-51
Ittner C. (2008) Does measuring intangibles for management purposes improve performance? A
review of the evidence, Accounting and Business Research, vol. 38, no. 3: 261-272
Brennan, N. (2001) Reporting Intellectual Capital in Annual Reports: Evidence from Ireland,
Accounting, Auditing & Accountability Journal, vol. 14, no. 4: 423-436
Olsson, B. (2001) Annual reporting practices: information about human resources in corporate
annual reports in major Swedish companies, Journal of Human Resource Costing &
Bontis, N. (2000) Assessing knowledge assets: a review of the models used to measure intellectual
capital, working paper, McMaster University, Hamilton
OReagan, P., ODonnell, D., Kennedy, T., Bontis, N. & Cleary, P. (2001) Perceptions of
Intellectual Capital: Irish Evidence, paper submitted to: Birgitta Olsson, Editor, Journal of
Human Resource Costing & Accounting, Personnel Economics Institute, School of Business,
Stockholm University, S-106 91 Stockholm, Sweden
Guthrie, J., Petty, R. & Ricceri, F. (2006) The voluntary reporting of intellectual capital: comparing
evidence from Hong Kong and Australia, Journal of Intellectual Capital, vol. 7, no. 2: 254-71
Guthrie, J., Petty, R., Ferrier, F. & Wells, R. (1999) "There is no accounting for intellectual capital in
Australia: review of annual reporting practices and the internal measurement of intangibles
within Australian organizations", International Symposium - Measuring and reporting
intellectual capital: experience, issues and prospects, June: 9-10
~392~
APPENDIX 1
The analyzed entities
1
2
3
4
5
6
7
8
9
10
11
12
13
Entities
Aerostar
Alro
Altur
Alumil Rom Industry
Amonil
Antibiotice
Armtura
Azomure
Banca Comercial Carpatica
Banca Transilvania
Bermas
Biofarm
Boromir Prod
Field of activity
Manufacturing
Manufacturing
Manufacturing
Wholesale and retail trade
Manufacturing
Manufacturing
Manufacturing
Manufacturing
Financial services
Financial services
Manufacturing
Manufacturing
14
15
16
17
BRD
C.N.T.E.E Transelectrica
Carbochim
Casa de Bucovina
Financial services
Manufacturing
Manufacturing
Tourism
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
Cemacon
Comcm
Comelf
Compa
Compania Energopetrol
Condmag
Contor Grup
Dafora
Electroaparataj
Electroputere
Farmaceutica Remedia
Grupul Industrial Electrocontact
Impact Developer & Contractor
Mecanica Ceahlu
Mechel Trgovite
Mefin
MJ Mailis Romnia
Oil Terminal
Oltchim
OMV Petrom
Petrolexportimport
Prodplast
Romcarbon
Rompetrol Rafinare
Rompetrol Well Services
S.N.T.G.N. Transgaz
S.S.I.F. Broker
antierul Naval Orova
SIF Banat Criana
SIF Moldova
Manufacturing
Manufacturing
Manufacturing
Manufacturing
Constructions
Manufacturing
Constructions
Mining and quarrying
Manufacturing
Manufacturing
Constructions
Manufacturing
Manufacturing
Manufacturing
Manufacturing
Transport
Manufacturing
Manufacturing
Manufacturing
Manufacturing
Transport
Financial services
Manufacturing
Financial services
Financial services
48
49
50
51
52
53
54
55
56
57
58
59
60
Entities
SIF Muntenia
SIF Transilvania
SIF Oltenia
Sinteza
Siretul Pacani
Socep
T.M.K. Artrom
Teraplast
Titan
Turbomecanica
Turism Felix
Turism, hoteluri, restaurante Marea Neagr
61
62
63
64
65
66
67
68
UAMT
UCM Reia
Uztel
Vae Apcarom
Ves
Vrancart
Zentiva
Zimtub
Field of activity
Financial services
Financial services
Financial services
Financial services
Manufacturing
Manufacturing
Transport
Manufacturing
Manufacturing
Manufacturing
Manufacturing
Tourism
Tourism
Manufacturing
Manufacturing
Manufacturing
Manufacturing
Constructions
Manufacturing
Manufacturing
Manufacturing
~394~
DETERMINANTS OF INTELLECTUAL CAPITAL

DISCLOSURE IN THE CASE OF ROMANIAN
COMPANIES
Maria Cristina MORARIU1
ABSTRACT
After reviewing the literature in area of intellectual capital disclosure (ICD) and
determinants of ICD we acknowledged the need for conducting similar studies in the case of
Romanian companies listed on the Bucharest Stock Exchange (BSE). Consequently, we carry
out a content analysis of the annual reports of Romanian companies having as a primary
objective the assessment of the extent to which they disclose information in respect of the
intellectual capital (IC). Furthermore, using descriptive statistics, T test, Pearson correlation
and multiple regression analysis we are testing if determinants like company size and industry
type have influenced the disclosure of IC. Achieving this, we believe that our study contributes
to the ICD literature, represents a basis for comparison with the results of other studies from
other developing countries; it challenges researchers to extend the area of analysis by
considering the relation between ICD and other possible determinants.
KEYWORDS: intellectual capital, disclosure, determinants, intangible assets, reporting,

Romania
INTRODUCTION
In time, economists such as Walras and Fisher considered human beings, or their
acquired abilities and skills (English Classical School) as a component of capital
(Kiker, 1966; Kendrick, 1961). Their reasons for inclusion were: (1) the cost of
rearing and educating human beings is a real cost; (2) the product of their labour adds
to the national wealth; (3) an expenditure on a human being that increases this product
will, ceteris paribus, increases national wealth (Kiker, 1966: 485). In our days,
perspective has changed in the way that researchers and practitioners concentrate their
attention on the abilities and skills embedded in the human beings. By doing so, in
time a new concept has been born, developed and continues to challenge practitioners
and researchers: intellectual capital (IC).
The concept of IC was advanced by Adam Mueller, Friedrich List (Kendrick, 1961:
105) and referred to technical knowledge, know-how, forms of organization and
tangible capital goods. It is the result of investment in the discovery and the spread of
productive knowledge. In 1997, Stewart defines it as packaged useful knowledge
that includes the organizations processes, technologies, patents, employees skills
1
Correspondencce address: Cristina Maria MORARIU, The Academy of Economic Studies,

Bucharest, Department of International Accounting and Financial Reporting;
email: cristina.m.morariu@gmail.com
~395~
and information about customers, suppliers and stakeholders (Luthy, 1998: 4). In
1996, Brooking defines IC as combined intangible assets that enable the company to
function and comprises market assets, intellectual property assets, human centred
assets, infrastructure assets (Luthy, 1998: 4). In Edvinsson and Malones view, IC is
formed of human capital and structural capital (customer, organizational, innovation
and process capital) and considers it as debt issue (Lonnqvist, 2002). OECD defines
IC as human capital and structural capital, where the former refers to software,
distribution and supply chain, and the latter refers to employees resources, customers
and suppliers (Lonnqvist, 2002). Lonnqvist (2002: 14) by considering it as a synonym
of intangible assets defines IC as immaterial sources of value related to employees
capabilities, organizations resources and the way of operating them and the
relationship with its stakeholders. Some authors (Roslender and Fincham, 2001: 387)
are saying that IC is the new goodwill, something that the business builds up over
time, and which provides the major foundation for its continued competitive
advantage. According to other studies, (Stanciu, 2008, Morariu, 2010) IC is an
underlying characteristic of the employees, from which future benefits are expected to
flow to the company and that encompasses the followings: skills, capabilities,
experience, knowledge and last but not least morality. Ricceri (Striukova et al., 2008)
launches the idea according to which IC encompasses both resources that exist at a
particular point in time (a stock of IC) and the fluid way these resources are used and
interact with other resources to achieve the organisations goal. In 1997 Sveiby
(Guthrie and Petty 2000: 242) developed a framework for understanding IC that
classifies intangibles into three parts: internal structure (consisting of items such as
patents, concepts, models research and development, computer and administrative
systems, organizational culture and spirit), external structure (relationships with
customers, suppliers, brand names, trademarks, reputation) and employee competence
(education, skills, training, values, experience). The difficulty of defining IC and the
multiple understandings assigned to this concept made that reporting of IC to be a
challenging task for both the reporters and for the users of information. Numerous
studies investigated the quantity an the quality of information that companies provide
in respect of IC (Guthrie and Petty, 2000; Brennan, 2001; Bontis, 2003; Goh and Lim,
2004; Abdolmohammadi, 2005; Wong and Gardner, 2005; Bozzolan et al., 2006;
Vergauwen et al., 2007; Ax and Marton, 2008; Bruggen, 2009; Yau et al., 2009;
White et al., 2010; Oliveira et al., 2010; Yi and Davey, 2010; Ousama and Fatima,
2010; Branco et al., 2011; Singh and Kansal, 2011) and several studies were carried
out to provide evidence regarding the factors that my have contributed to the
disclosure of IC (Bruggen, 2009; Orens et al., 2009; Yau et al., 2009; Rimmel
et al., 2010; Sharabati et al., 2010; Oliveira et al., 2010; Huang et al., 2010; Branco
et al. 2011).
The number of the above studies carried out in different countries and even different
continents corroborated with the lack of literature in the case of Romanian companies,
challenged us to the present paper. Hence, we carry out a study that has two major
objectives: to analyse the quantity and the quality of IC items made in the annual
reports of the sample companies; and to focus on the analysis of the determinants of
ICD for the same sample companies. Twenty one annual reports as at 31 December
2009 of Romanian companies listed on the Bucharest Stock Exchange were collected,
and represented the sample companies. IC framework used in this study is a
combination of that used by Guthrie and Petty (2000) and the framework resulted
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from the work performed by a panel of researchers from the World Congress on
Intellectual Capital (WCIC). The resulted framework is composed of 33 IC items.
Regarding the methodology, in order to achieve our first objective, we conducted a
content analysis considering both the number and the location of the 33 IC items
classified under three captions: internal (structural capital), external capital and human
capital. For the second objective, an IC disclosure index (ICD_Index) was constructed
for each company which had a common base containing the 33 IC items. Results
obtained for ICD_Index are used when testing (through descriptive statistics, T test,
Pearson correlation and multiple regression analysis) whether certain factors such
company size and industry type influence ICD.
Being a pioneering study, our paper contributes to the ICD literature by providing
empirical evidence of the status of IC reporting and of determinants of ICD in a
developing country context. In addition, the results obtained represent a basis for
comparison with those obtained by other studies carried out in other developing
countries; can be used in Meta analysis and challenges researchers to extend the area
of analysis by considering the relation between ICD and other possible determinants.
To address our objectives, the paper is structured as follows: the next section briefly
explores the relevant research studies carried out in the area of ICD and the
determinants of ICD using the results therein as arguments for our hypothesis
development. The following section then explains the research methodologies used to
conduct the empirical analysis. Independently, another section presents and examines
the results of the research. The final section provides a summary of the paper
including conclusions and also discussing the key limitations of the study and future
research implications of its findings.
1. LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT
The central research questions that are addressed by this paper can be presented as
follows: What is the nature and extent of ICDs made by public Romanian
companies? and What are the key drivers of voluntary disclosure?
There are several studies investigating the quantity and the quality of information that
companies provide in respect of IC and several studies carried out aiming to provide
evidence regarding the factors that may have contributed to the disclosure of IC. Few
examples of such studies are summarised below in chronological order. Guthrie and
Petty (2000) analysed the ICD practices in the case of 19 Australian companies and
found that internal capital and human capital are quite evenly matched (30%) while
external capital is the most disclosed with 40%. Brennan (2001) examines to what
extent Irish listed companies report IC information within their annual reports. As a
result of conducting content analysis on 10,000 Canadian companies, with the
objective to identify instances in which ICDs took place, Bontis (2003) found that
only 68 companies out of 10,000 even used the IC terms in their annual report.
Findings from Malaysia (Goh and Lim 2004) reveal the fact that companies in
Malaysia follow the trend of other countries to include IC information in their annual
reports in the way that external capital had been mostly disclosed (41%).
Abdolmohammadi (2005) investigates the nature and extent of ICD within the annual
reports of US companies. Findings from this study reveal that IC categories Brand
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(external capital), Competence (human capital), Partnership (external capital) and

Intellectual Property (internal) were IC attributes with the highest frequency of
disclosure. Having the same objective, Wong and Gardner (2005) analyzed the annual
reports of 60 companies from New Zeeland and acknowledged that external capital is
the most IC category disclosed with 48%. Bozzolan et al. (2006) compared ICD
practices of 30 Italian firms and 30 UK firms and concluded that sample companies
from both countries voluntarily disclose a substantial amount of information about
their IC. With regard to the relative importance of the three categories of ICD, the
focus on external structure ranks highest (52.38% for Italian firms and 60.22% for UK
firms). Analysing 60 firms from Sweden, Denmark and UK, Vergauwen et al. (2007)
found that relational capital has the highest amount of disclosure (46%). Disclosures
of IC were analysed by Ax and Marton (2008) in order to study the association
between human capital disclosure and human capital management practices and
carried out a content analysis on 27 Swedish companies. Bruggen et al. (2009)
analyzed 125 listed Australian companies and found that structural capital is the most
frequently disclosed category (97.5%). Yau et al. (2009) examines the extent and
nature of voluntary intellectual capital (IC) disclosure by 60 public companies in
Malaysia and how the disclosure may be explained by the economics or other
rationale of corporate disclosure. Feleaga et al. (2010) analysis the annual report of 18
companies from 6 European countries and concluded that internal capital with 42% is
the most disclosed IC category, followed by external capital with 34% and employee
competence with 24%.
Even if most of the studies are carried out in the area of ICD, there are several ones
considering the factors that may determine companies to disclose IC. According to the
previous literature, the following factors have been tested so to confirm whether they
influence ICD: company size, industry type, information asymmetry, leverage,
ownership, companys age, profitability, nationality, auditor type, listing status,
foreign activity. The empirical evidence has sometimes shown a clear positive
relationship (size; capital intensity; foreign listing; internationality; ownership
structure) and sometimes a mixed relationship (leverage, audit firm size, profitability)
with levels of ICD.
When trying to determine the extent of intellectual capital disclosure practices in the
case of a sample of 30 Swedish listed companies, Beaulieu et al. (2002) considered
the effect of three variables: size, profitability, and industry classification. The
empirical results indicate that only size is significantly associated with the disclosure
of intellectual capital items.
To provide some empirical insights to the factors that might explain the type and
amount of information disclosed about intangibles, Bozzolan et al. (2003) tested the
influence of size and industry on the extent and the content of ICDs. They found that
size and industry seemed to explain differences in IC reporting behaviour among
Italian companies. Extending the research in the field of ICD by considering a
comparison between Italian and UK firms, Bozzolan et al. (2006) considers more
variables that could possibly influence the level of IC disclosure that are to be: size,
industry type, leverage, ownership, profitability, and nationality. The results of the
study reveal a modest support for industry type influencing ICD and that firm size
influences ICD. Against expectations, the study finds no support for nationality
variable on ICD.
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Garcia-Meca et al. (2005) used univariate analysis and found a positive relation
between a proactive intangibles disclosure strategy (in presentations to sell-side
analysts) and size, international listing, market-to-book ratio and type of meeting.
They also used multivariate analysis and found that while leverage, profitability,
industry and an investor relations department have no influence on the extent of
disclosure of intangibles, a partial variation was explained by firm size and type of
meeting.
In their paper, Oliveira et al. (2006) study the disclosure practices in the case of 56
Portuguese companies and identify size, industry type, ownership structure, audit type
and listing rules as key variables of interest. Leverage, profitability and foreign
activity dont seem to influence ICD. In line with their results are those obtained by
Branco et al. (2011) that find size and industry to be explanatory variables for the
extent of ICD in the case of Portuguese companies after investigating ICD both in
annual reports and on the internet.
Boesso and Kumar (2007) examine what factors in addition to the needs of financial
markets drive the voluntary disclosure practices of companies in Italy and United
States. Results show that in addition to investors information needs, factors such as
company emphasis on stakeholder management, relevance of intangible asset, and
market complexity affect both the volume and the quality of voluntary disclosures.
White et al. (2007) are using an ICD index score of voluntary disclosures to test
statistically the relationship between voluntary disclosures and traditional agency
theory variables in the case of 96 biotechnological Australian listed companies. The
key drivers of voluntary ICDs were the level of board independence, firm age, level of
leverage and firm size. By extending the research, White et al. (2010) compare the
nature and extent of voluntary ICDs in the case of 156 UK and Australian
biotechnology companies. Considering the same continent, Bruggen et al. (2009) are
examining the determinants of the decision to disclose IC in annual reports in the case
of 125 Australian listed companies. The paper finds that industry type and firm size
play a key role as a determinant for the disclosure of intellectual property in annual
reports and no relationship between the level of information asymmetry and ICD.
Orens et al. (2009) are conducting a content-analysis of corporate web sites from four
continental European countries (Belgium, France, Germany and The Netherlands) on
the presence of IC information. The data show that IC disclosure is positively
associated with firm size, lower information asymmetry, and leverage.
As opposite to the results obtained before, in other countries, are the results obtained
by Rimmel et al. (2009). The authors applied a disclosure index regarding IC included
in the IPO prospectuses of Japanese companies to test whether industry type,
ownership structure prior to the IPO, company age and company size influenced
disclosure. The results show that the first three factors (industry, ownership and size)
are not significant when it comes to explaining voluntary disclosure of information.
Nevertheless, company age, did, however, have a significant influence on the extent
of disclosure for Japanese companies. Similar results are obtained by Huang et al.
(2010) but in the case of availability of internal IC information in the case of
Malaysian companies. With the aim to explore several contingency variables
(environmental uncertainty, business strategy, and technological advancement, market
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to book ratio, size, profitability and industry type) in the context of management
accounting and the availability of internal IC information, the authors developed a
questionnaire that was posted to managers of Malaysian companies. It is found that
industry and size are not significantly related to the availability of internal IC
information in Malaysian companies.
Table 1 below presents a summary of the features of the studies concerned with the
determinants of ICD.
Table 1. Feature of studies analysing the determinants of ICD
Authors
P. R. Beaulieu et al.
S. Bozzolan et al.
Garca-Meca et al.
S. Bozzolan et al.
L. Oliveira et al.
G. Boesso and K.
Kumar
Year
2002
2003
2005
2006
2006
G. White et al.
2007 Australia
A. Brggen et al.
R. Orens et al.
Country
Size
Sweden
yes
Italy
yes
Spain
yes
Italy and UK
yes
Portugal
yes
Italy and United
2007
yes
States
yes
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
yes
n/a
n/a
yes
n/a
n/a
yes
yes
n/a
no
n/a
n/a
n/a
n/a
n/a
n/a
n/a
2009 Australia
yes
yes
no
n/a
n/a
n/a
n/a
no
n/a
n/a
n/a
n/a
n/a
n/a
Belgium,
France,
2009
Germany and
The Netherlands
yes
n/a
yes
yes
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
no
yes
no
yes
no
n/a
no
yes
n/a
n/a
n/a
n/a
n/a
no
n/a
n/a
yes
n/a
n/a
n/a
yes
n/a
n/a
n/a
n/a
n/a
no
n/a
n/a
yes
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
no
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
yes
n/a
n/a
n/a
yes
n/a
13
10
11
100%
77%
15%
46%
31%
8%
38%
23%
15%
23%
8%
8%
8%
8%
85%
60%
50%
33%
75%
100%
0%
33%
100%
67%
0%
100%
100%
100%
G. Rimmel et al.
2009
G. White et al.
2010
C. C. Huang et al.
2010
M. C. Branco et al.
2011
Total studies where the
variable was tested
Total studies where the
variable influences ICD
% Studies where variable was
tested/Total Studies
% Studies where variable
influences/Total Studies
variable was tested
Legend:
Industry Info
Auditor Listing Foreign Business Business Techn
type Asymmetr Leverage Ownership Age Profitability Nationality type Status Activity Complexit Strategy Adv
no
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
yes
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
n/a
no
n/a
no
n/a
n/a
no
n/a
n/a
yes
n/a
n/a
n/a
n/a
yes
n/a
no
no
n/a
no
no
n/a
n/a
n/a
n/a
n/a
n/a
yes
n/a
no
yes
n/a
no
n/a
yes
yes
no
n/a
n/a
n/a
Japan
Australia & UK
Malaysia
Portugal
yes means that the variable was tested and that it influences ICD;
no means that the variable was tested but that it does not influences ICD;
n/a means that the variable was not tested
According to the mixed results obtained by previous studies we can observe that the
determinants of ICD are not clearly shown, yet. In addition, Romanian companies
were not the subject of a similar study at all. Like studies made by Beaulieu et al.
(2002), Bozzolan et al. (2003; 2006), Garca-Meca et al. (2005), Oliveira et al. (2006),
Boesso and Kumar (2007), Bruggen et al. (2009), Orens et al. (2009), Branco et al.
(2011) we propose that company size is an important factor for IC disclosure in the
case of Romanian companies as larger companies can afford the cost to provide this
voluntary information. In addition, size is the most commonly used independent
variable as all 13 studies reviewed (see Table 1) considered it in their analysis and
85% of the studies showed that there is a positive correlation between the size of the
company and the level of ICD. All these arguments lead to our first null hypothesis:
H1:
There is no relation between company size and IC disclosure
Prior research has also noted that voluntary disclosures are influenced by industry
membership. It has been found that voluntary disclosures are more frequent and
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comprehensive in some industries, such as, utility, and financial services, than others,
such as, publishing. Literature provides complementary interpretation keys for
explaining the industry effect on corporate disclosure: this is because proprietary costs
vary across industries (Meek et al, 1995); firms are pressed to disclose industryrelated information in their annual reports (Cooke, 1992) by external investors who
need information on a companys relative position in an industry in order to assess
company value (Dye, 1985); disclosure within an industry may also be shaped by the
behaviour of a dominant company (Cooke, 1992); the international exposure of a
particular industry might affect the extent of disclosure (Raffournier, 1995);
intellectual capital is in some industries more important than in others and therefore
value-relevant for investors. The results obtained with respect to the variable industry
type are mixed, in the way that the studies reviewed which considered that industry
type is a determinant for ICD (Bozzolan et al., 2003, Bozzolan et al., 2006, Oliveira et
al., 2006, Boesso and Kumar, 2007, Bruggen et al., 2009, Branco et al., 2011) were
almost balanced by the number of studies that concluded industry type does not have
influence on ICD (Beaulieu et al., 2002, Garca-Meca et al., 2005, Rimmel et al.,
2009, Huang et al., 2010). This, corroborated with the fact that 77% of the studies
tested this correlation, brought us to the following null hypothesis:
H2: There is no relation between type of industry (traditional versus knowledge
intensive) in which the company is operating and IC disclosure
Last but not least, we test whether there is any combination between company size
and industry type that may have influenced the level of ICD and formulate the
following hypothesis:
H3: There is no relation between the combination of company size and industry
type and IC disclosure
This section contains a description of (1) the sample and data selection; (2) the
content analysis used to assess the quantity and the quality of ICD; (3) the
methodology used to test if company size and industry type are determinants of the
level of ICD.
2.1. Data Selection
There is evidence from prior studies that ICDs tend to be predominantly discursive in
nature (Ax and Marton, 2008, Guthrie and Petty, 2000; Goh and Lim, 2004, Bukh et.
al 2005). According to the results obtained by Petty et al. (2008), 68% of their
respondents used the annual report to learn more about a company and as an aid to
decision-making. This is consistent with the literature that positions the annual report
as a key accountability document to stakeholders (Lang and Lundholm, 1993).
According to Garcia-Mecca (2005) analysts and investors, draw on annual report
information in their work and this is not only related to financial information, but also
to non financial and narrative reporting. Additionally, much of the literature suggests
annual reports as basis for gathering data. In order to provide comparison with these
studies and future ones, this paper uses annual reports only. Information that is
disclosed by other means, such as on websites is not included. In addition, this study
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analyses the quality of disclosures by examining the reporting theme, the form of
disclosure (quantified or not) and location of disclosure (Guthrie et al., 2004).
2.2. Sample
Our sample consists of Romanian firms that are listed on BSE, where a total of 98
companies are classified in four exchange segments: tier I (22), tier II (48), tier IIII
(1), unlisted (27). For the purposes of our study, we consider the analysis of the
annual reports in the case of companies traded within tier I. As the objective of our
study is to analyse to what extend Romanian companies disclose IC information, we
have eliminated foreign companies even if traded on BSE. Our final sample consists
of 21 companies. The reason for including the tier I companies was that they are more
likely to disclose more information and are generally more transparent. We believe
that this sample allows general conclusions on publicly listed Romanian companies.
For constructing a comparable framework with other studies, we have used for the
classification of the Romanian sample companies into sectors of activity and
industries, the classifications and the definitions provided by the Global Industry
Classification Standard (GICS) at June 30, 2010. Accordingly, the sectors and
industries that the sample companies belong to are: Materials sector (Metals &
Mining, Chemical industry) with 3 observations, HealthCare sector (Pharmaceuticals)
with 2 observations, Financial sector (Commercial Banks, Real Estate Management &
Development, Capital Markets) with 10 observations, Utilities sector (Electric
Utilities, Gas Utilities) with 2 observations, Industrials sector (Marine, Aerospace &
Defence) with 2 observations, Energy sector (Oil, Gas & Consumable Fuels) with 2
observations. Companies classification into sectors and industries has been revised
independently by a second researcher. Furthermore, for the purposes of testing our
hypothesis, the industries are classified into traditional industries (food, automobiles,
chemicals, construction, electronics, manufacturing, oil, utilities, textile/clothing, and
tourism/leisure) and knowledge intensive business services (KIBS) (internet
application provision, biotechnology, entertainment, IT distribution, high tech
manufacturing, media, retail, software, systems integration, telecommunications, and
web services. Accordingly from this perspective we shall have nine observations
under traditional industry category and 12 observations under knowledge intensive
industry. The Table 3 at the end of this section provides us with a picture of the
companies classified under both criteria: GICS versus KIBS classification criteria.
2.3 Methodology used to assess the quantity and the quality of ICD
As many previous studies carried out in this field (Petty et al., 2008; Bruggen et al.,
2009; Goh and Lim, 2004; Boesso and Kumar, 2007; Striukova et al., 2008) we
conduct a content analysis to scrutinize the IC reporting practices of the sample
companies. As a technique, it involves codifying information into pre-defined
categories in order to derive patterns in the presentation and reporting of information
(Guthrie and Petty, 2000: 245). For a content analysis to be effective there needs to be
clearly defined decision rules and a clear understanding of the coding framework
(Wong and Gardner, 2005). In this research, phrases are viewed to be the most
reliable and complete unit of analysis, as individual words have little meaning without
context. Choosing phrases also eliminates ones concern that content analysis
overemphasises quantity over quality through simple word counting. To ensure
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reliable data, a rigorous and transparent coding procedure was undertaken by two
different coders. Each coder was given clear and transparent coding procedures to be
followed, respectively: only code for voluntary disclosure, code for meaning rather
than exact words as concepts are broad, code only for positive and negative meanings.
Discrepancies were analysed for size and for resolution.
The content analysis involved coding the information in accordance with a selected
framework of IC indicators. The IC framework was derived from the one used by
Guthrie and Petty (2000). For the purpose of our study, we modified this IC
framework to achieve a better comparison with other studies. As such, we kept the
headings and the items used by Guthrie and Petty, but we have added extra items
identified in the framework resulted from the work performed by a panel of
researchers from the World Congress on Intellectual Capital (WCIC) (Bontis 2003).
Professional judgment was used to eliminate redundancies between these two
frameworks. The resulting IC items are presented in Table 2.
Table 2. Categories of IC used for this study
Internal (Structural) Capital
Intellectual Property
Patents
Copyrights
Trademarks
Infrastructure asset
Corporate Culture (Organisational Culture)
Management processes (Management
Quality)
Information Systems
Networking systems (Expert Networks)
Financial Relations
Corporate University/Corporate learning
Cultural diversity
Structural Capital
External (customer/relational) capital
Emplyoee competence (human capital)
Brand
Customers (Customer knowledge)
Customer loyalty (Customer capital)
Company names (Company Reputation)
Business collaboration
Licensing agreeements
Know how (Employee know-how)

Education (Employee Knowledge)
Skills - vocational qualification (Employee Skills)
Work-related knowledge (Expertise)
Work-related competencies (Productivity)
Human Capital
Favourable contracts
Human Assets
Franshising agreements
Relational Capital
Supplier Knowledge
The brackets present the terminology used by the researchers from the WCIC
corresponding to the one used by Guthrie and Petty (2000). Items that didnt overlap
were added to those already existing obtaining in this way a total of 33 IC items
(14 for internal capital, 11 for external capital and 8 for human capital). This
extension allowed us to measure both the level of disclosing IC components and to
ascertain whether companies disclose the word itself, the latter finding being a proof
of the importance that companies give to IC. The method used was for one researcher
to read the annual reports and record information related to each attribute (location,
quantity and nature of the information) on a coding sheet. A second coder
independently confirmed the score of each company. This gives a high degree of
confidence in the overall result. Our content analysis focuses on voluntary
information (that is it is not required by an accounting standard or corporation law).
This is consistent with other ICDs studies (Guthrie and Petty, 2000; Brennan, 2001;
Ax and Marton, 2008).The results represent a matrix of information identifying the
incidence of IC reporting across 33 IC attributes, which was used to facilitate an
overall assessment of the extent to which IC is reported by Romanian listed
companies. Considering the limited length of annual report as cost and design reasons
limit the number of pages, volume or disclosure of a particular item signals how
important it is considered to be (Striukova et al., 2008). Although content analysis is a
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source of rich data, it is labour intensive and time consuming methodology (Boesso
and Kumar, 2007; Striukova et al. 2008). As such, it is fairly common to find a
relatively small sample size in studies using this methodology
2.4 Methodology used for the analysis of the determinants of ICD
In order to analyse the determinants of ICD, we constructed an IC disclosure index
(ICD_Index) for each company which had a common base containing the 33 IC items.
In constructing the disclosure index, dichotomous scoring for each of the 33 IC items
was used (disclosure =1, non-disclosure =0). Hence, the maximum possible score
attainable by a company was 33 with a minimum theoretical score of 0. Furthermore,
ICD_Index is used to test (through descriptive statistics, T test, Pearson correlation and
multiple regression analysis) whether certain factors such company size and industry
type influence ICD.
2.4.1 Measure of ICD_Index (dependent variables)
Based on the total of the 33 IC items, we are constructing a weighted disclosure index
calculated in accordance with the following formula:
n
ICD_Index = ( di / M ) x100 percent

i =1
Where ICD_Index is the disclosure index dependent variable, di expresses item i

when the items value is 1 with disclosure and 0 when there was no disclosure, and M
is 33 (the total number of items being measured).
2.4. 2 Measure of company size and industry type (independent variables)
This section describes how the independent variables are measured.
Size: Researchers have commonly used different measures such as sales, revenue,
asset, and number of employees, as proxies for company size. Alternative proxies of
firm size include total assets (Oliveira et al., 2006; Bruggen et al., 2009); turnover
(Bozzolan et al., 2003; Bozzolan et al., 2006; Oliveira et al., 2006); market
capitalization (Garca-Meca et al., 2005; Oliveira et al., 2006; White et al., 2007;
White et al., 2010); and number of employees (Oliveira et al., 2006; Boesso and
Kumar, 2007; Huang et al., 2010). While market capitalization is a market-related
characteristic, the other three proxies are structure-related characteristics. For our
study we shall use as a proxy the company turnover (sales) for the year ending 31
December 2009 as we consider turnover to give us the market share no matter what
market one may refer to. Total assets are not that relevant unless comparison is made
within the same industry; the number of employees is less relevant as there industry
types that can be more labour intensive than other. For the purposes of our study, size
is measured as the natural logarithm of the firms sales taken from annual reports as of
31 December 2009.
Industry type: To capture the influence of industry on the voluntary disclosure of
intangibles information, we use a dichotomous variable (applying 1 for firms
belonging to high intangibles intensive industries; and 0 otherwise). Similar to other
studies in this area, we separate between traditional industries such as food,
automobiles, chemicals, construction, electronics, manufacturing, oil, utilities,
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textile/clothing, and tourism/leisure, and non-traditional Knowledge intensive

industries such as internet application provision, biotechnology, entertainment, IT
distribution, high tech manufacturing, media, retail, software, systems integration,
telecommunications, and web services. In general, intangible assets are assumed to
play a more important role in non traditional industries whereas traditional industries
depend more on tangible assets. It is expected that industries with high levels of
intangibles will voluntarily provide more information about intangibles, consistent
with prior studies. Table 3 below is presenting the companies analysed classified
according to traditional versus knowledge intensive criteria.
Table 3. Companies classified under the KIBS and GICS criteria
KIBS
Criteria
GICS
Criteria
Traditional Industry Knowledge Intensive

Materials sector
(Metals & Mining,
Chemical industry)
No of
3
companies
Company
ALRO S.A.
name
AZOMURES S.A.
OLTCHIM S.A. RM.
Knowledge Intensive
BIOFARM S.A.
Traditional Industry
Financial sector
Utilities sector
Industrials sector
Energy sector (Oil,
(Commercial Banks, Real
Estate Management & (Electric Utilities, Gas (Marine, Aerospace & Gas & Consumable
Utilities)
Defence)
Fuels)
Development, Capital
Markets)
HealthCare sector
(Pharmaceuticals)
ANTIBIOTICE S.A.
10
BANCA COMERCIALA
CARPATICA S.A.
C.N.T.E.E.
OIL TERMINAL
SOCEP S.A.
TRANSELECTRICA
S.A.
S.N.T.G.N.
BANCA TRANSILVANIA TRANSGAZ S.A.
TURBOMECANICA OMV PETROM
BRD - GROUPE SOCIETE
GENERALE
IMPACT DEVELOPER &
CONTRACTOR S.A.
S.S.I.F. BROKER S.A.
SIF BANAT CRISANA
SIF MOLDOVA S.A.
SIF MUNTENIA S.A.
SIF OLTENIA S.A.
SIF TRANSILVANIA S.A.
3. RESULTS AND ANALYSIS

3.1 Results and analysis regarding the quantity and quality of ICD
We first analyze the content of the annual reports. The results are shown in Table 4, at
the end of this section, where the number of hits is summarized in accordance with the
classification categories. We identified a total of 222 hits related to IC attributes.
Internal (structural) capital is the most frequently disclosed category representing
47.30% of IC attributes disclosed (105 hits out of 222), followed by the disclosures of
the external (relational) capital with 27.48% (61 hits out of 222) and employee
competence (human capital) with 25.22% (56 hits out of 222). When it comes to the
nature of the information disclosed, a significant percentage of the information
reported is qualitative 76% (169 hits out of 222) leaving the rest of 24% (53 hits out
of 222) for quantitative IC attributes disclosure. Companies that disclosed most
attributes in quantitative form are Transilvania Bank (for 6 attributes), Biofarm
(for 5 attributes) and OMV Petrom (for 5 attributes). Each of these companies belong
to different industries (Commercial Banks, Pharmaceuticals and Oil, Gas &
Consumable Fuels), industry specific not being explanation for this. Results obtained
confirm that Romanian listed companies are in line with other countries companies
disclosures trend in the way that ICDs are most of qualitative nature.
~405~
Furthermore, none of the 33 attributes scored 100% disclosure across sample

companies. It means that no attribute was disclosed by all 21 companies. Out of the
33 IC related terms considered for this study, only 22 terms appear in the annual
reports of Romanian listed companies. The maximum number of attributes disclosed
per company is 15 (is the case of Impact Developer and Contractor and OMV
Petrom), followed by a number of 13 attributes disclosed in the case of Alro and 12 in
the case of Antibiotice. Of those 22 terms, Management philosophy is disclosed
most frequently with 46 hits in the annual reports of 18 Romanian companies.
Considering the total sample of 21 companies, the number of companies disclosing
Management philosophy implies IC consciousness (86% of the sample companies).
However, these companies did not give a value to this attribute. Work-related
knowledge (Employee Expertise, Expert Teams) is the second most frequently
reported term with 23 hits in the annual reports of 15 companies. In this case
12 companies (80% from the total of 15 companies) assigned a quantitative value to
this attribute with 15 hits out of 23 being quantitative not qualitative. In addition,
work-related knowledge attribute is the attribute with the highest number of
quantitative information assigned (15 hits out of a total of a 53 quantitative
information hits). Still, in-depth analysis shows that about 65% of the hits for this
attribute are quantitatively disclosed (15 hits out of the 23 hits) which does not make
the Work-related knowledge attribute the leading item, but the Education one.
This latter attribute, Education is the third most frequently disclosed term in annual
reports with 18 hits in the annual reports of 11 companies. Out of these 11 companies,
8 companies (73%) assigned a quantitative value to this attribute with 12 hits out of
18 hits (67%) being quantitative not qualitative. Out of the 33 attributes, the ones with
the lowest disclosure frequency were: Networking systems (Expert Networks) with
1 hit disclosed by one company (Transilvania Bank), Favorable contracts with 2 hits
both disclosed by one company (Impact Developer and Contractor) and
Entrepreneurial spirit (Employee Value, Human Value) with 1 hit disclosed by one
company (Alro).
In terms of disclosure location, IC information is reported in diverse sections of the
annual reports. Notably, this information is extensively mentioned in the directors
report and operations and activities description sections. This demonstrates
companies concern for reporting IC. The variation in ICDs may be explained by
differences in information production costs. An alternative explanation may be that
firms focus their ICD on those IC elements that are most relevant for the companys
value creation process (Vergauwen et al., 2007: 1164). Below are examples quoted
from annual reports.
Eighteen companies disclosed on the significance of management philosophy, while
nine companies (43% out of full sample of 21 companies) disclosed on the importance
of Corporate University/Corporate learning. The importance of Corporate Culture
is also clearly shown as it is disclosed by 33% of the companies.
Corporate University/Corporate learning attribute is reported by Transilvania Bank as:
Training on products and services comprises a large range of sessions provided to
our staff to become thoroughly accustomed with the best possible practices to ensure
customer satisfaction. Annual Report, Human Resources section.
~406~

Different attributes of external (customer/relational) capital category are disclosed by
ten companies. Accordingly, Distribution channels is the most reported attribute as
it is disclosed by ten companies (48% out of full sample of 21 companies), followed
by Business Collaboration (43% of full sample companies) attribute reported by
nine companies and by Brand (38% of 21 companies) attribute disclosed in the
annual reports of eight companies.
Business Collaboration is reported by Azomures as:
The distribution of the production on the internal market is realized 94% though a
well established network of partners. It explains how the collaboration with
distributors allows the company to distribute virtually all of its production. Annual
Report, section 1.1.2. Markets
Employee competence (human capital)
A maximum of 15 companies disclosed information on the significance of Workrelated knowledge (that is 71% of 21 companies), while 11 companies (52% out of
full sample of 21 companies) disclosed on the importance of Education. The
importance of Skills is also clearly shown by its disclosure in the annual report of
6 companies (29% of the sample companies).
Work-related knowledge as reported by Transgaz SA:
in 2009 () 1602 employees have been professionally qualified for jobs like
electrician, welder ().Annual Report, page 20.
7
1
5
3
2
1
2
1
1
1
9
3
2
2
27
13
5
2
6
19
12
6
5
1
2
1
3
1
1
1
1
11
3
2
1
8
1
6
1
1
1
5
1
2
1
1
3
1
1
2
1
2
8
1
1
1
3
1
1
2
1
1
1
2
1
1
3
2
2
0
0
1
1
19
10
6
2
2
6
5
2
2
1
7
6
2
3
1
9
6
3
2
1
4
3
3
0
0
12
1
3
2
4
2
39
15
4
6
5
7
6
2
2
2
11
6
1
4
1
1
1
1
1
1
13
3
4
1
2
3
34
15
5
5
5
7
7
2
3
2
4
3
1
0
2
4
4
2
0
2
10
6
3
1
2
2
2
1
0
1
3
3
1
0
2
~407~
3
2
0
1
1
1
1
0
0
1
3
3
1
1
1
105 47%
13 6%
3
1%
0
0%
7
3%
0
0%
46 21%
13 6%
3
1%
3
1%
1
0%
0
0%
16 7%
0
0%
0
0%
56 25%
12 5%
0
0%
3
1%
3
1%
14 6%
9
4%
13 6%
2
1%
0
0%
0
0%
0
0%
61 27%
5
2%
18 8%
8
4%
23 10%
6
3%
1
0%
0
0%
0
0%
222 100%
130
52
39
39
97
12
3
0
5
0
46
13
3
3
0
0
12
0
0
46
6
0
3
3
11
8
13
2
0
0
0
26
2
6
6
8
3
1
0
0
169
Q u a n t it a t iv e %
Q u a n t it a t iv e
Q u a lit a t iv e %
Q u a lit a t iv e
T o t a l h it s
15
1
1
S ocep
T u r b o M e c a n ic a
S I F M o ld o v a
S I F M u n t e n ia
S I F O lt e n ia
S IF B a n a t
C risa n a
16
7
S I F T r a n s i lv a n ia
S .S .I .F . B r o k e r
3
1
O M V P e tr o m
S N T G N T ra n sg a z
3
1
5
1
I m p a c t D e v e lo p e r
a n d C o n tr a c to r
O il T e r m in a l
2
1
O lt c h im V a lc e a
2
1
C N T E E T ran s
e le c t r ic a
7
5
1
x
B R D G rou p e
S o c ie t e G e n e r a le
15
2
B io f a r m
A zom u res
9
1
1
B an ca
T r a n s ilv a n ia
15
A n t ib io t ic e

Intellectual Property
Patents
Copyrights
Trademarks
Infrastructure asset
Corporate Culture
Information Systems
Networking systems
Financial Relations
Corporate University/Corporate learning
Cultural diversity
Structural Capital
Brand
Customers (Customer knowledge)
Customer loyalty (Customer capital)
Company names (Company Reputation)
Business collaboration
Licensing agreeements
Favourable contracts
Franshising agreements
Relational Capital
Supplier Knowledge
Know how (Employee know-how)
Education (Employee Knowledge)
Skills - vocational qualification (Skills)
Work-related knowledge (Expertise)
Work-related competencies (Productivity)
Human Capital
Human Assets
Total hits
No of atributes hit, of which
B a n c a C a r p a tica
Company name
A lr o
Table 4. Results of the content analysis
8
1
0
0
2
0
0
0
0
0
1
0
4
0
0
10
6
0
0
0
3
1
0
0
0
0
0
35
3
12
2
15
3
0
0
0
53
92%
92%
100%
n/a
71%
n/a
100%
100%
100%
100%
0%
n/a
75%
n/a
n/a
82%
50%
n/a
100%
100%
79%
89%
100%
100%
n/a
n/a
n/a
43%
40%
33%
75%
35%
50%
100%
n/a
n/a
76%
8%
8%
0%
n/a
29%
n/a
0%
0%
0%
0%
100%
n/a
25%
n/a
n/a
18%
50%
n/a
0%
0%
21%
11%
0%
0%
n/a
n/a
n/a
57%
60%
67%
25%
65%
50%
0%
n/a
n/a
24%
3.2 Analysis of the results in the case of the ICD determinants

The data collected for this study was analysed through the use of T test, Pearson
correlation and multiple regression analysis using SPSS Version 13 software.
In order to have a first impression of the data introduced and to check for errors or
problems we have computed for the basic descriptive statistics; mean minimum and
maximum values for the entire variable in the case of each company. The Table 5
below presets our first descriptive statistics.
Table 5. Descriptive statistics
N
Internal_Structural_Capital
Intellectual_Property
Patents
Copyrights
Trademarks
Infrastructure_asset
Management_philosophy
Corporate_Culture_Organisational_Culture
Management_processes_Management_Quality
Information_Systems_Knowledge_Sharing_Knowledge_M
anagement Or
Networking_systems_Expert_Networks
Financial_Relations
Corporate_UniversityCorporate_learning
Cultural_diversity
Structural_Capital
External_customerrelational_capital
Brand
Customers_Customer_knowledge
Customer_loyalty_Customer_capital
Company_names_Company_Reputation
Distribution_channels
Business_collaboration
Licensing_agreeements
Favourable_contracts
Franshising_agreements
Relational_Capital
Supplier_Knowledge
Emplyoee_competence_human_capital
Know_how_Employee_knowhow
Education_Employee_Knowledge
Skills__vocational_qualification_Employee_Skills
Workrelated_knowledge_Employee_Expertise_Expert_Te
ams
Workrelated_competencies_Employee_Productivity
Entrepreneurial_spirit_Employee_Value_Human_Value
Human_Capital
Human_Assets
Industry_type
Frequency_IC_Item
ICD_Index
Company_size
Valid N (listwise)
~408~
Minimum
Maximum
Mean
0
21
21
21
21
21
21
21
21
0
0
0
0
0
0
0
0
1
1
0
1
0
1
1
1
0.29
0.14
0
0.14
0
0.86
0.33
0.1
21
21
21
21
21
21
21
21
21
21
21
21
21
21
21
21
21
21
21
21
21
21
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
1
1
0
1
0
0
0
1
0
1
1
1
1
1
1
0
0
0
0
1
1
1
0.14
0.05
0
0.43
0
0
0
0.38
0
0.05
0.14
0.48
0.43
0.33
0.05
0
0
0
0
0.14
0.52
0.29
21
21
0
0
1
1
0.71
0.14
21
21
21
21
21
21
21
0
0
0
0
0
1
0.03
15
1
0
0
1
15
0.45
23.53
0.05
0
0
0.52
6.1905
0.1876
19.6929
This output shows for each of the 40 variables, the number (N) of companies with no
missing data on that variable. The Valid N (listwise) is the number (21) which has no
missing data on any variable. The Table 5 also shows the minimum and the maximum
score that any company had on that variable. These value are normal considering the
dichotomous variable that can take a minimum of 0 value and a maximum of 1 as
applicable. It can be observed that for several variables, the maximum value is also
0 which means that they were not disclosed by any of the company analysed
(Copyrights,
Infrastructure_asset,
Financial_Relations,
Cultural_diversity,
Structural_Capital, External_customer_relational_capital, Customers_Customer_
knowledge, Franshising_agreements, Relational_Capital, Supplier_Knowledge,
Emplyoee_competence, Human_Capital, Human_Asset). In addition, the Table 5
provides the mean for each variable. It can be noted that: 86% of the companies
disclosed information about Management_philosophy; 71% of the companies
disclosed information about Employee_Expertise follwed by Education_Employee
disclosed in the case of 52% of the sample companies. Considering the sample
companies, we can also conclude that 52% of the companies belong to knowledge
intensive industry.
Further on we considered the frequency of scale variable to test whether ICD_Index
and Company_size are normally distributed. In this respected we have used the
histogram for ICD_Index and Company_size. These are presented below.
Graph 1. ICD_Index distribution
Graph 2. Company_size distribution
6
4
Frequency
Frequency
5
4
3
2
1
1
0
0.00
0.10
0.20
0.30
ICD_Index
0.40
0.50
Mean =
0.1876
Std. Dev. =
0.13161...
0
14.00
16.00
18.00
20.00
Company_size
22.00
24.00
Mean =
19.6929
Std. Dev. =
2.0397
N = 21
Considering the graphs obtained, we can conclude that Company_size is

approximately normally distributed (there is a small number of scores for low values
and a relative small numbers of scores for high values; that most scores are for the
middle values). In the case of ICD_Index, we can notice that the bars form a pattern
quite different from the normal curve line (there is a small number of scores for low
values but a relatively low number of scores for high values; the most scores are not
for the middle values) so it may be debatable whether it is normally distributed.
Because of this debate, we computed in the case of both variables the mean, median,
mode and skewness (see Table 6 below). They will help us to determine the central
tendency of the variables.
~409~
Table 6. Descriptive statistics for ICD_Index and Company_size

ICD_Index
21
0
0.1876
Mean
0.1818
Median
0.18
Mode
0.13161
Std. Deviation
0.966
Skewness
0.501
Std. Error of Skewness
0.42
Range
0.03
Minimum
Maximum
0.45
a. Multiple modes exist. The smallest value is shown
N
Valid
Missing
Company_size
21
0
19.6929
19.2080
15.00
2.03970
0.004
0.501
8.53
15.00
23.53
As it can be observed the mean and the median in the case of both variable are very
similar which support that ICD_Index and Company size are approximately normally
distributed. In addition, the statistic skewness is < 1 (0.966 and 0.004) in both cases
which also support that the variables are normally distributed. It is true that in the case
of ICD_Index the value is very close to 1, but as long as it is lower then 1, then we
can consider as being approximately normally distributed.
Before running any inferential statistics, first we examined the relationship between
the variables to determine how to conduct the hypothesis testing analysis.
3.2.1 Testing hypothesis H1
H1:
There is no relation between company size and IC disclosure
Within H1 hypothesis, the independent variable is nominal and the dependent variable
is an approximately normally distributed scale variable. Accordingly, H1 hypothesis
is a basic two variable difference hypothesis and for testing it we chose the T test. The
results of the T test are presented in the Table 7 below (since the independent samples
T test procedure compares the two group means, it is useful to know what the mean
values are so, we present their values in the Table 8). The test compares the means for
two groups of cases. We can observe that the significance value for Levene test is
high (0.147 that is greater than .05) and because of this we shall consider the results
that assume equal variances for both groups. Regarding the significance value for the
T test, we can observe it is also high (0.195 respective 0.207) and corroborated with
the fact that the confidence interval for the mean difference contains zero then we can
not conclude that there is a significant difference between the two group means. In
conclusion the results obtained dont reject the null hypothesis H1 and thus for
Romanian companies industry type does not seam to influence IC disclosure.
Table 7. Results of T test: Group statistics
Industry_type
ICD_Index traditional
knowledge_intensive
N
10
11
~410~
Mean
0.2273
0.1515
Std.
Deviation
0.15402
0.10141
Std. Error
Mean
0.04871
0.03058
Table 8. Results of T test: Independent samples test

Levene's Test for
Equality of Variances
ICD_Index Equal
variances
assumed
Equal
variances not
assumed
t-test for Equality of Means

95% Confidence
Interval of the
Difference
Lower
Upper
Sig.
df
Sig. (2tailed)
Mean
Difference
Std. Error
Difference
2.288
0.147
1.344
19
0.195
0.07576
0.05638
-0.04224
0.19376
0.207
0.07576
0.05751
-0.04658
0.19809
1.317 15.347
3.2.2. Testing hypothesis H2

H2: There is no relation between industry type and IC disclosure
In the case of H2 hypothesis both independent and dependent variables are scale so it
is a basic two variable associational hypothesis. Accordingly to test the hypothesis we
chose Pearson correlation.
For Pearson correlation we first must check whether the two variables have a linear
relationship. For this we are going to generate a scatterplot. We considered both a
curve and a linear line.
Graph 3. Correlation between ICD_Index and Company_size
0.50
ICD_Index
0.40
0.30
0.20
0.10
R Sq Quadratic =0.152
R Sq Linear = 0.139
0.00
14.00
16.00
18.00
20.00
22.00
24.00
Company_size
From the graph above we can observe that there is a positive correlation between the
variables, but that the correlation is relatively week (r squared is only 0.139 or 0. 152).
In addition, it seams that the linear line fits the point better than the curve so we can
consider that the variables have a linear relationship and we can continue out testing
with Pearson correlation. The Table 9 below presents the results obtained for Pearson
correlation (r). The Table 9 shows that the two variable are not significantly correlated
r (21) = 0.373, p > 0.05. Because the p value of 0.096 > 0.05 it means that r in not
statistically significant and thus it suggests that hypothesis H2 is not being rejected
and thus we can state that company size does not influence the IC disclosure.
~411~
Table 9. Pearson correlation results

ICD_Index
Company_size
ICD_Index
1
Pearson Correlation
Sig. (2-tailed)
Pearson Correlation
Sig. (2-tailed)
Company_size
0.373
0.096
1
0.373
0.096
a. Listwise N=21
3.2.3 Testing hypothesis H3

H3: There is no relation between the combination of company size and industry
type and IC disclosure
In the case of hypothesis H3 we have one normally distributed scale dependent
variable (ICD_Index) and two independent variables from which one is nominal
(Industry_type) and the other is scale (Company_size). Accordingly we are using
multiple regression analysis to test the hypothesis H3. The results of multiple
regression analysis are presented in Table 10, Table 11, and Table 12 below.
Table 10. Multiple regression results: Model summary
Model
R
R Square
Adjusted R Square
1
0.445
0.198
0.109
a. Predictors: (Constant), Industry_type, Company_size
Std. Error of the Estimate

0.12424
Table 11. Multiple regression results: ANOVA
Model
1
Sum of Squares
0.069
Regression
0.278
Residual
Total
0.346
a. Predictors: (Constant), Industry_type, Company_size
b. Dependent Variable: ICD_Index
df
2
18
20
Mean Square
0.034
0.015
F
2.220
Sig.
0.137
Table 12. Multiple regression results: Coefficients
Unstandardized Coefficients
B
Std. Error
-0.208
0.278
(Constant)
0.022
0.014
Company_size
Industry_type
-0.063
0.055
a. Dependent Variable: ICD_Index
Model
1
Standardized Coefficients
Beta
0.337
-0.245
t
-0.746
1.579
-1.146
Sig.
0.465
0.132
0.267
Simultaneous multiple regression was conducted to investigate the best predictors of

ICD_Index. When the combination of variables to predict IC disclosure included
company size and industry type F (2, 18) = 2.220, p = 0.137 > 0.05. The adjusted R
squared is 0.109 which means that 11% of the variance in ICD_Index was explained
by the model. According to the results obtained it means that we can not reject
~412~
hypothesis H3 and thus we can state that there is no relation between any combination
of company size and industry type and IC disclosure.
Our research paper had two major objectives: to analyse the quantity and the quality
of IC items made in the annual reports by Romanian listed companies; and to analyse
whether company size and industry type are determinants of ICD for the same sample
companies. 21 annual reports as at 31 December 2009 of Romanian companies listed
on the BSE were collected, and represented the sample companies. IC framework
used in this study was a combination of that used by Guthrie and Petty (2000) and the
framework resulted from the work performed by a panel of researchers from the
WCIC. The resulted framework was composed of 33 IC items. In order to achieve our
first objective, we conducted a content analysis considering both the number and the
location of the 33 IC items classified under three captions: internal (structural capital),
external capital and human capital. The results show that internal capital is the most
frequently disclosed category representing 47.3%, followed by the disclosures of the
external capital with 27.5% and employee competence with 25.2%. Furthermore, our
results support the findings according to which companies disclose IC more
qualitatively than quantitatively. For the second objective, an IC disclosure index
(ICD_Index) was constructed for each company which had a common base containing
the 33 IC items. In constructing the disclosure index, dichotomous scoring for each of
the 33 IC items was used (disclosure =1, non-disclosure =0). The study tested if
(1) company size is a determinant of ICD (H1 hypothesis) using Pearson correlation
analysis; (2) industry type is a determinant of ICD (H2 hypothesis) using T test
analysis; and last but not least (3) if there is any combination between company size
and industry type that can determine the level of ICD (H3 hypothesis) using multiple
regression analysis. According to the results obtained we concluded that in the case of
Romanian listed companies there is no association between the level of ICD and
company size (p=0.195 respective p= 0.207), industry type (r (21) = 0.373, p > 0.05)
and no combination between company size and industry type (F (2, 18) = 2.220,
p = 0.137 > 0.05). Our paper contributes to the ICD literature by providing empirical
evidence of the status of IC reporting and of determinants of ICD in a developing
country context. In addition, the results obtained represent a basis for comparison with
those obtained by other studies carried out in other developing countries. As any
research paper, our study is subject to a number of limitations. One limitation refers to
the content analysis. Analysing the annual reports based on the specified list of IC
related terms may not provide the whole picture or ICDs practices. Next, while we
believe that our sample is representative for Romanian listed companies, a larger
sample could help to further improve the extrapolation of this study. This study is
based on the annual reports for 2009 only; a longitudinal study could provide more
insights and could include not only levels of ICDs but also an analysis of changes in
ICDs. Some research on disclosure practice uses the survey method for collecting
data. Future research could consider interviewing managers about their disclosure
rationale. In addition, this study challenges researchers to extend the area of analysis
by considering the relation between ICD and other possible determinants.
~413~
ACKNOWLEDGEMENTS
This work was supported by CNCSIS UEFISCSU, project number PNII IDEI code
1859/2008, contract no. 837/2009.
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~415~
PS9 IFRS II
Chairperson
Dumitru MATIS, Babes-Bolyai University, Romania
IMPACTS AND CHANGES IN THE ACCOUNTING

POLICIES AFTER THE IAS ADOPTION:
A COMPARISON BETWEEN THE MANUFACTURING
AND THE COMMERCIAL SECTOR IN GREECE
Sotirios KARATZIMAS, Stella ZOUNTA, Vagia KYRIAKIDOU
IMPACTS AND CHANGES IN THE ACCOUNTING

POLICIES AFTER THE IAS ADOPTION:
A COMPARISON BETWEEN THE MANUFACTURING
AND THE COMMERCIAL SECTOR IN GREECE
Sotirios KARATZIMAS1 & Stella ZOUNTA
University of Aegean, Greece
Vagia KYRIAKIDOU
National and Kapodistrian University of Athens, Greece
ABSTRACT
The present study examines the changes that occurred in the accounting policies of the Greek
companies, after the adoption of IAS. More precisely, a comparison analysis between the
manufacturing and the commercial sector is conducted. In order to achieve that, we analyze
the impact of the IAS transition in the net income of the Greek listed manufacturing and
commercial companies by applying a new index on the field, we identify the most important
changes in accounting policies and we proceed by comparing the differences and similarities
between the two sectors. Results suggest that the application of the fair value is the
accounting policy that affected most significantly both sectors, while the similarities between
the two sectors seem to excel their differences.
KEYWORDS: Accounting policies, IAS, manufacturing sector, commercial sector, Greece

INTRODUCTION
From the 1st of January 2005 all listed companies in the European Union (EU) have
to prepare their financial statements according to the International Accounting
Standards (IAS) promoted by the International Accounting Standards Board (IASB).
The introduction of new international standards brought great changes in the way that
companies prepared their financial statements, especially in countries were the
domestic accounting standards were stakeholder oriented, (e.g. Greece, Germany,
France) since IAS are heavily influenced by the shareholder oriented Anglo-Saxon
accounting model.
The Greek accounting system is typically characterized as stakeholder-oriented and
tax-driven (Ballas, 1994; Spathis et al., 2003) and differs substantially from IAS,
which are shareholder oriented and independent of tax reporting considerations. The
different roles of the accounting systems have several important implications for
accounting standards. The Greek Generally Accepted Accounting Principles (GAAP)
generally encourage a prudent approach to asset valuation and liability recognition
to facilitate contract with stakeholders, thus allowing managers great flexibility in
valuing assets at the lowest amount possible to minimize tax liability, while IAS
1
Correspondence address: Sotirios KARATZIMAS, University of Aegean, Dept. of Business

Administration, Chios, Greece; email: skaratzimas@aegean.gr
~417~
promote a true and fair presentation of balance sheets to facilitate decision-making

for investors, limiting such flexibility (Spathis and Georgakopoulou, 2007).
In general, the new accounting standards appear significant differences from the
Greek GAAP and brought forth new basis in the preparation of financial statement
reporting and the analysis of financial information. The new standards have
significant deviations from the Greek legislation, while their application demanded
various changes in the internal environment of Greek companies, since a great number
of accounting policies that were used, had to be rejected and replaced by new.
Moreover, according to Rahman et al. (2002) studies that deal with accounting
policies in single country contexts indicate that the choice of accounting methods and
policies is also affected by the firm characteristics, which means that the changes in
the internal environment of the Greek companies could vary depending on the specific
sector characteristics of each company. In other words, the new accounting policies
that affected most significantly the manufacturing sector might differ from those that
mostly affected the commercial sector.
The purpose of the present study is to draw the picture of the changes in accounting
policies that occurred in the Greek manufacturing and commercial sectors, and to
compare the implications in the two sectors. In order to achieve that we analyze the
impact of the IAS transition in the net income of all the manufacturing and
commercial companies listed in the Athens Stock Exchange (ASE), we identify the
most important changes in accounting policies and we proceed by comparing the
differences and similarities between the two sectors. We quantify the impact by
presenting a new index on the field, and we investigate which IAS caused the most
significant changes in each of the two sectors, from the establishment of new
accounting policies.
The differences in the income statements between the two different accounting
standards are presented in the 2005 reconciliation statement, which also provides the
reasoning behind these changes in the form of adjustments. We proceeded by
analyzing the reconciliation statements, we examined the adjustments that took place
in every company of the two sectors and finally found the impact of the IAS transition
as it appears through the changes of accounting policies.
The remainder of the paper is organized as follows: In the next section the relevant
literature is reviewed. In the third section the surveys methodology is analyzed and in
the fourth the results are presented. Finally, in the fifth section we conclude by
discussing the outcomes of the survey.
1. PRIOR RESEARCH
The adoption of the IAS from the EU is considered to be one of the greatest changes
in the history of financial reporting, making IAS the most widely accepted financial
reporting model (Hung and Subramanyam, 2007). However, there is still an urgent
need for managers and investors to understand the implications of the transition. This
is especially true in European countries with stakeholder oriented accounting systems
such as Greece, Germany, France, Spain and Italy, since IAS is an accounting model
heavily influenced by the share-holder oriented Anglo-Saxon model. Consequently,
~418~
the IAS adoption caused fundamental changes in the basis of financial reporting of
many European countries.
Several studies have been conducted in order to compare IAS to national accounting
standards and to identify the impacts of the transition in European countries. For
example, studies that focus on the transition and implementation of IAS in the EU and
their impact on firms include those conducted by Jermakowicz (2004) in Belgium,
Street and Larson (2004), Shipper (2005) and Whittington (2005) within EU member
states, Sucher and Jindrichovska (2004) in the Czech Republic, Vellam (2004) in
Poland, Weissenberger et al. (2004), Haller and Eierle (2004) and Hung and
Subramanyam (2007) in Germany, while other studies investigate the financial
reporting and the quality of information under IAS (Glaum and Street, 2003; Tarca,
2004; Cuijpers and Buijink, 2005; Barth et al., 2005; Van Tendeloo and Vanstraelen,
2005, etc.).
Most of the studies investigating the impacts of the IAS transition, confirmed the
problems of implementing IAS (Jermakowicz, 2004; Sucher and Jindrichovska, 2004;
Hung and Subramanyam, 2007), while others analyzed the differences between
domestic financial reporting and the IASB conceptual framework (Vellam, 2004).
These studies concluded that the major differences between domestic and
international accounting standards are related to the linkage between financial
reporting and tax accounting. Greece has also been the setting for studying (e.g.
Bellas et al., 2007; Georgakopoulou et al., 2009; Apostolou et al., 2006, etc.), mostly
due to the countrys stakeholder orientation and the existence of several creative
accounting practices prior to IAS (Tsalavoutas and Evans, 2010; Baralexis, 2004).
The most common method to examine the transition from an accounting model to
another is by analyzing the reconciliation statements provided by the adopting
companies. Surveys that analyze the reconciliation statements include those of
Weetman and Gray (1990, 1991), Cooke (1993) and Hellman (1993) who examined
the differences between US GAAP and IAS as presented through the 20-F
reconciliation statements by applying Grays (1980) conservatism index. Adams et
al. (1993) extended the use of this index and of partial indices and were the first to
employ the index in comparing Finnish GAAP to IAS. By 1998, Weetman et al.
renamed the Gray (1980) index as comparability index, in order to highlight the use
of the index as a means of comparability.
The recent transition of European companies to IAS in 2005 and its impacts are
widely examined through the analysis of the 2004 financial statements which were
initially prepared on the basis of national GAAP and later restated under IAS, as
comparatives for the 2005 financial statements. Such recent studies, include the study
conducted by Bertoni and De Rosa (2006) who applied the comparability index to
net income, equity and partial adjustments on the 2004 financial statements of
companies listed in the Italian stock exchange and concluded that Italian GAAP are
more conservative than IAS, while Lopes and Viana (2006) applied the
comparability index in companies listed in the Portuguese stock exchange and found
that IAS had led to less conservative reported profits. Furthermore, by applying this
index to compare IAS and Greek GAAP Tsalavoutas and Evans (2010) found that
IAS have a significant impact on the financial position of Greek listed companies as
well as on gearing and liquidity ratios while Cordazzo (2008) provided empirical
~419~
evidence of the nature and the size of the differences between Italian GAAP and IAS
by proposing a new measure of accounting comparability, the proportionality index.
The present study is an attempt to identify which of the new accounting policies that
were applied following the IAS adoption caused the most significant changes in the
Greek manufacturing and commercial companies. Furthermore it is a first comparison
of the transitions implications between the two sectors. According to Watts and
Zimmermann (1990) there is ample evidence that companies with different
characteristics such as industry membership adopt different accounting practices,
subsequently, it is expected that different accounting policies had different level of
impact in the under-examination sectors. As Jaafar and McLeay (2007) note, the
conventional research focuses on variations in the accounting policies adopted by
firms between countries, presupposing that accounting methods and policies
systematically reflect rules and regulations of the country where the firms operate.
However, diversity of accounting policies results from the real differences in the
operating circumstances each sector faces (Jaafar and McLeay, 2007), while
furthermore, Aisbitt (2001) points out that, sector characteristics play a significant
role in accounting policy choice.
2. RESEARCH DATA AND METHODOLOGY
2.1 Scope of the study
The scope of the present study is to examine the impacts and changes that were
caused by the IAS adoption, in the accounting policies used in the Greek companies.
More precisely, we conduct a comparison analysis between the manufacturing and the
commercial sector. We attempt to draw the picture of the changes that occurred in the
accounting policies of the Greek listed manufacturing and commercial companies.
In order to achieve that, we analyze the reconciliation statements of the net income as
they are presented in the annual reports of the companies in the transition year 2005.
We analyze the adjustments on net income since they provide a great amount of
information concerning changes in accounting methods and policies as for example
those used for inventory valuation, assets valuation, impairment and depreciation,
determination of provisions, etc.
At first, we conduct a frequency analysis of the adjustments caused by each IAS
application in the sample, in order to gain a general view of the transition effects and
to identify the new accounting policies that affected the majority of the Greek
companies. Then, by applying the proposed index in the data, we quantify the total
impact of each IAS on net income and we find those accounting policies the
application of which affected most significantly each sectors net income in total.
2.2 Data collection
The sample under investigation includes all the manufacturing and commercial
companies listed on the Athens Stock Exchange, which have completed the transition
of consolidated financial accounts to IAS. According to IFRS 1 companys first
IFRS financial statements should include a reconciliation of shareholders equity and
net income. In order to have a more thorough view of the changes in accounting
~420~
policies, we examined the net income reconciliation statements. It turned out though,
that from the 87 manufacturing companies listed in the ASE, only 59 provided
adequate net income reconciliation statements, while from the 82 listed commercial
companies, only 54. It should be mentioned here that from the 59 manufactures, 3
belong to the Gas and Oil sub-sector, 13 to the Basic Resources sub-sector, 20 to
the Construction and Material sub-sector, 2 to the Chemicals sub-sector and 21 to
the Industrial Goods and Services sub-sector. While from the 54 commercial
companies, 8 belong to the Retail sub-sector, 26 to the Personal and Household
Goods and 19 to the Food and Beverage sub-sector.
2.3 Descriptive evidence
At first we gathered the net income reconciliation forms of the 59 manufactures and
the 54 commercial companies, and proceeded by analyzing the frequency of the
adjustments on the companies net income that were caused due to the IAS transition.
The net income reconciliation statements provide the following data (Appendix):
the net income based on the Greek GAAP,
the adjustments that were caused due to the application of IAS in the company
and finally
the net income based on the International Accounting Standards.
Table 1 shows the frequency of the adjustments to the net income caused by each
IAS, in order for the sample companies to convert to IAS.
Table 1. Frequency of all individual adjustments caused by IAS adoption
Adjustments by:
IAS
IAS 2
IAS 11
IAS 12
IAS 16
IAS 17
IAS 18
IAS 19
IAS 20
IAS 21
IAS 23
IAS 27
IAS 28
IAS 31
IAS 36
IAS 37
IAS 38
IAS 39
IAS 40
IAS 41
IFRS 3
Total No
of companies:
Title
Inventories
Construction contracts
Deferred taxes
Property, plant and equipment
Leases
Revenue recognition
Employee benefits
Government grants
Changes in foreign exchange rates
Borrowing cost
Consolidated financial statements
Investments in associates
Joint ventures
Impairment of assets
Provisions, contingent liabilities and
assets
Intangible assets
Financial instruments
Property investments
Biological assets
Business Combinations
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No of companies affected:
Manufacturing sector
Commercial sector
10
10
13
1
46
48
57
25
6
50
22
50
23
10
47
22
26
2
23
-
14
13
5
9
9
14
2
7
44
52
22
3
10
35
52
31
6
3
59
54
First evidence deriving from the examination of the net income reconciliation
statements of the manufacturing companies, show that the most frequent adjustments
were caused by the application of the following IAS:
IAS 16 - caused adjustments in 57 companies,
IAS 38 - affected 52 companies,
IAS 19 - affected 50 companies,
IAS 12 - affected 46 companies, and
IAS 37 - caused adjustments to 44 companies.
On the other hand, concerning the commercial sector, the most frequent adjustments
were caused by the application of the IAS as follows:
IAS 38, which affected 52 companies
IAS 16 - 50 companies
IAS 12 - affected 48 companies
IAS 19 - caused adjustments to 47 companies, and
IAS 37 - affected 35 companies
From the above first evidence it turns out that IAS 12, 16, 19, 37 and 38 affected the
majority of the sample companies both in the manufacturing and the commercial
sector. By examining the adjustments on the reconciliation statements it turns out that
the most important changes that occurred in the accounting policies from the
application of the above-mentioned IAS in both sectors, are the following:
Concerning IAS 16 the most important changes on accounting policies were:
The valuation of tangibles on fair value
The change in the depreciation rates of tangible assets
Regarding IAS 38 the most frequent adjustments in accounting policies were:
The differentiation of the depreciation rate for intangibles
The non-recognition of start-up costs as intangible assets
The most frequent adjustments deriving from the application of IAS 19 were:
The recognition of compensations due to retirement, and
The recognition of benefits to the personnel
Concerning IAS 12, the most frequent adjustments deriving from its application were:
The recognition of deferred taxes
The recognition of the income taxes of the period as expenses
And finally, the most frequent adjustments deriving from the application of IAS 37
turned out to be:
The general adjustments of the account provisions, and more specific
The provisions for bad debtors and for impairment of assets.
First evidence shows that the introduction of fair value for the valuation of tangible
and intangible assets (IAS 16 and 38), in contrast to the Greek historical cost
valuation, and the subsequent change in the depreciation amounts which are
calculated based on the useful life of the asset, are the new accounting policies that
affected the majority of the Greek manufacturing and commercial companies.
Moreover, the non-recognition of the start-up costs (IAS 38), in contrast to their
capitalization according to the Greek GAAP is another important change of policy,
while IAS 19 introduced compensations and employee benefits that were not
calculated according to the Greek GAAP. Another important change in accounting
~422~
policy was established by the recognition of deferred taxes (IAS 12), which is
different from the treatment based on the Greek GAAP, according to which the
concept of deferred taxes does not exist and there is no distinction between current
and deferred tax. Additionally, IAS 12 defines the expense of the income tax when
incurred, in contrast to the Greek non-recognition of taxes as an expense of the period.
Finally, the explicit distinction of provisions from contingent liabilities introduced by
IAS 37 is a different policy compared to the requirement of the Greek GAAP to
companies to recognize liabilities for any risk which can be defined.
After identifying the aforementioned evidence and in order to run into more valid
conclusions we quantified the impact from the IAS adoption and thus found which
IAS affected most significantly the net income of the two sectors, and consequently
the changes in accounting policies that affected most significantly the sectors
income.
2.4 Methodology
The indices that are used in the accounting literature to measure the impact of the IAS
adoption on a company can be also applied to quantify the impacts on the entire sector
the company belongs to. There is though a very important omission: they dont take
under much consideration the fact that particular IAS may affect only specific
companies and, thus, are difficult to be measured on a total basis in order for them to
be compared with other IAS that affected other companies so as to find the most
important IAS that affected the entire sector. In several cases, the application of a
particular IAS might affect only few companies but to a great extent. Moreover, the
adoption of IAS could have a different impact on the financial results of companies
belonging to different sectors, thus a subsequent comparison of the IAS implication
between the two sectors is conducted.
The proposed index can be used to analyze the impact of the transition, by taking as a
parameter of significance the extent to which each IAS affected the companies under
examination in each sector. The analysis is applied on the data extracted from the
annual reports of the Greek listed companies, examining the impact of IAS in a group
of 59 manufacturing and 54 commercial companies. The IAS that we examined were
those that turned out to appear more frequently in the adjustments that took place in
the income statement of the sample companies (Table 1). Specifically, regarding the
manufacturing sector, IAS 21 Changes in foreign exchange rates, IAS 18 Revenue
recognition and IAS 40 Property investments, which were found to have a very
small numeric impact on the net income, were excluded from the analysis. However,
the limited impact they have on net income is captured by the error term included in
the proposed index. While concerning the commercial sector, IAS 23 Borrowing
cost, IAS 28 Investments in associates, IAS 31 Joint ventures, IAS 40 Property
investments and IFRS 3 Business combinations were excluded due to the
very small numeric impact. The IAS that were eventually examined are presented in
Table 2.
The first step of the analysis aims to identify whether the companies of the sector
were affected at any degree by the application of the IAS under examination. For this
reason, a dummy variable was created for each IASi and we placed the data as
follows:
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0 in cases were the impact of the IAS application in a companys net income
was zero, i.e. IASi caused no change on net income
1 in cases were the impact of the IAS application in a companys net income
was either positive or negative
Then we proceeded by conducting frequency analysis and particularly central

tendency analysis in order to find the tendency of the impacts caused in net income by
the application of IASi (di). This analysis provides useful information concerning the
effect of IAS application on income. The results are presented in Table 2 and refer to
each specific sector. It is obvious that there is a noticeable differentiation concerning
the impact of each IAS to the income of the under-examination companies.
The second step of the analysis concerns the estimation of the coefficients of each
IAS. Thus a Regression analysis was conducted based on Ordinary Least Squares
(OLS) by using the following equation:
n
Y j = bi X i , j + i
Eq. 1
i, j
Where,
Yj is the difference between income calculated based on Greek GAAP and
income calculated based on IAS for each company belonging to the under
examination sector
the vector bi shows the estimated coefficient of each IAS under examination,
Xi,j is the observed difference of IASi over companyj, and
an error is added to the model in order to describe changes in income (before
and after IAS) depending on other parameters (other IAS).
From this equation the coefficient of each IAS under examination (bi) is calculated.
These coefficients comprise the sign of the change on income by the implementation
of the IAS. Finally, the following index is proposed resulting from the combination of
the above calculations:
Im pact Factori (IFi ) =
1
ci
Eq. 2
Where ci equals:
ci = bi
1
di
Eq. 3
And di is the score resulting from the central tendency of IASi.

The impact of each IAS on the income of the under-examination companies is
estimated by applying the index to the collected data (Table 2, Impact Factor). The
positive or negative figure of the Impact Factor shows the total positive or negative
impact that the application of the particular IAS had on the income of the
manufacturing or the commercial sector.
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Table 2. IAS under examination, tendency analysis and impact factor

Sectors:
Parameters
IAS 2
IAS 11
IAS 12
IAS 16
IAS 17
IAS 18
IAS 19
IAS 20
IAS 21
IAS 23
IAS 27
IAS 28
IAS 31
IAS 36
IAS 37
IAS 38
IAS 39
IAS 41
IFRS 3
Manufacturing
Tendency score
(di)
0,1525
0,2203
0,7627
0,9661
0,4068
0,8475
0,3729
0,0339
0,2373
0,2203
0,0847
0,2004
0,7288
0,8814
0,3559
0,1695
Commercial
Impact factor
0,183
0,308
1,375
2,660
2,998
0,304
-0,123
-0,002
0,157
-0,125
-0,102
0,205
1,151
1,998
0,290
0,748
Tendency
score (di)
0,1887
0,0189
0,9057
0,9245
0,6434
0,3774
0,8868
0,4151
0,434
0,1698
0,1321
0,6604
0,9057
0,5849
0,1132
-
Impact factor
-0,327
0,001
-1,155
-1,693
2,934
-0,427
-0,680
0,989
-0,327
-0,145
0,427
-0,862
-0,780
-0,537
-0,170
-
Finally, the absolute values of the impact factors provide the importance rate. That is
the significance of each IAS impact on the sectors net income. Thus as Eq.4 shows,
the Importance Rate of the IASi (IRi) is equal to the absolute value of the Impact
Factor of the specific IASi (IFi):
IRi = IFi
Eq. 4
Eventually the outcomes of the index we applied rated as most significant impacts on
the manufacturing sector, those caused by the application of IAS 17 (2,998), IAS 16
(2,660), IAS 38 (1,998), IAS 12 (1,375) and IAS 37 (1,151). Moreover, it turned out
that IAS 20, 23, 28 and 31 had in total a negative impact on the net income of the
manufacturing sector.
Concerning the commercial sector, it turned out that the most significant
impact on the entire sectors net income was caused by the application of IAS 17
(2,934), IAS 16 (1,693), IAS 12 (1,155), IAS 20 (0,989) and IAS 37 (0,862), while,
the vast majority of the IAS (IAS 2, 12, 16, 17, 18, 19, 21, 27, 37, 38 and 39) had a
negative impact in total on the sectors income. In the following table (Table 3), the
ranking of the IR of each applied IAS is presented together with the estimated weight
based on the proposed index.
~425~
Table 3. Importance rate

Manufacturing sector
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
IAS 17
IAS 16
IAS 38
IAS 12
IAS 37
IFRS 3
IAS 11
IAS 19
IAS 39
IAS 36
IAS 2
IAS 27
IAS 28
IAS 20
IAS 31
IAS 23
2,998
2,660
1,998
1,375
1,151
0,748
0,308
0,304
0,290
0,205
0,183
0,157
0,125
0,123
0,102
0,002
Commercial sector
IAS 17
IAS 16
IAS 12
IAS 20
IAS 37
IAS 38
IAS 19
IAS 36
IAS 39
IAS 18
IAS 21
IAS 41
IAS 27
IAS 2
IAS 11
-
2,934
1,693
1,155
0,989
0,862
0,780
0,680
0,620
0,537
0,427
0,327
0,170
0,145
0,144
0,001
-
CONCLUSION
According to Jaafar and McLeay (2007) the sector of operations determines the
financial reporting practices adopted by a firm. Consequently, we expected that the
IAS transition had different impact in the manufacturing and the commercial sector.
However, in this first attempt to compare the Greek manufacturing and commercial
sectors in terms of changes in accounting policies following the IAS adoption, the
similarities between the two sectors seem to excel their differences.
In the frequency analysis of the adjustments caused by the IAS transition, it turns out
that the majority of the companies belonging to either sector were affected by the
same IAS. Specifically, IAS 16 PPE, IAS 38 Intangible assets, IAS 12 Deferred
taxes, IAS 19 Employee benefits and IAS 37 Provisions, contingent liabilities and
assets. Consequently, as it turns out form the adjustments examination, the new
policies that were applied and affected the majority of the companies in both sectors
were the assets revaluation on fair value, the depreciation rates based on the useful
life of the asset, the non-recognition of start-up costs as intangibles, the recognition of
employee benefits, the recognition of deferred taxes and the expense of the income
taxes of the period, as well as the distinction of provisions from contingent liabilities.
A few differences turned out though, when we examined the accounting policies the
application of which had the most significant impact on the net income of the entire
manufacturing and commercial sectors. By applying the proposed index to the data
from the manufacturing sector, we found that the most significant impact on the entire
sectors income was caused from the application of IAS 17, IAS 16, IAS 38, IAS 12
and IAS 37. Regarding the commercial sector the respective IAS with the most
significant impact were IAS 17, IAS 16, IAS 12, IAS 20 and IAS 37.
It is very important to note that IAS 17 had the most significant impact on the entire
net income of both sectors, although it affected only 25 of the 59 manufactures and
23 of the 54 commercial companies. In particular, the new policies that were
established from the application of IAS 17, were the recognition of financial leasing
~426~
as tangible assets and their subsequent treatment concerning revaluation and

depreciation and the recognition of the profit gained from Sales and Leaseback
directly in income through transitional liabilities accounts, instead of initially
presenting this profit as non-operating profit and then through a tax regulation
transferring it to the tax-free reserves. This great impact shows that these new policies
affected the companies that operate with the use of leases to a great extent.
The most noticeable differences that turned out derive from the application of IAS 20,
IFRS 3, IAS 11 and IAS 41. IAS 20, Government grants, had a very significant
impact on the net income of the commercial sector while it didnt significantly affect
the manufacturing sector. In the meantime, this particular IAS affected the same
number (22) of companies in both sectors, which shows that it affected the
commercial companies to a greater extent and thus we could conclude that the
amounts of government grants are higher in the commercial sector. To be more
specific, the new accounting policy established by IAS 20 defines that government
grants shall be recognized as income over the periods necessary to match them with
the related costs, which are indented to compensate on a systematic basis, instead of
being credited directly to shareholders interests according to the Greek GAAP.
Contrarily, IFRS 3 Business combinations had a strong impact in the net income of
the manufacturing sector, while it had a minor impact on the commercial companies
and IAS 11 Construction contracts had an impact only on manufactures. More
specific, IFRS 3 defines that all business combinations within its scope, would apply
the purchase method and therefore will valuate and depreciate goodwill and recognize
negative goodwill directly on the income statement, in contrast to the Greek Law
which also permits the pooling of interests method. The fact that IFRS 3 affected only
10 of the 59 manufacturing companies, shows that it had a very strong impact to
companies that applied the pooling of interests method and were obliged to adopt the
purchase method. Regarding IAS 11, it is expected that its application would affect
only manufacturing companies which mainly deal with constructions, due to its
nature. Likewise, IAS 41 Biological assets is expected to affect only the
commercial sector.
Concluding, in general the two sectors appear to have more similarities than
differences regarding the impact and the changes in accounting policies that followed
the IAS transition. The most significant impact was caused from the new accounting
policies concerning the revaluation of assets on fair value and the new depreciation
rates which are linked to IAS 16, 38 and 17.
It should be mentioned here, that due to the insufficient or completely absent data
concerning the reconciliation statements of 28 companies belonging to the
manufacturing sector and 28 belonging to the commercial sector, we dont provide
evidence that picture the total view of the two sectors. However, the sample of the
study comprises from the 68% of the listed manufacturing companies and the 66% of
the commercial companies and thus is considered to be representative. As for further
research, it would be very interesting to compare the outcomes of the proposed
methodology with the outcomes of the classical approach by applying Grays
comparability and partial adjustment indices to the collected data.
~427~
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APPENDIX
Example of net income reconciliation statement
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
Net Income - 31 December 2004 - (Euro in thousands)

Balance as per Greek Consolidated Financial Statements
Difference between the provision for staff leaving indemnity (per Greek legislation) and
defined benefit plan with the provision as calculated by the actuarial valuation - IAS 19
Provision for deferred tax - IAS 12
Reversal of the revaluation of fixed assets and the effect of depreciation taken - IAS 16
Write off of capitalized costs with no future benefit - IAS 38
Write off of capitalized research and development costs and reversal of related depreciation
- IAS 38
Adjustment of tangible assets depreciation to conform with the group policy - IAS 16
Equity accounting (Differences from conversion to IAS of associates accounts) IAS 28
Other provisions / adjustments - IAS 37
Reclassification of grant from equity to deferred income or liabilities - IAS 20
Income tax for the period - IAS 12
Goodwill and depreciation of goodwill - IFRS 3
Exchange gains (timing differences) - IAS 21
Different method of stock valuation - IAS 2
Effect of IAS 39 IAS 39
Other
Balance as per IFRS Consolidated Financial Statements
~430~
91.283
1.262
(9.346)
186
5.036
(1.082)
23.009
(8.643)
(14.013)
1.285
(3.244)
4.602
9.808
31.446
(106)
(616)
130.867
PS10 Performance management

Chairperson
Petru STEFEA, West University of Timisoara, Romania
VALUE AND PERFORMANCE IN A REGULATED

ENVIRONMENT: THE CASE
OF TELECOMMUNICATIONS IN ROMANIA
Alina Carmen ALMASAN, Corina GROSU
QUO VADIS IN MEASURING BUSINESS

PERFORMANCE? A PRACTICAL SOLUTION
FOR THE IT SECTOR
Claudia Elena SERBAN, Oana-Adelina FLORICIOIU,
Radu-Daniel LOGHIN
EFFECTIVE AND EFFICIENT TOOLS IN HUMAN

RESSOURCES MANAGEMENT CONTROL
Mihaela Adriana DUMITRANA, Gabriel RADU,
Mariana Elena GLAVAN, Gabriel JINGA
FLEXIBILIZING THE TERMINATION OF THE

EMPLOYMENT CONTRACT: PROS AND CONS
Raluca DIMITRIU
~431~
VALUE AND PERFORMANCE IN A REGULATED

ENVIRONMENT: THE CASE
OF TELECOMMUNICATIONS IN ROMANIA
Alina Carmen ALMASAN1 & Corina GROSU
ABSTRACT
The purpose of this paper is to present a case study concerning the effects of regulation on the
performance management system. We often wondered how a company can manage its
performance operating in a highly regulated field. We chose to study Romanian traditional
telecommunications operator Romtelecom, because as dominant operator on the relevant
markets, it is subject to strict regulations and controls from the regulatory authority
(ANCOM). In this paper we have made a careful review of regulations that have a direct
impact on management control system and performance measurement, in order to identify
those elements which escape from regulation and that the company could capitalize to
create value and improve the performance. Multiple sources of data collection allowed us to
provide a more comprehensive picture of the phenomenon, so we can draw some conclusions
relevant to the studied issues.
KEYWORDS: performance, regulation, management control, telecommunication

INTRODUCTION
The telecommunications industry has undergone enormous changes over the past 20
years in entire Europe. Technological developments and the privatization of major
telecommunications operators have significantly changed the conditions under which
the former monopoly operators were accustomed to operate. Given the strategic
importance and size of such operators it is obvious that privatization has also
generated a considerable financial impact.
Romanian experience in telecommunications is not different from that of other states.
In addition, legislation in this area is strongly felt, significantly influencing the
performance of operators. In fact, this aspect of the impact that regulation has on the
performance of national telecommunications operators was less treated in the
literature. Palcic and Reeves (2010) have summarized the issues on which empirical
studies in the literature were focused:
the impact of privatization on the performance of British Telecom, as the first
major privatization in this area (Florio, 2001; Dnes, 1995; Megginson, 1998);
cross-country comparisons regarding the impact of privatization on
performance and cross-country studies of productivity and performance in
general (Bortolotti et al.; 2002; Daler et al., 2002);
1
Correspondence address: Alina Carmen ALMASAN, West University of Timisoara, Romania;

email: alina.almasan@feaa.uvt.ro
~432~
comparative analysis between countries on the impact of competition and

regulation on telecommunications operators (Boyland and Nicoletti, 2000).
Romanian literature in this area is still poor, the few published works mainly targeting
the use of management accounting and management control tools at main operators
on the Romanian market (Unchiasu, 2008, Almasan and Grosu, 2010).
This paper addresses two main questions: (a) to which extent telecoms regulations
affect the management control practices and thus performance measurement system?
and (b) which management control tools escape from regulation and can be
exploited in order to create value and improve company performance?
Further, the paper is structured as follows: the first section concerns the delimitation
of a theoretical framework on the issue of performance and regulation; the second
section contains a brief description of the organizational context of studied company the Romanian traditional telecommunications operator Romtelecom; third section
describes the research method and presents some research findings. The paper then
finishes with a discussion and conclusions section.
1. THEORETICAL FRAMEWORK
1.1. Value and performance: imperatives in current context
Any organization, through its actions, aims at becoming the best, the most powerful
company operating in the same area. In other words, companies constantly seek to
achieve performance. Johnson (1992) said that the only way a company can survive in
the current context is searching competitive excellence. Achieving superior
performance requires a rethink of all processes involved in the value creation
mechanism.
For many entities, creating value represents a strategic challenge, which requires
successful exploitation of all opportunities, in order to generate long term benefits.
Generally, organizations are oriented towards short-term objectives, directing their
attention to the company's current situation and taking fewer actions that will generate
long term future benefits.
For the customer, value has a relative character, on the one hand it depends on
consumer characteristics and the situation in which he founds himself, and on the
other hand depends on whether consumers will appreciate the value of an offer
compared to competitors offers.
Teller (1999) believes that the economic value offered to the consumer is "the relative
value that a product offers to the consumer in a special way. It is the maximum
amount that he will be willing to pay, assuming that it is perfectly informed about the
product, but also to competitive offerings."
For customers, price is a sacrifice that they make for the acquisition of several
functionalities. Given the functionalities provided to him by the good, the client will
decide if the price of that commodity is acceptable. Thus, the value is an opportunity
judgment on the relationship between functionality and price.
~433~
The resources of an enterprise are a real potential of functionality. Transforming them

into functionalities not always coincide with processes strictly carried out within the
entity. Many times, some activities are carried out by appealing to other organizations
(suppliers, distributors, etc.), getting out of the perimeter of an enterprise. Resource
transformation into functionalities (which corresponds to value creation system) must
be examined on the entire value chain, each entity being a "link" in this chain.
So, value is the result of a set of intended features. The fact is that it is determined
either by the market or by a customer's preferences, but in both cases it is found, not
built by the company. It is an information to be sought outside, not calculated inside
the company, through costs.
The issues mentioned above aimed at the customer value, but also must be discussed
the creation of shareholders value. Knight (1998) believes that a higher profitability
does not guarantee value creation for company shareholders, because value creation
requires three rules, namely:
level of profitability has nothing to do with value creating profit amount
does not represent a company's advantage over another;
all companies start from the same level in value creation;
each entity has to face different challenges.
Like Knight, many authors believe that profit is not the best indicator to assess the
value, in this regard considering the cash flow released by the activities to be the
relevant measure. Dalborg (1999) identified four fundamental elements in creating
shareholder value: operational excellence, achieving a proper financial structure,
focusing on all aspects and reliable earnings growth. The author believes that success
in creating shareholder value is a very good positioning in all four issues mentioned
above.
Performance measurement is not sufficient unless it is considered together with the
resources, activities and objectives. Furthermore, performance needs to be managed.
1.2. Regulation: a complex and difficult issue
With the elimination of monopoly on the telecommunications market, the industry is
proving to be extremely dynamic and unpredictable at the same time.
Telecommunications companies operate in a highly competitive environment, and
their efforts regarding the adoption of appropriate strategies are important. In such a
context, firms must be able to anticipate, develop and rapidly respond to
developments in the sector, in order to survive and gain an advantage over
competitors.
The environment is one of the factors that influence the strategy and performance of
an organization. Current environment, characterized by make competitive advantages
to be rapidly created and eroded.
The main forces to be considered when developing the strategy of a telecom operator
are (Terplan and Morreale, 2000): technology, regulation, customers and competition.
The major issue raised by the public services is that they require considerable
~434~
investment in infrastructure, once invested the amount can not be recovered by

assigning new destinations assets.
A widely discussed topic in the telecommunications literature is representing by the
role of regulation in industry development (Beardsley and Farrell, 2005; Michalis,
2001). Arguments have been both in favor of an active role played by the authorities
in protecting consumers' interests (Beardsley and Farrell, 2005; Haring and Rohlfs,
1997) and against excessive regulation (Haring and Rohlfs, 1997). This makes it
extremely difficult for any regulator to find a balance between various interests, often
conflicting, of those involved.
Beardsley and Farrell (2005) described the role of regulation as follows: "The purpose
of economic regulation should be the same in all sectors: to facilitate fair competition,
or, where there is a natural monopoly, to ensure proper pricing and a high level of
services quality. A real competition is a strong growth of the sector, which in turn will
generate a faster economic growth and benefits for all." Certainly, this goal is so
noble, but the practice has shown that authorities from everywhere are trying hard to
get a set of rules, neutral and convenient for all.
Although the regulation is not a recent issue, it raises a particular interest during the
last few years. An explanation of this fact could be that the need for regulation is
correlated with industry maturity (Vesa et al., 2005), in all respects.
In our opinion, a fully liberalized telecommunications market, without any
intervention by regulatory authorities, it is hard to imagine, if not impossible. As long
as these services are publicly available, user interests must be protected. Of course,
any excessive regulation is not desirable; it can restrict operators rights and limit the
competition.
The problem of regulation does not finish with the liberalization and privatization, of
at least two reasons (Hills, 1986):
where monopolies have operated for a long time, the market share of main
operator is dominant, even if the competition has been opened;
even after liberalization, if the market entry is easy, major operators require a
certain protection to allow them to recover the costs invested in infrastructure.
The regulation was designed to create benefits for consumers, so they can benefit
from telecom services at lower prices than those charged by a firm in monopoly. The
problem is that among the consumers could not be identified a common interest
(Hills, 1986), because service users are of different categories and their interests
differ. On long run, their common interest is to reduce expenses regarding network
access, but on short term no category of users is willing to bear additional costs in
order to benefit from universal service.
We believe that regulation of a complex and dynamic field, such telecommunications,
is an extremely delicate matter, for several reasons:
First, it must be impartial, even if governments still have a higher or lower part
of incumbent operators shares, former monopolists;
~435~
Secondly, it must cover all key issues for an effective development of

activities and must contain some aspects to ensure regulatory authority control
over compliance with obligations imposed on operators;
And thirdly, caution must be exercised not to create imbalances in the market.
Regulation is not a recent process, but concerns regarding this issue have been
intensified lately, with the technological and information revolution. Regulatory
authorities have been created in almost all countries; rules have been harmonized in
different countries within regional organizations and, later, at international level.
2. BACKGROUD TO THE CASE COMPANY
The company chosen for our study is the main Romanian telecommunications
operator - Romtelecom. The company had been founded in 1930, after the Second
World War was nationalized, and in 1990 Rom-Post-Telecom was created, stateowned company in telecommunications, post and broadcasting areas. Subsequently, in
1991, by separation of telecommunications services from the post services, the
company becomes Romtelecom - the state operator in telecoms, with monopoly on the
basic services. In 1997, Romtelecom has been transformed into joint stock company
for privatization. That same year two mobile operators were launched, which created
a highly competitive environment; the results were remarkable, the rate of increase in
the number of mobile users being among the highest in Europe at that time.
Romanian telecommunications have developed more slowly, primarily because of the
monopoly which operated for a long time, and state control, which was not able to
manage and fund a sector with a high growth rate. It could be observed that, where
competition was allowed, the results were significant.
A series of regulations were adopted during this period, primarily aimed at
transposing EU legislation. As a result, on February 1998 Romania's
telecommunications market was liberalized, except for fixed telephony and leased
lines, markets that were to be opened from January 2003.
Privatization has involved several steps. The first of these, in 1998, the Greek operator
OTE acquired 35% of Romtelecom shares, taking also the management of the
company, while Romanian government held the majority. Under the privatization
agreement, the government was required to keep the monopoly in fixed telephony
until the end of 2002. The second phase, aimed at taking over the majority by the
Greek company, the remaining shares being held by the Ministry of Communications
and Information Society, representing the state, its share being 45.99% currently.
After privatization and liberalization, the company was forced to act in order to adapt
itself to new business conditions. Romtelecom describes its mission as "ever-growing
delivering promptly ever-growing reliable telecommunication and entertainment
services" (Romtelecom's website, 2011). The company's vision can be summarized as
follows: "Romtelecom is the service company setting the standards within Romania,
by exceeding the expectations of customers, employees and shareholders in the
provision of high quality communication, entertainment and IT solutions
(Romtelecom's website, 2011).
~436~
Romtelecom has undergone a major transformation over recent years, successfully

managing to respond to the challenge of becoming more efficient and developing a
portfolio of alternative services, in addition to traditional fixed telephony offer. The
company currently offers to its customers a wide variety of services: voice, data and
broadband Internet services, combined packages that include IT equipment and
complex solutions for IT & C.
3. RESEARCH RESULTS
3.1. Research method
This paper is part of a broader study conducted during 2005-2010. The study uses
multiple sources to collect evidence, namely: regulatory package for
telecommunications, publicly available information, including Romtelecoms annual
reports and regulatory authority reports on company studied, as well as methodologies
developed by the company for computing the costs of regulated services. The access
to these data was relatively easy, being public information. We had the opportunity to
compare the sources, which allows us to provide a more comprehensive and
conclusive picture of the phenomenon.
The regulatory package has been provided by the regulator and it allowed us to cover
all aspects regarding the legislation that studied company must deal with.
Romtelecoms annual reports allowed us to understand the history of the organization,
the change it went through and how the regulation has had an impact on its results.
Regulatory authority reports on Romtelecom helped us to confirm or invalidate
certain conclusions drawn from analysis of data collected from company reports.
In the last part of the analysis we have tried to overlap the information obtained over
the theoretical framework, so we can respond to the questions raised in this paper.
3.2. Case findings
This section of the paper contains a brief description of the organization in order to
understand the entity's management control system, followed by a summary of the
effects generated by the regulations on management control system and performance
measurement.
With the full liberalization of the telecommunications sector, Romtelecom has been
forced to cope with the rigors of competition, which is why both the strategy and
structure had to be adapted to the new conditions.
As a former monopoly operator, with a vertical structure, Romtelecom experience
problems with the rigidity of its structure, overloaded in relation to the tasks required
and difficult to model, in a dynamic environment such as telecommunications. Taking
into account the three main forces acting in the telecommunications sector and,
implicitly, on analyzed entity - customers, competition, changes it has been
observed the need to "reinvent" the business. In 2007, Romtelecom has launched a
comprehensive process of business reengineering in order to improve internal
processes. In essence, this redesign is to create two business units and a support unit.
The two business units are: wholesale, covering infrastructure management and
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relationships with other operators, respectively, retail, whose objective is social

marketing and customer relationship management. Support unit provides support
services for both business units.
It can be noticed that, in fact, strategic business units were created, namely, division
of the company with their own mission and objectives, designed to maximize profit
and provide "relevant" services. Certainly, these units are small enough to be flexible
and, at the same time, large enough to control several factors that can affect long term
performance.
Romtelecom, like other traditional telecommunications operators, had to adapt to the
highly competitive market conditions. To ensure greater business flexibility and
reduce time to market for new services, in 2007 Romtelecom has refocused its
business strategy and launched the "Customer 1st" project, which aimed to bring
additional benefits to customers, either at the same or at a lower price.
The company aims to focus on new services whose markets are not subject to the
regulations, unlike the classical voice market, which is strongly regulated. In the latter
case, Romtelecom does not have the desired freedom; instead broadband Internet
services and digital television allow the company to display their creativity.
Regulation covers a set of rules on the quality of services provided to the public, but
also on cost accounting system, in order to set the prices based on costs. Romtelecom
was designated as having significant power on the relevant retail markets. This
position entails a number of additional rules the operator must comply with. From this
perspective, the entity subjected to our analysis has to face some pressure from the
regulatory authority and at the same time, from shareholders which pursue the
achievement of performance objectives, while creating value.
The interventions of regulatory authority are strongly felt in several areas: (a)
managerial accounting system; (b) divisional performance measurement system and
(c) pricing services.
(a) managerial accounting system
The ANCOM Decision no. 1380 / 2003 requires Romtelecom to elaborate a
"methodology for separate accounting implementation", which aims to prepare a set
of separate financial statements (for each business unit), using some information
provided by the managerial accounting system.
In addition, operators with significant market power are required to develop a topdown model for computing the long-run incremental costs (LRIC) for activities
related to interconnection and access to an operator network or to its associated
infrastructure, in order use these costs for setting cost-oriented prices. ANCOM
approved a regulation regarding the implementation of this model for Romtelecom
(Decision no. 1381 / 2003), as well as for the two mobile operators with significant
market power. LRIC practice is recognized as the best practice in the field, being used
by most European Union member states.
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LRIC models provide cost orientation of prices and, at the same time, a basis for
making investment decisions. ANCOM sets the prices after a reconciliation process of
bottom-up model developed by the regulatory authority with top-down model
implemented by the operator. To benefit from both models, practice uses a "hybrid"
model that involves reconciliation between bottom-up LRIC model and top-down
model.
(b) divisional performance measurement system
Even if internal transactions do not affect the overall performance of the organization,
performance assessment of each business unit should be discussed. The internal
transfers between business units are directed particularly from transport and access
network units to the "retail" division. The problem of determining the value of these
services is extremely important, in terms of assessing the performance of each
business unit.
The value of internal transfers it is settled differently, depending on business unit
located as provider (Decision no. 1380 / 2003). For transport network, the transfer
price is set on effective full cost basis, while for access network it is used the market
price determined on the basis of actual cost.
These transfer prices affect the profit of each division, so that performance
measurement of each division is distorted. In addition, financial measures used for
performance measurement are influenced by an indicator required by the regulatory
authority - the weighted average cost of capital.
In Romtelecoms case, the weighted average cost of capital used to prepare the
financial statements of each business units, for reporting to the regulatory authority, as
well as for computing the costs of regulated services, is communicated by ANCOM
after reconciliation between it and Romtelecom during the consultation procedure to
develop hybrid model of LRIC. The resulting rate is 15.24% and it has been used
throughout the period 2004-2009.
The calculation of an indicator such as economic value added (EVA) will require
additional recalculation using a real weighted average cost of capital. Moreover, the
operating result after tax for each business unit is also affected by internal transfers.
(c) pricing services
Pricing services offered by operators that have a significant position on relevant
markets is a delicate issue. Sure, the regulator has imposed prices based on cost, in
order to promote competition in telecommunications markets. The price of
telecommunications services is considered as a variable that corresponds to the ratio
between what the customer is willing to pay and the utility he receives in relation to
that service (Kollmann, 2000).
Pricing is only a part of a much broader problem regarding the determination of what
services will be maintained and those which will be dropped, the capacity to be
installed and how available capacity will be allocated (Balakrishnan and
Sivaramakrishnan, 2002). Also, problem of pricing services becomes a highly
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complex given that information regarding market and demand are plentiful (Banker et
al., 2002). But in this entire "landscape" appears the national regulatory authority,
which complicates much more the situation.
For Romtelecom, the operator designated as having significant power on relevant
retail markets, the regulatory authority established by Decision no. 1949 / 2007
control formula for price rising. Maximum average annual increase of prices is
determined by the consumer price index communicated by the National Institute of
Statistics.
In addition, any price change, introduction of new packages of services or discounts
should be communicated to the ANCOM. Authority has the right to verify if, through
its prices, Romtelecom fails obligation not to practice dumping prices, which aim at
limiting the entry or restricing competition.
Price checking by ANCOM is made based on information supplied by the operator in
its separate financial statements. Moreover, Romtelecom has the obligation to
transmit, at authority request, information on monthly traffic registered for different
categories of subscribers, identified by combinations or packages of services and
available options in the operator offer. If violations of obligations imposed are found
after this control, ANCOM can impose an appropriate change of prices or withdraw
the service packages.
The considerations explained above are only part of regulations imposed on the
company studied. We limited our description just to those that have a direct impact on
management accounting system and performance measurement system. Under these
circumstances, we ask ourselves: how company's performance can be managed in
these conditions? In the next section we will discuss the information collected and
draw some conclusions from the conducted study.
DISCUSSION AND CONSLUSIONS
Opening competition was a turning point in terms of how Romtelecom understood the
articulation of its actions by reference to the competitive environment in which
operated, an environment that no longer resembles to the one in which activated for a
long time. These changes have required the entity greater flexibility in its actions in
order to meet the needs of users of its traditional services (fixed telephony). In the
following, we are answering to the two questions addressed at the beginning of this
paper.
(a) to which extent telecoms regulations affect the management control practices
and thus performance measurement system?
Management control system of Romtelecom is strongly influenced by these
regulations, the freedom company has to choose and implement performance
management tools is strongly limited.
Performance measurement has suffered, especially when we talk about divisional
performance. Most regulations are affecting revenues, as well as costs of each
division and thus their profits. Because financial indicators that are based on profit,
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are primarily used for performance measurement is understandable that the

interventions of the regulatory authority distort the management accounting system
and performance measurement process.
Given that the regulatory authority exercises strict control over prices on the
telecommunications market, we believe that managing the costs is an imperative; in
this respect Japanese approach of target costing may be useful, supported by an
efficient activity-based management.
However, regulation should not be viewed as a negative aspect. It can also provide
benefits that can be capitalized. For example, for pricing the interconnection services,
LRIC costing model uses data from separate financial statements and relies on
information regarding operators recent performance, thereby enabling the elimination
of costs related to structural and operational inefficiencies, and estimating long-term
evolution of these costs.
(b) which management control tools escape from regulation and can be
exploited in order to create value and improve company performance?
Addressing the concept of performance, Alazard and Separi (2003) stated that
"performance requires a holistic view of interdependencies between internal and
external, quantitative and qualitative, techniques and human, physical and financial
management parameters." Trying to measure the value created by the organization
solely on the basis of purely financial indicators can lead to a manipulation of
numbers. These negative effects can be counteracted by supplementing the analysis of
financial indicators with non-financial elements. Service quality is one of these
elements, aiming at appropriate quality management.
Quality is increasingly recognized as a key competitive advantage and it is more and
more placed by enterprises in their global strategic choices. In order to improve
quality, the company must invest in prevention, with beneficial effects in saving other
cost categories. Quality in telecommunications can be appreciated by the customer
through the following features: fastness of service installation, promptitude in
replying to failures requests, signal quality, the time required for purchasing new
services, customer information, payment method, changing contractual terms, price,
service customization, compatibility with other services.
A common view in literature is that a satisfied customer is the best indicator of the
quality of any business. While much of the literature suggests that total quality
management facilitate customer satisfaction, Sharma et al. (2010) believe that this is
not necessarily true in the case of privatized monopolies. However, a solution could
be the implementation of a set of concepts and management tools aimed at involving
all staff in order to achieve continuous performance improvement (Hoque, 2003).
But organizational change often encounters resistance from actors who refuse to adapt
to these change. For example, sudden changes of regulations, of technologies or
customer requirements may cause institutional contradictions / inconsistencies
(Sharma et al., 2010). Such a situation was encountered in Romtelecom, when the
reengineering process started, in conjunction with the redesign of organization
structure and activity-based management implementation.
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This phenomenon is not unique, such problems being faced by other European
incumbent operators. Trying to implement activity-based costing system in the
Portuguese telecommunications incumbent operator found resistance from production
employees and managers (Major and Hopper, 2005).
We believe that paying an increased attention to encourage a behavior that contribute
to developing an organizational culture that promotes cooperation and a processoriented management, instead of perpetuating routine from public sector, can be an
action directed toward improving organizational performance.
Our analysis is limited to one case study. Therefore may not be applicable to other
Romanian telecommunications companies. Our intention has not been to develop a
comprehensive theoretical framework, but to explain and understand the effects of
regulation on management control system and identify practices that can be used in
order to achieve superior performance. Thus, the work may offer a different
perspective to companies that fail to find solutions to improve performance in a highly
regulated environment.
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QUO VADIS IN MEASURING BUSINESS

PERFORMANCE? A PRACTICAL SOLUTION
FOR THE IT SECTOR
Claudia Elena SERBAN1,
Oana-Adelina FLORICIOIU & Radu-Daniel LOGHIN
ABSTRACT
This paper aims to provide, in light of the growing importance of performance management
in all socio-human activities, a strategic planning and management system for the IT sector.
Using a strategic planning and management control system in an efficient way helps to
generate value and raise the living standards in a community. These form the premises for
sustainable growth, an ideal which should concern every active or inactive member of a
society. The contents of the paper are the result of applied positive research, as it tries to
shape an existing strategic planning and management system regarding the necessities of
information technology for the betterment of the economy.
KEYWORDS: performance, performance management, management control system,

performance monitoring, balanced scorecard
INTRODUCTION
The term performance originates in Latin, and its current meaning has been retained
in English as the ability of socio-human activity to reach its purpose, vision, and its
innate objectives. Attempting to define this notion from an economic point of view, a
notion which, as Jianu I. stated, is so sweet in meaning but so bitter in
complexity, we can distinguish three major directions pertaining to the success margin
in achieving strategic objectives as well as goals relevant for socio-human activities,
the ability of a socio-human activity to bring value to all related parties, as well as the
ability of socio-human activity to achieve a high level of effectiveness and efficiency.
According to the first direction, socio-human activity is performant when it achieves
its intended strategic perspectives. In desiring to follow the strategic perspectives,
enterprises or socio-human-activities develop monitoring systems, which are used to
trace out the appropriate course of action. Monitoring involves using goals as well as
some sophisticated valuation systems. In this context, enterprises, identical size, area
of interest and even socio-political-geographical factors are easily distinguishable
according to the vision set out by the human equity relevant to the economic sector.
Jianu I., in her work titled Evaluarea, prezentarea i analiza performanei
ntreprinderii, captures this aspect with the following paragraph: What is an
achievement in a given statement, set by certain goals and objectives may not be so
Correspondence address: Claudia Elena SERBAN, Bucharest Academy of Economic Studies;

email: claudiaserbanos@yahoo.com
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considered under a different statement, set by other objectives. Performance can be

considered only by achieving preset goals and objectives.
According to the second view, performance in enterprises (socio-human activities) is
anything that enhances the value-cost set and not just something that reduces costs or
increases value, as Jianu I. wrote in the same paper, mentioned previously. Added
value must be analysed through the perspective of all parties involved in the entitys
activity stock-holders, employees, customers, and not the least through the lens of
the social-political and natural enviroment in which the said activity occurs.
The last vision can be found in Niculescu M.s volume Diagnostic global strategic:
an enterprise is theoretically performant if it is at the same time both productive and
effective. Our opinion is that the meaning of performance cannot be reduced to the
meaning of these terms. Productivity expresses only a state of fact that characterises
the productive activity of an enterprise. The fact that an enterprise is productive does
not mean it is necessarily performant.
Every organization, regardless of type, needs a clear and cohesive performance
measurement framework that is understood by all levels of the organization and that
supports objectives and the collection of results, mentions Procurement Executives
Associations in Guide to a Balanced Scorecard Performance Management
Methodology. According to this guide, performance measurement is the process used
in determining the companies progress and meeting the goals, in matters of efficiency
(resource consumption), product quality and results.Performance management
means using performance measures to change processes, activities, and organizational
culture and to allow the establishment of policies and objectives as well as their
implementation. Performance measurement precedes and includes performance
measurement, wrote C. Albu and N. Albu in Soluii practice de eficientizare a
activitilor de cretere a performanei organizaionale.
Performance has to be tracked, measured and managed around the clock. We can state
that an organizations performance depends on its environment, strategy and mission
as well as its responses in matters of flexibility and adaptability. Measurements are
key. If you cannot measure it, you cannot control it. If you cannot control it, you
cannot manage it. If you cannot manage it, you cannot improve it and achieve
performance, state P. Kueng P. and A.J.W Krahn in Building a process.
Performance Measurement Systems: some early experiences.
As C. Albu and N. Albu mention in the article above, the way we perceive
performance is a representation of the businesss activities, it is a communication
means by establishing a common terminology, it helps us comprehend the
phenomenon, it has limits (like any other construct) and that is why the modeling
(construction, integration and model valuation) is more important than the model
itself. As they write, the control and measurement of the performance must be
coherent with the mission, the strategy, governance and organizations objectives, and
more they have to ensure their presence and compliance in the organizations current
actions.
The enterprise, as a complex and adaptive system, with a certain finality and being
permeable to influences from the exterior, can be considered a set of subsystems.
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Through the lens of the management, the enterprise is composed of the leadership
subsystem, the subordinated subsystem (operational) and the information subsystem
that links the first two. As C. Caraiani and M. Dumitrana wrote in Contabilitate de
Gestiune i Control de Gestiune, solving problems, identifying the connections
between the subsystems, revealing the appropriate information which allow the
operating and leadership subsystems to achieve the established goals can be favoured
by using performance monitoring and reporting statements. These monitoring
statements are the dashboard (DB), balanced scorecard (BSC), performance prism
(PP), and skandia navigator (SN).
Grafton, J. Lillis, AM and Widener, SK presented in the publication The role of
performance measurement and evaluation in building organizational capabilities and
performance, a study on the impact of using monitoring tools relevant to strategic
performance of the future direction of the organization. The study concludes that
management should use a wide range of financial and non-financial indicators in the
monitoring of strategic performance in order to achieve an increase in the value of the
organization, namely the sustainability of the business. Narrowing the area of
monitoring instruments, the authors state, has led to an incomplete feedback, therefore
to decisions affecting the profitability and sustainability.
A good performance measurement system is a way to see if the chosen strategy was
adequate, if it focuses the employees attention on what matters most for success,
represents a communication medium for all the company and is very well defined.
This means using quality data, establishing targets, around the clock monitoring to
ensure the targets are met, and initiatives to eliminate negative deviance from the said
targets. We will try to clarify this aspect in the following section. As the approach
varies from sector to sector, we have chosen to restrict the focus to the IT sector. The
contents of the paper are the result of scientific observation, in which the following
concepts are described: performance, performance management, management control
system, performance monitoring.
1. BALANCED SCORECARD (BSC) STRATEGIC PLANNING
AND MANAGEMENT SYSTEM
Balanced Scorcard was first proposed as a strategic planning and management system
for enterprises activities in 1992, by Robert Kaplan and David Norton, with a
backdrop of insufficiencies regarding American companies reporting practices.
Recent studies on the relationship between organisation size, product cycles, market
share and Balanced Scorecard usage show that there is a strong bond between the
organisations size and BSC usage, as Hoque and James wrote in the article Linking
balanced scorecard measures to size and market factors: Impact on Organizational
Performance The BSC has also been incorporated into management accounting
curricula, and has become a standard service offered within many management consulting
firms.
The main reason that large corporations are implementing BSC as a strategic planning
and management system is the fast access it offers to solutions to problems such as:
Constraints at the data level, which mostly appear in great companies, as a
consequence of decentralization and activity structuring.
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The need to simulate efficient transmission, which becomes more obvious

inside corporations.
Comprehensive information and measurement problems that appear in large
corporations (Kaplan & Atkinson, 1998, cited in Hoque & James, 2000).
Setting techniques to help evaluate performance levels (Hoque & James, 2000)
Managing a parameter creates inefficiencies in other unmonitored areas, in
addition to conflicts and gaming at an organizational level (Anthony &
Govindarajan 1998, Malina & Selto 2001, Smith 2002).
BSC is centered around 4 axes as follows:

Financial perspective (what are the stockholders expectations?)
Through the financial perspective, we measure the way in which financial
performance is viewed, meaning the number of debtors, cashflows and return on
investment. An enterprises financial perspective is vital for achieving success, but
financial data have two major drawbacks. First, they are historical data, and the
enterprises market value can greatly surpass the grand total of all net assets. The
difference between these two values is called intangible assets, as J. Tobin wrote in
A general equilibrium approach to monetary theory. These are not considered in
standard financial statements. Classic measures used to draw this perspective are:
profit, EBIT, EBITDA, EBT, increase in revenue, revenue obtained through new
products, gross profit in percentages, reduction of costs in key areas, economic value
added, return on equity.
Customer Perspective (what are the customers expectations?)
From the customers perspective we measure the direct impact taht the enterprise has
over its customers, meaning the necessary time needed to process a phone order, the
results of customer surveys, number of complaints received or the enterprises
standing among customers. Classical measures include: market share, level of
customer satisfaction, neccesary time to comply with a customers request, number of
customer complaints, and time spent with the customers.
Internal process perspective (to satisfy customers and stockholders, what key
processes must be controlled?).
This perspective measures the way in which performance is added in key processes;
for instance, in time spent surveying, the number of units that require reproduction, or
production costs. Classic measures include:
Innovation: production capacity, number of new products or services, time necessary
to develop new products, number of new production licenses
Operational process: productivity, number of flaws, the time necessary to deliver a
product to a customer, the percentage of deliveries in real time, the time necessary to
synchronise production with orders, time required for deployment and tunning, real
production time
Post-delivery services: time required to replace and repair malfunctioning products,
time required to train customers in using the product.
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Learning and growth perspective (to reach the objectives, what is the required
growth?)
This perspective is oriented towards the enterprises growth curve, for instance, the
number of employee suggestions or the required time to train employees.
In the balanced scorecard, we find many financial measures, but there are also
measures pertaining to customers, quality, internal efficiency, and its ability to grow
and improve and grow over time. The balanced scorecard is designed to comply with
an enterprises key manager requirements (strategic business unit); as it provides
specific measures for the enterprises four perspectives, it can be considered to be a
privileged global strategic planning and performance management system. Through
its information content, this performance control system is action-oriented and
prediction-oriented, as the result of a data selection process, so the information
provided to the management are not too comprehensive.
Classic measures: employee degrees and qualification, figures which show employee
satisfaction, employee productivity, the timeliness of information systems, the number
of control procedures proposed, the percentage of employee suggestions which were
implemented.
Among the pluses this system offers are: providing the companys leadership with a
clear view of the business, aligning the key performance initiatives with strategies, at
all levels; transmission and comprehension of the objectives and strategies, and
partners expectations.
Among the minuses of this system are as follows: the start point for modeling is
strategy, not the partners expectations; the number of the partners is limited to four
(neglecting the enviroment, suppliers, competitors; and including employees to
internal growth); it does not specify a link with the means to stimulate the employees.
In each perspective, a company must define the following:
Strategic objectives what is the strategy for that perspective;
Performance Measures how will progress be measured in that business;
Targets - the target for each measure;
Strategic Initiatives - what must be done to achieve the targets.
2. WHY SHOULD THERE BE A BALANCED SCORECARD
FOR THE IT SECTOR?
We focused on the Balanced Scorecard in order to provide an in-depth understanding
of the process in which the ideas found in management accounting entered the world
of specific organization practices and technologies.
Increasing public interest in the consequences of economic processes on the
environment or corporate social problems generated by these processes, are putting
pressure on companies management and require a certain type of transparent
reporting, which should respond to the satisfaction of all stakeholders, conclude Li, N.
and Toppinem, A. in the study presented in the paper Corporate responsibility and
sustainable competitive advantage in forest-based indusy: Complementary or conflict
goals?
~448~
We considered this as well, by using the balanced scorecard as a pilot instrument, an

array of economic and financial indicators (short-term monitoring instruments) goals, to identify failures in time, but at the same time to serve as a transparent
reporting to all stakeholders.
BSC was drawn into a series of influential articles and business bestsellers (especially
Kaplan & Norton, 1992, 1996), which now form the basis of a major consulting
industry and a set of organization practices. Society was fascinated by the concept of a
strategic planning and performance measurement system, which is now translated into
a multitude of specific practices, compiled today in a Balanced Scorecard.
We chose the IT sector because the challenges are greater when it comes to
performance management, which make it difficult to conclude if the existing
performance serves the strategic objectives. At least in principle, the IT organisations
measure, monitor and act according to the information they collect by applying a
variety of systems and performance management techniques. However, these tend to
measure technical performace. Information pertaining to non-technical performance is
rarely considered, especially data that allows managers to establish whether projects
unfold as planned. There are clues regarding potential performance problems, such as
projects that require the managements intervention or initiatives that have already
been taken to ensure that problems are solved.
3. THE PRACTICAL SOLUTION
The idea of forging a balanced scorecard to measure IT efficiency is not a new one, as
it has been implemented succesfully by numerous IT corporations. The key to
successfully executing this idea is the ability to clearly view the connection between
IT objectives and goals (as seen by a Chief Information Officer (CIO)) and broad
business goals and objectives (as seen by a Chief Executive Officer (CEO)). This
connection is not invariably obvious. A process for managing performance to reveal
both technical and volatile measures must be painstakingly built. This means
collecting data relevant to performance regarding critical performance measures,
analysing information to define the objective, establishing targets relevant for each
measure, frequent monitoring to determine potential driftage, discussing issues with
higher tier management and implementing adequate reforms. This process, however,
cannot work properly without appropriate performance measures (technical and nontechnical) which will help identify key areas, which require improvement.
Among some of many obstacles facing management, teams are the following:
dwindling product cycles
recruiting, rewarding and maintaining talents
operating and transmiting critical development decisions
following the demand and supplying the right products
the emergence of new technologies which invalidate existing products
unforseen vulnerabilities related to the enterprises systems
undetected threats with dire consequences over the business
To meet the demands of the sector, we can design a strategic planning and
performance management system in the form of a hybrid balanced scorecard, to
incorporate both aspects relating to IT strategic management as well as business
management.
~449~
Of special interest are the various threats and vulnerabilities in information

technology, as these present a unique aspect of the sector, while the rest are applicable
to other domains as well.
Table 1. Key aspects and focus which define IT management and monitoring
proposals
Aspect
Security
Management
(enterprise-wide)
Critical Business
Applications
Computer
Installations
Focus
Issues
Probed
How they affect the perspectives

set in BSC
Security management The commitment provided by

at enterpise level.
top management to promoting
good information security
practices across the enterprise,
along with the allocation of
appropriate resources. The
aspect in question deals with
vulnerabilites
caused
by
inadequate security policies
adopted
by
security
management, as well as their
ability to expose and encounter
threats.
User perspective: through the

enterprises policy towards user
requests relevant to its systems
A
business
application that is
critical to the success
of the enterprise
The security requirements of

the application and the
arrangements
made
for
identifying risks and keeping
them within acceptable levels.
Typical vulnerabilities for this
level include holes left by
programmers in the source
code of the applications in
question and bugs, and threats
come from inconsistencies
between data collection and the
application,
as
well
as
unauthorised copying of the
source code by competitors and
illegal users.
User
perspective:
through
applications which are able to
identify and block requests from
unauthorised users
How
requirements
for
computer
services
are
identified, and how the
computers are set up and run in
order
to
meet
those
requirements.
Typical
vulnerabilities for computer
services
include
storage
devices
and
hardware
frameworks that can be stolen
or damaged.
User
perspective:
through
satisfaction pertaining to the
technology used by the enterprise
A
computer
installation
that
supports one or more
business applications
Internal
process:
perspective
through the effectiveness of its
quality control policies and its
quality manual developed with the
help of the internal audit.
Financial perspective: through
costs linked with a decision made
to mentain a decent level of
security for the enterprises
systems.
Learning and innovation: through
policies which encourage the
development of a securityconscious culture, regarding data
handling that promotes individual
actions
Internal
process
perspective:
through procedures and functions
which allow the rapid compiling of
update packages
Financial perspective: through
financial-accounting applications
that dont distort user inputs
interactive simulation technologies
as well as evolving programming
enviroments.
Internal
process
perspective:
through the wear and depreciation
of the computer installations and
their compatability with various
equipments
Financial perspective: through their
amortisation rate during operations
technologies adaptive potential.
Networks
A
network
that How requirements for network User
perspective:
by
the
supports one or more services are identified; and how connection speed recorded while
business applications the networks are set up and run servicing their needs.
~450~
Aspect
Systems
Development
Focus
A
systems
development unit or
department, or a
particular
systems
development project.
Issues
Probed
How they affect the perspectives

set in BSC
in order to meet those

requirements. Threats from the
network are represented by
virus attacks and phishing
attempts, and vulnerabilities
pertain to the ill-managed acces
authorisations
in
the
enterprises own network and
inadequate encryptions for
inbound
and
outbound
transmissions.
Internal
process
perspective:
through
the
efficiency
of
transmissions between terminals in
the programming dept.
Financial perspective: through the
costs required to build and mentain
the network
How business requirements

(including information security
requirements) are identified;
and how systems are designed
and built to meet those
requirements. Vulnerabilities
can be caused by inadequate
testing in the development
stage of the systems and
products and threats can arise
from fatal errors neglected in
the development phase.
User perspective: through concern

shown towards their needs before
setting changes

the WAN acces to international
scientific databases
Internal
process
perspective:
through internal procedures used to
identify and encounter possible
threats.
Financial perspective: through the
value added to the market value of
the enterprise by the implemented
system
the percentage of innovation in the
actual development
*As Cisco Systems shows, the rising prices of IT sector stocks are volatile and depends on competitors
decisions as well as the brokers negotiation skills (R.D. Loghin, Implicaiile contabile ale achiziiilor
de fotbaliti de ctre cluburile de fotbal, 2010).
The ever-present shadow of vulnerabilities and threats to the system, as well as

classical problems, can prevent meeting organisational objectives, a fact that can be
checked through a set of measures meant to support active performance monitoring
efforts, and revealed through statistical, operational and accounting evidence.
Measuring performance and risk converge at a common ground, through different
trajectories: measuring performance becomes more risk-oriented through a set of
performance measures that can detect signals of weakness from the enviroment in a
timely fashion; risk measurement becomes more performance-oriented as it connects
potential threats and opportunities to the enterprises strategic objectives.
There are different studies in which, besides the classical performance oriented BSC,
there are references to approaches regarding enterprise-wide risk management.
(Mamoru, 2004; Nagumo, 2004; Beasley et. al. 2006; Woods, 2007). The set of
measures, in order for a more efficient layout, are structured into four perspectives,
and those are: user perspective, financial perspective, internal process perspective and
a learning and innovation perspective.
3.1. User perspective
We chose to replace the customer perspective with the user perspective, as the
recipients of information technology arent restricted to customers. Users is a term to
include all those who use information systems developed and mantained by the
enterprise. They have the ability to interact with the supplier and notify it about the
degree of those interactions. The GUI interface is intuitive, but for many users there
needs to be a support system capable of receiving calls and complaints. The enterprise
~451~
should respond to every request in an effective and efficient manner, an aspect that
can be measured by the number of the call centers telephone sessions. The
satisfaction of users does not only include the positive aspects, but also the negative
ones, such as complaints regarding the quality of operator-customer relations. Also in
focus is the time it takes to fulfill a request, expressed in hours, which should be
diminished as far as possible while maintaining the necessary quality.
A novel approach to user management is the inclusion of social aid and sponsorships
in the overall promotion strategy, as a viable alternative to advertising expenses.
The objectives of this perspectives are: customer satisfaction (monitoring measures
proposed: the total number of complaints, the total number of solved complaints, the
number of received calls, the number of first call resolutions); protection against
digital piracy (monitoring measures proposed: cost of digital piracy/Revenue*1000,
cost of digital piracy/total Revenue); positive image (monitoring measures proposed:
total protocol and sponsorship expenses to 1000 monetary units in revenue).
Table 2. User perspective design
Measure
Total number of complaints

Total number of solved
complaints
Number of received calls
Number of first call resolutions
Cost of digital
piracy/Revenue*1000
Cost of digital piracy/Total
Revenue
Total protocol and
sponsorship expenses to 1000
monetary units in revenue
3.2.
Metrics and
positive trend
Number, decreasing
Number, increasing
Number, decreasing
Number, increasing
Currency, decreasing
Currency, decreasing
Currency, no fluctuation
Data source
mails, phone calls,

surveys
surveys, session records
Phone bills
Phone bills, surveys
Police reports, income
statement
Police reports, income
statement
Income statement
Benchmark
none
none
none
none
Sector reports
Sector reports
Published financial
reports
Internal process perspective
To survive the passing of time, an IT enterprise must be in touch with the latest
developments, and this implies a constant renewal of user licenses. The information
technology market constantly bears witness to new technologies, which open new
venues for business while closing old and ineffective ones. Also, as Table 1 shows, in
information technology it is imperative to develop a quality handbook as well as to
measure all clues regarding the risks posed by threats and vulnerabilities for solid
operational, financial and investment activities.
The objectives of this perspectives are: ensuring system quality (proposed monitoring
measures: average period required to produce an update, no. of implemented security
procedures per employee, threats/update, the average time it takes to cover a
vulnerability, the average network downtime, average worktime of the equipment
divided by total work schedule, no. of required interventions to bring a system
online); adapting to new technologies (monitoring measures proposed: license
renewal rate, the frequency of installing new operating systems, variation of novel
equipment acquisitions as percentage of total balance sheet growth).
~452~
Tabel 3. Internal process design

Measure
Average period required to

produce an update
No. of implemented security
procedures/employee
Threats/Update
The average time it takes to
cover a vulnerability
Average network downtime
Average worktime of the
equipment divided by total work
schedule
No. of required interventions to
bring a system online
License renewal rate
The frequency of installing new
operating systems
Variation of novel equipment
acquisitions as percentage of
total balance sheet growth
Metrics and positive

trend
Hours, decreasing
Number, increasing
Number, increasing
Hours, decreasing
Data source
Benchmark
Development logs
None
Statements of
compliance
Source code
Development logs
None
Rival systems
Market-wide surveys
Percentage, decreasing
Maintenance logs
Maintenance logs,
schedules
None
None
Number, decreasing
Maintenance logs
None
Percentage, increasing
Invoices, inventory
lists
Maintenance logs
Financial statements
Balance sheet,
inventory list
Percentage,increasing
3.3. Learning and innovation perspective

An IT enterpises ability to improve its services and products is highly dependent on
the R&D expenses it plans to risk to develop a new product or service. The success
rate of such efforts can be measured by reporting R&D expenses to those which were
convertible into assets, as well as through counting independent, unfinanced
initiatives. One learning process that is vital for this field is attending industry-focused
and sponsored conferences and events. The objectives of this perspectives are:
attending relevant IT-focused events and conferences (monitoring measures proposed:
conference buget fluctuations as part of the overall buget fluctuation, the margin of
fulfillment for the revenue expected from attendance, number of attendees/overall
possible events); bringing new products and services (proposed monitoring measures:
unconvertible R&D expenses/capitalised R&D expenses, the number of new
programming languages learned by the employees).
Tabel 4. Learning and innovation perspective design
Measure
Conference buget
fluctuations as part of the
overall buget fluctuation
Margin of fulfillment for the
revenue expected from
attendance
Number of attendees/Overall
possible events
Unconvertible R&D
expenses/Capitalised R&D
expenses
Number of new programming
languages learned by the
employees
Metrics and positive trend

Currency, increasing
Data source
Annual budget
Benchmark
None
percentage, increasing
Financial predictions,
income statement
None
Event brochures, calls for

papers, attendance logs
Balance sheet, income
statement
Call for papers,

paper lists
None
Academic Degrees,
Queries
None
Number, increasing
~453~
3.4. The financial perspective

The IT sector is witnessing a period of unprecedented growth, and those responsible
for financial management of the entities are forced to reflect that growth into the value
they add to their stockholders. The stockholders look towards their stocks from the
lens of the value those stocks add to their personal fortune, from the time the titles are
purchased. This growth includes, on one side, dividends paid during all financial
periods and on the other, the growth of stock prices. These two elements combined
compose the shareholders earnings in the set of measures relating to the financial
perspective. The enterprise must afford selectivity, in case of a liquidity deficit. The
risk of information systems also plays a significat role in measuring the attractivity of
the company to its investors. A single model, measurable, can help decision-making,
regarding what and when to invest in, and more important, what it should not invest
in, in order to ensure what programs can provide the highest return in revenue.
The objectives of this perspectives are: increasing stockholder earnings (Monitoring
measures proposed: the growth of own stocks relative to that of the sector, business
market value, equity loss or win from reevaluation, loss of equity, economic value
added, turnover from dealing with own stocks); increasing dividends (monitoring
measures proposed: the increase of the dividend distribution rate, net dividend to 1000
monetary units in revenue); the increase of financial leverage (monitoring measures
proposed: financial leverage); reducing audit risks (monitoring measures proposed:
the proportion of information systems audit risks as part of the overall inherent and
control risks, the risk of ones own stocks relative to the market).
Tabel 5. Financial perspective design
Measure
The growth of own
stocks relative to that of
the sector
Business market value
Equity loss or win from
reevaluation
Loss of equity
Metrics and positive trend

Data source
Stock market
transaction data
Benchmark
Stock market
transaction data
currency, increasing
currency, increasing
Financial news
Equity statement
Increase of the dividend

distribution rate
Net dividend to 1000
monetary units in revenue
Self financing capacity
percentage, increasing
Valuation reports
Balance sheet, equity
statement
Balance sheet, income
statement
Currency, stable or increasing
Financial news
Currency, increasing
Income statement
The proportion of
information systems audit
risks as part of the overall
inherent and control risks
The risk of own stocks
relative to the market
Audit report
Financial
statements
None
Stock market reports
currency, decreasing
Financial news
Financial news
Stock market
reports
This set of measures can be used not only to help the three parties involved to follow
the guidelines, but also a a benchmark for determining management bonuses:
Bonus actual = Bonus precedent x(1-x)
(Formula nr.1)
Where x is the deviation from targets in percentages. This variable is determined, as

the next formula shows, by comparing the targets for the selected measures relevant to
~454~
the manager with the actual figures. This applies only to the measures where a
deviation is negative or undesirable by the owners, weighted according to their wish.
Finally, the bonus the manager recieves for his or her performance is determined
through comparison with the present bonus.
1n x n x p x p g i
x=
1g
i i
(Formula nr. 2)
Balsam, S., Fernando, GD, and Tripathy, A. published in February 2011, in The
impact of firm strategy on performance measures used in execution compensation, a
study on the correlation between business strategy, performance measurement
indicators and compensation management. In most cases, according to the study,
management is rewarded based on sales, resulting in its concern for achieving
competitive advantages in the market by reducing the selling price or increase of
physical supply of products, business decisions that often affect the stability. Strategic
performance monitoring focused mainly on elements that are related to the level of
executive remuneration is made at the expense of accounting tools that would allow
identification of failure, which is built in an aggressive start of event risk.
CONCLUSIONS AND FURTHER RESEARCH
Ignoranti, quem portum petat, nullus suus ventus est( the wind is never favorable to
those who don't know where they are going), said Lucius Seneca. Any business pilot
needs a direction and a solid navigating system to give him much-needed guidance for
meeting targets. Through a balanced scorecard, with its four perspectives, we get a
business compass, which can be mounted on any entity. Adapting the system for the
needs of the IT sector presents a challenge, in both promoting change for the recipients,
as well as integrating its many features with the sectors requirements. Threats and
vulnerabilities that threaten the business present a focused point for the IT sector, so any
initiative that plans to develop a BSC must consider them before implementing it. The
measures found inside the perspectives must not be taken individually under analysis, as
they form a network of more or less interconnected aspects, and one success may mean
another failure. There may be hostility towards the system from the management, as a
compass can take away freedom or evaluate their deviations in a credible way, with
implications stretching to their pockets. That is why the life expectancy of the system
depends foremost on the persuasiveness of its promoters.
In this paper, we evaluated the opportunity and structure of a strategic planning and
management system, and laid the foundation for such a system based on empirical
experience and professional reasoning. The targets and initiatives in the balanced
scorecard were of no interest for the paper, as no IT company was willing to test the
system. The critics of the model, who consider that BSC fails to consider all relevant
parties, address the first obvious limitation. Moreover, recent trends may someday
remove the identified threats and vulnerabilities alltogether, making the current
system obsolete. The lack of direct feedback from spokespersons representing the
sector is also a factor that somewhat diminishes its overall utility and desirability.
We hope that the current results will encourage further studies and stimulate the
management consulting industry to develop or refine its models for the IT sector, in
~455~
order to develop portable, intuitive and compressed BSC systems or systems similar
to BSC. We also plan to further our efforts to help IT companies apply the said BSC
and monitor their evolution. The result of the monitoring may be presented in a future
conference.
REFERENCES
Albu, C., Albu, N. (2005) Soluii practice de eficientizare a activitilor de cretere a
performanei organizaionale, Ed. CECCAR, Bucureti
Anthony R.N., Govindarajan V. (1998) Management Control Systems, Irwin-McGrawHill,
New York, NY,
Balsam, S., Fernando, GD, Tripathy, A. (2011) The impact of firm strategy on performance
measures used in execution compensation, Journal of Business Research, vol. 64,
no. 2: 187-193
Beasley, M., Chen, A., Nunez, K., and Wright, L. (2006) Working Hand in Hand: Balanced
Scorecard and Enterprise Risk Management, Strategic Finance, March,
Caraiani C., Dumitrana M. (2005) Contabilitate de Gestiune i Control de Gestiune, Editura
InfoMega, Bucureti,
Grafton, J. Lillis, AM, Widener, SK (2010) The role of performance measurement and
evaluation in building organizational capabilities and performance, Accounting
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Ionascu I. , Stere M., Andrei T. (2006) Control de gestiune, Editura Economica, Bucuresti
Jianu, I (2007) Evaluarea, prezentarea i analiza performanei ntreprinderii, Ed. CECCAR,
Bucureti
Kueng, P. Krahn, A.J.W. (1999) Building a process. Performance Measurement Systems:
some early experiences, Journal of Scientific& Industrial Research
Li, N., Toppinem, A. (2011) Corporate responsibility and sustainable competitive advantage
in forest-based industry: Complementary or conflict goals? , Forest Policy and
Economics, vol. 13, no. 2 (SI): 113-123
Loghin,R.D. (2010) Implicaiile contabile ale achiziiilor de fotbaliti de ctre cluburile de
fotbal,
Malina M.A., Selto F.H. (2001) Communicating and Controlling Strategy: An Empirical
Study of the Effectiveness of the Balanced Scorecard, Journal of Management
Accounting Research, Vol. 13
Mamoru, U. (2004) Risk Management and Risk Business Enterprise Risk Management using
Balanced Scorecard, Management Systems, Vol.14 No.2
Naguno, T. (2004) Aligning Enterprise Risk Management with strategy through the BSC: the
bank of Tokyo-Mitsubishi approach, Harvard Business Publishing
Niculescu, M (2003) Diagnostic global strategic, Ed. Economica, Bucureti
Lorino, P, (1995) Comptes et recits de la performance, Ed. DOrganisation, Paris
Procurement Executives Associations, Guide to a Balanced Scorecard Performance
Management Methodology
Smith M.J. (2002) Gaming Non Financial Performance Measures, Journal of Management
Accounting Research, Vol. 14.
Tobin J., (1969) A general equilibrium approach to monetary theory, Journal of Money
Credit and Banking cited in Phd. Thesis - Gavrila A. Integrarea sistemelor
informatice de gestiune pe internet
Woods, M., (2007) Linking risk management to strategic controls: a case study of Tesco
plc,International Journal of Risk Assessment and Management, Vol. 7 No. 8
*** http://www.smartofficenews.com.au/Business/Technology/W2M2N6L8
***http://www.informationweek.com/blog/main/archives/2005/11/outsourcing_it.html
~456~
***http://www.isaca.org IASCA site

***http://www.netmba.com/accounting/mgmt/balanced-scorecard/ - NetMba site
***http://www.balancedscorecard.org/BSCResources/PerformanceMeasurement/tabid/59/Def
ault.aspx the Balanced Scorecard Institute site
~457~
EFFECTIVE AND EFFICIENT TOOLS IN HUMAN

RESSOURCES MANAGEMENT CONTROL
Mihaela Adriana DUMITRANA1, Gabriel RADU,
Mariana Elena GLAVAN & Gabriel JINGA
ABSTRACT
The main objective of our study is to select the most important quantitative techniques that
may be applied as tools in human resources management control, in order to facilitate the
prediction of human resource indicators that may be presented under an appropriate form,
clear and user friendly and then used by managers in their decision making process. For this
reason we have analysed the regression analysis and the learning curves, tools that are
considered appropriate in human resources management control. The cases that presented in
our research form part of our cooperation projects with different companies, projects aiming
to improve and sustain an efficient human resources management control.
KEYWORDS: human resources, regression analysis, learning curves, balanced scorecard

for human resources
INTRODUCTION
A company uses a lot of resources such as: financial, natural or human resources
(HR). The most important of all, for a company, is still the human resource and this is
because without it, it would be impossible to accomplish the mission or to attain a
specific vision within a company.
The capital theory (Becker and Schultz, 1964) considers the employees as assets that
may be valued based on their competences. Human resources are the most important
capital of a company the vital contact with customers the key for success (Tom
Farmer, 2010).
Waterman recognized that the organization people, culture, capacity represents an
important source of competitive advantages. People are the strategy (Waterman, 1994,
p. 21-22). The increase in financial performances of a company is due to a good
implementation of a human resources strategy, a Knowledge Management.
The importance attributed to human resources is revealed by the seven principles of
total quality management. The sixth principle of the TQM sais that: people are the
organizations primary resource and these resources execute the organizations
processes. Machines are tools and contribute to the productivity of people. However,
they have no meaning without people to figure out how to use them in concert with
one another to create the companys outputs.
1
Correspondence address: Mihaela Adriana DUMITRAANA, Bucharest Academy of Economic

Studies, Romania; email: mihaelaadumitrana@yahoo.com
~458~
The concept of sustainable development (SD) and the concept of corporate social
responsibility (CSR) have a major influence over the way that HR is managed. For
example, in the case of SD, considering the priority of values, the natural resources
comes first, followed by humanity saving. On the contrary, CSR concept considers
that the management priority must be given to HR, followed by to the life standards.
HR is associated with values such as: ethics, engagement for a long period of time,
interrelationship between internal and external actors, objectives etc. Consequently,
the balanced scorecard proposed in our research is based on these concepts and the
indicators are linked to priorities.
1. QUANTITATIVE TECHNIQUES IN HUMAN RESOURCES FORECASTING
1.1 Regression analysis
In order to prepare a balanced scorecard for the presentation of certain indicators
needed by the management is necessary to compare forecasts against real amounts. To
emphasize better the objective of our research we shall calculate the predetermined
and real indicators for the human resource. We consider the application of the
regression analysis as for being a worthy solution in forecasting, because we want to
prove the interrelationship between two variables selected for human resources, e.g.
total cost and training expenses. Based on these two variables we want to calculate the
influence of training expenses on the total cost for a certain level of training expenses.
This will be a first effect, because another will influence the quantity and the quality
of goods or services produced by company. Regression analysis is a forecasting
method based on historical data meant to find the best fit between two variables one
dependent on the other, and use the straight line to predict future values. The equation
of a straight line is:
y = ax+b
where:
a
b
n
is the gradient or slope

is the intercept with the y axis
is the sample size.
On the horizontal axis we have the independent variable training expenses, and the
dependent variable, y, is located on the vertical axis total cost.
The formulas applied to calculate a and b, are the following:
a = (nxy- x y)/(nx2-(x)2)
b =y/n-ax/n
Supposing we have, the following data, for a small company, for a period of six
months:
Month
April
May
June
July
August
September
Training expenses (mu)

2,000
4,000
5,000
3,000
1,000
2,000
~459~
Total cost (mu)

34,000
33,000
33,000
31,000
30,000
30,000
we want to compute the total cost, if training expenses will be mu 6,000.

To forecast costs, when training expenses are known, we must calculate the following
elements:
Month
April
May
June
July
August
September
Total
2
4
5
3
1
2
17
X2
XY
34
33
33
31
30
30
191
68
132
165
93
30
60
548
4
16
25
9
1
4
59
Y2
4,624
17,424
27,225
8,649
900
3,600
62,422
a = (6*548-17*191)/(6*59-172) = 0.63
b = 191/6-0.63*17/6 = 33.58
When training expenditure is zero, costs will be mu 33,585, and for every mu 1 spent
on training, costs will increase by mu 0.63. If training expenses will be mu 6,000, the
total cost will be:
Y = ax + b = 0.63*6 + 33,585 = 33,589
For forecasting costs for any level of training expenses, the equation of straight line
shall be used. Also for all costs related to human resources, regression analysis may
be used as a relevant tool.
If we want to show the strength of the linear relationship between the two variables,
we can achieve this by calculating the correlation coefficient (r):
r = (nxy-xy)/(nx2-(x)2((ny2-(y)2)
The correlation coefficient may have values within the interval [-1; +1]. The
interpretation of this instrument may be as follows:
r is close to +1: there is a strong positive correlation between the two variables;
r is close to -1: there is a strong negative correlation between the two variables;
r is close to 0: there is a weak relationship between the two variables.
For our example r will be:
r = (6*548-17*191)/(6*59-172)(6*62,442-1912) = 0.0087
r is close to 0 meaning that between training expenses and total cost is a weak
relationship, due to the small amount of training expenses in total cost. For small
companies, the budget meant for personnel training is not as important as for big
companies, where the relationship between variables is strong positive.
2.2. Learning curves
Estimates are forecasts of our expectations based on past conditions and on all
changes predicted for the future. A relevant example may be the learning curves as an
application of non-linear equations.
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Managers need to know all about the time needed to produce a number of units of
output, especially for new products that the company intends to launch on the market.
In this case experiences show that learning is more rapid in the first periods, and after
that, the learning rate decreases gradually until the realization of a certain number of
products or jobs, when time becomes a constant (the Bell curve).
Why is it important to calculate the learning curves effect? The answer is a simple
one, because there is always a link between the number of hours needed to produce an
expected number of products or to realize a number of specific jobs and the number of
human resources employed for this reason. The number of persons that is asked for all
tasks must be remunerated and their salaries and wages influence the costs per unit of
output, the total cost and the efficiency. If the learning curves effect is calculated, it is
possible to determine how productivity increases and consequently how to decrease
the cost per unit.
In conclusion the effect of learning curves is declining in average time and in average
cost per unit.
Wrights Law states the following: as cumulative output doubles, the cumulative
average time per unit falls to a fixed percentage (the learning rate) of the previous
average time (Lucey, 2001, p. 167).
When the curve becomes horizontal, the learning effect is lost and production time per
unit becomes a constant.
The effect of learning curves can be calculated using two methods:
1. cumulative average time method;
2. marginal method.
Both methods use the same general formula, although they have different manners of
defining the elements.
The learning curve is a non-linear function and the formula used is:
Y = axb
Where:
a time taken to produce the first unit or batch
b learning coefficient
x cumulative output expressed in units or in batches.
The definition of Y is different from one method to the other. For example, for a
cumulative average time method, Y is cumulative average time per object, for x
objects, while for a marginal method, Y is the marginal time for object x.
a) Cumulative average time method
It involves the preparation of a table where the average time is reduced by the learning
rate each time that the output doubles.
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Researchers have demonstrated that the trend is to decrease the time it takes to
produce an object at a constant rate equal to the rate at which the output increases. For
example, a 90% learning curve shows that, as cumulative total output doubles, the
cumulative average time to produce one object decreases to 10%.
The example that will be presented is based on the data provided by a small
manufacturing company that intends to launch a new product. They asked us to
calculate the total time needed for the production of sixteen batches, when the
learning curve was anticipated at 90%.
The data we used in order to make the calculation is the following:
Cumulative number of batches
(1)
1
2
4
8
16
Cumulative average time per

batch (hours)
(2)
200
180 (200*90%)
162 (180*90%)
145.5 (162*90%)
131.22 (145.5*90%)
Cumulative total hours
(3) = (1)*(2)
200
360
648
1,166.4
2,099.52
The last figure of this table 131.22 and is not the time needed to produce the sixteenth
batch. If we want to calculate this time, two steps must be performed:
Step 1 Calculate the average time for the fifteenth batch and cumulative average time
to produce 15 batches;
Step2 Calculate the time for sixteenth batch as a difference between cumulative total
hours for 16 batches and cumulative average time to produce 15 batches.
Step 1
General relation: Y = axb
b = log (1-proportionaldecrease)/log2 = log(1-0.1)/log2 = log0.9/log2 = -0.1520

a = 200; x = 15
y = 200*15-0.152 = 132.5 hours average time for batch no. 15
Cumulative average time to produce fifteen batches = 132.5*15 = 1,987.5 hours
Step 2
Time for the sixteenth batch = 2,099.52 1,987.5 = 112.02 hours
b) Marginal method
The basic assumption in a marginal method is: the time needed to produce a marginal
unit of a batch will be reduced with a given fixed percentage when the cumulative
output doubles.
Using the same example, the illustration of a marginal learning curve, for a 90% rate,
will be:
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Table 3
Cumulative number of batches
(1)
1
2
4
8
16
Cumulative average time per

marginal batch (hours)
(2)
200
180
162
145.5
131.22
Cumulative total hours
(3)=(1)*(2)
200
360
?
?
?
In this table, figures are the same as in Table 2, but the significance is different. So
that, the numbers of column 2 (200, 180, 162, 145.8, 131.22) represent the number of
hours used to produce batches number 1, 2, 3, 4,.,16, and not the average hours to
produce the first batch, the second, the third,, because we do not have the marginal
time needed to produce batches number 3, 5, 6, 7, 9,,15. To calculate these values
the formula is: Y=axb, where Y is the time to produce the marginal batch (unit), and is
used to calculate the time to produce the sixteenth batch. The steps are the following:
a) To calculate the time for batch nr. 16
Y = 200*16-0.152 = 131.22 hours
b) To compute the cumulative time for cumulative number of batches (16).
It is impossible to calculate directly this time. In order to find out this value we will
calculate for each batch from 1 to 16, and the sum of those durations will be the
answer of our question.
Time to produce batch no 3 = 200*3-0.152 = 169.2 hours
Time to produce batch no 9 = 200*9-0,152 = 143.2 hours
Total time calculation = 200 + 180 + 169.2 + 162 + 156.6 + 152.32 + 148.7 + 145.8 +
143.2 + 140.94 + 138.9 + 137.08 + 135.43 + 133.9 + 132.5 + 131.22 = 2,407.79 hours
After a comparison between the two methods, few conclusions have aroused:
The general formula was the same, but the results were different because Y was
interpreted in different manners.
Total time for sixteen batches was by method 1: 2,099 hours and by method 2:
2,407.79 hours. A difference of 308.79 was calculated, due to the reduction of
production time for each unit of output, in the marginal method.
Learning curves are not equivalent for two different methods.
~463~
Because results are so different it is important to select carefully what method

to apply. In our opinion, the first method is appropriate because it is simple and
the cost-benefit relation will be a favourable one.
The number of predetermined hours once calculated, will be the starting point
for determining the number of employees needed to achieve the target output as
well as salaries and wages, as an important part of the total cost.
3. BALANCED SCORECARD FOR HUMAN RESOURCES
A balanced scorecard (BSC) is a performance measurement and reporting system that
strikes a balance between financial and nonfinancial measures, links performance to
rewards, and gives explicit recognition to the diversity of organizational goals
(Horngren et al., 2008).
BSC is an important tool for managers because they may understand the effect of their
actions on the nonfinancial and financial indicators, allowing them to analyse how the
company attained its goals, for a certain period, as part of a long term strategy.
Generally, a BSC is prepared for the company as a whole, but we propose a BSC only
for the human resources, because we consider this resource as for being vulnerable
and it must be treated accordingly.
A BSC for human resources (HRBSC) may include indicators grouped in four axes:
9 Economic axis
9 Life quality axis
9 Ethical axis
9 Societal and environmental axis
and may be presented as follows:
Table 4
Economic
Total employees
Shares allocated to employees (% in total equity)
Revenue per employee
Average cost per employee
Cost of HR function per employee
% of cost reduction due to learning curves
Productivity (sales revenue/direct labour hours)
% of training cost in total cost or in sales
% reduction in process cycle time
Ethic
Average salary/sector salary
Women salaries
Men salaries
Number of handicap employees
Average salary per handicap person
Women managers
% of internal rules respected
Life quality
Working conditions
Working hours
Working accidents (%)
Illness time
Part time employees
Access to services (transport, kindergarten)
Employees implication in management
Qualification and autonomy
Training days per employee
Leadership competence
Negotiation capacity
Societal and environmental
Number of employees implicated in external actions
HR policy in respect with the environment
Number of employees participating to humanitarian
actions
Tutorial hours for young employees
This HRBSC contains indicators for: human effectiveness; employment;

competences; motivation; that in our opinion, are enough to analyse the contribution
of HR to the global performance.
~464~
From another point of view, indicators may be used to manage a corporate social
responsibility, because they may measure human resource performance, based on four
axes, both internal and external, so that all kind of analysis are possible.
Indicators presented in HRBSC must be calculated as predetermined figures versus
real figure, facilitating the calculation of variances, the identification of causes leading
to differences and, respectively, the decision making process on how to eliminate the
causes that influence performance.
CONCLUSIONS
i.
ii.
iii.
iv.
v.
HR strategy is influenced by SD and CSR.

HR strategy is contributing to the increase of global performance of a company.
The concept of HR is linked to human capital.
To forecast HR indicators quantitative techniques are the best solution.
All kind of costs related to HR may be treated as independent variables in
relation with a dependent variable.
vi. We have calculated only the effect of training expenses, in order to prove that a
strong relationship exists, if the amount is a relevant one.
vii. To calculate the effect of the learning curves is something important from two
points of view: first of all because productivity increases, and secondly because
the cost per unit of object decreases. These are important when the number of
employees and total salary costs are calculated.
viii. HRBSC proposed by this research is different from the classical content of a
BSC, where the four axes are: financial, process, customers and competence.
ACKNOWLEDGEMENTS
This work was supported by CNCSIS UEFISCSU, project number PNII IDEI
1858/2008
MANAGEMENT
CONTROL
IN
THE
SUSTAINABLE
DEVELOPMENT OF THE HUMAN RESSOURCES.
REFERENCES
Berland N., De Ronge Y., (2010) Controle de gestion: perspectives strategiques et
manageriales, Ed. Pearson,
Caraiani C., Dumitrana M., (coordonatori), (2010) Control de gestiune, Ed. Universirar
Horngren, Sundem, (2008), Management accounting, Pearson International Edition, Stratton,
Schatzberg, Burgstahler
Pfeffer J., (2010), Resursele umane n ecuaia profitului, Ed. All
Stephany D., (2003), Developpement durable et performance de lentreprise, Ed.Liaisons
Waterman R.H., (1994), What America Does Right, W.W. Norton
~465~
FLEXIBILIZING THE TERMINATION OF THE

EMPLOYMENT CONTRACT: PROS AND CONS
Raluca DIMITRIU1
ABSTRACT
The changes in the Romanian Labour Code appear to be a way of implementing the concept
of flexicurity in our system of law. And among all institutions changed by the new law,
probably the one related to termination of employment has the most dramatic effect within
labour relations and the very application of the principle of workers protection. The
Governments goal was to offer the possibility for the employers to dismiss and employ
personnel more easily, allowing him/her to select best employees at a time of economic crisis.
However, as a result of an analysis of how the flexicurity principles were applied in other
states (especially in case of the new member states) one may be very much afraid that
flexicurity cannot be obtained by just un-protect the employees and simplify the dismissal
procedure. This is why the changes in the Labour Code, particularly with the intention to
render more flexible the labour market and the contractual arrangements were received by
trade unions, and by the entire society with deep concerns and skepticism. From the
perspective of trade unions, if the implementation of the flexicurity concept seems to be
successful in some of the European states, since it guarantees a certain level of protection, in
Romania such a process would be disadvantageous for employees in terms of the special job
stability they enjoyed. The paper aims to put into light the advantages and disadvantages of
the very recent changes in the Labour Code, and to configure a possible perspective in this
regard.
KEYWORDS: Labour law, employment contract, dismissal, flexicurity

INTRODUCTION
Although the tendency is to be gradually diminished, the role of the state within the
perimeter of the Romanian labour law is still significant. This is manifested, on one
hand, through its specialized bodies especially Labour Inspection, for controlling the
manners of application of the legal provisions. Moreover, for a long time, the state has
intervened by subsidizing certain inefficient industries, in order to avoid the massive
reduction of the work places; for the moment, it has renounced to such a policy.
On the other hand, the states intervention in labour relations is manifested through
the detailed regulation of the work relations, which are left to the collective
negotiation to a lesser extent than in other law systems. And this is why one of the
main issues of the current controversy regarding the modification of the Labour Code
was related to the way in which an employment contract should end. The Labour
Correspondence address: Raluca DIMITRIU, Labour Law Department,

Faculty of Accounting and Management Information Systems, Academy of Economic Studies, 6,
Romana Square; email: raluca_dimitriu@yahoo.com, Raluca.Dimitriu@cig.ase.ro
~466~
Code has been modified through Law no. 40/2011, published in the Official Monitor
of Romania no. 225 from 31 March 2011.
How far should the legislator intervene in order to leave the employers decision free,
but still to protect the employee against potential abuses? This is obviously a question
each of the social partners should answer in his own way: the trade unions by
revealing the importance of labour protection and the fact the very reason of existing
labour law is to take care of employees, and the employers organisations by insisting
that the employer actually created the working places, so he should normally be
allowed to decide what to do with them and with the employment contracts.
The point here is that a law, even a perfect one, can never protect against its own
breaching. In other words, the problem that many employers behave abusively and
disrespect the law cannot be solved by changing the law itself. It is the tools of
applying the legal regulations which have to become stronger, i.e. Labour Inspection.
In order to fully understand the meaning of changing the Labour Code in respect with
the termination of labour contracts, as well as its responses within Romanian society,
one should first have a look at the evolution of Romanian law in this regards.
The previous Labour Code of 1972 was adopted at the time of a regime in which,
within the labour legal relations, the employer was practically always a state
enterprise. Protecting the employee in relation to the employer meant, in fact,
protecting the individual from the state. This is one of the reasons the jurists were
unanimous in restrictively configuring the regime of dismissal.
On the other hand, the communist labour legislation did not even allow the individual
to freely move from one state enterprise to another. Though formally stipulated by
law, resignation was rare, being considered rather reprehensible and leading to the
loss of certain rights, as a consequence of discontinuing the length of service.
Unemployment was out of the question and each person had a certain guaranteed job.
The graduates of higher education were obliged to receive employment in the
enterprises assigned to them, most often far away from home.
As compared to the full guarantee of the working place that the communist laws
ensured, the Labour Code of 2003 could not bring about a complete flexibilisation,
since the workers kept expecting or demanding the same level of stability. On the
contrary, under the pressure of trade unions, but also of the general public opinion,
whose expectations continued to stay high, the present Code maintained a whole
series of restrictions concerning dismissals, as well as the complete and express
regulation of the reasons for which an employee could be dismissed.
However, after eight years in force, the Labour Code has been changed, aiming at rebalancing the powers of the parties over the issue of the termination of the
employment. These changes may lead to a new content of the concept of job security,
and also to a new approach of the idea of career.
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1.
TERMINATION BY LAW
The employment contract is concluded intuitu personae, which makes its effects cease
automatically when the employee dies. Indeed, a contract is said to be intuitu
personae when it is entered into in the consideration of the person of the cocontracting party, i.e. where such consideration is essential for the contract. The very
substance of the employment contract depends on the workers personal qualities; if
he dies, the contract is automatically terminated. The same regulation may be found in
case of disappearance of the natural person; the law stipulates the procedure of legally
declaring death.
The employment contract also terminates de jure in case the employee is declared
legally incompetent. Indeed, according to art. 13, para. 4 of the Labour Code, it is
forbidden to employ persons that have been declared legally incompetent. Normally,
if the legal declaration of incompetence occurs during the fulfilment of the contract, it
will automatically trigger the termination of the contract, as the labour contract
presupposes the employees full discernment.
However, the symmetrical hypothesis, namely the death of the employer - natural
person, respectively the dissolution of the employer - legal person, did not represent a
case of the de jure termination of the employment contract. In such a case, the
employees had to be dismissed, for reasons independent of them.
This was the result of a change in the Labour Code, made in 2006, with the purpose to
allow these employees whose enterprises have been dissolved to benefit from the
protection measures related to collective dismissal, while other requirements are
complied with as well.
Such a strange asymmetry led to many difficulties in practice. The employment
contracts could not be legally terminated in case the employer disappeared; the firm
has been dissolved or even the employer - natural person died. Many authors
repeatedly suggested that this cases should be included among the ones in which a
contract is automatically terminated (Ticlea, 2009: 516)
This is why the new law attained to include among the reasons for termination by law
not only the case where the employee disappears or dies, but also the case where the
same happens with the employer natural person, or if the employer legal person
dissolves.
An unsolved problem remains thou. The dissolution procedure takes time, and
meanwhile, some of the employees are still needed, in order perform the liquidation
stage, making the payments to the creditors and organising the process of winding up.
However, the employment contracts are terminated, with no exceptions, so the
employer should re-hire some of the employee in order to run the process of
liquidation. Those new contracts would be concluded for a fix term contract, but this
case is not provided under art. 81 of the Labour Code, among the cases where a fixedterm contract can be concluded.
~468~
Another reason for termination of an employment contract under the law is the case of
retirement of the employee. The new law solved a major problem resulted from the
modification of the Labour Code through Law no. 49/2010.
Until 2010, the contract was considered as ended on the date when the decision for
age limit retirement, anticipatory retirement or invalidity retirement has been
communicated by the Pension Authority. If the employee did not request retirement,
although he fulfilled the standard requirements for age limit and pension
contributions, the employer could dismiss him, according to art. 61, letter e) of the
Labour Code.
The Law 49/2010 changed this rule, provided that the moment when the employment
contract was considered as ended is not the one when the Pension Authority
communicated the decision, but the very moment when the employee fulfilled the
standard age requirements and the level of pension contributions. The only problem
here was that the new law completely forgot about the case of invalidity retirement.
Invalidity retirement occurs when the total or at least half of the working abilities are
lost due to labour accidents, occupational diseases, TB, common diseases or accidents
that are not related to work. According to the requirements of the working place and
the level of the reduced working ability, invalidity is:
first degree, characterised by the total loss of the working abilities, the selfservice, self-control or spatial orientation abilities, the invalid needing care or
permanent supervision by another person;
second degree, characterised by the total loss of the working abilities, the
invalid having still the capacity of self-service, self-control and spatial
orientation, without needing help from another person;
third degree, characterised by the loss of at least half of the working abilities,
the invalid being unable to perform any professional activity.
Of three degrees of invalidity, the first two lead to incompatibility between the status
of a pensioner and that of an employee. Only in case of the third degree invalidity
pensioner is allowed to cumulate his pension with the salary, continuing his activity
either in the same working place, or in another.
However, no mention regarding the moment of ending the employment contract of
persons who are retired for invalidity was left in the Labour Code during 2010, and
this situation created many problems. In practice, employees preferred to resign, in
order not to lose the right to the invalidity pension.
The recent modification of the Labour Code by Law no. 40/2011 refers both to the
age retirement and to the invalid retirement, redressing the provision on termination
by law. According to the Labour Code, the employment also ends de jure when the
demand of reinstatement in the position hold by a person unlawfully or groundlessly
dismissed has been admitted, from the date of the final reinstatement judgment.
This is the situation of an employee illegally dismissed, who brought an action in
court not only for cancelling the dismissal, but also for reinstatement in the previous
position. If on that particular position another worker was in the mean time hired, his
employment will be automatically terminated. This text practically represents an
~469~
application of the nullity theory. Indeed, the nullity of the decision to dismiss the first
employee represents the cause of termination the employment contract of the second
one.
However, for a long period of time doctrine and practice faced a very specific
difficulty here: how will be ended the employment of an employee who did not
request reinstatement in court? It may be the case of an employee who found an
alternative job, so he/she wouldnt have to comeback into the same position. But
Labour Code contained no solution on how the original employment should end. It
wouldnt be a dismissal, since the dismissal decision has been annulled by the court,
nor it would be a resignation, since the employee didnt formally resigned, and it
wouldnt be a termination by mutual consent (even thou both parties did want to end
the contract) since the parties were in fact in a dispute.
The modification of the Labour code includes this case among the cases of
termination under the law, which is one of de lege ferenda proposals made by most of
the authors lately.
Indeed, according to art. 78 para. 3 recently introduced in the Labour Code, in case
the employee does not appeal in court for re-instatement in the job he had prior to the
dismissal, his/her employment will end under the law from the moment when the
court decision is final. This will mean that, even thou the dismissal has been cancelled
in court, the contract would be still considered as ended, but on another ground,
namely the ground of law itself.
Another new regulation is provided by the law changing the Labour Cod in respect
with the withdrawal of official recognition and legal authorisations.
In certain cases, the employment contract can only be fulfilled by persons who
received official recognition, authorisation or attestation for carrying out the
respective activity. For instance, Law no. 333/2003 on guarding objectives, goods,
values and on the persons protection, stipulates that: Employment of the personnel
with guarding duties or as bodyguards is made on the basis of the attestation issued by
the police, of the certificate attesting the graduation of the professional training
course, of the certificate of criminal record and, according to case, of the police gun
permit.
Similarly, according to Law no. 126/1995 on the regime of explosives, the conclusion
of the labour contracts for employees working as artificers depends on their
professional authorisation issued by the administrative bodies.
Withdrawal of authorisation, permit or attestation will automatically lead to
termination of the employment contract.
The new regulation here includes the case in which the authorisations have not been
withdrawn, but they expired. Until this new change of the Labour Code there have
been no solutions for this case, so one couldnt say how such a contract would end. As
a result of changing the Labour Code, the employment will be considered as
terminated by law from the moment when the period for which the official recognition
~470~
and legal authorisations expired. However, the employee still has 6 months in which
he may renew the authorisations requested to do the profession.
In case the authorisations or official recognitions have not been withdrawn, but
suspended, a new case of suspension of the employment occurs - recently regulated
by the new changes in the Labour Code. Indeed, according to art. 52 para. 1 f), the
contract is suspended by law during the suspension, by the competent authorities, of
the authorisation, permit or attestation requested for exercising of the profession. The
employee has no right to salary during this suspension, but he will remain bound by
the rest of contractual rights and obligations, e.g. by the fidelity obligation.
The administrative decision to withdraw or to suspend an authorisation may be
contested in court, according to Law no. 554/2004, on administrative disputes. In case
the court considers that withdraw or suspension was not decided according to the law,
we consider that the employee will have the right to re-instatement, with the payment
of the due salary owed for the period he was deprived of this right. However, not the
employer will pay but the authority whose decision has been successfully contested.
A change which led to many controversies was the one regarding the relation between
termination of employment and suspension of the employment. In fact, we consider
this has not been a real change, because the jurisprudential solution was the same even
before this new law. According to art. 49 para.5 and 6, each time when during the
time of suspension of the employment a reason for termination by law occurs, the
cause of termination will prevail. In case of suspension of the labour contract, all
terms related to conclusion, modification or termination of the employment contract
will be correspondently suspended, except those related to the termination of the
employment by law.
This is just an explanation of how the relation between termination and suspension
works; it is not really a new rule. For instance, even before this changed, if at the
moment when a fixed-term contract expired, the employee was in medical leave, the
employment still ended. The employee had the right to proper indemnity for
incapacity to work, but the employment ended inexorable.
However, trade unions argue that because of this new article, the employee is less
protected than he/she was before.
2.
DISMISSAL
2.1. Protection of the Employee

The separation between labour law and civil law was based on the legislators often
vigorous intervention in regulating relations between the parties. Their legal equality
ceases with the conclusion of the labour contract. From then onwards, one of the
parties is subordinate to the other and even enters a relation of dependence towards
the other. Though still considered as belonging to private law, labour law has many
imperative provisions, norms of public order meant to re-balance the relation between
the two parties.
~471~
In Romanian legislation, art. 6 of the L.C. stipulates the principle of employees

protection in the context of the provision regarding the prohibition of any
discrimination in exercising rights granted by law. The text must be understood in
relation to the provisions of art. 41, paragraph 2 of the Romanian Constitution,
according to which employees have the right to social protection measures. These
refer to the employees safety and health, womens and youth working conditions, the
setting up of minimum national gross wages, weekly rest, paid leave, the carrying out
of the activity in special conditions, professional formation, as well as other specific
situations, established by law.
As a result, the protection of employees is one of the main principles of labour law.
When it comes to the regulation of dismissal, such protection is even stronger, being
ensured, among others, by the following:
The employer shall make use of all possible reasonable means to avoid
dismissal;
Strict procedures shall be enforced so that non-compliance with these
procedures shall incur annulment of the dismissal;
The dismissal decision shall be issued in a written form;
The elements of the dismissal decision shall be imposed under the law.
Absence of any of these elements shall entail annulment of the dismissal;
Dismissal shall be forbidden for any other reasons except for the 5 reasons
accepted expressly by the law;
Dismissal of certain categories of employees who are during special periods,
shall be forbidden;
The dismissed employee shall have the right to go to court; the burden of
proof shall lie with the employer;
The employer shall have the obligation to submit the evidence from the very
first day of the trial;
The employee shall have the right to obtain reintegration and damages in
court, if the dismissal has been annulled.
Moreover, under the Labour Code, employees shall not be dismissed while they are in
one of the following cases:
during the time of temporary incapacity of work, ascertained by medical
certificate;
during quarantine leave;
during the period of pregnancy, as long as the employer is informed about this
fact, prior to issuing the decision of dismissal;
during maternity leave;
during childrearing and care giving leave until the child reaches the age of two
or, in the case of a disabled child, until he becomes three;
during the care giving leave for a sick child up to the age of seven or, in the
case of a disabled child, until he reaches the age of 18;
while holding an eligible position in a trade union, except for the situation
when dismissal is ordered due for disciplinary reasons;
while on holiday;
during the maternal risk leave, as well as during the leave granted to those
employees who have recently given birth or who are breastfeeding. The
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interdiction of dismissal can be extended only once, for up to six months, from
the date the employee has returned to work within the enterprise.
The collective labour contracts can include other periods of time when dismissal may
be forbidden. For instance, some of them stipulate dismissal of women who returned
from the child-rearing leave during the first 6 months from the date they returned of
work, for reasons of lack of professional standards.
The collective labour contracts also stipulate compensation pays owed to the
employees dismissed for reasons that are not related to them.
Besides these protective rules, the recent change of labour legislation aims to allow
the employer to freely organise the working force and to dismiss employees more
easily than before.
As a result, the interdictions to dismiss are subject to change. They will be not
applicable in case of dissolution of the company, a case not taken into account by the
legislation prior this change. Of, course, in fact, the interdictions couldnt be applied
in such case, continuing the employment being practically impossible, but until now
there has been no regulation in this respect.
More importantly, the interdictions to dismiss in case of trade unions leaders and
employees representatives are tremendously diminished. Until now, they couldnt be
dismissed for the entire period of the mandate, and for another 2 years afterwards. The
dismissal was allowed not even for incompetence. The union leaders protection was
considered in itself an element of union freedom (Dimitriu, 2007: 18).
Indeed, if the union leader is not adequately protected from pressure exerted by the
employer or a third party, the union organisation or union freedom of its members can
be endangered. This explained the meaning of many decisions taken by the Romanian
Constitutional Court, regarding the legal differentiation between union leaders and
other employees. The question was: is it normal that the law creates a special legal
system for a certain category of employees whilst excluding others? The prohibition
against dismissing union leaders was considered by the Constitutional Court not to
constitute a privilege, but a measure of protection ensuring equal treatment of the
trade union on the one hand, and the trading company on the other, as parties to the
collective labour contract. The employee representatives elected to the leading trade
union bodies are in different situation than other categories of employees.
Consequently, they cannot be treated in the same way.
However, according to the recent change of the Labour Code, the trade unions
leaders and the employees representatives can be dismissed immediately after the end
of their mandate, and for any kind of reasons, including incompetence. It is no
surprise that trade unions were deeply unsatisfied with this new regulation, in our
opinion this being one of the major concerns of the trade unions, a ground for a
negative reaction to the enforcing of the new law.
~473~
2.2. Dismissal for lack of professional standards

Another element of the new legislation is related to the dismissal for incompetence.
According to art. 61, letter d) of the L.C., the employer can order the dismissal of an
employee in case he is professionally unfit for the job position he holds. Among the
grounds for dismissal provided by art. 61 of the L.C., dismissal for professional
inadequacy represents the ground closest to common law.
Indeed, the circumstance that the employee is not professionally fit for the job
position he holds represents nothing else than the failure to fulfil the contractual
duties by one of the parties, a typical case for termination for breach of the contract in
the common law. Practically, professional inadequacy represents (or should represent)
the most frequently invoked ground for dismissal: the employer is not content about
his employees work.
The grounds wherefore a person might be considered professionally unfit have been
most often divided into objective circumstances (related to the non-fulfilment of the
requirements for studies or training), and subjective (related to the employees skills
or abilities).
According to art. 63 para. 2 new inserted into the law - dismissing an employee on
that ground can be decided only after a prerequisite evaluation of the employee,
according to a procedure established by the collective agreement or by internal
regulations.
The employee has to be informed about the criteria for this evaluation for the very
moment he is hired. This is an application, into Romanian labour law, of a general
principle regarding the workers right to information and consultation. There is now a
broad legislation of the European Community on employees information and
consultation in both individual and collective relations. The EC Law prescribes that
specific information and consultation takes place in cases of mass dismissal or the
transfer of an undertaking. And the Directive on the European Works Council
provides for a duty of information also in general questions, but it only applies to
large undertakings that are involved in cross-border activities. Moreover, in many
Member States the statutes nowadays establish that the employer has to
give information to the employees in questions of general importance (Rebhahn,
2004: 123).
Also before this recent change of Labour Code the employer had the right to examine
the competence of the employee, according to some criteria established either by the
employer himself, or by a contract concluded with the trade union. This right of the
employer is today expressly provided, so it wouldnt be possible anymore for a trade
union to request or expect to be consulted in this regard.
We have to point out here that this is again not a completely new solution.
However, the recent change in Labour Code does bring a new approach in this regard.
In order to understand the new element, we should first look over the way the
dismissal for incompetence was regulated in the recent past in our Labour Code.
~474~
Though dismissal due to professional inadequacy should represent the specific

ground for dismissal, in relation with which all the other grounds for dismissal would
rather seemed as exceptions, the legal procedure for dismissal due to professional
inadequacy was so cumbersome and difficult to comply with, that in reality the
employers avoided to order dismissal on this ground, trying to terminate the labour
relations by invoking other grounds.
Indeed, according to Art. 63, paragraph 2 of the Labour Code, the employees
dismissal due to professional inadequacy could be ordered only after the employees
preliminary evaluation, in accordance with the evaluation procedure established by
the applicable collective labour contract, concluded at national level, branch of
activity or group of enterprises, as well as by the internal regulations.
Yet, the Collective contract concluded at the national level for 2007 - 2010 had not
provided an evaluation procedure, but one of preliminary investigation, similar to the
compulsory investigation in the case of disciplinary dismissal. As such, before the
recent modifications of Labour Code, dismissal due to professional inadequacy was
conditioned by carrying out both procedures, regular evaluation, as well as
preliminary investigation. Even if a procedure of the employees regular evaluation
could be inserted in the collective labour contracts concluded at branch or company
level, preliminary investigation still remained compulsory for everybody, because it
was provided in the Collective labour contract concluded at the national level. Thus,
an employee couldnt be automatically dismissed for professional inadequacy, only on
the basis of the poor results of the evaluation.
Investigation prior to dismissal for professional inadequacy was carried out according
to the procedure provided by Art. 77 of the Collective labour contract concluded at the
national level. According to it, the investigation of the employee for professional
inadequacy was made by a commission appointed by the employer. The commission
summoned the employee and conveyed to him in writing the following, at least 15
days in advance: the date (exact time and place when the commission meets) and the
manner in which the investigation will be carried out.
This entire procedure is no longer in force. Currently in Romania there is no
Collective contract concluded at the national level, because the one concluded for
2007 2010 expired, and a new contract, thou negotiated between social partners at
the national level, never entered into force because it wasnt registered at the Ministry
of Labour.
As a result, today the law is directly applicable in the labour relations. And in the law
there is no preliminary procedure provided in order to dismiss an employee for
incompetence. The only condition is that such an evaluation should be provided, and
the Labour Code, recently modified, enlarged the possibility of the employer to apply
his own criteria in evaluating the employee.
In fact, the change intervened in the Labour Code is more important than it appeared
at the first view, because it has to be connected with the lack of a Collective contract
concluded at the national level. Therefore, today, in case of dismissal for lack of
professional standards, the employer shall do a prior assessment of the employees,
under criteria that should be known by the employees from the date when they are
hired. The assessment can be done also to select employees that are to be dismissed
for economic reasons.
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2.3. Dismissal for economic reasons

The Labour Code, modified by Law no. 40/2011, stipulates some gradual measures
that the employer can take in case of economic difficulties, prior to dismissal. He shall
therefore do the following:
Reduce the working days. According to the changes in the Labour Code
introduced in March 2011, in case of temporary reduction of the activity, for
economic reasons that exceed 30 days, the employer can reduce the working
days to 4 days per week and can reduce the salary correspondingly, until the
situation is remedied;
Suspend the labour contracts of the employees, and pay them 75% of their
salaries;
As a last resort / ultima ratio, lay them off.
The employer shall give the employee the chance to be transferred to another job
corresponding to the employees training and skills, and if the employer has no such
vacancies, the employer shall inform the local Employment Agency about the
employee laid off, so that the agency could identify an available job, dismissal cannot
be annulled for the reason that the employer has not ensured re-training (professional
reconversion) of the employee.
The employer shall offer the employee a job corresponding to his current
competences, not to his potential competences.
The rule of proportionality shall not apply, and the court shall assess the legality of
the dismissal exclusively against the way in which the employer has fulfilled his prior
obligations stipulated either by the law or in the collective labour contract.
In the case of collective dismissal, according to the new regulation, the employer will
be allowed to give priority to performance criteria (not to social criteria, as it currently
happens). Today, prior to any social criterion of establishing the order of priority in
cases of collective dismissals, the employer is free to evaluate the employees
performances. The criteria related to the professional performances of the employees
will prevail upon the social criteria.
With respect to selection or ranking criteria, international labour standards guidance is
provided by Article 23 of the Termination of Employment Recommendation (No.
166) which stipulates that the selection by the employer of workers whose
employment is to be terminated for reasons of an economic, technological, structural
or similar nature should be made according to criteria, established wherever possible
in advance, which give due weight both to the interests of the undertaking,
establishment or service and to the interests of the workers. In comparative practice,
the criteria most often applied relate to occupational skills, length of service, family
circumstances, with preference sometimes being given to a particular criterion such as
the protection of a vulnerable category of workers or the difficulty of finding
alternative employment. The determination of the selection and/or ranking criteria
should be guided by the specificities of each national labour market, including the
existence of active labour market policies and institutions to support redundant
workers. It is, however, of particular importance to ensure that, as a result of the
preference given to some criteria, certain protected workers, such as workers
representatives, are not dismissed in an arbitrary manner on the pretext of a collective
termination of employment (International Labour Organisation, 2011).
~476~
The rules regarding the collective dismissal are no longer applicable to public
employees (workers employed by public administrative bodies). Until now, the
Romanian legislation has not excluded them from the rules of collective dismissal,
even though the Directive 98/59/EC was not applicable to these employees.
Until now, if the employer re-launched the activities whose interruption have led to
massive dismissals before the 9 month-term ended, the employees who have been
dismissed had the right to be re-employed in the same job positions they previously
held, without any examination, job competition or probation time. According to Law
no. 40/2011, this term has been reduced to just 45 days. After this short period the
employer will be allowed to re-establish the jobs, employing other persons that the
ones dismissed. Not surprisingly, the trade unions declared their dissatisfaction
regarding this change in the law.
2.4. The notice
According to the Labour Code, the employees dismissed for non-imputable reasons
shall be given a prior notice. The term stipulated in the notice does not depend on the
years worked by the employee in the company or any other criteria. Under the law,
the term stipulated in the notice shall be at least 15 working days. The collective
labour contracts include derogations that are advantageous to the employees by
stipulating longer terms. The employees on probation period shall not be given prior
notices.
The term of notice is suspended if the employment contract is also suspended.
Moreover, the collective labour contracts provide that during the term of the notice
the employees are allowed to shorten their working time by 4 hours, as compared to
the working schedule of the enterprise, in order to look for another working place,
without their wages and other rights being restricted because of that.
During the term of the notice, the employee has all the rights and obligations resulting
from the employment contract: he still has the duty to carry out work, to refrain from
any act of disloyal competition, as well as from any act of indiscipline. If he does not
comply with all these duties, he will be dismissed on disciplinary grounds, without
being necessary to wait for the end of the notice term.
The Law no. 40/2011 prolonged the notice period; it is now 20 days. This is because
the prior version of Labour Code provided 15 working days as a notice term
mandatory in case of dismissal, but the collective contract concluded at the national
level for 2007-2010 provided 20 days. At present, since the previous contract
concluded at the national level expired, and no other contract has been registered with
the Ministry of Labour, the legal provision would be directly applicable. The change
in the Labour Code could also mean that the legislator assures that even in the case no
other collective contract at the national level will ever enter into force, the minimum
period of notice will still be 20 days.
~477~
3.
RESIGNATION
According to art. 79 para. 2 of Labour Code, as it was recently modified, the employer is
obliged to register the employees resignation, otherwise the latter being allowed to prove
the resignation by any means. The new element here is that the employer will be
sanctioned, if he fails to register the resignation, with a fine from 1,500 to 3,000 lei.
This change was made as a result of many cases when the tendency of the employers
not to register employees resignation can be noticed, since no fine has been provided
for this behaviour (Stefanescu, 2010: 464)
When it comes to resignation, the major issue here is the way in which notice in case
of resignation is regulated. It is prolonged to 20 working days in case of executive
functions and 45 working days in case of managerial positions.
Labour Code priory provided only 15 calendar days for executive positions and 30
days for managerial positions. Therefore, the length of the notice has been changed.
But the real problem here is that the law provides a minimum period of notice. The
parties may convene through the individual or collective contract a longer period of
notice, which cannot be shorter than the legal one. This rule is not only
disadvantageous for the employee, but also it breaches the major principle according
to which the parties may only convene in the advantage of the employees. It is the
only provision in the entire Labour Code in which the parties are obliged to convene
in pejus, so the employees may only have a worst situation that the one provided in
law. From a juridical point of view, such a provision is completely wrong, especially
in respect with the general rules of labour law.
CONCLUSIONS
The European Union is trying to find its own way in the attempt to increase
competitiveness while maintaining, at the same time, a high level of social protection
within the Social European Model. On the theoretical level, in the new member states,
one of the effects of joining the European Union is the reception of the concept of
flexicurity and the debate surrounding this issue.
One of the starting points of the debate is that the idea that one size fits all may still
be a dangerous approach when it comes to the concept of flexicurity. On the
contrary, the experience of the new member states may lead to new nuances when
debating the flexicurity concept.
Furthermore, the existing research on flexicurity shows that neither flexibility nor
security is an unambiguous concept.
If flexibility is seen as the opposite of rigidity, then without any doubt its occurrence
in an economy on the move appears as desirable. Flexibility is considered to be an
inherent feature of labour demand and supply. Both being driven by individual
interest, they tend to become flexible in order to meet each other as none of them can
survive independently (Ghinararu, 2010: 77).
~478~
If, on the contrary, the flexibility of labour relations implies deregulation and the
removal of restrictions on contractual freedom, then it may create even more
problems, rather than solve them. As already said before, between the strong and the
weak, between the rich and the poor, it is freedom that oppresses and the law that sets
free. These are, in fact, the circumstances wherein the labour law has emerged and
defined itself as a protective law.
If security is not concerned with the certainty of a working place, but with the security
of a career or, to put it more generally, with the socio-economic security, focusing on
protecting the more vulnerable groups, then it may ensure the necessary balance
between insiders and ousiders.
But if it only aims at maintaining the existing job security, without the appropriate
absorption of the outsiders on the labour market (an idea that sometimes creeps in the
very discourse of trade unions, as the main representatives of the existing employees),
imbalances on the labor market may grow deeper, instead of becoming less visible.
The simultaneous protection of insiders and outsiders implies their uniform treatment,
not as two distinct categories of persons, but as one single class of persons able to
work, whether they are carrying out an employment contract or not, at that precise
moment. Theoretically, the excessive protection of the employment contracts leads to
lack of protection granted to the outsiders, who find themselves facing an
insurmountable wall when it comes to getting access to a job. Moreover, the
employers competitiveness suffers from this situation, as long as he is not in the
position to permanently select the most suitable workers in a continuously changing
economy.
Getting more people into good jobs is an objective, while flexicurity is (or may be)
one method. The extent to which the application of the method leads to reaching this
aim is still an open question. Flexicurity itself demands to be flexibly adapted from
case to case, from one state to another.
Some authors consider flexicurity a political strategy rather than a scientific concept.
The policy of flexicurity is, in most cases, qualified as a win win type of policy,
considered to be a somehow hypocritical qualification by certain market analysts in
the new member states, because beyond theory, it seems that in practice workers are
losing rather than gaining something out of it.
From the perspective of trade unions, if the implementation of the flexicurity concept
seems to be successful in some of the European states, since it guarantees a certain
level of protection, in Romania such a process would be disadvantageous for
employees in terms of the special job stability they enjoyed, in the context of the
Labour Code. The changes in the Labour Code, particularly with the intention to
render more flexible the labour market and the contractual arrangements were
received by trade unions, and by the entire society with deep concerns and scepticism.
A segmentation of labour market is a common European trend. Many authors
suggested not to enhance but rather to circumvent the protective legislation on
individual dismissals that exists in all European countries by resorting to atypical
contracts that fall outside the sphere of protection (Veneziani, 2009: 127). In the same
view, the Romanian law maker may focus not as much on protection of the workers
~479~
in case of dismissal than on extension of some of the rules of protection for the case of
the persons who dont formally work on a ground of an employment contract.
In fact, when approaching the question of flexicurity, perhaps the starting point should
not be the legislation itself, as the practice of applying it. Besides, the new member
states have several particularities in implementing the concept of flexicurity, among
which we can identify at least 4: psychological particularities, coming from the shock
of adapting to a new system for the workers trained during communism, particularities
derived from the competitive disadvantages of economies in the new member states,
particularities concerning the type of social dialogue practiced and those concerning
the labour force itself, in the context in which the phenomenon of workers migration
reaches unusual dimensions.
In this context, the changes in the Romanian Labour Code appear to be a way of
implementing the concept of flexicurity in our system of law. And among all
institutions changed by the new law, probably the one related to termination of
employment has the most dramatic effect within labour relations and the very
application of the principle of workers protection. The Governments goal was to
offer the possibility for the employers to dismiss and employ personnel more easily,
allowing him/her to select best employees at a time of economic crisis. However, as a
result of an analysis of how the flexicurity principles were applied in other states
(especially in case of the new member states) one may be very much afraid that
flexicurity cannot be obtained by just un-protect the employees and simplify the
dismissal procedure.
Consequently, will the Governments goal be attained? Or perhaps the scepticism of
the Romanian society in respect with the new labour legislation is justified? Only time
will answer this question, for sure.
ACKNOWLEDGEMENTS
This work was supported by CNCSIS-UEFISCU, project number PN II 1772/2008.
REFERENCES
Dimitriu, R., (2007), Romanian Industrial Relations Law, Antwerp, Ed. Intersentia
International Labour Organisation, (2011), Memorandum of Technical Comments on the Draft
Labour Code and the Draft Law on Social Dialogue of Romania, http://www.araco.org
Ghinararu, C., (2010), Flexicurity and social dialogue in Romania perspectives on the
implementation of flexicurity principles in Romanian undertakings, European Institute
of Romania
Rebhahn, R., (2004) Collective Labour Law in Europe in a Comparative Perspective, The
International Journal of Comparative Labour Law and Industrial Relations (II),
Vol. 20/1: 107-132.
Stefanescu, I.T., (2010), Theoretical and Practice Treatise of Labour Law, Bucharest, Ed.
Univers Juridic
Ticlea, Al., (2009), Labour Law Treatise, Bucharest, Ed. Univers Juridic
Veneziani, B, (2009), The transformation of Labour Law in Europe, edited by Hepple, B,
Veneziani B., Oxford and Portland, Hart Publishing
~480~
PS11 Management information systems II

Chairperson
Iuliana IONESCU, Bucharest Academy of Economic Studies,
Romania
A CASE STUDY FOR START-UP COMPANIES

IMPLEMENTING E-BUSINESS TECHNOLOGIES
Carmen TIMOFTE

Carmen TIMOFTE
MODELING ON A SEMANTIC-BASED
REPRESENTATION OF PEDAGOGICAL OBJECTS ELEARNING-TYPE IN ORGANIZATIONAL MEMORY:
CONNECTING ONTOLOGY WITH LOM META-DATA
Iuliana IONESCU, Vasile FLORESCU,
Bogdan IONESCU, Ofelia Ema ALECA
SEMANTIC ANNOTATION AND ASSOCIATION OF

WEB DOCUMENTS: A PROPOSAL FOR SEMANTIC
MODELING IN THE CONTEXT OF E-RECRUITMENT
IN THE IT FIELD
Bogdan IONESCU, Iuliana IONESCU,
Vasile FLORESCU, Andrei TINCA

Dragos STOICA, Pavel NASTASE
~481~
A CASE STUDY FOR START-UP COMPANIES

IMPLEMENTING E-BUSINESS TECHNOLOGIES
Carmen TIMOFTE1
ABSTRACT
The World Wide Web has dramatically changed the way corporations conduct business. This
paradigm shift has made it paramount that company managers fully understand and
appreciate the important advantages of E-Business technologies. Which e-business
technology to chose, if you will have the opportunity? This is why I tried to present an
overview of these technologies and the you will learn how and when you can chose one of
theme, implemented in open software, personal software or platform of e-business.
KEYWORDS: e-business, e-commerce, protocol, technology, SEO.

INTRODUCTION
E-Business is now a very familiar term with most businesses and people. This has
now taken such a wide coverage and reach that it is no longer an alternate means of
business transactions, but an integral part of any kind of business. The term e-business
(e-biz) now encompasses almost every opportunity, either commercial or interaction,
and provides a wide range of choices of technologies and means to offer them.
Internet and web technologies are driving fundamental changes in the way that
businesses interact. We need to implement to the rapidly changing technologies and
approaches to implementation underpinning these changes. I want to develop an
instrument to enable you to interpret, select and utilize a shifting set of protocols and
standards from the emerging technologies, based on close examination of a small set
of core standards and knowledge gained from studying prevailing protocols and
development technologies.
1. OVERVIEW
The direction toward Web services will particularly help Net Generation
companiescompanies that are born on the Webto become successful by allowing
their services to be easily discovered worldwide and easily integrated with other
services ranging in scale from other Net Generation services to enterprise-scale
services.
In a few short years, e-business has gone from a simple concept to an undeniable
reality, and for good reason. It works for everyone: consumers, businesses, and
1
Correspondence address: Carmen TIMOFTE, Economic Informatics Department, Academy of

Economic Studies, Bucharest, Romania; email: carmen@ase.ro
~482~
governments. The primary values of e-business, such as cost savings, revenue growth,
and customer satisfaction, are proving to be only the tip of the iceberg. Having
realized the benefit of Web-enabling individual business processes, many companies
now seek further return on investment (ROI) by integrating new and existing ebusiness applications and technologies. The key to their success is to find a way to
give customers what they want without the expense of traditional business operations.
E-business is the system re-engineering of business processes to take advantage of the
efficiency afforded by information technology and electronic communications. It
may consist of something as simple as establishing a retail website, or might involve a
complete overhaul of the way a big company handles orders internally.
The common factor is communication.
Most business processes are based on moving data from one point to another. It is
only during manufacturing or after a deal has been consummated that physical goods
must be moved. As a result, most improvements in business result from advances in
information technology, a field that is changing so rapidly it is difficult even for
professionals to keep up with it.
It is always a question how to select in a fast-moving technological subject. The
philosophy is that professionals must learn not technology alone, but how to keep up
with technology.
Sometimes, its not important to have the newest technology in your company, but
you need to use the most appropriate one for your e-business, based on factors like:
permitting an easy and rapid way for updating the system,
making periodically/permanent changes this is the way to keep you site
alive; a lot of studies demonstrate that a static site had a short life duration,
comparing with the dynamic sites; the life of site = the live of e-business;
dynamic site= site with a lot of daily changes;
have qualified persons for supporting all the changes in systems, platforms,
technologies.
2. TECHNOLOGIES USED IN E-BUSINESS
E-business technologies can be split into 2 categories: packaged solutions and web
development, both of them implemented by big software companies, as well like open
software foundation.
Packaged Solutions - there are a lot of packaged solutions which enable eBusiness operations starting from larger enterprise packages for Customer
Relationship Management (CRM), Supply Chain Management (SCM) or
Enterprise Resources Planning (ERP) to smaller and leaner packages for
limited set of functions such as Email Applications, Peer-to-Peer computer
networking software, etc. These packaged solutions are also customizable to a
certain extent to suit the individual e-Business providing organization.
E-Business web development - on the other hand, most of the e-Business
enablement is carried out by customized web applications built to address
specific needs of the e-Business products or services.
~483~
Typically, following are some of the common technology aspects that need to be
considered while deciding and during development of e-Business website or web
applications.
Architecture of an e-Commerce system: function and implementation of major
system components (web servers, browsers, proxies, caches, databases);
critical system properties (scalability, reliability, security, safety);
Developing e-Commerce systems: development team, development process;
Web data formats: XML, HTML, XHTML, WML, RSS and ways of
transforming and displaying them;
Data modeling and storage: relational database management systems
(RDBMS); SQL; data warehousing;
Web Services: introduction to the concept of web services and serviceoriented architectures (SOA), OSOA (Open SOA); XML and SOAP; web
services description and discovery (WSDL, UDDI);
Development tools and technologies: The Open-Source software stack
(Apache, Tomcat, Axis); Microsoft .NET, Java, Java 2 Platform, Enterprise
Edition (J2EE), Common Object Request Broker Architecture (CORBA),
Transactions;
Advanced topics: Security and privacy, search engine technology.
Many of these technology choices continue to evolve and expand as the open
standards specification evolves to include a broader view of the enterprise
architecture. E-Business models go forward through use of Open Source, Web 2.0 and
m-Commerce. Currently many Open Sources solutions are available on the market,
which provide the e-Business providers options to customize these systems to
whatever extent they want.
Various business models such as SaaS (Software as a Service) are gaining popularity
due to the flexibility offered with maximum customization, less cost and minimal
system ownership. Furthermore, e-Business transactions are no longer limited to
computers, but can also be transacted through mobile devices such as mobiles, PDAs,
i-Phones and so on.
Considering the leaps taken by technology and infrastructure, there are no limits to
what form and shape would e-Business take in the years to come.
3. CASE STUDY
After 10 years of studies and working with e-commerce systems, I have identified
several issues that have to be addressed in order to choose the right technology and
system for your business.
This is why I chose to conduct a case study to identify what people would choose
when they need to develop an e-commerce system.
There are 2 types of companies:
the start-up when they want to start from the beginning an e-commerce
business;
~484~
with legacy applications- who need the package solution, like Customer
Relationship Management (CRM), Supply Chain Management (SCM) or
Enterprise Resources Planning (ERP).
I chose the start-up companies, with different type of company size:
small company with 2-10 employees, 1-20 products;
medium company with max 50 employees, 20-40 products;
large company with hundred employess and products; this type of companies
exist in traditional business, but want to start online business from scratch (like
start-up, but with o lot of employees, traditional product etc.)
There are a few ways to develop e-commerce systems:
(1) starting from zero, writing code for a specific application;
o using Java, .Net, php with mysql etc.
o need a hosting site, database, web server etc.
o problems with: testing the application, extended for a larger application;
(2) using freeware template from Internet,
o with application customization, including writing code; using Java, .Net,
php with mysql;
o need a hosting site, database, web server etc.
o short time of implementation, possible problems with understanding the
application code;
(3) downloading software programs for creating e-commerce application;
o free for test available 2-4 weeks;
o commercial software;
o can be installed them on your system;
o you need hosting server, databases, web servers etc.
(4) using an existing platform for develop e-commerce application; all
components remote;
o free: for testing and starting with minimum of cost; easy to implement; not
too many options customizable; hosting, SEO optimizations including,
easy to test, payment and security integrated;
o not free: paying by month, by traffic or percentage of sales; hosting, SEO
optimizations including; easy to test, payment and security integrated with
the platform.
(5) buying an e-commerce platform; all components remote;
o object oriented;
o o lot of personalized choice;
o expensive (prices from 5.000-80.000$, and more);
o tested be a team;
o recommended for large company, with hundred of products;
o or for company who want to offer hosting and e-commerce platform
o SEO, payment, security, protocols (SET) included;
This study is about the start-up companies, with different type of budget.
An e-commerce/e-business platform can use 1/many e-business technology and
permit to host hundred/thousand e-commerce site, like an umbrela (all use the same
technology, payment system, e-commerce protocols, included SEO optimisation,
trafic analysis, report by hour/dday/week/month/product/sales/ users etc.).
~485~
The case study was made on a sample of 115 young persons who wanted:
to launch small personal electronic business;
or group (2-5 people)- for starting e-business;
to propose launching a new business direction (electronic) in the companies
they worked for.
The next table presents the most important result of the case study:
Type of
e-commerce
system
Non e-commerce platforms

(2)- using
freeware
templates
Caracteristics
(1)
programming all
the code
Type of company
Small
Small
Difficulty of
implementation
Duration of
implementation
Modularity
Personalization
Cost of software
Cost of
implementation
Efficiency
Code reuse
Application testing
Number of persons
required
Percentage of
people questioned
e-commerce platforms
(4)- using a
platform
(3)- software
existing
(5)- buying a
platform
Small/Medium/
Large
2
Large
Small/
medium
3
2
5
0
2
3
3
0
2
2
2
3
3
0- for free/3
2- for free/3
0- for free /3
0
5
5
5
0
3
0
5
2-5
2
5
4
1-2
3
3
2
3-8
3- for free /4
5
3
1-3
5
5
2
2-3
19
10
22
41
(Personal research)
The number represent a

5= maxim/difficult/expensive.
scale
value
from
0=minim/easy/cheap,
to
The study highlights the fact that you can create e-commerce/e-business sites with
minimum effort and maximum efficiency using stable platform, with secure and
proven technology.
If you want a lot of personalizations, you have time, a small budget, you can chose to
write direct the code aplications. If you are a large company, with experience in
traditional business and you want to start a new section on-line, you can choose to buy
a stable e-business system, modular, with a lot of personalization, expensive, but
secure and robust.
CONCLUSION
E-business is booming as organizations strive to gain efficiencies through improved
workflows, resource management, just-in-time provisioning and business
relationships. This paper explores the driving forces behind such developments,
introducing fundamental technologies and protocols (on previous articles) upon which
new systems and services can be built - including Service Oriented Architectures, web
services, XML and associated security standards. Case studies illustrate the business
~486~
strategies behind the deployment of e-business technologies. All of them will explore
professional and ethical issues surrounding web technology developments, use
software tools to create schemes and web service models, deploy collaborating
applications, and consolidate your learning in a final project, a viable ebusiness
application.
REFERENCES
Xu, J., Quaddus, M. (2009) Foundation of E-Business and E-Business Technologies,
www.techrepublic.com/whitepapers/overview-part-i-foundation-of-e-business-and-ebusiness-technologies/1908243/;
Timofte, C. (2007) E-business Technologies- revistaie.ase.ro/content/44/14-timofte.pdf;
Timofte, C. (2007) E-business Technologies - Proceeding of International Conference on
Informatics in Economy
Timofte, C. (2009) Trends in E-commerce Protocols - Carmen Timofte, Proceeding of
International Conference on Informatics in Economy;
(2010) How to Create a Successful E-Business -www.ehow.com/ how_5952307_createsuccessful-e_business.html;
(2011) TechWeb White Paper Library White Papers, Webcasts, Case Studies and Research
Papers - whitepaper.techweb.com/ cmptechweb/ e-business technologies.htm;
(2009) e-Business, ebusiness provider, eBusiness technology provider, eBusiness
technologies_files, www.alletec.com/knowledge_ebusiness.htm/;
(2004) e-business Technology, Solution, and Design Overview_files www.redbooks.ibm.com/Redbooks.nsf/IBM Redbooks Student Edition IBM;
(2007) Cover Pages SGML and XML News 2007 Q1.htm -xml.coverpages.org;
(2007) Cover Pages Open SOA Collaboration Vendors Advance SCA and SDO Specs for
Standardization.htm - xml.coverpages.org, , march;
(2008) LLC improving your business processes through the Internet.htm www.ebiztechonline.com/eBusiness Technology;
(2010) E-Business Scenario and Technological Implementation- www.altiusdirectory.com/
Computers/e-business-scenario.html;
(2010) The Advantages of E-Business Technologies -www.ehow.com/list_5991399_
advantages-e_business-technologies.html;
(2007) www.osoa.org.
~487~

Carmen TIMOFTE1
ABSTRACT
Many researchers have looked at the problem of verifying e-commerce protocols, but much
work remains to be done. On the final, I present the trends for the utilization of formal
methods for the verification of modern complicated protocols and protocol suites for the real
commercial world.
KEYWORDS: E-commerce, protocols, SET, AADS, 3D Secure, SSL.

INTRODUCTION
Electronic commerce requires protocols of great complexity. To make a purchase over
the Internet, the customer typically submits his credit card number to the merchant,
protected by a protocol such as SSL. However, many potential customers are uneasy
about revealing their credit card number over the Internet. The SET protocol has been
proposed by a consortium of credit card and software companies.
SET aims to protect sensitive card-holder information, to ensure payment integrity
and to authenticate merchants and card-holders.
The paper provides a review of the existing e-commerce protocols, making an
analysis of their most important characteristics. The purpose is to determine the trends
and to present a formal method for verification of these protocols.
1. OVERVIEW OF EXISTING PROTOCOLS
All existing protocols (A & M, 2007) use cryptographic functions like: message
digest (integrity), secret key encryption (privacy), public key, encryption (privacy and
authentication), digital envelopes (integrity and privacy), digital signatures
(authentication), digital certificates (authentication).
E-commerce protocols that were developed and some of them, used, more often or
less often, are:
SET (Secure Electronic Transaction)- in 1996 it was developed by Visa i
Mastercard, with the assistence of IBM, Microsoft, Netscape, GTE, SAIC,
Terisa and Verisign;
Correspondence address: Carmen TIMOFTE, Economic Informatics Department, Academy of

Economic Studies; email: carmen@ase.ro
~488~
iKP (Internet Keyed Payments Protocol) it was developed by IBM, the

Research Center T.J.Watson in collaboration with Zurich Research
Laboratory; is a protocol based on public key to making payments on the
Internet, involving at least three parties.
Secure Courier it was proposed by Netscape, to create a secure electronic
commerce on the Internet. It wants to be a protocol for the next level of SSL.
OPT (Open Trading Protocol)- it was created in 1997 by the consortium of
28 companies (IBM, Oracle, Sun Microsystems, Netscape, Nokia, HP, AT &
T, Fujitsu, etc..) to create a trade on network completely unprotected;
SNPP (Simple Network Payment Protocol)- it was proposed by M.I.T.,
Laboratory of Computer Science, in 1992;
IBS (Internet Billing Protocol)- it was developed by Carnegie Mellon
University in 1994; is inserted into SET; first variant of this protocol is based
on Kerberos, using a private key and batch invoices to ensure services both
traders and buyers.
JEPI (Joint Electronic Payment Initiative) it was developed by W3C and
CommerceNet
EMV it was developed by EuroPay and use the chips technology on credit /
debit cards;
E-Check (Electronic Checkbook)- working on a SmartCard of FSTC USA
(Financial Services and Technology Consortium);
SEPP (Secure Electronic Payment Protocol) accepted by MasterCard, IBM
and Netscape;
STT (Secure Transaction Technology) developed by Visa and Microsoft;
TLS (Transport Layer Security) its a secure protocol for simple task, whos
coding information on credit cards, sent to the Web and ensure that
transactions are not intercepted by a third party. It is developed by IETF
(Internet Engineering Task Force) and is similar to SSL (Secure Socket Layer
of Netscape). It is an open protocol, high level, which allows the addition of
new technologies for authentication and encoding / decoding;
P3P (Platform for Privacy Preferences) developed by W3C and provide a
platform for online transaction, allowing different preferences, the cultural
norms and environments to various legislative;
OPS (Open Profile Standard) its a complement of P3P and provides a
secure storage of user profile information. Ensure the protection of individual
data and the exchange of data on-line and may establish specific consumer
marketing environment.
2. THE MOST IMPORTANT E-COMMERCE PROTOCOLS

The e-commerce community can choose from a wide range of protocols when
designing new applications, but SET distinguishes as the most popular. Companies
such as Hitachi, IBM and VeriSign are currently testing SET-based products (for
example, Microsoft Wallet). Some security experts feel that, for various reasons, SET
will never gain widespread acceptance. Whether it does or not, we can be certain that
new e-commerce protocols will be developed. Unlike SSL, they will not require the
customer to trust the merchant. These new protocols will probably share much of
SET's architecture.
~489~
SSL (Secure Socket Layer)

SSL protects the communication between a client and a server and provides
authentication to both parties. SSL (TLS) resides below application protocols and
above transport protocols. Most common use of SSL is to secure web protocol HTTP,
TCP/IP and others Internet applications, like e-commerce.
Most Internet merchants use the SSL protocol to prevent eaves droppers from learning
customers account details, adopting the classical idea that bad persons are always
outsiders. This arrangement has two major limitations:
customers must trust merchants to keep these details secure, and merchants
may be dishonest or, more often, incompetent.
merchants must trust customers, who do not sign anything, and have little
protection from stolen cards or from customers who repudiate their
purchases.
Visa and MasterCard designed the SET protocol to solve these problems by keeping
sensitive information confidential and by authenticating Cardholders and Merchants.
The SET Protocol
The overall architecture of SET is based on a rooted hierarchy of Certification
Authorities (CAs), whose task is to provide customers with digital certificates for
signature and encryption. Customers must generate and safeguard their private keys
(R, 2000).
A normal run of the SET protocol consists of five phases. The first two phases
Card-holder Registration and Merchant Registration are used by the protocol
participants to register their keys and to get the appropriate certificates. The remaining
three phases Purchase Request, Payment Authorization and Payment Capture
constitute the electronic transaction itself. To accomplish these tasks SET uses
numerous combinations of hashing, public key and symmetric key cryptography
based on the PKCS#7 standards from RSA Laboratories.
Problems with SET
significant changes in the existing payment infrastructure
changes in the business model
it is slow: banks need 750 transactions per second, and SET offers 1
transaction per second
the sheer size of the documentation which takes over 1000 pages.
more substantial obstacle is the protocols complexity. Academic protocols
are typically short, straight-line programs; they seldom go beyond two levels
of encryption and generate few secrets.
SET has many features that make its verification hard (P, 2002):
Multiple nested encryptions and duplicate message fields require
abbreviations.
Ubiquitous generation of random numbers and keys cause a state-space
explosion in model checking.
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Many alternative protocol paths make it hard to single out the few key roles
used either by manual analysis or by model-checkers to restrict the search
space.
SET was based on X.509 certificates with several extensions and was intended to
become the de facto standard of payment method on the Internet. Despite heavy
publicity, it failed to win market share (B & S, 2009). Reasons for this include:
network effect - need to install client software (an e-wallet); cost and complexity for
merchants to offer support and comparatively low cost and simplicity of the existing
SSL based alternative; client-side certificate distribution logistics. SET needs to be
revived by introducing an emerging, alternative technology: AADS - Account
Authority Digital Signatures.
AADS (Account Authority Digital Signature)
The most important objective of AADS is to incorporate strong authentication into
existing business infrastructures, with public key digital signature. Neither a PIN nor a
password is required to be transmitted to the receiver for validating the identity of the
sender (W & W, 2004).
An AADS transaction eliminates the need to append a certificate to a digitally signed
transaction. The transaction/document with appended digital signature is all that is
necessary for an AADS transaction (with no appended certificate). At the receiving
party, the appended digital signature is authenticated by retrieving the public key from
the associated account record (not from an appended certificate).
There have been some early electronic commerce pilots that have relied on certificatebased bindings which minimize the software changes to existing business
implementations. Benefits from small pilots would typically be less than expense of
modifying existing business process implementations (especially if it hasn't yet been
determined exactly what the changes should be long term).
3D Secure
The basic concept of the protocol is to tie the financial authorization process with an
online authentication. This authentication is based on a three domain model (that is
the 3-D in the name). The three domains are: Acquirer Domain (the merchant and the
bank to which money is being paid), the Issuer Domain (the bank which issued the
card being used) and finally the Interoperability Domain (the infrastructure provided
by the credit card scheme to support the 3-D Secure protocol).
The protocol uses XML messages sent over SSL connections with client
authentication (this ensures the authenticity of peers, the server and the client, using
digital certificates).
3. THE IDEAL E-COMMERCE PROTOCOLS
Researchers have identified a number of desirable characteristics that must be
satisfied by e-commerce protocols (B&P, 2002):
should ensure fair exchange,
~491~
should not require manual dispute resolution in case of unfair behavior by

one party,
each party should be assured that the item he is about to receive is indeed the
correct one,
should not require the active involvement of an online trusted third party,
should ensure anonymity for the customer and optionally for the merchant.
Fair exchange: Ideally fair exchange requires that either both the parties involved in
the transaction receive each others items or none do. However, researchers have
often used the term in a weaker sense: the protocol gathers enough evidence during
execution so that, in case one party behaves unfairly and obtains the others item. If a
dispute occurs, a judge looks at the evidence and delivers his judgment. The dispute
resolution is performed after the protocol execution, that is, after the customer has
obtained his product or the merchant his money. However, such after-the-fact
protection may be inadequate in an e-commerce environment where the customer and
the merchant may be unreachable after the transaction (R & R, 2001).
Avoiding manual dispute resolution: The need for manual dispute resolution, when
one party behaves unfairly, does not arise if protocols provide true fair exchange
under all circumstances either both the parties receive each others items or none do.
Protocols providing true fair exchange typically use an online trusted third party. The
third party receives the information from each party involved in the e-commerce
transaction and then forwards it to the other party. As a result if any party misbehaves
or prematurely quits, no harm is caused to the other party.
Ensuring correct item will be received: Before exchanging the items, each party must
have the confidence that the item he is about to receive from the other party will
indeed be the correct one. The use of an online trusted third party helps to meet this
requirement as well. Although using a trusted third party helps meet some
requirements, the third party is a source of bottleneck for these protocols. Not only is
the performance of the third party an issue, but also its vulnerability to denial of
service attacks.
Reducing involvement of the third party: Several protocols have been proposed that
do not use the third party unless a problem, such as, a party misbehaving or
prematurely aborting, occurs. Such protocols are termed optimistic. Most of these
protocols do not ensure true fair exchange.
No existing e-commerce protocol that we know of satisfies all of these requirements
simultaneously. There are a lot of things to develop in the e-commerce protocols. This
is why the research community works with de software companies to obtain the ideal
protocol, accepted by all.
4. PROTOCOLS VERIFICATION
In the analysis of conventional communication protocols (G & L, 2001), three kinds
of techniques have been applied to this problem:
Inference-construction methods are utilizing modal logics similar to those
that have been developed for the analysis of the evolution of knowledge and
belief in distributed systems. These methods are widely used and a number of
~492~
specific problems are associated with them, related to: the analysis of zero
knowledge protocols, the detection of parallel session multi-role flaws, the
transformation of messages and prepositions to idealized messages, the fact
that there is no complete semantics for the logic, and the modeling of
freshness.
Attack-construction methods construct probable attack sets based on the
algebraic properties of the protocol's algorithms. These methods are targeted
towards ensuring authentication, correctness, or security properties; they are
not dependent on the correctness of a proposed logic. Their main
disadvantage lies in the big number of possible events that must be examined
and the exponential searches. They can be divided into three sub-categories
based on their theoretical foundation: methods based on general purpose
validation languages, algebraic simplification theoretic model methods and
special purpose expert system, scenario based methods.
proof-construction methods a recent approach, which has the potential of
being as thorough as attack construction in finding possible attacks, while
avoiding exponential searches by replacing them with theorems about these
searches. It is complementary to inference-construction methods, since they
are also based on the problem formalization through hypotheses and
authentication properties, but rely on problem-specific properties and a
specification at a finer level of precision.
The robustness principles are therefore helpful, in that adherence to them contribute to
the simplicity of protocols and avoid a considerable number of published confusions
and mistakes: be very clear about the security goals and assumptions; be clear about
the purpose of encryption (secrecy, authenticity, etc.); do not assume that its use is
synonymous with security, be careful that your protocol does not make some
unexamined assumption about the properties of the underlying cryptographic
algorithm; be sure to distinguish different protocol runs from each other; do not
assume that a message you receive has only a particular form, even if you can check
this; sign before encrypting; the identity should be mentioned explicitly in the
message.
5. TRENDS
Several researchers believe that in the near future, more effort will be spent on
designing secure protocols and less on formal verifications (K & a, 2005). As
expected, this trend has received criticism similar in nature to that expressed towards
the use of formal methods in program design and implementation.
Other researchers argues that design specifications do not guarantee that protocols
will meet security goals that were not foreseen by the design approach, that the
protocols designed are sometimes impractical, and that due to the imprecision of
design principles flawed protocols may in any case be designed.
A protocol analysis toolkit-based can be described as follows:
initially, use an inference-construction method, like BAN, to determine what
the role of each message of a protocol should be and to ensure freshness
properties;
~493~
then, use an attack construction method, like NRL Protocol Analyzer, for
finding simple attacks quickly;
and finally, utilize a proof-construction method to investigate deeper
properties with a modest amount of effort.
Furthermore, some areas where current research is conducted have emerged.

Another interesting research direction is the investigation of the potential integration
of methods (like the NRL Protocol Analyzer) and the Interrogator model within the
methodology of fail stop protocols in the cases of protocols that do not satisfy the failstop requirements. To ease and extend the use of these it would be useful to achieve
automatic translation of a higher-level protocol specification language, using
exhaustive finite-state analysis and formal logic methods.
The research community is also working towards developing tools that take easy-towrite specifications of protocols and the expected properties and quickly perform
formal analyses checking for failures of these protocols to achieve their desired
properties.
An interesting research trend lies in the fact that many current activities use formal
methods for analyzing and verifying modern protocols and protocol suites to be used
in the commercial world. These suites consist from a set of single protocols which
interact with each other causing, previously unknown, potential vulnerability.
CONCLUSION
The research community, working towards developing more effective techniques to
design protocols that are guaranteed to be reliable and correct in the first place, has
implemented the synthesis approach. Most of the recent research in this area is
focused on the application of the notion of channels in order to effectively implement
the layered approach.
Researchers have identified a number of desirable properties of e-commerce
protocols: should ensure fair exchange, should not require manual dispute resolution
in case of unfair behavior by one party, each party should have the assurance that the
item he is about to receive is the correct one, should not require the active
involvement of a trusted third party.
These properties must be introduced in the next generation of e-commerces protocols
for having secure e-commerce world.
REFERENCES
Anderson, R.& More, T., (2007) Information security economics and beyond, Advances
in Cryptology Crypto, LNCS 4622, available on-line at www.cl.cam.ac.uk/
~rja14/Papers/econ_crypto.pdf, (date of consultation: may, 10, 2011);
Bella, G. & Paulson, L. C., (2002) The Verification of an Industrial Payment Protocol,
Proceedings of the 9th ACM Conference on Computer and Communications Security,
available on-line at www.dmi.unict.it/~giamp/Seminars/SETCCS02.pdf, (date of
consultation: may, 10, 2011);
~494~
Boping, Z. & Shiyu, S., (2009), An Improved SET Protocol, Proceedings of the 2009
International Symposium on Information Processing (ISIP09), Huangshan, P. R.
China, August 21-23, pp. 267-272, available on-line at www.academypublisher.com/
proc/isip09/papers/isip09p267.pdf, (date of consultation: may, 10, 2011);
Grgens, S. & Lopez, J., (2001) Suitability of a classical analysis method for e-commerce
protocols, Information Security, 4th International Conference, ISC 2001, volume
2200 of lncs, www.informatik.uni-trier.de/~ley/db/conf/isw/isc2001.html;
Katsaros, P., Odontidis, V., Gousidou-koutita, M., (2005) Colored Petri Net based model
checking and failure analysis for E-commerce protocols, Dept. of Computer Science,
University of Aarhus, pp. 267-283;
Paulson, L. C., (2002) Verifying the SET Protocol: Overview, International Conference on
Formal Aspects of Security (FASec), LNCS, available on-line at
http://www.cl.cam.ac.uk./~lcp/papers/Auth/SET-overview-2002.pdf
(date of consultation: april, 10, 2011);
Ramakrishnan, G., (2000) Secure Electronic Transaction (SET) Protocol, available on-line
at
www.isaca.org/Journal/Past-Issues/2000/Volume-6/Pages/Secure-ElectronicTransaction-SET -Protocol.aspx (date of consultation: april, 10, 2011);
Ray, I. & Ray, I., (2001) An Anonymous Fair Exchange E-commerce Protocol,
Proceedings of the International Workshop on Internet Computing and Ecommerce,
pp. 172-179;
Wheeler, A. M. & Wheeler, L. H., (2004) Account Authority Digital Signature (AADS)
System, available on-line at www.wikipatents.com/US-Patent-6820202/accountauthority-digital-signature-aads-system (date of consultation: may, 10, 2011);
~495~
MODELING ON A SEMANTIC-BASED
REPRESENTATION OF PEDAGOGICAL OBJECTS ELEARNING-TYPE IN ORGANIZATIONAL MEMORY:
CONNECTING ONTOLOGY WITH LOM META-DATA
Iuliana IONESCU1, Vasile FLORESCU,
Bogdan IONESCU & Ofelia Ema ALECA
ABSTRACT
The emergence of Internet technologies, especially of Web technologies has really opened the
perspective of online use for pedagogical content, also-called pedagogical objects (OP),
based on the structure of learning scenarios (Learning Design). The semantic-based
representation of pedagogical objects by associating an ontology with LOM meta-data makes
the objects more accessible, reusable and customizable in the context of training activities.
The present paper is structured in two main sections: the first section represents a review of
the reference literature concerning the modeling on a semantic-based representation of elearning training in organizational memory. The second section contains several instances of
the models presented in the first section and the operational models for the teaching unit
"economic and financial analysis of organizations business".
KEYWORDS: Organizational Memory of e-learning, Learning objects, Standards of elearning, Meta-data, Ontology, Indexing
INTRODUCTION
The emergence of Internet technologies, especially of Web technologies has really
opened the perspective of e-learning training, available to those interested in
pedagogical content accessed by users on the Web (Bourda, 2002, Abel et al., 2003)
and used online on the structure of pedagogical scenarios (Hernandez et al., 2008;
Florescu & Aleca, 2009). However, the use of pedagogical resources of e-learning,
stored in organizational memory, could cause problems of access, management, reuse,
and finally integration on a technical and pedagogical level.
In removing these inconveniences the representation and indexing of these
pedagogical objects is of importance (Benayache, 2005; Hernandez et al., 2008). In
fact, a non-indexed pedagogical resource is unavailable, and therefore cannot be used.
According to Abel et al. (2003), the applied organizational memory e-learning also
contains other elements than pedagogical objects, related to the pedagogical training:
the elements concerning the actors involved in training process (specificity, actors
Correspondence address: Iuliana IONESCU Academy of Economic Studies, Management

Information Systems department, Bucharest, Romana str., No. 5, Sector 1;
email: ionescu.iuliana@gmail.com,
~496~
behavior - meaning how to act over the time, profiles, etc.) and the administrative
management of the educational process, as well (registration, marks, and so on).
In the present paper, our approach is a research-development type: the literature
review, where we approached the major aspects regarding the pedagogical objects of
e-learning training in organizational memory, followed by the development of a
methodology for defining an ontology which, starting from a reference nucleus
(corpus) describes an educational area circumscribed to the financial and economic
analysis. To achieve our research work we passed through two important steps,
which are:
The literature review which approaches the modeling issue on a semanticbased representation of e-learning pedagogical objects in organizational
memory;
Instantiation of the models on a semantic-based representation of pedagogical
objects on economic and financial analysis of business organizations area,
provided by the academic curriculum of the e-learning training in economics.
At the same time, our research work makes a conceptual clarification regarding the
semantic-based representation of pedagogical objects and also referring to the
perspective of computer-assisted conversion from an UML conceptual model to an
ontology in OWL language (Web Ontology Language) or RDFS (Resource
Description Framework Schema).
2.1. Organizational memory of e-learning training
According to Abel et al. (2003), an educational process is always organized based on
the main actors (tutor and student, secretary, manager, technician), the knowledge of
the actors (which interfere with the educational environment), the skills of the
educational process involved, and the different types of information (definitions,
exercises, solutions, case studies, etc.) prepared under different forms (reports, books,
website, and so on) and stored on various media (paper, video, etc.). This way, one
could say that an e-learning educational process can be assimilated to an
organizational entity.
The organizations resources are managed by an organizational memory training
(MOF). As a matter of fact, MOF capitalizes on the following: the Learning Object
(LO), also-called pedagogical objects (OP) related by the content of the field training,
the relationships between them, and also the information about the actors (their
specificity, their activity over the time, and the kind), the information regarding the
administrative management of training process (registration, student marks, and
so on).
Choosing the formalism for representing and accessing the OP in MOF is a very
significant, but also a difficult problem concerning the semantic-based representation
of pedagogical objects. It is important that the models of representation of OP
articulate the LOM meta-data (Learning Object Metadata) with the application
~497~
ontology, with the purpose of ensuring the semantic-based access on e-learning

training programs. The MOFs pedagogical resources are provided for all e-learning
trainers by the local warehouse, also-called Learning Object Repositories (LORs). In
essence, an e-learning system which has the MOF support should allow the trainers to
formulate several informational requests in order to find out the particular OP.
2.2. Pegagogical objects
For e-learning training programs, a so-called Learning Object Repository (LOR) is
set up, where all pedagogical objects are stored and indexed (OP). Our scientific paper
is mainly focused on the representation of pedagogical objects related to the content
of the training field, which is often identified with the pedagogical resources of the
training process. The working group IEEE-LTSC (Learning Technology Standards
Committee) defines the OP as any numerical or non-numerical entity which can be
used, reused or referenced during the computer-support learning activity.
To clear away any possible confusion, Strijker (2004) removes the non-numerical
data, like books and libraries, from the conceptual definition. Wisconsin University
(Wisc-Online, 2007) defines the pedagogical objects as small autonomous learning
units in line; they are small enough to be well-integrated into an educational activity, a
lesson, a module or a course. According to Hernadez et al. (2008), an OP represents
a semantic unit of learning resource. In its assessment evaluation methodologies of
distance learning educational standards, the Romanian Agency for Quality Assurance
in Higher Education (ARACIS) defines the learning unit as the structural element of
the course, which is unitary from thematic standpoint, integrates a set of specific skills
and, finally, is completed by an evaluation. This is equivalent to one or more chapters
of a semester course.
Pernin (2003) classifies the pedagogical objects into three fundamental categories,
which are:
pedagogical units, which allow the structuring of the training and its
organization in space and time;
pedagogical activities, which define the certain modalities of acquisition,
validation and communication of one or more knowledge (the IMS-LD standard
was specifically developed to define learning scenarios);
pedagogical, physical and numerical resources required by the carrying out of
the activities.
Our research work is aimed at the pedagogical objects representing learning units,
also-called learning objects.
An OP is often segmented into a finer granulation to allocate the production activity
between different actors (Charlet et al., 2008). A granule represents a pedagogical
object meaning the smallest possible learning pedagogical unit of a pedagogical
pathway. According to IEEE-LTSC (2002) an OP can develop from the smallest
possible learning pedagogical unit to a complete course. Depending on the granularity
level, an OP can be classified in two categories: an elemental OP (text, image, video
and animation) and a composite OP. Each pedagogical object (OP) can be composed
of one or more Web pages, each of these representing different parts of the reference
corpus.
~498~
Structuring the educational content of any domain consists in breaking up the

knowledge in basic units of fine granularity, allowing for indexing, filtering and
reusing operations. A pedagogical unit (educational discipline) can be organized into
a structure which includes: curricula, pedagogical unit, courses, lessons, exercises and
elements of self-valuation. To represent the educational resources of a pedagogical
unit, the framework model is defined using an UML diagram (Figure 1). Within the
curriculum, the courses are planned; these contain the lessons, which are made up of
pedagogical objects, and the connections are actually represented - within the
framework model - by the aggregation of relationships between the appropriate
classes (pedagogical unit, curricula, lesson and pedagogical object).
Figure 1. Objectual structure of a pedagogical unit for e-learning training
Within the framework module we specify the particularities of the pedagogical object
including: the type (course, module, assisted-activity and so on), the name, and its
format. As we have already seen, the pedagogical objects are divided in two
categories (elemental OP and composite OP) depending on their complexity and
usage. This classification is represented by the aggregation of relationships between
the classes - composite pedagogical object, elemental pedagogical object and the
class - pedagogical object. In turn, the composite pedagogical objects consist of one
or more pedagogical objects (elementals or composites), which is represented in the
model by associating the classes composite pedagogical object and pedagogical
object.
The pedagogical objects composing a lesson can refer to: the content of the lesson, the
bibliographical sources, and the set of exercises and tests. The diversity of
achievement and presentation of the lessons and pedagogical objects presumes a
variety of resources (multimedia resources such pictures etc.). Once created, a
pedagogical object must be:
reusable in different educational contexts;
independent by the distribution support and training platform;
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indexed described so that they can be easily accessed.
All the pedagogical objects for a specific training field constitute the so-called
pedagogical file.
2.3. Meta-data and description standards of pedagogical objects
2.3.1. Meta-data for description of pedagogical objects
The meta-data represent, in fact, the structured data which describe other data, in the
present case, data about pedagogical objects. They are represented by a set of
pedagogical object descriptors which are structured by using a meta-data schema.
These descriptors are used with the purpose of indexing the pedagogical objects, the
only way to easily locate them in the OP database. According to Iles et al. (2008) the
objectives of the meta-data are:
Description of the pedagogical objects, with varying level of detail;
Improving the search capability into OP databases or warehouses;
Facile and quick evaluation of OP content adequacy;
Improving the management of access rights;
Organizing of pedagogical object warehouses;
Certifying the intellectual authority of the content (author, created date,
responsible authority, upgrade date, and the kind).
2.3.2. LOM and SCORM standards
A standardized OP description is essential in ensuring the reuse and access to OPs.
The reference literature (Hernandez et al., 2008, Florescu & Aleca, 2009) refers to the
complementarity of LOM (Learning Object Metadata) and SCORM (Sharable
Content Object Reference Model) standards (see Figure 2):
Figure 2. SCORM and LOM descriptions
(Source: According to Hernandez et al., 2008)
A pedagogical object represents a LOM object and consists of SCORM elements, and
can contain more pedagogical objects. According to the LOM standard, the
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pedagogical object is annotated using different elements or meta-data such as its

associated access rights, technical requirements and features, educational
particularities, etc.
The LOM standard (2002) specifies the syntax and semantics of the pedagogical
meta-data and also defines the necessary attributes for an appropriate and complete
description of pedagogical objects, by regrouping these objects in nine categories
(generalities, life cycle, meta-meta-data, technical information, pedagogical
information, rights, relationships, comments and classification). The purpose of LOM
is to allow retrieval of OPs, prepare them, and introduce certain pedagogical
dimensions in their description. It should be noted that many research papers propose
the substitution of one or more LOM elements by concepts which belong to
ontologies, in order to solve some problems of semantic ambiguity. Implementing the
LOM standard can be done using XML or RDF (Ouafia et al., 2009).
The SCORM standard (2004) guides the creation of structured pedagogical resources
and also treats the following elements (Pernin, 2004):
Packing allows the transfer of the pedagogical objects content, focusing on
their structure. A package represents an archived file that contains educational
resources, such as HTML, JPG, Word files, attended by an XML file
containing multiple sections, including the section reserved for meta-data
(where the package is described), the resources section (which consists of a
list of resources along with the connections to the (URL), and an organization
section (which contains the structure of resources).
Meta-data allows the structuring of information which describes the nature
and the objectives of the content.
Communication manages the access to the pedagogical objects within the
learning network.
Sequence and browsing establish the access mode in terms of the activities
tree.
The aggregation of content is structured on three levels:
Basic digital resources represent the basis of pedagogical objects and can be
found in the form of simple elements, such as HTML files;
Shared objects are composed of multiple basic objects, in accordance with the
SCROM protocol. They represent the lowest level of granularity that the
pedagogical objects can have in an e-learning platform;
Aggregation of the content consists in a number of educational resources,
structured as modules and lessons.
A pedagogical object can combine more elementary components: DOC, JPG, PDF
files, or other pedagogical objects. The LOM meta-data and the SCORM structure
allow, on one hand, the description and the indexing the pedagogical objects using the
LOM meta-data and, on the other hand, structuring of the pedagogical objects in
conformity with the SCORM standard.
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3. ONTOLOGIES
3.1. Briefly about ontology
For many years, the ontology science has been used in Knowledge Engineering (IC)
and Artificial Intelligence (IA) in order to structure the concepts of the specific field
of study. The ontology allows the definition of overall concepts shared within a field
of study, in a formal, explicit, referential and consensual manner (Gruber 1993; Studer
1998). This presents the organization of the concepts and relationships. The
ontologys core contains four (Stumme & Maedache, 2001):
O:=(C,C, R, R)
where:
C
C
R
R
represents the set of concepts,

represents the partial order on C,
represents the set of relationships defined on CxC, and
represents a partial order on R.
Once defined, an ontology must be clear, coherent, intelligible and easy to use and
expand (in fact, easy to update when an evolution occurs).
3.2. Ontology for e-learning
E-learning training technology is based on the following elements: the actors
(students, tutors, designers, administrators); learning fields; educational resources
used for learning (courses, cases of study, complementary documents). The basic
elements are modulated as sub-technologies of the global training ontology.
Nowadays, many researches are based on ontologies for indexing and accessing of
pedagogical objects in support systems for e-learning training (Abel et al., 2003;
Lenne et al., 2005; Knight, 2005). Semantic representation of pedagogical objects is
based on two important concepts: field ontology and training ontology, respectively.
Elements of the field ontology
The field ontology describes the specific concepts of a certain application field, such
as, Data Analysis, Financial Management, Databases, and so on. This is an explicit
and formal specification of a shared conceptualization, proper to a particular
application field (Borst, 1997; Charlet et al., 2008). In addition, it presents the
advantage of allowing a normalization of the concepts, which provides a better
representation of knowledge. The concepts represent the objects, precepts and ideas of
the field and the relationships represent the connections between these concepts.
Actually, the structure of the field ontology defines the relationships established
between the concepts.
The reference literature on the field ontology conveys the following terms: concept,
relationship and axiom. Within an ontology, a concept is uniquely identified and its
various meanings are represented by labels. Semantic relationships represent a type of
interaction between the concepts of the application field. The concepts links can be
taxonomic (relation of specificity/generality) or non-taxonomic (also-called
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associative). This aspect is represented on the conceptual schema of ontology through

an association of a reflexive class. The axioms are always true expressions. Including
axioms into an ontology can have more objectives, such as: defining the sense of the
components, setting out the restrictions on the attributes values, determining the
arguments of a relationship, verifying the validity of specified or inferred information
(Hernandez et al., 2008).
The field ontology allows the representation of the pedagogical objects in relation to
the percepts (concepts) approached by the field (Hernandez et al., 2008). This is
significant for semantic-based granulation of the applications field knowledge.
According to Hernadez (2005), we must distinguish between the fields knowledge
which describe factual situations, and ontology which define a number of constraints
on the structure and content of the fields knowledge. The field ontology can be
plotted using an UML model and especially the class diagrams, mainly because they
allow the modeling of the concepts (entities) of the field. In Figure 3 we present the
generic framework for representing a field ontology using the UML formalism.
Figure 3. Extract from the field ontology of the discipline Relational Database
The option for UML is primarily motivated by the fact that it is well-known, and
secondly, this mode of representation is recommended by the opportunities offered on
the line of creating an ontology, starting from the class diagrams orientated on a
precise field (Faucher et al., 2010), corroborated with mail use proposed by Mefteh et
al. (2009) and presented in Table 1. In Figure 4 we present the relation between the
UML model, the annotated UML model, the RDFS ontology and the pivot UML
model.
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Figure 4. Transforming process: UML model. Ontology in RDFS
(Source: According to Faucher et al., 2008))
Tabel 1
UML
Class
Generalization
Association
Attributes
InstanceOf
Multiplicity
RDF(S),OWL
owl :Class
rdfs :subclassOf
owl :ObjectProperty
owl :DatatypeProperty
rdf :type
owl :minCardinality, owl :maxCardinality
By annotations, all the interesting elements of the model are selected. The annotation
mechanism uses the intrinsic possibilities of UML extension, such as: profiles,
stereotypes, and labeled values. Then, the annotations are exploited while the
ontology is built up, in order to guide the process of model transformation. The
annotated UML model represents an extension of the UML model, which is orientated
on a precise activity field. The pivot model, actually an UML model of ontology,
contains the information required for building up the ontology, in accordance with the
UML meta-model. The second change is based on the connections between the UML
elements and an ontology structure, like RDFS or OWL.
Elements of training ontology
The training ontology describes the specific concepts of the training process, such as:
type of actors involved in the training process, type of pedagogical activities, type of
documents etc. According to Benayache (2005), the training field performs with
specific training concepts:
Actors of the training process (teacher, student, secretary, administrator,
technician etc.);
Documents (reading notes, slides, books, Web pages, Web sites and so on);
Educational resources (digital resources, teaching aids etc.).
All these concepts and relationships constitute the training ontology. The standard
structure of the training ontology, according to Abel et al. (2004), is presented in
Figure 5.
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Figure 5. The structure of training ontology
(Source: According to Abel et al., 2004))
Integration of ontologies
The two types of ontology (field and training) are not independent. The description of
field ontology (knowledgeBeanObject) requires some additional references to the
appropriate concepts of training ontology (trainingOntologyObject). For example, if
we need to specify that a document contains knowledge related to concept Indicators
of financial analysis, we only need to link the concept Document (belonging to the
training ontology) with the concept Indicators of financial analysis, belonging to the
field ontology for Economic and Financial Analysis module. The pedagogical
relationships like prerequisite or uses that occur between concepts of the field
ontology are defined in the training ontology. Figure 6 presents the general framework
of integration between the two ontologies for a training-type e-learning process, with
application in the financial and accounting field - adapting the general model of Abel
(2004).
At the basis of the two integrated ontologies we find the E MemFC concept which
contains:
all the concepts of the field ontology designated by the Application Concept
class;
all the concepts of the training ontology designated by the Field Concept
class;
the KnowledgeBean class which contains all the concepts that belong to a
field ontology; besides, these concepts must be studied in the training
program by all the trained students;
TrainingProperty represents the class of relationships occurring between
concepts.
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Figure 6. General framework of ontology integration for e-learning in financial

and accounting field
The two classes, inherited from the concept E_MemFC, are sub-classes of the
E_MemFC class. The relationships between the concepts can be created anytime in
each of the two ontologies.
3.3. Associating the ontology of field with LOM meta-data
To address the problems related to the lack of semantics in terms of representing and
accessing the pedagogical objects (OP), one can associate the ontologies to certain
elements of LOM (Phaedra & Permanand, 2006, Ouafia et al., 2009). There are two
ways to achieve this association:
Substituting of one or more LOM elements by concepts found in ontologies;

Building up a field ontology based on the description schema of LOM.
In fact, the second solution resolves much better the problem concerning the inclusion
of semantics in the OP representation, referring rather to Who contains? instead of
What contains?.
3.4. Languages for defining of ontologies
A language for defining ontologies must provide the epistemological fundamentals
necessary to describe the ontologys concepts (classes), their properties and
relationships (attributes and roles), and the constraints on these properties. Currently,
there are various languages for defining and manipulating ontologies. Many of them
are semantic web-orientated: XML to manage the markers used for structuring
documents, RDF (Resource Description Framework) to manage the meta-data of
XML documents, DAML+OIL to represent the meta-data and ontologies, OWL
(Ontology Web Language standard of World Wide Web Consortium) to formalize
the ontologies.
Among all, the most representative language is OWL, which is a revised version of
the DAML+OIL language. OWL represents a dialect of XML (eXtensible Markup
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Language) and an extension of RDF and RDFS (RDF Schema), as well. In Table 2 we
present an adaptation to Chrisment et al. (2006) for encoding the conceptual schema
elements of a Web ontology using the OWL language.
Table 2
Conceptual schema elements
Class
Label of class
Taxonomic relationships between classes
Concept of starting relationship
Concept of incoming relationship
Representing in OWL
<owl:Classrdf:about="unique ID"
<rdfs:label>
<rdfs:subClassOf>
rdfs:domain
rdfs:range
Non-taxonomic relationships between classes
<owl:ObjectProperty>
It is possible to create and edit an ontology in the OWL format using a software
application, for example, the Protege application created by Stanford University.
3.4. Semantic-based indexing of OPs
The purpose of the indexing operation is to provide a semantic representation of OPs,
in order to access them quickly and possibly on a semantic basis. Using the meta-data
suggested by the LOM standard is insufficient to resolve the problem of accessibility
and reuse of OPs. It is known that in meta-data, the semantics of content is present
within the limits of some keywords. Using ontologies comes to complete the
semantics of indexing OPs. In general, the ontology can provide the vocabulary and
its semantics with the purpose of exploiting the content of meta-data related to
annotated resources (Hernandez et al., 2008). In e-learning training systems, the
ontology provides the knowledge required to improve the results of the searching
process. In the process of semantic-based indexing of OPs, the following aspects are
notable (Hernandez et al., 2008; Iles et al., 2007):
The ontology of the field regroups the concepts of the field in a formal
specification;
Meta-data are optional, according to the LOM standard;
Object structuring is in accordance with the SCORM standard;
Educational theories are used during a scenario.
The OPs can be indexed and stored in OP warehouses, or organized on the structure
of a semantic Web. This way, an OP local warehouse will contain:
A classical database (relational, object-orientated, relational-object) where the
OP are stored;
A set of LOM descriptors and semantic descriptors (annotations) resulting
from the indexing phase.
4. INSTANTIATION OF THE REPRESENTATION MODELS
OF PEDAGOGICAL ENTITIES FOR E-LEARNING TRAINING
IN THE FIELD OF ECONOMIC AND FINANCIAL ANALYSIS
4.1. Instantiation of the objectual structure model
In the curriculum of Accounting and Management Information Systems field
(license studies and master) one can find more training modules, among which
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Economic and Financial Analysis, Accounting and Management and

Information Systems. For the Economic and Financial Analysis module, one can
define more courses, structured in pedagogical entities or learning entities. In the
Figure 7 we have presented the component of the course Analysis of output
activities, and also the content of two learning entities within it.
Figure 7. General framework of ontologies integration for e-learning in Financial
and Accounting field
4.2. Instantiation of the Oriented on activity specialization model using UML

for the ontology that defines the Economic and Financial Analysis
in a formative context
The instantiation of the representation model corresponding to the ontology of
Economic and Financial Analysis, firstly involved building the domains ontology,
by defining the concepts and the relations between the concepts. It is well-known that
the process of building up and improving an ontology is quite difficult. Besides,
building up an operational ontology occurs in three main steps:
Conceptualization, consisting in identifying the knowledge within a
representative area of the field, regrouping in semantic classes and structuring
them in networks;
Defining the ontologies, implying the formalization of the conceptual model
attained in the previous step;
Operationalization, presuming the transcription of the ontology in a formal
and operational language of knowledge representation.
In the present paper we already completed the first two steps. The conceptualization
step was performed based on the reference corpus for the Economic and Financial
Analysis field (guidebooks, books, articles, Web pages and so on). In fact, to
complete the conceptualization step it was absolutely necessary to rely on a thesaurus
created by experts in the field. Regarding the second step, the research team has
proceeded to transcribe the ontology in the UML language.
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Reviewing some relevant papers (Isfanescu & Robu. 2002, Valceanu and Robu, 2005
and Dinu, 2001) we built a knowledge base which allowed us to set up the postulant
terms for the ontology, the concepts and the ontologys terms, respectively. The field
of Economic and Financial Analysis is based on set of methods, techniques and
tools for information processing with the purpose of diagnosing the status of an
economic entity (Dinu, 2001). The diagnosis can be an internal one, required by the
decision support systems or, on the contrary, performed for the benefit of an external
entity, such as some clients, auditors, or financial institutions.
The financial indicators system represents the main working tool in economical and
financial analysis. These indicators can be either simple or aggregated, based on other
indicators. The diagnosis is accomplished based on the significance level of the simple
indicators which explains a particular event. The methods and techniques frequently
used in the analysis process rely on a set of indices and rates.
The structuring of the concepts and of the relationships is based on the semantic
connections between the terms. It is represented in an ontology by the relationships
between classes - relationships of association, aggregation or inheritance (see Figure 8).
Figure 8. Meta-model of the ontology in the Economic and Financial Analysis field
Source: According to Florescu & Aleca, 2009 and Reynaud & Tort, 2000
The ontology of the field can be structured into several levels of detail. In the
proposed instantiation, the research team has proceeded to detailing the indicators
nodes (see Figure 9) and methods and techniques (see Figure 10).
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Figure 9. Ontology for detailing the indicators node
(Source: According to Dinu, 2001)
In the process of detailing the node methods and techniques we have to identify,
within the methods and techniques, the following: devising and comparing the results,
benchmarking, grouping, modeling, defining charts, evaluation scores, the ABC
method and the scores method.
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Figure 10. Ontology for detailing the methods and techniques node
Chain substitution method
ABC method
Scoring method
Evaluation grid
Modeling
Indices
Methods and Techniques
Benchmarking
Comparison
Averages
Relative sizes of the structure
Division
Rates
Rate of return
Rate management
Rate of financial balance
Rate on debt management
Rate of liquidity and solvency
CONCLUSIONS
In the context of extending the use of e-learning, the pedagogical object representation
must ensure the reuse and interoperability, taking into account the specific standards
of the field (LOM and SCORM). In the present paper we brought a number of
clarifications on the conceptual level, and we also described the semantic-based
representation models of pedagogical objects for e-learning training, and we
instantiated the models in the scenario of the pedagogical entity belonging to
Economical and financial analysis of organizational activity. In the future, our
research work will focus on defining a methodological framework in order to create
the ontology of the field, further developing the thesaurus of the field and the content
of the pedagogical objects.
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SEMANTIC ANNOTATION AND ASSOCIATION

OF WEB DOCUMENTS: A PROPOSAL FOR SEMANTIC
MODELING IN THE CONTEXT OF E-RECRUITMENT
IN THE IT FIELD
Bogdan IONESCU1, Iuliana IONESCU,
Vasile FLORESCU & Andrei TINCA
ABSTRACT
The emergence of the Internet has widely opened opportunities for web applications based on
the modeling of textual knowledge from electronic documents, with the aim of identifying the
useful parts. This is also the case of e-recruitment applications, which aim at the optimizing
and automating the processes by semantic association between CVs an job offers. Our paper
considers the problem of semantic-based annotation of semi-structured documents, and
proposes a semantic model for e-recruitment in the IT domain.
KEYWORDS: e-recruitment, ontology, semantic annotation, information system, similarity

measure
INTRODUCTION
The Internet has become essential, and the web is currently the dominant paradigm for
the optimization of the recruitment processes. Most of the job seekers post CVs on
web servers, and employers post job offers. The employment market is gradually
moving onto the web using semi-structured documents (Rafter and Smyth, 2000:1;
Bizer et al., 2005:1; Kessler et al., 2009:2; Kessler, 2010:16; Popescu and Popescu,
2010:1), which translates into massive databases containing CVs and job offers,
which are difficult to process in the absence of adequate techniques. This is the reason
why research is done in the area of optimizing recruitment processes using Internet
technologies, by adding semantics to standardized documents containing information
regarding CVs and job offers (Figure 1).
The semi-structured documents are semantically annotated (based on their content)
and they are related to a field ontology. In the particular case of recruitment, the field
ontology is inspired from the most significant parts from CVs and job offers
(Yahiaoui et al., 2006). Intelligent programs can compare document instances using
the common reference (ontology) and also detect ontological similarities between
multiple instances.
Despite significant progress in the area of semantic annotation of semi-structured
documents, the process of creating the annotations and particularly the matching of
1
Correspondence address: Bogdan IONESCU, ASE Bucharest, Piata Romana nr.6, Sector 1
Bucharest; email: ionescub@gmail.com
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these documents are still difficult and resource-intensive. An essential factor to the
recruitment process is the creation of a controlled vocabulary for the field, and the
construction, maintenance and update of the ontology (concepts, properties and
relations). These two elements guide the process of data extraction from semistructured documents and thus ease the process of their semantic annotation (as
compared to annotations generated in the absence of an ontology).
Figure 1. Generic framework for the recruitment process
Our paper considers the problem of semantic-based annotation of semi-structured

documents, and proposes a semantic model for e-recruitment in the IT domain.
The paper is structured as follows: Section 2 presents the research methodology.
Section 3 presents the literature review in the area of semantic annotation of semistructured documents related to the recruitment process (CVs and job offers) and their
pairing using an ontology. Section 4 proposes a global framework for modeling the
ontology of e-recruitment in the IT field. We conclude with the last section, where we
consider the implementation of the proposed models by developing an e-recruitment
platform.
In our research, we have taken an action-based, constructivist approach: the literature
review (where the fundamentals of semantic-based modeling for e-recruitment
documents) is followed by the proposal of a controlled vocabulary and an ontology
for the semantic annotation of recruitment documents in the IT field.
The semantic-based approach to the optimization of data-flows within the human
resources (HR) domain, in connection with the profiles of the job offers, is followed
by our conceptual clarifications regarding the process of annotation and pairing of
semi-structured documents. The results of our research recommend a new approach to
human resources management, and offer support for developing an e-recruitment
platform, founded on the utilization of the field ontology in the processes of
annotation and semantic pairing of semi-structured documents.
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2.1. E-recruitment and the job market
The recruitment process is based on the sum of the actions required to find candidates
matching the job offers. E-recruitment involves the use of IT and communications
technologies, and particularly the web (Bizer et al., 2005:2, Trichet and Radevski,
2006:1; Yahiaoui et al., 2006:2). However, e-recruitment does not yet have a strictlydefined sense and understanding (Fondeur, 2006:2; Mellet, 2006:3). As a cousin of
e-business, it refers to the instruments used to facilitate and eventually automate the
web-based recruitment process. According to Kessler et al, (2008:1), there was a
quick transition from pure intermediary, informative processes to externalizing the
recruitment towards entities specialized in e-recruitment. The success enjoyed by erecruitment has led to the creation of many job portals, also called job boards
(Yahiaoui et al., 2006:2; Kessler et al, 2009:3; Popescu and Popescu, 2010:2). This
has created awareness and risen the interest in the modeling and semantic search of
semi-structured web documents.
The formal modeling of a documents contents in terms of obtained (as is the case
with CVs) and required (job offers) with the help of an ontology, between profiles for
applicants and work requirements, opens the possibility to automate the processes of
comparing, matching and associating these documents on a semantic basis, yielding a
matching coefficient (Trichet and Radevski, 2006:2; Kessler et al, 2008:3; Kessler et
al., 2009:3; Thiam, 2010:5).
2.2. The Annotation and Association of Web documents, based on content
2.2.1. General Framework
The semantic annotation of web documents (Fig. 2) is essential for their storage, as
well as the search and retrieval of the documents relevant to a particular need
(Hernadez and Aussenac-Gilles, 2004:3; Abrouk, 2006:5, Thiam, 2010:5).
By semantic annotation, we attach a note to semi-structured documents; in other
words, meta-data which describes the contents both in a formally and explicitly. This
note can be stored inside the document or in another document related to the content
through an URI (Uniform Resource Identifier), being available to users or agent
programs with the purpose of finding documents relevant for a certain requirement
(Abrouk, 2006:7). The construction of the note is based on a thesaurus, or a field
ontology (Guiss et al., 2009:4), both founded on a controlled vocabulary. A variety
of programs which annotate semantically are already available (Aussenac-Gilles et
al., 2008:3; Thiam, 2010:6). Mathet and Widlcher (2009:2-3) introduce generic
annotation instruments such as Glozz, a platform which processes linguistic objects
(especially discursive).
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Figure 2. Framework for semantic annotation and pairing
A controlled vocabulary is defined as a collection of terms, defined by experts in a

field (Hernandez:4, 2005). The term is a word (e.g., State budget), or a group of words
(e.g., Public debt). The meaning of the words is not necessarily defined, and there is
no logical connection between the terms. There are two broad categories of terms:
Descriptors, which explicitly represent a concept contained in a reference text;
Non-descriptors (synonyms), always linked to a descriptor
The controlled vocabulary can be used to label content. A catalogue is a typical
example of a controlled vocabulary. A thesaurus is a hierarchical dictionary of
normalized terms, also called descriptors. A descriptor shows the context for term
usage, and has a unique, non-ambiguous sense (multiple senses and synonyms are
eliminated).
A lexicon contains descriptors (representing a concept of the field) and nondescriptors (linked to a descriptor, generally synonyms);
A collection of definitions, also known as notes;
A classifying structure (also known as a direct semantic medium), expressed
as a structure of relations between a lexicons terms.
In Figure 3 we present the classifying structure for Human Resources management,
according to the on-line thesaurus MOTBIS (2011). For the description of the
semantic medium we use several types of descriptors: generic (GD), specific (SD) ,
equivalent (ED), and associative (AD).
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Figure 3. Extract from Company Management Thesaurus
GD
Organisation
Management
ED
Personnel management
Competency management
Hman
Resources
Management
TA
Work law
Jobs
Proffesion: administration
and management
SD
Carrer management
Personnel recruitment
Benefit system
(Adapted from MOTBIS, 2010:on-line rendering)
A field ontology corresponds to a generic, conceptual description of the entities
belonging to a field, and is required for building applications based on knowledge. An
ontology is composed of classes and entities. The classes are composed of entities
which are similar. A machine-understandable class id equivalent to the term
concept, as understood by a human. Thus, a field ontology consists of concepts
specific to a particular domain. The field ontology is superior to a thesaurus from a
conceptual and semantic point of view, but some of the hierarchies stem from the
thesaurus. In practice, an ontology is a graph structure, where the nodes represent the
concepts, and the links represent the relations (or roles) between concepts. The
generic framework for semantic annotation is presented in Figure 4.
A field ontology can be encoded using OWL (Web Ontology Language), which is
based on XML. Several editing programs are available (TERMINAE, Differential
Outology Editor, Ontology Editor, Protege2000, Ontolingua, etc.).
The semantic structures (meta-data) obtained through this guided extraction (using a
thesaurus or ontolgy) are associated to semi-structured documents (Desmontils and
Jacquin, 2002:3). The documents are retrieved according to the link between the
semantic structure and the source document.
The semantic indexing of semi-structured documents is based on the meta-data
extracted from the sources. The indexing facilitates semantic queries issued for a
specific order. According to Guiss et al. (2009:2) the indexing is used to describe the
sum of the semantic annotation, seen as a space between texts and a semantic
structure. The authors differentiate three sub-structures for an index, which describe:
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Figure 4. Semantic annotation using an ontology
(Adapted from: Yahiaoui and Boufaida, 2006:8)
Which text fragments are documentary units (du), which can be used to
establish an indexing link;
Which semantic units (su) can be associated to documentary units, and which
relations these units have (a thesaurus or an ontology)
The association of documentary units to the semantic units(dui, sui), in other
words, an indexing link.
Generally, an indexing link can be represented as (li; dui; sui), where li is the list of
properties linking dui to sui. The structure of the index is in accordance with the
structure of the ontology for the field where the documents belong. The semantic
indexing of semi-structured web documents can be realized:
Automatically, by determining in an automated way the most important terms
of the document, for further analysis. This is how search engines process Web
pages, by crawling the web and associating an index to pages;
Semi-automatically, using specific techniques for knowledge engineering and
automated treatment of language documents (Desmontils and Jacquin,
2002:2), having a human who aides and guides the process.
The similarity between the concepts of an ontology, calculated from the taxonomical
link is-a , can form the basis of XML document indexing (Zargayouna and Salotti,
2004:5).
The semantic querying of databases containing semi-structured XML documents is
based on using the ontologies and identifying the similarities (Bizer et al., 2005:7;
Boucetta et al., 2005:4) in: ontologies, queries and semi-structured XML documents,
and in semi-structured XML documents.
2.2.2. Semantic annotation of CVs and Job Offers
The first step in the annotation process is the creation of a HR ontology. Currently, the
most widely used standard for publishing job offers and applications is HR-XML,
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which is developed and maintained by the HR Consortium (which is an independent

association dedicated to improving the automation of human-resources related dataexchanges through the use of XML.) Because the hiring process is not longer
restricted to a national level, the process of semantic indexing must rely on the
occupational classifications specific to a certain language/geographical zone. In the
US, according to the Standard Occupational Classification, the workers are classified
into 840 occupations (23 major groups and 97 minor groups). In the Euro area, given
the differences in languages and education systems, there are ongoing efforts to level
the playing field. The process is set up so that each country must have its input into
the European Qualifications Framework. This framework will provide a common
reference used to asses knowledge, skills and competences.
According to Bizer et al. (2005:9), the HR ontology is split into several subontologies, as follows:
Figure 5. Sub-ontologies within the HR Ontology
(Source: Bizer et al., 2005:9)
Each sub-ontology must be modeled taking into account the particularities of the
national standards, and we must mention that the development of such standards
requires considerable effort and expert skills. Also, the ontologies must be
permanently updated, which is a difficult process when multiple national actors are
involved, such as in the EU.
2.2.3. Semantic Matching between CVs and Job Offers

Semantic matching is the process in which the metadata extracted from a CV is
compared to the metadata of a job offer, using a controlled vocabulary associated to
the domain. The result of the matching process must be a Matching Index (MI).
The MI indicates the quality of the match, by comparing several concept hierarchies
(such as qualifications and competencies) expressed as a tree structure (Bizer et al.,
2005:10).
Besides the basic requirements, there are several criteria which should be satisfied by
the matching process:
It must account for employer preferences regarding the weighting of
competencies expressed in the job offer;
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It should verify the credentials presented in a CV, based on evidence such a

electronically signed documents. The quality of the credentials should
influence the weighting.
Figure 6. The process of annotation and matching
HR Ontology
CV
Semantic Annotation
Job
Offer
CV Metadata
CV-JO
Matching
Semantic Annotation
Matching
Index
JO Metadata
HR Ontology
The following example relies on ideas from Bizer et. al., (2005:11), and Boucetta et.
al. (2005:9). To measure the similarity between two concepts we must calculate the
distance (d) between the concepts, as represented by their position in the hierarchy.
For concepts c1 and c2, their similarity is expressed as simc(c1, c2)=1-dc(c1, c2).
However, the distance between concepts situated higher in the hierarchy (for example,
medicine and IT) is greater than the distance between concepts lower in the hierarchy
(databases and programming). To account for this, a milestone is attributed to each
level, as follows:
k is a factor larger than 1 which indicates the rate at which the value decreases
throughout the hierarchy, and l(n) is the depth of the node in the hierarchy, as
illustrated in Figure 7.
In our example, we have set k = 2, and for the root, we consider l(n) =0. We note that
the path between any two concepts on the graph passes through a common parent, and
so, the distance between concepts will be measured by their milestones and the
milestone of their closest parent:
where ccp is the closest common parent of c1 and c2. This model supports the
assumption that the distance between close brothers (like C++ and Java) is
smaller than the distance between cousins (such as Invoicing and Oracle
Databases).
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Figure 7. Ontology component with associated milestone values
1/2
General Competencies
1/4
Finance
1/8
Accounting
Treasury
1/16
IT
Databases
Invoicing
MySQL
Programming
Oracle
C++
Java
(Adapted from Bizer et. al., 2005:11)
To illustrate, we wish to calculate the distance between the concepts of MySQL and
C++. The closest common parent is IT, and thus the calculation is:
dc(MySQL, C++) = dc(MySQL, IT) + dc(C++, IT)
= (1/4-1/16) + (1/4-1/16) = 0,25
Thus, the similarity between the two concepts is:
simc(MySQL, C++) = 1 0,25 = 0,75
The distance between two remote concepts would be:
dc(Invoicing, OracleDatabase) = (1/2-1/16) + (1/2-1/16) = 0,875
and their similarity:
simc(Invoicing, OracleDatabase) = 1-0,875 = 0,125
Bizer et. (2005:11) al propose a scheme for integrating competence levels (cl)
required by a job offer using the following formula:
Where 0<0,25 is a factor which indicates the rate at which the similarity simp
decreases with the increasing gap in competence levels. For example, assume an
expert in databases has cl=5 and a novice in programming has cl=1. Setting =0,2, we
have simp = 1-0.25(5-1) = 0,2. This value, multiplied with the concept similarity
(calculated
at
0,25)
yields
simc(databases,
programming)*
simp(expert,novice)=0,2*0,25=0,05. This insures that similarity between more
important concepts has more weight in the final calculation.
Therefore, the formula for calculating the matching index (MI) between a job offer
(jo) and a job seeker (cv) is
[( (
((
)(
))
MI(jo,cv)= (i l) w c joti max{[(sim)] c c joti, ccvti [(sim)] p p c joti , p pcvti j /})]
[(
where w ( )]cijo = 1
il
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Each skill from the job offer ( ) is compared with each skill in the cv ( ), taking
in account both concept and required competence similarity. The best match is
multiplied by the weight factor; the sum represents the final matching index.
2.2.4. Support system for semantic annotation and matching of CVs
and job offers
In the current context of an increasingly virtual job market, a multitude of instruments
support systems based on ontologies are developed, with the aim of enhancing the
data-flows. In Figure 8 we present the general architecture of a an annotation and
matching (pairing) system for e-recruitment, relying on the human resources ontology
(HR_Ontology).
Figure 8. The architecture of an e-recruitment system
(Source: adaptation from Yahiaoui et al., 2 006:3 and Boucetta et al., 2008:3)
The actors of such a system (job seekers, employers, recruiters) are assisted in erecruitment processes for the following types of activities:
Semi-structured documents are uploaded on the web (CVs, job offers) in a
XML data repository
The documents undergo the process of semantic annotation using the HR
ontology, the result of this process is meta-data which are stored together with
the documents
A user launches a query to determine the matches found on the server, the
query is formalized and forwarded to the association component, which relies
on meta-data and on the ontology, using an inference engine. The result
expresses the association (match) index, and the elements specific to the
document (URI, matching index according to: personal qualifications,
requirements, competencies). The result is presented as a quadrulpe,
assisting the user in making a decision.
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The human resource ontology is constructed for the semantic annotation of CVs and
job offers. Its concepts and relations between concepts are inspired from the common
parts of the most significant sections of CVs and job offers (personal qualifications,
requirements, diplomas, personal experience and competency).
3. PROPOSAL FOR AN E-RECRUITMENT ONTOLOGY,
WITH AN EXAMPLE OF AN ONTOLOGY IN THE DATABASE AREA
3.1. Modeling the common reference for e-recruitment in the IT area
The IT field is of special interest to large corporations, from a human resource point
of view. The optimization of the e-recruitment processes involves, firstly, a common
reference (ontology) able to link the employer requirements and job seekers offers,
namely, what the job seekers obtained by studies and professional experience. In our
research we opted for three types of ontologies on which the recruitment process
should be based (Figure 9):
Job seekers based data extracted from CVs
Employers based on requirements related to the job offers
The national accreditation of qualifications and occupational standards based
on a national occupational classification.
Figure 9. Generic framework for the definition of IT ontologies
The competencies represent the shared part for the three types of ontologies, and at
the same time the fundamental component for the development of a support system in
the e-recruitment processes.
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3.2. IT competency ontologies within job offers

For the IT field, regarding the job seekers, we define a generic ontology named
Competencies. Within this competency, we find the IT Competency sub-ontology,
present in the majority of the CVs and job requirements issued by employers. This
sub-ontology is composed from knowledge and technical skills found in the IT field,
and implemented in the corporate IT systems.
According to the specific requirements found in job offers, some IT Competency subontologies can be considered as complementary to main (specific) ontologies, related
to well-defined activity areas (accounting, analysis, marketing etc), in connection to
the specificity of the job offers. However, for the IT field, the sub-ontologies
stemming from IT Competencies can be considered of special importance.
For the field of IT, three sub-ontologies are of interest, and each of them can be
further organized into sub-ontologies:
Theory and Technical Foundations -- these define IT specific competencies,
both from a theoretical and practical point of view. Some examples are:
technical and functional architecture of IT systems, the design and
development of IT systems, database management, IT governance, data and
application security, communication, networking etc.
Organizational competencies these define the elements of organizational
culture, adjacent to the IT field; these are required for the implementation,
integration and maintenance of IT systems in the corporate environment. Some
of these competencies gaining traction in the IT field are: audit knowledge,
accounting, activity budgeting, human resource and occupational standards
management, quality management, legal knowledge, etc.
Techincal skills referring to ones capacity to use technologies and products,
and behavioral skills, referring to action and anticipation, pedagogy, problemsolving, professional efficiency (adaptability, integrity, pragmatism, rigor),
management skills (leadership, management, organization), and relational
(good listener, communication), etc.
3.3. Ontologies based on employer requirements within job offers
The employers specify, for job openings in the IT area, requirements focused mainly
on competencies, in correlation with national and European occupational standards. In
the IT domain, the job offers fall within the following sections:
IT systems management
IT project management
The design, development, implementation and maintenance of an IT system;
The study, design, implementation, integration and operation of IT
infrastructure
Technical support offered to users
Control, audit, and IT security
Operational managementfor IT employers (budget, decision)
Each sub-ontology can be developed on other sub-ontologies (or subjects), which, at
this level, are essentially job offers (which must be issued in accordance with the
national occupational standard). In turn, these offers are associated to sub-ontologies
described in the competency sections relating to applicants CVs.
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For example, for the sub-ontology The design, development, implementation and
maintenance of an IT system, which actually represents the lifecycle of software
products, we can define the next positions:
Specialist for currently-implemented IT systems;
IT systems designer;
IT systems tester;
Application integrator;
Product customization
3.4. Ontologies based on occupational standards
The ontologies based on occupational standards are issued by national entities which
define and implement occupational standards. Periodically, these entities publish a
classification which contains professional competencies required by employers to
recruit qualified work force.
This classification is the result of the experience of human resources directors from
the IT field, and aims to be a formal instrument for a common description of
employment requirements in professions related to organizations within the field of
informational systems. Essentially, this occupational standard classification offers a
clear image of the evolution of corporate IT systems. The formalization of the
professions and occupational standards related to corporate IT systems is a procedure
which is frequently updated due to the constantly changing nature of the IT field,
which brings along structural modifications in the requirements for IT jobs.
The common reference for occupational standards in the IT recruitment field has
undergone several mutations recently, due to the orientation towards IT
competencies, complementary to occupational standards based on jobs. This new
orientation brings the possibility if an international reference for IT competencies (eCompetence Framework) which, is implemented in Europe by CNN/ISSS (European
Committee for Standardisation / Information Society Standardisation System).
The structuring of competencies and occupational standards in the IT field is, in
essence, a technical view of an information system. The occupational standards
specific to IT will undergo structural changes, moving away from an emphasis on
technical aspects related to the IT jobs, towards a global view, in which corporate IT
systems are directly linked to the business and its strategy, and that IT systems are not
only technical, but their role is strongly connected with enterprise functions.
In Romania, eighteen occupational standards are defined in the field of IT and
telecoms (CNFPA, 2010):
1. Application administrator
2. Computer and network operator
3. Data input technician
4. Text and image manipulation technician
5. Operator in the field of computer-assisted design
6. Specialist in the field of computer-assisted design
7. Graphic designer (DTP designer);
8. Web designer (high-school level studies);
9. Systems software engineer
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10. Computer network administrator

11. Information systems programmer
12. Auxiliary programmer
13. Information system consultant
14. IT department directors
15. Analyst
16. Information systems architect
17. Database administrator
18. Specialist in IT security and processes
These occupational standards, which in light of the semantic web are actually
ontologies, are not currently associated to domains specific to IT.
3.5. Formalizing an unitary ontology for e-recruitment in the IT field
For the design of an e-recruitment portal, all the components based on
competenciesoffered by the job seekers and required by employers, and included in
the Romanian occupational standards, must be included in an ontologyeven if the
components are not hierarchical. Thus, in the current paper, we propose to develop the
sub-ontology related to IT scientific/technical competencies.
This IT scientific/technical competencies ontology can be hierarchically organized in
more sub-ontologies which actually define information technologies, useful both for
research and in the corporate environment. In building such a hierarchy we must
cover all IT domains according to the related disciplines, from an applied science
point of view. The correctness of such an undertaking depends on the association
between the know-how of the informational field and the ontologies found in CVs and
required by employers in the recruitment process.
We briefly introduce some semantic aggregations related to the IT field:
E-learning;
Intelligent systems;
Databases;
Management information systems;
IT&C;
Web Based Communities;
Interfaces and Human Computer Interaction;
Data Mining;
Networks; e-technologies;
Computer Graphics;
Collaborative Technologies;
Informatics, etc.
Each sub-ontology can be placed in a hierarchy according to the Theory
Foundations and Technical aspects criteria. We present some examples of sub-subonotologies, according to the aforementioned criteria, for the field Informatics:
1) Theory Foundations: algorithms; architectures; Artificial intelligence;
Compilers; Complex Systems; Data modeling; Expert Systems; Interfaces;
Numerical computation; Object Orientation; Ontologies; Programming
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Languages; Programming Techniques; Scientific Computing; Service Oriented

Architecture (SOA)
2) Technical aspects: Adaptive Systems; Computer Aided Design; Computing
Practices; Database Management; Embedded Systems; Interoperability;
Networking; Simulation; Software Development; Software Engineering;
System Integration; UML.
The sub-ontologies are quantified by attributed which are finally used to form scores,
by successive aggregations. These are generally attributed by the employer, according
to the importance defined by the requirements if the job offer. At an atomic level, the
ontologies contain themes, or subjects. This themes describe the last level of subontology in the hierarchy.
3.6 Sub-ontologies applied to the database field
For the IT field we propose a number of significant semantic aggregations of a subontology which describes the necessary competencies for a recruitment candidate,
required by the employer for a job in the field of databases (Figure 10). According to
this target, the database sub-ontology was divided in more sub-ontologies, according
to Theory Foundations and Technical aspects. Thus, two new sub-ontologies
emerged, namely: Data Modeling, quantified with a score of 30%, and Database
Management, quantified with 45%.
Figure 10. Ontology for the database field
While the majority of the sub-ontologies belong almost exclusively to the Database
sub-ontology, more precisely, to Theory Foundations and Technical aspects,
some of them belong to the fundamental domain of database utilization (XML and
databases and Designing a Business Intelligence Solutions).
In parallel with the definition of sub-ontologies directly referring to fundamental and
technical aspects related to databases, according to employer requirements, more
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items were required, such as Working with operating systems, Programming

concepts, Understanding of server management. These sub-ontologies belong to
other ontologies, related to distinct areas within the IT field, such as: operating
systems architecture, programming languages and physical server architecture.
We present an example of ontologies for the database domain (100%):
Working with operating systems (5%)
Programming concepts (10%)
Understanding of server management concepts such as roles and tracing (10%)
XML and databases (5%)
Describing XML functionality
Shredding XML data
Working with XML data types
Applying data integrity to XML data
Describing best practices for working with XML data
DATA Modeling (30%)
Core relational database concepts (10%)
Designing databases at both the conceptual and logical levels (10%)
Data Integrity Using Constraints (5%)
Describing data integrity
Enforcing domain integrity
Enforcing entity integrity
Enforcing referential integrity
DATABASE MANAGEMENT (45%)
Implementing DataBases (15%)
Work with the data types
Design and implement tables and views
Manage the concept of an index.
Design and implement stored procedures.
Managing and Monitoring Transactions
Implement table types, table valued parameters.
Describe transactions.
Querying Relational Data (15%)
Retrieve data.
Explain and perform single table queries.
Perform joins between tables.
Summarize data and aggregate functions.
Modify data.
Write a sub-query.
Use Stored Procedures.
Database administration (10%)
Administer server and surface security, access, and network configuration;
Import, export, transform, and replicate data
Manipulate schemas, tables, indexes, and views
Automate maintenance and implement policy-based management
Monitor server activity and tune performance
Manage log shipping and database mirroring
Perform backups and recovery.
Designing a Business Intelligence Solutions (5%)
Design a Business Intelligence (BI) architecture in client-server databases.
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Design a strategy for implementing the extract, transform, load (ETL).

Design a strategy for managing packages.
Design an online analytical processing (OLAP) solution architecture.
Design queries for an OLAP solution.
Design and develop a Reporting solution architecture.
Design data mining solutions.
CONCLUSIONS
The topic of semi-structured web document annotation, with the aim of finding and
associating the relevant documents, is of interest to academia, but also to the job
market. Our paper starts with a literature review, then focuses on the semantic
modeling of e-recruitment documents, then proposes an ontology for the database
field, and concludes with further research topics. The proposed ontology is inspired
from the common parts, which we considered significant, of CVs and job offers in the
field of databases.
The papers also brings clarifications regarding the essential concepts for the semantic
modeling of e-recruitment systems: field ontology, semantic annotation, semantic
indexing, and semantic association of documents. For the continuity of the research,
the authors envision three objectives. The first objective is to design an e-recruitment
system, integrating the proposed models. The second objective is the development of
a support system for semantic annotation of semi-structured documents related to erecruitment processes. The third objective is to add new functionality to e-recruitment
systems, increasing the relevance of meta-data extracted from the CVs and job offers,
by offering advice to job seekers based on their profiles, and helping employers
formulate better job offers.
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Gap between Text and Knowledge: Selected Contributions to Ontology learning from
Text, IOS Press
Bizer, C., Heese, R., Mochol, M., Oldakowski, R., Tolksdorf, R., and Eckstein, R. (2005)
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Dragos STOICA1 & Pavel NASTASE
ABSTRACT
Organizations are forced to be overly dependent on past experience due to the lack of usable
information, or the inability to quickly and effectively analyse unstructured data. Significant
amounts of data are ignored, mismanaged or underutilized - one in three business leaders
report making critical decisions with incomplete or untrustworthy information (Merv Adrian,
2010). This is no longer acceptable. With the growing velocity, volume and variety of complex
data, organizations will have to rethink and reshape the way they work. The data has to be
changed into information that yields fast and conclude answers, thus allowing the decision
factors to make choices that lead to the improving of the performance inside the company.
Due to a lack of timely and accurate information, project and process management within the
software and systems development and delivery lifecycle often rely more on guesswork than
good insights. At the same time, marketplace and budgetary pressures force teams to
continually make faster progress with fewer resources. To optimize business results and
competitiveness, organizations need to give decision makers and teams the ability to make
informed decisions based on real-time information. This paper explores how an inability to
quickly access and analyze data within the development lifecycle limits the effectiveness of
project teams and explains how organizations can create transparency across the processes
that support effective software delivery. Also the paper shows the benefits of capturing the
right data and delivering it to the right people at the right time. Business Analytics with
Business Intelligence are the key factors which contributes to making successful business
decisions and supporting.
KEYWORDS: Decision making, Business Analytics, Business Intelligence,

DECISION MAKING - INTRODUCTION
Organizations operating in todays global economy are faced with unprecedented
competitive and regulatory pressures and a heightened level of uncertainty. Driven by
geopolitical trends and financial scandals, national and international regulatory
agencies have performed rules with far-reaching impact on the daily operations of
organizations in all industries. By most accounts, the uncertainty is more profound
than in the past decades, and is likely elevated by the amount of data and information
available to decision makers nowadays. Hence, there is a trend towards continuously
shrinking decision cycles where improved, faster, more accurate, insightful and
flexible decision making commands a premium and serves as basis for competitive
advantage. However, significant shortcomings persist in the ability of organizations to
address the decision-making needs of its employees.
1
Correspondence address: Drago STOICA, IBM Romania, Ph. D Student at Bucharest Academy of
Economic Studies, Romania; email: dragoshstoica@yahoo.com
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The current limitations in the quality of decision making and information delivery
range from an inability of organizations to capture the right data and deliver it to the
right people at the right time, to poor data quality, system complexity and the
disconnect of business analytics from operational systems. Those shortcomings are
due to the lack of appropriate investment in business analytics solutions and the
differences between the information delivery and decision support functionality of
most of those solutions.
Organizations need to know what is happening now, what is likely to happen next and
what actions should be taken to get the optimal results. The lack of control over
information is likely felt by users and decision makers in their daily jobs. Managers
may lack confidence in their information, may frequently use the wrong information
and may even miss information they should be using. The differences between timely,
accurate information and the people who need it can broadly affect the quality of
decisions and business outcomes.
Most organizations claim that their data is an asset; many have built data warehouses
to collect and store data. However, in some cases, the more suitable metaphor should
be data landfills. Many organizations have become efficient at capturing data, but
much less capable of organizing, analysing, extracting and delivering it from those
data stores to enhance the overall decision-making quality. If data is indeed an asset,
market research suggests that a large amount of it remains inactive and is not
leveraged to its full potential (IBM White Paper, 2009).
Creating intelligence by collecting real insight from this data is what continues to
elude organizations. Despite years of discussions about scorecards and metrics,
experience and perception are often the guide lines for making important, even critical
decisions, although current research reveals a clear link between business
performance and the use of business analytics (Gros Mary E., Goul Michael &
Demirkan Haluk, 2011). Hence, the question is what exactly is business analytics and
how can it help an organization to improve its business process.
Business analytics is, simply, the application of analytical techniques to resolve
business issues. It provides organizations with a framework for decision making,
helping organizations solve complex business problems, improve performance, drive
sustainable growth through innovation, anticipate and plan for change while managing
and balancing risks (Trkman Peter, McCormack Kevin, Valadares de Oliveira Marcos
Paulo & Bronzo Ladeira Marcelo, 2010).
1. DECISION-CENTRIC BUSINESS INTELLIGENCE
Effective decision making requires a business analytics framework that incorporates
the people, processes, technology and the culture of an organization. This common
framework provides flexibility across the entire range of analytical decision-making
types from highly managed operational analytics to discovery-based analytics such as
credit fraud scenarios or setting dynamic credit limits.
Assigning meaning to data, deriving knowledge from data, building the appropriate
models from and about the data, and deriving optimal management decision support
are the key activities to support organizations in business processes from all fields of
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the process chain, technical design, control, production, quality control, logistics, and
strategic management. This set of key activities is summarized under the term
business intelligence.
The purpose of Business Intelligence is to take a companys historical and operational
data, process it with analytics software and present the data in an easy-to-read and
familiar format to enterprise users.
In todays highly competitive and challenging environment, companies need to
continually assess and redirect their actions in order to stay on top of the markets they
choose to serve. In order to make the needed changes, many companies are asking
questions such as:
Which of our customers are most profitable to do business with?
Which products and services can be cross-sold most effectively?
Which sales channels are most effective for which products?
How can we boost marketing campaign results?
How can we improve customer loyalty?
What is the real cost of retaining a satisfied customer?
How can we improve the overall quality of our customers experience with us?
Business Intelligence systems can help provide the answers to these types of
questions. The general concept of business intelligence approach is outlined in Figure
1. The methodology focuses completely on the business relevant aspects, i.e. on the
business input and the business output. Business input means that the problem is
analysed and solved, together with the corresponding data, while business output is
the problem knowledge or problem solution generated by the approach, which can be
turned into business operations to improve desired aspects of the business. The critical
tasks on the approach from problem and data to an optimal business solution are the
data mining/data analysis and optimization tasks.
Figure 1. Business Intelligence
(Source: Back Thomas (2002), Adaptive business intelligence based on evolution strategies:
some application examples of self-adaptive software, Information Sciences 148 113121)
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The assurance of Business Intelligence is in specific and timely knowledge about

customers, products and markets. This knowledge can help boost profits, reduce costs
and support better, more effective management. Based on comprehensive, detailed
and relevant information, this knowledge is fundamental to achieving and sustaining a
competitive advantage. However, organizations implementing a Business Intelligence
solution may face several challenges:
Integrating complex data from heterogeneous hardware platforms and
software environments;
Managing distributed systems that have no single point of control and timesensitive operations;
Improving data access while reducing expenses;
Performing frequent updates across already overtaxed networks with rapidly
increasing traffic;
Backing up, recovering and archiving data within diminishing availability
windows;
Incorporating efficiencies of new technologies without requiring massive
downtime, costs or retraining;
Providing scalable servers to run multi-terabyte applications;
Providing storage that protects data and is scalable, open and manageable.
Business Intelligence requires information on demand achieved by combining
multidimensional data analysis and data mining with advanced statistical and
analytical functions in a real-time, integrated environment. Data collection methods,
multimedia files and rapid-access tools that grow and adjust as needed create this
dynamic system. Constant vigilance, including tuning and monitoring of these
systems, helps maintain a sharp focus for overall enterprise effectiveness.
The essential criteria for building a Business Intelligence system include:
What critical information enables an enterprise to deliver competitive value;
Who needs access to information and in what form;
What criteria and processes will be used to manage and protect information
access;
Can the organization financially afford to implement these processes;
Can the organization build and manage the skills and systems needed to
collect, validate and synthesize the data.
Furthermore, to be able to understand the complexity of the business intelligence
system I will present four tiers which will be applied on a case study. These
considerations aim to help provide a preliminary framework for implementing a
Business Intelligence system. The stages are used to help define the scope of Business
Intelligence infrastructure required by an organization.
1.2 Tier I: Identifying mission-critical information and enterprise success
factors
The main question is what data is vital to the health of the enterprise and is strategic
and tactical to its business. Operational indicators could include data such as load
factors for transportation companies, aging backlog at a manufacturing plant, welldrilling count for oil exploration companies and on-shelf inventory for retailers. These
operational details can affect strategic shifts such as realignment of profit goals;
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investment in skills or technology; consideration of mergers, acquisitions or

partnerships; repositioning of the company; or targeting a key segment. Such
enterprise success factors constitute critical information.
Business Intelligence provides access to information required to keep the enterprise
vibrant and competitive. A clear understanding of strategic and tactical information is
the cornerstone of a Business Intelligence system. Anything less may not trigger alerts
when potentially fatal trouble-spots occur. A thorough analysis and validation process
can help determine the information requirements for the overall design of a Business
Intelligence system.
Moreover, for a better understanding of the first stage an example is needed. We will
take the case of a company that sells IT equipment and has communication
deficiencies between departments. If there is a lack of information between the
financial department and sales department this can result in delays in payments (both
accounts receivable and accounts payable), thus outstanding invoices, overcharging,
penalties, and unsatisfied customers that will drive to poor market share. However,
every business aims to improve its overall performance and increase profits. Success
factors derive from efficient workflow and transparent information within the
company that will lead to faster process execution, satisfied and loyal customers, and
increasing profit.
Figure 1. Typical Process Problems without Business Intelligence
1.3 Tier II: Determining who needs access in the system, the essential criteria
and processes
The goals of a Business Intelligence system are to help maintain a competitive edge,
allowing to respond in a timely manner to competitive opportunities or threats.
Business Intelligence system should help monitor the vital statistics of the enterprise
in a real-time environment and to mobilize team response as appropriate. Determining
who needs access, what criteria will govern that access and what processes will be
used to manage access will influence networking, processing and analysis costs.
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In the case study mentioned at tier one it is essential to determine who needs access
and to what information. If we refer to a company that sells IT equipment, the
information transparency between the sales and finance departments is essential. For
example when selling a laptop the invoice is done by a sales representative and should
be available in real time on the system for the finance department. Also the sales
department should be able to see the stock on the system and request additional items
if necessary. On the other hand, the finance department must inform the sales
representative if there are any issues with the customers in terms of payments,
supplementary costs or VAT/ import regulation changes. The system consolidates all
the information inserted by the sales representatives at the end of the week in order to
create a report for the finance department. The layer sits between people and systems,
and manages the process across those participants, thus prioritizes the work, but also
gives visibility and control.
Figure 2. Layer for Control and Visibility
1.4 Tier III: Calculating the costs

Several factors affect the cost of implementing a Business Intelligence system, such as
the amount of information gathered and analysed and the frequency needed to refresh
the information. In addition, analysis can become expensive, and the time spent
modelling can be length. Cost decisions will influence the system design - for
example the choice of servers, storage and software.
After determining the options and the cost of installing or updating an enterprise
Business Intelligence system, it is needed to decide what kind of system to build. Can
the current system deliver sufficient results by upgrading some of the components?
Will partial upgrades be feasible in the future? Is the best in the industry components
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desired? What is the cost of installing new systems versus performing upgrades of the
current system? Does the return on investment (ROI) incorporate post-installation or
post-migration maintenance and upgrade costs?
In the case of the company stated above, implementing the system involves high costs
at start-up, but it pays off rapidly due to less employees, the reduce maintenance costs,
no additional expenses, prompt reply to customers and better services provided. All
of these are key factors that drive a success business.
1.5 Tier IV: Building the necessary system which comprises the essential skills
Tier one, two, and three formed the basis of the Business Intelligence system. Along
with tier four the system is complete, but due to fast evolution of technology and high
competition the system will be improved on periodical bases. The system is starting
from a human interface, input data, and based on defined business rules is facilitates
the workflow and provides a well-organized, competent, resourceful and professional
business data management.
A system which comprises these essential skills is not sufficient as the management
team need metrics and analytics that drive decision optimization in order to have a
better view and understanding of the business. Looking at tier 2, the case study shows
that the system runs a sales report at the end of each week and it can also run other
reports at different time period as it was designed according to every companys
needs. For example the sale department manager needs to extract information
regarding the number of contracts sighed by a seller into a certain period of time, to
evaluate the performance of that seller or to see whether these customers have
complied with the contract terms, the manager runs the Business Intelligence System
which generates a complete report. This system is set-up according to any business/
department requirements and can be changed/ modified as needed, anytime after it
was created by the user.
Figure 3. The essential system capabilities
2. ANALYTICS DRIVE DECISION OPTIMIZATION

Improve decision-making, productivity and efficiency through an environment where
relevant, actionable, accurate and timely information is provided to monitor and
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improve performance. The ability to optimize performance within a company

typically depends on a decision-makers' ability to measure and understand business
analytics, then act upon the information at the right time. Using data to derive insight
requires more than operational reporting and financial roll-ups. Data should be
transformed into insight and rapidly delivered at the point of need, on demand in the
right time, in formats that your enterprise can use to act in ways that are beneficial to
the business and optimize performance.
Business analytics enable the fundamental shift to a different way of making
intelligent decisions: evidence-based. This demands real data, derived from every
possible source, governed and secured, with assured quality and known provenance,
with a clear organization consensus about its meaning. The information agenda helps
to ensure this is in place. It allows repeating that data is what matters the most,
therefore nothing happens without it.
The information platform is the informational core system, designed to gather data
wherever it is needed and filter it through the organizations strategy-driven
evaluative processes to ensure the facts needed are always available. In reality it is
more than that, the platform provides the processing power to serve up real-time
streaming data, combine it with historical data as needed, and analyse it in everchanging, increasingly sophisticated ways. There was a time when reporting was the
state of the art just being able to deliver an organised presentation of what happened
in the business yesterday, last month, or last quarter was a great leap forward. Some
organizations still focus on this simple delivery of history in new visualizations with
portal technology and mobile devices as if these were sufficient, but it is not.
In the latter years of the 20th century, there was a great focus on what-if, simple
scenario building that substituted possible values in standard models of how the
business works. It was coupled with improvements in online analytical processing,
ways to drill down into pre-designed summary reports to see what drove the results.
These two steps forward allowed more sophisticated business intelligence, but they
fell far short of statistical techniques long in use for rich modelling of outcomes.
Comparing what is or what was to what should have been depends on a rich
understanding of statistical techniques, a normative model of how the business ought
to be.
Nowadays, business analytics offers benefits to these older approaches could only
grope towards. They can function as the brain of the nervous system that the
information platform provides, moving from data gathering and interpretation to
model building, real-time comparison of current reality to forecasted and hoped-for
outcomes. Most important, they also serve as the basis for action: sometimes
automated, sometimes requiring human intervention, but always goal-directed, aimed
at improving results and moving the business forward.
The skills needed to realize this vision are not widespread; most organizations have
local resources of business power users who know both the business and some of
the requisite technology, but few have a real centre of excellence for advance analytic
techniques. Those that do, often isolate those scientists by design or by accident, from
the everyday practical realities of the business.
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Putting these pieces together is more than defining a strategy, implementing a

technology roadmap, and a solution installation. It is a journey that involves maturity
assessment, skills acquisition, cultural change, and a clear vision. To achieve these
goals, organizations need help with planning, prioritizing, and executing on their
chosen projects together with a framework that leverages those efforts and makes
them part of a broader initiative to sustain transformation as a continuous process.
Building predictive models is an iterative process in which a model is created from an
initial hypothesis and then refined until it produces a valuable business outcome or
discarded in favour of another model with more potential. Developing and then using
predictive models involves the following tasks:
Scope and define the predictive analytics project. What business processes will
be analysed as part of the initiative, and what are the desired business
outcomes?
Explore and profile organization data. Because predictive analytics is a dataintensive application, considerable effort is required to determine the data that
is needed for the project, where it is stored and whether it is readily accessible,
and its current state.
Gather, cleanse and integrate the data. Once the necessary data is located and
evaluated, work often needs to be done to turn it into a clean, consistent and
comprehensive set of information that is ready to be analysed. That process
may be minimized if an enterprise data warehouse is leveraged as the primary
data source. But external and unstructured data is often used to augment
warehoused information, which can add to the data integration and cleansing
work.
Build the predictive models. The model builders over here, testing models and
their underlying hypotheses through steps such as including and ruling out
different variables and factors, back-testing the models against historical data,
and determining the potential business value of the analytical results produced
by the models.
Incorporate analytics into business processes. Business analytics tools and
models are of no business value unless they are incorporated into business
processes so that they can be used to help manage (and hopefully grow)
business operations.
Monitor the models and measure their business results. Predictive models need
to adapt to changing business conditions and data. The results produced need
to be tracked to illustrate which models are providing the most value to the
organization.
Manage the models. Reduce the models with little business value, improve the
ones that may not yet be delivering on their expected outcome but still have
potential, and adjust the ones that are producing valuable results to further
improve them.
The system proposed designed as a library that supports all types of users in all three
environments: Design, Execution, and Optimization with all tools around a single
shared model. All the users share access to the same process model. This eliminates
not just the need for separate tools for business people and departments, but also the
major transformation and round tripping problems that exist.
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One key benefit to our system is that it is much easier for business people to
collaborate between departments because everyone is sharing the same common
process models. The shared model also makes it possible for business people to do a
lot more of the process design work themselves, which gives them more control and
allows them to make business process changes more rapidly. A third major benefit is
that the shared model enables massive reuse. Everything is in the same library which
makes it easy to share components across projects. Finally, the shared model
integrates process performance data with the process design data. This allows to
automatically provide powerful graphic interfaces for business users enabling them to
understand and manage work.
Figure 4. Shared Model Architecture
The proposed system capability offers a full range of reporting, analysis and
dash-boarding to enable managers to quickly gain new insights and take actions to
drive better business outcomes. The system drives improved business outcomes with:
A single consistent view of the business;
A full range of decision making capabilities;
Easily accessible information wherever and whenever needed;
Deeply optimized solutions for unparalleled performance;
Rapid time to value and return on investment (ROI), including the flexibility
to grow with the business.
The key change that an analytic culture brings about is that decisions are made where
and when they are needed most by the people who are close to the issues and have the
most at stake. For example, ideas about a customer retention and customer loyalty,
total view of best customers ultimately mean more in the hands of a banker advising
its clients than they do to an information architect, because the banker can create
value with them. Delivering it depends on the right data, a capable platform, and a
rich set of analytics in the hands of people who can use them. The result is
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information that makes a difference and it can have transformational implications for
a business. Organizations that build the systems to power that transformation will
drive past those that do not at an accelerating rate as the use of advanced, predictive
analytics changes the way business is done.
By envisioning and acting on new ways to use information, organizations are
transforming themselves into smarter, intelligent enterprises. New information
strategies are making it possible to create new revenue opportunities, reduce costs and
differentiate from the competitors. The goal is not just to manage information
intelligently but to operate differently and more effectively by using real-time analysis
of massive amounts of information to optimize critical business activities.
In the current economic conditions the need for transformation becomes more urgent.
Even with the flood of data in the organization, one in three business leaders are
frequently making major decisions with incomplete or distrusted information.
Business is all about taking risks assuming that the odds are in the organizations
favour. Business success depends on organizations being able to forecast scenarios
accurately to make business plans and deploy resources so that they are able to seize
opportunities, neutralize threats and mitigate risks. Clearly, predictive analytics can
play a key role in day-to-day business operations. It can help organizations focus on
strategy and continually make plans based on actual performance and expected
scenarios.
Business analytics is a natural evolution path for Business Intelligence. It is something
that many users desire, but have often needed to obtain separate from their current
Business Intelligence tools. Business analytics can play a fundamental role in
day-to-day business operations. If they are available to workers, business analytics
modelling tools can help business people continually make their plans based on what
if analyses and forecasts that leverage both deep historical data and fresh streams of
current event data.
The most important assurance of business analytics is that it will become pervasive,
guiding all decisions, transactions and applications. For the technology to achieve that
challenge, organizations must move toward a comprehensive advanced analytics
strategy that integrates data mining, content analytics and in-database analytics.
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Grossmann Wilfried (2010), A Conceptual Approach for Data Integration in Business

Analytics, International Journal of Software and Informatics, vol 4, no 1: 53 - 67
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PS12 Corporate governance and ethics

Chairperson
Nicoleta FARCANE, West University of Timisoara, Romania
CORPORATE VALUES, THE COMPANIES

FRAMEWORK OF ETHICAL BEHAVIOUR
Elena Roxana ANGHEL-ILCU
HOW CAN CORPORATE GOVERNANCE

MITIGATE FRAUD?
Victoria STANCIU, Ali EDEN, Veronica IVANCENCO

Valerica MARES, Marius Daniel MARES
CORPORATE GOVERNANCE PRINCIPLES:

AN EVOLUTIONARY APPROACH IN TERMS
OF DIRECTORS-MANAGERS RELATIONSHIP,
IN THE DEVELOPING ECONOMIC CONTEXT
OF 21ST CENTURY
Maria GROSU, Roxana-Manuela DICU, Daniela MARDIROS
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CORPORATE VALUES, THE COMPANIES

FRAMEWORK OF ETHICAL BEHAVIOUR
Elena Roxana ANGHEL-ILCU 1
ABSTRACT
This paper aims to find the corporate values that guide companies operations in everyday
activities and then to establish a general value system of the companies which we consider to
be a moral framework of ethical conduct. Our research is conducted in the European context;
we considered a sample that consists of British and French companies. There are few studies
related in the existing literature, and the opportunity of this research is justified through the
necessity of establishing the boundaries of corporate activity and decision-making under the
imperative of profit grows. The originality of this paper is the statistical apparatus that is
used in the aggregation of initial data. We consider that the companys steps in the
identification of the inner corporate values after a selection process, is similar with a voting
system, more specific, a preferential voting system which permits to a company to give its
vote of confidence to a specific value and the vote of no confidence to another different
value. A preferential voting system allows a hierarchical systematization between more
competing options and, thus, in our opinion, is more suitable for our goal rather than a
simple frequency determination. Our results present the corporate value system that is
applicable at the time present in a European context. We also confronted this value system
which is practiced in the British and French companies with a theoretical one formulated by
scholars. This has revealed that the existing corporate value system can be easily challenged
because of the lack of consistency and the significant number of weakness discovered.
KEYWORDS: Corporate Values, Corporate Value System, Preferential Voting System,

European Companies, Comparative Studies
INTRODUCTION
Knowing what values we stand for and what values customers over time have
come to appreciate us for is vital for the companies success. The values rooted in
the organisation need to resonate with the values perceived and appreciated by the
customers over time, and vice versa (Urde, 2009).
Bearing these thoughts in mind, our aim is to find the corporate values that guide
companies operations in everyday activities and then to establish a general value
system of the companies which we consider to be a moral framework of ethical
conduct. Our research is conducted in the European context; we considered a sample
that consists of British and French companies, a representative exhibit of two opposite
and paradigmatic accounting traditions: the Anglo-Saxon accounting system and the
Continental accounting system. There are few studies related in the existing literature,
1
Correspondence address: Elena Roxana ANGHEL-ILCU, Academy of Economic Studies, Bucharest,

Romania; email: ilcu_roxana@yahoo.com
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and the opportunity of this research is justified through the necessity of establishing
the boundaries of corporate activity and decision-making under the imperative of
profit grows. The originality of this paper is the statistical apparatus that is used in the
aggregation of initial data. We consider that the companys steps in the identification
of the inner corporate values after a selection process is similar with a voting system,
more specific, a preferential voting system which permits to the company to give its
vote of confidence to a specific value and the vote of no confidence to another
different value. A preferential voting system allows a hierarchical systematization
between more competing options and, thus, in our opinion, is more suitable for our
goal rather than a simple frequency determination. Our results present the corporate
value system that is applicable at the time present in a European context. We also
confronted this value system which is practiced in the British and French companies
with a theoretical one formulated by scholars. This has revealed that the existing
corporate value system can be easily challenged because of the lack of consistency
and the significant number of weakness discovered.
This paper is organized in two main sections: the first section includes the literature
review with discussion on four hot topics: corporate trust, corporate identity, codes
of ethics and corporate values. The second section is dedicated to the statistical
apparatus that is used to establish the general value system of the companies in the
European context.
1. IS CREDIBILITY A SYNONYM FOR TODAYS CORPORATE
ACTIVITIES?
1.1. Trust, a Milestone for Todays Companies
According to Garcia-Marza (2005), trust is one of the companys most important
intangibles. Trust is paramount for product acceptance, a good working atmosphere
and smooth relationships. It enables cooperation, promotes network relationships,
facilitates effective responses to crises, reduces harmful conflict, decreases transaction
costs and facilitates the effective functioning of groups (Sundaramurthy, 2008).
Although trust is recognized as a decisive factor for the company in relation with
every stakeholder, little effort is being made to manage it. According to Garcia-Marza
(2005), business ethics aims to provide advice and indications on how to approach
this situation.
Ethical behaviour is a precondition for an enterprise to obtain the status of a credible
and trustworthy partner, which, in the long-run, ensures the companys success.
Enterprises should not only be concerned about making a profit, but also be engaged
in actions that appear to further some social good, beyond the interests of the firm and
what is required by law (Lindgreen, Swaen and Johnston, 2008). A companys moral
responsibility is defined according to the possible agreement among the interests of all
enterprise stakeholders. Interests common to all stakeholders exist; to be satisfied,
stakeholders demand a specific orientation in management decisions and actions. The
company needs credibility or societys consent to be able to act and achieve its
objectives (Garcia-Marza, 2005).
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1.2. The Lack of Trust or the Crisis of Credibility

An enterprises ethical behaviour demands a conscious and positive attitude from the
enterprises key stakeholders towards the enterprises core values, culture and climate
in a way that stimulates the desired achievement of business ethics (Lindgreen, Swaen
and Johnston, 2008). This is a real challenge for companies to achieve. According to
market and social trend analyst Daniel Yankelovich, the publics widespread cynicism
toward businesses today is a real crisis of confidence that companies must face. The
recent global financial crisis is, in fact, a major crisis of trust. The current wave of
disapproval began in 2001 with the bursting of the dot-com bubble, the ensuing bear
market, and the financial scandals involving Enron, WorldCom, Tyco, and others
(Van Lee, Fabish and McGaw, 2005). Business people may attribute recent corporate
scandals to a few bad apples, but the public needs more than that to be convinced. A
2002 Gallup Poll found that almost 80 percent of the public believes corruption is
endemic in the corporate world and that executive greed and immorality are the top
causes of current economic woes (Rosell and Yankelovich, 2003).
The first crisis of confidence was the Great Depression of the 1930s which continued
until World War II. Although scholars have not agreed on the exact causes and their
relative importance, it is considered that some of the events that generated the Great
Depression were the massive banks failures, the stock market crash, actions taken by
the US Federal Reserve that contracted the money supply, as well as the Britains
decision to return to the Gold standard (Bernanke, 1995). These were marked by a
weakening of confidence in the free-market economy and public disillusionment in
big business, respectively.
Rosell and Yankelovich (2003) suggest that the current crisis of confidence is
different because senior executives, not just corporations, are viewed as being directly
responsible for the scandals. Their over-the-top compensation, excessive management
perks, and perceived willingness to trade jobs, environmental standards, and labour
rights for profits squeezed out of globalization have fanned mistrust in the individuals
who run companies and, secondarily, in the companies themselves. The impact so far
has generated new norms and provisions such as the Combined Code (UK Corporate
Governance Code), that sets out the requirements of disclosure for the public listed
companies on delicate issues such as director remuneration, accountability and audit,
appointment of the directors, relationships with shareholders etc. (FRC, 2010).
Companies are required to break out of narrow frameworks that reinforce mistrust and
create blind spots. Companies should learn to understand the viewpoints of others
who see the world differently and use that understanding to inform actions and
develop trust equity (Rosell and Yankelovich, 2003). Change at this deeper level can
open up new possibilities both for addressing the current wave of mistrust and for
creating competitive advantage.
In regaining trust, we consider that companies should think and act a strategy of real
value creation for all the stakeholders, in a transparent and credible manner, starting
with defining a corporate identity that should always be aligned with an ethical
conduct.
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2. ORGANIZATIONAL IDENTITY AND CORPORATE IDENTITY

Identity construction in social practices has constituted one of the main foci of
research in sociolinguistics over the last twenty years (De Fina, 2007). Within identity
theory, social constructionism is perhaps the most general perspective. It views
identity as a process, not as a given or a product, always embedded in social practices
and thus takes an anti-essentialist view of the self. The approach is a dynamic one,
allowing for constant flux and interplay between different aspects of an individuals
diverse social and personal identities in response to contextual influences (Holmes,
2006).
Hatch and Schultz (1997) distinguish between organizational identity and corporate
identity. The discussion of identity within the organizational literature has developed
around the concept of organizational identity, while the marketing literature focuses
on corporate identity.
Organizational identity refers to members perceptions, feelings and thoughts about
their organization. Scholars and academics share a common orientation towards
organizational identity as a dynamic, processual phenomenon (Oliver, Statler and
Roos, 2010).
Bhatia and Lung (2006: p.266) define corporate identity as a multidimensional
and dynamic construct that is realized in and through the discursive practices of
members of business and disciplinary cultures. Corporate identity is conceptualized
as a function of leadership and it is formulated by top management. There are cases,
like the one described by Grard Mestrallet, the Chairman and CEO of GDF Suez
(France), where the corporate identity of an entity is the result of a bottom-up,
grassroots movement in which all employees participate. However, this is the
exception rather than the rule. The corporate identity lays the ground rules of the
ideology and performance of the corporation, and it is usually put together by top
management. The construction of corporate identity is constrained by the goals of the
corporate world and its ideology and is moulded on the basis of the differences
between specific communities. Identity is co-constructed in relation to a specific
audience (Garcs-Conejos Blitvich, 2010).
We consider that the identity assessment is crucial in formulating an eligible discourse
that represents the vision of the company. Most of the cases, the companies set out
this discourse in a formal manner as a set of principles, objectives, policies which are
aggregated in one document, or a set of interrelated documents that comprise the
companys code of ethics or conduct.
3. CORPORATE CODES OF ETHICS AND CODES OF CONDUCT
Langlois and Schlegelmilch (1990) defined a code of ethics as a corporate statement
that registers corporate principles, ethics, rules of conduct, codes of practice, or
company philosophy concerning responsibility to stakeholders, the environment, or
any other aspects of society external to the company.
Corporate codes of ethics contain valuable information about corporate commitments
regarding desired behaviour of management and employees. Such commitments have
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an impact on the individual behaviour of members as well as on the organization as a

whole in order to propagate its moral norms and values. Corporate codes of ethics are
the normative claimed and desired practices that an organization develops with
respect to moral behaviour. Codes articulate norms for the regulation of the actions
and moral responsibilities of management and employees toward its stakeholders.
Codes of ethics express the corporate mission and the normative responsibilities to
which the organization aspires (Donker, Poff and Zahir, 2008). Kaptein (2004) states
that a code of ethics clarifies the objectives the company pursues, the norms and
values it upholds and what it can be held accountable for. A code of ethics contains
the companys responsibilities, principles, values and/ or norms. A code of ethics thus
demonstrates a companys awareness of ethical issues and indicates how it will deal
with such topics. An important but underemphasized function of codes involves the
fact that, by making a firms values explicit, an effective code equips members of an
organization with ethical justifications that can be used in resolving individual and
organizational dilemmas (Donker, Poff and Zahir, 2008).
Caracsco and Singh (2003) examined the content of the codes of conduct of the
worlds 50 largest transnational non-financial firms (ranked by foreign assets) in
2000. They analyzed three main areas:
(a) behaviour and actions covered by the code,
(b) enforcement procedures and,
(c) penalties for noncompliance.
Also, the firms were concerned about conduct that promoted positive values and
relationships (e.g., relations with customers/ suppliers, employees, and the
environment) and conduct that was negative either in a legal or ethical sense (e.g.,
conflict of interest and insider trading) but it should be noted that concerns relating to
the latter were more emphasized in the codes the authors examined.
Kaptein and Wempe (2002) suggest that corporate codes can be instruments for
achieving cohesion in daily operations. A code of ethics that articulates corporate
values and norms offers employees guidance and support in order to fulfil corporate
goals. Corporate reputation regarding ethical behaviour of management and
employees can have an important impact on economic corporate performance.
Organizations choose to assess their way of making business either in a code of ethics,
a code of conduct, or sometimes, the both of them. The differences between the two
have been clearly established by Painter-Morland (2008): A code of ethics is
normally slightly longer, but still aspirational rather than directive in tone. Codes of
conduct, however, are directive in form and intent. Their purpose is to provide
employees with behavioural guidelines.
There are no generally accepted standards with respect to the names that are used to
refer to various kinds of codes. There are many examples of shorter documents that
are nevertheless referred to as codes of conduct, and brief value statements that are
called codes of ethics. Sometimes companies have a brief values statement that is
fleshed out in more detail in a code of ethics and that is supported by a number of
more specific codes of conduct. In many cases, these codes are supported by a whole
hierarchy of policy documents and organizational procedures. This array of
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documents has long been regarded as one of the most important elements of a
successful ethics management program.
4. CORPORATE VALUES, A FRAMEWORK OF MORAL BEHAVIOUR
4.1. What Are the Corporate Values?
First, the field of corporate values research is particularly relevant in todays difficult
economic conditions because the positive attitude of an enterprise towards the core
values with ethical content and ethical climate will have an important impact on the
solving recent financial crisis as well as future economic and social development
(Duh, Belak and Milfelner, 2010).
Corporate values can be defined as operating philosophies or principles that guide an
organizations internal conduct, as well as its relationship with the external world
(Garcs-Conejos Blitvich, 2010). Van Lee, Fabish and McGaw (2005) also define
values as a corporations institutional standards of behaviour. A similar approach to
the concept of value appears in Fritzsches (1995) article, in which he defines values
as the explicit or implicit conception of what is desirable that has an influence on
behaviour, based on appropriate behaviour standards. According to several authors
(Garcia-Marza, 2005), the ethical behaviour of an enterprise is not possible without
ethical core values.
The ethical behaviour of enterprises is possible only when the key stakeholders (the
shareholders and the top management) of an enterprise have a positive attitude
towards the ethical core values. If so, they will impact the emergence of such
enterprise culture and climate that will support and enable the ethical behaviour.
Therefore, the enterprises ethical behaviour demands a conscious and positive
attitude towards the enterprises core values, culture and climate in a way
that stimulates the desired achievement of business ethics (Duh, Belak and
Milfelner, 2010) and which is essential for the enterprises long-term success
(Garcia-Marza, 2005).
4.2. Purpose and Role
Corporate values determine the organisations behaviour (Schwartz, 2001). Craig and
Douglas (2006) suggest values could be examined at different levels: the level of the
individual; and the level of the society, where specific groups, organisations and
people interact.
The corporate values are about what the company stands for and how its employees
conduct themselves. Corporate values frame a role for the corporation that gives it a
purpose beyond profit (Cha and Edmondson, 2006). Most importantly, the corporate
values primary target public is the companys employees, who are expected to derive
a sense of collective identity from the values stated, and to infuse those values into
their professional practices (Garcs-Conejos Blitvich, 2010), in other words, a
sense of purpose and identity in a world that is in flux (Lagace, 2006). Therefore,
the primary purpose of the corporate values is socialization and enculturation of the
companys employees.
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By making their corporate values public, companies want to present a positive image
of the corporation, one that is in accordance with current standards of ethics. Although
there is no certainty as to whether its corporate values will be read and by whom, by
making them public, a companys corporate values can be compared with those of
other companies and make them more attractive for investors or future employees.
Thus, corporate values external, secondary purpose is promotional, i.e., to promote
and market the company as well as to recruit potential talent (Garcs-Conejos
Blitvich, 2010) and also, to promote a positive image of the company and generate
confidence amongst its stakeholders.
4.3. The Need of Corporate Values
According to Paine (2003), the corporate values developed as a response to the need
for corporations to be measured in terms of both financial and ethical standards.
Ethical standards are determined by the context in which a corporation is operating,
and are therefore in constant flux. Companies should also try to set a higher ethical
standard and contribute to broader societal goals. In other words, companies should
achieve profitability in ways that help build a better society.
Although the long-term changes are still underway, it seems that companies whose
primary value is profit no longer achieve superior market performance (Collins and
Porras, 1994). Hultman (2005: p.41) indicates that although some managers may find
organizations being both humanist and practical counterintuitive research
clearly indicates that this is not only possible but also necessary.
An example of the reorientation of companies as a response of changes occurring in
the elderly culture could be the green, environmentally-friendly approach to
business observed in many corporate values statements of companies, which reflects
the current, more environmentally-conscious mentality of the culture as a whole
(Garcs-Conejos Blitvich, 2010).
The need of corporate values is also set on a monetary basis reflected in the
companys financial performance. But most companies are not measuring their Return
on Value indicator (ROV). In a business environment increasingly dominated by
attention to different definable returns on specific investments, most senior executives
are surprisingly lax in attempting to quantify the ROV (Van Lee, Fabish and McGaw
2005), even when different studies already show statistically significant evidence that
corporate values positively correlate with companies performance (Donker, Poff and
Zahir, 2008). In a similar manner, a 1992 study by Digital Equipment Corp. found
that managers in Great Britain share the familiar concern about aligning actual
business practices with espoused beliefs, thus managing the gap between rhetoric and
reality. Of the 429 British managers surveyed, 80 percent said their organizations
have written values statements, 89 percent agreed that values provide organizational
stability in a chaotic world, and 82 percent asserted that values contribute to the
bottom line (Filipczak, 1993).
Generally, companies follow the same values cycle: They articulate a set of
corporate values and attempt to embed them in management practices, which they
hope will reinforce behaviours that benefit the company and communities inside and
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outside the firm, and which in turn strengthen the institutions values (Van Lee,
Fabish and McGaw, 2005).
4.4. Personal Values and Corporate Values
A value system is a set of consistent ethic values and measures used for the purpose of
ethical and/or ideological integrity. A value system can be understood when
considering one person as an individual and we refer, then, to a personal value
system or, if we take into account a group of persons organized as a distinctive
entity, we refer, then, to a corporate value system.
According to Mujtaba and Sims (2006), individuals have their own set of values that
guide their personal and professional decisions. People create these values, in part,
during the socialization process, which is an important component of the informal and
formal measures of business ethics implementation that key stakeholders must
consider for their enterprises to be successful. The value system of the individual is
the group of personal values, arranged hierarchically on the basis of the relative
importance that each individual assigns them (Fritzsche, 1995). In a similar manner,
we consider that it is also a system that is both self-imposed and followed by its own
author, in a voluntary manner to create the premises for conduct and decision-making
in day-by-day activities. This system acts as a mental barrier between what is
considered to be good and what is considered to be wrong in the self-conduit to set
a state of personal interior comfort for ones actions. It is worth to notice that the
concept of good and bad is a very relative one; it depends on personal feelings,
culture, education, being also a product of social interact, geographical location,
religion, tradition, philosophy and so on, thus the value system may differ
significantly from one person to another at a first glance; and secondly, the personal
value system may differ significantly from a corporate value system.
An individual who possess a personal value system that is employed, has to confront
his/her value system with the corporate value system of the employer and this
situation could lead to some unpredictable personal conflicts of interests. These
conflicts can be managed in a two-folded manner: (a) the person adheres to the
corporate value system, and (b) the person influences the corporate value system.
(a) The person adheres to the corporate value system
The adherence to the corporate value system can lead to two possibilities: (1) in
the confrontation of the two value systems, the personal value system remains
unchanged, and (2) the individual changes his/her personal value system.
The first situation where the person maintains unchanged the personal value
system in the confrontation with the corporate value system leads to some
major interior conflicts of interest. The person must act against his/her credo in
order to complete every-day tasks assigned by the manager. This is from far, the
most undesirable situation because it can lead to some catastrophic effects on
the health and safety of one individual.
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The second situation appears when the personal value system is changed by the
corporate value system. It is interesting to notice, however, that the change may
happen with or without the persons awareness.
In a similar manner, Cambra-Fierro, Polo-Redondo and Wilson (2008) consider
that the influence of corporate values on individuals values system is not
immediate and that employees may need time to be persuaded that certain
values are correct.
The same authors make an interesting connection between the company size and
the influence of the corporate values on the personal values. They suggest that it
is very possible that in smaller companies, or in family business, the
relationships between shareholders, managers and workers are much more
personal and closer. So the chance that there is an identification of the
individuals values with the companys increases, while in larger companies
where the distance between management and workers is larger and the
relationships are more anonymous and impersonal, this may be more difficult to
achieve.
We find this idea to be relative true in its theoretical approach, but, in our
opinion, this may not be true at all when we look for it in the day-by-day
companies existence. The authors suggest that the employees hired in larger
organizations are less likely to be influenced by the corporate values because the
relationships between managers and staff are more anonymous and
impersonal. We consider that the attributes of the professional relationships are
not a decisive factor in establishing whether personal value system of one
employee is affected by the corporate value system. We suggest that one
decisive factor that generates such an influence is the number of the working
hours. A survey conducted by the European Management Association (EMA) in
2006 among middle, senior managers and directors from all sectors of activities,
including public, private and voluntary in five European countries (Germany,
Lithuania, Malta, Spain and the UK) shows an average working day that range
between 12 hours allocated for working time solely plus the time allocated for
travelling to and from work in Germany and 10 hours for the same purposes in
Lithuania.
Considering that the time allocated to work solely plus the time allocated for
travelling to and from work exceeds by far all other activities during an average
day (in descending order: rest time including sleep, 8 hours on average; time
with family 3 hours on average; sports/leisure time 1 hour average), it is almost
impossible not to be influenced by the working environment and by the
corporate values. Also, in a similar manner, the results of the EMA (2006)
survey states that in all countries, the majority of respondents do feel that their
personal behaviour is affected by the culture and philosophy of the company/
organisation within which they work. Malta was the country which had the most
respondents indicating that their personal behaviour was totally affected by the
culture and philosophy of the company/ organisation within which they work
(17.5 per cent of respondents hit response 1 = totally agree). Overall, the impact
of culture and philosophy of the company/ organisation appears to be strongest
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in Germany where over 89 per cent of responses were between 1 and 3 where 1
= totally agree and 5 = not at all agreement.
Cambra-Fierro, Polo-Redondo and Wilson (2008) also consider that the extent
of corporate values influence on personal value system go beyond the mere
working environment, but having an impact on employees global values system
outside of the work environment. In particular, this is evident in the buying
behaviour practices in relation to supplier loyalty and environmental concern.
We find this statement to be poorly argued because it analyse only two
corporate values, i.e. buying behaviour practices in relation to supplier loyalty
and environmental concern. The analysis takes into account too few values for
drawing such a conclusion on employees conduct outside the work
environment. Also, the two values contain from the beginning an intrinsic
essence of desirable behaviour in the community, regardless the fact they were
stated by the company. Who does not want to be perceived as an
environmentalist?
(b) The person influences the corporate value system
In day-by-day activities, at the confrontation of the personal value system with
the corporate value system, the former can bear a decisive weight in making
decisions. It has been suggested that a lot of managers act in their own interest,
by so-called psychological selfishness that is to say, that they are trying to
align their companys behaviour towards a value system similar to their own.
This will enable them to feel good as they will not have to face a contradiction
between their personal values and their work behaviour (Hemingway and
Maclagan, 2004).
The fact that the personal and corporate values do not always match can relate
to the level of power an individual has in the workplace. As those with power
may be able to bring the organisations behaviour nearer to their own individual
value system and those with less power have to put up with the imposed values
(Vitell and Ramos-Hidalgo, 2006). In addition other authors (Hemingway and
MacIagan, 2004) have established that a societys group of values and its
culture also affect an organisations corporate values which clearly suggest that
there is interaction between individual values, social values and corporate
values.
5. SAMPLE SELECTION AND METHODOLOGICAL ASPECTS
The empirical contribution of this paper to the existing literature aims to offer a
representative image of the values system of the European companies, determined in
accordance to a specific methodology which consists of a hierarchical aggregation of
every individual corporate value found mostly in the corporate codes of ethics or
conduct published on the companies website. Thus, our research question is: What
is the corporate ethical framework that guides the European companies in day-by-day
activities?
In order to achieve this, we need to select a sample of companies that is representative
for Europe, thus we took into account two selection criteria: the activity sector and the
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geographical area. Regarding the first selection criteria, the activity sector, we used
the instrument offered by Euroland.com to select the major company for every listed
activity sector, ranked by market capitalization indicator at 31st December 2008. Thus,
our final sample consists of the major 21 European companies corresponding to 21
activity sectors: Aerospace & defence, Mining & metals, Entertainment & leisure,
Diversified services, Health & pharmaceuticals, Banks, Oil & gas, Retail, Consumer
products food, beverages, Telecom, Chemicals, Transportation, Insurance, Utilities,
Consumer products non-food, Autos & transport equipment, Manufacturing, IT
Information technology, Real estate, Construction & materials and Media (Eurolands
denominations). Regarding the second selection criteria, geographical area, our
sample reflects the two European countries that are well-known in the existing
literature for their opposite paradigmatic accounting tradition: the United Kingdom
and France. Thus, we have a balanced sample of 10 British companies and 11 France
companies. A detailed image of the final sample is found in Table 1.
Table 1. Final sample companies, grouped by country and activity sector
No.
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
Share
Country
Activity sector
BAE Systems (LSE)

BHP Billiton (LSE)
Compass Group (LSE)
Experian (LSE)
GlaxoSmithKline (LSE)
HSBC Holdings (LSE)
Royal Dutch Shell (LSE)
Tesco (LSE)
Unilever (LSE)
Vodafone Grp (LSE)
Air Liquide (PAR)
APRR (PAR)
Axa (PAR)
GDF SUEZ (PAR)
L'Oreal (PAR)
Renault (PAR)
Schneider Electric (PAR)
STMicroelectronics (PAR)
Unibail-Rodamco (PAR)
Vinci (PAR)
Vivendi (PAR)
London
London
London
London
London
London
London
London
London
London
Paris
Paris
Paris
Paris
Paris
Paris
Paris
Paris
Paris
Paris
Paris
Aerospace & defense

Mining & metals
Entertainment & leisure
Diversified services
Health & pharmaceuticals
Banks
Oil & gas
Retail
Consumer products food, beverages
Telecom
Chemicals
Transportation
Insurance
Utilities
Consumer products non-food
Autos & transport equipment
Manufacturing
IT, Information technology
Real estate
Construction & materials
Media
In our target sample, the values statement was presented in the code of ethics or
conduct for 71.43 percent of the total companies. The rest of the 28.57 percent of the
companies presented their corporate values statements in their corporate annual
reports (APPR: 2008 Annual Report, pp.32 and Schneider Electric: 2008 annual
report, pp.13), in a specific brochure (AXA: Axas Commitements, pp.5) and directly
on a webpage of the website (Experian, HSBC Holdings and Vivendi). According to a
related survey conducted by the American Management Association (AMA), on its
council and executive members in April and May 2002, to establish how the corporate
values are communicated to the employees, 86 percent of the total 175 executives
who responded said their companies specifically write or state their values, including
them in employee handbooks (71 percent), in company brochures (67 percent), on
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their Web sites (50 percent) or on wall posters (41 percent) (Anon, 2002b). Our
results on the corporate values communication differ significantly from the AMAs
results, but these differences are expectable considering the fact that we have no
comparability between the two target samples and the data collection methods.
The content analysis that was carried out to find the corporate values of the
companies, allowed us to extract some preliminary conclusions regarding the
quantitative formulation of the corporate values statement of the companies. The
number of corporate values presented by one company range between one value to a
maximum of seven values, most of the companies being situated at the middle of the
corporate values distribution. A detailed image of this statistic is presented in Table 2.
Also, the total number of corporate values that were presented by all the companies in
the target sample is 42. Thus, our distribution of corporate values contains 42 items,
and every company present up to a maximum of 7 items in their corporate values
statement.
Table 2. The number of values presented by one company
Corporate Values Interval
Absolute Frequencies
Relative Frequencies
1 2 Corporate Values
6 Companies
10 Companies
5 Companies
.28
.48
.24
A statistical methodology to aggregate and arrange the corporate values was needed in
our quest to find the value system of the target sample companies. We consulted the
existing studies in the literature to find what methodologies were also used for
obtaining some related results. The studies identified in the existing literature, AMA
(2002), Filipczak (1993) and Van Lee, Fabish and McGaw (2005) use the same
statistical apparatus: the authors use a statistical survey as method for collecting
quantitative information on corporate values, this survey is then sent to a large
numbers of executives, managers or directors of different companies and different
activity sectors and the rate of responses is no more than 9-10 percent. Then, the
authors simply aggregate the responses and choose the corporate value with the
highest frequency regardless others important factors such are value rankings and
hierarchy. Some further limitations of this statistical apparatus regard the fact that it
does not collect written and, therefore, unchangeable data from a corporate value
official statement, it collects what the respondents know to be the corporate values,
enhancing thus the degree of human mistake. Also, because of the survey method, it is
possible to send the same survey to more than one manager in the same company,
therefore, the values of one company being considered at the moment of statistical
aggregation more than just once in the detriment of the values of other companies,
resulting in a biased result.
We propose a methodology for establishing the value system of companies that
overcomes all these limitations, as discussed as follow:
(a) Regarding the data collection, we replaced the statistical survey with the content
analysis of official corporate documents that contain the corporate value
statement, thus removing the human mistake and the biased results. Our sample
is representative for every activity sector; we have chosen the major company in
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sector ranked by market capitalization at 31st December 2008. These

improvements, however bear an inner limitation regarding the relative small
size of our target sample;
(b) A more complex approach for the results aggregation was needed to establish
the value system of the sample companies, because the presentation of the
corporate values met some specific characteristic that should be considered:
i. The corporate values are presented in a hierarchical manner. The first
corporate value presented is the most important for the respective company;
ii. No company chooses the same value more than once. This means that every
value have a specific weight and importance in the corporate value statement;
iii. Every corporate value is chosen by at least one company. This creates the
premises of a wide variety of corporate values a total of 42 items in our
corporate values distribution. This characteristic is important because it
considers the willing of one company to choose or not to choose a specific
value;
iv. The number of corporate values presented differs from company to company.
As discussed earlier, the companies in our sample presented up to 7 different
corporate values in their corporate values statement.
Since all these characteristic are met in the process of the corporate values
assessment, we consider that the methodology that applies at their aggregation is the
preferential voting system which can be defined as an electoral system in which voters
rank parties or candidates on the ballot paper in order of their choice (Reynolds,
Reilly and Ellis, 2008). The companies choose a specific value from the entire range
of existing values based on inner considerations, it is a preferred corporate value and
they give it a vote of confidence detrimental to another value which is not preferred
thus receiving a vote of no confidence. The system enables voters (the companies)
to express their preferences between candidates (the corporate values) rather than
simply their first choice. For this reason, it is often known as preferential voting
(Reynolds, Reilly and Ellis, 2008).
The Alternative Vote, the Borda Count, the Single Transferable Vote and the
Supplementary Vote are all examples of preferential voting systems. Considering the
four characteristics of the corporate values mentioned above, we consider that the
preferential voting system that applies for our goal is the Borda Count.
The Borda Count is a candidate-centred preferential system used in either single- or
multi-member districts in which voters use numbers to mark their preferences on the
ballot paper and each preference marked is then assigned a value using equal steps.
For example, in a ten-candidate field a first preference is worth one, a second
preference is worth 0.9 and so on, with a tenth preference worth 0.1. Because it
sometimes elects broadly acceptable candidates, rather than those preferred by the
majority, the Borda Count is often described as a consensus-based electoral system,
rather than a majority one (Reynolds, Reilly and Ellis, 2008).
The process of data collection met all the conditions and criteria discussed above, as it
follows: on the basis of content analysis, we ranked the corporate values with 1 for the
first company choice, 2 for the second choice and so on, till the last choice, which was
ranked with 7. On our way of consulting more corporate values statements of different
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companies, we continued to add new corporate values until we reached the 42nd
corporate value.
After accomplishing this step, our primary data consists of the final list of 42
corporate values and their different votes of confidence which were ranked from 1 =
most preferred corporate value to 7 = less preferred corporate value. We also
identified the vote of no confidence which was ranked with 8 = the corporate value
is not preferred.
The number of points given to each corporate value for each ranking is determined by
n which is the maximum number of the proposed corporate values of one company
considering also the vote of no confidence. Thus, the most preferred corporate value
(ranked 1) receives the maximum of 8 points ( n ); the second preferred corporate
value (ranked 2) receives 7 pointes ( n 1 ), and so on, until the less preferred
company value (ranked 7) receives 2 points ( n 6 ). The vote of no confidence
receives the minimum of 1 point ( n 7 ).
When all the votes have been counted, and the points added up, the corporate value
with the highest number of points win. Thus, in the descending order of number of
points received, we establish the value system of our target sample companies.
6. RESULTS AND DISCUSSION
6.1. The European perspective
The final count of points revealed the value system of the European companies. The
final ranking consists of 17 positions, some of the corporate values obtaining the same
number of points, thus sharing the same position.
It is also interesting to notice the maximum and the minimum number of points that a
corporate value may obtain in the final count. If all the sample companies would have
ranked the same corporate value with the vote of confidence as their first preference,
then the value would achieve a number of 168 points. Also, on the opposite side, the
minimum number of points would be achieved if all the sample companies would give
the vote of no confidence to a specific corporate value. In this theoretical
assumption, the total number of points would be 21. But this theoretical assumption
infringes the third characteristic of the corporate values that states that Every
corporate value is chosen by at least one company. Thus, is necessarily that at least
one company to give the immediate number of points above the minimum to the
respective value. Considering this, the minimum number of points that a corporate
value may achieve is 22 and shows that the respective value is less preferred.
The top three values of the European companies are: Integrity with a score of 78
points, Respect with a score of 58 points and Honesty with 48 points. The
corporate values with the lowest number of points, with an equal scoring of 23 points,
are Tenacity and Work Smart, Play Hard. A detailed image of the corporate value
system of the European companies is found in Table 3. An interesting corporate value
that appears in our ranking is High Performance. Although it does not score a high
position, it is still a presence in the ranking, and our concern is that the financial high
profits are not compatible with a value system, which is more a framework of ethical
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behaviour. Only few managers will admit that profitability is not just an unfortunate
requirement but a cherished value (Filipczak, 1993).
Table 3. The value system of the European companies
Value
Integrity
Respect
Honesty
Openness
Professional
Transparency
Trust
Responsibility
Safety
Ethical
Passionate
Team Spirit
Effectiveness
Accountability
Points
78
58
48
43
42
36
35
35
34
34
32
30
29
28
Top Value
1
2
3
4
5
6
7
7
8
8
9
10
11
12
Points
Beauty
Confidence
Drive
Curiosity
Consumer focused
Commitment
Fairness
Patient focused
Connected
Innovation
Cultural Diversity
Rigor
Daring
Excellence
28
28
28
28
28
27
27
27
27
27
27
27
26
26
Top Value
12
12
12
12
12
13
13
13
13
13
13
13
14
14
High Performance
Straightforward
Dependable
Pragmatism
Value Creation
Cohesion
Example
Courage to Lead Change
Win-Win Relationships
Creativity
Lucidity
Humility
Tenacity
Work Smart, Play Hard
Points
Top
26
26
26
26
26
25
25
25
25
25
24
24
23
23
14
14
14
14
14
15
15
15
15
15
16
16
17
17
Based on data collection extracted from official corporate documents, our results
reflect the existing corporate value system which is in use at the moment present. But
the corporate value system is also a theoretical challenge for different authors. As
such, Garcia-Marza, (2005) proposes that fundamental corporate values representing
the corporate constitutional framework that would establish the basic rules of the
relations between the company and various groups are: integrity, credibility, fairness,
dialogue, transparency, dignity, legality, civic commitment, environment and
responsibility. Eliminating any of these values means that a dialogue will no longer
represent a process of reaching agreement, but will instead become a mere strategy or
compromise, whereby the final outcome is decided by the more powerful side.
On confrontation between the two value systems of corporation, we find some
similarities among major discrepancies. We need to identify the correspondence
between the corporate values in both value systems. This assignment can be achieved
if we have a correct definition of the analysed terms. According to Garcia-Marza,
(2005):
1) Integrity: Coherence between what is said and what is done;
2) Credibility: Trust in the expectations placed in the company;
3) Fairness: Equal distribution of burdens and benefits;
4) Dialogue: Possibility for participation and consensus mechanisms among the
various groups involved and/or affected;
5) Transparency: Truthfulness, intelligibility and accessibility in internal and
external communication structures;
6) Dignity: Respect for and encouragement of human rights and of the values
involved in reciprocal recognition between individuals;
7) Legality: Compliance with laws and legal provisions;
8) Civic commitment: Contribution to local and regional development, coresponsibility for social order;
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9)
Environment: Position on the maintenance and improvement of the

environment;
10) Responsibility: Capacity for anticipation of and response to social expectations
and demands.
The existing corporate value system is similar with the theoretical corporate value
system regarding 4 corporate values, meaning: Integrity (78 points), Fairness
(27 points), Transparency (36 points), and Responsibility (35 points). Other
similarities can be assigned based on the definitions above, meaning: the theoretical
corporate value Credibility can be assigned to existing corporate value Trust
(35 points) and the theoretical corporate value Dialogue can be assigned to existing
corporate value Openness (43 points). Considering the rest of the discrepancies, we
find that the corporate value statement, i.e. the corporate value system of the existing
companies, is not coherent, and lacks of important pillars, which were not taken in
considerations, thus we have unasserted areas on important aspects like: Dignity,
Legality, Civic commitment and Environment.
6.2. The British and French Perspective
Having a balanced sample between the British and the French companies
(10 companies from UK and 11 companies in France), we can establish what is the
British corporate value system, and also, what is the French corporate value system. A
detailed image of these value systems can be found in Table 4 and Table 5.
Table 4. The value system of the British companies
Value
Integrity
Respect
Honesty
Openness
Safety
Ethical
Trust
Responsibility
Accountability
Professional
Curiosity
Patient focused
Connected
Transparency
Points
43
42
37
26
23
21
17
17
17
17
17
16
16
15
Top Value
1
2
3
4
5
6
7
7
7
7
7
8
8
9
Points
High Performance
Dependable
Passionate
Beauty
Confidence
Drive
Commitment
Fairness
Daring
Excellence
Straightforward
15
15
14
14
13
12
10
10
10
10
10
10
10
10
Top Value
9
9
10
10
11
12
13
13
13
13
13
13
13
13
Cohesion
Effective
Example
Lucidity
Tenacity
Innovation
Pragmatism
Team Spirit
Consumer focused
Cultural Diversity
Value Creation
Creativity
Rigor
Humility
Points
Top
10
10
10
10
10
10
10
10
10
10
10
10
10
10
13
13
13
13
13
13
13
13
13
13
13
13
13
13
The top three British corporate values are identical with the general ranking. We
obtained Integrity (43 points), Respect (42 points) and Honesty (37 points).
Thus, we can state that the European corporate value system has a British influence.
In France, the ranking is quite different. Although the top corporate value remains
Integrity (35 points), the next places are held by Professional (25 points) and
Transparency (21 points).
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Table 5. The value system of the French companies

Value
Integrity
Professional
Transparency
Team Spirit
Effective
Trust
Responsibility
Beauty
Confidence
Drive
Passionate
Consumer
focused
Openness
Commitment
Points
Points
Top
35
25
21
20
19
18
18
18
18
18
18
Top Value
1
2
3
4
5
6
6
6
6
6
6
Fairness
Innovation
Cultural Diversity
Rigor
Respect
Daring
Excellence
Straightforward
Pragmatism
Value Creation
Cohesion
Points
17
17
17
17
16
16
16
16
16
16
15
Top Value
7
7
7
7
8
8
8
8
8
8
9
Humility
Ethical
Tenacity
Honesty
Safety
Accountability
Patient focused
High Performance
Connected
14
13
13
12
11
11
11
11
11
11
11
10
11
11
12
13
13
13
13
13
13
13
18
Example
15
Dependable
11
13
17
17
7
7
Creativity
Lucidity
15
14
9
10
Curiosity
11
11
13
13
It is also interesting to notice that the British and French companies have a different
view in assessing their corporate values. This conclusion is easily drawn when we
analyse the number of specific, traditionalistic British corporate values and the
number of specific, traditionalistic French corporate values. In the total of
42 corporate values, a number of 10 corporate values were chosen by British
companies only and a number of 22 corporate values were chosen by French
companies only.
These values are those who received the least number of points in every country value
system: the British corporate value system contains 22 corporate values which scored
10 points, i.e. 10 votes of no confidence from the 10th British companies (one vote
of no confidence score 1 point according to Borda Count algorithm) and the French
corporate value system contains 10 values which scored 11 points, i.e. 11 votes of no
confidence from the 11th French companies. This state that the French companies
have a significant higher propensity to a larger horizon and a whole spectrum of
different corporate values that can be elected than a British company. These results
are in concordance with some well-known inherited and specific country traditions,
i.e. the strictness and rigour of British people, and the specific French laissez-faire.
Regarding the manner of presentation of values, we found that the corporate values of
many companies starts by including their vision and then proceeds to list each
significant value, which is followed either by a series of bullet points describing the
ways in which the value is instantiated or by a brief narrative that carries out the same
function. However, this layout is not the only type of realization of the genre to be
found. In the corpus, for example, Royall Dutch Shell uses a diagram to present its
vision and values. GlaxoSmithKline uses bullet points to list their values, but these are
followed by very long narratives. Most statements contain an abstract noun to refer to
the specific value, and the narrative or bullet points that follow it make the
abstractness of the value concrete by detailing specific ways in which the value is
enacted. Also, these findings are in concordance with the results found by GarcsConejos Blitvich (2010).
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CONCLUSIONS
This paper studied the corporate value system in a European context, and specifically,
a value system that can be found in British and French companies. Also, the statistical
apparatus is primer in the existing literature; we considered the methodology of a
preferential voting system in selecting the preferred corporate values. Our results
show that the top three corporate values are Integrity, Respect and Honesty, values
found also in the British corporate value system. A slighter difference is found in the
French corporate value system; here the top three values are: Integrity, Professional
and Transparency. We confronted the existing corporate value system with a
theoretical value system formulated by scholars and this lead us to the conclusion that
the existing corporate value system lacks in consistency, therefore is a challengeable
system with visible weaknesses.
We consider that the companies should adopt a more responsible conduit in the
relationships with different groups of stakeholders. A company has the main purpose
to use the existing resources to obtain profit, but it should never forget that the
resources are all limited, and when we state resources, we refer not only to the most
visible, like raw materials and plant, property and equipment, but an entire spectrum
ranging from the human life, to biosphere, the atmosphere, in different words, the
entire ecosphere.
The companies should revise their corporate value system, in a manner to achieve
consistency and credibility, thus to regain the communities confidence and thus, to
overcome the existing crisis of credibility. After all, a corporate value system is a
moral framework of ethical behaviour, and the abatement from this framework should
not be compromised in the continuing battle between ethics and financial
performance.
The limitations of our study is inherent because this subject matter is constantly in
flux, implying that such studies can be no more than a snapshot at a certain point in
time. Such studies have a very short Product Life Cycle (PLC) (Ulhoi, 1993). As
stated before, other important limitation is the relative small size of the target sample.
This being the case, we consider that this study can be further developed by
considering a larger target sample companies from a wider geographical area.
ACKNOWLEDGEMENTS
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HOW CAN CORPORATE GOVERNANCE MITIGATE

FRAUD?
Victoria STANCIU1, Ali EDEN & Veronica IVANCENCO
ABSTRACT
Fraud is a risk that should not be ignored. Studies on accounting field have showed the
seriousness of fraud problem and the nature of fraud. Researches within this area have
emphasized the fraud models and suggested how to prevent, detect and investigate frauds.
Strong corporate governance and a solid corporate culture are important pillars for fraud
prevention. Important professional communities and professional bodies have analyzed the
causes of the actual crisis, and all the surveys emphasized weaknesses in corporate
governance and risk management. That is why important improvements are expected in
corporate governance field. In crisis time, there is also a potential higher risk of fraudulent
financial reporting. Whether is using a simple or sophisticate scheme fraud might affect
people, processes and companies or individuals reputation.
The objective of this paper is to examine the fraud phenomenon and fraud vectors aiming at
identifying appropriate prevention actions. The authors focus on the link between strong
corporate governance, a solid internal audit function and the role of external auditors in the
fight against fraud.
KEYWORDS: fraud, fraudulent financial statement, internal audit, corporate governance

INTRODUCTION
The accounting and audit professional literature have analyzed in detail the well
known cases such as Enron, WoldCom, Xerox in US and the European fraudulent
reporting cases as for example Vivendi, Parmalat. The researches in accounting and
forensic accounting have emphasized the nature of frauds and the causes that have
facilitated them. The final objective of all those studies was to reveal the professional
framework for fraud prevention, detection and investigation.
Important results in the fraud research were publishes by Donald Cressey in the mid20th century. Cressey is the author of the classic theory of fraud that identifies the
well known fraud triangle. The fraud triangle seeks to explain the necessary frame
for fraud to occur: opportunity, pressure/incentive and rationalization. In Cresseys
opinion, if any one of the three elements is missing, fraud may not occur. In order for
fraud to occur, there has to be an ability to commit fraud. Incentive has also been
called pressure and can be materialized in various forms but any of these determine
the perpetrator to seek gains via financial fraud. If we analyze the three elements
defining the fraud triangle one characteristic can be emphasize: opportunity and
Correspondence address: Victoria Stanciu, Academy of Economic Studies, Bucharest Romania;

email: stanciuvictoria58@hotmail.com
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incentive only exist or they dont or, in other words, exists or they potential exists. In
opposite, rationalization depends on the individual and the circumstances he is facing.
In difficult periods, as the one we are passing through, the fraud risk is increasing.
There is also a higher potential risk for registering fraudulent financial statements.
The Association of Certified Fraud Examiners' (ACFE) 2010 Report on the Nation
estimates the cost of fraud to be 5% of businesses annual revenues. Globally, this
translates to approximately $2.9 trillion of economic losses due to fraud (ACFE,
2010). Since 1950s professionals and academicians have offered important insights
that have gone beyond the fraud triangle. Their research had as objective to define
effective ways to prevent, detect, investigate, and remediate fraud. Even so, it appears
that fraud in all its various forms remains a problem that is increasing in frequency
and severity. KPMGs Fraud Survey 2003 showed a flag alert emphasizing an
increase in overall fraud levels since its 1998 survey and noted that fraudulent
financial reporting had more than doubled from 1998 (KPMG, 2003). The most recent
surveys confirm the ascendant trend of fraud, in all its forms. Everybody is aware that
it is impossible to detect and/or prevent all the frauds but is essential to design and
implement an effective fraud risk management process.
The present paper aim at emphasizing the characteristics of fraud and to present the
authors research results regarding means of improvement of fraud risk management
process. In this respect the authors opt for an empiric study. The research imposed a
large documentation in the professional specialized literature, focusing on surveys and
studies on fraud topic issued by international professional bodies and international
organizations. The conclusions retain from the accounting and fraud forensic
literature, the opinion of recognized specialists in the field and the authors personal
practical experience have been valuated in the deductive and inductive
methodological process in order to identify the aspects that can be considered flag
alerts for possible fraudulent financial reporting and means for fraud prevention in its
various forms.
1. FRAUD PREMISE
To understand why people commit fraud, the authors research started from the
Casseys theory, the fraud triangle analysing the three elements determining fraud:
Opportunity is the ability to commit fraud and has its roots in the perpetrator believe
that its actions will remain undetected. As a remark, opportunities do not have to be
real; they only must be perceived as real by the perpetrator. The perpetrators believe
that he can run its actions without being detected is based on identified weaknesses in
the internal control, internal audit inclusively (were this function is implemented),
poor management oversight, inadequate external oversight and monitoring (run by
external auditors, supervision entities, governmental units), the companys failure to
establish adequate procedures to detect fraudulent activity, lack of prosecution of
perpetrators, weak ethical culture (as for example poor tone at the top), limits in the
implementation of segregation of duties principle, the existence of a financial and/or
emotional motivation. Cases as Enron emphasized as an opportunity the
environmental complexity and related parties. The Enron structure was very complex
as a result of merges and usage of special entities (related parties) created in order to
hide losses and fraud and maintain the image of a profitable and successful company.
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Studies on frauds have emphasized that opportunity is created also through the use of
position and authority of the individuals. A top position in the company confers power
and the possibility to attract co-perpetrators by inducing fear of punishment or
promising rewards.
All the surveys and studies have emphasized that opportunity is the element over
which business owners have the most control. Limiting opportunities for fraud is one,
and very important, way a company can reduce fraud. This is an important conclusion
the authors retain in their effort to identify means for mitigate fraud.
The pressure is a very strong factor and has financial and non-financial nature. It is
important to underline that pressure takes different forms: high financial needs, need
to report better results comparing with the real financial status of the company,
frustrations related to the work environment, professional aspiration and the desire to
reach it sooner, relationship needs, the competitive professional environment and
sometimes just the persons will to prove he/she can defeat the system, the increase of
bonuses (the remuneration system) and the list can continue. Professionals in fraud
forensic concluded that pressure is generally nonobservable. This conclusion is very
important for external auditors work: they have limited interaction with the
companys employees, potential perpetrators inclusvelly, and they cant evaluate
current behavior of individuals and its change. As a result, people changing behaviour
is identifiable by their coleagues and direct managers. Internal audit has also an
important role being more close to the activities and people involved in those
activities.
In crisis years, the potential of fraudulent financial reporting is higher as a result of
pressure registered by the executive management to fulfill the business objectives, so
that their own financial position or even professional status in the company not to be
affected. In such context, the adoption of a more aggressive accounting can create
the perception of solid financial statements. This pressure is higher in the case of the
companies rated on the market.
In crisis years, the management is focused more on business objectives and costs
decreasing. As a result, it is the risk of diminishing the attention related to risk
management field. The possible consequences are the postponing or even omission of
updating the risk management process according with the existing conditions.
Rationalization is considered by many specialists to be a crucial component in most
frauds. For those who are generally dishonest, it is probably easier to rationalize theirs
fraud actions. But what it happens with those with higher moral standards? In many
cases, persons that had proved in time ethical and professional integrity are the
initiators of frauds or fraudulent financial reporting. How can be explained this new
situation? Cressey indicated that a morally acceptable rationalization is necessary
before the crime takes place and this is the result of the fact that the perpetrator does
not view himself as a criminal. This statement is confirmed by the 2007 Oversight
System Report on Corporate Fraud indicating that 40% of the respondents have
declared they do not consider their actions fraudulent (Oversight Systems, 2007).
The fraudster fills like justifying his misdeeds to himself before he commits them so
that he perceives his illegal behavior is as acceptable. The justification can take
different forms:
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his/her action is, in fact, benefic for the company,

there is no other option for the moment and this situation will be changed soon,
it is just a solution for the moment,
she/he will payback the money, the fraud being considered a loan.
By rationalization the fraudster is preserving his self-image as an upright and

trustworthy person.
All the above mentioned justifications are linked to the pressure registered and the
perceived opportunity retain by the perpetrator. Like pressure, rationalization is not a
readily observable characteristic, and for the auditor (internal or external) its not
possible to identify it.
As a recognize of the its importance, fraud triangle theory has became an integral
part of Statement on Auditing Standards No. 99 issued by American Institute of
Certified Public Accountants (AICPA). SAS 99 became effective for audits of
financial statements for periods beginning on or after December 15, 2002.
Concluding, the fraud triangle can explain the fraudulent financial action itself but it
cant explain how are attracted other persons in this action being known that such
action involves in many cases top management, head of accounting, individuals with
internal control attributions and simple accountants. The professionals in fraud
detection have recognized the importance of Cresseys theory, but they emphasized
that the triangle alone is an inadequate tool for deterring, preventing, and detecting
fraud. This is the result of the two of the characteristics - pressure and rationalization that cannot be observed. As a response to this fact, the researche effort continued
aming to develop fraud models able to provide an alternative view of the fraud act.
Some of those models were considered to be more appropriate tools in deterrence,
prevention, and detection.
2. FROM FRAUD TRIANGLE TO THE FRAUD DIAMOND
The fraud diamond concept was issued in 2004 by David T. Wolfe and Dana R.
Hermanson. They added at the already known three components of fraud triangle
the fourth: the individuals capability. In financial statement frauds, involving large
amounts, the solid accounting knowledge and specific abilities are essential. Wolfe
and Hermanson have selected four observable characteristics that can be identified in
case of frauds involving large amounts (Wolfe, 2004):
Authoritative position or function within the organization;
Capacity to understand and exploit accounting systems and internal control
weaknesses, possibly leveraging responsibility and abusing authority to
complete and conceal the fraud;
Confidence (ego) that she will not be detected, or, if caught, that she will talk
herself out of trouble;
Capability to deal with the stress created within an otherwise good person
when she commits bad acts.
The fraud diamond highlights the fact that the capabilities to commit fraud are
explicitly and separately considered in the assessment of fraud risk. As a result, the
fraud diamond moves beyond viewing fraud opportunity largely in terms of
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environmental or situational factors. The capabilities are generated by the persons

position or function within the organization that may offer the ability to create or
exploit an opportunity for fraud not available to others. If we consider one important
conclusion retained by the Fraudulent Financial Reporting: 19871997, An Analysis
of U.S. Public Companies (Beasley et al., 1999) namely that corporate CEOs were
implicated in over 70% of public-company accounting frauds (indicating that many
organizations do not implement sufficient checks and balances to mitigate the CEOs
capabilities to influence and perpetuate fraud) the above statement is valid. The
fraudster understands and exploits internal control weaknesses and uses his position to
the greatest advantage. This fact is confirmed by the Association of Certified Fraud
Examiners 2010 survey conclusions: 51% of the perpetrators of occupational fraud
had at least a bachelors degree, 49% of the fraudsters were over 40 years, 46% of the
frauds the Association recently studied were committed by managers or executives
(ACFE, 2010).
The fraudster has a strong ego and great confidence that he will not be detected, and
he believes that he could easily talk himself out of trouble if caught. It is important to
emphasize that a person with a very persuasive personality may be able to convince
others to go along with a fraud. This explains what Cresseys model couldnt.
In the article The Human Face of Fraud Allan Roddy notes that the perpetrator
makes unusual and significant demands of those who work for him or her, cultivates
fear rather than respect and consequently avoids being subject to the same rules
and procedures as others. Many financial reporting frauds are committed by
subordinates reacting to an edict from above to make your numbers at all costs, or
else (Allan, 2003).
The research in fraud field reveals a fraud model named MICE. MICE is the acronym
from money, ideology, coercion, and ego (entitlement). Jason Thomas defined the
model taking into consideration that in financial reporting fraud the motivating
elements are monetary incentives, bonuses, or stock options. In this respect, top
executives feel the presure to provide solid financial results, based on above
mentioned elements, being to the delimitated nonshareable individual pressure
described by Cressey. The present paper authors appreciate that MICE model
responds to the well known cases of Enron, WorldCom, Adelphia, Phar-Mor. In all
these cases, the perpetrators appeared to be motivated by money, ego, and entitlement.
The MICE model includes also the ideology aiming at explaining frauds like tax
evasion and terrorist financing.
3. PERPETRATORS PROFILE
The authors documentation on fraus and forensic accounting literature reveals the
existance of a two defined types of perpetrators: the predator and the accidental
fraudster.
In their work, Forensic Accounting and Fraud Examination, Kranacher, Riley, and
Wells characterize "accidental fraudster by the following characteristics: first-time
offender; middle-aged; well-educated; trusted employee; in a position of
responsibility; and considered a good citizen through service works at the office, in
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the community, or at a charitable organization (Dorminey, 2010). This profile is

recognise in Cresseys fraud triangle.
In opposition with the accidental fraudster, the specialits have defined a new profile
specific for the predator, represented by an individus or an organization (Dorminey,
2010):
Predators seek out organizations where they can start to scheme almost
immediately upon being hired.
At some point, many accidental fraudsters, if not caught beforehand, will move
from the behavior characteristic of an accidental fraudster to that of a
predator.
Financial statement fraud perpetrators often appear to start as accidental
fraudsters, or even just as earnings managers, and sooner or later become
predators.
The antifraud professionals concluded that the perpetrators are better organized, have
better concealment schemes, and are better prepared to deal with auditors and other
oversight mechanisms or entities. As a result, the recommended tools for exposing
them are professional skepticism, brainstorming and critical thinking. In essence, all
these tools, are recommended by the international audit standards as for example
ISA 240.
The losses caused by individual fraudster can be substantial, but, in case of collusion,
losses increase dramatically. Cressey analysed the individual and accidental
fraudulent. The big and complex fraud cases, registered in the last years, impose a
new approach in fraud detection: predators and fraud under conditions of collusion.
The fraudster can be considered to have a strong personality, a good self control and
deals also very well with stress: the fraudster lies convincingly and possesses the skill
to keep track of the lies, so that the overall story is credible. In this respect, for
internal and external auditors it is more difficult to detect fraud cases being known the
fact that fraudsters also alter or hide or alter documents.
4. WHAT ARE THE STATISTICS SAY?
In May 2010, COSO published its survey on US public corporations fraudulent
financial statements (COSO, 2010). The survey covers an extended period, 19982007, few years being subsequent to the issuance of the Sarbanes-Oxley Act. This fact
is not altering the surveys conclusions; separate analysis on the period after SOX
implementation didnt reveal significant changes in the conclusions.
The survey emphasize that 26% of the companies registering fraudulent financial
reporting have changed the auditors in the period between the last correct financial
statement and the first fraudulent one; 60% of the them have changed the auditor in
the period when they registered the fraud and the rest of 40% have changed the
auditors in the previous fiscal period they registered frauds. This can be explained by
the fact that the new auditor needs time to understand the specificity of the companys
activity and its internal control system. This is more time consuming in case of big
and complex companies, having particular activities. This is the reason why, an
important attention is needed by the financial auditor in the client acceptance phase
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and later in the documentation phase. For the auditor is crucial to analyze and
understand the internal control system of the auditee. In this respect, it is necessary to
be fulfilled all the ISA 315s requirements.
Another important conclusion of the survey is that the majority of the frauds were
registered in more that 1 year, the average period being 24 months.
Starting from the responsibilities of the board and audit committee members, the
survey analyzed some board governance characteristics aiming at finding correlation
between these characteristics and fraud actions. In this respect, the survey has
analyzed characteristics like:
composition of boards
audit committees composition and number of meetings. It is important to
emphasize that 95% of the companies registering fraudulent financial reporting
had the audit committee composed by three members, many of them
(comparing with the companies having correct financial reporting) having
knowledge and experience in accounting and finance.
The survey showed that 11% of the board members had knowledge in accounting and
finance, having a higher weight comparing with non fraudulent companies. The
fraudulent companies scheduled more board meetings. This fact can be explained by
the possible existing financial pressure at the top.
The survey didnt revealed significant differences in the composition of boards
between the fraudulent companies and the non-fraudulent ones. As a result, we can
conclude that more important are:
the governance process itself,
the quality of the documents and analysis at this level,
communication between the executive managers and the external auditors,
audit committee and executive managers and audit committee and external
auditors.
focusing the board meetings debates just on financial figures without assessing
the financial reporting process can be the cause of cases of fraudulent financial
reporting.
In this respect, we appreciate that for the auditors will be useful to check to what
extent were analyzed by the audit committee and the supervision committee the fraud
detection and prevention process and the overall internal control system. Studies in
the filed have emphasized that companies had implemented whistleblower
applications, permitting to report - under anonymity frauds and unethical behavior,
had diminished by 50% of fraud cases.
The same survey retained that there were no differences between fraud and no-fraud
firms in the number of directors who left the board during the first fraud year. In the
same time, a large majority of both fraud and no-fraud firms had compensation
committees and were registered relatively few differences in their characteristics.
The COSO study emphasize that fraudulent financial reporting was registered in all
industries and in companies with different size. Even new companies were identified
as fraudulent. It is proved that big companies have registered less fraud or fraudulent
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reporting cases, but the implied amounts were significant more important. The
explanation for the frauds in small firms stays in the fact that they are more exposed
to fraud because of lack of controls or the inadequate internal control system.
The fraud remains undetected in many cases. The same survey showed that big
six/four audit companies audited 79% of the fraudulent companies. For the
223 fraudulent companies in the survey sample, 43% obtained unqualified auditor
opinion, 56% obtained unqualified auditor opinion along with explanatory language.
Just one firm registered qualified auditor opinion. This conclusion emphasize the fact,
underlined by IASs, that detecting fraud imply different tests and procedures that
those imposed by financial audit reviews. We all must be aware of the fact that will be
never possible to prevent and detect all frauds. It must be taken into consideration the
significant number of accounting records determining sampling and substantive tests.
The samplings, even performed on most accurate techniques together with the
substantive tests aim at identify routine errors determined by inadequate or missing
controls and unintentional errors in accounting system. In case of frauds, we are
dealing with intentionally actions, run based on predefined schemas aiming to hide the
action. The red flags can appear in relation with a limited number of transactions that
can or can not be selected in the audit sample.
Studies on fraud problem have emphasized that the fraud was detected as a result of:
information provided by the employees, clients, providers, anonym sources or
accidentally. A recent document issued by ACFE (Association of Certified Fraud
Examiners) notes that The inherently clandestine nature of fraud means that many
cases will never be revealed, and, of those that are, the full amount of losses might not
be uncovered, quantified or reported (ACFE, 2010). The ACFE study retains that
individuals having high position in the organization, and implicitly having experience
and high education level, register the highest rate of fraud. As a result, the study
brings up the problem of trust given to the employees. Individuals who work for an
organization a longer period of time engender more trust from their co-workers. They
may also acquire higher level of authority; they succeed to consolidate professional
relation inside and outside the company and get better understanding of procedures
and means to evade internal controls. Their skills, abilities, authority and position will
permit to conceive sophisticated fraud schema. As a result the losses increase. For
higher position in the organization operate less standard controls and the individuals
on these position based on their expertise and knowledge have the ability to avoid the
existing controls. As we already stated in a previous chapter, they have the power to
attract other individuals in the fraud actions.
5. HOW WE CAN MITIGATE THE FRAUD?
Based on the analysis on fraud cases the auditing profession has adopted more
rigorous auditing standards and procedures underling the importance of professional
skepticism, promoting discussions in the audit team regarding moments or activities
that can provide opportunities for fraud, adequate test considering fraud when
conducting a financial statement audit etc. Regulators have issued more severe rules
and legislation. Complex teams build from fraud forensic specialists and software
developers have develop dedicated software aiming at adding continuous monitoring
features to back-office systems. But the continuous increasing trend of frauds imposes
more efforts to mitigate the fraud problem.
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Knowing the factors that contribute to the fraud it is more easily to find ways to
mitigate the phenomenon. In this respect, the most important factors that contribute to
fraud success can be considered the followings:
1. Inadequate leadership at the top;
2. Poor internal controls, including inadequate monitor or individuals work
review;
3. Management override of internal controls;
4. Autocratic senior management;
5. Aggressive accounting policies;
6. Collusion between employees;
7. Collusion between employees and third parties;
8. Management less focus on ethical values and culture;
9. Insufficient external and internal oversight.
It can be mentioned that, in cases of collusion, internal controls centered on
segregation of duties are generally ineffective in preventing fraud and other financial
crimes. Many companies have recognize that the frauds could be prevented by
implementing effective controls. In this respect organizations are implementing
tighter controls and broader oversight. The management is more aware that fraud
prevention and detection processes must be design, implemented and periodically
tested and improved. Their measures must focus on controls that diminish the
opportunity to commit fraud. Management cant operate on the employees need and
rationalization but can limit the fraud opportunity. In this respect, organizations must
design and implement processes, procedures and controls that effectively detect
fraudulent activity if it occurs. An important role plays the organization culture and
ethic. The employees must be aware of the fact that the fraud phenomenon must be
revealed and that they are the first to report the events even if it is a suspicion of
fraud. The employees can be the first to identifying changes in the behavior and life
standard of theirs co-workers that can be important flag alerts of possible unethical
actions.
Distinct red flags can be established for employees and management. Some red flags
that may indicate the fraud risk in case of the employees can be considered the
followings:
uncomfortable being reviewed their work or uncomfortable to share
responsibilities with another colleague;
strong desire for personal gain or higher gains;
showing a beat the system attitude;
frustrations;
live beyond their means, changes in individuals lifestyle and behavior;
significant personal debt and credit problems;
too close relationship with customers or vendors;
refusal to take vacation or sick leave;
high employee turnover, especially in those areas which are more vulnerable to
fraud;
lack of segregation of duties in the vulnerable area.
For the management part, red flags can be considered (DiNapoli):
refuse to provide information to auditors;
engaging in frequent disputes with auditors;
making pressure on the auditors (see Enron case for example);
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management decisions are dominated by an individual or small group;

weak internal control environment;
inexperienced accounting personnel;
decentralization without adequate monitoring;
changes in external auditors;
company assets sold under market value;
high employee turnover rate;
unexpected overdrafts or declines in cash balances;
financial transaction that doesnt make sense;
service contracts result in no product;
photocopied or missing documents, delays in offering information and
documents.
Studies on fraud cases consistently shows that red flags were present, but were either
not recognized or were recognized and no response answer was performed. We
believe that in the fraud detection process, it is important to recognize the difference
between error and fraud and remember that responsibility for follow-up investigation
of a red flag should be assign to the most experienced, skilled and responsible person.
The success of the fraud management process implemented in the company stays in
the role of the employees communication. A milestone, from the companys
perspective is the ethical work environment based on a code of ethic (or code of
business conduct). Continuous communication and training are critical to enforce a
solid ethical culture and building a positive work environment and encouraging selfreporting of unethical actions and/or compliance violations. In order to mitigate the
fraud, the organization must understand the unique nature of its workforce and the
vectors that motivate this workforce.
The AICPA guide, "Management Override of Internal Controls: The Achilles' Heel of
Fraud Prevention - The Audit Committee and Oversight of Financial Reporting,"
identifies six key actions that the audit committee should consider in performing these
duties:
Maintaining skepticism,
Strengthening committee understanding of the business,
Brainstorming to identify fraud risks,
Using the code of conduct to assess the financial reporting culture,
Ensuring the entity cultivates a vigorous whistleblower program, and
Developing a broad information and feedback network.
In the article, "Preventing and Detecting Collusive Management Fraud" (The CPA
Journal, October 2008), Stephen E. Silver, Arron Scott Fleming, and Richard A.
Riley, Jr., suggest that, beyond the review of management's fraud risk assessment, an
audit committee should consider the following questions:
Do the internal auditors and the audit committee have the knowledge,
education, and awareness of the various fraudulent management override and
collusive schemes that may be perpetrated by management?
Has the audit committee reviewed a comprehensive fraud risk assessment,
including how collusive fraud and management override schemes are
mitigated and detected?
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Have audit committee members participated in continuing education

programs that can prepare them for appraising management's fraud risk
assessment?
Did the audit committee assist in the collusive and management override fraud
risk assessment process, or did it rely solely on the internal or external audit
group?
Does the audit committee have direct oversight of the internal audit or do the
internal auditors report to management?
The present paper authors appreciate that the above questions are essential in
understanding the skills, knowledge and implication of internal auditors and audit
committee members on fraud topic. The audit committees members should focus on
the personality traits and skills of top executives and others responsible for high-risk
areas when assessing fraud risk or seeking to prevent or detect fraud. Routine
background checks on new employees can identify past criminal convictions
(Wolf, 2004).
In the authors opinion, mitigating fraud risk implies a joint effort of board, executive
management, audit committee, ethic committee, remuneration committee and units
ensuring compliance, internal audit and risk management functions. External auditors
must take part to this effort too.
The main actors remain the board members and the audit committee members. The
tone is provided by the board that has to fully adhere and respect its responsibilities
related to the overall risk management, fraud risk being imbedded in the overall risk
management process. The tone at the top means a clear signal insight and outsight
of the company that fraud risk tolerance is zero. The board oversight will focus on the
compliance with regulations regarding fraud and the effectiveness of the fraud
prevention, detection, investigation and remediation. Good corporate governance
determines strong ethical principles an organizational culture promoting those ethic
principles and values. The art and knowledge of the top management is to come
down these principles from the written code in the day-to-day activities and make all
the employees adhere to them. The board has to oversee the antifraud process
implemented by the executive management and assess its effectiveness. If the
executives are let to operate without ensuring the proper feedback, the board is in the
impossibility to cover its responsibilities in an appropriate manner.
Non executive members of the board are also members in the audit committee and
they must become the catalysts in the overseen process. They are an important vector
implementing the board requirements in the audit (internal and external), compliance
and risk area work and ensuring the feedback from the audit committee to the board
regarding the conclusions of the financial reporting, internal control and monitor
processes effectiveness and compliance. The authors believe that the role of audit
committee increases as a result of the new requirements in the risk management and
compliance area. From the fraud management perspective the audit committee must
ensure a proactive approach in fraud risk process.
In order to mitigate fraud the implemented process must be tailored on the companys
characteristics. In this respect, for the fraud mitigation program success, it is
compulsory to be identified the critical areas that can be subject of fraud actions and
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the potential schemas that can be used. A periodical internal control system
assessment will emphasize the week controls or the ones that can be avoided by
different executive and managerial positions. All these information, put together will
emphasize the real fraud exposure and the prevention techniques needed.
As the authors emphasized in a previous chapter, that it is impossible to prevent all
risks and the companies must be aware that frauds can remain undetected or their real
extent is not possible to be always establish. In this respect it is realistic to determine
an acceptable fraud loss (exposure). All the control systems will be then calibrated to
maintain fraud risk exposure under this accepted level. The fraud detection controls
will be added to the prevention ones.
The audit committee is asked to oversee the audit activities. In this respect the
committees members are asked to understand how internal audit is strategically
address fraud and how internal audit work is run for fraud detection. The same
approach is to be considered in relation with the external auditors. The
communication with external auditors must be characterized by transparence and
openness from both parts. The audit committee must allocate time for assessing the
executive management actions and monitor on fraud area and analyze litigations,
fraud tips and fraud events. Being a communication bridge between board, on one
hand, and, on the other hand, internal and external auditors, executive managers and
supervision entities, the audit committee dispose of all the information related to the
risk exposure and control and can provide its assessment and conclusions to the board
so that the most adequate risk-related decision to be taken.
The audit committee in its continuous monitor over the internal audit function must
ensure audit improvement. Risk oriented approach in internal audit work is essential.
Internal audit is asked to adjust its work to the identified risks and adapt its procedures
and techniques to fraud detection. More than ever, today is necessary to put in
practice continuous audit approach. The software tolls can ensure the extension of the
transaction analysis so that sampling concept to achieve another perception. Another
important role of internal audit is to ensure its support in the companys ethical
culture. Internal audit is not just a control entity it has also the role to make everybody
aware of risk and ethical values. In the authors opinion, for the effectiveness of the
control activities in general and internal audit in particular, is not enough to identify
unconformities and determine their impact, maybe is more important to make aware
the one that has generated the unconformity about the risk the company is exposed as
a result of its action.
6. FRAUD EDUCATION AND TRAINING
The growing rate of fraud and the low rate of success of fraud identification raise a lot
of questions related to the adequacy of the regulatory framework, the quality of the
internal and external auditors work and management quality. The importance of the
phenomenon by extent, implications and impact, social inclusively, determined
substantial concern for professional bodies (accountants, internal auditors, financial
auditors and fraud examiners), regulatory bodies and governments. Their response
was reflected in:
IASs review;
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strengthen regulations as for example Sarbanes-Oxley Act with its implications

for both auditors and companies, The Combined Code on Corporate
Governance and many others;
practical guides issued by professional bodies in many cases based on a joint
effort as for example Managing the business Risk of Fraud issued by IIA,
AICPA and ACFE.
Another important issue is related to the education area. Can we talk about
insufficient ethic training during university studies? Are the graduates prepared to
deal with the real ethical dilemmas or accounting and fraud forensic? Are their
accounting and auditing knowledge strong enough to ensure a solid base for their
professional activity and further developments? Is there a gap between the theoretic
and practical training of the graduates? How the universitys curriculum can be
improved?
The authors opinion is that improvements are necessary in both theoretical and
practical training. Important changes can be considered in the curriculum also
ensuring more space for fraud and ethical courses.
Another question waiting for an answer is: How is most appropriate to teach ethics, as
a stand alone topic or imbedded in accounting and/or audit topics? The authors
appreciate that any of the approaches can be followed but a theoretical presentation is
not going to provide the expected result. Study cases, debates, investigation
techniques will increase not just the students interest for the topic but will succeed to
offer a solid professional knowledge base for future developments.
The fraud problem, in all its forms corruption, asset misappropriation, fraudulent
statements, registers a continuous upward trend. It is a problem affecting public
organizations and private companies as well in all the countries, and all the
industries/sectors. All the surveys issued on this topic emphasize this phenomenon
and its increasing financial impact over the economies. The governments and
regulatory bodies issued regulations aiming to strengthen the control over the fraud
risk and limit its likelihood and impact. The fist documents issues in the field are from
the 1990s: U.S. Sentencing Guidelines (1991), COSO (1992), Financial Services
Action Plan (1999), U.S. Department of Justice Enforcement Guidance (Holder
Memo) 1999. In 2000s, the regulatory bodies increased the requirements issuing new
important regulations as for example: Sarbanes-Oxley Act of 2002, The Combined
Code on Corporate Governance 2003, European Council on Economic Fraud 2003,
Revised Combined Code with Turnbull, Smith, and Higgs Guidance 2005/2006. The
response to the fraud problem stands not just in the regulatory environment and the
supervision bodies monitor, but also in the companies improved governance.
Companies must understand that if they are not proactively managing risk fraud the
consequences could be very severe. In some industries as for example the financial
and insurance, a major fraud could put out the business over night or can damage so
deep the companies reputation that the business recovery could be extremely costly
and uncertain.
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As the surveys showed, solid governance ensures a diminished incidence of fraud.

The key of the problem stands in the organizations board and supervisory bodies
vision and decision. The solution stays in the implementation of a tailored fraud
prevention, detection and monitor process. The process effectiveness must be monitor
and the executive management must perform periodical assessments in order to ensure
the needed improvements. There is no common and predefined solution for the fraud
risk management. Being part of the overall risk management process, it has to be
tailored to the companys size, profile and characteristics.
The ethical aspects and the organization culture are extremely important for the fraud
prevention and detection process. The code of ethic existence, its full understanding
by the employees - meaning implications of fraud and unethical actions, way of
conduct and reaction in specific circumstances, are compulsory. The periodic
trainings on this topic must reveal that the code of ethic is not just a written document
but an attitude and way of conduct in day-to-day activities. Here the top management
implication is critical, at this level is provided the so called ton on the top which is
very important for the employees acceptance and alignment to its requirements.
The companies must be more are more aware that good governance, strong fraud
prevention processes help increase investors, regulators and the general public the
confidence in the integrity of companys financial reports and this could help to attract
and retain capital.
There are no surveys on fraud topic published for Romania. The authors believe that
there is an imperative need for transparence in this problem. The fraud exists whether
or not it is detected or recognized and in order to limit this phenomenon we must know
its specific characteristics. These characteristics are generated by the regulatory
framework (taxation one being extremely important), the quality of the supervision
bodies monitor, the quality of the organizations governance, the people level of
education, ethic and training and many other factors. Romanian public surveys on
occupational fraud will reveal all these aspects and, what is more important, the ways
frauds are committed so that the most adequate solution to be found. As long as we
are not going to understand were we are and how this fraud problem is affecting
Romanian companies the results in the fraud prevention and detection will remain
modest and ineffective. These surveys on Romanian organizations will make more
aware the managers on the importance to implement an effective fraud prevention and
detection process.
The efforts and resources implied by these surveys are important, but the benefits are
huge. A joint effort of the professionals and academic bodies having the support of the
regulatory and even governmental bodies will ensure the project success.
The universities curriculum must extent the space allocated to ethics, fraud and audit
forensic. Practical training based on strong theoretical knowledge will ensure the
graduate success in their professional life.
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REFERENCES
AICPA (2005) Management Override of Internal Controls: The Achilles' Heel of Fraud
Prevention - The Audit Committee and Oversight of Financial Reporting, available online at http://www.businesswire.com/portal/binary/com.epicentric.contentmanagement.
servlet.ContentDeliveryServlet/services/ir_and_pr/ir_resource_center/editorials/2005/AIC
PA.pdf, 20th Match 2011.
Allan, R (2003) The Human Face of Fraud, CA Magazine, May 2003, available on-line at
http://www.camagazine.com/archives/print-edition/2003/may/regulars/camagazine23440.
aspx, 2nd of March 2011.
Association of Certified Fraud Examiners (ACFE, 2002) Report to on Occupational Fraud
and Abuse. 2002, available on-line at www.som.yale.edu/faculty/Sunder/FinancialFraud/
2002%20Report%20on%20Fraud.pdf, 10th January 2011.
Association of Certified Fraud Examiners (ACFE, 2010) Report to the nations on
occupational fraud and abuse. 2010 Global Fraud Study, available on-line at
www.acfe.com/rttn/rttn-2010.pdf, 10th January 2011.
Carcelo J., Nagy A. Auditor Industry Specialization and Fraudulent Financial Reporting,
available on-line at http://aaahq.org/audit/midyear/03midyear/papers/Specialist.pdf, 10th
March 2011.
Cohen J. Krishnamoorthy G, Wright A. The Corporate Governance Mosaic And Financial
Reporting Quality. Journal of Accounting Literature, 2004, pp. 87-152, available on-line
at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1086743, 5th of March 2011.
COSO (2010) Fraudulent financial reporting 1998-2007. An analysis of U.S. public
Corporations, available on-line at www.coso.org/documents, 25th January 2010.
DiNapoli T. Red Flags for Fraud. State of New York Office of the State Comptroller,
available on-line at http://www.osc.state.ny.us/localgov/pubs/red_flags_fraud.pdf, 10th
March 2011.
Dorminey, D and al. (2010) Beyond the Fraud Triangle, CPA Jurnal, July 2010, available at
http://findarticles.com/p/articles/mi_qa5346/is_201007/ai_n54718070/, 15th March 2011.
Gursen H. F. Fraud profile-Fraudsters Work and Result, available on-line at
www.cimejes.com, 5th March 2011.
IFAC Manual de Standarde Internaionale de Audit i Control de Calitate. Audit financiar
2009. Ed. Irecson.
IIA, AICPA, ACFE (2008)Managing the Business Risk of Fraud: A practical Guide.
Executive Summary, available on-line at http://www.aicpa.org/InterestAreas/
ForensicAndValuation/Resources/PractAidsGuidance/DownloadableDocuments/managin
g_business_risk_fraud_excerpt.pdf, 25th March 2011.
KPMG KPMG Forensic -Fraud Survey 2003, available on-line at
http://www.amr.kpmg.com/aci/docs/surveys/Fraud%20Survey_040855_R5.pdf,
20th
December 2010.
Laflche D, Elzinga D, Seeto R. Trust and occupational fraud. How to trust is just as
important as whom to trust. A Grant Thornton white paper. 2001, available on-line at
http://www.grantthornton.ca/resources/insights/white_papers/Trust_and_occupational_fra
ud_2010_electronic.pdf, 5th March 2011.
Oversight Systems The 2007 Oversight System Report on Corporate Fraud, available on-line
at
http://www.ethicsworld.org/ethicsandemployees/PDF%20links/Oversight_2007_
Fraud_Survey.pdf, 3rd March 2011.
Silver S, Fleming A.S, and. Riley, R. Jr. (2008) Preventing
and
Detecting
Collusive
Management Fraud. The CPA Journal, October 2008, available on-line at
http://findarticles.com/p/articles/mi_qa5346/is_200810/ai_n30993408/, 1st of March
2011.
Wolfe, D and Hermanson, D The Fraud Diamond: Considering the Four Elements of
Fraud, available on-line at http://www.nysscpa.org/cpajournal/2004/1204/essentials/
p38.htm, 10th March 2011.
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Valerica MARES1
Marius Daniel MARES

Spiru Haret University, Romania
ABSTRACT
In this article the authors aim to create a presentation of the triangle morals-ethicsresponsibility with an accent on the current globalized society. Business ethics has to
disseminate in all the corners of a company, and first of all it has to be understood.
Understanding the moral criteria of behaviour in business is important because the new
Organizational structures create new complications, related to information flow and
information administration inside various workgroups and in the entire organization, for
which there are no traditional precedents.
KEYWORDS: business ethics, informatics criminality corporatist social responsibility,

ethical investments, green energies
INTRODUCTION
Eudaimonia means happiness, and the first to talk on this theme was the philosopher
Aristotel in Nichomahic Ethics where he talks about virtue that is needed by people to
lead the best possible life. The main idea of Aristotel is that there are different
opinions about what is best for people and these differences have to be resolved. The
question is: What is good? Aristotel doesnt look for a list of things thatd be easy to
make, Aristotel looks for the highest of the goods and considers that this, no matter
what itd be, has three characteristics: it is desirable in itself, it is not desirable for
another thing, and all the other things are desirable for it. Nobody lives for a certain
goal except the one of goodness. And all the subordinated aims, as health and wealth
are wished for the reason that they promote good and because they are good in
themselves.
The term ethics has at least three different meanings. First of all ethics refers to the so
called manners, customs and traditions specific to different cultures. Business ethics
implies introducing in daily decisions and in management strategies more norms than
the law requires. P. V. Lewis defines business ethics as that set of principles or
arguments that should govern the business behaviour, individually or collectively. A
company that is socially responsible, that is it takes into account not only the interests
of the shareholders but also the interests of all the groups affected by its activity, so
business ethics is a cost and implies delegating resources from the trajectory imposed
by a strict computation of economic efficiency. The problems and the opportunities
1
Correspondence address: Valerica MARE, Bucharest Academy of Economic Studies,

Faculty of Accounting and Management Information Systems; email: maresvalerica@yahoo.com
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created by the new technology, by the globalization process, by the privatization of

the media raises new ethic and spiritual challenges for those who work in social
communications. These challenges can be effectively met by those who accept the
fact that, in order to serve a human being, building a community based on solidarity,
justice and love, and presenting the truth about the human life are and will remain
aspects central to ethics.
The increase in the importance given to business ethics can be explained through the
changes suffered by the strategies and the structures of the corporations. Recent
currents in the managerial theory and practice, as total quality management, as well as
restructuring and redimensioning processes for top companies left to abandoning
many traditional practices for managing economic processes. Intricate and rigid
managerial hierarchies have been considerably flattened. As a consequence, the
authority and the decisional responsibility have been dispersed more and more inside
the company: important decisions are taken at lower hierarchical levels and by more
employees. Thats why it is required that each employee, not just the management,
should understand as well as possible the complexity of the problems and how they
should be reflected in the practical behaviour of the company in the economic
environment.
Business ethics costs: money, human resources and time, expertise, opportunities, as
investments or development. Moreover, business ethics and its most visible form, the
social involvement of the companies, are options that are not required by low. In the
classical form of the corporatist philanthropy, in the regulated form of donation and
sponsorship or in the modern form of corporatist social responsibility integrated in the
management strategy, the social involvement of the companies has been perceived for
a long time as a less and less necessary cost, a luxury of large corporations.
On the one side, involvement in the community is the appanage of the strong ones, a
distinct sign of economic power. Thus, it has taken the image of the generosity of
prosperous companies. Corporations, as well as organizations that have the social and
economic power, have to assume not only the role of economic agents, but also the
role of caretakers of the public interest, acting to assist the communities in whos
neighbourhood they operate. As wealthy members of the society, the large companies
felt they were obliged to help the poorest social groups.
On the other side, when it comes to companies that imply some risk, as the tobacco,
food, pharmaceutical companies, the ones that extract and process oil, community
involvement took the socially convenient form of risk management strategies, being
considered an efficient means to prevent and resolve the cries created by pollution,
deleterious products, by the improper working conditions. Until recently, business
ethics and social responsibility programs have been considered the jewellery of the
crown of large corporations.
Business ethics consider businesses from a larger perspective that is all the members
of the society have different material needs that they have to satisfy in the economic
system, through production activities, services, distribution, repairs etc. Businesses
are not the only possible way to satisfy these material needs. They appeared, during
the rise of the capitalism, as the most efficient solution to sustain a rapid and constant
economic growth (although not lacking in crises and difficult periods), an increase in
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the economic efficiency, of quality and the variety of products and services, a relative
or absolute decrease of prices etc. It is essential that the society doesnt exist for the
business people to profit from it, but on the contrary, it exists to support social needs.
1. SOCIAL RESPONSIBILITY AND THE NEW DIMENSIONS
OF GLOBALIZATION
The social responsibility of an entity means what the society expects from an
organization from an economic, legal, ethic and philanthropic point of view at a
certain moment.
Figure 1. Level of ethic
Social responsibility is a concept regarding the contribution that companies have to

have at the development of the modern society, and it is also called corporate
citizenship, corporate philanthropy, corporate societal marketing, community affairs,
and community development.
International states and institutions realized that the assimilation of the principles of
social responsibility by the companies serves the objectives of durable development
and led to the appearance of international standards for defining what meansdesirable
corporatist behaviour. United Nations, European Union and the Organization of
Economic Cooperation and Development are the most important institutions that
committed themselves in creating a framework for defining social responsibility and
for establishing indicators through which they can be evaluated in a transparent way.
This framework has been accompanied by recommendations and principles to guide
the states and the local authorities in formulating public policies that could promote
and ensure transparency and support social responsibility initiatives.
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Figure 2. Connection between companies and communities
In order to prove that it is socially responsible, a company has to understand which is

the social responsibility principles promoted at an international level and to
periodically report in order to integrate these principles in its activities.
Without being perceived as a sign of economic power, social responsibility takes now
a form of corporatist civics a way of keeping the business relationships stable and
profitable for all the parts involved, a non-aggressive way, a least detrimental
functioning way next to a community, a friendly way to communicate with the
society. In this form, social responsibility is nothing less than a modern, open and
flexible way of management. The practices and programs of social responsibility thus
become accessible and more and more interesting for small enterprises in their
business environment.
Social responsibility is often seen wrongly as the exclusive responsibility of the brand
manager, rather than a common responsibility of all the top managers in a company.
This happens because, indeed, many companies started doing social responsibility
after being surprised by the answer of the public to some of the aspects of their
activities that they didnt see as part of their business responsibilities. For example
NIKE had to stand a mass boycott after the media denounced the abusive work
practices of some of their suppliers in Indonesia.
In the business practices from small enterprises, the differentiation between
management and shareholders is vague and employees have multiple roles and the
main activities aim at solving the daily problems, which is done mainly through
informal relationships and communication. Also the interpersonal relationships play a
very important role. Moreover, when it comes to small enterprises, one can talk of an
increase degree of interdependence in the relations with the communities. Often, the
companies get involved in the life of the community through charitable actions. It
should not be forgotten that the small enterprises are vulnerable on the market; they
are subject to pressures done by the large companies for which they are suppliers of
products and services. The standards and the models of social responsibility are
promoted as a solution to the more and more difficult problems that the small
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enterprises have to confront on the European market. The uncertainty generated by the
pressures of the large companies, the unstable position on the former traditional
markets force the small enterprises to create strong partnerships, personal
relationships that can offer trust. It will be noticed a tendency of the small enterprises
to compensate the instability on the market with an increase of stability of the
interhuman relationships, with the employees, the business partners and the clients.
The social involvement of the small enterprises leads to an increase of the reputation
in the community, to improving the personal image of the owner and of the
administrator, and to increasing the trust in the enterprise, to increasing the loyalty
towards the company. All these guarantee the stability of the relationships with the
business partners, with the employees and the community.
There are also other factors that discourage the practices of social responsibility in
small companies: lack of managerial culture of the owners and administrators, an
aggressive attitude towars the market and competition of the small company
managers, the paternalist and authoritarian management style, conservatism, the
refuse of innovation in business practices.
In order to support companies the General Secretariat of the UN has created a
program Global Compact which is a partnership between United Nations and
companies for attaining a durable development at global level. Global Compact is a
network that comprises agencies of the United Nations, companies, union
organizations, business organizations, academic organizations, civil society
organizations, governmental/administrative institutions and is oriented towards social
responsibility on the basis of 10 universal principles, divided in domains of interest
and on dimensions: internal and external.
2. THE ETHIC INVESTMENTS IN IT
As soon as the interest of the public towards corporate responsibility increases, there
appears and grows considerably a new category of shareholders, who are interested
not only in the profitability of their investment, but also in the moral correctness and
the social responsibility of the companies in which they have shares. Unlike militant
shareholders, the adepts of ethical investments dont use directly their investments for
forcing companies to listen to their opinions and take them into consideration. They
look for those investments which are in the same time profitable and compatible with
certain ethical standards. In Cowtons definition, ethical investments are those that
use ethical, social and ecological criteria for selecting and administrating investment
portfolios when it comes to shares of certain companies.
The criteria for evaluation and selection of the companies can be negative or positive.
Those removed from the list of ethical companies are often the companies that
produce or trade alcohol, tobacco, military equipment and any products that are
detrimental to the environment or whose production is pollutant and consumes
nonregenerable resources. Companies that support oppressive political regimes
exploit cheap work labour from poor countries and employ minors; and finally the
companies that violate the rights of animals, that endanger biodiversity and those that
promote genetic engineering etc.
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The companies that meet the positive criteria are those that are involved in conserving
and protecting the environment, in improving public transportation and living
conditions, repairing and conserving buildings and architectural monuments, those
that promote green energies and those that ensure the equality of chances when
promoting employees, work safety conditions etc.
Besides the normative ethic motivation, the ethic investments can be desirable also
from a strictly economic point of view. The risks of having the public boycott some
products that are not accepted or the risk of ecologic disasters can influence the
dynamics of shares and the ethic companies are less exposed to such risks.
On the other side, the success on the market of ethic products can make the
investments they finance very attractive. The majority of ethic investment funds make
the selection of companies in whose shares are interested starting from the data
offered by the market. The profitable companies are then selected from ethic
onorability criteria, resulting a classification that is periodically re-evaluated and
made public. In practice the selection of the criteria and of the companies that meet
them is not at all easy. For example, many corporations from the electronic industry
produce household and medical equipment as well as military equipment. In the same
time, the investment in bank shares is not safe enough, because banks can finance
companies that dont meet the criteria of ethic investors.
In Romania, far from being an ethic undertaking, social responsibility is a possibility
of the companies to move the attention of population to legal obligations they should
meet in welfare actions. For example a company that is a big polluter advertises for its
action of planting trees that it does with volunteers, calling these actions corporatist
social responsibility and ethic investment.
The ethic investment movement spread considerably, with effects that are not
negligible. By aiming at investments towards corporations that meet certain moral
standards, investors dont exert an influence just on the policies of a certain company,
but also stimulates the other corporations to reconsider their ethic behaviour in order
to avoid a possible and predictible decrease of their attractiveness on the capital
markets in a short tem perspective.
3. THE ETHICS OF THE IT WORKFORCE
The sensitive personnel problems confronting the multinational IT corporations are
the following:
1) The payment of the employees, who work for multinational companies in
countries with a development level sensibly lower than in their home countries. It is
imputed to foreign investors that they exploit the labour from underdeveloped
countries, paying a couple of times less expensive the same labour done by employees
in their home countries with similar qualifications. On the other side the former are
disadvantaged by the fact that, by moving the investment and the production units to
the third world, there will be an increase in unemployment in the developed countries.
Transnational corporations are fiercely criticized for adopting selfish policies, in the
pursuit of maximizing profit, and they break that hypothetic social contract with
different categories of shareholders, causing prejudices to employees from their home
countries who lose their work and whos union pressure decreases in intensity when
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the owner can menace with relocation of investments in other countries and to
employees from the third world who are exposed to an equivalent work load to
those in developed countries but are paid worse. The counter arguments are numerous
and powerful. First of all the alternative for the employs in the underdeveloped
countries is to have a low pay (compared to the employees from the developed world)
or to not be paid at all, as long as the main point of interest for the foreign investors is
the low cost of the work force. It can be stated, many times rightly, that the salaries
offered by multinational corporations are sensibly higher than the average from the
poor countries in which these companies operate.
Besides the work environment offered by these multinationals is more correct, more
civilized and some principles when recruiting ad promoting labour are being
implanted in the countries from the Third World, thus creating more evolved models
for the leadership for treating the workforce.
On the other side, well paid employees from advanced countries are invited to accept
the lows of the market and of competition. Maintaining high salaries is not an absolute
privilege, not correlated with efficiency, productivity and efficiency. It is said that is
the work places would be maintained at any cost, as well as the very high level of the
salaries, the competition would take advantage and would invade the poor countries,
where it would create products and services with a similar quality, but much cheaper,
which would allow them to reconquer the market, ruining in the end the competitors
that dont adapt. The end would be tragic: bankruptcy, that is unemployment, reduced
budgetary funds for social assistance, fewer internal resources for investments (newly
created work places) etc In a word, after a short while a social policy of
multinational corporations would have extremely bad consequences for everybody.
2) The management of branches from other countries of multinational
corporations raises a lot of ethic problems. Many companies prefer to offer low credit
to local managers, and implant managers from their home countries to the
management of local branches. These managers sometimes dont know well enough
the traditions of the local problems and are not flexible enough towards the wishes
and the difficulties of the partners and the employees from the countries where they
are implanted. This is the main reason why, in these last years, multinational
corporations adopted a policy of managerial adaption, and promoted more and more
actively local leaders, trained professionally in the west, where they can learn the
methods and techniques of modern management.
3) Women discrimination is a delicate problem; the investor companies are not
necessarily culpable of it, because it is not its managers are those who impose it, but
the local traditions and religious beliefs. Multinational corporations are criticized by
the public opinion from the origin countries that they are not more determined in
having an active policy, even aggressive, for eliminating women discrimination from
the Third World, where it represents a hard to combat practice. Other, more
reasonable critics, refer to the fact that, in some countries where religion doesnt
prevent women from playing a role in economic life, the sexual discrimination takes
other forms, as employing mainly women because their salaries are lower than those
demanded by men.
4) Employing minors is, obviously, the most often incriminated aspect and
obviously the most criticable, in terms of personnel problems of the multinational
corporations. Thus it is deemed that without the material support of the children
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employed, their families would lack subsistence means, and those kids would have to
choose between dying of hunger and begging, stealing and roving. It is certain that
education, health and psychosomatic development of the children that work while still
young, are affected, and their future is sombre. By removing an appreciable number
of children from the educational circuit, the qualification of labour from the poor
countries stagnates at a very low level, with long term consequences in the
development and modernization of these countries. Thus the evil is done at individual
as well as at social level.
5)The measures taken to protect the employees constitute a problem for
international companies in terms of their public image in the origin countries and less
in the weakly developed countries in which they operate., although it is the employees
in poor countries that suffer. In the third world the labour legislation is weakly
developed or practically inexistent, thus the standards for protecting the personnel at
the work place are very low compared to the developed countries. Thats why
multinational corporations take much fewer measures for protecting the labour in the
branches from the third world as they do, forced by the legislation and by the public
opinion. In their origin countries, as a consequence there are many accidents, with
victims and grave mutilations of the employees at the work place. It is imperatively
required that the multinational companies should be more exigent in terms of work
safety. They dont reject the idea and take some measures, but not much, invoking
profitability and competitively. If they spent as much as necessary for the safety of the
employees, the costs would increase significantly and if some competitive companies
dont take these measures, they risk to be pushed out of the market, which should
bring back again the old dramatic dilemma of the workers from the poor countries:
risks and low salaries, versus no salaries. All that can be achieved through good
intentions is a compromise of the two requirements the economic and the moral
ones.
When we want to talk about these we have to have an emphasis on people more than
on simple technological actions in themselves. The teologic perspective on hackers is
that theyre nothing else than the effect of sin that once entered in the world affects all
its domains. No punishment will succeed in removing these deeds, because the real
change of man should not start from the exterior towards the interior, but from interior
towards exterior. The majority of those who are caught and jailed will not learn
anything from this experience, but this doesnt mean they dont deserve to be
punished for what they did, but they have to realize they need a change from interior
towards exterior. When their heart will be good, when their thoughts will be pure,
when their conscience will not condemn them anymore because their deeds are good,
then they will be truly changed. But it is not enough to condemn just the sin, thus
becoming irresponsible for our deeds. The sin has entered the world through the first
people but this doesnt mean were not able to be the masters of the sin. We have to
respect ourselves and for the ones around us, because once we have this respect we
will not allow ourselves to enter the private domains of those around us without
asking for permission.
4. SECURITY OF INFORMATION SYSTEMS AND E-CRIMINALITY
The impressive development of technology led to an increase in profits, on the one
side, and to an increase in dangers and fearfulness on the other side. As the electronic
media become more accessible to the general public, the informatics criminality is
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developed and diversified, becoming more than traditional fraud or falsification. On

Internet, information became the cheapest weapon in the world, but the problem of its
security gives headaches to the worlds powers, as on Internet every computer is like a
leaf of a tree and the network components are like branches. It is enough to cut a
branch and its result is equivalent to cutting the leaf.
The sophisticated world of the informatics systems is extremely alluring being a
digital world where are possible electronic businesses, efficient documentation over
Internet, distance learning, instantaneous communications, but apart from that the
information technology is not lacking in risks one of the most important being the
criminality.
The notion of informatics criminality is now more than the traditional definition
referring to criminality against informatics systems, and also includes most crimes
that can be done over the Internet using information systems.
Informatics criminality has a very high price in economic terms as well as from a
human security perspective. Before the age of developing informational technologies,
the main concern in regard to informatics data was keeping their confidentiality,
something that could not be achieved by simply protecting them physically (for
example, by locking them with a key in the rooms were information was being
stored).
Nowadays, along with the confidentiality there are the important aspects of security of
the IT that have become a complex and concerning problem for all organization types,
being in the same time a legal requirement. In order to ensure the security of the IT
and of the personal data, the authorities and public institutions with competences in
the field, the service providers, nongovernmental organizations and other
representatives of the civil society have common activities and programs in order to
prevent e-criminality.
Criminals can launch massive attacks with informatics viruses against
telecommunication networks for defence, electric power, gas and water or against the
systems for traffic control for aeronautic, naval and terrestrial industries, against
informatics systems of banks, stock exchanges, insurance societies, that can disturb
the activities in these fields.
The security requests of the informatics systems are based on a number of operational
and integration, legal, social, moral and human aspects with other informatics
systems. Informatics criminality can have severe consequences that can extend to
heavy financial and reputation losses that also come together with the security events,
and in these conditions the security management of the informatics systems becomes
extremely important.
In respect to criminality in the field of data networks, especially Internet, one can
distinguish the infractionality that aims at paralyzing the entire system or a part of it
or a structure that works with it, through virus programs or attack of the type Denial
of Service (DoS).
The age in which hackers wanted to prove their programming abilities has passed.
Meanwhile they discovered opportunities to make profit over Internet, as through
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Phishing. There are numerous traps through which criminals can get rich in the virtual
space, as by cloning the sites of banks, when the client receives an e-mail in which it
is required to enter on the site of the so called bank, the account data, the username,
the password and the secret access codes, and all the thief have to do is to empty the
account. According to the estimates of the Organization for Security and Cooperation
in Europe (OSCE), the informatics criminality produces an annual loss of 100 billion
dollars. The German association of the commercial society claims that in Germany, in
2007, the total value of the damage amounted to 13 billion euro. Other studies say that
e-criminality has become even more profitable than drug traffic. The international
authorities for legal pursuits have identified three regions in the world from which
come the majority of the trap e-mails: Russia, China in Brazil, areas in which the
illegal businesses flourish. The interest of the hackers is mainly focused on the
passwords of top-managers, in order to obtain extremely valuable information.
In the current crisis conditions it is to be noted that e-criminality is done more
frequently through:
a larger number of viruses, worms and Trojans that attack computer networks;
sending by email of false deduction coupons in the name of well known
companies;
an intensification of attacks caused by spyware, scanning ports, informatics
sabotages, pornography, computer thrift (desktop and mobile), abuses of
employees;
an increased incidence of attacks from within organizations;
attacks executed from outside that are aimed at countries like: USA, China,
Russia, Nigeria, South Korea, Germany and India.
More and more attacks are done through zombie computers grouped in networks
called boot net through which criminals pirate computers, without the knowledge of
the owners of the computers and use them for sending spam or for destroying other
computers. Programs can be distributed in different ways, one of them being as
attachment to e-mail or downloads from certain sites. Few technologies can provide
protection against all these phenomena that continue to increase (e.g. in December
2007 approximately 65% of all e-mails were spam) and a solution is being searched
which would solve the current challenges. The concept of Unified Threat
Management (UTM) offers a global approach to the problem of the security of IT, by
protecting the clients against attacks of versions types as:
scanning IP Reputation;
anti-spam based on patterns of messages;
white lists and blacklists;
antivirus based on signatures of families of viruses;
protection against zero-hour outbreaks;
intrusions prevention systems at the e-mail level.
The informatics criminality does not comprise only spam and viruses; it can also
strike other aspects of the economic and social life. There have been cases when the
adepts of different terrorist organizations, on certain occasions, as the success of some
of their actions, build site of sympathy for such groups, presenting details for
preparing them and congratulating the courage and the mastership of terrorists as if it
was a game. Other sites provide updated information for creating bombs or
instructions for manipulating explosive substances.
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Another category of terrorist activities over Internet is the dissemination of messages

of hate and incitation to violence through the Web pages and unfortunately things
dont stop at such activities, which in most cases are a precursor of real terrorist
actions and can get to incitation to attack and finally to organize grave criminal acts.
Criminal organizations have converted with an amazing speed to the most
sophisticated technologies and they use encrypted software for communicating over
Internet with a high degree of security. Network is a formidable means also for
organized bands that deal with drugs and arms traffic, as well as medicines, with
washing black money etc. because these bands understood that Internet is an ideal
communication means, cheap, fast and pretty secure when using encryption software.
In many countries of the world, displaying and distributing obscene materials in
public is against the law. There is no doubt that Internet, through its open nature, has
become such a place. Thus, performing such activities through a mega - network, is
most of the times prone to breaking the law. Nevertheless locations that contain
materials for adults are very numerous and the growing number of these sites and the
negative impact of disseminating obscene materials, of popularizing child
pornography on Internet have led to an increasing concern of the public opinion
regarding the multiplication of such an activity over the network. The fact that deviant
behaviour has moved their place of action does not change their criminal nature.
Apart from the older forms of e-criminality related to Internet, there are also some
new ones like: offers for adoption that cover selling of children or organs for
transplant.
Despite the sustained efforts of a company to protect its clients, a growing number of
users of the Internet have lost their faith in the efficiency of the security methods and
thats why a new culture of security is required in the contemporary society.
Pirating computer software represents another form of criminality related to Internet.
It is achieved by downloading programs spread over the Internet, on a computer,
when this operation is not authorized by the titular of the author rights.
The European Union and the Council of Europe have projects on cooperation against
cybercrime in Eastern Europe. Public and private sector organisations and initiatives
engaged in this field, such as the European Union, OECD, Interpol, ICMEC, ECPAT,
eNACSO, La Strada and Microsoft promoted good practices and contributed to the
discussion on strategies and policies to promote a safer Internet for children.
5. ETHIC CONTROVERSIES OVER ENVIRONMENT PROTECTION
This is the battlefield of the most disputes concerning global warming and
multinational corporations are the first to be incriminated, because environment
destruction, which often claims lifes, produce grave, often irreversible effects not
only in the countries where they take place, but they also affect the global climate, the
quality of water and air on a global scale. The causes of ecologic destructions are the
same as in the case of insufficient employee protection at the work place: the
legislation is very permissive, the local population has a low degree of technological
~590~
competence and doesnt understand the dangers to which it is exposed, the high costs
of non-polluting technologies etc.
In fact, the case that brought a focus on international business ethics was the disaster
from Bhopal, in India, but the earthquake and the tsunami from Japan, from March
2011 and the explosions at the nuclear power plant from Fukushima is enhancing this
discussion. Faced to these phenomena, the reaction and the pressure of the
international public opinion have been strong enough to force transnational
corporations to accept that they have an obligation to take radical measures for
ecologic protection in the countries where the local legislation doesnt impose very
high standards, by covering the higher costs that are required by non-polluting
technologies as well as by advertising and training the personnel and the population.
Faced with this set of problems, the competitors (their vast majority) have silently
agreed to be more responsible towards the ecologic dangers, because the public
opinion from their origin countries have an extremely hostile attitude towards the
companies with a dubious reputation in terms of environment protection policy.
Due to the variety of cultural values and moral principles around the planet and
because the accommodative policies had inacceptable effects, there appeared more
and more strongly the idea of elaborating international ethic codes, with the explicit
agreement of government or non-government associations, in which the main role
goes to the large transnational corporations.
The International Institute for Business Ethics proposes the following three basic
principles for companies:
INTEGRATION: Business ethics has to be implemented in all the aspects of
the organizational culture and it has to be reflected in managerial systems.
Companies have to start by integrating the ethics in fixing the objectives and
the practices for recruiting, employing and promoting the personnel.
IMPLEMENTATION: The ethic behaviour is not just an idea; it is also an
effort for implementing a plan for changing the attitude in different activity
branches of a corporation. Examples: changing the reward and stimulation
systems, promoting better practices for protecting the environment, consulting
experts whenever it is required.
INTERNATIONALIZATION: The ever more extended opening towards a
global market is necessary for any successful business in the 21st century. It
can be achieved through international partnerships, commercial blocks and by
implementing GATT agreements or other similar agreements. The clarification
of a companys definition of the moral integrity, so that it can transcend
national borders, is necessary for any corporation that operates on the global
market, and has as result an action plan and an ethic code without a specific
cultural colour, which doesnt require essential changes when applied in a
global context.
CONCLUSIONS
1. The last decade saw an explosion of ethic behaviour codes of multinational
corporations in international business. The majority of these codes are created
according to the principles established by OECD (Organization of Economic
~591~
Cooperation and Development) and ICGN (International Corporate Governance

Network). Unfortunately, many of these behaviour codes state vague truisms, and top
managers and analysts recognize that there is a lot to be done in implementing the
principles declared in these codes in the daily activity of companies that operate on a
global level.
2. Informatics criminality is a phenomenon which implied ethics and it affects
the international image of a country in a negatively way.
3. Many problems are still waiting for a solution that is strongly proofed
theoretically and verified in practice. It is important that the most pressing problems
have already been formulated and accepted by the community of transnational
corporations, which is a lot. Once started, the process of evolution of ethics in
international business will continue for sure, in an accelerated rhythm, hopefully with
positive results, for more and larger categories of interactive groups in the global
economy.
REFERENCES
Cowton, Ch., Crisp, R., (1998) Business Ethics. Perspectives on the Practice of Theory,
Oxford University Press
Crane, A., Matten, D. (2004) Business Ethics. A European Perspective, Oxford University
Press
Lewis, P. V. (1995). Defining Business Ethics: Like Nailing Jello to the Wall Journal of
Business Ethics 14 / 1985, p. 839-853
Petre Ru (2010) Infracionalitatea pe calculator http://www.rap.freehosting.net/Infract
Stella Petecel (1998) Aristotel Etica nicomahic, Bucureti, Editura tiinific i
Enciclopedic
Tudor Amza, Cosmin Amza (2003) Criminalitate informatic, Ed. Lumina Lex, Bucharest
http://www.coe.int/cybercrime
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CORPORATE GOVERNANCE PRINCIPLES:

AN EVOLUTIONARY APPROACH IN TERMS
OF DIRECTORS-MANAGERS RELATIONSHIP,
IN THE DEVELOPING ECONOMIC CONTEXT
OF 21ST CENTURY
Maria GROSU1, Roxana-Manuela DICU & Daniela MARDIROS
"Alexandru Ioan Cuza" University of Iasi, Romania
ABSTRACT
Corporate governance is intended to guide companies in adopting best practices and
appropriate behaviour both in management and in relations with the stakeholders. This paper
aims to examine corporate governance principles through three different approaches. First
one refers to the temporal evolution of the principles starting with their appearance in 1992
until present days, presenting the countries and the bodies which had the highest influence in
this evolution (Great Britain, France, United States of America, and Organization for
Economic Co-operation and Development). This part contains a special reference to the
application of corporate governance principles in Romania. A second approach takes into
consideration the degree of development of worlds economies and their attitude on
willingness to adopt and develop corporate governance principles. The third perspective
analyzes the principles, considered significant in our opinion, with their presentation both
from a general point of view and in the particular case of Romania: the fair treatment of
shareholders and of the stakeholders vs. the well-known conflict between them, the role and
the responsibility of the Board of Directors, and the transparency and the dissemination of
information. In this context, an analysis of the Romanian business environment emphasises
the lack of authority of the Board of Directors members, a requirement to independence, and
to transparency. Based on the evolution of corporate governance principles and on the
current state of Romanias codes, the results of the research are to be a base for
reconsidering the principles of corporate governance in Romania and worldwide.
KEYWORDS: corporate governance, managers, Board of Directors, corporate

governance codes, responsibility
INTRODUCTION
The globalization of businesses, the development of new information technologies
and communications have created an environment which allowed the development of
the worlds economies. Managers and directors had to adapt and to cope with
situation of unknown complexity and with difficulties created by a world in constant
motion. This development required a new perspective from the companies and a new
approach of their management, in terms of ethics, responsibility and practice, all
known as corporate governance. In addition, valuing human capital, the importance of
1
Correspondence address: Maria GROSU, Alexandru Ioan Cuza University of Iasi, Romania;
email: maria_lia24@yahoo.com
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skills and expertise of employees, their institutionalized knowledge, has positive

valences, in the context of the 21st century.
Corporate governance (CG) is a system through which a company is managed and
controlled, according to best practices in a specific field. At the enterprise level,
corporate governance investigates the distribution of power and responsibilities
between the organization of shareholders, directors and managers. Currently the
definition of the concept has expanded and it is used to describe the act of governing,
the way to administer, manage the states, world bodies and businesses. As a system, it
has rules, principles and guiding lines, all these being presented in an evolutionary
context.
1. THE EVOLUTION OF CORPORATE GOVERNANCE PRINCIPLES
AT EUROPEAN LEVEL
In Europe, the first corporate governance code was the Cadbury Code (issued in
1992), which formed the basis for the Corporate Governance Code of the London
Stock Exchange and held three basic principles of corporate governance (Cadbury,
1992): transparency, integrity and responsibility. The Code took the name from Sir
Adrian Cadbury, who was the Chairman of the Board of Directors for Cadbury
Company for 14 years.
If transparency, demonstrated through publication and dissemination of information,
promotes a determined Board of Directors (BD) and allows stakeholders access to
information about the company, the principle of integrity requires the company to
behave honestly in all undertaken activities. An appropriate conduct and disclosure of
information required by all those interested, especially by the shareholders, should
lead, according to the Code, to the principle of accountability. Responsibility as a
principle of corporate governance is the effective duty of the BD and is manifested by
the provision of information that meets the quality requirements in order to be
relevant to decision making.
Later, as a result of financial scandals that have destabilized the operation of the
British system, the importance of corporate governance was reconsidered, quality of
implementation of recommendations contained in the Cadbury Code being discussed
in a series of progress reports issued in the coming years. Thus, in 1995, the
Greenbury Report was prepared, which highlighted the problems of managers
remuneration and the reality of wage amounts released. In 1998, the Hampel Report
appeared which, on the one hand, synthesized the application of recommendations
from Cadbury Code for the last five years, and, on the other side hand, made a series
of new proposals. After wards, the Hampel Report was followed by the Higgs Report,
which gave special attention to independent non-executive directors (audit
committee), monitoring how to respect the interests of shareholders.
Summarizing, the recommendations contained in the Cadbury Code have considered
the following aspects:
Division of responsibilities at the top level of the company to be clearly
formulated and accepted by all;
The Board of Directors must be constituted of both executives and nonexecutive directors to represent the independent interests of shareholders;
~594~
Executive directors should be appointed by the shareholders for a term of

three years, as a rule, and must be subject to annual review process;
Non-executive directors should work in the independent committees (audit)
and are mandated to represent shareholders' interest in fields covering results,
strategy, quality management etc.
Auditor independence is essential; therefore, the Audit Committee has the
task of selecting auditors so that their mission is one of quality.
Even if the failure of these recommendations has not been sanctioned by law,
however, the compliance of listed companies has resulted in their self-discipline.
Starting from the Cadbury Code and given the reports for monitoring the progress of
implementation of the recommendations, in 2000 the Combined Code of corporate
governance is completed. It was perceived as a code of best practices and became an
imperative requirement for listed companies at the London Stock Exchange. The
Combined Code contains two parts: one part for the principles of good governance
and a second part, covering the code of best practices. Both parts consist of two
identical sections: Section I - Companies (A. Executive, B. Remuneration of
management, C. Relationship with shareholders, D. Accounting and auditing) and
Section II - Institutional Investors. The principles of good governance, set out in the
first part of the Combined Code, were six and were referring to:
Every company has to be effectively managed by a Board of Directors;
Between the Presidency and the Executive Director must be a clear division
of responsibilities;
The Board of Directors activity should be based on stability and
independence;
Managers' remuneration should be linked to their achieved performance;
The Board of Directors should establish formal and transparent procedures of
internal control and maintain appropriate relationships with company
auditors;
In the relationship with shareholders, companies must be prepared to engage
dialogue with institutional investors, but also with private ones.
In addition, to implement these principles in the companies, the Code makes a number
of recommendations with preventive role that refer to both sections mentioned above.
Even if this code is voluntary, institutional investors require companies to either
comply or explain reasons for not apply the principles and recommendations.
In response to the British initiative in relation to corporate governance standards, the
French doctrine envisaged both the regulatory process and the preparation of reports,
the same way as the British doctrine. Regarding the legislation, in 1996, considered to
be a starting year, a law was issued, that offered two models which could guide
companies in their corporate governance systems. Compared to the Cadbury Code,
which allows the coexistence in the BD of both executive and non-executive directors,
the French notion considered a radical solution (Richard and Miellet, 2002), the
application of the dualist model of governance, through a clear separation of the
Executive from the Board of Directors / Supervisory Board. Another French model is
the monist model, that is closer to Anglo-Saxon concept, meaning that both
executives and non-executive directors met in a single (but collegial) Board.
However, the monist model has been criticized because allowed increasing the power
~595~
of the President-Chief Executive Officer, directors not being able to take action than
in a collegial manner. So, on the one hand, the belief was that managers had an overall
responsibility, but, on the other hand, their power could only disapprove without
acting in the direction of the President's conduct.
In these circumstances it was considered necessary to issue rules that would enhance
the power of the directors, developing a series of reports prepared by experts and
monitored by the French parliament. It is about Vinot I Report, issued in 1995,
Marini Report, issued in 1996, Vinot II Report, issued in 1999 (Richard and Miellet,
2002), which offered several recommendations, not necessarily implemented, the
reason being the rejection of the idea of change. However, since 1999, listed French
companies have agreed to report on corporate governance, while respecting the
principle of transparency (the publication of salaries of managers) and they have
showed that they had recourse to the appointment of independent directors. An issue
that has raised much discussion was the fact that the French doctrine sustained the
social interest of the company over the interest of shareholders, and, because of that
situation, many abuses were committed in the name of social goodness, in violation
of law or by finding legal openings (Onofrei, 2009).
These drawbacks were alleviated by changes in French corporate governance law,
namely:
the Law adopted on May 15, 2001 introduced the obligation to publish salaries
of managers by all companies (listed and unlisted); this specification is
required to ensure a balance between the power of decision-making bodies, to
avoid membership in several Boards of Directors, to observe the minority
shareholders rights and to ensure the transparency of information;
Financial Security Law of 2003 provided the compliance of good practices by
both companies and financial markets to ensure investors confidence; thus,
due to financial scandals in the U.S. (see Enron, Worldcom), it was denied, by
that law, the initiation of takeover bids without shareholder approval.
Regarding the imposed rules, studies have shown that approximately 54% of listed
French companies have complied with the corporate governance reports. In this sense,
the dual governance structure was most common (either by separating the positions of
President and the Chief Executive Officer, either by separating the Directorate and the
Supervisory Board), to comply with a legal obligation to publish the remuneration of
managers. It appeared more frequently the presence of independent directors, and
companies have responded positively to Government's initiative to ensure
transparency through the dissemination and publication of information, knowing that,
this way, stakeholders shared information about the company.
In the EEC, public information about the Corporate Governance in Europe appeared
in June 1995. Changes and improvements to the Codes of CG occur during this
period, so in March 2010, the Code ecoDa Corporate Governance Principles and
Guidance for Unlisted Companies in Europe was adopted. It was issued by The
European Confederation of Directors Associations (ecoDa). This Corporate
Governance Code includes a set of 14 principles that focus specifically on the
protection of minority shareholders in the face of possible abuses by controlling
shareholders.
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The corporate governance system in Europe is considered an insider system (Clark,

2007), characterized by the presence of active shareholders within the corporation and
it is in direct business relationship with the entity. Therefore, concentrated ownership
is associated with the control, the mission of management seeks the interest of
stakeholders groups, to increase added value for them. In addition, business strategy
proclaims active long term involvement of the stakeholders.
Important to note is that, by Directive 2006/46/EC, the Commission adopted an
Action Plan announcing measures to modernize Companies law and to enhance
corporate governance in the Community. Short-term priorities of Community action
in this area have involved, inter alia, the following: confirmation of the collective
responsibility of directors and improving information on corporate governance
practices applied in companies. According to the plan of action, members of the
administrative, management and supervision bodies of a company must act according
to the powers which have been conferred by law. Also, companies whose securities
are admitted to trading on a regulated market and which have their registered office in
the Community are required to submit an annual statement on the CG when the
company applies the corporate governance provisions other than those set by national
laws, whether these provisions are set directly into a corporate governance code of the
company or any corporate governance code which the company may decide to apply.
For the adopted system of corporate governance to contribute to improving the
company's potential for creating value, it is not sufficient only the concern for legal
and financial dimension of corporate governance (separation between property
function and directorate function), but it is also important the managerial dimension,
which makes the creation of value an effect of applying a set of skills in a context
based on discipline and accountability.
2. THE AMERICAN DOCTRINE A DIFFERENT APPROACH
OF CORPORATE GOVERNANCE
North American doctrine, in relation to corporate governance, comes in conflict, in
some points, with the rules of European law (in particular, French law), namely:
In the U.S., the audit committee appoints the independent external auditor,
while in France, General Meeting of Shareholders is one that takes the
decision as a response to the Board of Directors proposal;
U.S. law strengthens the protection of employees who provide important
information to leadership;
Directors who amend the annual financial statements may be required, under
U.S. law, to repay bonuses and other remuneration received, while French
law prohibits such practices;
Under U.S. law, auditors must provide information and documents on the
company's activity to Securities Exchange Commission and other inspection
authorities; the French law considers it a breach of confidentiality.
For a better understanding of this specification, we must mention the fact that in US,
the first Official situation of corporate governance was issued in September 1997,
and the first set of Corporate governance principles was framed in 1999.
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If we consider the evolution of corporate governance principles in the U.S., we can

report that, in terms of managers remuneration increase (especially in the form of
stock-options), in the 90s there was a relaxation of the ethical principles of
management, and corporate social responsibility was put in a shadow by personal
interest. The serious bankruptcies in the 2000s destroyed investors confidence and
thus the principles of corporate governance were re-imposed, especially in terms of
improved quality and transparency of financial reporting.
Therefore, the scandals in 2000 formed the basis of reflection for improving corporate
governance legislation in the U.S., but not only. In this regard, in July 2002, SarbanesOxley Federal Act was issued, known as The accounting reform of public companies
and investors protection law, applicable to all companies operating in the U.S.,
whether indigenous or not (there were about 1,300 foreign companies operating in the
U.S.). Among the important provisions of this law, we can enumerate: the president
must certify under oath the company's financial statements; managers are not allowed
to credit the managed company; in the event of subsequent changes to previously
announced results, the managers participation to the profit will be readjusted; audit
committee must be composed entirely of independent directors; the protection of
employees' rights and their contributions to pension funds; on suspicion of fraud,
Securities Exchange Commission will be able to dismiss managers without agreement
with the General Meeting of Shareholders.
We have noted that, under the provisions of this law, the intention was to restore
investors confidence in American capital markets by increasing the stringency of
corporate governance rules. To supplement the provisions of Sarbanes-Oxley, Richard
Breeden (Chairman of the Securities Exchange Commission and the administrator
appointed by the U.S. bankruptcy judge for overseeing WorldCom's bankruptcy)
published in 2003 a report that makes 78 recommendations on corporate governance,
including: a prohibition of overlapping of the function of President of the Board of
Directors with General Manager; better remuneration of directors, with the obligation
to invest 25% of net income on the stock market, buying shares in the administered
company; a prohibition for administrators to be members of the Board of Directors in
more than two companies; a convergence of interests of shareholders with those of
managers, etc.
Although the U.S. attitude towards corporate governance system was appreciated,
however, the financial crisis in 2007 could not have been prevented. In particular, this
was due to the acute lack of liquidity, the chain of bankruptcies, which had
repercussion on investors in the sense that their confidence in capital markets was
destroyed.
3. THE INTERNATIONAL POINT OF VIEW ON CORPORATE
GOVERNANCE PRINCIPLES
Internationally, the OECD (33 members) is the organization which, in May 1999,
adopted five principles of corporate governance that have emerged as the global
benchmark (WB and IMF are guided by these principles in preparing their reports)
and have inspired the development of corporate governance codes not only for the
Member States (from 2010 are OECD members three more countries: Chile, Israel
and Slovenia), but also for other countries. The corporate governance principles were
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set out by the OECD in a general manner, each Member State being able to apply
them according to specific national circumstances.
To analyze the evolution of principles issued by the OECD, in the table below we
present the codes adopted since 1999, the last update being in September 2005,
according to European Corporate Governance Institute (see table 1). It is noted in the
presented situation that the five principles of corporate governance, adopted in 1999,
were completed both with three principles (or rules), and a general framework, issued
within five years of the first initiative in this direction. Of course, in addition, some
nuances have taken place in expressing, some of them quite significant. In this sense,
if in 1999, the term corporate governance rules was used, the version of the 2004
Code used the phrase corporate governance regime. In addition, very importantly, a
new formulation is introduced, must instead of should, therefore the corporate
governance principles are becoming imperative, these no longer being seen as
recommendations. Consequently, improved versions of the Codes issued by the
OECD increase the value of corporate governance principles and contribute to
international financial stability.
Table 1. The evolution of corporate governance principles according to OECD
Principles and regulations
1. The shareholders rights and their key

positions
2. Fair treatment of shareholders
3. The role of stakeholders in the corporate
governance
4. Transparency and dissemination of
information
5. The responsibility of the Board of Directors
6. Ensuring an effective legal framework for
the companies in the Member States
7. The state in the position of shareholder
8. Fair treatment of all stakeholders
General framework for corporate
governance
May
1999
*
Corporate governance code

Jan
Apr
Dec
2004
2004
2004
*
*
*
Sept 2005
*
*
*
*
*
*
*
*
*
*
*
*
*
*
*
*
*
*
*
*
*
Given the different goals of the reform of the corporate governance on the American
continent, the question of convergence of these systems was asked, especially for the
reason that the business environment has features in common, without excluding
management errors, accounting manipulation, bankruptcy, loss of value of assets,
massive layoffs of employees, etc. In this respect, OECD has developed a guide for
the convergence of corporate governance codes, which contains a minimal set of six
rules applicable to listed companies, namely:
applying the principle of comply or explain;
defining the audit functions and establishing limits of action for auditors;
improving transparency;
defining conflicts of interest and their control;
improving and simplifying voting procedures and increasing the role of
General Meeting of Shareholders;
increasing the role of independent directors (non-executive directors) in the
company.
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The implementation of these rules has been monitored by the OECD in 30 countries,
and results showed that 11 states have made changes in corporate law with an impact
on five or four of the six rules listed (Switzerland, Italy, Belgium, USA, Germany,
Greece, Czech Republic, Poland, South Korea and Japan), eight states have not taken
any change in this regard (Finland, Australia, Hungary, Denmark, Slovakia, Norway,
Luxemburg and Iceland), while other states have made changes in Corporations law
which affected less than four rules.
4. CORPORATE GOVERNANCE PRINCIPLES IN ROMANIA
In Romania, the need to implement the rules of corporate governance was determined
by the privatization process which required companies to improve management
practices, on the one hand, and by to transfer the control and surveillance from
political organizations to specialized Board of Directors, on the other. By the issuance
of the first law of privatization (in 1991), the State Council was replaced by General
Meeting of Shareholders and the Board of Directors was established. The
implementation of corporate governance rules was a way to harmonize internal
business environment with a functioning market economy requirements.
The first corporate governance code in Romania was issued in June 2000 by The
International Center for Entrepreneurial Studies and targeted public companies listed
on Bucharest Stock Exchange. The code rules have not been so well received by the
market, the last one focusing especially on the ground that protects minority
shareholders.
Subsequently, in 2008, the Code of Corporate Governance of BSE was issued,
including a number of 19 principles. Of 19 principles, 14 principles aimed, directly,
the Board of Directors, its powers and functions, with emphasis on the independence
of non-executive directors. This situation is surely due to the recommendations of The
World Bank for our country as a result of a study undertaken for the period 2001-2006
in 17 countries in transition (McGee, 2008). The study focused on changes in
corporate governance practices, being analyzed the way companies comply with its
principles. The results of the analysis revealed that Romania was ranked five, along
with Bulgaria and Slovakia in terms of compliance of corporate governance
principles. In these circumstances, the recommendations of World Bank were
following two directions:
The need to increase the role of the Board of Directors and the need for
creating specialized committees to advise the board;
At the General Meetings of Shareholders in the listed companies, external
auditors should take part in order to provide explanations for how the
shareholders had honored their obligations under the contracts.
According to authors study on the public information on Corporate
Governance, presented by 65 listed companies on Bucharest Stock
Exchange (1st and 2nd category) on their websites, few conclusions can be
drawn:
Only three of the analyzed companies (5%) are managed under a dualist
system (Carpatica SA, OMV Petrom SA, Prodplast SA);
Eight companies (12%) have adopted their own Corporate Governance codes
(Alro SA, Antibiotice SA, Azomure SA, Transelectrica SA, Ropharma SA,
Transgaz SA, Altur SA and Carpatica SA);
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32% of the companies (21 out of 65) have no mentioning about corporate
governance system or rules on their websites or in their reports;
A weakness for 35% of the listed companies on BSE (23 out of 65) is the fact
that they are managed under a monist system (which reunites in a single
Board both executive and non-executive directors), without the position of
President to be separated from that of CEO.
The percentage of the companies that dont publish any information about corporate
governance (32%) poses a question mark on the assurance of transparency, one of the
base principles of corporate governance, according to Cadbury Code.
In conclusion, the same as political power, economic power must be limited by
separating the executive directors (managers) of non-executive directors, and by
dispersing ownership. Any shareholder has the tendency to abuse his power of
control, and lack of separation of the two categories of directors will lead undoubtedly
to a concern for personal interest, let alone the interests of the company.
5. A DIFFERENT VIEW ON CORPORATE GOVERNANCE PRINCIPLES.
DO THE RAPID ECONOMIC GROWTH
AND THE INDUSTRIALIZATION PROCESS MATTER?
Another way of approach the corporate governance principles is through the personal
involvement of states, the concerns for improving these principles. This may be
reflected by the number of codes issued, but also by their topicality. According to a
date analysis of the worlds codes on corporate governance, the Great Britain has
issued the most codes (31), the last one being issued on 2010, so it has further
concerns on this line. The most recent code was issued by Egypt (February 13, 2011).
Components of the worlds economy, emerging economies are characterized by the
fact that they belong to nations whose social and business activity is in a rapid process
of growth and industrialization. One argument for this assertion is the fact that 28
emerging market economies were recorded in 2006 according to classifications, and
their number reached to be over 40 in 2010. Considered to be in the process of
transition between developing economies status and status of developed economies
and wanting to accede as soon as possible to the latter status, emerging economies
have openly adopted codes of corporate governance, in order to facilitate the conquest
of new market segments (transparency - the dissemination and disclosure, honest
behavior - valence which shows integrity and accountability in all undertaken
activities -translated in providing information that is relevant for decision making).
However, these codes are the way through they guide their behavior, designed to
serve non-traditionalist customer, open for new products and services, for innovation
and investment in technology. The situation of emerging economies that have adopted
codes of corporate governance is presented in Table no. 2.
~601~
Table 2. Worlds emerging economies that have adopted CG codes

Period
Emerging economies and corporate governance codes
1994
South Africa has adopted the first code of CG
1998
India has adopted the first code of CG

Thailand has adopted the first code of CG
1999
Mexico has adopted the first code of CG

Korea has adopted the first code of CG
India has adopted the second code of CG
Thailand has adopted the second code of CG
2000
Indonesia has adopted the first code of CG

Malaysia has adopted the first code of CG
Romania has adopted the first code of CG
India has adopted the third code of CG
2001
Brasilia has adopted the first code of CG

China has adopted the first code of CG
Czech Republic has adopted the first code of CG
Peru has adopted the first code of CG
Singapore has adopted the first code of CG
Indonesia has adopted the second code of CG
2002
Pakistan has adopted the second and the last code of CG

Hungary has adopted the first code of CG
Russia has adopted the code of CG
Slovakia has adopted the first code of CG
Taiwan has adopted the first and the last code of CG
South Africa has adopted the second code of CG
Thailand has adopted the third code of CG
Brasilia has adopted the second code of CG
Peru has adopted the second and the last code of CG
2003
Lithuania has adopted the first and the last code of CG

Nigeria has adopted the first code of CG
Turkey has adopted the first code of CG
Korea has adopted the second and the last code of CG
2004
Argentina has adopted the first and the last code of CG

Bangladesh has adopted the first and the last code of CG
Brasilia has adopted the third code of CG
China has adopted the second and the last code of CG
Czech Republic has adopted the second code of CG
Singapore has adopted the second code of CG
2005
Latvia has adopted the first code of CG

Singapore has adopted the second and the last code of CG
Turkey has adopted the second and the last code of CG
2006
Egypt has adopted the first code of CG

Egypt has adopted the second code of CG
Estonia has adopted the first and the last code of CG
Saudi Arabia has adopted the first and the last code of CG
Sri Lanka has adopted the first code of CG
Thailand has adopted the fourth and the last code of CG
2007
Bulgaria has adopted the first and the last code of CG

Columbia has adopted the first code of CG
United Arab Emirates has adopted the first and the last code of CG
Indonesia has adopted the third and the last code of CG
Malaysia has adopted the second and the last code of CG
Hungary has adopted the second code of CG
Nigeria has adopted the second code of CG
~602~
Period
Emerging economies and corporate governance codes
2008
Morocco has adopted the first and the last code of CG

Slovakia has adopted the second and the last code of CG
Hungary has adopted the third and the last code of CG
Nigeria has adopted the third and the last code of CG
Sri Lanka has adopted the second and the last code of CG
2009
South Africa has adopted the third code of CG

India has adopted the fourth and the last code of CG
Romania has adopted the second code of CG
Brasilia has adopted the fourth and the last code of CG
Columbia has adopted the second and the last code of CG
2010
Bahrain has adopted the first and the last code of CG

South Africa has adopted the fourth and the last code of CG
Mexico has adopted the second and the last code of CG
Latvia has adopted the second and the last code of CG
2011
Egypt has adopted the third and the last code of CG
According to our study, the situation of the countries with developed economies is
different. Their status impose a continuous preoccupation for corporate governance
because, unofficial, they give the international tone in terms of applying the principles
and code of corporate governance, in being responsible and in updating the codes and
rules of corporate governance. We consider relevant a commentary on the situation of
issuance of corporate governance codes in 2010.
As we can notice, Great Britain remains the most prolific in issuing corporate
governance codes, with five updates. United States and Germany are next countries
whose preoccupation in terms of corporate governance is obvious, considering the
number of codes already issued until 2010 (13).
Table 3. Developed economies that have adopted corporate governance codes
in 2010
Period
2010
Developed economies and corporate governance codes

Australia has adopted the 10th and the last code of CG
Norway has adopted the 6th and the last code of CG
Germania has adopted the 14th and the last code of CG
France has adopted the 9th and the last code of CG
Great Britain has adopted the 27th, 28th, 29th, 30th, 31st and the last code of CG
USA has adopted the 14th and the last code of CG
Greece has adopted the 3rd and the last code of CG
Ireland has adopted the 3rd, the 4th and the last code of CG
Portugal has adopted the 8th and the last code of CG
Denmark has adopted the 8th and the last code of CG
Sweden has adopted the 7th and the last code of CG
Next to emerging economies and developed economies, frontier economies, as a

subset of emerging economies, do not had preoccupations for corporate governance
codes, because their activity is not yet focused on principles of high conduit and
behavior. Although, there are some tendencies towards a code of corporate
governance, as follows:
~603~
Table 4. The codes of corporate governance in worlds frontier economies

Period
Frontier economies and corporate governance codes
2001
Malta has adopted the first code of CG
2002
Cyprus has adopted the first code of CG

Kenya has adopted the first and the second (last) code of CG
2003
Cyprus has adopted the second code of CG

Ukraine has adopted the first and the last code of CG
2004
Slovenia has adopted the first code of CG
2005
Malta has adopted the second and the third (last) code of CG
Slovenia has adopted the second code of CG
2006
Cyprus has adopted the third and the last code of CG
2007
Slovenia has adopted the third code of CG
2008
Serbia has adopted the first and the last code of CG

Tunisia has adopted the first and the last code of CG
2009
Croatia has adopted the first and the last code of CG

Slovenia has adopted the fourth and the last code of CG
2010
As we can notice, the codes were issued in the first decade of the 21st century, and
Slovenia was the most prolific in developing and improving a national corporate
governance code (four codes), being followed by Cyprus with three codes and Malta
with also three codes.
6. THE FAIR TREATMENT PRINCIPLE. THE DIRECTORS
PERSPECTIVE ON THE SHAREHOLDER-STAKEHOLDER DISPUTE
Another approach on the principles of corporate governance is through the principles
which were given more importance over time. In our opinion, one is the fair treatment
principle, whether it is about stakeholders or shareholders.
Directors and manager need to be aware of the interests of stakeholders in corporate
governance; however their responsibility towards them is valued and questioned.
According to OECD, which presented a condensed list of stakeholders in corporate
governance, they include the follows (Frmond, 2000):
Employees: There is widespread agreement that they are a prime stakeholder.
Their internal position, their direct role in business development and
productivity, the dependence of a company on their knowledge, abilities, and
expertise are the main arguments in this direction;
Shareholders: Some would say that shareholders are the first stakeholder,
hence the controversy over the main concerns of directors, presented in this
paper;
Management: Controversial, but some believe that managers are
stakeholders, because they help maintaining and developing companys
capital, establish strategies, based on known data;
Creditors: Creditors rights are often protected under contract and backed by
collateral so they are seldom treated as owners as the shareholders are;
Trade unions: Some argue that this group is redundant with the employee
group;
~604~
Customers: Most stakeholder models include customers;

Suppliers: Often considered a stakeholder;
The local community: Broader definitions of stakeholders widen the concept
to include responsibilities to local communities and, more generally, civil
society;
Future generations: Sustainable development is at the center of the
stakeholder debate and this suggests a responsibility to future generations those who will one day be reliant upon the physical environment - as a
stakeholder group.
So, stakeholders are any entity (person, group or possibly non-human entity) that can
affect or can be affected by the actions or policies of an organization. It is a bidirectional relationship. Each stakeholder group has different expectations about what
it wants and different claims upon the organization.
A problem is the attitude of directors towards taking strategic decisions involving
shareholder-stakeholder conflicts (Adams et al., 2010). There is considerable dispute
about whose interests should be taken into account. The shareholder model states that
the purpose of the corporation is to promote shareholder value, but the stakeholder
model states that the purpose of the corporation is to serve a wider range of interests.
The legitimacy of each stakeholder will depend on ethical and political perspective on
whether certain groups should be considered as stakeholders.
Enhancing shareholder value is a desirable strategy, but international accounting
regulations are referring to all the stakeholders, as users of financial information. Of
course, the investor is considered to be the main stakeholder, hence the orientation
towards him. Stakeholders are equally principled, yet views shareholders as one
among several stakeholders whose interests deserve consideration. The
preoccupations either for stakeholders or for shareholders are polar strategies, but
most decision makers, however, will follow their principles to find a middle ground in
light of the context.
In this context, we may consider that the board members will endorse corporate
actions that benefit shareholders the more they hold values that are compatible with
the economic interests of equity investors, but board members who represent a
particular non-shareholder constituency (employee representatives) exhibit a
stakeholders stance in general because their role calls on them to balance the interests
of several constituencies.
Whether corporate governance should be monist or dualist can be a theme in debates
over stakeholder/shareholder approach of the Board of Directors. So, are the Directors
custodians of shareholders money and thus are accountable only for shareholders or
are they leaders of an enterprise which has responsibilities for all the stakeholders?
So, the problem is if the directors are acting in respect of maximizing the
shareholders profits or they are pursuing less profitable, but more responsible actions
which concern the interest of employees, the environment and the society as a whole
(Lee, 2006).
The principle The role of stakeholders in the corporate governance suffered some
tinting over time, in the sense that it insists on equal treatment of all stakeholders
~605~
(see Principle no. 8 of the table 1). Among them, an important category represents
employees, as prime stakeholders and indispensable component of the companys
information system, without which no entity could function. In the current economic
context, we must make a special mention about Peter Druckers demarcation between
manual workers (who work with their hands and produce goods and services) and socalled knowledge workers (who work primarily with the mind, not with hands, and
produces ideas, information, knowledge), analyzed in his book The Effective
Executive (1966), becomes increasingly important. Both part of the intellectual
capitals component known as human capital (the abilities, skills, expertise of the
employees), the knowledge distinction make the transition from traditional
approach of capital to the new modern one.
Thus, we consider the company's employees as its greatest asset and indeed the prime
stakeholder (along with material and financial resources), because they are the only
subjects in the triad of factors of production: labor-capital-nature, the other two
factors are only objects that can be handled according to subjects knowledge, skills
and abilities. Under these conditions, fair treatment of employees is absolutely
necessary and imperative, even if we bear in mind that, in some cases, as both
stakeholders and shareholders in their company, employees are exposed to greater
risks than other shareholders who have diversified portfolios.
7. THE DIRECTORS AND THEIR STATUS IN THE COMPANY.
CONCERNS FOR A QUALITY MANAGEMENT
In line with quality of human capital and the principle of Transparency and
dissemination of information, an important category of information that corporate
governance requires aims remuneration policy of both managers/officers (presented
below) and non-executive directors, their selection procedure, competences and
previous experience. Strategic and effective oversight of a company are functions that
are incumbent upon the Board of Directors, responsible for ensuring quality
management by recruiting key managers, determining their remuneration and by
developing and implementing measures to punish or replace them, according to the
provisions of management contracts.
Corporate governance reforms following the corporate scandals of the turn of the
century focused heavily on increasing the representation of outside directors,
managers and officers. In addition, listing standards were changed to require boards to
have a majority of outside directors, as mentioned before in this paper. Many
countries have introduced requirements on the percentage of outside directors on
boards as well as on the fraction of outside directors on the nominating committee,
compensation committee, and audit committee (Fahlenbrach et.al, 2010).
This context requires a few special mentions about Romania. First, all corporate
governance codes, including Romanias, distinguish between executive and nonexecutive directors. Thus, Romania has aligned itself with global trends in listing
standards. So, non-executive directors are those who are not related to executive
management and have the majority in the Board of Directors (at. 138^1 of the
Companies Law). Art. 140^2 of the Companies Law includes clear references to the
members of the remuneration, nomination and audit committees. At least one member
of each committee must be independent non-executive director. The Audit Committee
~606~
and The Remuneration Committee consist only of non-executive directors. At least

one Audit Committee member must have experience in application of accounting
principles or audit.
As for independence, art. 138^2 from the Companies Law stipulates that one or more
members of the Board of Directors to be independent, only if specifically mentioned
in Companys status. In appointing an independent director, the General Meeting of
Shareholders considers the following criteria:
a) he is not a director of a company or of companies controlled by it and not
have accomplished such a position in the last five years;
b) he has not been an employee of a company or a company controlled by it or
to have had such a close relationship over the past five years;
c) he did not receive or have received from the company or a company
controlled by it an additional remuneration or other benefits, other than those
corresponding to its quality of non-executive director;
d) he is not significant shareholder of the Company (owns less than 10% of the
stock);
e) he does not have or have had in the past year business relationship with a
company or a company controlled by it, either personally or as a partner,
shareholder, director, officer or employee of a company that has a
relationship with the entity, if, by their substantial nature, they are likely to
affect their objectivity;
f) he is not or have been within the last three years financial auditor or person
associated with the current auditor of a company or a company controlled by
it;
g) he is a director in another company where a director of the company is a nonexecutive director;
h) he hasnt been non-executive director of the company more than three seats;
i) have no family relationship with a person in one of the situations mentioned
in points a) and d).
Contrary to the trends worldwide, however, the Companies Law provides that the
management company may be delegated to one or more managers, one of which is the
general manager (Chief Executive Officer - CEO), and these executives may be
among the BD members, executive directors, given that the corporate governance
codes require a separation of executive from the directorate.
Another issue that arises is that of internal and external directors. Related to abovementioned independence, a director can be chosen from outside the entity. Wellmeaning, this way cannot always be beneficial if a company takes into consideration
the costs and benefits of outside directors into account. Inside and outside directors
face different trade-offs when deciding whether to stay on the board or resign. An
inside director who resigns from the board most likely also has to resign from his job.
Consequently, an inside director who has doubts about the firms future or knows that
the firm will reveal bad news may find that her best course of action is to stay on the
board and work to improve the firms performance. Outside directors are particularly
valuable in situations where the firms performance is troubled since at such times
their independence enables them to assess objectively the performance of executives
and make changes if they are appropriate.
~607~
So, in contrast, an outside director in the same situation who does not resign faces the
risk of experiencing a loss of reputation as an outside director when the bad news
breaks. Such a loss of reputation may make it harder for the director to obtain other
board seats and perhaps even to keep the seats he already has. Furthermore, the
director would likely face an increase in his workload as the firm undergoes change
and restructuring. We believe that all these references to the directors may be
submitted under the auspices of the principle of responsibility of the Board of
Directors.
8. THE MANAGEMENT FROM THE PERSPECTIVE OF CORPORATE
GOVERNANCE PRINCIPLES: BETWEEN COMPETENCE, ABILITIES,
REPUTATION AND RESPONSIBILITY
A clear delineation of requirements for managerial positions in an enterprise, of the
skills required for them is specific to the dualist system of corporate governance. If
managers are elected by the Board of Directors from outside the enterprise, then most
likely they are chosen on the basis of competence and skills, as evidenced by learning
and experience. In the monist system, the choice for Chief Executive Officer can be
considered subjective. In Romania, the practiced system is no clearly defined, given
that art. 143, par. (3), says that the president of Board of Directors can be Chief
Executive Officer, offering this way the possibility for en enterprise to choose it.
We believe that the most appropriate would be for managers to be fully delimited
from the Board of Directors, so there could be a proper coordination at the enterprise
level. To support this statement, we must specify that the Companies Law the
organization of the dualist system in Romania, as Supervisory Board and the
Directorate, which are two separate entities, with separate responsibilities.
Related to Romania, corporate governance principles issued by Bucharest Stock
Exchange, do not have a separate chapter focusing on the responsibilities of
management for achieving a high level of corporate governance, it is evident that
management has an essential role to play if a company is to meet the governance
standards of the revised principles. The principles underline the fact that high ethical
standards, are in the long term interest of the company: they are essential if the
company is to be regarded as being credible and trustworthy. Many companies have
found it useful to develop company codes of conduct, often based on professional
standards and, sometimes, broader codes of behavior. There is a mention though to
the confidentiality of documents and information received, kept and signed during the
mandate period.
In terms of reputation, the problem is the conflict of interest which can arise in
managers case, regardless their level. They have the obligation to tell the truth, but
simultaneously have incentives, so they are motivated to send biased information to
the users. In the context of financial reporting, managers are relevant information
providers, who jointly produce financial reports with the auditors. Incentives for
biased reporting may arise for managers when bonuses are linked to performance
(Koch and Schmidt, 2010).
~608~
CONCLUSIONS
Starting from transparency, integrity and responsibility, the principles of corporate
governance have followed a continuous development, but their main focus was
always on the separation of functions between directors and managers, on applying a
fair treatment for stakeholders and shareholders and on establishing a clear role for
both the Board of Directors and the managers.
Regarding the Board of Directors, in the first place, an overlapping of functions was
allowed in the case of president of the Board of Directors and Chief Executive
Officer. Later, after the financial scandals in the 2000s, a prohibition was issued in
this sense. This was completed with a supplementary specification, regarding the fact
that a director cannot be member in more than two boards. In respect of shareholders,
USA supports the increase of power for the majority shareholders. Comparing to that,
in Europe, the role of the Board of Directors is less significant, the main focus being
on the better protection of the minority shareholders, against possible abuses of
majority shareholders.
Because of all these differences, OECD, from its position of international body, has
developed a guide for the convergence of corporate governance codes, which contains
a minimal set of six rules applicable to listed companies, namely: applying the
principle of comply or explain; defining the audit functions and establishing limits of
action for auditors; improving transparency; defining conflicts of interest and their
control; improving and simplifying voting procedures and increasing the role of
General Meeting of Shareholders; increasing the role of independent directors (nonexecutive directors) in the company.
Romania does not choose yet its path. According to Companies law, Romanian
companies must specify in the Companys status the applied system. If the monist
system is chosen, the managers can be elected from the executive directors, the Board
of Directors being formed by both executive and non-executive directors. For the
latter ones, there are clear specifications related to their participation in non-executive
committees (audit, remuneration or nominating). This is the most frequent situation,
but the modifications of the Companies law have included, in the past few years, the
international alternative of complete separation between the directors and the
managers. For these changes, the leadership of a company takes different names: the
Board of Directors becomes Supervisory Board and the executive management
becomes the Directorate. The flexibility of the managing/supervising structures is a
way through which the companies can adapt to the competitive environment, but also
adjust the power between shareholders, directors and managers.
In our opinion, as a conclusion, the structure and the functioning of the Board of
Directors/Supervisory Board provides from inside the company, seen as a whole,
information about its value and ethics. Although this role of the Board of Directors is
undeniable, in present days, the media attention is oriented on the Chief Executive
Officer of a company. We consider that the Board of Directors needs to regain and to
bring in front its hidden authority.
The practice demonstrated that the simple opposition of the shareholders is neither
efficient nor sufficient to influence the managing style of the officers and their
~609~
decisions which often can be considered as subjective. As a solution, it is

recommended that the most of the Board of Directors members to be independent,
and from outside the company, as much as possible.
As a response to all these aspects, in the last years, it is aimed the transition from
Agency Theory to Stewardship Theory, with direct impact on managers behavior and
on their relationship with the shareholders, in the decision making process. If the
Agency Theory has economic roots, the Stewardship Theory has psychological and
sociological origins. Applying the Stewardship Theory in Romania means in fact to
choose the dualist system and a new, approach on the management of a company,
through the separation between the supervising structures and managing ones. This
way, the managers will be elected based on their competences, abilities and
knowledge, and the Supervisory Board will justify its mediating role in a company.
ACKNOWLEDGEMENTS
This work received financial support through the project Post-Doctoral Studies in
Economics: continuous training program of elite researchers, contract
no. POSDRU/89/1.5/S/61755, financed by the European Social Fund in Romania, by
the Sectoral Operational Programme for Human Resources Development 2007-2013.
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~610~
Richard, B. and Miellet, D. (2002), La dynamique du gouvernement dentreprise, Edition

dOrganisation, Paris
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***, 2006/46/CE Directive of European Parliament and Council from the 14 of June 2006
amending Council Directives 78/660/EEC on the annual accounts of certain types of
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~611~
PS13 Issues in financial accounting

Chairperson
Tudor GRECU, KPMG Romania
IMPACT OF FUNDED STATUS OF PENSIONS ON

BORROWING COSTS OF STATES
Maria-Iuliana SANDU
THE IMPACT OF UNREALISED FOREIGN

EXCHANGE DIFFERENCES
Georgiana TOADER, Mihaela Adriana DUMITRANA
VALUE RELEVANCE OF CONSOLIDATED VERSUS

PARENT COMPANY FINANCIAL STATEMENTS
Victor-Octavian MULLER
THE ADVANTAGES VS. THE DISADVANTAGES

OF OUTSOURCING THE ACCOUNTING
AND FINANCIAL SERVICE
Vasile-Daniel PAVALOAIA, Ioan ANDONE
~612~
IMPACT OF FUNDED STATUS OF PENSIONS

ON BORROWING COSTS OF STATES
Maria-Iuliana SANDU1
ABSTRACT
The paper offers a general view of the pension performance measures as they are understood
by current research. Each measure detailed in the study follows the intuition that
performance can be measured only by comparison to a fixed item, being it asset benchmarks,
minimum revenue or minimum operating costs. The paper follows a structure that highlights
the main performance measures developed until present moment. The results of the paper
bring upfront the difficulties that the Romanian pension market has to overcome in order to
ensure valid information about the retirement income. In order to asses the state of the art in
the field I conducted a literature survey.
KEYWORDS: pension, performance,, portfolio, rate of return

INTRODUCTION
Financial collapse met demographic crisis and resulted in a testing time for pension
systems all over the world. The need for an efficient measure of pension performance
is more stringent as the system has to insure against indigence in old age. As many
pension systems are asset backed, the retirement amount depends on the uncertainties
of investment markets. The study follows the recent studies regarding pension
performance and intends to give an overall image of the subject with commentaries on
the Romanian case.
1. OPTIMAL LONG-TERM BENCHMARKS
As employees savings for pensions go into the capital market, the immediate trend in
performance measurement for pension plans was to use the same methods used in the
case of mutual funds. Antolin [2010] identifies this as a problem of performance
valuation, as different investment horizons should determine different performance
measures. Short-term returns overlook factors that affect pension performance (i.e.
administrative and investment management costs, behavior of participants, retirement
age, benefits from other social insurance programs, patterns of lifetime earnings).
Under the short-returns performance criterion and minimum return guarantee, fund
managers can seek short-term performance instead of a long-term one, although longterm performance is the objective of a pension system. Antolin [2010] considers
optimal long-term benchmarks as the best option for pension performance evaluation.
Correspondence address: Maria Iuliana SANDU P.hD. Candidate, Bucharest Academy of Economic
Studies Romana Square, no. 6, Sector 1, Bucharest, Romania; email: iuliana.sandu@cig.ase.ro
~613~
Some policy makers believe that the optimal asset allocation is set by competition on
the pension market. The assumption in these cases is that the participant does not
suffer from financial illiteracy and that the data available on the market is complete.
Castaneda [2010] addresses the belief that competition can lead to optimal asset
allocation by analyzing the performance of pension fund managers that are subject to
restriction as minimum return guarantee. The results show that managers can
underperform.
Campbell and Viceira [2002] introduce strategic asset allocation a portfolio choice
for long-term investors and address in this way the difference between mutual fund
investors and pension fund investors.
n Romania defined contribution type funds (DC) have monopoly. According to
Viceira [2007] there are two major sub-types of DC that provide rebalancing between
asset classes: (i)lifestyle plans that automatically rebalance their holdings toward a
target asset mix that remains constant over time and (ii) life-cycle funds where the
target mix varies across time, becoming more conservative over time.
In analyzing the life-cycle funds, Viceira [2010] makes the distinction between
financial wealth and human wealth. He argues that for a typical working investor,
human wealth represents the largest part of the wealth at a young age whereas the
financial health is predominant as the worker ages. This separation between financial
wealth and human wealth create a pattern of investments that dictates the asset
allocation. Thus, when human capital is not correlated with systematic risk (measured
by the correlation of labor income and stock returns) the investor allocates most
financial wealth to stock whereas if human capital risk (i.e. shocks to labor income) is
correlated with stocks, then the investor invests mostly in bonds. There seem to be a
lower degree of correlation between systematic risk and human capital at an earlier
age in the workers life.
The most common plan in developing economies where the regulatory constrains are
rigid is the life-cycle fund with a heavy asset allocation towards fixed income assets.
Viceira [2009] offers two reasons for the heavy allocation of developing countries in
domestic government bonds and cash instruments. The first one is the local belief that
fixed-revenue investments minimize short-run return volatility and therefore are
considered the less risky investment choice. The second reason relates to fiscal deficit
financing considerations and the fact that governments try to use the pension
contributions to finance their fiscal deficits. Unfortunately, the modern theory of longterm asset allocation suggests that holding large amounts of government bonds is not
in line with the retiree objective even if it might be a safe investment option.
2. REPLACEMENT RATE
Another problem in extrapolating the performance measures of mutual funds to
pension funds is the myopia regarding human capital risk. The traditional measures of
performance do not capture the specific human capital risk: volatility in labor
earnings, uncertainty in hours of work, length of work life and length of life after
retirement. Mitchell [2010] addresses the performance as a replacement rate,
identifying a rate between benefits paid by a pension system (or projected to be paid)
and a minimum criterion (i.e. countrys income-based poverty line, the minimum
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wage level, national average earning measure). Other references to replacement rates
describe it as the amount of income a retiree receives as pension to an active worker
income level OECD [2009].
Nevertheless, there are critics made to the replacement rate measure that refer to the
core of the rate: consumption measure. Many replacement rates fail to express the
consumption level appropriate for a retiree. Developing a replacement rate involves
other several difficulties such as: indicator used as numerator , numerator indicator in
net or gross form, inflation perturbance, life span after retirement, household
composition alteration, retirees expense or medical costs.
3. NET VALUE ADDED
As the purpose of a pension fund is to maximize, subject to liability-related and
operational risk constrains, the long term net return of the pension fund,
Ambachtsheer [1996] introduces to the literature of pension performance the notion of
net value added (NVA). In this approach, the value creation of pension funds, and
thus performance, has two sources: (i) strategic asset allocation that generates returns
above the minimum return required and (ii) active asset management. The model
emphasizes on the importance of operational costs in the overall performance of a
pension fund. According to Viceira [2010] a plan that charges an operating fee of 1
percent of assets and has an expected return gross of costs of 7 percent will cost plan
participants 39 percent of their assets over an investment horizon of 35 years.
The results offered by the NVA measures were biased by the size of the pension fund
(total fund pension assets) as increased size determines increased economy of scale
and by the passive management of the investments.
The need to measure performance of pension funds was tackled by researchers like
Keith Ambachtsheer and John McLaughlin when they decided to initiate CEM
Benchmarking Inc., a global benchmarking company based in Toronto. CEM stands
for Cost Effectiveness Measurement data base and includes various statistics from
pension funds including rate of returns and operating fees. The organization has over
700 pension funds as clients that receive performance guidance for their activity. The
outputs of CEM follow the same methodology: obtaining standardized information
from the fund and compare the results with those of the peers.
4. CROSS-COUNTRY PENSION PERFORMANCE COMPARISON
Antolin [2008] summarizes a study undertook by the Organization for Economic
Co-Operation and Development (OECD) and the World Bank that was intended to
compare investment performance of privately managed pension funds across several
OECD, Latin American and Central and Eastern European (CEE) countries.
The methods used to assess pension performance across countries include standard
risk-adjusted measures (e.g. Sharpe ratios) and artificially constructed benchmarks
portfolios using Markowitz portfolio optimization approach with historical data.
Sharpe ratios measure the excess return on a risk unit and it is frequently used to
determine the most favorable investment strategy. Accordingly, in an investment
strategy the investor should choose the portfolio that returns the highest Sharpe Ratio.
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Cross-country performance comparative analysis has several faults that must be

highlighted:
asset allocation between equity and bonds show a wide variation among
different countries;
different levels of liquidity on capital markets make way for different asset
valuation methods;
different calculation methods for rate-of-returns (reported returns gross of
management fees or net of management fees);
Sharpe ratio can be used under the assumption that a riskless rate exist or if
proxies for it are used instead;
regulatory environment;
idiosyncratic characteristics of each country pension system.
The conclusion of Antolins study [2008] is that Sharpe ratios and Markowitz meanvariance approach with historical data can be used to compare the pension plan
performance to artificially constructed benchmarks. However, in countries were
private plans have recently been implemented the historical data on which the study
might be based is scarce. Antolin [2008] suggests that progress should be done in data
collection as to enhance the development of international standards for the reporting
of pension fund performance that could support more in depth performance
evaluation.
5. RESULTS
At the present moment Romania uses short-term returns to measure performance for
pension funds (24 months periods). As mentioned by Antolin [2010], the high rates of
return exhibited by pension funds in developing countries might be related to high
interest rates in the economy or a country-specific risk premium arising from lack of
development of domestic capital market, making short-term returns not viable as a
pension performance measure.
Another major issue in the Romanian case is that there is no investment option that
can be regarded as a risk-free asset for long-term investors. Treasury bills might be
risk-free from a short-term point of view but on the long run they fail to provide
protection against reinvestment risk. Government bonds provide protection against
reinvestment risk (long-term bonds protect investors from reinvestment risk because
falls in interest rates are compensated with capital gains in the value of the bond) but
cannot manage the inflation risk. Viceira [2010] considers that true riskless assets for
developing countries are long-term inflation-indexed bonds but Walker [2010]
recommends the short-term bonds as an alternative for protection against unexpected
changes in inflation rates.
Private pension participants in Romania suffer from the capital market infancy.
Defined contribution plans imply that participants choose where to invest their
contributions, which exposes them to capital market risk arising from directly holding
the asset.
The strict regulation of the Romanian pension market can affect the overall
performance of a pension fund. Imposing the limits of asset allocation and relying
heavily on local investment assets induce myopia towards currency hedging. Holding
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foreign currency in reserve currencies as the euro or commodity-based currencies as

the Australian dollar might reduce the portfolio volatility when there is no domestic
asset that is riskless in real terms Viceira [2010].
Table 1. Private pensions issues in the Romanian case
Low density of contributions (in this case the individuals have low accumulated assets and face low
retirement income)
Minimum return guarantee issues (determine underperformance of pension fund managers and can
focus managers on short run performance rather than the necessary long run performance)
Restrictions on maximum equity exposure (involve poor diversification of portfolios, thus
underperformance of pension fund)
No studies regarding the optimal level of equity exposure (default option for investment triggers
passive management)
Absence of real risk-free assets
Capital market infancy (generating unjustified rates of return because of the country specific risk
premium)
Private pension infancy (triggers high operating costs)
Lack of currency hedging (trigger suboptimal performance)
(Source: Author)
CONCLUSION
Romania faces the pension transformation from pay-as-you-go redistributiv system to
a multi-pillar approach. The distribution of wealth at retirement is of interest to
sponsors, members and policy makers as the failure of assuring a competitive income
in retirement translates into social crisis Although measurement solution for pension
performance do not seem as a necessity in the accumulation period that the present
Romanian pension market is experiencing, the moment when the future retirement
incomes must be paid has to be carefully planed in advance. The information provided
from different pension environments is of utmost importance but strategies have to be
tailored for the unique case of Romania
This literature review shows how pension performance is tackled in various countries
from mutual fund specific performance measures to measures adapted for the pension
objective. This study intends to be a starting point for the search of performant
pension measures adapted for the Romanian pension system that can provide future
retirees with competitive income levels.
AKNOWLEDGEMENTS
This work was supported by DoEsEc project - Doctoral Studies in Economy at
European Knowledge Standards , co-funded by European Social Fund through the
Sectorial Operational Programme for Human Resources Development 2007 2013,
and coordinated by The Bucharest Academy of Economic Studies.
REFERENCES
Ambachtsheer, Keith; Capelle, R., and Scheibelhut, T. 1998, Improving Pension Fund
Performance, Financial Analysts Journal
Antolin, P., and Tapia, W. 2010, Investment Performance of Privately Managed Pension
Funds: Overview of the Available Data, Evaluating the Financial Performance of
Pension Funds Directions in Development, the World Bank
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Bagliano, F., Fugazza, C., Nicodano, G. 2010, Pension Funds, Life-Cycle Asset Allocation,
and Performance Evaluation, Evaluating the Financial Performance of Pension Funds
Directions in Development, the World Bank
Castaneda, P., Rudolph, H. 2010, Portfolio Choice, Minimum Return Guarantees, and
Competition in Defined Contribution Pension Systems, Evaluating the Financial
Performance of Pension Funds Directions in Development, the World Bank
Grinblatt, M., Titman, S.1993. Performance Measurement without Benchmarks: An
Examination of Mutual Fund Returns, Journal of Business, vol. 66, no.1
Heinz P. R., Hinz R., Antolin P., and Yermo J. 2010, Evaluating the Financial Performance
of Pension Funds, Evaluating the Financial Performance of Pension Funds
Directions in Development. The World Bank Bank
Mitchell, O., Turner, J. 2010, Labor Market Uncertainty and Pension System Performance,
Evaluating the Financial Performance of Pension Funds Directions in Development.
The World Bank
Viceira, L. 2010, Application of Advances in Financial Theory and Evidence to Pension
Fund Design in Developing Economies, Evaluating the Financial Performance of
Pension Funds Directions in Development
Walker, E., Iglesias, A. 2010, Financial Performance of Pension Funds: An Exploratory
Study, Evaluating the Financial Performance of Pension Funds Directions in
Development. The World Bank
http://www.reuters.com/
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THE IMPACT OF UNREALISED FOREIGN EXCHANGE

DIFFERENCES
Georgiana TOADER1 & Mihaela Adriana DUMITRANA
ABSTRACT
The present study is intended to be an analyze of the main Romanian legal provision in what
concerns the impact of foreign exchange differences and potential consequences at the level
of financial statements for companies. In Romanian legislation, the issue of the foreign
exchange differences is treated at a general level: these are recognized as a Profit and Loss
item and as a consequence, they are included in the taxable base when booked in the
accounting. Our legislation does not provide for specific treatments depending on the
realization moment of these differences or depending on the conditions for recognizing a
gain / loss from foreign exchange differences. For the unrealized exchange differences arising
from the application of accounting rules on monthly assessment of foreign currency monetary
items, there isnt a specific event or transaction to determine income or expenditure. This
monthly review depending on the National Bank of Romania foreign exchange rate valid on
the last day of the month aims to bring closer to reality the financial position of an entity.
The exchange rate is a monetary policy item set by the central bank and may be influenced by
various factors such as: monetary policy of the BNR; inflation target objectives and rate of
exchange stabilization or reduction efforts, as is the case of BNR in the last years to fulfil EU
criteria for adoption of the EURO; periodical influences of speculative capitals on the
exchange rate level; economic status and especially exports and imports. However, a
taxpayer should not be charged unless there is evidence of the "economic enrichment"
thereof. However, this enrichment, seen as a rising economic value of the company, depends
on the perspective from which is seen: the owner of the company or the tax authorities. The
exchange differences impact also the value of the owners equity for which a minimum level is
requested under the commercial company law. In case of negative values, this triggers
various risks at the level of the continuity principle or even endangers the existence of the
company.
KEYWORDS: foreign exchange differences, profit allocation, accrual principle, economic

enrichment, realised income/profit;
INTRODUCTION
The ongoing study on the impact of differences must be based on accounting
principles underlying their recognition in accounting. This is the main factor
determining other tax related effects, profit allocation and consequences on the
financial statements. The basis for elaborating this study consist of an range of
practical observations undertaken in connection with the consequence of law
provisions (accounting, taxation, legal) related to the unrealised foreign exchange
differences, on the allocation manner resulting from their inclusion in the taxable
1
Correspondence address: Georgiana Gabriela TOADER, Bucharest Academy of Economic Studies;

email: geogiana.toader@vtm.ro
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base, as well as on the potential bias over the fair image of the financial statement for
a company.
According to Order 3055/2009, in Romania is applicable the accrual principle which
includes recognition of the effects of transactions and other events as they happen and
not as cash or its equivalent is received or paid. Due to the accrual basis and the duty
to monthly assess claims and liabilities in foreign currency, these rules lead to
monthly recognition in the profit and loss account of the foreign exchange differences.
Their recognition from an accounting perspective represents the motivation for their
inclusion in the taxable basis, as specified in the Tax Code.
Among the international studies on the complex consequences of the exchange
differences, both fiscal and accounting, the most recent is the General Report prepared
by International Fiscal Association in 2009, based on observations received from 37
countries, of which are: Australia, Austria, Brazil, Canada, Denmark, Germany,
Japan, the Netherlands. Based on the comments submitted by each of the 37 countries
the IFA issued a report that captures a wide range of implications of transactions
generating foreign exchange difference, in the form of observations:
Most countries have not developed an adequate tax system that takes into
account the impact of exchange differences on income measurement. While
some concepts are addressed in national law, such as the nature of exchange
differences, timing of recognition or source, however it is shown that there is
insufficient knowledge about the process of identifying differences, especially
with regard to the possibility of distorting income measurement.
There is no common treatment with regard to considering the gains or losses
from exchange differences as an ordinary element, recognized in the profit or
loss account or a an element of capital (in the proper conditions) based on
connection or lack of connection with another transaction. As it results from
the observations received from the countries included in the study, in the
majority of the cases the exchange rate differences are recognized in the profit
or loss account.
There are different approaches when recognizing the effects of exchange
differences. Although it is difficult to establish universal conclusions, the main
trend however can be identified as the need to find a state of "economic
enrichment" which can be qualified as income. A taxpayer should not be
charged unless there is evidence of the "economic enrichment" thereof.
However, this enrichment, seen as a rising economic value of the company,
depends on the perspective from which is seen: the owner of the company or
the tax authorities.
In certain countries, the tax rules allow the use of currencies other than the
national currency for tax calculation. This is a recent approach found in some
countries to allow accurate measurement of economic income, especially for
multinational companies (Canada, USA, Italy, Australia, Netherlands and
UK). The principle of this approach requires that in cases where the "natural
currency" used to conduct business is other than that of the company's country
of residence, allows calculation of net taxable income in the natural currency
of the business, following that for effective reporting, it will be eventually
converted back into the currency of that country. In this way it avoids any
distortions related to the measurement of taxable income that could be caused
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by the foreign exchange differences and which would not in fact create real
economic value for the company.
Not enough attention was paid to the development of separate paragraphs in
the double taxation conventions to address this aspect, which may affect the
level of taxable income. The reason for which this approach has not been
possible is the difficulty of determining the location of the exchange
differences (in which of the two countries in the convention) and especially
the precise identification of what represents income. Inevitably, with respect to
this issue, questions arise about in which currency should be kept track of
income and the way in which countries will establish tax rules to determine
and control how these are calculated.
The Chairman of IFA congress held in Vancouver in 2009, Mr. Gregory May (USA)
has emphasized that any international transaction assumes the existence of foreign
exchange differences and therefore of complicated and intricate tax complications.
Transactions undertaken by a company that involves at least two currencies raise, in
general few very important aspects:
Timing and measurement;
Source;
Characterization of the gain or loss (ordinary income, as an auxiliary result
from economic transactions or financial income as main result from financial
transactions).
This is a well discussed issue but the idea of bringing it back in the current discussion
is necessary due to the implications on the level of taxation, especially in obtaining
financing in this difficult time for companies that have resisted so far without debt
(especially in the last three years since the crisis started), but especially those who
could not avoid calling on loans. It is known that the tax laws and accounting of a
country are a deciding factor for investors who want to place their capital in a given
region.
Currently, according to Romanian legislation, the unrealized differences affect the
profit loss account (PLA) and implicitly the default rate of taxation. Exchange
differences are recognized in the accounts as income, respectively as expenses in the
period to which they belong, thereby determining the outcome of accounting and
taxation. Depending on the company's degree of debt and the source of the funds
obtained from foreign sources, exchange loss is deductible or not. If it is nondeductible this year, such a loss is carried forward to subsequent years until its full
recovery. In case which the foreign exchange difference is a gain it represents a
taxable item that will increase the income tax owed by the entity.
Recognizing the exchange differences via PLA, affecting the result, through the
financial statements, has an impact on owners equity, which can increase, in case of
gains, or decrease, in case of losses. Primarily, this material wants to follow at least
three aspects related to the influence of unrealized foreign exchange differences on
the finances of a company which funds its activities through long-term lending in
foreign currency, obtained either from the banks or from associates:
Recognition means in accounting;
Influence on the taxation level and the possible snowball effect;
Effect on the level of owners equity.
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1. RECOGNITION MEANS IN ACCOUNTING

Order 3055/2009 on accounting regulations in accordance with the Fourth Directive
of the European Economic Community and the Seventh Directive of the European
Economic Community specify the criteria for recognition in the revenue and
expenditure accounts.
a) revenue represents recorded increases in economic benefits during the
accounting period, in the form of inputs, or increases in assets or reductions in
debt, which are reflected in increases of equity other than those resulting from
shareholders contributions;
b) expenditures represent reductions of recorded economic benefits during the
accounting period, in the form of outputs, or decreases in assets or increases in
debt, which are reflected in decreases of equity other than those resulting from
shareholder distribution.
Based on these definitions it is noted that there are no recognition differences between
revenue/expenditure elements realized or not, because there is no definition of the
term realized from this point of view. The only definition for the term realized
revenue is met in case of re-evaluated assets for which the re-evaluation surplus is
recognized as realized revenue through transactions related to the respective assets.
(3) The re-evaluation surplus included in the re-evaluation reserve is
capitalized through the direct transfer to the reserves (account 1065 Reserves
representing income from re-evaluation reserves), when this surplus
represents a realized income.
For the current regulations, the income is considered realized at removal
from records of the assets for which the re-evaluation reserve is made.
However, part of the income can be realized as the asset is used by the entity. In
this case, the transferred reserve value is the difference between depreciation
value based on revalued book value and the depreciation based on original cost
of asset.
Although the definition of the income or expense items does not meet any evidence
showing what means "realized" yet, it can be shown that their production is based on
an activity or a transaction, for which exchange differences registration is not
applicable, because they occur as a consequence of a basic transaction (a loan) and the
monthly assessment of accounting rules, and not as an independent transaction.
For the unrealized exchange differences arising from the application of accounting
rules on monthly assessment of foreign currency monetary items, there isnt a specific
event or transaction record to determine income or expenditure. This monthly review
depending on the National Bank of Romania foreign exchange rate valid on the last
day of the month aims to bring closer to reality the financial position of an entity.
From the perspective of equity and fair image of earnings at the end of the month, the
recognition elements of foreign exchange is a tool to update, depending on the
exchange rate, the value of the entity at that time. But the question arises whether this
monthly amount update actually produces an increase in economic value (in case of
profit from exchange rate differences) or a reduction in economic value (in case of
loss) that can be recognized as a taxable item?
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However, the entity has not conducted any activity in this respect, meaning that it
cannot determine or controls the obtainment of gains or losses from exchange
differences. The exchange rate is a monetary policy item set by the central bank and
may be influenced by various factors such as:
Monetary policy of the BNR;
Inflation target objectives and rate of exchange stabilization or reduction
efforts, as is the case of BNR in the last years to fulfil EU criteria for adoption
of the EURO;
Periodical influences of speculative capitals on the exchange rate level;
Economic status and especially exports and imports.
Assume the following example: A company has at the end of the year a debt of
1,000,000 EURO - Loan from an associate. The official exchange rate RON/EUR for
31.12.2010 was 4.2848, so the loan will have an equivalent value of 4,284,800 RON.
On 02/28/2011, the exchange rate is 4.2139 RON / EUR. The loan will be presented
in the accounts amounting to 4,213,900 RON with an unrealized gain from the foreign
exchange amounting to 74.500 RON for which a tax is due (assuming that amount
only) of 11.920 RON.
In the example above we can see that the company has not undertaken any activities
to this end to get that "revenue" of 74.500 RON, however it owes taxes for that
amount. If we assume that the company is in the development period, immediately
after its incorporation, and the only way to receive funding is loans from associates
(financial institutions rarely support early development projects or start-ups). Suppose
that the funds necessary to pay taxes are only calculated on the basis of a new
currency loan, which in turn will generate an increased rate differences impact on the
financial statements.
Suppose the example situation as valid at the years end, i.e., following the
revaluation of the loan, at the end of the year there is a profit of 74.500 RON
(ignoring the effect of other transactions). After recording the income tax expense 11,920 RON - a net profit of 62.850 RON is obtained. Relating to this result some
questions arise:
Is this result distributable as dividends to the associates?
Is this profit an indicator of the companys performance, based on which it
can obtain credits from a financial institution?
How will the companys feasibility rates be calculated, taking into
consideration the realized profit?
Which would be the result if these transactions were entered in the business
currency - EUR?
Related with the "distribution" of the profit or not, in the Order 3055/2009 (or
Accounting Law 82/1991) there are no provisions that prohibit or specify what
conditions must be fulfilled for the results to be distributed as dividends. For example,
in case of the revaluation reserve it is directly specified under what conditions
distribution can be made and what are the consequences of breaching these
provisions:
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Art. 124 - (1) In case the reassessment of tangible assets is to be performed,

the difference between the value resulting from revaluation and the value at
historical cost must be presented in the revaluation reserve as a distinct subelement in "Capital and reserves (account 105 "Revaluation reserves").
Treatment of the revaluation reserve for tax purposes must be presented in the
notes.
(8) No part of the revaluation reserve may be distributed directly or indirectly,
unless the revalued asset was exploited, in which case the revaluation surplus is
actually realized revenue.
And for this specific case, there is the definition for "actual gain realized": it involves
the removal from evidence (by sale, disposal or other similar transaction) of the asset
that generated it. So, unlike the case of exchange differences where that are
immediately recognised in the PLA and taxed as such, in case of assets revaluation,
the same accounting treatment no longer applies and, as a consequence, neither does
the fiscal one. There is a reference in the Companies Law, Article 67 relating to the
distributable profit, but it refers to the way of determining what actually represents a
matter of accounting principles and rules.
Art. 67. - (1) Profit part which is paid to each associate constitutes a dividend.
(2) Dividends are distributed to shareholders in proportion to their
participation to the share capital, unless the articles of association stipulates
otherwise. They are paid within the period set by the general meeting of
shareholders or, where appropriate, established by special laws, but not later
than six months from the date of approval of annual accounts for the year
ended. Otherwise, the company will pay damages for the period of delay at the
statutory rate if the articles of association or the decision of general meeting of
shareholders approved the accounts for the financial year did not establish a
higher interest rate.
Par. (2) was modified by pt. 36. of Law no. 441/2006 beginning with
01.12.2006.
(3) Dividends can only be distributed from lawfully determined profits.
(4) Dividends paid contrary to the provisions of par. (2) and (3) are returned,
if the company proves that the associates knew of the irregularities of their
distribution or, under the current circumstances, should have known.
(5) The right to receive the dividends, paid against the provisions of par. (2)
and (3), is prescribed in 3 years from their distribution.
Art. 2721. - The founder, manager, director or legal representative of the
company shall be punished with imprisonment from 2 to 8 years, in case of:
1. spreading false news or using other fraudulent means which employ the
effect of raising or lowering the value of shares or company bonds or other
securities owned by company for the purpose of obtaining for himself or others,
a benefit at the damage of society;
2. receives or pays dividends, in any form, for fictitious or non-distributable
profits, or otherwise lacking the financial situation resulting from this.
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What means "fictitious or non-distributable profits? Is the situation presented in our

example in this category? Regarding the other two questions, the answers are obvious:
No financial institution will take into account the profits made from exchange
rate differences as a "realized" profit or achievable in the future;
The rates of return that would take into account such a profit will also express
vague clues on the financial status of the company for unsuspecting users.
The principle of prudence stated in Order 3055/2009 clearly refers to the recognition
of profit at the balance sheet:
41 The prudence principle. When drawing-up the yearly financial statements,
the evaluation must be made cautiously and, especially:
a) in the profit and loss account can be included only the balance date
profit;
However there are some elements which could complete the given statement:
The realized profit definition and the recognition criteria;
The fact that not only at the end of the year, but after every transaction just the
realized profit must be recognized;
With regard to the last question (Which is the result if these transactions were
highlighted in the business operation currency EURO?) we can take the example
amounts and perform the calculation just in EURO, to determine the taxable basis.
Data from the above example are: Debt - 1,000,000 EUR - Loan from associate.
Official exchange rate RON/EUR for 31.12.2010 was 4.2848,
Since the exchange rate has no influence on the euro value, which remained
unchanged, the result will be zero because there are no differences. Suppose that the
company prepares external reports, to the parent company, in EUR and that the result
achieved at the end of the year is only the exchange differences in the amount of
74,500 RON, net profit after tax. Under the rules of conversion, the elements of the
PLA will be converted into the reporting currency at the average EUR exchange rate
(assuming that it is 4.2 RON/EUR). In this case, the Romanian company would report
to the parent company a profit of 17,738 EUR. We can assume that the parent
company wants exclusive distribution of this result and that the dividends tax will be
paid for, according to Double Tax Conventions.
The conclusions drawn from the cases described above merely highlight, to a lesser
extent, the effects of the exchange differences resulting from recognition in the PLA
and their inclusion in the taxable basis:
Recognition of a gain/loss from unrealized exchange rate differences affect
(distort?) the result obtained;
Generate income tax (or tax cuts for the deductible loss);
Can generate dividend through the distribution of the result that incorporate
elements of exchange rate differences;
Distorts the reporting prepared in the currency for conducting business if the
reporting is based on amounts in lei, based on the rate of closure (for the
review) respectively the average rate (for the PLA).
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If the records should be kept exclusively in EUR, it has been observed that there
is an unrealized exchange rate difference and thus there would be no impact on
the distributable fees or profit;
For cancelling or balancing these effects, the taxpayers can take measures to
counteract, through initiating financial transactions such as currency hedging
transactions or by directing the economic activities dependent of the existence
of a strong currency in the country. This will affect the taxpayers' behaviour and
even more the accuracy of the criteria used for measuring economic income.
2. INFLUENCE OF THE TAXATION LEVEL AND THE POSSIBLE

SNOWBALL EFFECT
Immediate recognition through PLA of exchange differences generates effects over
the tax level, and thus on the final price established by the companies for services
rendered or goods sold in order to recover their costs. In the example above we have
presented the case where the funds to pay the necessary tax are calculated on the basis
of a new loan in foreign currency.
Suppose that the company borrows an amount of EUR 100,000 necessary to pay the
income tax at the end of the first quarter, the exchange rate being 4.2 RON / EUR.
Income from exchange rate differences will be worth 1.1 million * (4.2139 - 4.2000)
= 15.290 RON and corresponding tax amount will be 2.446 RON. It is noted that the
taxation of such income from exchange rate differences will create a "snowball" type
self-generating situation. This situation will be reflected in prices that will increase
systematically. There is the possibility that such costs can be capitalized in the amount
of investment for a long term project.
Notice of 22/12/2003 on measures concerning the organization and conduct of
management accounting permit differences of the associated borrowing in value of
assets or long-term services:
Other expenses that may be included in certain specific circumstances the cost
of goods, works, services:
- Borrowing costs may be included in cost of goods, works and services, etc.
only insofar as they are directly attributable to the acquisition, construction or
production of qualifying asset production, in accordance with applicable
accounting regulations.
Borrowing costs include interest and other expenses incurred by a legal
entity in connection with loan funds.
A qualifying asset is a manufacturing asset that necessarily takes a
substantial period of time to get ready for its intended use or sale;
- General administrative expenses may be included in cost of goods since they
represent costs incurred to bring the goods to the final form and place and
justify their taking into account under specific conditions of operation.
As such, the unrealized exchange differences, to not immediately affect the PLA, will
be included in the cost of the respective asset and will be part of the depreciation or
costs for operation or sale. So the value of the assets will be influenced by the
unrealized rate of exchange differences requiring a periodical market value testing so
that a non-sustainable value is not reflected in accounting. Presently, due to the
~626~
difficult economic situation at general level, the need to call on credits is more
stringent and this is overlaid over the suspicion of the banks to grant credits which
creates extremely high eligibility criteria which block access to financing. In this case
a company has few solutions to support itself financially:
Maximum usage of the suppliers credit;
Careful following of receivable;
Cost and unsustainable contract restructuring.
Because of this, it might be recommended from an accounting point of view, but also
fiscally, a relaxation of rules for the exchange differences:
Either by increasing the degree of debt which allows deductibility of exchange
differences loss;
Or by separating the accounting aspect from the fiscal one, meaning
recognition of the exchange differences in the PLA at evaluation, but taxing
them at realization.
3. EFFECT ON THE LEVEL OF OWNERS EQUITY
One of the effects of exchange differences registration consists in the reduction of
owners equity below the minimum level specified by the commercial company law
or even taking negative values, posing the issue if the continuity principle is still
applicable or even endangering the existence of the company.
Art. 15324. - (1) If the board of administration, respectively directors, find that,
following certain losses, set by the lawfully approved yearly financial
statements, the net worth of the company, determined as a difference between
the total assets and the total debts, reduced to less than half the underwritten
share capital, it will immediately convoke the extraordinary general meeting to
decide if the company must be dissolved
(2) Through the articles of association is can be established that the
extraordinary general meeting can be convoked even for a less significant
reduction of the net worth than the one specified in par. (1), establishing this
minimum level of the net works via reporting to the underwritten share capital.
..
(5) In the case of non-convoking the extraordinary general meeting as per
par. (1) or if the meeting could not validly deliberate on the second
convocation, any interested party can approach the court to ask the dissolution
of the company. The dissolution can be requested in the case the companys
obligation acc. to par.(4) is not respected. In either case, the court may give the
company a period, not exceeding six months, to rectify the situation. The
Company shall be dissolved if the net worth cannot be reconstructed up to a
value at least half the share capital until the court decision, regarding
dissolution, becomes irrevocable.. "
Another aspect is related to the degree of debt provided by the Tax Code for
deductibility of interest and exchange differences: the loss from exchange differences
reduces the result and thus the equity result.
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CONCLUSIONS
As could be determined from the above, the impact of exchange differences on both
accounting and taxation level is extremely important for an item that cannot be
controlled by the firm. Normally, the activity of a company and its level of taxation
should be influenced only by transactions which it can determine or it can control in
order to obtain profit. Also, information users should have access to clear information
on the impact of exchange differences in business activity. Due to the impact of
exchange differences, financial systems have developed in some countries in order to
prevent or protect against currency risk, which currently in Romania are not available
or not applicable. Therefore, a reconsideration of how to recognize the accounting
definition of profit/ gain realized, as is already the case for revaluation of tangible
assets, but especially when it is taxed such exchange differences could be very useful
in the present economic situation.
REFERENCES
Ana Stoian (2003) Accounting and tax administration, Ed. ASE, Bucharest;
Gabriel Radu (2005) Accounting and Taxation: from theory to practice, Ed. Ex Ponto,
Bucharest;
George Vintil (2005) Financial management of company, Ed. Didactic and Pedagogical,
Bucharest;
Ion Stancu (1994), Financial management of traders, Ed.Economic, Bucharest;
Review The Economic Amphiteatre, 2011, published by ASE;
Review The Journal of Accounting and Management Information System, 2009 2011,
published by the Accounting and Management Information System Faculty;
Accounting Law no. 82/1991;
Companies Law no 31/1990;
General Report of IFA Vancouver Congres 2009;
International Reporting Standards, Ed. CECCAR, Bucureti, 2009;
Order no 3055/2009 on accounting regulations in accordance with the Fourth Directive of the
European Economic Community and the Seventh Directive of the European Economic
Community;
Tax Code;
Nick Pantaleo (Canada) and J. Scott Wilkie (Canada), 2009, General Report available
online at http://www.ifa.nl/members_only/congress_documents/pages/default.aspx
IFA Cahiers 2009, Volume 94B, Foreign exchange issues in international taxation,
available online at http://online2.ibfd.org/kbase/
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VALUE RELEVANCE OF CONSOLIDATED VERSUS

PARENT COMPANY FINANCIAL STATEMENTS
Victor-Octavian MULLER1
Babe-Bolyai University, Romania
ABSTRACT
Within the European Union, parent companies have to prepare and publish both consolidated
and individual financial statements. The objective of financial statements with general
purpose is to give information regarding the financial position, performance and changes in
financial position of the reporting entity, information that is useful to investors and other
users in making economic decisions. In order to be useful, financial information needs to be
relevant to the decision-making process of users in general, and investors in particular.
Therefore, the following question arises naturally which of the two sets best serves the
information needs of investors (and other categories of users), respectively which of the two
sets is more relevant for investors? In our scientific endeavor we set to carry out an empirical
association study on the problem of market value relevance of consolidated financial
statements and of individual financial statements of the parent company, searching for an
answer to the above question. In this sense, we analyze the (absolute and relative) market
value relevance of consolidated accounting information of listed companies between 20032008 on the largest stock markets in Europe (London, Paris, and Frankfurt). Through this
empirical study we intend to contribute to the relatively limited literature on this topic with a
comparative time analysis of the absolute and incremental relevance of financial information
supplied by the two categories of financial statements (group and individual).
KEYWORDS: Consolidated Financial Statements, Parent Company Financial Statements,

Market Value Relevance
INTRODUCTION
The objective of financial statements (with general purpose) is to give information
regarding the financial position, performance and changes in financial position of the
reporting entity, that is useful to a wide range of users in making economic decisions.
According to the conceptual framework of IASB (par. 10), considering that investors
are suppliers of risk-bearing capital, issuing financial statements that satisfy their
information needs allows satisfying the information needs of other categories of users
of financial statements, as well. This conception of IASB (as well as of FASB) is
maintained in the exposure draft for phase A regarding the improvement of the
Conceptual framework, where the two boards consider that the needs of the other
members of the primary user group will be in general and essentially the same with
the needs of ordinary shareholders (IASB, 2008a: BC 1.20).
Furthermore, in order to be useful, financial information needs to be relevant to the
decision-making process of users in general, and investors in particular, meaning that
1
Correspondence address: Victor-Octavian MLLER, Babe-Bolyai University, Cluj-Napoca,

Romania; email: victor.muller@econ.ubbcluj.ro
~629~
it must have the capacity to influence their economic decisions. Relevance represents,
in fact, one of the main characteristics of financial information quality (Francis et al.,
2004). It is well known that relevance is now considered (see the stipulations of IASB
Conceptual Framework) one of the qualitative characteristics of financial information
together with reliability, understandability and comparability. Moreover, in the
exposure draft regarding the improvement of the Conceptual framework, IASB and
FASB named relevance and faithful representation as the two fundamental qualitative
characteristics of financial information (IASB, 2008a: QC2). According to the two
boards, relevance is linked to connecting economic phenomena to the decisions of
capital suppliers and of other users of financial information (IASB, 2008a: QC12).
Therefore, in order to make assessments on the quality of information of financial
statements, it is absolutely necessary to quantify this relevance (capacity to influence)
of financial information.
A fertile environment to perform such a measurement is the capital market, where
investors decisions (as users of financial information) are reflected directly in the
share price of the reporting entity. In this context, market value relevance is measured
by the ability of financial information to capture or summarize information that
influences share prices (Francis & Schipper, 1999). According to the same authors
market value relevance means the existence of a statistical correlation/association
between financial information and prices or returns, and also the fact that this
information explains market prices to an extensive measure, starting from the
presumption of the efficient market in which prices reflect the available information
(Francis & Schipper, 1999: 326). This approach presumes that the function of
financial information is to reflect economic income represented by stock return and
economic value, respectively, represented by market prices (Hellstrm, 2006: 326).
Financial information is supplied mainly through financial statements of entities
(listed on the capital market). In the majority of cases (at least on the large European
stock markets) listed companies own one or more subsidiaries, and therefore are
obligated (through national accounting legislation as well as stock exchange
regulations) to prepare consolidated financial statements for the group they own. At
the same time, as legal persons, companies are legally obligated to present individual
financial statements. Consequently, parent companies are obligated to a dual reporting
materialized in two sets of financial statements one at individual level, the other at
group level. Therefore, the following question arises naturally which of the two sets
best serves the information needs of investors (and other categories of users),
respectively which of the two sets is more relevant to substantiating decisions. Of
course, the possibility of both sets at the same time best serving the information needs
is not ruled out.
Considering all these aspects, in our scientific endeavor we set to carry out an
empirical association study on the problem of market value relevance of consolidated
financial statements and of individual financial statements of the parent company,
searching for an answer to the above question. Market value relevance can be
evaluated through event studies in which the market reaction to financial information
announcements is analyzed, or through association studies used to measure the
explicit connection between indicators of company market value (e.g. stock price)
and financial information. This second perspective of evaluation is applied in most
~630~
market value relevance studies (Hellstrm, 2006: 328) and has also been approached
in our research.
In this sense, we pursued an analysis of (absolute and relative) market value relevance
of consolidated and parent company accounting information of listed entities between
2003-2008 on the largest stock markets in Europe (London, Paris, and Frankfurt). We
chose a time frame of several years in order to be able to follow the evolution in time
of the relevance (absolute and relative) of consolidated financial statements. It must
be mentioned, however, that strictly from the point of view of the calendar year
relevance is measured for the period 2004-2009, because statistical associations are
based on stock prices from April the following year.
The reminder of the paper is organized as follows. The next section (first numbered
section) relates our study to previous technical and academic literature. Section 2
explains the research methodology (including sample selection and data sources as
well as the development of hypotheses and empirical models). Section 3 reports the
descriptive statistics while in section 4 we expose the empirical results obtained. The
final section provides a discussion of results and conclusions.
The importance and currentness of this problem results, to a great extent, from the
recent concerns of IASB and FASB, published in the Discussion paper entitled
Preliminary views on an improved conceptual framework for financial reporting
The Reporting Entity (IASB, 2008b), in which the problem of dual reporting and the
utility of the two categories of financial statements is under discussion, presenting
different points of view from the accounting world (for and against dual reporting).
This discussion paper was published by IASB in May 2008 and is part of Phase D of
the project (unreeled jointly with FASB) of improving the current Conceptual
Framework. The preliminary view of the two bodies is that a parent company should
always present consolidated financial statements. However, at the same time, the
boards consider that through the conceptual framework presenting individual financial
statements by the parent company should not be prevented as long as these are
included in the same report as the consolidated financial statements (IASB, 2008c:
137-140).
Concerning the empirical research that has tackled this matter, there are only a few
studies which could be identified in the international literature. In general, they bring
evidence in favor of the superior relevance of consolidated financial statements (ex.
Harris et al., 1994, Niskanen et al., 1998, Abad et al., 2000) respectively evidence
regarding a lack of relevance increment of individual financial statements of the
parent company (Niskanen et al., 1998, Goncharov et al., 2009).
In their study, Harris et al. (1994) compare the value relevance of accounting
measures for U.S. and German firms matched on industry and firm size. One of their
conclusions based on their empirical findings states that the explanatory power of
accounting data is increasing in the level of consolidation and that unconsolidated
data perform poorly relative to the consolidated data. Niskanen et. al (1998) examine
the information content of consolidated versus parent-only earnings, using accounting
and market data from Finnish firms. Their results show that consolidated earnings are
a significant incremental explanatory variable for stock returns, while parent-only
~631~
earnings are not, thus indicating that consolidation improves the information content
of earnings, and that the requirement to disclose parent-only earnings should be based
on arguments other than their value-relevance to shareholders.
Abad et al. (2000) investigate the value relevance of consolidated versus parent
company accounting information on a sample of Spanish firms listed on the Madrid
Stock Exchange. The authors use the Edwards-Bell-Ohlson valuation framework to
generate the results. The empirical findings show that, from this valuation perspective,
consolidated information dominated parent company (non-consolidated) information.
Finally, Goncharov et. al. (2009) examine the possibly different economic functions
of company (single) and group (consolidated) accounts using a large number of
accounting and market-based metrics from a sample of German companies. Their
analysis indicates higher value relevance, predictive ability, and timeliness of group
accounts as compared to company accounts. Furthermore, they could not identify an
incremental usefulness of single accounts.
Also regarding the value relevance of consolidated information are empirical
studies which investigate the value relevance of consolidated financial
statements in the context of the IFRS transition. A series of empirical studies
have proven the rise of market value relevance following IFRS adoption (Bartov
et al., 2005; Jermakowicz et al., 2007, Barth et al., 2007; Lin and Paananen,
2007). However, there are also studies showing that IFRS has not lead to a rise in
the market value relevance of consolidated financial statements (Callao et al.,
2007; Hung and Subramanyam, 2007; Gjerde et al., 2008; Paananen, 2008).
According to a recent study (Armstrong et al., 2010), the mandatory application
of IFRS when presenting consolidated financial statements starting with 2005
determines an improvement of the quality of accounting information as seen by
the investors.
2.1. Sample selection and data sources
In this empirical research we followed the analysis of market value relevance of
consolidated accounting information on companies on the large European stock
markets in 2003-2008. The European stock market (monitored by Federation of
European Securities Exchanges FESE) comprises capital markets from EU countries
as well as Iceland, Norway and Switzerland. The large European capital markets
(which exceed the threshold of 5% of the total European capital market) include,
according to table 2: BME Spanish Exchanges, Borsa Italiana, Deutsche Brse,
London Stock Exchange, NASDAQ OMX Nordic, NYSE EURONEXT and SIX
Swiss Exchange. The criteria chosen to estimate the size of a stock market (and
implicitly of selecting it) is market capitalization and the volume of share trading
(within and outside of the electronic system) for each year of the analyzed period. In
order to form a representative sample of the large European stock markets we decided
to include in our sample the top European stock markets that together exceed 50% of
the total size of the largest European stock markets and respectively 50% of the total
size of the European capital market for each of the six years. Of course, we dare think
that such a sample can be considered representative at the level of the European
~632~
capital market as a whole, since the large European markets for which the sample is
representative represent over 90% of the total European capital market.
So, as seen in table 3, the largest stock markets are Deutsche Brse, London Stock
Exchange and NYSE Euronext, which together exceed the conditions aforementioned
in each year of study. On average, for the analyzed period, the three stock exchanges
represent 67,5% of the transaction volume, respectively 60,3% of the market
capitalization of the European capital market. In fact, these are the only stock markets
that individually exceed 10% of the total market capitalization, respectively of the
total volume of share trading on European stock markets for the six years of the
analyzed period, which constitutes an additional argument for considering the sample
as representative for large European stock markets.
From the four stock exchanges that make up NYSE Euronext we chose Paris Stock
Exchange (the largest of the four, accounting for 70% of the companies included in
the EURONEXT100 index) and for the German stock market we chose, of course,
Frankfurt Stock Exchange (again the largest of the seven component stock
exchanges). To continue, the main criteria for selection that we established for each
stock exchange is the belonging to the main index which includes the first 100 of the
largest and most traded companies on that particular stock exchange. So, for the
London stock exchange we chose FTSE 100, for the Parisian stock exchange
EURONEXT 100, and for the Frankfurt stock exchange HDAX 110. The HDAX 110
index represents the extended version of DAX 30 and includes companies from the
DAX, MDAX and TecDAX. We chose this index since it is the closest as structure
and number of included companies to FTSE 100 and EURONEXT 100.
We excluded financial and insurance companies from the sample because their
structure and accounting practices differ significantly from those of non-financial
companies (Hellstrm, 2006: 335). As well, to eliminate composition differences of
the sample from one year to the other (which would affect comparability of results in
time), we excluded companies that have not been listed on the stock exchanges for the
whole analyzed period. At the same time, to increase the homogeneity of the sample
and to use the same time span (31.03 30.04) to determine average share price,
companies who close financial years (for financial statement purposes) at a date
different from 31.12 were excluded. Therefore, after going through these steps, the
final sample is made up of 98 companies, respectively 588 firm-year observations as
can be seen in table 1. The sample constitutes, therefore, a two-dimensional balanced
panel data noted Xit, which is practically a data set containing observations on the
individual characteristics (e.g. equity, income) of the same (i = 1,..., 98) for a number
of year (t = 1,..., 6).
Based on this complete sample, throughout the paper we constructed different subsamples for each year, stock exchange or other sub-samples which have been
described in the study at the moment when they were used. It must be mentioned that
we did not study comparatively the market value relevance of consolidated (and
individual) financial statements for the three stock markets. Creating sub-samples is
only meant to get confirmation (to strengthen) of the empirical results obtained from
the complete sample.
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Table 1. Final sample composition

Frankfurt Stock Exchange
London Stock Exchange
Paris Stock Exchange
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
BASF
Bayer
BB Biotech
Beiersdorf
BMW
Celesio
Continental
Daimler
Deutsche Brse
Deutsche Lufthansa
Deutsche Telekom
Eon
Elring Klinger
Fuchs Petrolub
Gildemeister
Heidelbergcement
Henkel
Hochtief
Hugo Boss
Krones
Leoni
Metro
MLP
Morphosys
Nordex
Pfeiffer Vacuum Techno
Pfleiderer
Rheinmetall
Rhn-Klinikum
RWE
Salzgitter
SAP
United Internet
Volkswagen
Vossloh
AMEC
Anglo American
Antofagasta
Astrazeneca
Autonomy
Bae Systems
Balfour Beatty
BG Group
BP
British American Tobacco
Cairn Energy
Capita Group
Centrica
Cobham
Foreign&Col Investment
Glaxosmithkline
Hammerson
Intertek Group
International Power
Liberty International
Pearson
Randgold Resources
Reed Elsevier
Rexam
Rio Tinto
Rolls-Royce Group
Segro
Serco Group
Smith & Nephew
Tullow Oil
Unilever
Xstrata
Accor
Air Liquide
Bouygues
Cap Gemini
Carrefour
Christian Dior
Ciments Francais
Danone
EADS
Eramet
Essilor International
Iliad
Imerys
Klepierre
L'oreal
Lagardere
Michelin
Peugeot
PPR
Publicis Groupe
Renault
Saint Gobain
Sanofi-Aventis
Schneider Electric
Technip
TF1
Total
Vallourec
Veolia Environ
Vinci (Ex.Sge)
Vivendi
Total companies included in the final sample: 98

Total number of observations (company-year) included in the final sample: 588 (98 companies x 6 years)
Consolidated and individual financial information (group equity, parent company

equity, group earnings, parent company earnings, number of shares) was collected
manually from the annual reports for the 588 year-observations of the complete
sample, after being previously downloaded from the official web-sites of the
respective companies. For many German companies using parent company annual
reports was necessary because annual group reports did not include parent company
financial statements, but only consolidated financial statements.
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Share prices for the sampled observations were also collected manually from the
finance.yahoo.com database. This database can be accessed without charge and is
recommended by Andrei & Bourbonnais (2008: 30). For the development of the
study, we computed average closing share prices for 31.03 30.04 of each year,
making sure that companies have already published the annual reports for the
preceding year. We consider that using average closing prices for a certain period of
time (as opposed to using the closing price of a certain day for example 31.03) has
the advantage of neutralizing possible daily fluctuations of the prices, caused by
factors that are not linked to the financial information published in the annual reports.
A very important aspect for every empirical study based on testing linear regressions
is the problem of identifying and eliminating outliers (Martin & Roberts, 2006: 703).
In this respect, we established two filters: the first filter (applied by Hellstrm, 2006)
eliminated observations that, in the first stage, exceed five standard deviations from
the average value of equity (consolidated and individual, respectively)/share price and
net income (consolidated and individual, respectively)/share price and then (after
eliminating these ones) the ones that exceed three standard deviations from the
average. The second filter (applied by Collins et al. 1997, Gu, 2007) eliminates
outliers for which residuals have absolute values exceeding 4 standard deviations
from zero for consolidated financial statements regressions, respectively for parent
company individual financial statements. This methodology was applied for the
complete sample (n=588), as well as for each sub-sample used throughout the study.
The final dimension of each sample is indicated in the first column of each table,
which represents the empirical results for the various regression models employed.
2.2. Hypotheses development
For the purpose of this study, we formulated the following four hypotheses related to
the confrontation on the relevance of consolidated financial statements and parent
company individual financial statements.
Hypothesis 1: Information supplied by consolidated financial statements are more
value relevant than information supplied by individual financial statements of the
parent company. This hypothesis represents the starting point and basis for
elaborating and testing the next hypotheses. Naturally, for its development we took
into consideration empirical results of previous research, which support the thesis of
consolidated financial statement superiority (Harris et al., 1994, Niskanen et al., 1998,
Abad et al., 2000, Goncharov et al., 2009). As mentioned before throughout this
scientific endeavor, the capacity of individual financial statements of the parent
company to reflect its real economic power is reduced. The information supplied by
these statements often appear insufficient, especially for those users of accounting
information whose fulfillment of individual goals depends on the activity of more or
all of the companies within the group (Theisen, 2000: 494). Therefore, consolidated
financial statements, which reflect the economic power of the whole business
combination (presenting information on all the resources and activities within the
scope of the reporting entity), should supply more relevant information to the stock
market investors.
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Table 2. Evolution of trade volume and market capitalization for the European stock
markets in 2004-2009 (percentages)
(Source: Federation of European Securities Exchanges www.fese.be and authors

calculations)
Table 3. Evolution of trade volumes and market capitalization for the main European
stock markets in 2004-2009 (millions Euro)
(Source: Federation of European Securities Exchanges (www.fese.be) and authors

calculations)
~636~
Hypothesis 2: The value relevance of information supplied by consolidated financial

statements has been increasing (in the analyzed period of time). At the basis of the
development of this hypothesis lies, on one hand, the results of previous studies
(Collins et al. 1997, Gjerde et al, 2007), which show that the relevance of financial
statements has increased over time. On the other hand, we also start from the
presumption that the qualitative level of the regulations for presenting consolidated
financial statements has increased over time, especially considering the adoption of
IFRS in 2005 and their constant improvement in time as a result of IASB concern
(together with FASB) to elaborate global standards of high quality.
Hypothesis 3: The value relevance surplus supplied by consolidated financial
statements as opposed to individual financial statements of the parent company has an
increasing trend (in the analyzed period of time). This hypothesis represents, to a
certain extent, a blending of the first two aforementioned hypotheses. For its
development, we also took into consideration the fact that the European and national
accounting regulations on presenting parent company financial statements generally
evolve at a slower pace (compared to international standards), and have not been
substantially modified in the analyzed period of time.
Hypothesis 4: Information supplied together by consolidated financial statements and
parent company statements are more value relevant as opposite to information
supplied only by consolidated financial statements. While consolidated financial
statements are meant to offer a true and fair view on the financial position and
performance of the economic entity (the group), individual financial statements have
not only the role to inform on the financial position and performance of the legal
entity (the parent company), but also represent to starting point in determining taxes
and computing distributable income (Goncharov et al., 2009: 335). Therefore, it is
plausible for information supplied by parent company financial statements to bring a
surplus of relevance (market value relevance), beyond consolidated information,
which leads to the fact that a dual reporting is superior (from the point of view of
relevance) to consolidated reporting.
2.3 Development of empirical models and description of the variables involved
In order to empirically test the research hypotheses on the market value relevance of
information supplied by consolidated and parent company financial statements, we
developed a series of econometric valuation models which measure the degree of
association between share price and accounting information supplied by financial
statements (equity and net income). The starting point in developing these models was
the following linear regression (whose parameters are to be estimated using ordinary
least square OLS):
Initial model:
Where
Pit
=
Cpit
=
Rezit
=
it
=
Pit = 0 + 1 * Cpit + 2 * Rezit + it

share price of company i in year t
equity/share of company i in year t
net income/share of company i in year t
residual value (error term) for company i in year t
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(1)
This regression model in which the dependent variable is the share price level (price
level regression), has the advantage that it is affected in a small amount by an
eventual inefficiency of the market, since price level regressions reflect information
accumulated since the establishment of the companies (concentrated for example in
net assets) (Aboody et al., 2002: 978). At the same time, another advantage of this
model is that it can be decomposed, so that the two explanatory variables (equity and
net income) are broken down to their components. The basis for this is the Ohlson
(1995) valuation model, which expresses share price as a function of current
accounting value of equity plus discounted value of future (abnormal) results. The
model was initially proposed by Preinreich in 1938, later used by Edwards and Bell
(1961), Edey (1962) and Peasnell (1982), but it was restored and popularised in
accounting literature through papers written by Ohlson and respectively Feltham and
Ohlson in 1995 (see Abad et al., 2000: 165).
To compare relevance in absolute values of information supplied by consolidated
financial statements, respectively by parent company financial statements, the
following empirical models were elaborated:
Model 1:
Pit = 0 + 1 * pBVit + 2 * pEit + it
(2)
Model 2:
Where
pBVit
pEit
cBVit
cEit
Pit = 0 + 1 * cBVit + 2 * cEit + it
(3)
=
=
=
=
book value of parent company equity/share of company i in year t

parent company net income/share of company i in year t
book value of group equity/share of company i in year t
group earnings/share of company i in year t
In order to make inferences regarding incremental utility of information supplied by

consolidated financial statements (considering that both sets of financial statements
are published by the sampled companies) we developed a model to include both
categories of information:
Model 3: Pit = 0+ 1 * pBVit+ 2 * cBV it+ 3 * pEit+ 4 * cE it + it
(4)
Where
cBVit
= difference between group equity and parent company equity/share of
company i in year t
cEit
= difference between group earnings and parent company
earnings/share of company i in year t
These three empirical models will be used to test the first three hypotheses. Therefore,
in order to confirm hypothesis 1 regarding consolidated information relevance
superiority, explanation power of model 2 quantified by adjusted R2 must be greater
than the explanation power of model 1. Since R2 coefficient of determination
increases with the introduction of new exogenous variables (and thus not being
adequate to make comparisons between models with a different number of
explanatory variables), we use coefficient of determination corrected with the number
of degrees of freedom (or adjusted R2).
~638~
In order to test if an eventual relevance difference (that is relevance increment Adj.

R2) is statistically significant, we use models 1 and 3, checking the level of R2 change
of model 1, after introducing supplementary variables from model 3 (corresponding to
consolidated information). As well, to confirm/refute hypothesis 3, we verify if the
difference between explanatory power of model 3 and explanatory power of model 1
follow an increasing trend in the analyzed period of time. About hypothesis 2, we will
of course follow the evolution in time of explanatory power of model 2.
A fourth empirical model was developed to verify hypothesis 4, regarding the market
value relevance superiority of information supplied (together) by consolidated and
parent company financial statements as opposed to consolidated information. This is
based on model 2 (based on consolidated information) and also includes information
supplied by parent company financial statements:
Model 4: Pit = 0+ 1 * cBVit +2 * pBV it +3 * cEit +4 * pE it + it
(5)
Where
pBVit = difference between parent company equity and group equity/share of
company i in year t
pEit
= difference between parent company earnings and group
earnings/share of company i in year t
To confirm hypothesis 4, the explanatory power of model 4 must be superior to the
explanatory power of model 2, and the change in explanatory power, as a result of
introducing the two variables which represent information regarding the parent
company, must be statistically significant.
3. DESCRIPTIVE STATISTICS
From the descriptive statistics analysis presented in table 4 (absolute values) and table
6 (values per share) there are more relevant conclusions that can be extracted
regarding the variables considered in this study. To begin with, an increasing trend of
the average share price and total market capitalization can be noticed (for the
companies of the sample) until 2006, followed by a slight decrease in 2007 and a
more steep one in 2008, due to the economic-financial global crisis, of course. A
similar evolution can be noticed for consolidated equity, consolidated income and
parent company income (expressed in values per share). However, a clear trend
cannot be identified for parent company equity. Worthwhile to remark is the increase
(up until the beginning of the crisis) in the difference between group equity and parent
company equity, respectively between group earnings and parent company earnings,
indicating an increase in time of the contribution of subsidiaries to consolidated
equity, respectively to consolidated earnings.
If we concentrate the analysis on the three stock exchanges (that form the sample),
what stands out is the fact that the average of all variables is very low compared for
the companies listed at the London Stock Exchange compared to those listed on
Frankfurt or Paris Stock Exchange, which is due especially to the high average
number if shares issued by English companies (1.814 million shares/company)
compared to German companies (341 million shares/company) and French
(332 million shares/company). This state of facts is based on the long tradition in
financing of the big companies on the Great Britain stock market (country with an
~639~
Anglo-Saxon economy). By analyzing absolute values results that companies listed on

Paris Stock Exchange (and included in the sample) have, on average, the highest
market capitalization and the highest consolidated equity. The market capitalization
average values for the three sub-samples are situated in the same size range (tenths of
billion Euros) deviating from the average of the complete sample (13,9 billion Euro)
with 14% at the most, indicating a relatively homogenous complete sample (from the
point of view of company size).
Table 4. Statistical synthesis of variables (absolute average values in mil. Euro)
Period/Sample
No. Shares
Average
price
Variables
Average
Mk. cap.
cBV
cE
pBV
pE
2003-2008 (n=588)
819.2
36.0
13886.0
7620.8
1231.7
6034.0
865.0
2003 (n=98)
2004 (n=98)
2005 (n=98)
2006 (n=98)
2007 (n=98)
2008 (n=98)
799.1
803.6
781.7
824.8
827.9
878.1
25.3
27.5
40.4
48.9
46.7
26.8
10505.2
11677.4
14746.4
17643.8
16831.9
11911.4
6156.2
6721.2
7731.5
8328.3
8590.4
8197.5
668.5
964.1
1425.9
1600.2
1594.9
1136.8
5339.6
5561.8
5985.4
6173.9
6698.8
6444.3
652.9
600.4
874.2
904.7
1374.6
783.0
341.1
1814.2
331.9
41.5
9.3
57.3
11596.9
14950.4
15371.8
7396.5
6464.5
9067.8
869.4
1554.1
1308.0
4740.4
5277.7
8275.1
617.2
1202.0
796.8
Frankfurt St. Ex.

(n=35)
London St. Ex. (n=32)
Paris St. Ex. (n=31)
Regarding the existent associations between the variables employed in the

econometric models (see Pearson correlation matrix in table 5), it can be seen that
there are strong significant correlations between the dependent variable (share price)
and the explanatory variables ( equity, respectively earnings per share, at consolidated
and individual level), which signals the relevance of these accounting values to
explain the market value of companies. Correlations between share price and
consolidated accounting values are higher, suggesting the possibility (or even the
probability) of superiority (from the market value relevance point of view) of
consolidated financial statements as opposed to parent company financial statements.
Of course, this supposition is to be confirmed or refuted by statistical inferences
(econometric models).
It must be mentioned, as well, the existence of significant correlations between some
explanatory variables used in the same econometric models. We are referring
especially to group equity and group earnings (per share). These correlations, which
indicate the existence of multicollinearity between variables are, however, common to
such studies, since they are present in numerous empirical research (see Naceur &
Goaied, 2004; Aboody et al., 2002; Hevas et al., 2000; Abad et al., 2000; Rees, 1997;
Collins et al., 1997).
~640~
Table 5. Correlation matrix of variables

Pearson Correlation
Price
1.000
Price
0.776
cBV
0.781
cE
0.679
pBV
0.620
pE
0.552
cBV
0.534
cE
cBV
cE
1.000
0.788
0.784
0.407
0.729
0.481
1.000
0.598
0.404
0.601
0.709
pBV
1.000
0.510
0.146
0.251
pE
cBV
1.000
0.099
-0.329
cE
1.000
0.489
1.000
*All correlations are significant at 0,01.
To examine if multicollinearity generates instability of empirical results, we

computed, for each coefficient of the explanatory variables from the econometric
models, the variance inflation factor (VIF), which quantifies to what extent the
variance for a coefficient is increased due to collinearity (Andrei & Bourbonnais,
2008: 274). When variables are not correlated, the variance inflation factor is 1. VIF
values of more than 5 (see Jermakowicz et al., 2007) or even 10 (see Kutner et al.,
2004) are regarded in the specialty literature as indication of (serious) autocorrelation
problems between independent variables.
Table 6. Descriptive statistics for variables (expressed in values per share)
Variables (per share)
Period/Sample
2003-2008
n= 548
2003
n= 88
2004
n= 86
2005
n= 88
2006
n= 83
2007
n= 87
2008
n= 89
Frankfurt Stock
Exchange
n= 192
London Stock
Exchange
n= 174
Paris Stock
Exchange
n= 171
Average
Median
Std. deviation
Average
Median
Std. deviation
Average
Median
Std. deviation
Average
Median
Std. deviation
Average
Median
Std. deviation
Average
Median
Std. deviation
Average
Median
Std. deviation
Average
Median
Std. deviation
Average
Median
Std. deviation
Average
Median
Std. deviation
Price
cBV
pBV
cBV
cE
35.971
19.848
13.978
5.833
27.775
13.560
10.780
1.490
39.356
21.656
13.872
13.363
25.312
17.305
13.450
3.656
20.930
11.920
10.010
1.105
25.528
18.009
13.092
11.183
27.543
18.987
14.160
4.828
24.240
14.100
11.230
1.835
21.315
19.074
12.960
11.189
40.372
19.477
13.567
5.910
35.315
12.640
10.650
1.600
33.977
20.823
13.065
11.713
48.908
20.784
14.813
5.970
46.410
14.940
11.510
1.190
41.670
22.312
14.736
13.050
46.694
20.326
13.513
6.812
34.535
14.640
10.220
1.500
61.331
22.894
13.573
14.913
26.771
19.766
13.206
6.560
20.605
13.350
9.230
1.640
32.389
24.231
13.029
16.773
41.481
23.021
14.597
8.424
34.070
17.925
12.465
4.220
32.489
17.834
9.213
13.410
9.291
3.112
2.427
0.666
6.220
1.640
1.610
0.075
8.551
3.285
2.411
2.220
57.290
34.610
26.199
8.411
48.000
25.550
21.850
3.610
49.157
26.072
15.897
19.113
~641~
pE
3.039
1.985
3.714
1.964
1.210
2.177
2.622
1.435
3.110
3.137
2.020
3.613
3.247
2.420
3.408
3.672
2.780
3.893
3.168
1.875
4.605
3.458
2.870
3.232
0.683
0.370
0.894
5.337
3.370
6.422
1.770
1.065
2.133
1.395
0.710
1.899
1.412
0.940
1.447
1.685
1.110
1.773
1.723
1.170
1.844
2.174
1.120
2.329
1.750
1.225
2.083
2.136
1.545
2.212
0.431
0.205
0.634
2.749
2.060
2.408
cE
1.201
0.560
2.937
0.433
0.175
1.857
1.161
0.520
2.406
1.531
0.620
2.620
1.608
0.820
2.225
1.509
0.580
2.873
1.433
0.560
3.565
1.287
0.725
3.123
0.228
0.120
0.695
2.596
1.310
5.879
4. EMPIRICAL RESULTS
As we mentioned when we described the empirical models developed, in order to test
the hypothesis regarding the superior value relevance of consolidated financial
statements (as opposed to parent company financial statements), in the first stage we
compared the absolute value relevance of information supplied by the two types of
financial statements, based on two regression models. The empirical results regarding
the two models are presented in table 7 and illustrated graphically in figure 1. By
comparing the explanatory power (Adj. R2) of the two models for the whole analyzed
period (2004-2008) as well as for each year and each stock exchange included in the
sample, the superiority of the value relevance of information provided by consolidated
financial statements clearly stands out. Concerning the coefficients of the two
regressions, they are significant (and positive) for each sub-sample and for the
complete sample, usually at 0,001 level (at least at 0,05 level for model 2 related to
consolidated reporting, respectively at 0,1 for model 2 related to individual reporting).
At the same time, the estimated coefficients have values of variance inflation factor
(VIF) under 5, indicating the fact that there are no worrying aspect regarding the
effects of multicollinearity between explanatory variables of the model. In the second
stage we considered testing the relevance difference between group statements and
parent company financial statements (that is incremental Adj. R2) to see if it is
statistically significant. Therefore, based on models 1 and 3 (see table 8 respectively
figure 2) we checked the level of statistical significance of changing the explanatory
power of model 1 after introducing supplementary variables corresponding to
consolidated information from model 3, and concluded that the relevance surplus is
statistically significant at 0,001 level. Consequently, the first hypothesis regarding the
superiority in terms of relevance of consolidated financial statements (as opposed to
information provided by parent company statements) is statistically confirmed.
At the same time, from the analysis of the empirical results obtained (see table 7 and
figure 1) we clearly observe the increasing trend of relevance (market value
relevance) of consolidated financial statements, starting with a value (of the
explanatory power of model 2 Adj. R2) of 64,7% in 2003 and reaching 77,9% in
2008. The slight decrease of the power of explanation from 2007 against 2006 is
singular, and can be credited, of course, to the financial-economic crisis and does not
affect, in our opinion, the increasing trend of the analyzed period. Therefore, this
statistical evidence permits to confirm the second hypothesis regarding the increase in
time of the relevance of consolidated financial statements.
~642~
Table 7. Empirical results for regression models 1 and 2
**** significant at 0.001; *** significant at 0.01; ** significant at 0.05; * significant at 0.1
Figure 1. Evolution of value relevance (in absolute terms) of consolidated financial

statements (CFS) and parent company financial statements (PFS)
2003
Adj.
R2
Model 1 PFS
Adj.
Model 2 CFS
R2
Adj. R2
2004
2005
2006
2007
2008
2003-08
56.3%
57.3%
65.4%
64.4%
49.4%
53.0%
53.2%
64.7%
65.9%
69.0%
79.4%
74.2%
77.9%
66.3%
8.4%
8.6%
3.6%
15.0%
24.8
24.9%
13.1%
In order to test hypothesis 3 regarding the increase in time of the relevance variance
between the two categories of financial statements, we verified if there is a trend over
the analyzed period for the difference measure between the coefficient of
~643~
determination of model 3 (corresponding to consolidated financial statements) and the

coefficient of determination of model 1 (corresponding to individual financial
statements). In this respect, to better delineate the trend, we split the analyzed period
(2003-2008) in three sub-periods of two years, computing for each sub-period the
average explanatory power for the corresponding years (see figure 2). From the
conducted analysis results an increase in time of the difference between the two
coefficients of determination, from 8,8% (for 2003-2004) to 25,8% (for 2007-2008).
Considering the statistical significance of the respective difference certified by
statistic tests applied to verify hypothesis 1 (at 0,001 level), we can conclude that the
third hypothesis, as well, regarding the increasing trend of the relevance surplus
provided by consolidated information is statistically confirmed.
Table 8. Empirical results for regression model 3
Period/
Sample
2003-2008
n= 548
2003
n= 88
2004
n= 86
2005
n= 88
2006
n= 84
2007
n= 87
2008
n= 89
Frankfurt
n= 192
London
n= 174
Paris
n= 171
Alfa
t
VIF
Alfa
t
VIF
Alfa
t
VIF
Alfa
t
VIF
Alfa
t
VIF
Alfa
t
VIF
Alfa
t
VIF
Alfa
t
VIF
Alfa
t
VIF
Alfa
t
VIF
0
10.343
8.885****
9.072
4.663****
9.34
4.173****
12.484
4.354****
15.198
5.542****
-
pBV
0.725
9.493****
1.83
0.629
3.761****
2.545
0.572
3.166***
2.562
1.095
5.151****
2.165
0.882
3.589****
2.295
12.184
3.926****
8.54
4.245****
17.465
6.418****
4.376
6.894****
24.288
6.963****
-
0.383
1.943**
1.777
0.371
2.881***
1.643
0.355
2.137**
1.22
0.634
3.008***
1.449
0.395
2.934***
1.505
Characteristics MODEL 3
cBV
pE
0.386
5.167
4.885****
10.051****
1.865
1.905
0.374
3.714
2.599***
2.996***
1.452
3.177
0.449
5.433
2.957***
3.624****
1.338
2.156
0.615
4.344
2.802***
2.681***
1.959
2.28
0.612
5.634
2.683***
2.817***
2.198
2.343
0.433
1.743*
3.451
0.041
3.17***
2.988
0.408
3.335****
1.496
0.423
1.875*
1.33
0.282
2.133**
2.018
7.369
6.241****
1.833
4.052
5.572****
1.345
5.012
6.485****
1.543
5.029
6.100****
1.446
5.216
5.779****
1.516
cE
3.139
8.682****
1.881
2.197
2.306**
1.994
1.336
1.731*
1.656
1.415
1.475*
1.816
4.506
3.335****
2.209
4.82
3.651****
3.62
4.078
6.303****
3.404
3.523
6.491****
1.581
2.964
4.172****
1.341
2.507
5.876****
2.109
272.155 68.40%
37.159
65.60%
38.119
65.60%
51.127
71.50%
79.46
80.10%
60.571
74.40%
78.3
79.60%
46.899
50.90%
35.461
47.10%
59.001
58.90%
**** significant at 0.001; *** sig. at 0.01; ** sig. at 0.05; * sig. at 0.1
~644~
Adj R2
Figure 2. Evolution of value relevance increment of CFS relative to PFS
Adj. R
Model 1 PFS
Adj. R2 Model 3 CFS*

Adj. R2 (M3-M1)
Sig.
2003-2008
2003-2004
2005-2006
2007-2008
56.8%
64.9%
51.2%
53.2%
65.6%
75.8%
77.0%
68.4%
8.8%
0.000
10.9%
0.000
25.8%
0.000
15.2%
0.000
To continue, we tested regression model 4, developed to verify the hypothesis

regarding the superiority for the capital market of information provided (together) by
consolidated financial statements and parent company statements as opposed to
consolidated information. The empirical results are synthesized in table 9.
Table 9. Empirical results for regression model 4
Period /
Sample
2003-08
n= 548
2003
n= 88
2004
n= 86
2005
n= 88
2006
n= 84
2007
n= 87
2008
n= 89
Frankfurt
n= 192
London
n= 174
Paris
n= 171
Alfa
t
VIF
Alfa
t
VIF
Alfa
t
VIF
Alfa
t
VIF
Alfa
t
VIF
Alfa
t
VIF
Alfa
t
VIF
Alfa
t
VIF
Alfa
t
VIF
Alfa
t
VIF
0
10.279
9.093****
9.266
4.739****
10.02
4.932****
12.334
4.585****
14.847
5.456****
11.779
3.948****
8.933
4.597****
17.099
6.411****
4.384
7.464****
23.66
6.972****
-
cBV
0.692
9.220****
4.525
0.58
3.211****
6.361
0.57
3.536***
5.223
1.042
5.064****
2.165
1.039
4.698****
7.03
0.4
2.042**
5.211
0.346
2.770***
5.82
0.356
2.207**
4.504
0.47
2.175**
3.145
0.385
2.917***
4.099
Characteristics MODEL 4
pBV
cE
pE
0.381
5.384
1.845
4.049**** 10.640**** 3.862****
2.75
5.916
3.247
0.211
3.954
1.341
1.08
3.023***
1.455
2.628
4.631
1.588
0.284
4.565
2.123
1.447
3.533****
1.526
2.715
8.844
5.786
0.444
4.946
3.688
1.646*
3.248***
2.382**
1.959
2.28
1.816
0.422
4.298
-0.36
1.737*
2.523**
-0.204
2.93
9.714
4.457
-0.51
7.403
2.702
-0.196
6.349****
2.124**
3.864
5.228
3.386
0.289
4.036
-0.004
1.962*
5.670****
-0.005
3.959
6.621
5.279
0.76
5.347
1.287
0.382
6.844****
1.931*
3.97
3.508
2.342
0.16
5.275
0.992
0.667
6.964****
1.091
1.875
2.881
2.099
0.117
5.385
2.803
0.755
6.165****
3.481**
2.983
10.7
7.699
282.185
68.60%
36.676
65.50%
43.689
67.80%
54.156
71.40%
80.453
79.70%
64.171
75.10%
76.529
78.40%
48.063
50.80%
44.292
52.30%
63.212
60.00%
**** significant at 0.001; *** sig. at 0.01; ** sig. at 0.05; * sig. at 0.1
~645~
Adj. R2
As mentioned before, this has the starting point in model 2 (based on consolidated
information) and also includes information offered by parent company financial
statements. The comparison between the explanatory power of the two models (see
table 10) reveals a superiority (statistically significant) of model 4 (based on dual
information) of 2,3% for the whole sample.
Table 10. Empirical results regarding the difference of value relevance between
models 2 and 4
Adj. R2
Adj. R2
Adj. R2
Sig.
Adj. R2
Adj. R2
Adj. R2
Sig.
Model 2 SFC
Model 4 Dual
(M4-M2)
2003
2004
2005
2006
2007
2008
64.70%
65.50%
0.80%
0.164
65.90%
67.80%
1.90%
0.038
69.00%
71.40%
2.40%
0.014
79.40%
79.70%
0.30%
0.202
74.20%
75.10%
0.90%
0.091
77.90%
78.40%
0.50%
0.151
2003-08
66.30%
68.60%
2.30%
0.000
Frankfurt
Londra
Paris
50.30%
50.80%
0.50%
0.133
52.20%
52.30%
0.10%
0.409
57.10%
60.00%
2.90%
0.001
Model 2 SFC
Model 4 Dual
(M4-M2)
However, bringing the analysis at the level of each year, respectively of each stock
exchange (from the sample), there is a fluctuation of the difference (between the
explanatory power of the two models) in the interval 0,3% - 2,4%, respectively
0,1% - 2,9%. From the six years, only for 2004 (1,9%) and 2005 (2,4%) the difference
is significant (at 0,05 level). As well, only for the French stock exchange (2,9%) there
is a statistically significant value (at 0,001 level). These mixed results allow, in our
opinion, only a partial confirmation of the fourth hypothesis regarding the superior
relevance of dual reporting as opposed to consolidated financial reporting.
DISCUSSIONS AND CONCLUSIONS
In this study we investigated using econometric regression models the absolute and
relative market value relevance of consolidated financial statements for companies
listed during 2003-2008 on the largest stock markets in Europe (London, Paris, and
Frankfurt stock exchanges). For this purpose we focused on the confrontation
regarding the value relevance between consolidated financial statements and parent
company financial statements. As expected (and in accord with previous empirical
studies, for example Harris et al., 1994, Niskanen et al., 1998, Abad et al., 2000,
Goncharov et al., 2009), the results have shown an increase in superiority (statistically
significant) of the relevance of consolidated statements (in detriment of individual
ones). While in the analyzed period, consolidated financial statements have seen a
positive trend of relevance, individual statements have had an oscillating relevance
(inside some limits).
These results prove, of course, the importance (usefulness) of consolidated financial
statements especially for investors on the capital market. Therewith, they question the
necessity of publishing parent company financial statements (according to national
regulations) as long as they present consolidated financial statements. As a matter of
fact, in the USA the obligation to publish parent company financial statements was
eliminated since 1982, following the issuing of Accounting Series Release no. 302.
~646~
(Francis, 1986: 394). We consider that these conclusions are valid not only for large
European capital markets, but also for emerging capital markets (such as the one in
Hungary, Poland, Romania, Bulgaria).
In the end, some aspects regarding the limitations of this study should be mentioned,
as well as the perspectives of future empirical research. First, it is possible to raise the
problem of sample representativeness (and implicitly of the results obtained) for the
large European capital markets and respectively for the whole European capital
market. In this respect, future research could extend the analysis (and the sample) to
other capital markets in Europe, as well as to companies that are not included in the
main index of the stock market they are listed on. Second, the obtained results are
based only on testing linear price level regression models. Future research could
employ nonlinear models, for example logarithmic models (see Hellstrm, 2006)
respectively return regression models (see Bartov et al., 2005). And third, the present
study investigates relevance and therefore usefulness for decision making of
consolidated financial statements only from the point of view of the investors on
capital market. So, a future research theme less approached until now (see Goncharov
et al., 2009) would be to investigate the relevance of financial statements from the
perspective of other categories of users (for example financial institutions in their role
as creditors).
ACKNOWLEDGEMENTS
This paper is part of the research project POSDRU/89/1.5/S/59184 Performance and
excellence in postdoctoral research within the field of economic sciences in
Romania, Babe-Bolyai University, Cluj-Napoca being a partner within the project.
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THE ADVANTAGES VS. THE DISADVANTAGES

OF OUTSOURCING THE ACCOUNTING
AND FINANCIAL SERVICE
Vasile-Daniel PAVALOAIA1 & Ioan ANDONE
"Alexandru Ioan Cuza" University of Iasi, Romania
ABSTRACT
In January 2010, Forbes magazine published an article by an attractive title: Romania
became an accounting outsourcing destination. The article states that our country has fully
entered the market of accounting service outsourcing. Also, the results of a study ordered by
PricewaterhouseCoopers in 2010 confirm that outsourcing has encountered a revival in the
last six months and the trend is ascending. The director of PricewaterhouseCoopers says that
companies still resort to service outsourcing primarily to reduce costs but at the same level,
customers began to also appreciate other aspects such as high efficiency, high quality
services and, of course, access to high-level talent and expertise. In the above mentioned
context, in authors opinion, the theme of the current research seems appropriate as it
proposes and emphasize of the fundamental aspects of outsourcing in general and specific
issues related to outsourcing the services of accounting and financial analysis. This study
illustrates novel aspects related to the requirements for outsourcing accounting services in
our country and captures the authors' opinion on the possibilities of outsourcing the financial
and economic analysis services, since these belong to a quite sensitive category. If this
information comes across foreign hands, the financial and accounting information can be
used for destructive purposes.
KEYWORDS: outsourcing, outsourcing accounting service, outsourcing financial analysis

service
1. MEASURING THE BENEFITS OF OUTSOURCING FINANCIAL

SERVICES
Although outsourcing is a common practice in the business environment, a survey
[Stancu, 2008] conducted by KPMG International reveals that 42% of outsourcing
contracts are not based on a formal framework meant to assess the strategic benefits
obtained by the enterprise. The study identifies a number of other issues, caused by
the outsourcing agreements that the businesses face. Among those issues are
identified the following: uncertainty regarding the costs involved in the process of
selecting a provider for the outsourced services, long time required for completion the
tendering phase (KMPG recommended that this phase should not exceed 6 months),
the human factor (60%) and not technology (12%) is the main problem encountered in
the development of the outsourcing process. Even though companies covered by the
survey consider outsourcing as a process with real benefits to their business, they
1
Correspondence address: Vasile-Daniel W. PVLOAIA Ph.D. Lecturer, Alexandru Ioan Cuza

University of Iasi, Faculty of Economics and Business Administration, 22, CAROL I Boulevard,
EACSI Dept.; email: danpav@uaic.ro
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must be able to accurately demonstrate the measure of the obtained profits as

decisions based on intuition or some unsubstantiated allegations, are not the
appropriate means of action.
A study of the level of outsourcing services from our country, the analysis of
Romania's balance of payments from the 2005, reveals the following information:
Informatics services recorded a deficit of 14 million euros, which represents an
outsourcing amounting to 149 million euro and an internalisation of 163 million
euros. By analyzing the evolution of legal services, financial & accounting and
management consulting can be concluded that the internalization is higher than the
outsourcing, since they have achieved revenues of 117 million euros worth in the
terms of making payments of 222 million euros. From this brief analysis conducted in
late 2005 we notice that, even since then, Romania can be considered an attractive
country for outsourcing, both in services and industrial sectors [CNP, p.5].
Concerning the international services outsourcing, during the year of 2005, they
accounted for only 0.1% of GDP in Romania. The analysis took into the account the
IT services area, while legal services, financial, accounting and management
consultancy recorded and internalisation amounted to 101 million euros,
approximately 0.2% of GDP.
Table 1. Classification of business process outsourcing
Business
process
outsourced
Finance and
accounting
Service suppliers
Types of services associated

to outsourced process
Internal Audit
Management of expenses
Receivables and payables analysis
Billing
Financial Reporting
Management services taxes
Tax Reporting
Budgeting
General Accounting
Treasury
Finance
Accenture
Capgemini
CGI
CSC
EDS
HCL Tech
iGate
Patni
Satyam
Wipro
Accounting
BDO Seidman
BKD
CBIZ
Convergys
CroweChizek
Delloite & Touche
Ernst & Young
Intelenet Global
IQ Backoffice
KPMG
Mellon Financial
Outsource Partners International
PriceWaterhouseCoopers
Grant Thornton
RSM McGladrey
(Source: [Brown-Wilson Group, 2007]; [Mattoo, 2004, p.4])
Thus, in order to improve the activity of outsourcing the financial services, both
companies (beneficiaries) and suppliers (outsourcing service providers) should apply
the following rules [Pvloaia, 2008]:
to define the indicators necessary to assess the contribution of outsourcing to
achieve economic goals;
not ignore the human factor issues;
to have a common vision (customer-supplier) into the the definition of
success;
the selection processes used should be flexible;
there should be a strong and transparent business relationship between supplier
and recipient;
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to use auditing standards;

outsourcing should be based on best international practices.
The literature contains numerous references to the classification of business process
outsourcing. They are based on the type of economic process for outsourcing. In
Table 1 are presented only specific types of services related to finance and accounting
processes as well as firms that are located into the top providers of such services.
In Romania, too during the recent years it has been established a number of firms,
especially small, aiming to provide services in financial accounting. They activates
alongside with world renowned companies which have entered the market from the
our country one by one. The firms are Deloitte & Touche, KPMG, Ernst & Young and
PriceWaterhouseCoopers, also known as the group of four, title granted after
ArthurAndersen firm collapse. Thus, strictly linked to the economic environment, in
Table 2 are presented as an example the supply of outsourcing services firm Deloitte
Romania and structure.
Table 2 .The offer and structure of the outsourcing services
from Deloitte Romania firm
Type of outsourced
service
Types
of activities
Accounting and financial

services
Payroll and secretarial

services
Tax Administration
Complete records, including

reports and financial
statements for management
use.
Review of accounting records
Preparation of annual
statements for income
taxes withheld from
wages.
Payroll Preparation
The program of staff

agreements
Other services: electronic
banking, etc.
Payroll
Record of the Financial

Administration for
income tax, VAT and
other taxes.
Preparation of tax
returns
-
(Source: Adaptation after [Delloite, 2008])
For the year of 2009, the Black Book of Outsourcing study [Brown-Wilson, 2008, p.
15] predicts that a number of functional areas such as finance, accounting and IT
infrastructure, will continue their upward trend in increasing the share of types of the
outsourced services. Thus, financial accounting services will increase by 75.2%
compared to 2008, being located on the 2nd place (due to their rate of growth) after
acquiring services, brokerage, sales management and payments whose growth is
estimated at 83.4%. The knowledge society has triggered activity centered on
knowledge process outsourcing, called KPO - Knowledge Process Outsourcing. As a
direct result, interpretations, diagnostic, market research, data analysis etc. are the
work of specialists whose advance preparation is very laborious. As part of KPO, the
level of qualification of human resources used and the degree of involvement of the
beneficiary of these services will be much higher, since between the two partners
must exist a close communication, and the customer will be responsible for validating
or providing guidance to customer into its activity.
~652~
Market surveys show that the main processes or activities subject to outsourcing are:
manufacturing (53%), logistics (51%), HR (35%), sales and marketing (33%),
research and development (32%) and finance and accounting (24%).
Although outsourcing finance and accounting service are located on the last places we
ilustrate that a strong tendency to increase their share into the outsourced services is
expected. On the other hand,the reason for not widely outsourcing the accounting
functions in Romania, can be explained by the fact that the information in this area are
considered crucial because the company supports the foundation of strategic decisions
and, as a result, managers are reluctant to outsourcing.
2. SERVICES OUTSOURCING OF ACCOUNTING AND ECONOMIC
AND FINANCIAL ANALYSIS
In order to establish the financial and accounting activities that are suitable for
outsourcing is necessary to make a careful analysis that takes into account an
important criteria regarding the importance of the data and processed information.
Thus, we can distinguish a number of situations that correspond to the following three
classifications: (1) financial and accounting activities that are most often outsourced
(known into literature [Sako, 2006, p. 507] as special transactional processes), (2)
financial and accounting activities that are good candidates for outsourcing
(outsourcing is suitable but there are some concerns about the loss of the internal
competences due to outsourcing) and (3) the strategic financial and accounting
activities, that normally are not outsourced.
While specific financial accounting transactional processes are easily outsourced as
the applicable solutions are standardized, the activities involving a high level of
expertise, as internal audit, budgeting, taxes, economic and financial analysis, are
more difficult to outsource. They involve a high degree of knowledge of enterprise
and internal and /or external factors that may affect the decisions and objectives
fullfillement. If the latter activities will be outsourced,the processes will be called
transformational processes because, in order to conduct them, the provider must
perform a variety of customizations. Thus, in Figure 1 are graphically presented, the
financial and accounting activities according to their degree of outsourcing.
The taxonomy of the outsourced activities greatly influences the management manner
of company providing accounting services. Thus, the main activity can be structured
in accounting, auditing and other services, such as valuation services, research,
restructuring, financial analysis etc. Latest services refer to more complex activities
that requires high-level skills.
At the start of start outsourcing services towards a customer, it can be carried out
routine accounting activities such as information processing accounts and primary
records, and later may move forward to providing of value added services such as
diagnosis and economic and financial analysis that helps the accounting officer officer
or chief financial officer into the specific decision-making processes
[www.outsourcing-journal.com].
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Figure 1. Classification of the financial and accounting activities according

to the degree of outsourcing
(Source: Adaptation after: [Rehmann Goup, 2007]; [Morgan Chamber, 2007])
2.1 Accounting service outsourcing

Accounting firms in Romania are organized in double circuits, namely financial
accounting (also known as general accounting) and management accounting (also
called management accounting or analytical) which is not normalized, being applied
according to the needs and particularities of the business.
In Romania, the Accounting Act had established by Article 10 that "the responsibility
for organization and management accounting is the administrator, officer or other
person who is liable for the management of that unit". Specific accounting tasks can
be carried out into two variants [Horomnea, 2007]: throughout their functional
departments or through agreements regarding the supply of accounting services. In the
first case, firms held a finance and accounting department under the leadership of
chief financial officer, chief accounting officer or another person empowered to
perform these functions. In the second case, the accounting can be performed on a
contractual basis for the provision of services of accounting, done with individuals
(accountant, chartered accountant) or legal persons authorized members of the Body
of Expert and Licensed Accountants from the Romania (CECCAR) . In this situation,
changes to accounting by the enactment of Law no. 259/2007 refers to the art. 10
paragraph 4 of that responsibility lies with the organization and management
accounting service provider, according to the contractual provisions and applicable
laws.
The information presented above helps us detach from the Romania Accounting Act
that the law allows any enterprise, that belongs to either public or private sectors, to
outsource the entire accounting functions or only certain accounting work to a third
~654~
party, with only one condition: that the supplier of these services is an authorized
member CECCAR.
Standardization of financial accountings work led to the outsourcing with greater
ease of this branch of accounting. The flexibility of the organization as well as the
specific features that characterize the information in the course of managerial
accounting industry, makes managerial accounting more difficult to be outsourced.
We believe that outsourcing accounting services leads to an increased fairness and
legality of business transactions reflected within the documents from both the
beneficiary and the customer.
By outsourcing its accounting services, the company, through its employees, will fully
concentrate its resources and creative force for the purposes of carrying out those
activities in which the firm excels, while ensuring the overall management and
flexibility of conditions that no longer feel the risks associated with outsourcing
activities, as they are transferred (through the conditions from the the agreement) to
the supplier [Pvloaia, 2009].
There should not be overlooked the access to industry best practices and latest and
more advanced technologies. Unlike enterprises, outsourcing providers have every
incentive to keep up with the latest innovations in order to ensure their market
competitiveness. Thus, if accounting is a back-office function for a firm, for the
outsourced company is the main objective of activity and is, therefore, treated
accordingly.
2.2 Outsourcing the economic and financial analysis service
In general, studies reveals that it is not possible for small and medium enterprises to
hold employees which can develop industry-specific situations and analysis specific
to the economic and financial analysis. Preparation of its specific synthetic
documents, involves along with a time consuming activity , a rather important and a
high level of expertise that should be paid accordingly. Furthermore, analysts must
constantly participate to specialized training in order to be informed about the best
and current practices in the field. Neither the specific legislation should not be
neglected. Rather, it should always be considered and therefore, employees must
constantly update their knowledge on legislation. The experience gained by them is
the expertise they own in this field and it is composed from the specific cases and
general knowledge facts about the economic and financial area. Therefore, the above
issues constitute some sources that could stand as the basis for calculating the
personnel costs involved in the activities of economic and financial analysis.
In the light of the above information, outsourcing of financial services must take into
account several criteria, among which in our opinion, the most important would be the
size of the enterprise. Thus, SMEs must be treated differently than large companies.
While the first category of companies is not motivated in holding their own
employees for those somehow seasonal but highly complex activities, the last
category must have at least one department or even a team of economic and financial
analysis [Pvloaia 2010].
~655~
An outsourcing model is shown in Figure 2. It is obtained by combining the two

models developed by the author Zhu [Zhu, etc., 2001, p.39, 373-378] and Lever
[Lever, 1997, p.20, 37-48].
Figura 2. An outsourcing process model
Planning*
Development*
Implementing*
Surviving*
Discovery**
Negociation**
Transition**
Evaluation**
(Source: Adaptation after [Marshall, .a., 2005, p. 348])
At the strategic level, the issues and circumstances that must be considered in the case
of outsourcing the economic and financial analysis are [Pvloaia 2008]:
establishing the competence over the firm that takes over the activities (degree
of competence and expertise of employees), hence the quality of prepared
statements;
establishing confidence, loyalty of the external partner, the degree of trust
toward the partner, that will ensure confidentiality on company accounts;
the size of the company that takes over the activities, the ratio of customers
and employees; could the partner complete the tasks in due time ?;
the costs involved in outsourcing, it would be desirable to establish a fixed
amount paid monthly or annually for the possibility of a proper budget
allocations.
One way of resolving or, more secure, to mitigate the effects of the above problems
would be to specify all the details in the contract that covers outsourcing services
contract between the beneficiary and provider.
For many businesses, regardless of size, outsourcing could be an essential element in
achieving its objectives, including those that relate to business profitability. Therefore,
we mention some of the reasons why a company is forced to turn to the outsourcing of
financial and economic analysis:
diminish and control costs;
restoring the company's vision and focus on its core competencies;
using a high-level expertise and know-how;
release the internal resources and focus on other aspects;
a high-performance services contribute to the added value of the enterprise;
outsourced business resources are not available within the enterprise.
The effects of outsourcing specific economic and financial analysis can be identified
through the annual accounts, as they present the following aspects: an increase in
working capital, because the entity no longer purchase computer equipment for
specific records; a reduction in borrowing cycle operation, whereas the external
benefits are paid at intervals greater than the wage debts; a reduction of value added,
because the fees will take the place of wages and social expenditures.
Also, by working with an external provider, the company is exempt from
responsibility for drawing up the synthesis documents specific to accounting and
reporting, which is taken over by the provider under the law governing financial and
~656~
accounting activity. Also, professional risk insurance (which every accounting firm is
required to hold) guarantees compensation in case of errors.
Closely related to the outsourcing company's financial and economic analysis, in
Table 3, is illustrated the projections presented by Black Book of Outsourcing
[Brown-Wilson Group, 2008] on trends for 2009 budgets for outsourcing.
Table 3. Outsourced areas and the trend of budgetary allocation in 2009
The field intended for outsourcing
IT Infrastructure
Computerised applications
Accounting and financial processes
Knowledge processes
Mediation processes
Transactions and business processes
Call centers
Human resources
The trend of budget allocation

63,4 %
55,1 %
21,8 %
11,7 %
11,3 %
6,9 %
0,7 %
-2,4 %

In conclusion, we point out that in Romania, the firms that provide financial and
accounting services, consulting and/or audit, are members of professional
organizations such as CECCA.R. and/or C.A.F.R. These bodies that gouverns the
accounting profession and the manner of keeping the accounts in our country. Under
these circumstances, the firms are sheltered under the umbrella of those bodies that
ensure quality financial and accounting services to members through regular audits.
The main advantage that outsourcing brings to a company is cost diminishing. Thus,
variable expenses consumed by financial-accounting turns into fixed costs, and this
action allows avoiding the costs of seasonal activities, characterized by over-activity
(overtime payment) and/or sub-activity periods (assumption downtime). Outsourcing
leads to costs reduce and eliminates the costs of employee access to legal expertise
and fiscal accounts in Romania. Thus, employees must participate in training courses
on a regular basis. Such trainings can be quite expensive, and through outsourcing,
their cost is passed on to the service provider. Due to outsourcing, the company no
longer needs to keep up with technology and computer software, which brings a new
set of economies, worthy of consideration.
In addition to these advantages, we point out that outsourcing the accounting function
entails some risk. Firstly, the company could lose control of the essential functions
that includes information regarding other core business functions, such as commercial
office, production, personnel. Secondly, confidentiality and integrity of financial
accounting information is a strategic goal, which must thoroughly observed. Thirdly,
a number of mandatory accounting justifing statements, can not be accessed quickly,
as long as they are in the posession of the service provider. This deficiency could be
removed by e-accounting, which would allow 24/7 access to company accounting and
financial information. Finally, credibility, expertise and reputation of the service
supplier must be thoroughly tested and checked before signing the agreement with the
provider. This way can be prevented a number of drawbacks such as fraud, missing
the deadline dates for the financial statements, over-invoicing, lack of
professionalism, etc.
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ACKNOWLEDGEMENT
This current research is conducted under the auspices of the Postdoctoral
ProgramStudii Post-Doctorale n Economie: program de formare continu a
cercettorilor de elit SPODE developed by the Romanian Academy (POSDRU
Grant POSDRU/89/1.5/S/61755) and financed by Fondul Social European prin
Programul Operaional Sectorial Dezvoltarea Resurselor Umane 2007-2013.
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Morgan Chamber, (2007) Finance and Accounting Outsourcing. A Morgan Chamber
Factsheet, Morgan Chamber 2007, http://www.morganchambers.com/downloads/
Finance_and_Accounting_Fact_Sheet_Mar07.pdf
Horomnea, E., Tabr, N., Budugan, D., Georgescu, I., Be ianu, L., (2007) Bazele
contabilitii, Edi ia a IIa, Ed. Sedcom Libris, Ia i 2007.
Zhu, Z., Hsu, K. and Lillie, J., (2001) Outsourcing a strategic move: the process and the
ingredients for success. Mgmnt Decision, 2001.
Lever, S., (1997) An analysis of managerial motivations behind outsourcing practices in
human resources. Hum. Resource Planning, 1997.
Marshall, D., Lamming, R., Fynes, B., (2005) The development of an outsourcing process
model, International Journal of Logistics: Research and Applications,
Taylor&Francis, Vol. 8, No. 4, December 2005.
Business Process Outsourcing: The Finance and Accounting Process, Outsourcing Journal,
septembrie 1999, www.outsourcing-journal.com.
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PS14 Management information systems III

Chairperson
Javier de ANDRES, University of Oviedo, Spain
AUDITING NEW INFORMATION TECHNOLOGY

SOLUTIONS FOR ECONOMIC GROWTH
Delia BABEANU, Gabriel COZGAREA, Adrian COZGAREA,
Ilie TAMAS, Nicolae DAVIDESCU
A TEST OF DIFFERENT MODELS

FOR THE ESTIMATION OF THE LABOR COSTS
OF SOFTWARE PROJECTS
Javier DE ANDRES, Pedro LORCA

Marius Daniel MARES, Valerica MARES
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AUDITING NEW INFORMATION TECHNOLOGY

SOLUTIONS FOR ECONOMIC GROWTH
Delia BABEANU1, Gabriel COZGARE, Adrian COZGAREA,
Ilie TAMAS & Nicolae DAVIDESCU
ABSTRACT
Auditing solutions for economic growth is tied in large part by factors that have major impact
on the development of a company. Among the most important factors it is included the
permanent identification of new threats and vulnerabilities and the manner in which
companies adopt the best solutions for treatment. It also requires the development of a
customize information strategy related the growth and modernize of a company, as well as an
efficient business plan involves the objective analysis of how the society, from its founding
until now, the performance achieved and identified critical processes.
A security solution adopted in IT&C to cover economic growth and global competition is to
outsource the tasks that are not part of the main object of activity of the company by external
entities to reduce costs and to preserve and concentrate its efforts towards achieving the main
activity through more efficient use of human resource, capital and technology. But this is not
enough, because to ensure flexibility and to reduce costs it is necessary to use and improve
work with modular and integrated services on a platform level, like cloud computing.
KEYWORDS: threats and vulnerabilities, information strategy, outsourcing, cloud

computing
INTRODUCTION
In the digital era, in a continuous update of the way in which economic growth leaves
its traces in our lives, information systems, just like any other science, knows the
major developments. These developments are related to the needs of users of any
type, whether end-users or companies who develop new technologies of software
applications or hardware.
The speed of their implementation in relation to the needs of an entity, but also users,
lead to the emergence of risks to the activities of the business. Thus, the creation of
methods, procedures, security policies to ensure the proper functioning of computer
and information system, is a continuous process, but useful, which requires time and
experience in the field.
The period of accelerated transition to the model of the economy and society,
characterized by laborious and profound transformations in all areas of activity, with
particular economic implications, has a magnitude and rapidity unknown since now.
Correspondence address: Delia BBEANU, Bucharest Academy of Economic Studies, Romania;

email: delia.del@gmail.com
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Due to these changes in the economy, demand and supply at the global level have an
important role, involving increasingly internet technology.
The process of modernization and development of a company, in terms of commercial
activities, is a permanent concern for both the primary managers of companies, as
well as for its employees, through a process of restructuring and adapting to new
requirements imposed after our country join to the European Union.
Development of a customize information strategy related the development and
modernize of a company, as well as an efficient business plan involves the objective
analysis of how the society, from its founding until now, the performance achieved
and identified critical points. The use of information technologies and
communications stimulate global competition, economic growth and overall control
accelerates the economic-financial monetary transactions.
Radical changes occurring in a company, and the whole economy based on
information technologies induce the "new economy", which is based on knowledge.
Therefore, the problems are of convergences and divergences nature between "new
economy" and "traditional" economy, but also by the difference in economic
behavior: the new face of the existing (cries, 2011).
The new economy is linked, in the current language, of internet-based economy and is
sometimes called the "digital economy", "network economy" or "e-economy". But, it
does not refer only to the internet economy companies. This is a complex merge
between the digital economy (internet, digital goods and services, new business
models, new ways of work), globalization, innovation, sustainable development.
Innovation and competition constitute the engine of development, and rapid and
profound structural changes at the macro and micro economic level imposed by the
global character of technological change and economic activities involve balancing
the activities between the internal and external levels, local and global. Basic concepts
of the new economy are the emergence of future activities carried out from
development/remote, of information technologies and communications. Existing
activities are carried out faster, more productive, and at a lower cost, and the
emergence of new economic sectors with an impressive growth is due to intangible
activities and processes of learning and knowledge.
The main processes occurring in the new economy are provided by the accelerated
development of advanced communications, with the predominantly to network
internet. Development of electronic commerce, the emergence of new models of
business restructuring/re-engineering companies, promote new rules and forms of
organization, based on predictive society, on innovation and the expansion of forms of
activity and working remotely. These processes have three defining characteristics,
namely: access and instant response, personalized service, as well as the simultaneous
presence in several places (ubiquity).
The modality for research data collection consists in studying the sources and nature
of solutions adopted in information technology, explanations and interpretations, all
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of the techniques, methods and procedures adopted in terminology work to carry out
terminology research.
We propose to start with literature review in identifying new IT threats and
vulnerabilities continue with a case study regarding information strategy for online
business and proposal to eliminate threats and vulnerabilities by using outsourcing
and cloud computing.
As we know, information strategy must be aligning to IT novelty, so the future studies
will be according to new technologies for online business to improve the economic
performance.
The next steps present the flow of the research:
Defining the research and development of its approach
The first step in the research was the definition of the problem to study. To define
correct strategies, it was considered important the existing relevant information, and
establishes the necessary information for making decision. The definition of the
problem involved discussions with decision makers of companies, interviews with
experts in the field, secondary data analysis and qualitative research sometimes, such
as "focus group".
This technique was used to see how viable is a new software product or a new service
as proposed for implementation. We set up a group of 8-9 managers, from a company
to discuss some of the issues on which we have proposed. The group was led by us
together with an IT specialist manager moderator at company which conducted the
interview. He started the discussion at a very general level, and then, gradually, was
focused on the subject in question, in the form of information security along the flow
of information; the participants were not told before that is the subject of the question,
but only the area of interest.
Focus group website has proven to be useful for understanding the perceptions and
behavior of the users' computer system; generating new ideas for software or
hardware products located at maturity; getting impressions, information related to the
launch of new software products; the development of concepts, new ideas in regards
to advertising for products developed in society; reactions to the change in the price of
services, obtaining preliminary reactions to specific marketing programs.
The research plan
Research plan represented a guide for conducting research. Established procedures for
obtaining the required data and its purpose was to present a study, which give answers
on how to identify security risks, security breaches and provide information related to
their appearance for the preparation of a detailed final conclusions with
recommendations.
Research plan involved taking the following steps: analysis of secondary data,
qualitative research, quantitative methods of data collection, the definition of the
necessary information, documentation, sample proposal and setting the size of the
sample, the data analysis plan (security policy, organization, management of
information security, human resources security, physical security and the
environment, communication and management of logical operations, control of access
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to the computer system, the acquisition, development and maintenance of information

systems, management of information security incidents, business continuity
management, compliance with legal requirements).
Collecting data
The process of data collection included personal interview. Careful selection of the
data, training where necessary interdisciplinary approach, the control and evaluation
of information received were essential to minimize errors which could arise in the
process of collecting data.
Processing and analyzing information
The processing of the information included grouping, editing, coding, transfer and
verification of the replies given by the interviewee. Each data was inspected carefully
and where necessary, corrected. The data was transcribed into a database and verified
the accuracy. The last step is to analyze data.
Presenting research conclusions
The conclusions of the entire project analysis contain research problem and
objectives, the plan of research, the collecting data, the procedures adopted for the
analysis and the results obtained. The results are set out explicitly in order to be easily
implemented and follow in a future research.
2. LITERATURE REVIEW IN IDENTIFYING NEW IT THREATS
AND VULNERABILITIES
Vulnerabilities and threats are the risks of computer networks of a company. These
vulnerabilities result from removing the damage through network attacks. A
vulnerability of a computer system is a weakness in an application or operating
system, application code or configuration that makes it possible to exploit a threat in
the system (or the underlying network) by creating a negative impact or damage.
Threats are units that take action on the vulnerabilities by trying to exploit. A threat
may be an unauthorized user, such as a hacker or even a system administrator by
trying to gain access to a system beyond the level authorized in advance. It rarely
happens that the application or system processes can act as threats.
The discovery of these vulnerabilities requires prioritizing their mitigation and
determination of the impact on infrastructure. Priority will not be accorded the
vulnerabilities that are accessible to those who have not been exploited nor have an
immediate impact on the infrastructure. In setting priorities on cutting vulnerabilities
will keep into account the sensitivity of the data on computer systems that are
affected. Must know at first what data in the network are very sensitive. For this it is
necessary to a classification of such data by labeling them as: highly sensitive,
moderate, minimal, non-sensitive.
Any date that puts business continuity in the game should be classified as extremely
sensitive date. The data that can be easily recreated and are read-only public are
susceptible. Some organizations make the mistake of fixing vulnerabilities to be
exploited, than to watch what impact have these in the processing of classified data.
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IT infrastructure is based on tools for automated vulnerability assessment to find

vulnerabilities in their systems and networks. Vulnerability assessment tools, also
known as scanning tools can be run without an IP address, a range of IP addresses,
host websites, firewalls, routers and other critical infrastructure in order to discover
the vulnerabilities associated with these systems and networks.
Companies Security Policy typically define the following activities as unacceptable:
outside reconnaissance probing, penetration - inside reconnaissance, escalate privilege
- gain foothold and pillage, expand influence - exploit and cleanup to cover tracks,
profit. For these problems we have the following situations:
Network Reconnaissance of the footprint of the target system is trace route to
present potential access paths and vulnerable entry points through the target
network. NMAP(Network Mapper) open source utility developed reports the
operating systems of OSs and firewalls;
eTrust from Computer Associates can capture the packets of all protocols on a
network and save (non SSL) pages viewed on desktops, use techniques which
do not harm target machines, identify which machine names are alive with a
ping sweep, identify which services are available on each machine using a
UDP/TCP port scan/strobe;
Take advantage of vulnerabilities to break into target systems: crack logon
passwords using dictionary or brute-force attempts using, modifying cookies
to access other accounts, sending shell commands in input fields, initiate
emails infected with worms and Trojan horse viruses;
Once elevated privilege is obtained: hide evidence of intrusion, reduce
detection during future incursions, Provide services to other hackers, such as
storing files on the compromised machine for others to obtain files, Use
infected system to launch Distributed Denial of Service attacks on another
target;
Profit from attack like: steal information, run up charges, on client browsers,
point the default website to a malicious site, and deface web pages served on
web servers (such as IIS).
In other words, the definition of the risk is:
Risk = Threat x Vulnerability
Where: risk is being exposed to threats, risks are the potential to incur consequences
of harm or loss of target assets, a risk factor is the likelihood of resources being
attacked, threats are dangerous actions that can cause harm. The degree of threat
depends on the attacker's skills, knowledge, resources, authority and motives.
How we may build a risk is shown in the table below.
Table 1. Samples of risk appearances
No.
1.
2.
3.
4.
5.
Threat
Hacker
Insiders
Industrial espionage
Cracker
Terrorist
Vulnerability
Improper use of technology
Inability to control technology
Inability to react quickly enough
Concentration of data
Incorrect Data entry
Risk
Hacking
Social engineering
System intrusion, break-ins
Unauthorized system access
System penetration
(Source: Information security threats and vulnerability, 2011

http://www.wilsonmar.com/1secvul.htm)
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The importance of IT Risk and Compliance management has grown dramatically as

business operations are increasingly dependent on information systems technology. IT
related failures can have a serious impact on business performance and thus managing
IT risks is a necessary component to ensuring overall corporate health.
3. PROPOSALS FOR REMOVING THREATS AND VULNERABILITIES
One of the best modality to reduce risk is use outsourcing services which means the
transfer of the management and/or day-to-day execution of a process of deal
processed by external service provider. Another term is usually used to refer to
outsourcing and Business Process Outsourcing business process Outsourcing or
BPO. In any outsourcing arrangement, there are at least two parties involved. The first
is the company client, acting to achieve one or more processes to deal with a foreign
party, and the second is vendor (provider) company that runs the business processes in
the interests of the client.
The decision to outsource the tasks that are not part of the main object of activity of
the company by the external entity is usually taken in order to reduce costs and to
preserve and concentrate its efforts towards achieving the main activity, through more
efficient use of manpower resources, capital and technology.
The organizational structure of a company benefiting from these services change
through acceptance of the completion of these activities, foreign contract. To call
upon the services of other companies as part of its business, it takes as between the
company and the service provider to have a consolidated partnership of trust and
responsibility assumed. On the basis of this partnership, the supplier is in charge of
purchasing all the means necessary to achieve the secondary activities of the firm,
including manpower, material resources and the necessary technology.
The organizational structure of a company benefiting from these services change
through acceptance of the completion of these activities, foreign contract. To call
upon the services of other companies as part of its business, it takes as between the
company and the service provider to have a consolidated partnership of trust and
responsibility assumed. On the basis of this partnership, the supplier is in charge of
purchasing all the means necessary to achieve the secondary activities of the firm,
including manpower, material resources and the necessary technology.
In large building outsourcing is more complex. An example is agent (broker), which is
a service that finds the intercooler in the interest of the customer, the suppliers by
connecting some of the external management and operations responsibilities
(Bragg, 2006).
Classification of outsourced business processes can be achieved through three main
categories of outsourced business processes:
Information Technology-Information Technology Outsourcing outsourced (IT

Outsourcing) Outsourcing the design, development, implementation and
management of IT products and processes provided by a third party;
Outsourcing business processes that are not listed in the previous categories.
Example: accounting, marketing, sales, administrative development.
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Securing services outsourcing

It was observed an exponential growth in the number of companies which have
concluded that the lack of control of activity was and is the main reason for not
wanting outsourcing services. Overriding question to that effect would be if
outsourcing is safe or not. Recommendations for determining safe levels of exposure
we can pose when outsourcing a service (in the present case, a cogent example is
outsourcing IT) require: data classification, the classification of organizations,
choosing a service provider and expanding the low-risk activities (Allen G, 2003).
The choice activity suitable for outsourcing will be watching: penetration testing
security consultants and Auditors, in case of disaster planning and business
continuity; analysis and processes restructure, system performance/load testing,
support for hardware and software, as well as the development and integration
activities, Automation scenarios, detect intrusions.
Safety strategy of outsourcing for services technology contains four stages (micro
sourcing 2008):
identification of problems and current commercial potential, including: secure
the data, improving operational efficiency, enhancing the speed of
responsiveness to customer requirements, reduce operational costs;
the adaptation of new technology-based solution to the problem of the most
important of the society;
establish evolutionary phase in which the company;

ensuring that the immediate option of technology will help the future
development of society.
In conclusion, the risk factors of security at the outsourcing of activities will be, in the
vast majority of cases, those who will provide the benefits of outsourcing. If a
business depends on the actual costs, then you must take into account the services
provided by the remote provider (offshore vendor).
Table 2. A few common objectives and parallel between outsourcing and customers
Factor objective
Cost per unit of
service the
opposite goal
Quality of servicethe opposite

objective in a way
Operations-objective
opposite in some
way
The Customer (Internal)

Customers want to obtain the least
expensive services:
-Definition of the precautionary and
control services and associated costs;
-Proposals for application from suppliers
in the sphere of big business;
-Good price Negotiation (not the smallest,
an acceptable price/quality ratio).
Customers want the important guarantees
at the level of services, joined the metric,
with the major objective of predefined
(unfavorable payments) if the provider of
outsourced services do not meet the quality
of services. Customers want compensation
for loss in business.
Outsourcer (Extern)
The objective of this vendor is to maximize
long-term profitability through:
-High-cost rate;
-The proposal price flexibility in rules to
allow an additional income;
-Large volume of standard services;
-Large customers retention;
-The economy of the ranges of products.
Vendors prefer loss or lack of minimum
level of services with the requirements in the
quality specification of unsatisfied events of
the level of service.
The vendors wish to be responsible only for
a fee subscription type.
Services and systems provided by the

outsourcer must be integrated well and
easily with other operations of our clients.
This assumes the application in some
cases, a considerable customization and
system services.
Services and systems provided by outsource

must be integrated well and easily with other
operations of our clients. This assumes the
application in some cases, considerable
customization and system services.
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Factor objective
Complexity a
similar Objective
The Customer (Internal)

Systems and services can be complex
undercover, but can be simple to use.
Easy to use a
similar Objective
Systems and services must be simple and

intuitive, requiring minimal training and
helpdesk by phone.
Outsourcer (Extern)
Systems and operations must be easy to
handle in order to maintain and change, but
with a high cost of entry customers trying to
be competitive on the market through them.
Systems and services must be intuitive and
simple, require a minimum technical support
customers.
In the recommendation of the general risks of outsourcing's namely: loss control

service; the viability of the service provider; the quality of services; issues of trust in
partner; the performance of applications and services; lack of experience in the field;
hidden costs and unreliable; customizations and enhancements limited; transfer of
knowledge; shared environments; elements of legacy.
When all the risks of outsourcing are taken into consideration, there is at least one to
which you take the decision to use a third party. Anyway, there are a number of
proofs for these categories of risks occur often and are satisfactory to the purchaser
and seller prospects.
Outsourcing was a tool with the help of which multinational companies tried to reduce
overhead costs. However, even for the multinationals there were some problems
managing offshore projects. Remoteness, lack of openness and transparency in
relations between a customer and service provider, cultural barriers could bring to
nothing all potential savings and benefits.
Another proposal to remove threats and vulnerabilities is cloud computing. The
comparison between the outsourcing and cloud computing is presented in the
following figure, where the arrows show the information flow.
Figure 1. Comparison between outsourcing and cloud computing
Cloud computing can be defined as a new style of computing in which dynamically

scalable and often virtualized resources are provided as a services over the Internet.
Cloud computing has become a significant technology trend, and many experts expect
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that cloud computing will reshape information technology (IT) processes and the IT
marketplace. Advantages of the cloud computing technology include cost savings,
high availability, and easy scalability.
These are presented by detail in the figure below.
Figure 2. Advantages and disadvantages in cloud computing
reduce capital costs

reduce IT human resources costs
business scalability grow
high availability, flexibility
increase storage, more mobility
highly automated
Dependent on the Internet/Intranet

Legal aspects relating to the
ownership of data
Inefficient use of computer
peripherals
ADVANTAGES
DESADVANTAGES
Cloud
Computing
In traditional data centers, the common approaches to security include perimeter

firewall, demilitarized zones, network segmentation, intrusion detection and
prevention systems, and network monitoring tools.
Figure 3. Followed processes in IT management assessment through Cloud
Computing
(Adapted after: Iron Mountain, 2011)
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The security requirements for cloud computing providers begins with the same
techniques and tools as for traditional data centers, which includes the application of a
strong network security perimeter. However, physical segmentation and hardware
based security cannot protect against attacks between virtual machines on the same
server. Cloud computing servers use the same operating systems, enterprise and Web
applications as localized virtual machines and physical servers. Therefore, an attacker
can remotely exploit vulnerabilities in these systems and applications.
Virtualization increase the number of machines to manage, service provision becomes
crucial since it directly affects service management and maintenance and operation
efficiency. Automation, the next core technology, can make resources available for
users through self-service without getting the service providers involved. A stable and
powerful automation management program can reduce the marginal cost to zero,
which in turn can promote the scale effect of cloud computing. (B Furht, A Escalante,
2010)
Cloud computing is a solution in today's principles competitive world when business
strategies should be made quickly. Comparing with conventional IT outsourcing, an
approach of cloud computing allows customers:
to reduce expense for building infrastructure, security in information
strategy and business responsiveness with faster time to market coverage;
to acquire online business strategies, using online process and reducing
capital investments;
staying flexible to the market by growing business efficiency without

losing business control (more efficiency for business). (D Kharchenko,
2010)
4. GENERAL FRAMEWORK FOR INFORMATION STRATEGIES

Improving productivity performance is essential to companies and not only if they are
competitive at the global level and have a strong economic growth. Adoption in the
business of all new technologies will lead to ensure the realization of the proposed
performance and getting revenue for development.
4.1. Building a complex strategy
According to the terms of the business, but also financial, IT & C advanced
technologies combined with innovation in the business will lead to economic
transformation and the new media business in the coming years. Factors acting on
entities in relation to ICT are: business environment, culture, business structure,
standard procedures, business processes, policies and security management, decision
management, etc.
In this way, an information strategy at the entity level to obtain business directs
performance. The model of information society strategies is shown in Figure 4. Based
on the system of Knowledge, Understanding and Exploiting the Information
Resources (KUEIR) we build information society strategies.
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Context
Figure 4. System of knowledge, understanding and exploiting

the information resources
T
FU
UR
ST
PA
(Adapted after: Roceanu, Buga, 2003)
We start from the fact that the triangular strategy components are known, which is
based the construction, namely:
A triangular strategy 1 (ST1) represents the organizational or management
strategy;
A triangular strategy 2 (ST2) entered in this Assembly through informational
strategy, based on the IT strategy;
A triangular strategy 3 (ST3) considered to be the marketing strategy.
A triangular strategy is a simple framework for understanding the impact on business

information systems, which link the information systems strategy and organizational
strategy and describes the balance to be maintained in the planning of the business.
The triangular strategy requires security for all of the elements. Risks which are
subject to the strategy are always identified and assessed, leading to difficulties in the
current functioning of the company in terms of the use of new technologies. For this
we propose a security strategy of the alignment to the triangular strategy to ensure
proper development from the company's creation until maturity of business activities.
We also need to take into account updating the activity objects of the company, as
well as the suspension or permanent dissolve of activity and the destruction of data
and information which are no longer used.
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Figure 5. General framework for information strategies
(Source: PhD Thesis Information strategies for merchandise societies using internet
technologies, 2008)
The security strategy is reported still in the phase of preparation and planning to
KUEIR and building step by step along with other strategies, assessing the impact that
it has at any stage of development of company. Implementation of the security
strategy ensures the continuous provision of information and related services.
The security model of the strategy shall be implemented on any type of company, not
only for online business. A better correlation of all the components between the
strategies leads to development activities in conditions of maximum safety in the
design phase of a task.
The information strategy at company level, as shown in Figure 6 presented by using
BPMN (Business Process Model and Notation), is needed because all information
components are defined in the empirical phase of the company development.
Implementing ISMS (Information Security Management System) according to ISO
27001 requires that the system which must certified to be already designed and
implemented. In the strategy case, the system is in the design phase, it still does not
exist physically or logically, and at this stage we can implement security controls and
procedures to ensure the proper development of future activities.
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Figure 6. General framework for information strategies

Management
IT Strategy
KUEIR
ISMS
Marketing
IT Security
KUEIR
Process
Management Processes
IT Strategy Process
Marketing Processes
Security Processes
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ISMS Process
(Source: Applying ISO 27000 in business strategies)
4.2. Managing the implementation of ISMS according to ISO 27001

An ISMS (Information Security Management System) is a management system based
on a systemic approach to the risks to which the company is exposed to and aims to
establish, implement, operate, monitor, review, maintain and improve information
security policies, information systems and personnel.
Entities which considered that the information in the framework of the activities and
not only, must be protected, should have a management system to control the risks
arising from all levels of access. According to the ISO 27001 (ISACA, 2008), keeping
information by implementing a management system and certification of information
security, it will represent the business card of the organization for customers and
business partners.
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We mention the advantages to deploying such a system:

increase credibility in front of customers and partners;
elimination of risks due to leakage of information;
sensitivity of users information system with regard to the security of
information at national level and the link with the external environment;
the existence of a proper environment to the elimination of problems related to
information security;
implement and development of best practices-level entity, ensuring business

continuity.
Figure 7. Security scenario in business environment
(Source: Adapted after: ISO 27000 series)
Implementing an Information Security Management System (ISMS), according to the

standard, presumes the following stages: determination of purpose; analysis of
documentations; analysis of the processes of the entity; inventory of information
assets of the entity; risk identification; risk management; setting goals and means to
mitigate those risks; defining information security policy; development and
implementation of procedures; training of personnel; monitoring compliance with the
requirements of ISMS information system of business; evaluation of the effectiveness
of the measures taken to minimize the risks; certification of ISMS's implemented.
Benefits of certification include: offering by managers a better control over
information flows from the certified entity; identification and monitoring of risks
which affect the activity of the organization, the impact of events on the proper
functioning of the Organization (example: an employee leaving, spying, intentional
destruction of property of the entity, etc.); offering to customers and business partners
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greater confidence in the organization certified; indication of the performance by the

organization of the conditions of the standard ISO 27001 (this standard contains
among other things, the best recommendations made by the experts in security);
reducing the need for a possible system security assessment on the part of customers
or business partners; the opportunity to meet all the conditions of eligibility to tender,
where certification of ISMS is a criteria; better image and position in the market, in
the face of competition (ISO27001, 2008).
Quantification of costs is one of the core issues in the information strategy. Thus, in
the phase of setting up the company, the risk is due to the latest generation
technologies used and untested enough, leading to high costs.
In the maturity stage of the business, the costs are due to outdated technologies which
must be replaced by those of the last generation. The acquisition of advanced
technologies will lead to the elimination of a part of risks, if they are chosen
according to the requirements of business and are implemented at normal parameters.
Advantages of the implementation of information strategies are due to the large extent
exact which planned parallel development stages are: marketing, management, IT,
security. Also, the implementation there of in the framework of a business entity level
leads to clarity of the requirements of the business of supply, ensuring the quality and
efficiency of an activity at low cost.
Synthetic, in relation with the business requirements, we consider the original input
data, as in company, the information system. As data output, we ask for information
system performing, secure, based on innovation and competition.
At the level of internal processing company, we have: models of strategy, models of
security (security policy), the re-technology model of a task, the methodology for the
audit of security, the methodology for the audit of information systems management,
model of outsourcing services, model predictive society architecture informational
strategy analysis of society based on the experience of other undertakings resulting
from the development of a set of questionnaires.
CONCLUSIONS
The proposals for detailed building information develop strategies based on the
following requirements: online Business and marketing website; the establishment of
a security policy of the level of the entity that contains both information system and
computer system; management, planning and organization of the information system;
the latest generation of advanced technologies and their appropriate use in business
activities; predictive aligned with the Business Entity online; informational flow
within the framework of the strategies and risk assessment; outsourcing services and
risk assessment of internal and external company; model of re-technology if renewing
a technology aged and not only; the development and consolidation of information
strategies; methodology of information systems audit and security management.
IT infrastructure of an organization is adopted to meet the requirements of current
capabilities to improve trade and network expansion requirements to partners and
service providers. Trends such as virtualization and wireless are related to
infrastructure concerning the optimization and flexibility. Also, rising security threats
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with increased capabilities, are exploring new ways to find vulnerabilities in the
infrastructure of your organization and reduce the maximum damage in the
exploitation. For many of the threats that are identified, an organization must take
immediate measures to mitigate them.
However, threats evolve and add a different set of challenges, which require
continuous monitoring of new threat scenarios that run as a result of the discovery of
new vulnerability.
A security solution must find in all parts of the business: management strategy,
marketing strategy, IT strategy and security strategy and to ensure that the resources
of the organization are protected against threats present or evolving.
Due to restrained budget allocated for IT security, in companies we meet often a
precarious or even at all security. However, there are situations in which this service
is outsourcing or uses virtual rent resources.
To ensure a good developments and economic growth in large part depend on IT
security strategy implemented and tested constantly, updated whenever necessary.
A detailed analysis, based on results from interviews with managers on a sample of
companies, but also the manner in which is used security strategy is required in the
future.
Update continuously information strategy is a necessity for the maintenance and
development of a business plan in an enterprise, as well as the development of new
objects of activity. This is done usually by testing an older information strategy,
analysis and implementation of new elements, and finally to retest. Informational
strategy analysis is carried out on the basis of questionnaires, which must define each
activity. The questionnaires drawn up aimed at laws, standards, guidelines and
procedures governing practice in successful information system, own experience in
the field of computer systems, in order to implement new structures in the security
policy. Preparation of the questionnaire would based in particular on the identification
of risks at the level of information strategies of companies, and their analysis is a plan
for improving information security in the implementation of new internet
technologies.
ACKNOWLEDGEMENT
The strategies describe in this paperwork are presented detailed in PhD thesis of the
first author and related paper works in references.
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A TEST OF DIFFERENT MODELS

FOR THE ESTIMATION OF THE LABOR COSTS
OF SOFTWARE PROJECTS
Javier de ANDRES1 & Pedro LORCA
University of Oviedo, Spain
ABSTRACT
The development of methods for the estimation of the labor costs (effort costs) in the
development of software projects is of key importance for the management of this kind of
projects. In the present research we test the accuracy of two models derived from the CobbDouglas production function against a linear model. The Cobb-Douglas function allows
variable returns to scale, while the linear model implies hypothesizes constant returns to
scale and a certain level of fixed costs. Our main results indicate that a linear model with
constant returns to scale provides more accurate estimations than the Cobb-Douglas-derived
cost functions. We found that Cobb-Douglas models are not stable in the presence of outliers.
Finally our results suggest a limited influence of software development capital on effort
(labor) costs.
KEYWORDS: labor costs, Cobb-Douglas, software effort, scale returns, fixed costs
INTRODUCTION
Nowadays, software development activities are important for many organizations, and
primarily for software companies. More than $300 billon are spent each year on
approximately 250,000 projects, which equates to an average budget of $1,2 million.
The financial implications of this are substantial (Boetticher, 2003). So, there is a
growing interest in the management techniques for software projects.
When managing software projects one of the most important tasks is the estimation of
the costs. An estimate of the costs is desired even during the earlier stages of the
development (Xu and Khoshgoftaar, 2004). Hu et al. (1998) indicate that a 200 to 300
percent cost overrun and a 100 percent schedule slippage would not be unusual in
large software systems development projects. Millions of dollars have been wasted in
projects that are abandoned because of severe cost overruns and schedule slippages
(Keil et al., 1995; Rothfeder, 1988). The main components of software project costs
are hardware costs, training and travel costs and effort costs, which are the costs for
paying software engineers. While the former are easy to estimate, effort costs are
harder to assess in the earlier stages of a project (Heinrich, 1997).
Some models have been proposed to estimate such costs. Most of the models rely on
the use of heuristic procedures based on statistical/machine learning models. Some
1
Correspondence address: Javier de ANDRS, University of Oviedo, Faculty of Economy and

Business, Department of Accounting, Avda.del Cristo s/n, Oviedo 33006, Spain; E-mail:
jdandres@uniovi.es
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others imply theoretical assumptions and can be used to complement the former.
Among these, those who use econometric theory have been paid certain attention.
These models consider software development as an economic process where a series
of inputs (labor, capital) are transformed into an output which is the software product.
Some of the models postulate for the software production process a Cobb-Douglas
function with variable returns to scale and a multiplicative relationship among
production factors.
However, despite decades of research in this domain, software estimation is still
considered a challenge for most researchers and practitioners, and no research
approach has currently been recognized as having produced estimation models that
are considered to perform well enough to meet market needs and expectations (De
Barcelos et al., 2007). The reason maybe that most of the prior research that found
variable returns to scale was developed using heterogeneous datasets, which may
originate a better fitting of nonlinear functions. In the present research we test two
bivariate cost functions derived from the Cobb-Douglas model against a linear
function which assumes that costs follow an additive pattern with constant returns to
scale. We use a homogeneous case base of real data which comprises projects
developed by only one software company.
The remainder of this paper is structured as follows. Section 1 reviews related
research on the estimation of software effort costs. Section 2 details the models that
we test as well as the procedures used to assess their goodness of fit. Section 3
explains the main features of the analyzed sample and defines the variables used in
the study. Section 4 outlines the main results. Finally, section 5 contains the main
conclusions and directions for future research.
1. PRIOR RESEARCH ON THE ESTIMATION OF SOFTWARE EFFORT
COSTS
Research on the estimation of software effort costs has a long history. According to
Pendharkar (2010), researchers have followed two approaches: statistical and machine
learning techniques and theory-based techniques.
The former are heuristic methods that examine relationships between a series of cost
drivers and software effort, which acts as the dependent variable of the model. These
models do not involve a-priori considerations on the functional form of the
relationship among variables. Among the applied techniques we can highlight back
propagation-trained multilayer neural networks (Wittig and Finnie, 1994), case-based
reasoning (Shepperd and Schofield, 1997; Kadoka et al., 2000), genetically-trained
neural networks (Shukla, 2000), rule induction systems (Mair et al., 2000), genetic
programming (Burgess and Lefley, 2001), radial basis function neural networks (Shin
and Goel, 2000; Abbas, 2002), analogy and regression towards the mean (Jrgensen et
al., 2003), fuzzy logic (Xu et al., 2004), ordinal regression (Sentas et al., 2005),
support vector machines (Oliveira, 2006), Bayesian statistics (van Koten and Gray,
2006), wavelet neural networks (Vinay Kumar et al., 2008), fuzzy clustering (Aroba
et al., 2008), regression trees (Elish, 2009), genetic algorithms (Oliveira et al., 2010),
fuzzy logic (Muzaffar and Ahmed, 2010 Azzeh et al., 2011), probabilistic neural
networks (Pendharkar, 2010), and functional networks (El-Sebakhy, 2011). Some
authors even suggest that software effort estimation could be improved by using
hybrid regression approaches (Mukhopadhyay et al., 1992; McDonell and Shepperd,
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2003; Braga et al., 2007). For a review of different models see Burgess and Lefley
(2001) and Jrgensen (2004).
However, it must be pointed out that most techniques require large training sets to
achieve good predictions. This means a limitation, as most of the available databases
for research are of small size. A way to obtain large databases is to include projects
from different software houses, but this poses additional limitations which will be
explained later. Furthermore, these models yield complex regression surfaces. Then
there is a substantial risk of overfitting, that is, the accuracy of the model can
dramatically fall when applied to data not included in the estimation set. In fact, many
authors withdraw only a few cases for validation, and remove outliers from the
sample in order to achieve better results.
Nevertheless, these limitations do not imply that machine learning/statistical
approaches must be rejected. As Shepperd and Schofield (1997) indicate, additional
and complementary methods of software project effort prediction should be applied.
In this regard, the second type of models, that is, those who incorporate some
theoretical assumptions in the estimation process, are of special interest. A
theoretically sound model could yield some insights into the fundamental behavior of
software development processes that were not apparent form empirical models (Hu et
al, 1998).
In this regard, a fruitful approach is to consider software development as an economic
production process where inputs are converted into outputs. Then, software cost
estimation problem becomes the problem of understanding the relationships between
input and output variables (Pendharkar et al., 2008). If we follow this approach, two
key issues are to determine if the relation among independent variables is additive or
multiplicative, and whether economies/diseconomies of scale do exist. A production
process exhibits local increasing returns to scale if, at a fixed volume, the marginal
returns of additional input exceed the average returns. Among the reasons for
economies of scale in the software development process are labor specialization
(learning curves), and the use of CASE tools (Banker and Kemerer, 1989). Among the
reasons for diseconomies of scale are higher team size leading to increased
communication requirements and increased conflicts, project complexity and
increased project overhead activities, such as planning and documentation (Banker
and Kemerer, 1989; Conte et al., 1986; Jones, 1986). In presence of economies of
scale the returns of the process increase marginally as the volume of the production
increases, that is, the marginal cost of producing an additional unit decreases as more
units are produced. The opposite happens if there are diseconomies of scale, where the
marginal cost of producing an additional unit of output increases.
The first relevant theoretical model is the constructive cost model (COCOMO),
developed by Boehm (1981). COCOMO estimates effort using the following
exponential function:
Y =a(KLOC)q
(1)
Where Y is the effort in person-months, KLOC is software size measured in terms of

thousands of lines of code, and a and q are constants determined by the environment
and the complexity of the application to be developed. COCOMO has three levels
(basic, intermediate and advanced), with increasing refinement in the estimation of
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a and q. The exponential approach has later been used in other models such as
COCOMO II (Boehm et al., 1995) and Constructive Systems Engineering Cost Model
(COSYSMO) (Valerdi, 2008), among others.
In the exponential models the parameter q is of special importance as it determines the
existence of economies/diseconomies of scale. These models generally assume q>1
which means that diseconomies of scale are present no matter the software size we
consider. Another two drawbacks of COCOMO and related models are a) the
subjectivity of the cost drivers used to determine a and q (Fenton and Pfleeger, 1997)
and b) the high correlations among such cost drivers (Chulani et al., 1999).
Other popular models which assume multiplicative relationships among variables are
the software lifecycle analysis (SLIM) (Putnam, 1982), and the SELECT cost
estimator (Boehm et al., 2000).
An alternative to the multiplicative models is the assumption that the relationship
among variables can be described using a linear function. An example of this is the
following:
Y = a + b (size)
(2)
Where a and b are constant parameters. This approach means constant returns to scale
and the existence of a certain amount of fixed costs. It has been successfully used in
the Esprit Mermaid project (see Kok et al. (1990) for further details). Furthermore,
Mair et al. (2000), McDonell and Shepperd (2003) and Cuadrado-Gallego et al.
(2007) used linear regression-based approaches.
Data envelopment analysis (DEA) has also been applied to investigate the existence
of economies/diseconomies of scale in the software development process. The works
of Banker and Kemerer (1989), Banker et al. (1994), and Pendharkar (2006) are
outstanding examples. However, the results of some of the studies are inconclusive,
and Kitchenham (2002) indicates that the assumptions of DEA are unsuitable for
estimation of production function form of software engineering variables.
More recently, the Cobb-Douglas production function has been applied to software
effort estimation (Hu, 1997; Pickard et al., 1999; Pendharkar et al., 2008, among
others). It takes the following general form:
Output = C0 (Input 1)C1 (Input 2)C2
(3)
Where Input 1 and Input 2 are usually labor and capital, respectively, and Ci are fixed
parameters. Note that the values of C1 and C2 determine the existence of
increasing/decreasing/constant returns to scale.
For the specific case of software development the output is usually considered as an
independent variable rather than the dependent variable of the model, as the size of
the software product to be delivered depends on requirements assessment and client
needs. Then, the production function is transformed into a cost function, as follows:
Y = A(x)b (z)c
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(4)
Where Y is the software effort, x is the software development capital and z is the
output (a measure of the size of the software product). The parameters to be estimated
are A=C0C1, b=C2C1 and c=-C1.
Software engineering researchers have shown a lot of interest in the value of variables
b and c of the software development effort function. If b and c are less than one then
software effort function shows increasing returns to scale. When b and c equal one
then the software effort function shows constant returns to scale. If b and c are greater
than one then returns to scale are decreasing.
The cost model derived from the Cobb-Douglas production function can be
understood as an extension of exponential models. However, some studies which used
the Cobb-Douglas function (e.g., Pendharkar et al., 2008) as well as some others
which used DEA (i.e., Banker and Kemerer, 1989) found evidence of significant
economies of scale. This is not in accordance with COCOMO and related models,
which assume decreasing returns to scale.
As Kitchenham (2002) indicates, the results of research efforts on software cost
estimation are heavily dependent on the used dataset. For example, Pendharkar et al.
(2008) used the International Software Benchmarking Standards Group (ISBSG)
database, which merges data from many organizations, and this may lead to the fitting of
a nonlinear model even when the true relationship is linear. Figure 1 exemplifies this.
Figure 1. Individual size-effort graphs
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Figure 2. Aggregated size-effort graph
It can be seen that a linear model such as that of equation (2) fits better the data for
individual organizations (figure 1 graphs), with projects which are more homogeneous
in terms of productivity and fixed costs. However, when we merge data from different
companies (figure 2 graph), with projects of different size, and different productivity
and fixed costs a nonlinear function, such as that derived from the Cobb-Douglas
function, provides better fitting. This may lead to the biased conclusion that
economies/diseconomies of scales do exist.
In the present research we try to determine the most adequate model when considering
a homogeneous set of projects from only one organization. The specific tested
models, and the description of the dataset used are discussed in the following two
sections.
2. THE TESTED MODELS AND THE ACCURACY MEASURES
In this paper we have taken several alternative cost functions. According to Dolado
(2001) there are two basic criteria, apart from those of statistical validity, which make
a cost function valid and comparable to other functions. The first, consists in that the
function defined must have economic plausibility, which means that the relation
identified should show a reasonable behavior, and should make economic sense. The
second criterion consists in that the cost functions are only valid within the range of
the data used to derive the equation. If cost functions are to be compared, they should
be derived under the same assumptions.
The first model is the cost function that derives from the Cobb-Douglas production
function (equation (4)). There are several properties of the CobbDouglas function
that make it of interest for the estimation of software projects costs (Pendharkar et al.,
2008). First, the CobbDouglas function is a strictly convex function which means
that the minimum for a CobbDouglas function is a unique absolute minimum
(Chiang and Wainwright, 2005). Second, if the software effort function takes the
CobbDouglas form then this means that there exists a unique software size and team
size combination that will theoretically provide the lowest software development
effort. Third, the CobbDouglas function is homogeneous of degree (b + c). This
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means that multiplying inputs x and y by an amount k will alter the effort y by the
proportion (k)b+c. Fourth, some prior researchers (i.e. Pickard et al., 1999) found that
this model is very stable in software engineering data sets with regard to outliers.
In this model parameters A, b and c were estimated by using a nonlinear least-squares
procedure. This is what we call a non-linear Cobb-Douglas model (NL-CD).
The second model represents also a Cobb-Douglas based cost function and is obtained
by taking logarithms on both sides of (4) and solving the resulting equation using least
squares linear regression:
Ln(Y)=Ln(A) + bLn(x) + cLn(z)
(5)
This model is denoted as Log Linear Cobb-Douglas (LL-CD).

The last model we tested is a least squares linear regression estimated using the
original variables:
Y = A + bx + cz
(6)
As settled above, this model assumes fixed costs and constant returns to scale. With
regard to the measurement of the goodness of fit of the three models, we computed
four global accuracy measures. First, for each of the cases in the sample we calculated
the magnitude of relative error (MRE), as follows:
MRE=
Yi Y
i
Yi
Where, Yi denotes the actual effort of ith project, and

ith project.
(7)
denotes the estimated effort of
The first two global measures are the mean and the median of MRE (denoted MMRE
and MdMRE, respectively):
MMRE =
1 n
MRE
n 1=i
MdMRE = median (MRE)
(8)
(9)
These indicators, especially MMRE, are commonly used in studies on software effort
costs (see, Shepperd and Schofield, 1997; Cuadrado-Gallego et al., 2007; Vinay
Kumar et al., 2008, and Mittas et al., 2010, for a few examples). Small MMRE and
MdMRE values indicate the low level of estimation error. However, MMRE is
unbalanced and penalizes overestimation more than underestimation (Lie et al., 2009).
MdMRE is an aggregate measure which is less sensitive to extreme values (Foss et
al., 2003). It exhibits a similar pattern to MMRE but it is more likely to select the true
model especially in the underestimation cases.
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Another indicator which is often calculated is Pred(25), which is the percentage of

projects for which MRE is less than 25% (see, e.g., Shepperd and Schofield, 1997,
and Vinay Kumar et al., 2008):
Pr ed(25) =
1 n
(MRE 0,25)
n 1=i
(10)
The last measure is the average square root error index (ASREI):
ASREI =
1
N
[(
Y
Y
i
i
i =1
)]
(10)
Where N is the number of projects in the sample. ASREI is a robust indicator which is
commonly used to evaluate goodness of fit on data (see, e.g., Hale et al., 2000; Smith
et al., 2001; Pendharkar et al., 2008).
Since LL-CD model predicts log effort, for the calculation of the accuracy measures
corresponding to this model we take the anti-log values to compute the value of
model-predicted effort. This procedure is commonly used in studies that consider loglinear models (see, e.g., Pendharkar, 2008).
The four measures are calculated both using the original sample and a jackknife
procedure. Jackknife is a validation technique consisting in removing each case and
then using the rest of the cases to predict the removed one. This method has been used
by some of the prior researchers (e.g., Shepperd and Schofield, 1997). The reason is to
detect the overfitting problems that nonlinear/nonparametrical models often suffer.
3. SAMPLE AND VARIABLES
In this research we used the Desharnais dataset, which comprises 81 commercial
projects developed by a Canadian software house in the late 80s. This dataset was
initially compiled by Desharnais (1989) and is currently available at Sayyad Shirabad
and Menzies (2005). It has been extensively used by researchers on software effort
costs (Shepperd and Schofield, 1997; Burgess and Lefley, 2001; Oliveira et al., 2010;
Azzeh et al., 2011, among many others).
Despite the projects in the Desharnais database are more than 20 years old it is
noticeable that it is still used in scientific research. One of its advantages is that all the
projects were developed by the same software firm and the time span is relatively
short. This leads to a better assessment of the models, as it guarantees the ceteris
paribus requirement which must be fulfilled in the estimation of econometric models.
That is, the variability of the sample with regard to organizational and technological
factors which are not explicitly represented by variables in the dataset is lesser than in
other datasets which comprise projects from several houses / several decades.
Projects n. 38, 44, 66 and 75 of the Desharnais dataset have missing data. As well as
many of the previous researchers that used this dataset, we discarded these projects.
So, our final sample comprises the 77 cases with complete information.
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The Desharnais dataset contains eleven attributes. Three of these variables are suitable
to the estimation of our models. First, as a measure of the software output we
considered the adjusted functional points. The function-point method was proposed by
Albrecht (1979) and is based on the functionality of the software rather than on its
size in terms of lines of code. Most of the prior research efforts use functional points
as the proxy for size. More recently, extensions of this methodology have been
developed, as for example the object-point method (Sneed, 1996).
Second, as proxy for the software development capital we chose the developers team
experience, measured in years. As for some of the cases the value of this variable was
equal to zero, we added 0.1 to all the observations in order to allow the log
transformation. In our view, this attribute is a better proxy of the software
development capital than others which are often used such as team size (see, e.g.,
Pendharkar et al., 2008). It is not clear that a bigger team size leads to higher
productivity because bigger teams may involve increased communication
requirements, increased conflicts and increased project overhead activities (Banker
and Kemerer, 1989).
Finally, with regard to the the project effort, its measurement can be considered a
challenging endeavor. The Project Management Institute (2008) defines the project
effort metric as the number of labor units required to complete an activity or other
project element. This is usually expressed as staff hours, staff days, or staff weeks and
should not be confused with duration. So we measured project effort using the
amount of person-hours needed to the completion of the project, as Desharnais dataset
does not include the total cost in monetary units. A limitation of this, which is shared
with the majority of the prior research efforts, is that our models do not take into
account that the experience of the developers has an effect on the costs of the project.
Wages of developers with more experience are generally higher.
Table 1 contains some descriptive information on the studied variables.
Table 1. Descriptive information
Statistics
Mean
Standard Deviation
Minimum
Maximum
Percentile 10
Percentile 25
Percentile 50
Percentile 75
Percentile 90
Y (Software effort)
4833.909
4188.185
546
23940
1093.4
2306.5
3542
5848.5
10733.8
x (team experience in
years)
2.298
1.328
0
4
1
1
2
4
4
z (adjusted functional
points)
298.013
182.263
73
1127
116.8
171
258
379.5
523
4. RESULTS
Table 2 shows the estimation results. We provide parameter estimates and the
accuracy measures explained above. It is noticeable that LL-CD and linear models
show significant levels of heteroskedasticity, so robust standard errors are provided.
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Table 2. Estimation results

NL-CD
Parameter estimates
A coefficient
19.146
(standard error)
(13.460)
t-statistic
1.42
A coefficient
0.116
(standard error)
(0.101)
t-statistic
1.16
A coefficient
0.955
(standard error)
(0.118)
t-statistic
8.07
R2
0.790
Accuracy measures (in-sample)
MMRE
0.679
MdMRE
0.307
Pred(25)
41.558%
ASREI
0.589
Accuracy measures (jackknife)
MMRE
4.8721045
MdMRE
0.998
Pred(25)
25.974%
ASREI
1.2301024
LL-CD
Linear
2.906
(0.705)
4.12
0.238
(0.155)
1.54
0.902
(0.130)
6.92
0.441
-313.316
(921.541)
-0.34
186.046
(261.509)
0.71
15.774
(3.978)
3.96
0.498
0.602
0.364
36.363%
3.110
0.713
0.315
42.857%
0.001
2.249
0.485
28.571%
16.280
1.917
0.501
37.662%
3.031
It is noticeable that with regard to the estimation sample and the most usual accuracy
measure (MMRE) the Cobb-Douglas models outperform the linear approach.
However, on a global basis, an especially when we consider the most robust measures
(ASREI and jackknifed indicators), the linear model is superior. In this regard, in NLCD c is very close to 1, and the 95% confidence interval for this parameter contains
this value.
So, our data suggest that software effort follows an additive rather than a
multiplicative/exponential pattern, with constant returns to scale. This is not in
accordance with prior researchers (Hu, 1997; Pickard et al., 1999; Pendharkar, 2006;
Pendharkar et al., 2008) which suggested the existence of economies of scale in
software development. As noted above, the reason may lay in the fact that some of the
prior researchers merged data from a variety of software houses, while our dataset
contains projects from a single organization.
Our analysis also reveals that NL-CD performance falls dramatically when jackknifed
measures are considered. This is an evidence of overfitting, which reduces the utility
of the model. LL-CD and linear models seem to be more robust.
Another interesting finding is that in the three models the 95% confidence interval for
b contains the value zero. This implies that either software development capital is not
a relevant cost driver or the proxy for its measurement which is available in the
Desharnais dataset (the team experience) is not an accurate one. In this regard, we
must remark that Pendharkar et al. (2008) found that software development capital is
a relevant factor, but they used as proxy the size of the team of developers. This
question is a matter for future research efforts.
Furthermore, it is remarkable that MMREs are always higher than MdMREs. So, the
distribution of MRE is asymmetrical. In addition, an examination of the residuals
leads to the conclusion that the estimation errors are caused by a few cases which are
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very far away from the predicted value. In this regard, a large amount of error in the
NL-CD model is caused by a single case (n. 81). Size and effort for this case are 1127
and 23940, respectively. These values are approximately 3Percentile 75 and
4Percentile 75, respectively, so on a univariate basis we can consider case n. 81 as
an outlier with regard to both variables. Then, we removed this observation from the
sample and proceeded to the reestimation of the models. The results are detailed in
table 3.
Table 3. Estimation results after the deletion of case n. 81.
Parameter estimates
A coefficient
(standard error)
t-statistic
A coefficient
(standard error)
t-statistic
A coefficient
(standard error)
t-statistic
R2
Accuracy measures (in-sample)
MMRE
MdMRE
Pred(25)
ASREI
Accuracy measures (jackknife)
MMRE
MdMRE
Pred(25)
ASREI
NL-CD
LL-CD
Linear
59.183
(48.720)
1.21
0.104
(0.094)
1.11
0.761
(0.141)
5.40
0.763
3.073
(0.739)
4.15
0.231
(0.155)
1.49
0.872
(0.136)
6.39
0.402
357.891
(752.083)
0.48
190.053
(245.508)
0.77
13.141
(3.457)
3.80
0.353
0.676
0.314
40.789%
0.751
0.600
0.341
38.157%
3.112
0.710
0.318
42.105%
0.994
6.1591010
0.980
26.315%
3532516.8
1.799
0.527
30.263%
11.135
2.139
0.322
44.736%
4.321
It is noticeable that the deletion of the outlier is more beneficial for the Cobb-Douglas
models than for the linear approach. This is especially true for the NL-CD model.
This result is not in accordance with findings of prior researchers, which suggest that
the Cobb-Douglas model is very stable with regard to outliers (see, e.g., Pickard et al.,
1999). However, even after dropping observation n. 81 the linear model still
outperforms the other two in terms of the most robust accuracy indicators. So, we can
conclude that the additive model with constant returns is superior.
5. SUMMARY, CONCLUSIONS AND DIRECTIONS FOR FUTURE
RESEARCH
The estimation of software development costs is an important task in the management
of software projects. In most cases the major cost factor is labor. For this reason
estimating development effort is central to the management and control of a software
project. However, these costs are not easy to anticipate. So, a series of models have
been proposed. Some of them are heuristic methods that solely rely on the use of
statistical / machine learning techniques.
However, these models can be complemented with others that incorporate theoretical
assumptions. Some of these systems are based on exponential functions which assume
the existence of decreasing returns to scale while others state that significant scale
economies do exist. Other models are linear systems which postulate that returns to
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scale are constant. Nevertheless, most of the research that found variable returns to
scale was developed using heterogeneous datasets, which may originate a better
fitting of nonlinear functions. So, in the present research we tested the accuracy of
two models derived from the Cobb-Douglas production function against a linear
model. We use data from a single organization, which guarantees a better fulfillment
of the ceteris paribus assumption that should be present in the estimation of
econometric models.
Our main results indicate that a linear model with constant returns to scale provides
more accurate estimations than the Cobb-Douglas-derived cost functions. In addition,
we found that Cobb-Douglas models are not stable in the presence of outliers. This
result has practical implications. The most important is that we should be cautious
when using models derived from a dataset containing projects from organizations
which are very different. Software production process heavily depends on immaterial
assets such as engineers abilities and the efficiency of the organizational structure.
These factors are mainly firm-specific.
Another result of our research is that the influence of software development capital on
software costs is very little in our models. This means that either software
development capital is not a relevant cost driver or the proxy for its measurement is
not an accurate one. This is an interesting avenue for future research.
Finally, we must also mention others directions for future research. First, additional
datasets can be obtained and analyzed in order to gain further evidence of the results
of the present paper. Second, and due to the existence of outliers, robust regression
procedures could improve estimation results. In this regard, and having into account
the presence of heteroskedaticity, a quantile regression approach could yield a better
understanding of the behavior of software effort costs.
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Marius Daniel MARES1
Spiru Haret University, Romania
Valerica MARES
ABSTRACT
The direct development of information systems is proved to be a risky en audit report
enterprise if its not forgone by activities meant to require a team, and unified technology of
analysis, design, development, implementation, operation and maintenance, aspects that have
to be taken into account when making an information systems audit. The audit is requested
by the developer or by the beneficiary in order to get that information that give trust in
application, the certitude that the expected results are correct, complete, in the requested
structure and they are obtained in real time.
KEYWORDS: operation and maintenance strategy, emerging organizations, utility and

usability, audit report
INTRODUCTION
The information system is meant to cover all the problems of the economic agent, to
create interactions between components, so that in the information plan a structure is
overlapped on the physical structure of the system attached to the economic agent.
The production flows have correspondents in information flows. Transmitters and
receivers of different levels of processing information are associated to the actors
involved in the processes. The information systems are complex work, completed
during several years, and they need;
Large funds, very large in some cases;
Complex and stable teams of analysts, designers, programmers and staff dealing
with testing, implementation and maintenance;
The setting of objectives;
The definition of a development, operation and maintenance strategy;
The acquisition of equipments and tools necessary to make processing,
connections and development of the external flows.
The competence of the staff in order to correctly and efficiently use the system;
1. IT A CHALLENGE FOR MANAGERS
The complexity of the information systems and their quite long making timescale are
causing a series of problems which have to be taken into account and solved so that,
the expected results are finally got.
1
Correspondence address: Marius Daniel MARE, Spiru Haret University, Faculty of Management,
Finance and Accounting, Bucharest; email: maresdaniel@yahoo.com
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First, during the development cycle of the information system changes occur within
the managerial team of the beneficiary. In case a new managerial team has another
vision upon the agreed indicators on which its decisions are based, changes in
specifications occur, involving modifications of the information systems structure.
Secondly, the latest information technologies that appear require the ongoing
adaptation of the information systems development team. Changes occur in the
approach of the assistance tools and in the use of the options. Using the latest
resources, a series of components are finally designed. The information system
becomes inhomogeneous in terms of technologies of development.
Thirdly, the development of the company by purchasing new equipments, the
reorganization of the production flow, the transition to the making of new products,
the introduction of the elements of total quality management come to influence the
structure and functions of the information system in terms of quality and amount. The
problem of data acquisition acquires a new dimension when it comes of tools with
programmed command or in case of robotic production lines.
Fourthly, during several years, the team of programmers, web designers, testers and
implementers undergoes itself modifications. Different specialists reunify the team.
All these fluctuations are reflected in the working system, in the quality of
components or stages of the information systems.
Fifthly, the economic environment, the legislation and the dynamics of the processes
of the information society leads to evolutions that have to be reflected in the
information systems. The modifications of some calculation algorithms, the need to
use new coefficients, the appearance of some information exchange between the
company and the public institutions of state also have to be reflected in the
information systems being designed.
All these processes are simultaneously deploying producing combined effects while
the objective initially set the one of making an information system for companys
management remains unchanged. There are situations in which even the target date
remains unchanged. In case the new requirements lead to a significant increase of the
final products complexity the information management system to supplement the
resources needed to develop a higher workload the increase of the amount of
investment is required. The increase of workload simultaneously deployed requires
new approaches at the level of conception of the information system.
The goal of a maintenance manager is to employ a management system that optimizes
the use of scarce resources (manpower, equipment, material, and funds) to maintain
the facilities and equipment that are the responsibility of the maintenance
organization. The system should provide for integrated processes giving the manager
control over the maintenance of all facilities and maintainable equipment from
acquisition to disposal. The following lists what the system should do:
Address all resources involved,
Maintain maintenance inventory,
Record and maintain work history,
Include work tasks and frequencies,
Accommodate all methods of work accomplishment,
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Effectively interface and communicate with related and supporting systems

ranging from work generation through work performance and evaluation,
Support each customer's mission,
Ensure communication with each customer,
Provide feedback information for analysis, and
Reduce costs through effective maintenance planning.
A modern Computerized Maintenance Management Systems (CMMS) meets these
requirements and assists the facilities maintenance manager with work reception,
planning, control, performance, evaluation, and reporting. Such a system will also
maintain historical information for management use. The manager should evaluate
management data requirements and establish electronic data needs prior to acquiring a
system or additions to, or replacement of, an existing system.
2. THE IT DEPENDENCES
An information system has in its structure processing modules such as MO1, MO2,
Mon and data structures as Str1, Str2, and Strm. Their physical configuration is very
varied depending of the used development technique.
The Ann correspondence matrix for modules is constructed.
The element aij = 1 if only the MOi module is called by the MOj module, otherwise
aij=0.
The Bmn matrix is constructed in order to establish the relationship module-data.
The element bij=1 if the Moj module uses the Stri data structure, otherwise bij=0.
The Ann matrix highlights the references between the modules.
The Bmn matrix highlights the references provided by the modules.
The Nrm indicator the total number of modules references, is marked by the
operation:
Nrm =
i =1
j =1
ij
The Nrd indicator the total number of data references - is calculated by modules
using the operation:
Nrd =
b
i =1 j =1
ij
The complexity of the information system CSI, in Halstead acceptance, is given by the
relation:
CSI = Nrm log2 Nrm + Nrd log2 Nrd
In case that are taken into account the modification that appear during the
development cycle, the process of system execution gets a convergent iterative nature.
Ak iteration includes all the processes that are created between two modifications. As
the process of the information systems making gets to an end, the convergent nature
targets to fulfil the basic objective, in the same time with the reduction of the effort of
inclusion modifications. For each k iteration k are defined
rm N, k
rd N , respectively CSIk.
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If its calculated:
k = CSIk CSIk-1,
The convergent iterative nature targets that:
the string 1, 2 , ... L is a string with finite number of terms

1 > 2> >L = 0.
A relation between the CO cost of the information system and its complexity is
established as follows;
CO= CSI +CO e ,
where , and are the estimated coefficients of the model
Between the W productivity of those who elaborate an information system and its
complexity there is a relation as follows:
W= f(CSI)
The relation between complexity and productivity is given by:
W=
eCSI +
where , and are estimated coefficients.

Depending on the complexity and the ns number of employees the D making
timescale of an information system is given by;
D = h(CSI, ns)
In function of the systems complexity and its timescale of making the ns number of
employees is given by the relation:
ns = g(CSI1, D)
In order to keep the same turnkey deadline, if are taken into account the l and L
iterations of the information systems making process the following levels are
estimated:
n 1s = g (CSI 1 , D )
1,
n sL =g(CSD D)
and the subtraction:
L1 = n sL - n1s
Means the increase of the number of employees necessary to set the making of the
information system within the agreed deadline, even though there are everyway
modifications regarding the information system.
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3. IT PART OF THE MANAGERIAL STRATEGY

The making of an information system is meant to support the decisional deed at all
levels. The increase of information, its quality, and its getting promptness are strong
arguments to determine a quality leap undertaken by the knowledge-based society.
Based on these reasons, the implementation of an information system must generate
positive effects both for its users and especially for its direct beneficiaries of the
processed information.
In order to obtain this desideratum, within the making process, is needed the
application of all the requirements regarding the management of quality of the
information system. It is also necessary to make the audit of the information system in
order to obtain the guarantee that this one is correctly and completely making the
processing for which its been designed, and any data combination, other than the
correct and complete one, is reported and its not generating side effects in medium
and long term.
Within the making of audit processes regarding the information systems
development, its necessary to take into account the features of the organization for
which the system is designed and first, the stability of the organization. The
development of the information systems is made in the context of the evolution of
socio-economic environment. No matter their dimension, the dynamics of the changes
within the organization requires the adaptation of development methods of the
information systems to the latest requirements or the appearance of some new
concepts and methods of developing the information systems.
The developing organization, in English emerging organizations, are the organizations
whose constant is the continue attempt of adaptation to fluctuant environments but
they never reach the stability for which they are acting.
This type of organization is very different from the stable ones. Because of the
fundamentally different hypothesis regarding the reality and the development of the
information systems, the processes of making the information systems for stable
organizations, respectively emerging ones are different. In fact, the objectives of the
two processes are contradictory.
The development of the information systems for stable organizations takes into
account the following objectives:
the economic advantages of a detailed analysis;
the satisfaction of the users;
abstract requirements;
complete specifications and without ambiguity.
The proposed objectives for the development of the information systems designed for
the emerging organizations are:
the dynamic analysis;
the negotiation of the dynamic requirements;
useful but ambiguous and incomplete specifications;
continue redevelopment.
~698~
For emerging organizations, among the methods used within the development of the
information systems we can find: the conceptual modelling and the evaluation of the
utility and usability. The conceptual modelling at the remaking of systems
modifications and the evaluations of the usability might be seen as an analysis form in
terms of constant analysis which requires to be applied to the emerging organizations.
The analysis published in the special literature and some of the authors researches
prove that within the information systems changes is always necessary, aspect that is
taken into account during the audit of the information systems.
There are two results for a product subjected to an audit. The first case, the
unfavourable one, corresponds to the situation in which the audit process leads to the
conclusion that there are essential differences between the real information system
and the one expected by the user; the information system doesnt integrally execute
the established processing functions; the reports obtained are only a part of the
established ones; the auditors advise the addition of new modules meant to develop
the planned but unmade processing; the differences that appear are caused by the
incomplete results of the report; it is advised to add modules which bring the reports
at the required level of completeness; the differences refers to the way of indicators
calculation; it is recommended to make modifications within the sequences of the
program, which either include all the processing elements or modify the filtration
criteria, or modify the evaluations expressions; if there are identified causes on the
main levels of the tree associated to the information system the requirements of
modification demanded in the audit report have a greater importance. In all the cases
the differences are specified and its established the necessity to cut them out or
reduce them. The audit doesnt provide any solution. The audit report doesnt transfer
credibility and it is in fact the report of observation. Its not reasonable in this context
to make out an audit report because of the fact the developer has available a document
by which, if he presents garbled information, he hints that the information system has
been audited. If the negative result of the audit is presented, its understood that the
audit was positive. The developer of the information system wont be held liable for
not detailing if not requested in advance. After the making of the modifications, in
software and databases, the audit process is resumed and the observation report turns
into an audit one, a certificate is delivered by the auditor by which the qualities of the
information system are recognized and the users have to trust the audited system.
In the second case, the favourable one, the differences between what was expected by
the users and what was made are insignificant or favourable to products quality
enhancement. The audit report is a complex work developed by the audit teams
members. Like a book structured on chapters, it has a tree structure. Every node of the
tree has information with a standard structure:
objective;
inputs, outputs,
content;
processing;
recording of the analysis result;
evaluation of process;
conclusions;
competence.
~699~
The aggregations are made from the base to the root of the tree structure. The audit
report is a work of maximum detail. The presented approach clearly shows the
difference between other activities and the audit. Its clearly seen that the audit has an
analysis as result, a series of evaluations and the exact prominence of the differences
between the information system requested by the user and depicted in the agreed
specifications, on the one hand, and the information system ready to be delivered, by
the other hand.
The audit is meant to transfer certitude and trust within the information system by the
positive result established by an auditing team which belongs to a consulting agency
having the authority provided by previously made audits. The management of the
audit has specific particularities mainly related to auditors capacity of learning
procedures and especially to unitary applies these procedures.
Any spontaneous or elation display brings about differences of approach which are
turned into contradictions in choosing the patterns, in collecting data. The
comparability of data is so reduced and the data aggregation is reduced up to the
impossibility of operating with datasets which regard components of a same class.
The audit of an information system involves an important amount of work because the
whole process followed by the team is revised and even more, because the
specifications along with the sources on which they are based enter the analysis. If the
audit result is reliable the immediate effect of the information systems audit is its
trustful use. If it passed the audit test, the information systems development team has
favourable conditions to develop new information systems much more complex.
In case the information system didnt pass the audit test, serious problem appear in
terms of management of the software company which develops such a system. Major
changes must appear at the level of management and development teams. Technique
of analysis, projection, program testing, implementation, maintenance, efficiency has
to be taken up in order to generate compatibles development flows.
The audit involves an active way of product correction, release versions in current use
if its requested. The audit is needed for all the information systems. Its obvious that
the company covers all the damages when an information system that hasnt been
audited generates errors. The lack of the audit means assumed risks. The risks means
costs and they have to be covered by the one who assumed them at a level which
exceeds the rational limits.
The audit is an optional process up to a point. In terms of public software in which the
citizen develops processes of treatment in self-interest, the audit is a must, becoming
compulsory. The compulsoriness is a measure of self-preservation of the company
which uses public software to deploy services for citizens with own resources to
satisfy the requirements of the citizens. This kind of organization doesnt have to take
risks. The audit means transfer of trust and maintenance of risks at bearable levels
ensuring a good level of profitability.
Given the conditions of the information society the connection to a new information
systems architecture of audited information systems is effective if only the systems
~700~
which connects is audited and the result of the audit allows the connection. Otherwise,
the effects of multiple drives at the level of risks become incontrollable.
CONCLUSIONS
A) The information society develops a new attitude unto the audit. It is considered to
be an essential element for the construction of public utility complex software
architectures in continuous regime and without any assistance. The creation of the
civilization based on information interactively obtained starts from the idea of
completeness and correctness of the information got. In order to have low costs, the
information systems have to use the resources at the lowest levels. Only within the
auditing process results if the way to minimize costs has been followed. There are
arguments, there are measurements and the entire undertaking must be sustained by
efficiency calculations.
B) The audit must be seen as a supplementary investment. The software company that
develops an information system and deploys audit procedures creates the selfprotection premises against the risks that generates expenses that exceed the
companys potential.
C) A new attitude unto the information system audit is considered something else
than a required activity or a necessary evil, turning itself into the only way whereby
real warranties are obtained upon the quality of the information system, warranties
that the users perceive in time.
Once implemented, an information system must be regularly audited to make sure it
meets all the requirements at the highest level of efficiency and effectiveness. The
growth of the organization and of the business amount, the changes in business
environment, the changes in technologies and the latest information requirements all
these are placing an increasing requirement upon the existing information system and
they are often requiring the modification or the extension of the information system.
Examples of a running information systems audit:
the re-evaluation of the information requirements;
the verification of the proposed modifications to the existing basic projections;
the investigation of the latest technologies opportunity;
the enhancement of the operating procedures.
In practice its has been observed the need to audit an information system once every
three years or each time the appeared changes require it.
REFERENCES
Ash JS, Sittig DF, Dykstra R, Campbell E, Guappone K.(2009) The unintended
consequences of computerized provider order entry: findings from a mixed methods
exploration. Int J Med Inform ./ Apr 2009;78 Suppl 1:S69-76.
Bias RG, Mayhew DJ. (2005) Cost-Justifying Usability: An Update for the Internet Age. San
Francisco, CA: Morgan Kaufman.
Conner J. (2006) Managing at the Speed of Change. New York: Random House
Schaffer E. (2004) Institutionalization of Usability: A Step-By-Step Guide. Boston: AddisonWesley
http://www.sfia.org.uk
~701~
PS15 XBRL
Chairperson
Sorin BRICIU, 1 Decembrie 1918 University,
Alba Iulia, Romania
THE EFFICIENCY OF SMALL AND MEDIUM

ENTERPRISES BY THE IMPLEMENTATION
OF WEB-BASED ACCOUNTING
Sorin BRICIU, Florin MIHAI, Constantin GROZA
13 YEARS AFTER: AN XBRL LITERATURE

REVIEW AND OVERVIEW
Claudia URDARI, Adriana TIRON TUDOR
THE INFLUENCE OF FIRM-SPECIFIC

CHARACTERISTICS ON THE EXTENT
OF VOLUNTARY DISCLOSURE IN XBRL:
AN EMPIRICAL ANALYSIS OF SEC FILINGS
Devrimi KAYA
~702~
THE EFFICIENCY OF SMALL AND MEDIUM

ENTERPRISES BY THE IMPLEMENTATION
OF WEB-BASED ACCOUNTING
Sorin BRICIU1
1 Decembrie 1918 University, Alba Iulia, Romania
Florin MIHAI
Constantin GROZA
1 Decembrie 1918 University, Alba Iulia, Romania
ABSTRACT
The modernization of small and medium enterprises represents a priority, considering the
role they have in the economic development. A way to achieve this modernization would be
the implementation of an accounting system based on web technology. The present article
presents the main characteristics of a web-based accounting system, how it should work and
which would be the factors that influence the implementation of the web-based accounting
with the SMEs. Web-based accounting by the implementation of XBRL as the method of
reporting the main accounting information could be a way to promote accounting standards
within the SMEs. Through web-based accounting, the SMEs could implement solutions for
cost reduction, increase of efficiency and facile access to accounting information for external
users like suppliers, customers etc. and for internal users: accountants, managers and other
interested users.
KEYWORDS: Web-based Accounting, Small and Medium Enterprises (SMEs), Web

Technology, XML, XBRL.
INTRODUCTION
The accounting software for microcomputers has had a dynamic evolution,
considering its relatively short history (Deshmukh, 2006). From simple accounting
applications (software) based on a single computer (CBAS), which could work
independently, with a reduced consume of hardware (single user, low memory, and a
relatively low capacity processor) the shift was quick to relational database systems
available in the system client-server, with several users and even to object-oriented
databases. These, in their turn, were quickly overtaken by the apparition of other
applications based on complex technologies and informational systems of
communications. In this context, it was considered that the accounting system of an
organization would follow the development trend imposed by the IT technologies at a
certain point (Pushkar et al., 2007).
Correspondence address: Sorin BRICIU, 1 Decembrie 1918 University of Alba Iulia;

email: sbriciu@yahoo.com
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Web-based applications in accounting are considere as one of the most important

innovations brought to this function of the business (Deshmukh, 2006).
For the presentation part at the level of user interface, web-based applications use
simple systems (Internet browsers). The application part and the database require a
complex relational system facilitated by the development of communication
techniques via Internet.
A web-based accounting system, unlike the CBAS, is unitary as a function but
distributed in space, from the point of view of the inclusion area, of database and
hardware support. This is because it is based on the use of communication
technologies and the resources of some servers and less on the resources of the users
computers. The technology used is based on XML with multiple data (content)
storage and transmittal capacity. What made these systems really strong and
unanimously accepted is their capacity to storage and transmit any type of
information, be it a picture, film, drawing, complex mathematical calculations, but
especially digits.
Accounting is one of the business functions that had developed faster in the area of
web-based informatics systems, as compared to other functions. The capacity of web
technologies to storage and transmit accounting information in real time, this is in the
moment the described event is produced or appears, turns accounting into an active
function, not a post-active one, being a function even more integrated into the
operational management (Deshmukh, 2006).
SMEs, as the most dynamic and innovative branch of business, could not remain
expectative to this informational explosion. Because from reasons of financial
restraint they could not always afford the buy or build these systems (in house) like
ERP, which is considered as the most complex accounting application at the time
being, it was the turn of the developers of accounting applications to meet the needs
of the SMEs. The sellers of ERP software like SAP, Oracle and Microsoft, offer now
enterprise software at a low price.
If from the point of view of the cost the problem was more or less solved, from the
point of view of efficiency and use of these software things are still at the beginning.
It is claimed that within SMEs only 10-20% of the capacities of an accounting
software are being used. (Pederiva, 2010). The reasons of this reduced use of capacity
of accounting software within the SMEs are multiple, and we mention as possible
causes: a construction which is too sophisticated and not adapted to the needs of the
SMEs and the lack of education and training of the users of such systems.
There are two main directions for accounting in this sector. On the one side the
facility of collecting and processing accounting information and on the other side the
integration of accounting in the business function and transmittal of accounting
information in due time to the users. In other words this is the development of
accounting itself and on the other side the perfecting of reports and integration of
accounting in business.
Both can be done in real time with the help of web-based technology. In the following
we shall present the main characteristics of web-based accounting as well as the
factors that could influence the adoption of web-based accounting by the SMEs.
~704~
1.
LITERATURE REVIEW
1.1. Tendencies in the research and modernization of SME accounting

Regarding the present tendencies of modernization of SME accounting, one may
notice a constant preoccupation of the researchers and responsible factors for policies
in this area, to find ways and means to stimulate the implementation of the accounting
system adapted to the international requirements and practices (Briciu et al., (2009). A
very important help came from the discoveries in the IT. As it is well known, the big
issue SMEs are confronted with comes from the lack or financial and human
resources for the implementation of sophisticated and complex accounting systems
like ERP. This has often led to the outsourcing of accounting by the SMEs. The
solution could come either by creating simple and cheap solutions to satisfy the
implementation requirements of accounting systems, or by sharing the costs of
programs like ERP among several SMEs.
There are few studies focused on the introduction of new informational technologies
within SMEs. This is so because there are few data to be analyzed due to the improper
system of reporting or to the limited resources SMEs have for the implementation of
such technologies, or due to the pioneering character and a very recent history of these
services. It is worth though mentioning the studies in the field of the management of
implementation of IT systems within the SMEs (Suraweera et al., 2006), the use of
the Beta accounting index for risk determination at non-listed enterprises (Pierre et
al., 2006) or the analysis of the relation between SME performance and the adoption
of (Accounting Information System) (Ismail et al., 2005). As we have mentioned
before, the system of web-based accounting accelerated the implementation of some
modern systems of collecting, processing and transmittal of accounting information to
the SMEs as well. This has determined the apparition of some studies in this area. It is
worth mentioning in this respect the work Digital Accounting The Effect of Internet
and ERP on Accounting by Ashutosh Deshmukh as a landmark work in the field of
using web-based technology in accounting.
In the above mentioned work it is claimed that: Accounting has evolved together
with information technology. The distinction between the message of accounting and
the environment of information technology is blurring even faster. (Deshmukh,
2006) paradoxically to the idea of accounting as a science less developed in the sense
that it is reactive and reacts only to the evolutions in business and information
technology. True or not, we notice that the development of accounting information is
accompanied by the rapid development of information technology (Zhou, 2010).
That is exactly why in our days we assist to an explosion of accounting information
and the development of the International Accounting System (AIS) as well as of the
research in this area. Of course, there are quite a few researchers who consider that the
use of accounting software as compared to the manual accounting can only bring
benefits for the SMEs because it would be easy to use (Banzacar, 2010). Considered
from the point of view of the accounting praxis, things do not look that simple. Even
professional accountants complain that the accounting software is too sophisticated
and difficult to apply. It is claimed that in average only 10-20% of the capabilities of
an accounting software are being used in the SMEs (Pederiva, 2010).
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Some studies have focused on the analysis of the possibilities of integrating

accounting software into business (Schubert, 2005). The author tries to accredit the
idea of creating ERP software for SMEs. At the end of the study the same author
reaches the conclusion that the implementation of ERP systems depends though
largely on the size of the company.
There are many opinions on the subject in the specialized literature and in the
specialized forums: http://www.focus.com/profiles/tom-coyes/public/. It is claimed
this way that integration can not be achieved by the use of a single accounting
software and that other applications are needed to facilitate this integration. In this
respect the so-called MiniERP is proposed as a variant of ERP for SMEs (see
http://www.devantiscapital.com).
We are not against such approaches but we consider that one must take into
consideration the characteristics of this sector of economy which functions with
limited resources. We consider that an approach of this sector from the point of view
of the ERP is not possible, at least at the present stage of interconnectivity of the
SMEs among them and in the relation to the institutions of the state. For these it
would be needed, in our opinion, to have simple systems to cover first that what
businesses require and once interconnectivity, resources and the degree of education
increase, applications should be extended even to the ERP.
Like other authors have already mentioned, the accounting system is moving to an
area where the communication language will be XML. The strong point of this
language is that it can be adapted to understand various forms of the explained object
by using reference standards (Bonsn et al., 2009), (Murthy et al., 2004) mention that
the future accounting systems are susceptible of being constructed using XML
technologies that incorporate a close (internal) set of XML tags for purposes of
internal reports as well as open tags for extensible languages (XBRL) used for the
external reports of the business.
The idea is to create a set of accounting principles and reporting methods to allow the
comparison of corporative financial data and reports, even if these come from
different countries, where different accounting principles are being used. How is this
done? By using an adequate language which is similar to the translation from one
language to another. It is practically the same thing as running a laboratory analysis.
In the analysis laboratory one element called standard is introduced and the other
studied elements are compared to it. The languages used in the standards of business
accounting like XBRL and ebXML or UBL (Mihai, et al., 2007) facilitate the
comparison and access of these standards, used by companies to exchange
information (Bergeron, 2003). The problem was easy to solve regarding the access to
the standards by using these languages. In this respect, as we have shown, various
classifications have been created, the so-called taxonomy that can be accessed from
applications, which are a map of the logical structure of information, helps these
standards to be used in a uniform way. A second important point is that these
languages are used to communicate and read information with the help of a computer
or a browser. From this point of view it is worth mentioning that Microsoft was the
first company to issue financial reports in the XBRL format and the most recent
application of XBRL is to simplify the processing of information from the area of
government activity like taxation. Practically, several countries, especially those
~706~
included in the category of developed countries have started to accept financial

reports to calculate taxes in iXBRL format (extensible business language of line
reporting). We mention here countries like the USA, Canada, and most recently
England, where all companies, starting with 2010, will have to prepare reports in
electronic iXBRL format: (Callaghan and Nehmer, 2009), (Gray et al., 2009). This is
only one area. Let us not forget that numerous bodies for the regulation of the
investment activity requested that reports of listed corporations to be in XBRL format
(SEC). What makes XBRL reports to be attractive is the fact that they are more
accurate and there are smaller chances for them to be wrong. In another respect,
XBRL reports are easier to access and practically they can be accessed at any hour,
day or night. Therefore, it is a reporting method with a reduced consume of paper and
toner, by accessing the data base instead of the paper supported documents. The
challenge now is to use a web-based accounting system which can update
automatically accounting data and norms. In other words, using XBRL and other
reporting languages one can practically access directly (in real time) any document
contained by the databases.
There are several ways to describe accounting by using web services or an XMLbased accounting system. We named here the Web-Based Accounting a term e
consider to be the most adequate to describe the use of web services in accounting.
We have not found so far an explicit definition of web-based accounting. Relying
though on what other authors have mentioned in this respect and on the definition
given by Wikipedia (Web Dictionary), for web-based services, we have reached to the
conclusion that the most adequate definition of web-based accounting is that of
accounting software that registers, stores and processes accounting transactions, using
XML as a technology for data transmittal and storage, HTTP as primary
communication protocol, and the presentation of information in HTML format.
Web-based accounting systems, destined for the SMEs, could register a new evolution
with the perfecting of the cloud computing technologies which are based on
resource sharing via Internet, and the software and information circulated are supplied
by other devices by request. Though, from a conceptual point of view, the basic
concept related to cloud computing is not a recent one, as John McCarthy
mentioned in 1961 (in a speech held to celebrate the MIT centenary) that
computation may someday be organized as a public utility. From a technical point
of view, the software for the implementation of cloud computing technology has
developed slower and at high costs. Of course, the main beneficiaries of this
technology are enterprises and the government. In order to improve the process at the
level of international organizations and states there are resources allocated to develop
these technologies. One of these projects is e-billing and e-public Procurement
launched by the European Commission in 2007. The two main objectives of the
project are to contribute to the use of electronic billing in the public sector, in
conformity with the objectives from the action plan i2010 e-government and the
action plan e-Procurement. A second objective is to contribute to the creation of a
European frame of electronic billing (IAE), which is under the responsibility of the
experts group concerning e-billing "(www.epractice.eu / cazuri / ePRIOR). The
solutions developed within the European Commission will allow the suppliers who
use web-based services to upload and download XML messages: catalogues, orders,
invoices, disputes, credit notes etc.
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1.2 The relation between computerized accounting and web-based technology

There are quite a few researchers or software developers who consider that there are
no differences between accounting software and web-based accounting. It is
considered that both systems do the same thing, the difference coming from the
preferred work mode: local or web-based. This because in the specialist literature the
analysis of the evolution of accounting software is done from the perspective of the
evolution in hardware and less regarding the evolution of the programming languages
(Deshmukh, 2006). We do not deny the existence of a correlation between the
development (history) of accounting software and the evolution concerning the
computer world (hardware) but we consider that more attention should be paid to the
studying of accounting software correlated to that of the programming languages
when we analyze the web-based accounting.
If we observe well, there is no great difference between these two terms, both have a
common term, that of program or programming, the difference lying in the fact that
the first expresses calculations that can be done by a computer and the second
supplies instructions and tells a computer what it has to do. In other words, the
language creates the frame and the software populates this frame. The software can be
regarded as a written program, using the programming language, used by the
computer to be able to work. There is a great overlap between these two terms.
Neither can work without the support of the other just as the software can not work
without the hardware. In particularly, the accounting software is a software which
deals with the accounting functions and the financial part (Deshmukh, 2006).
One may notice that programming languages destined to be used at the beginning of
the computer era mainly for writing accounting programs like ABLE, Dexterity and
even COBOL, Assembler, FORTRAN, RPG for mainframe or Basic, Pascal or dBase
II for PC are no longer in use today, being gradually replaced by more flexible
languages used mainly to deal with programming in the system Client-Server, Local
Area Networks, Wide Area Networks.
According to some studies it was noticed that the most popular programming
languages used today would be (chart 1): C, Java, C++, JavaScript, Pyton, etc.
Chart 1. The most popular programming languages used today
(Source: http://langpop.com/)
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It was interesting to discover which are the most recent programming languages used
to write accounting software. We have not found a source like the above mentioned
but we created a table based on what we found on the site:
http://www.sourcecodeonline.com/code/accounting_system.html
The result is reflected in the chart 2.
Chart 2. Accounting software
Accounting software
CFML
Java
CGI/PERL
ASP.net
PHP
C/C++
Delphi
0
10
15
20
25
30
35
Users
According to the data gathered we notice that the most used for writing accounting
programs are PHP, Delphi, CGI/PERL, ASP.NET and C/C++. Generally, the
developers of big accounting programs do not use a single programming language but
several ones, according to what they want to develop. Many accounting software
developers do not explicitly mention the programming language used, because they
use several programming languages to write the soft. QuickBooks for instance, a very
popular accounting software in North America could use C++ for the interface, SQL
for the database, and other languages including XML for some reports. The
interesting part of the issue is that all that overlapping between the programming
language used and the developed software could have led to the apparition of a new
information technology that has the capacity to process, store and transmit
information themselves.
Il looks like everything started with the apparition of the Internet and web-based
technologies. Between the client and the system of data storage (server) there is now a
new server, the so-called Web Server which lies between the application, client and
database. From the architecture client-server the accounting software passed rapidly to
the architecture browser-server, or in other words a client server web architecture. In
this architecture the data stored via Internet browser can be accessed and managed
through applications stored in the same browser. It is most interesting that both
accounting applications (software) and the interrogation of the databases can be used
by several users without having to install the application for each client.
For small and medium enterprises the sharing of the cost of accounting applications
and of data base management as well as their accessing from anywhere and at anytime
is a dream largely come true, as applications become more and more developed. Even
the ERP application can be now, thanks to the web-based technology, shared among
several clients which means a lot especially for small businesses.
~709~
What does that mean for the accounting software? A lot. This is so also because
nowadays there are languages that incorporate both software and technology (XML)
which have changed fundamentally the work and the understanding of the
informational phenomenon.
Customized accounting applications for a single user have become obsolete and many
users orientate themselves already to the web-based technologies. This can be noticed
also from the analysis of the programming languages used for writing accounting
applications (see fig. 1) where languages that are used to write web-based accounting
applications (PHP) have outrun other traditional languages C/C++ or Visual Basic.
The idea is to serve as much as possible the business needs of the served companies,
developing the so-called integrated accounting software. Our opinion is that very soon
even small companies will be able to use ERP type packages by sharing costs in web
system using technologies of the cloud computing type.
The novelty for SMEs will be that the automation of many processes of data
gathering, and the introduction only one time of data into the system will be realized
by gathering data from a single source, like those realized through bank accounts, or
the creation of documents that could be read by computers by using a RDDL-type
language (Resource Directory Description Language).
2.
WORK METHODOLOGY AND ANALYSYS RESULTS
2.1 The research method and the questions we answer

Like some researchers have already mentioned, accounting systems are susceptible of
being built with the use of XML technologies (Murthy and Groomer, 2004). The
objectives of this study were to answer the following questions: Why was it necessary
for this new technology to be applied for SME accounting? What is the novelty it
brings and how do such systems work? Which are the factors that could influence the
adoption of web-based accounting?
In order to answer the first question we relied on the results of researches conducted
in the field, and especially on the historical analysis and the evolution of accounting
software and web-based technology. We wanted to underline and explain how
accounting software, including the web-based technology, can influence research and,
why not, the development of SME accounting.
For the second question we tried to show how such a system should work within a
SME. Finally, the answer to the third question is based on the result of a study relying
on a questionnaire conducted at 48 SMEs from Canada. This questionnaire was
destined first to the responsible factors for the implementation of accounting systems
(managers, owners and accountants of SMEs) as well as the users of accounting
information (managers, owners, investors). Due to the characteristics and complexity
of such an interview, we do not deny that the answers and cooperation at some of the
questions could be influenced by subjective factors. That is also why the
generalization of the results could have certain limits.
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2.2 Why are web-based applications and web accounting needed?

An answer to this question, although it seems simple at a first glance, requires actually
a series of other questions we have to answer: what is a web application, what is web
accounting? And finally what is XBRL? We answered part of these questions when
we spoke about theoretical aspects in the modernization of SME accounting by using
web-based technology (Groza et al., 2010). In the present study we shall focus on the
study of web-based accounting as compared to the traditional accounting software.
The popularity of web-based applications is due to their capacity of being maintained
and accessed without having to install them on a computer. We mention here as
applications: online retail sales, online tendering, web-mail, wikis and many others,
and nowadays one can speak also about systems of internet operations and web
applications framework which will determine without any doubt an informational
explosion. In a recent study concerning XBRL, (Haley, 2009) underlined that in the
years to come accountants will have to become more familiarized with accounting
software as well as with the use of taxonomies, tags, web documents (instance
documents) and their validation. This is a surprising statement because not long ago
accountants were considered persons who register accounting events being assisted
only by certain machines to ease their calculation work.
Regarded from the perspective of today, the statement is not surprising at all. Can we
still speak today of accountants who do not know how to use a computer or the
accounting software? Certainly not. The computer has become a commodity, not only
as a new way of working and doing business, but also as a way of life in our homes.
When we speak about computers we also speak about the internet. It is very difficult
to imagine today a computer without a connection to the internet. And if we came to
the internet we certainly think that not only the computer uses the internet. The
telephone, TV set, complex installations in the laboratory or production, robots and
other instruments also use the internet as a way of transmittal and their manipulation.
The accounting information is maybe one of the most sensitive because we are
speaking about information that express first of all money. To transmit and
manipulate it through the internet has become today as popular as any other
technology. Since many business functions like marketing and sales went online,
accounting also had to find its online sense. Like we have already shown on other
occasions, the registration of the accounting event after it has been produced; this is
the post active function, passed to the proactive function, the registration of the
accounting information the moment it is produced and its communication in due time
in order to have an operative management. And what could make it more operative,
efficient and complete than web-based accounting.
Of course, web-based accounting has numerous advantages in financial and
managerial reporting, like the elimination of data reintroduction in order to be
presented in different electronic environments, their easy accessibility by different
users: banks, government, investors, employees, auditors and maybe the relatively
reduces consume of time and resources for the manipulation of accounting
information, this to name only a few examples. And because the great majority of
accounting information circulates already translated into electronic languages, there is
only a small step to have all the accounting system transposed into an electronic
language (Web). This is why we can say that the web-based accounting system
~711~
appeared as a necessity to modernize accounting evidence and to integrate it as a

business function (Groza et al., 2010). The difficult problem of web-based accounting
that determines also a still reduced rhythm of implementation is the high risk or
vulnerability of the security and data protection systems on the internet (Collins,
2010). And if for the part of reporting this is not a big issue, for the part of data base
there are a lot of reluctance and reserve. For how long? We believe that the problem
will we arranged soon and the security of databases will be solved. Web-based
accounting is looking more and more, as it continues developing, like ERP, meaning
that very soon it might be possible for SMEs to have access to this type of software.
WE shall present some similarities between an ERP system and web-based
accounting. Generally, when speaking about ERP, the specialist literature analyses it
from the perspective of some characteristics like: integration, visibility and control,
centralization, flexibility and standardization of information and processes
(Seethmaraju, 2008).
A first remark to this is that if ERP is considered to be one of the most important
innovations in business (Davenport, 2000), we consider that the web system may be
the most important innovation in informatics for accounting. If ERP focus is in the
integration of activities from different functions and hierarchical levels of an
organization (Markus and Tanis, 2000), web-based accounting focus can be
considered, the integration and accessing of information from anywhere and at
anytime, as location and time. For SMEs, the adoption of ERP is a critical decision
considering the financial restrictions but also for the provocations resulted from the
adoption of this system by other companies (Seethamaraju, 2008). The adoption of
web-based accounting on the other side by the SMEs, just like the ERP is determined
by the necessity of improving operative management by increasing the quantity,
quality and accessibility in real time of accounting information (Raymond et al.,
2004). In an article published in ASA Research, J. Carlton Collins finds at least 10
advantages for the adoption of web-based accounting and only 5 disadvantages of
adopting
web-based
accounting
(htttp://www.asaresearch.com/articles/
web_accounting). And if the great majority of the last is based on operation and
security issues of the databases, we consider that the future will demonstrate that this
system is in itself just like the internet will be for the future. The same author claims
that this system will change dramatically the face of accounting ... opening the gates
for a wide range of changes. How long and how far it remains to be seen. It is clear
that the system has started to be implemented by the big producers of ERP software
and it is certain that soon we will see that kind of software implemented in web
technology.
2.3 A schematic presentation of web-based accounting
The case presented here is an academic project of explanation of web-based
accounting. For this study we shall present a schematic diagram of applications of
web-based accounting for small and medium enterprises. We mention that the system
is conceived to take over automatically some data via internet. All communication is
planned to be done via internet using any instrument which can display a web page.
The system can use Internet Explorer, Mozilla, Netscape or other browsers. In figure
1 we present a first work image of web-based accounting.
~712~
Figure 1. Web based accounting architecture
WEB
SERVER
Browser
ACCESS
DATA
Data
gathering
Spreadsheet
Internal Reports
Data Base
In this example, the browser is any device that does not host the software of the
accounting system or the database, but can display data by request. The server is the
one that stores all applications (software), of communication and of databases. Using
a PHP language and transporting data in XML format databases are created which are
accessed via internet. This system allows the user to access through the internet all
instruments of accounting and reporting. We presented the accounting web
application for small and medium enterprises in two stages and six modules. We shall
start with the module of data gathering. In this first stage, data are collected from the
source and get to the database through the intermediary of the browser using the
internet. One must mention that under certain circumstances the browser might store
data also offline, and these will enter the system as soon as it will have an internet
connection available. In this case the browser must have the capacity to access a local
server (MySQL platform).
Considering that all operations are transmitted and operated via internet, a series of
information can enter the system automatically like operations done through the bank
or credit card like VISA or MasterCard. One may also consider that the account
statements from the bank to be taken automatically into the system.
Figure 2 presents as a scheme this procedure of automatic overtaken of data.
Figure 2. Automatic data acquisition process
BANK
DATA
.csv
format
ACCESS
DATA
MAP
DATA
AccountingData
~713~
The data overtaken from the banking system following the various transactions done
through the intermediary of the account notes cards or with a check and in cash are
accessed and transferred in the system in csv format. The next step is to account
electronically, using the accounting plan and than the data are processed and
electronically registered into the database. As we may notice, the only activity is that
of counting which is also largely automatic, because the system retains an important
part of the history of transactions and each time a transaction repeats itself the system
takes the account from the previous counting.
After the data have been taken into the system there comes the registry into the log
book and general ledger for the editing of accounting reports. The activity of reporting
and accessing the accounting information can be adapted to the management
requirements and to the other users who solicit this kind of information: banks,
shareholders and investors, governmental agencies. Because the editing of accounting
reports and information is in electronic format the transmittal of information to these
can be done also in electronic format being more efficient from the point of view of
the speed of processing and transmitting, not to mention the reduced consume of
paper, toner and time of collecting and processing these information. The system
emphasizes the data collected from banks because they are more reliable, complete
and correct and the possibility of errors is quite reduced. In the same time,
information are not reintroduced into the system, being processed directly from the
source a single time. Figure 3 shows the way this system works using also the XBRL GL scheme.
Figure 3. The way the system works using the XBRL
Web
Server
Internal
Reports
Browser
XBRL - GL
Scheme
XML
Document
XBRL Document
Report Display :.
pdf,.html,xsl
Internal reports are produced by the accounting software according to the collected
and processed accounting data. We have to mention that not al reports are public and
therefore they do not have to be published. Many of them are used strictly inside to
satisfy the needs of the management.
~714~
From this module data are translated and transported to the module XML documents
by the use of software written in PHP, using a browser that can be any instrument able
to display a web page. The conversion of reports into XML and their preparation to be
validated and transported to the system take place here. In this module there is the
first validation operation to see if the instance document is well formed, this is if it is
well written from the point of view of the XML language and if there are no errors. In
the next module, XBRL-GL, documents will be checked with the scheme to see if the
document corresponds to the XBRL-GL standard, where the operation of validation of
the XML document takes place and it is deposited at the web server via internet.
In the second stage we ask for the accounting reports from the module web server,
which will validate the XBRL-GL module, if the data are concordant with the
schemes done according to accounting standards, these are translated using the XBRL
language and are transformed into XBRL reports and then displayed in various
formats by request like pdf, xslt or html. From here user can ask for any published
information, being sure that these correspond to the accounting standards. Each
module will have web services which supply data, by request, about the information
processed and executed in that module. We have to mention that once the data reach
this module, it can be accessed from anywhere and at anytime because it is accessible
via the internet 24 hours a day.
2.4 Factors that could influence the adoption of web-based services by the SMEs
In a recent study in Canada, done on a sample group of 48 SMEs using questionnaires
with predefined questions and answers we noticed the following: We found only one
organization (SME) that uses web-based accounting due to the distrust and the
pioneering character of these services in accounting. This company was not included
into the study but it will be the object of a future case study. The type of scale used to
analyze the answers in this study was nominal polytomous, in the case when the
respondents had more than two selected options. The study was done in order to find
out which are the key factors that determine the management of the SME to use webbased services and web accounting. The respondents from this study were managers,
owners, accountants and other persons involved in the process of implementation of
the informational accounting system.
Within this analysis the correlation of each two pairs of variables was investigated.
The first pair of variables analyzed was the users behavior and perception for
accounting information and the level of knowledge of the user related to the web
services and the way how the accounting system is organized.
The relation between the behavior of the user and his/her level of knowledge of the
accounting system in force is presented in table 1.
Based on the obtained values, we have reached to the following conclusion:
Those users (owners of small enterprises, managers, accountants or even
investors), who have knowledge about the accounting system and the internet
are more likely to use web-based services.
The users of web-based services are increasing. More than 95% of those
questioned use the internet and a browser to do business [(20 +14+ 6 +6) / 48]
* 100 and 70.83% of them have accounting knowledge [(20 +14) / 48] * 100.
~715~
We discovered that 54.17% of the respondents [(20 +6) / 48] * 100 used some
web services for accounting purposes: account statement downloaded into
their accounting system, information from clients and suppliers via e-mail that
have to be registered, etc. In the same time more than 68% of the respondents
see web-based services as a new way to do and control business.
In the second pair of variables considered we analyzed the relation between
the level of knowledge of the user related to the web services and the way the
accounting system is organized. WE summed up the result in table 2.
Table 1. The relation between the behavior of the user and his/her level of knowledge
of the accounting system in force
1
2
4
5
New way to do
business and control
transactions
New way to do
business and
communicating via
internet
Improval of
marketing policy an
of the control of the
business
Use of the internet to
communicate
Internet is not used
Total
Total
The questioned do not have knowledge about the

accounting informational system and the internet.
Users understand accounting information produced

by a qualified accountant outside the organization
din afara organizatiei and use the internetul
or other display devices for running the business

by a qualified accountant or IT and use the internetul
or other display devices for communicating some
accounting information

by a qualified accountant and use the internetul
or other display devices for running the business
The level of knowledge of the user related to the web services
User are involved in the registration of accounting

information and use the internetul and browser
for some registrations
Users behaviour and

perception for internet
and web services
No. Caracteristica
14
11
33
0
20
0
14
0
6
0
6
~716~
1
2
2
2
48
Table 2. The relation between the level of knowledge of the user related to the web
services and the way the accounting system is organized
User are involved in the

registration of accounting
information and use the
internetul and browser
for some registrations
Users understand accounting
information produced by a
qualified accountant and use
the internetul
or other display devices for
running the business
qualified accountant or IT and
use the internetul
communicating some
accounting
qualified accountant outside the
organization din afara
organizatiei and use the
internetul
running the business
The questioned do not have
knowledge about the
accounting informational
system and the internet.
Total
Total
There is no organized accounting

system or accounting software
There is an organized accounting

system but no accounting software is
being used but outside the organization
There is no organized accounting

system or accounting software

system but no accounting software is
being used
The organization of accounting activities

system and accounting software is
being used
Level of knowledge of the user

related to the web-based services
No.
Characteristics
16
20
14
22
10
48
We noticed that 58.33% of the respondents use accounting software to do and control
business (22 +6) / 48] * 100. This number is close to those who use web-based
services in accounting (54.17%). We consider that there is a vrey close relation
between the use of software for accounting and the use of web-based services. Finally,
we believe that those who use accounting software will migrate to web-based
accounting. Therefore, the increase of the number of accounting software users will
lead eventually to the increase of the number of those who use web-based accounting
services.
~717~
CONCLUSIONS
In our opinion web-based accounting will be the new wave for the future of SMEs.
Such a system can bring enormous benefits to those entities considering their
characteristics as well as the characteristics of economy as a whole. This system is
easy accessed, with reduced costs of maintenance and use, requires few technological
knowledge are has wide possibilities of application. It is a system open to a great
number of integrated solutions, internally and for third parties for the extension of
functionality and for fitting the specific needs.
The system has great possibilities of integration with other applications, especially
Excel in the analysis and reporting as well as for importing information into the
system. It has also great chances for the development of business intelligence
especially by accessing accounting information in due time by the company
management. At last but not at least, this system allows the integration and easy
transition to the XBRL reporting system as well as the transition to the EDI
(Electronic Data Interchange) system. Actually, this is one of the great advantages of
the so-called cloud based accounting.
The web technology is one of the areas with the widest spread today, and SMEs
cannot stand by and not apply these technologies.
Although security related problems can still occur with these systems, mainly
concerning the transmittal of information and databases, we consider that these will be
solved in the near future. We rely for this on the fact that several banks and companies
started to work exclusively online already, engaging 100% of their activity in this
way.
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Bergeron, B. (2003) Wireless handheld computing, MedGenMed Medscape General
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~718~
Groza C., Briciu S., Cordos A.M, (2010) Challenges of management accounting of small and
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~719~
13 YEARS AFTER: AN XBRL LITERATURE

REVIEW AND OVERVIEW
Claudia URDARI1 & Adriana TIRON TUDOR
Babes Bolyai University, Romania
ABSTRACT
In 2008, SEC proposed new rules that mandate listed companies from US stock exchange to
prepare their financial statements in accordance with US GAAP or IFRS and to file the
financial statements content in XBRL format beginning with 2009. The purpose of this article
is to review the current state of academic research articles related to XBRL that are
published in ScienceDirect and Springerlink databases, in order to identify the trends and
researchers contributions and to assess the XBRL capabilities and its future. Although there
are lots of XBRL calls for papers, after 13 years from XBRL development, the number of
academic articles on XBRL topic are still few, the research questions are increasing, more
and more researchers becoming interested in this topic.
KEYWORDS: XBRL, literature review, Springerlink, ScienceDirect, database

INTRODUCTION
One of the most important principles of corporate governance states that companies
should ensure that timely and accurate disclosure is made on all material matters
regarding the corporation, including the financial situation, performance, ownership,
and governance of the company. (OECD Principles, 2004), making reference to
information transparency and disclosure.
Over the years, the need for more and more data caused the switch from paper
disclosure to online disclosure. After 90s, the accounting environment was merged
with the electronic one (Bierstaker et al., 2001; Flowerday et al., 2006). The internet
usage and development of new online systems became the new trend for financial
reporting disclosure. Data analysis went from the use of Html (Hyper Text Markup
Language) to XML (eXtensible Markup Language) and now to XBRL (eXtensible
Business Reporting Language), an electronic language that is specifically used for
financial information disclosure.
All these changes were developed for a simple reason: the more transparent the data
was (for the majority of interested parties meant more data disclosure), the more
difficult data extraction and analysis become. Using the paper format meant to collect
the information, but almost impossible to read it all. More the information was- more
paper we had, but less knowledge about the whole information. So, practitioners had
the idea to use Html. But there was a big disadvantage: Html has the capability to
1
Correspondence address: Claudia URDARI, Babe-Bolyai University, Faculty of Economics and

Business Administration, Department of Accounting and Audit, Cluj-Napoca, Romania; email:
claudia.urdari@econ.ubbcluj.ro
~720~
present the information, but is difficult to extract it (Alles et al., 2004). The solution
was the use of XML. This language adds all the information in tags, making easier for
computers to read the data, to search and to extract it in different kind of programs.
XBRL is created based on XML. It has the same proprieties, but it usage refers to just
financial data exchanging. (Srinivas, 2004)
XBRL is an electronic communication reporting language that facilitates disclosure of
financial information over the internet, simplifying disclosure and allowing
companies to communicate financial information more readily (Zambon and
Marzo, 2007).
The communication language is gaining more and more field in financial information
disclosure research. At the present, there are 18 countries with XBRL established
jurisdictions and 5 countries that have provisional jurisdiction. Besides them, there are
5 other independent jurisdictions, including International Accounting Standards
Board. Only in Europe there are 11 established jurisdictions and 3 provisional
jurisdictions.
The history of XBRL begins in 1998, when Charles Hoffman, a certified public
accountant, has the idea to develop an XML version for accounting and audit. But the
fast forward jump was made in 2008, when SEC (Securities and Exchange
Commision) proposed new rules that mandate listed companies from US stock
exchange to prepare their financial statements in accordance with US GAAP or IFRS
and to file the financial statements content in XBRL format beginning with 2009.
Due to SECs XBRL adoption and to its fast widespread over the world, we
considered that a research on XBRL is needed. The purpose of this article is to review
the current state of academic research on the XBRL topic between 1998 and 2010,
after 13 year of the communication languages life.
The discussion focuses on two databases: ScienceDirect and Springerlink database for
scientific Journals, identifying the trends and researchers actively contributions to this
development. Another goal is to assess XBRL capabilities and its future.
The ScienceDirect database search has been motivated by the possibility to access
more than 1,200 of the most commonly-used academic journals, searchable back to
1967 and covering subjects as diverse as the physical and social sciences to business
and management. Furthermore, ScienceDirect's website is comprehensive and easy to
use. The user can perform general topic, author, or title searches among all available
documents, or narrow the search to a specific subject or year (Beth, 2009).
With a platform that offers over 2200 journals, Springerlink database was considered
as the second choice for the XBRL literature review. Among the research domains are
included all the ones related to our topic: economic, informatics and engineering.
Including articles from 1996, the implemented system reduces the search time, being
more efficient for research developments (www.springer.com). The platform also
includes numerous book chapters, but giving the fact that our review was focused just
on article search, the book reviews were excluded from the start. However, the search
has a disadvantage: the search is performed just in the title, abstract, tables of contents
and not in the whole paper as in the case of ScienceDirect.
~721~
The reminder of the paper is organized as follows: in the first section we emphasize
the importance of performing a literature review. In section two we discuss our
research design. The results of our research are reported in the Section 3, followed by
Section 4 that present our conclusions and, in the same time, discuss the limits and
further developments of this paper.
1. LITERATURE REVIEW DISCUSSION
It was proven that the literature review plays an important role in delimiting the
existing research problem in the field of social sciences. For this reason, many
researchers have chosen to develop a literature review in different fields of research
(Gray et al, 2002). Also, the literature review is considered to be the primordial
method in distinguishing what has been done from what needs to be done, identifying
relationships between ideas and practices, establishing the context of the topic or
problem, understanding the structure of the subject, relating ideas and theory to
applications, identifying the main methodologies and research techniques that have
been used, and placing the research in a historical context to show familiarity with
state-of-the-art developments.
While the majority of researchers consider that the most relevant and complete
literature review can be found in accounting journals, based on journal rankings
and/or impact factors (Gendron, 2008), others think that top articles should also be
searched in non-top journals.
To avoid being one side or the other one, we positioned our research at internet search
and/or availability level, considering that all the databases that are available online are
primordial source for article analysis. Thus, beside ScienceDirect and Springerlin
databases, this review can be continued by studying the literature from at least other
six online databases: Wiley Interscience, Emerald, JSTOR, Highwire, EBSCO
and SSRN.
2. RESEARCH DESIGN
The review was conducted using a search command for the word XBRL on a
number of two databases available online: ScienceDirect and SpringerLink. The
search engine performed a quick overlook in the title, abstract or the whole paper,
including references of all journals included in these databases.
After collecting the articled, the first step was to divide them in four categories, as
follows:
XBRL articles: articles whose content refer at XBRL - descriptive articles,
data extraction, data process and so on;
XBRL chapter: articles that include a chapter or a significant part about
XBRL;
XBRL mentioning: articles that mention XBRL existence or make reference
to XBRL usage inside the text;
XBRL reference: articles that include the word XBRL inside the
References section.
~722~
The second step was to establish the information associated with the articles that were
extracted from the databases:
Author(s);
Title;
Journal Name;
Language: not all the articles were in English, but we preferred to keep a track
on all XBRL related articles, even if we didnt review the ones in another
foreign language;
Type of research: Economic, Computer Science and Others. Given the fact
that two of the analyzed articles couldnt be included in none of the first two
categories, as we initially developed them, we created a new category, called
Other. The two articles included here discuss about critical research
literature review in accounting and accounting education.
This information was stored in Excel in order to facilitate a further detailed analysis.
Also, we stored in Word a brief description of the most important points of the paper,
in order to facilitate the comparisons between different articles. This type of
information included: the subject, the procedure, the motivation, the target group, the
results and our subjective point of view regarding the paper. To facilitate the data
storage, search and data examination, we allocated in Excel a number for each paper
(example 148), that was also given to the articles (example 148_a) and to our
comments (example 148_c).
The third step was to analyze the articles keeping in mind some questions that we
considered to be important for our research: What themes emerge and what
conclusions can be drawn? What are the major similarities and differences between
the various writers? Are there any significant questions which emerge and which
could form a basis for further investigation? The answer to all this questions and the
link between the articles were included in the discussion and result section.
3. DISCUSSION AND RESULTS
During 13 years of XBRL existence, 78 articles related to this subject were published
in ScienceDirect and Springerlink databases (Table 1). The first two articles were both
published in the same volume: one was concluding that both XML and XBRL would
improve financial disclosure (Debreceny and Gray, 2001) and the other one was
discussing the problematic of XBRL in the context of continuous auditing (Woodroof
and Searcy, 2001). For early period adoption, there were other articles that focused on
the use of XML in financial reporting, the majority of them also emphasizing the
widespread adoption of Internet for financial reporting usage (Debreceny et al., 2002;
Dull et al., 2003; Beattie and Pratt, 2003; Vasarhelyi and Greenstein, 2003).
As it can be seen in Figure 1, ScienceDirect database journals shown a high interest
for articles related to XBRL topic. During 1998 2010, there were 62 articles
published in 25 journals included in ScienceDirect database. On the other hand, the
Springerlink database search lead to 16 articles, included in 3 Journals, all related to
the computer science filed.
~723~
Table 1. Publications with XBRL included in the title,abstract or in the body

of the paper
Year
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Total
Number of XBRL related articles

2
1
6
14
7
8
8
9
8
15
78
Figure 1. The number of XBRL related articles in ScienceDirect and Springerlink

databases
As shown in Table 2, we found 29 Journals that published XBRL related articles.

From these ones, 2 seemed to play a key role in XBRL academic research
publications: International Journal of Accounting Information Systems (Srivastava
and Kogan, 2010; Alles and Pietchocki, 2010; Debreceny and Gray, 2010) and
Lecture Notes in Computer Science (Bao et al., 2010; Lara et al., 2006, Hou et al.,
2006). The diversity of academic journals that published articles related to XBRL
suggest that academic community is engaged in the development and implementation
of web-technology for financial reporting disclosure and business data extraction, the
improvement of financial information transparency, real-time disclosure and real-time
audit.
Table 2. XBRL related articles appearing in academics journals
1
2
3
4
Academic Journals
Accounting Forum
Accounting, Organizations and Society
Advances in Accounting
Automation in Construction
~724~
Total
1
2
1
1
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
Academic Journals
Computer & Security
Computer Fraud & Security
Computer Standards & Interfaces
Critical Perspectives on Accounting
Decision Support Systems
Digital Investigation
Total
1
1
2
3
2
1
Expert Systems with Applications

Information & Management
Information Systems
Information Systems Frontiers
International Journal of Accounting Information Systems
International Journal of Information Management
Journal of Accounting and Economies
Journal of Accounting and Public Policy
Journal of Business Research
Journal of Retailing and Consumer Services
Lecture Notes in Computer Science
Management and Accounting Research
Public Relations Review
Research in Accounting Regulation
Scientific and Technical Information Processing
Technology in Society
The British Accounting Review
The Journals of Systems and Software
Total
1
1
1
1
24
2
1
4
2
1
14
1
2
3
1
1
2
1
78
As explain in Section 2, we have divided the XBRL related articles in 4 groups.

Analysis of publication volumes show that XBRL related articles were slightly
increasing from year to year (Table 2), excepting 2002 and 2009, when they had an
insignificantly decrease (1 article) and 2004, when the number of articles doubled.
This fact can be explained by looking at Table 4, were we can see that the number of
articles that mention XBRL tripled during 2004. A more detailed look over these
articles will show that they dont include short description of XBRL, neither a link
with it. The authors just mention the business language as an example for voluntary
disclose (Xiao et al., 2004), a model of customization for financial reports (Beattie,
2004), organizations increasing surveillance possibilities (Poullaos, 2004), and so on.
Thus, they cant be considering as articles that argue the importance of XBRL. This
would mean that our first conclusion, of slightly increasingly publication numbers
from year to year, remains valid.
Table 3. XBRL related articles
Year
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Total
Number of
XBRL articles
2
1
2
2
4
1
2
2
8
24
Number of XBRL
chapter articles
1
1
1
2
1
6
Number of XBRL
mention articles
1
3
10
4
3
6
4
2
5
38
~725~
Number of XBRL
reference
1
1
1
1
1
3
2
10
From the analyzed articles, 31% represent research on XBRL topic (Table 3), 8%
include a chapter on XBRL as tool for financial information disclosure or for
transparency improvement. The rest of 61% of these articles are either mentioning
XBRL, at a higher or a lower level, or just include in the reference part XBRL
articles.
Figure 2 graphs the volume of economic versus computer science XBRL related
articles. Although the figure indicates a general uptrend, this is not a constant one. A
closer look shows as that the big difference appears in 2004, referring to the fact that
we concluded above, in articles content part. As for the type of the articles, economic
and computer science, it can be seen that their lines play together as in a spiral. This
fact happens because each time a practitioner develops a new application model, their
results can be used by the researchers from the economic field as a start for their
research. In the same time, each unanswered question of the economists will bring a
new research question for the practitioners. This way, the financial reporting field,
will be continuous under developing improving data disclosure and extraction term of
time waste.
Figure 2. The number of XBRL related articles in ScienceDirect and Springerlink
databases
The primary interest of this paper was the economic articles related to XBRL topic.
Thus, Table 4 shows the publishing outlet by year for economics articles. As it can be
seen, they represent 62% of analyzed articles. From all 28 analyzed journals, just 16
contain XBRL economic related articles. The majority of the articles were by far
published in International Journal of Accounting Information Systems (21 articles),
followed by Journal of Accounting (4 articles) and Public Policy and Research in
Accounting (3 articles).
~726~
12
13
14
15
16
2010
11
2009
10
2008
2007
2006
2005
2004
2003
3
4
Accounting Forum
Accounting,
Organizations and
Society
Computer & Security
Computer Fraud &
Security
Critical Perspectives on
Accounting
International Journal of
Accounting
Information Systems
International Journal of
Information
Management
Journal of Accounting
and Economies
Journal of Accounting
and Public Policy
Journal of Business
Research
Journal of Retailing
and Consumer Services
Management and
Accounting Research
Public Relations
Review
Research in
Accounting Regulation
Technology in Society
The British Accounting
Review
Total
2002
1
2
2001
Academic Journals
Total
Table 4. Articles that mention XBRL in their references (XBRL references)
21
46
11
Given the fact that XBRL represents a relatively new topic in accounting domain,
most articles in academic journals point out the benefits and that accrue from adoption
of XBRL (Kaya, 2011). The XBRL related articles are divided in two types of
categories: economic articles and computer science articles. The first ones include a
wide variety of areas that interest accounting academics such as corporate
governance, management, IFRS and audit issues. The numbers of articles that were
published by the academic community are relatively small, as also shown in one of
Roohani et al. articles (2010).
One paper that drawn our attention was the one of Srivastava and Kogan (2010),
which discusses the problematic of data assurance. Since June 15, 2009 SEC
(Securities and Exchange Commission) required that the top 500 companies add their
fillings in XBRL format, although they are not requiring a third party assurance on the
information that is in this manner available on the internet. Their paper brings a new
vision on XBRL assurance, developing and discussing assertions on XBRL assurance.
~727~
Nevertheless, we have to mention that several other authors mention the subject of
auditing XBRL data: Debreceny, who is currently developing a project financed by
IAAER, called The implications of XBRL for the Financial Statement Audit,
Flowerday, Bluntell, von Solms, Woodroof, Searcy, Onion, Rezaee and so on.
One aspect that is related to XBRL is the disclosure improvements. Yoon et al. (2010)
analyzed if XBRL reduces the information asymmetry in the case of Korean stock
markets. As we previously mentioned, the majority of the accounting and finance
researchers consider that when the level of financial disclosure increases, the
information asymmetry decreases. However, the authors conclude that XBRL may
lead to the reduction of information asymmetry from the point of view of the
investors. They prove that the information asymmetry reduction is stronger for the
larger companies than for the medium and small sized companies. Yet, for their result
to stand up it would be necessary to analyze a longer sampling window for the
selected companies, for at least two years
One of the studied articles refers to corporate governance (Premuroso and
Bhattacharya, 2008), even if it uses a small sample of companies, sows that corporate
governance is associated with a firms decision to be an early filer in XBRL format.
Another study that analyses the XBRL influence on corporate governance is the one
of Alles and Piechocki (2010). They discuss about the decision making process and
state that XBRL has the potential of significantly improving the governance process,
but the full usage of this advantages depend on how the users put it in use. They need
to understand that XBRL is not just a distributor mechanism, but it can also do data
modeling and be linked to analytical software. They emphasize that other programs
can also do that, but it would take a lot of time to do it and it will also imply a higher
cost, which should never be ignored in a business environment.
Bonson et al. (2009) discuss about IFRS adoption at European level in 2005 and the
IFRS decision to use XBRL in order to create a global set of standards. They draw the
conclusion that the idea to use XBRL as a common ground for international
companies is very usefully, but they also stipulate that IFRS-GL taxonomy has some
deficiencies that must be corrected if IASB wants to reach his goal. They are the only
authors that analyze this subject of research from all the analyzed articles.
Nevertheless, in the practitioners area, the subjects of the articles are as interesting as
in the economic one. Herein, they were going from XBRL and XML descriptions,
their advantages in comparison with other electronic languages, to data extraction
programming, such as structured and unstructured information from financial
reporting disclosed on the stock exchanges websites. Another issue that has to be
mention is databases development for different types of financial information.
So, as a general conclusion that can be drawn from these articles, XBRL is seen as the
best communication language that can assure a unique accounting standard all over
the world. But the use of XBRL draws over himself the need for a reliable and
accurate audit tool that can assure the interested parties for its precise information.
We can conclude that the XBRL topics cover subject as corporate governance
(Premuroso and Bhattacharya, 2008; Alles and Piechocki, 2010), audit (Srivastava
~728~
and Kogan, 2010; Debreceny et al., 2010; Flowerday et al., 2006; Flowerday and von
Solms, 2006; Daigle and Lampe, 2004, Murthy and Groomer, 2004), internet
disclosure (Yoo et al., 2010; Mena et al., 2010; Williams et al., 2006, Boritz and No,
2005), IFRS (Bonson et al., 2009), system development for business disclosure
(Spies, 2010), system development for financial data extraction (Maynard et al., 2007)
and financial database development (Mendez Nunez et al., 2008.
As regarding the questions that emerge from the studied articles, the most important
one is: how much the XBRL filling errors could affect the decision made by interested
parties. Other questions that are interesting are the following ones: Are the models of
continuous auditing really viable? The audit programs use continuous audit in the
present? If yes, what are the problems that continuous audit encounter? To all this
questions related to audit, we add one more regarding IFRS: are there any studies
about users opinion on IFRS taxonomy?
This literature review was conducted by searching two online databases, during 19982010. The summary and information regarding the XBRL related articles were kept in
both Microsoft Excel and Word, in order to facilitate detailed analysis. The aim was
to identifying the trends and researchers actively contributions to XBRL development
and to assess XBRL capabilities and its future.
We believe that our results sustain the lack of academic XBRL publication in
accounting: 24 articles with XBRL content, including the ones from the computer
science field. Although during this search we also find lots of call for papers, it seems
that the researches in this field are still at their start-ups and that the topic of XBRL
can be further discussed and new studies can be developed.
The research tendency in this field is to start with describing the communication
language, its advantages and disadvantages and comparison with other online
financial disclosure languages. At this point of the research it can be state that in the
countries with provisional jurisdictions the main research point is what is XBRL, how
can be developed in this countries and always include descriptions of XBRL, its
advantages and disadvantages. Also, our results show that after the countries gain an
established jurisdiction, their main research interest tends to be related to continuous
auditing. This fact could be related with the increasingly need of financial information
disclosure assurance.
Although we went through all the articles from ScienceDirect and Springerlink
databases, there are other available databases, books and practitioners reports that
werent yet reviewed.
This review of the literature will be further developed, intending to include at least
other six online databases: Wiley Interscience, Emerald, JSTOR, Highwire, EBSCO
and SSRN and to perform a broader analyze on XBRL related articles, including the
authors origin, research methodology and so on.
~729~
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20Articles/PROFESSIONAL%20PAPERS/P27.%20real%20time%20reporting%20an
d%20assurance147.pdf (retrieved at 17.01.2011)
Alles, M. and Piechocki, M. (2010) Will XBRL improve corporate governance? A
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Beattie, V. (2004) Moving the financial accounting research front forward: the UK
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Beattie, V. and Pratt, K. (2003) Issues concerning web-based business reporting: an analysis
of the views of interested parties, The British Accounting Review, vol. 35: 155-187
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Bierstaker, J.L., Burnaby, P. and Thibodeau, J. (2001) The impact of information technology
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Bonsn, E., Cortijo, V. and Escobar, T. (2009) Towards the global adoption of XBRL using
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Boritz, J.E. and No, W.G. (2005) Security in XML-based financial reporting services on the
internet, Journal of Accounting and Public Policy, vol. 24: 11-35
Daigle, R. and Lampe, J. (2004) The impact of the risk of consequence on the relative
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Debreceny, R. and Gray, G.L. (2001) The production and use of semantically rich
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Debreceny, R., Farewell, S., Piechocki, M., Felden, C. and Graning, A. (2010) Does it add
up? Early evidence on the data quality of XBRL filings to the SEC, Journal of
Accounting and Public Policy, vol. 29: 296-306
Dull, R.B., Graham, A.W. and Baldwin, A.A. (2003) Web-based financial statements:
hypertext links to footnotes and their effect on decisions, International Journal of
Accounting Information Systems, vol. 4: 185-203
Flowerday, S., Blundell, A.W., Von Solms, R. (2006) Continuous auditing technologies and
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Gendron, Y. (2008) Constituting the academic performer: the spectre of superficiality and
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Hodge, F., Kennedy, M. and Maines, L. (2002) Recognition versus Disclosure in Financial
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Hou, X., Hu. G, Ma, L., Liu, T., Pan, Y. and Qian Q. (2006) Ontology Driven Securities Data
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***www.springer.com
***www.xbrl.org
~731~
THE INFLUENCE OF FIRM-SPECIFIC

CHARACTERISTICS ON THE EXTENT
OF VOLUNTARY DISCLOSURE IN XBRL:
AN EMPIRICAL ANALYSIS OF SEC FILINGS
Devrimi KAYA1
University of Erlangen-Nuremberg, Germany
ABSTRACT
eXtensible Business Reporting Language (XBRL) is an open standard for the electronic
preparation and exchange of business information. The purpose of this paper is to empirically
investigate the influence of several firm-specific characteristics on the extent of voluntary
disclosure in XBRL. I define voluntary disclosure in XBRL as being an offer of information,
whether financial or non-financial, in a new format via the SECs Voluntary Filing Program
(VFP) in addition to official 10-K and 10-Q filings. The extent of voluntary disclosure is
measured by a disclosure index with 54 financial and non-financial items. Based on a sample
of 51 U.S. listed firms, this study states that the extent of overall disclosures is significantly
and positively related to firm size and the firms level of innovativeness. Moreover, the results
of the study indicate that different factors are important in explaining the voluntary
disclosures of financial, non-financial, and general information. The findings of this study
should be of interest to firms that prepare, consumers that use and regulators that monitor
financial reporting disclosures.
KEYWORDS: Financial Reporting, Voluntary Disclosure, XBRL, Annual Reports, U.S.

stock exchanges, SEC
INTRODUCTION
In times of an incredible volume of information in annual reports, it is becoming
difficult for users to analyze all the information. A relatively new technology called
eXtensible Business Reporting Language (XBRL), an XML-based data standard, is a
system for tagging information which is exchanged electronically so that it can be
given contextual meaning in the systems of those receiving it, e.g. banks, regulators,
and investors (Wagenhofer 2003). XBRL provides an increase in standardization and
comparability of available financial and non-financial information (Baldwin et al.
2006). The Securities and Exchange Commission (SEC) adopted rule amendments
(33-8529) establishing the XBRL Voluntary Financial Reporting Program (VFP) on
the EDGAR System on March 16, 2005 (SEC 2005). These amendments enable
voluntary filers to furnish XBRL documents on EDGAR additionally to official
filings such as 10-K and 10-Q. In January 2009, the SEC then announced rule 339002, which requires corporations to file their financial statements in XBRL with the
requirement being phased-in over three years (SEC 2009). From quarters ended June
1
Correspondence address: Devrimi KAYA, University of Erlangen-Nuremberg, Department of

Accounting and Auditing; email: devrimi.kaya@wiso.uni-erlangen.de
~732~
15, 2009 on, the largest companies with public float greater than $5 billion are
required to submit their financial statements and block tagged notes in XBRL format
(SEC 2009; IASCF 2010). All other filers in US-GAAP, as well as all issuers using
IFRS, will phase-in by 2011 (Debreceny et al. 2010). However, in many other
countries all over the world, such as Germany, United Kingdom, and Canada, XBRL
filings are still on a voluntary basis.
Previous literature examined the firm-specific drivers for voluntary filing in XBRL
rather than the extent of information, which was voluntarily disclosed. Research has
shown that factors such as liquidity and firm size influence the decision of firms to
voluntarily adopt XBRL (Premuroso and Bhattacharya 2008; Callaghan and Nehmer
2009). Little attention has been devoted how voluntary adopters use XBRL to
disseminate information. One would also expect that there are potential disparities
between voluntary filers in their disclosure level and the amount of financial and nonfinancial information disclosed. Some descriptive evidence exists that companies file
predominantly financial tagged information (Boritz and No 2008). Notes
accompanying the financial statements, supporting schedules, and Management
Discussion & Analysis could be excluded in the phase of voluntary filing. However, if
a company decides to include notes in XBRL filings, it has to invest significant time
and effort to prepare these documents in their entirety. Thus, in determining the
optimal level of voluntary disclosure in XBRL, firms have to weigh the specific cost
factors against the potential benefits (Botosan 1997; Wagenhofer 2003). Voluntary
filers may potentially expect to be rewarded by capital markets and financial
statement users for increased transparency, as well as comparability, of their financial
statements, and hence do exhibit a larger extent of disclosed financial and
non-financial information in XBRL. Thus, such disclosures are aimed at reducing
the information asymmetry between managers and investors, and the firms costs
of raising capital (Spero 1979; Cooke 1989; Healy & Palepu 2001; Boesso &
Kumar 2007).
The purpose of this paper is to therefore empirically investigate the influence of
several firm-specific characteristics on the extent of voluntary disclosure in XBRL. In
this context, I define voluntary disclosure in XBRL as being an offer of information,
whether financial or non-financial, in a new format via the SECs VFP in addition to
official 10-Q and 10-K filings, which are required by law. This definition is in line
with literature that studies voluntary disclosure of financial information on the internet
(e.g., Ausbaugh et al. 1999; Craven and Marston 1999; Trabelsi et al. 2004). Other
studies focused on voluntary disclosures as disclosures beyond the required content in
the financial statements (e.g., Gary et al. 1995; Kumar et al. 2008). The specific
research questions considered in this study are:
1. How widespread is voluntary disclosure in XBRL?
2. What is the nature of XBRL disclosures?
3. To what extent is the variability in voluntary disclosure in XBRL explained by
a number of firm-specific characteristics?
Answers to the research questions provide insights about voluntary disclosure
practices. The focus of this study is on the well-developed U.S. VFP, which was
launched by the SEC. In this program, financial and non-financial data of U.S. and
foreign firms is accessible for every interested person. Furthermore, the U.S. has a
large capital market that exerts a dominant influence on disclosure of financial
~733~
statements. The study examines the contents of the entire annual report, which was
filed in the last year of the VFP, not just the financial statement part, as has typically
been empirically investigated in previous work on voluntary disclosure. Thus, the
sample of 51 firms includes all voluntarily filed annual reports of 2008. Following
Gray et al. (1995), the entire annual report is seen as a disclosure package. The focus
on the annual report is not the only way by which companies voluntarily provide
information to investors or other interested parties. For example, conference calls and
analyst meetings can provide relevant information to stock market participants
(Debreceny et al. 2002; Healy and Palepu 2001; Frankel et al. 1999). Nevertheless,
the annual report is the most widely disseminated source of information on publicly
and privately held firms (Arnold et al. 1984; Chang et al. 1983; Gray et al. 1995). The
extent of voluntary disclosure is measured by a disclosure index with 54 items.
Moreover, I examine voluntary disclosures by type of information, namely financial,
non-financial, and general information. This procedure is supported by the
expectation that there may be differences in the disclosure behavior of firms
depending on the type of information (Gray et al. 1995). As in recent studies, this
paper considers the hypothesis that certain firm-specific variables may explain the
observed variation in voluntary disclosure. Following Lang and Lundholm (1993),
independent variables were categorized in structure-related variables, performancerelated variables, and market-related variables.
The study provides several interesting findings. The findings show that voluntary
filers predominantly provide financial tagged information to financial statements
users. However, contrary to earlier research (e.g., Boritz and No 2008), the results
indicate that due to more experience in XBRL filings, firms included notes and
Management Discussion & Analysis (MD&A) in their filings. Thus, the development
of XBRL taxonomies for narrative parts of the annual report is becoming increasingly
important. The results show that firm size and the level of innovativeness of the firm,
measured by the ratio R&D expenditures to sales, to be significantly and positively
related to the extent of voluntary disclosure. Both variables also seem important in
explaining the sub-category financial information disclosures.
The potential contributions of this current study are several. First, examining the
voluntary disclosures of U.S. listed companies should be useful worldwide for
companies that are thinking about adopting XBRL. These companies have a likely
interest in knowing how other firms have followed the complex cost-benefit trade-offs
associated with voluntary disclosures in XBRL format. In addition, voluntary
disclosures often foreshadow trends in worldwide financial reporting and research on
voluntary disclosure will represent an addition to knowledge. Second, the acceptance
and implementation of XBRL around the world has considerably grown during the
last few years. For example, in Europe, a wide range of European countries have
admitted the voluntary submission of financial statements in XBRL format. Still,
several other countries in Europe, such as Lithuania, Czech Republic, and Slovenia, as
well as large parts of Africa and Asia, have not yet dealt with the implementation of
XBRL business reporting at all. Consequently, the results of this study might be
relevant for governments that consider regulating XBRL business reporting for listed
and not listed firms and developing XBRL taxonomies at the national level. However,
only national taxonomies are not able to correspond to the increasing demand for
standardization and comparability on capital markets (Wagenhofer 2003). Therefore,
~734~
common base taxonomies like an IFRS and US-GAAP taxonomy with additionally
national and firm-specific supplements is an obvious concept for cross-sectional
comparability (Richards et al. 2006). Thus, the results of this study should be of
particular interest for standard setters like IASB and FASB.
The remainder of this paper proceeds in seven additional sections. The following
section examines potential benefits of XBRL business reporting. Section 3 reviews
the literature. In section 4, independent variables are discussed and hypotheses are
developed. Section 5 describes the data, disclosure index, and research methodology,
while section 6 presents the descriptive and empirical results. Section 7 concludes the
study with final comments, limitations of the study, and suggestions for future
research.
1. POTENTIAL BENEFITS OF XBRL BUSINESS REPORTING
XBRL is a language that is used for a standardized exchange and representation of
business information. Based on the eXtensible Markup Language (XML) (Premuroso
and Bhattacharya 2008), XBRL also marks information with unambiguous and
predefined attributes, the so-called tags that could be compared to labels or
barcodes on goods (Ramin and Kesselmeyer 2007; Efendi et al. 2009). With the
introduction of tags, the information is not treated as a block of text, as in a printed
document or PDF-file, but is computer readable and enables automatic and efficient
processing by providing an identifying tag for each individual item of data. An XBRL
taxonomy (e.g., U.S.-GAAP Taxonomy) includes and fully structures all elements that
are valid for an XBRL instance document by defining each specific tag (Richards
et al., 2006; Bergeron, 2003; Wagenhofer & Ewert, 2003; Hannon, 2005; Richards
et al., 2006).
Firms participation in XBRL business reporting in addition to traditional disclosure
practices is preceded by a careful process of the evaluation of potential benefits and
costs. The major benefit of XBRL is to reduce inefficient processes of information
communication and to act as a standardized interface for the internal and external
reporting of business information. Its support of various languages simplifies the
exchange of information within international organizations. Other potential benefits
that distinguish XBRL business reporting from other voluntary disclosure practices
are as follows. First, disclosure in XBRL format can reduce firms disclosure costs.
Costs of the adoption of XBRL include the costs of implementation and preparation of
XBRL filings, which are generally not very high. Stantial (2007) outlines the
relatively affordable prices for tagging software and the significant occurrence of
learning curve effects. As manual processes are reduced due to the adoption of XBRL,
time and cost savings can be realized. According to a survey by Pinsker and
Li (2008), cost savings can result from rising efficiency, i.e. a reduction of data
redundancy, and through declining bookkeeping cost. Second, in todays financial
reporting it is complex for the users to select important information within a
200 pages annual report in a paper- or PDF-format. Most of the users do not have the
time to separate not relevant information from relevant information. In addition, firms
historically have provided aggregated information to the financial statements users
(Wallman 1995; Ausbaugh 1999). Therefore, users drew on the services of databases
like Thomson Financial Datastream or Compustat to have access to disaggregated
data. By engaging in XBRL reporting firms may increase their financial disclosures
~735~
and lower users information costs. For instance, XBRL may improve the ability to
provide more timely data in comparison to voluntary disclosures in periodic reports
(Wallman 1997). The provided disaggregated data can be historical costs, fair values,
and forecasts (e.g., monthly or quarterly sales), as well as values in different
currencies. Third, voluntary disclosures in traditional disclosure formats have
important limitations in accessibility. XBRL disclosure is accessible to all users of
financial statements and is flexible in format (Debreceny 2002). Thus, XBRL
improves the orientation towards users` information needs. Due to the better
accessibility, tagged information can be easily acquired and automatically extracted
from various parts of the financial statements and the footnotes without searching the
annual report manually. Hodge et al. (2004) investigate in their study the potential of
XBRL to improve non-professional investors use of financial information in
investment decisions. The authors state that in the context of recognition versus
disclosure of stock option compensation, participants of the study who use XBRL are
more likely to acquire and to integrate the footnote information. In another study,
Arnold et al. (2010) examine the impact of tagging qualitative information on
investors decision making. They determine that the presentation of MD&A in a
tagged form information leads to more efficient incorporation of risk information into
decision making of professional and non-professional investors. The empirical results
of both studies suggest that XBRL improves the transparency of financial reporting,
since transparency is associated with the idea that annual reports should be presented
in a manner that is easily understood by financial statement users (Hodge et al. 2004).
Finally, XBRL disclosure is also likely to enhance the comparability of financial
statements across firms. The more firms and countries adopt XBRL, the more
valuable XBRL will become because comparability increases with the size of the
network (Meeks and Swann 2009). Currently, many countries all over the world
require or permit IFRS reporting. A special XBRL taxonomy for IAS/IFRS was
developed, which even allows cross-country comparison between companies in all
nations using this standard.
Higher comparability and improved transparency in financial reporting are linked to
important economic consequences, e.g. market liquidity and the firms cost of capital
(Hodge et al. 2004; Christensen 2007). Generally with increasing voluntary disclosure
in XBRL format, investors costs of gathering and processing information may
decrease, mitigating information asymmetries on the security markets. Therefore,
adverse selection and insider trading problems can be attenuated, increasing investors
willingness to participate on the security markets and thus, boosting market liquidity
(Ball 2006). Furthermore, disclosure in XBRL may bring forward the international
integration of capital markets, since it allows companies to approach potential
investors worldwide. If investors are provided with more useful and timely
information for their decision making, information asymmetries and adverse selection
problems further decrease, and thus, market liquidity is expected to increase even
more. If the application of XBRL can increase the liquidity of a companys shares by
reducing information asymmetries, investors liquidity premia might decrease (Hail et
al. 2010a, 2010b).
~736~
Figure 1. Benefits of XBRL Business Reporting

Economic Benefits of XBRL Business Reporting
Increasing comparability
Integration of
worldwide
capital markets
Improving transparency
Decreasing
information
costs
Improving information
quality for investors
Decreasing information asymmetries
Increasing market liquidity
Decreasing investors estimation risks
Decreasing liquidity premia
Decreasing risk premia
Decreasing costs of capital
It is important to note that a key factor for the success of XBRL worldwide is the data
quality of filings (Debreceny et al. 2010). If financial statements users cannot trust the
data which is submitted to regulatory bodies, such as the SEC, the expected benefits
of XBRL adoption will not occur. Currently, there is limited empirical evidence on
data quality of XBRL filings. For instance, Boritz and No (2008) analyzed filings in
the SECs Voluntary Filing Program. They found that two-thirds of the XBRL
instance documents furnished under the VFP contain validation exceptions,
inconsistencies, and errors. The authors came to the conclusion that the quality of
XBRL filings has not improved since the SEC launched the VFP (Boritz and No
2008). One main reason for these results might be that firms that participated in the
VFP were not required to audit their XBRL filings. In a recent study, Debreceny et al.
(2010) stated that one quarter of the filings of 400 large corporations in the first round
of mandatory submissions to the SEC contained errors. Typical errors were missing
fact values in calculation relationship or wrong fact values. Therefore, the authors
suggest several actions, such as better warnings within the SECs interactive data
submission program, to prevent and detect the cause for these errors. This early
evidence on data quality can raise an issue about the potential manipulation of
reported financial and non-financial information in XBRL. Another critical point
regarding the comparability of a standardized taxonomy, such as an U.S.-GAAP or
IFRS taxonomy, is that companies are using different types of extensions in their
XBRL filings. These extensions can be firm-, sector- as well as country-specific.
Firms can easily add or modify elements of a taxonomy, which is basically the
innovative idea of XBRL (Boritz and No 2008). But an increase in extensions
worsens the cross-sectional comparability of financial data simultaneously. We might
~737~
speculate how standard setters might solve this problem. One solution might be a
limitation of extensions and options provided by accounting standards like IFRS and
U.S.-GAAP because financial statement users find it difficult to follow up individual
specifications.
Most of the articles in practitioner journals point out the benefits that accrue from the
adoption of XBRL and give an overview of the technological details of XBRL.
Sinnett (2006) states that the most commonly reported benefits are internal and
external processing efficiencies. Malhotra and Garritt (2004) discuss the implications
of XBRL on accountants, investors, analysts, and the financial services industry.
Furthermore, Debreceny et al. (2005) examine the role of XBRL in financial
reporting, concerns with XBRL taxonomies, and the impact of XBRL on the SECs
filing program. Roohani et al. (2010) state in their analysis of XBRL literature that
practitioner journals have published XBRL related articles at significantly higher rate
than academic journals.
However, due to the exceptional accessibility of submitted reports in XBRL format,
several research studies focuses on the SECs Voluntary Filing Program. Efendi et al.
(2009) were examining the characteristics of voluntary adopters. The authors state
that the number of submitted files and the number of first-time filers in the VFP were
increasing over time, whereas the reporting lag was decreasing (the reporting lag is
the time difference in days between filing date and the reporting period). In addition,
they compared several characteristics of companies taking part in the VFP to their
industry average finding out that voluntary filers are larger, more profitable, and more
innovative (Efendi et al. 2009). The assumption whether or not the number of
reporting lines will also increase over time could not be verified. Premuroso and
Bhattacharya (2008), as well as the study of Callaghan and Nehmer (2009),
empirically investigate the drivers that motivate companies to file annual reports in
XBRL format. Premuroso and Bhattacharya (2008) found that firm-specific factors
like liquidity and firm size influence the decision of firms to be an early and voluntary
filer in XBRL. In another empirical study Callaghan and Nehmer (2009) analyze a
final sample of thirty-nine companies that had been filing their annual reports under
the VFP. They figured out that XBRL adopters are bigger, less financially leveraged,
and have lower corporate governance ratings than their pair-matched control group.
However, comparisons of liquidity, profitability, and external risk measures provide
no evidence of group differences (Callaghan & Nehmer 2009). These results are
partially consistent with studies that analyzed Internet Financial Reporting (IFR) in
the past. For example, Ashbaugh et al. (1999) examined voluntary IFR practices of
firms as a supplement to their traditional financial reporting. They found that firm size
is an important determinant of IFR practices, whereas equity and profitability do not
affect voluntary IFR practices. Craven and Marston (1999) state that IFR practices of
the largest U.K. firms are positively associated to firm-specific characteristics, such as
firm size. Additionally, Ettredge et al. (2002) examined that firm size explain the
disclosures of the same financial reports through the internet as the one filed with
SEC, and size and reputation of a firm have a positive relationship with voluntary
disclosures of all other information.
~738~
3. INDEPENDENT VARIABLES DISCUSSION AND HYPOTHESES

DEVELOPMENT
Voluntary disclosure in XBRL is the process of providing information to the financial
market and interested parties, although this information is not statutorily required by
the enforcing authorities. Thus, voluntary disclosure represents free choices of a
companys management to provide information in a new format in addition to official
filings, such as 10-Q and 10-K filings. Different theories have been used in prior
studies to explain voluntary disclosure (e.g., Marston and Shrives 1996; Gray et al.
1995). In particular, agency theory may be relevant in the context of voluntary
disclosure in XBRL. Agency theory models the relationship between the principal and
the agent. In this context, the agent (manager) acts on behalf of the principal
(shareholder) (Jensen and Meckling 1976; Eisenhardt 1989). Managers with better
access to a firms specific situation can communicate reliable information in XBRL
format to external owners and investors in order to raise capital on the best available
terms (Gray et al. 1995; Bujaki and McConomy 2002). Additional financial and nonfinancial disclosures may help voluntary filers in XBRL to attract new shareholders,
thus enabling companies to reduce information asymmetries and to enhance the value
of the firm. In an increasingly globalized world, the demand of accounting
information by capital market participants for valuation and investment decisions is
becoming more important (Broberg et al. 2009). It is assumed that as the worldwide
use of XBRL increases, companies will have more incentives to voluntarily provide
useful and timely disclosures.
Many studies have been carried out on the extent of voluntary disclosure and
empirical literature suggests several firm-specific variables that may explain voluntary
disclosures. In considering relevant firm-specific characteristics as proxies for the
degree of variation of voluntary disclosure in XBRL, this paper follows the approach
of Lang and Lundholm (1993). They found that firms that access the capital markets
are more likely to engage in voluntary disclosure. This paper expects the incentives to
be same for the dissemination of information in XBRL, and categorizes according to
Lang and Lundholm (1993) the independent variables into three categories (Lang and
Lundholm, 1993):
1. Structure-related variables (firm size, leverage ratio, and firm age)
2. Performance-related variables (return on assets, current ratio, and
innovativeness level)
3. Market-related variable (auditor type)
3.1 Structure-related variables
Size. Much evidence from past studies has stated a positive and significant
relationship between firm size and extent of disclosure of annual reports (Wallace et
al. 1994; Ahmed 1995; Meek et al. 1995; Zarzeski 1996). Also, Premuroso and
Bhattacharya (2008), as well as Callaghan and Nehmer (2009), state that the variable
firm size is significantly and positively associated with a firms decision to be a
voluntary filer of information in XBRL format. Larger firms may tend to disclose
more information for several reasons:
Large firms have the resources for collecting, analyzing, and presenting
financial data in new formats like XBRL;
~739~
Compared to smaller firms larger firms are in the public spotlight; therefore,
they are more likely to disclose more information;
Large firms are able to attract highly skilled professionals necessary to
introduce more sophisticated management reporting systems;
Revealing more information may positively impact a firms future cost of
obtaining new funds at lower cost (Botosan 1997).
Furthermore, Chow and Wong-Boren (1987) argue that agency costs increase with
firm size, and thus, large firms voluntarily disclose more information to ease agency
conflicts. Therefore, the following hypothesis is tested:
H1: The extent of voluntary disclosure in XBRL is positively related to the firms size.
Leverage ratio. A widely held view is that highly leveraged firms may tend to
disclose more information to reassure their creditors regarding their future debt
requirements than less leveraged firms. Particularly, if a firm raises debt in public
security markets, it has more requirements to satisfy the needs of related creditors
than firms with little or no public debt. Firms with higher debts are prone to higher
agency cost and higher agency cost suggests a positive relationship between voluntary
disclosure level and leverage (Fama and Miller 1972). Various studies stated leverage
as a variable positively affecting the extent of voluntary disclosure (Belkaoui and
Kahl 1978; Malone et al. 1993; Naser 1998). However, other studies did not provide a
significant relationship between leverage and extent of disclosure (Carson and
Simnett 1997; Hossain et al. 1994). The following hypothesis is examined:
H2: The extent of voluntary disclosure in XBRL is positively related to leverage.
Firm age. In recent studies the age of a company as an independent variable is
examined. Older firms might have more experience with their financial reporting and,
hence, improved their financial reporting practices over time. With regard to this
study older firms might be more involved in the recent developments of financial
reporting, such as internet financial reporting practices, than young firms. In the study
of Alsaaed (2006) a significantly positive relationship between the age and the
disclosure level could be stated. In contrary, Al Mamum (2009) does not find any
relationship between the age of the company and Human Resource Disclosure
(HRAD). The study tests the following hypothesis:
H3: The extent of voluntary disclosure in XBRL is positively related to the firms age.
3.2 Performance-related variables
Return on assets. A firms profitability is often measured by its return on assets (e.g.,
Callaghan and Nehmer 2009). Empirical results provide mixed evidence between
profitability measures and the extent of disclosure. For example, Singhvi and Desai
(1971) found that higher profitability might persuade management to supply more
information to illustrate its ability to maximize the shareholders value and to increase
its managerial compensation. Similarly, management of a profitable company may be
more willing to disclose more information to the public to signal positive effects of its
performance. In contrast, low profitability may force the management to disclose less
information (Richard 1992). Lang and Lundholm (1993) stated that the link between
the performance and disclosure is rather unclear and, additionally, McNally et al.
~740~
(1982) found no link between profitability measures and the extent of voluntary
disclosure. Based on the theoretical framework in section 2, it is more likely that
managers of a profitable firm will voluntarily disclose more information in XBRL to
the market to enhance the value of the firm. Therefore, the following hypothesis is
examined:
H4: The extent of voluntary disclosure in XBRL is positively related to the firms
profitability.
Liquidity. Liquidity can be defined as the ability of a company to fulfill its short-term
liabilities. Current ratio can be selected as a proxy for liquidity. It may be assumed
that the sounder the financial condition of the firm, the greater the incentives to
disclose more information in XBRL. Premuroso and Bhattacharya (2008) stated that
liquidity is positively associated with the voluntary XBRL filing decision. An
alternative viewpoint on this subject may be that firms with a weak financial position
have greater incentives to voluntarily disclose more information in order to mitigate
fears in the capital markets (Camfferman and Cooke 2002). Similar to the
performance-related variables like return on assets, the empirical evidence regarding
the relationship between liquidity and the extent of disclosure is not clear. Cooke
(1989) stated that the more liquid the financial condition of the firm, the greater the
incentive for it to disclose and signal its strength to the market. In contrast, Belkaoui
and Kahl (1978), as well as Malone et al. (1993), found no relationship between
liquidity and firm disclosure, while Wallace et al. (1994), as well as Camfferman and
Cooke (2002), found a significantly negative relationship. I believe that filers in the
VFP signal their strong financial condition and therefore disclose more information in
order to meet current obligations to short-term lenders or suppliers (Premuroso and
Bhattacharya 2008). In this study the following hypothesis is tested:
H5: The extent of voluntary disclosure in XBRL is positively related to the firms
liquidity.
Innovativeness. Certainly, there is a link between innovation and Research &
Development (R&D) (Staw 1976; Staw and Ross 1978; Fox and Staw 1979). R&D
can be seen as the organizational process most directly involved with innovations.
Firms have incentives to invest in R&D if post-innovation market competition allows
them to profit from their investments. The ratio of R&D expenditures to sales can be
used as a measure for input in innovation. Prior research examined the value
relevance of R&D Expenditures (Lev and Sougiannnis 1996; Chan et al. 2001). To the
best of my knowledge, only one study, done by Efendi et al. (2009), has examined the
effect of innovativeness of a firm on the likeliness of voluntary filing in XBRL
format. They state in their descriptive analysis that adopters are likely to be more
innovative firms as they spent on average 4.5% of sales amount for R&D compared to
only 2.9% the industry average. The innovativeness of a firm seems to be an
important issue for research in XBRL. Since XBRL technology is a new format in
business reporting, R&D intensive companies in science- and knowledge based
industries might have a great interest in innovative trends in business reporting. The
prospects of R&D intensive firms are tied to the success of new technologies (Chan et
al. 2001). Based on their business environment and the experiences of many research
projects, these firms might be willing to disclose more information. In comparison to
their long-term investments in R&D projects that are highly unpredictable, the
implementation of XBRL technology in business reporting is quite short and the
~741~
usefulness not limited in time (Debreceny et al. 2002; Debreceny et al. 2010).
Therefore, this hypothesis is tested:
H6: The extent of voluntary disclosure in XBRL is positively related to the level of
innovativeness of the firm.
3.3 Market-related variable
Auditor type. Worldwide audit firms are divided into the Big 4 and the non-Big 4. The
Big 4 firms are widely spread and operate globally while non-Big 4 audit firms
operate primarily in their domestic countries. Empirical evidence on the relationship
between audit firm size and the extent of disclosure is rather ambiguous. Craswell and
Taylor (1992), Ahmed (1995), Raffournier (1995), Mahmood (1999), Camfferman
and Cooke (2002), and Naser et al. (2002) all stated a positively significant
relationship. In opposition to these findings, Wallace and Naser (1995) noticed a
significantly negative relationship between the disclosure level and audit firm size.
Presently, all Big 4 audit firms are members of XBRL International. Therefore, I
expect that the Big 4 firms encourage their global clients to report in XBRL format in
order to ensure compliance with international regulations regarding financial
reporting. Also, Owusu-Ansah (1998) argues that audit firms can play a major role in
influencing policies and disclosure practices of their clients.
H7: The extent of voluntary disclosure is larger for companies audited by a Big-4
audit firm.
4. RESEARCH METHODOLOGY AND STATISTICAL DESIGN
4.1.
Sample Selection and Data Collection
The study focuses on U.S. listed firms that voluntarily disclosed their annual reports
of 2008 in XBRL format on the well-developed U.S. VFP (http://viewerprototype1.
com/viewer) (Viewer 1). The purpose of the VFP is to encourage firms to voluntarily
file reports using the XBRL format. XBRL filings on the VFP are accessible for every
interested person and, hence, useful for several research questions. This program was
launched by the SEC on the EDGAR System on March 16, 2005. Additionally,
voluntary filings were compared with the Bowne Interactive XBRL Viewer
(https://xbrlviewer.bowne.com/) (Viewer 2) in order to ensure that all data was
collected correctly. Adjustments were made for mutual funds, subsidiaries, and nonU.S. issuers as well as for U.S. firms from the banking/insurance industry. Financial
data required for the firm-specific characteristics was obtained using the database
Infinancials (www.infinancials.com) or obtained directly from the firms latest audited
annual report. Considering there are approximately 4,500 companies listed on NYSE
and NASDAQ (Efendi et al. 2008), the final sample covers only 51 U.S. listed firms
and includes all voluntary filed annual reports of 2008.
~742~
Table 1. Overview of Sample firms

Nr.
CIK
Firms
Country
SICCode
1
2
3
4
5
6
7
8
ABB
ADBE
AES
AGL
AA
FCL
AMED
AEP
ABB Ltd
Adobe Systems Inc
AES Corp
AGL Resources Inc
Alcoa Inc
Alpha Naturals Resources Inc
Amedisys Inc
American Electric Power Inc
Schwitzerland
USA
USA
USA
USA
USA
USA
USA
3613
7372
4991
4924
3350
1221
8082
4911
9
10
11
ASML
ADSK
ADP
Netherlands
USA
USA
3559
7372
7374
12
13
14
BR
CAR
CVX
ASML Holding NV
Autodesk Inc
Automatic Data Processing Inc
Broadridge Financial Solutions
Inc
Carolina Power & Light Co
Chevron Corp
USA
USA
USA
6199
4911
2911
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
CME
CXG
COCA
CMCSA
CMA
CNX
CSX
DD
EDGR
ENG
ERIE
FAST
FLORIDA
FLR
FORD
GE
GIS
USA
USA
USA
USA
USA
USA
USA
USA
USA
USA
USA
USA
USA
USA
USA
USA
USA
6200
1311
2086
4841
6021
1221
4011
2820
7389
8711
6411
5200
4911
1600
6159
3600
2040
32
33
34
35
HCP
IBM
ICUI
CME Group
CNX Gas Corp
Coca Cola Enterprises Inc
Comcast Corp
Comerica
Consol Energy Inc
CSX Corp
Dupont E I De Nemours & Co
Edgar Online Inc
Englobal Corp
Erie Indemnity Co
Fastenal Co
Florida Power Corp
Fluor Corp
Ford Motor Credit Corp
General Electric Co
General Mills Inc
Hancock John Sovereign Bond
Fund
HCP Inc
IBM
ICU Medical Inc
USA
USA
USA
USA
6798
3570
3841
36
37
38
39
40
INFY
IP
ITRI
LBTYA
MSFT
Infosys Technologies
International Paper
Itron Inc
Liberty Global Inc
Microsoft Corp
India
USA
USA
USA
USA
7371
2621
3825
4841
7372
41
NDAQ
Nasdaq Omx Group, Inc
USA
6200
42
43
44
45
NETC
NEM
NBL
NOC
Net Servicos De Comunicacao SA

Newmont Mining Corp
Noble Energy Inc
Northrop Grumman Corp
Brazil
USA
USA
USA
4841
1040
1311
3812
~743~
Comments
Foreign
Incorporation
Foreign
Incorporation
Subsidiary
Bank, Brokerage
etc.
Commercial Bank
Subsidiary
Subsidiary
Fund
Foreign
Incorporation
Bank, Brokerage
etc.
Foreign
Incorporation
Nr.
CIK
Firms
Country
SICCode
46
47
48
NYSE
OMC
ONNN
NYSE Euronext
Omnicom Group Inc
On Semiconductor Corp
USA
USA
USA
6200
7311
3674
49
50
51
52
53
54
55
56
57
58
59
OTEX
PZZA
PEP
PCG
PBI
PX
PGN
PLD
RRD
SD
LUV
Open Text Corp

Papa Johns Intl. Corp
Pepsico Inc
PG & E Corp
Pitney Bowes Inc
Praxair
Progress Energy Inc
Prologis
RR Donnelley & Sons Co
Sandridge Energy Inc
Southwest Airlines Co
Canada
USA
USA
USA
USA
USA
USA
USA
USA
USA
USA
7373
5812
2080
4931
3579
2810
4911
6798
2750
1311
4512
60
61
62
63
64
65
TEVA
UPL
UTX
UNH
WU
XRX
TEVA Ph. Industires Ltd

Ultra Petroleum Corp
United Technologies Corp
Unitedhealth Group Inc
Western Union Corp
Xerox Corp
Israel
USA
USA
USA
USA
USA
2834
1311
3724
6324
7389
3577
Comments
Bank, Brokerage
etc.
Foreign
Incorporation
Foreign
Incorporation
4.2. Disclosure Index Construction

A disclosure index was constructed to measure the level of disclosure by listed firms.
The literature on the use of indexes is divided between unweighted and weighted
indexes. Regarding the unweighted index, dichotomous scores are used. 0 is given
for non-disclosure and 1 is given for a disclosure item. The unweighted scoring
approach assumes that each item of disclosure is equally important. The weighted
index is based on the rank a user of the annual report attaches to the information
disclosure item. The supporters of weighted indexes believe that such a score reflects
both the extent and importance of each disclosure item (Robbins & Austin 1986). The
criticism of the weighted index is due to the fact that this index is subjectivity based
on the ranking by the researcher(s) or by a number of financial statement user(s)
(Naser and Nuseibeh 2003). The use of an unweighted index has been critized on its
assumption that all disclosed items are equally important (Barako et al. 2006).
However, previous research studies stated support for the notion that there is no
significant difference between weighted and unweighted disclosure indexes (Spero
1979; Chow and Wong-Boren 1987). For the scope of this study, the unweighted
index was chosen. Based on this studys definition of voluntary disclosure as being an
offer of information via the SECs VFP in addition to official 10-Q and 10-K filings,
the contents of all voluntary filings in XBRL format were examined. The unweighted
checklist consists of 54 items. For the purpose of detailed analysis the checklist was
categorized into three main categories as follows: financial, non-financial, and general
information. Financial information that is tagged can be the consolidated balance
sheet. An example for a non-financial item, which is voluntarily filed in the VFP, is
the accounting policies of a firm. Non-financial items predominantly refer to positions
in the balance sheet or income statement, while general information does not have a
concrete reference to the financial parts of an annual report. The category financial
~744~
information covers 40 items, non-financial information 10 items, and general

information 4 items. Thus, voluntary U.S. filers in XBRL format predominantly focus
on disclosing tagged financial information. Financial information has obvious
decision relevance to investors in the capital market (Gray et al. 1995). However,
table 2 also shows that 31 firms of my sample filed notes in the VFP and 44 firms
disclosed MD&A in their XBRL filings. Contrary to the study of Boritz and No
(2008) these results show that firms invest significant time and effort to voluntarily
file their notes and MD&A in XBRL (Boritz and No 2008). It is important to note if
notes are included, they must be included in their entirety.
Table 2. Number of Voluntary Disclosure Items by Category
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
Financial Information
(Consolidated) Income Statement
(Consolidated) Income Statement Parenthetical
(Consolidated) Income Statement (Including Gross Margin)
(Consolidated) Income Statement (Excluding Gross Margin)
(Consolidated) Statement of (other) Comprehensive Income
(Consolidated) Balance Sheet
(Consolidated) Balance Sheet Parenthetical
(Consolidated) Statement of Cash Flows
(Consolidated) Statement of Cash Flows Direct Method
(Consolidated) Statement of Cash Flows Indirect Method
Cash Flow Supplemental
(Consolidated) Statement of Stockholders Equity
(Consolidated) Statement of Stockholders Equity Parenthetical
(Consolidated) Statement of Financial Position
Schedules
Statement of Partners' Capital
Interim Reporting
Cash and Cash Equivalents
Receivables, Loans, Notes Receivable, and Others
Investments, Debt and Equity Securities
Deferred Costs, Capitalized, Prepaid, and Other Assets
Property, Plant, and Equipment
Intangible Assets, Goodwill and Other
Payables and Accruals
Exit Or Disposal Cost Obligations
Deferred Revenue
Debt
Other Liabilities
Equity
Other Income and Expenses
Research and Development
Income Taxes
Discontinued Operations and Disposal Groups
(Net) Earnings Per Share
Segment Reporting
Statement of Cash Flows, Supplemental Disclosures
Derivative Instruments and Hedging Activities
Fair Value Measures and Disclosures
Foreign Operations and Currency Translation
Leases, Operating
Inventory
SEC Schedule, Article 12-15
Unconsolidated Investees
Assets Held for Sale and Discontinued Operations
Long term Compensation
Selected Quarterly Financial Data
Total Disclosures:
~745~
51
8
15
50
50
38
4
1
2
2
4
5
2
5
4
2
3
2
5
4
5
1
1
5
1
5
6
3
4
3
1
1
3
1
3
1
1
1
1
1
305
1
2
3
4
5
6
7
8
9
10
1
2
3
4
Non-Financial Information
Notes to the (consolidated) Financial Statements
Accounting Changes and Error Corrections
Accounting Policies
Commitment and Contingencies
Compensation Related Costs, General
Compensation Related Costs, Share Based Payments
Compensation Related Costs, Retirement Benefits
Business Combinations
Minority Interest
Subsequent Event
Total Disclosures:
General Information
Organization, Consolidation and Presentation of Financial Statements
Document and Entity Information
Uncategorized Items
Management Discussion and Analysis
Total Disclosures:
31
1
6
6
1
3
4
5
1
1
59
1
2
4
44
51
The scoring rewards both quantitative and qualitative information. Consistent with
most previous disclosure studies, I use the dichotomous scoring where 1 is assigned
when an item is disclosed and 0 otherwise. The extent of voluntary disclosure over
all 54 items was measured by a disclosure index (DIj) calculated as follows:
nj
DI j =
x
i =1
ij
nj
Where:
nj = 54;
xij = 1 if ith (applicable) item is disclosed and 0 otherwise;
so that 0 DIj 1.
Additionally, disclosure indexes based on the categories financial (40 items), nonfinancial (10 items), and general information (4 items) were calculated. Table 3 shows
the scores over all 54 items as well as the scores of the three subcategories.
Table 3. Index Scores of sample firms
No.
1
2
3
4
5
6
7
8
9
10
11
12
13
Firms
Adobe Systems Inc

AES
AGL Resources Inc
Alcoa Inc
Alpha Natural Resources
Amedisys
American Electric Power
Autodesk Inc
Automatic Data Processing Inc
Broadridge Financial Solutions Inc
Chevron Corp
CNX Gas Corp
Coca Cola Enterprices Inc
Overall
Disclosures
XBRL
Index-Score
(54 items)
0.7778
0.1296
0.2778
0.1111
0.0926
0.1111
0.1111
0.0741
0.0741
0.0926
0.1296
0.1111
0.0926
Financial
Information
Index-Score
(40 items)
0.7750
0.1250
0.2500
0.1000
0.1000
0.1000
0.1000
0.1000
0.1000
0.1000
0.1250
0.1000
0.1000
~746~
Nonfinancial
Information
Index-Score
(10 items)
0.70
0.10
0.40
0.10
0.00
0.10
0.10
0.00
0.00
0.10
0.10
0.10
0.00
General
Information
Index-Score
(4 items)
1.00
0.25
0.25
0.25
0.25
0.25
0.25
0.00
0.00
0.00
0.25
0.25
0.25
No.
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
50
51
4.2.
Firms
Comcast Corp
Consol Energy Inc
CSX Corp
Du Pont E I De Nemours & Co
Edgar Online Inc
Englobal Corp
Erie Indemnity
Fastenal Co
Fluor Corp
General Electric Co
General Mills Inc
HCP Inc
Icu Medical Inc
International Paper
IBM
Itron Inc
Liberty Global Inc
Microsoft Corp
Newmont Mining Corp
Noble Energy Inc
Northrop Grumman Corp
Omnicom Group Inc
On Semiconductor Corp
Papa Johns Int Co
Pepsico Inc
PG & E Corp
Pitney Bowes Inc
Praxair
Progress Energy Inc
Prologis
R.R. Donnelley & Sons Co
Sandridge Energy Inc
Southwest Airlines Co
Ultra Petroleum Corp
United Technologies Corp
Unitedhealth Group Inc
Western Union Co
Xerox Corp
Overall
Disclosures
XBRL
Index-Score
(54 items)
0.1296
0.1111
0.1111
0.1111
0.1111
0.0370
0.1852
0.1111
0.1111
0.0926
0.0741
0.1296
0.0926
0.1111
0.1481
0.0926
0.1296
0.4074
0.1296
0.1111
0.1296
0.0926
0.1111
0.1296
0.0926
0.0926
0.1111
0.0926
0.1296
0.4815
0.1111
0.1111
0.0926
0.1296
0.3889
0.1111
0.1296
0.4259
Financial
Information
Index-Score
(40 items)
0.1250
0.1000
0.1000
0.1000
0.1000
0.0500
0.1750
0.1000
0.1000
0.1000
0.1000
0.1250
0.1000
0.1000
0.1500
0.1000
0.1250
0.4000
0.1250
0.1000
0.1250
0.1000
0.1000
0.1250
0.1000
0.1000
0.1000
0.1000
0.1250
0.5000
0.1000
0.1000
0.1000
0.1250
0.4000
0.1000
0.1250
0.4500
Nonfinancial
Information
Index-Score
(10 items)
0.10
0.10
0.10
0.10
0.10
0.00
0.10
0.10
0.10
0.00
0.00
0.10
0.00
0.10
0.10
0.00
0.10
0.40
0.10
0.10
0.10
0.00
0.10
0.10
0.00
0.00
0.10
0.00
0.10
0.50
0.10
0.10
0.00
0.10
0.40
0.10
0.10
0.40
General
Information
Index-Score
(4 items)
0.25
0.25
0.25
0.25
0.25
0.00
0.50
0.25
0.25
0.25
0.00
0.25
0.25
0.25
0.25
0.25
0.25
0.50
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
Model Development
Earlier discussion has suggested that there is no theoretically correct way to describe
the link between dependent and independent variables (Lang and Lundholm 1993;
Cooke 1998). Therefore, Lang and Lundholm (1993), as well as Wallace et al. (1994),
suggested the use of ranked (OLS) regression as a technique for coping with data sets
with non-linear and monotonic relations between dependent and independent
variables (Lang and Lundholm 1993). Following Camfferman and Cooke (2002) and
Alsaeed (2006), this study uses the unranked OLS approach. It is worth noting that the
essence of the quality of disclosure as the dependent variable is not firmly defined.
Wallace et al. (1994), as well as Camfferman and Cooke (2002), used the term of
comprehensiveness. Following Patton and Zelenka (1997), I use the term of extent as
the dependent variable.

~747~
The full specification of the regression is:

Disclosure Index Scores = 0+ 1Size + 2Leverage + 3Age + 4ROE + 5Liquidity +
6Innovativeness + 7Auditor + i
Size
Leverage
Age
ROA
= Log of the book value of total assets (in millions of U.S. $)

= Leverage ratio (total liabilities divided by total assets)
= Log of the age of firm (in years)
= net income divided by the average of the last two years total
assets
Liquidity
= current assets divided by current liabilities
Innovativeness = research & development expenditures divided by net sales
Auditor type = Big 4 audit firm = 1 and non-Big 4 audit firm = 0
= Slopes of the independent variables while 0 is a constant or
the
value of Y when X values are zero.
i
= The error term, normally distributed about a mean of 0.
5. ANALYSIS AND DISCUSSION OF RESULTS
5.1. Descriptive Results
Table 4 presents the descriptive statistics for the dependent and independent variables.
There is a wide range of variation within the disclosure indexes as indicated by the
minimum and maximum values. The disclosure index over all 54 items vary between
sample firms and range from 3.7% to 77.8%. The mean of the overall index is 15.1%.
The low amount of items disclosed in the last year of the VFP could be explained on
the basis that XBRL is still a relatively new technology in business reporting. Thus,
the preparations of XBRL documents are based on very limited guidance and
experience. As assumed, within the information subgroups the mean of the index of
financial information is the highest (14.95%), followed by the subgroups nonfinancial information (11.57%) and general information (2.5%). Table 4 also shows
the considerable variation in the independent variables, which reflects the diversity of
voluntary filers in XBRL. For example, the youngest firm that files in XBRL format
is three years old. In contrast, the oldest firm is 206 years old. 14 firms in my sample
had R&D activities. The maximum value of the innovativeness level is 24.9%. Not
surprisingly, the majority of voluntary filers use Big 4 firms for their annual audits.
~748~
Table 4. Sample Characteristics

Variables
Min
Max
Standard
Deviation
Mean
Median
51
51
51
0.037
0.05
0.00
0.778
0.7750
0.70
0.128
0.1291
0.1419
0.151
0.1495
0.1157
0.111
0.10
0.10
Dependent Variables
INDEX_All
INDEX_FINANCIAL
INDEX_NONFINANCIAL
INDEX_GENERAL
Independent Variables
Sizea b
51
0.00
1.00
0.1414
0.025
0.025
51
797,769.0
112,895.1
39,445.2
14,308.0
Leverage
Firm Age a
ROA
51
51
51
1.022
206.000
0.227
0.195
51.847
0.1084
0.670
65.824
0.043
0.694
46.000
0.054
Liquidity
Innovativeness
Industry type
Auditor type
51
51
51
51
13.00
6
0.107
3.000
0.400
0.116
0.000
0.000
0.000
8.169
0.249
1.000
1.000
1.433
0.056
0.476
0.238
1.530
0.025
0.333
0.941
1.120
0.000
0.000
1.000
Notes: a size and firm age are provided only for sample characteristics. In the regression
analysis, log of these values are applied. b total assets figures are in million US-$.
By analyzing the annual reports of 2008, only one company disclosed at least 70% of
54 items contained in the overall disclosure index (Table 5). Fifteen companies
(29.41%) disclosed equal to or less than 10% of items. Thirty companies (58.82%)
reached a disclosure score between 11-20%.
Table 5. Voluntary Corporate Disclosure Scores overall 54 items
Items INDEX_ALL
<=10
11-20
21-30
31-40
41-50
>50
No. of companies
15
30
1
2
2
1
%
29.41%
58.82%
1.96%
3.92%
3.92%
1.96%
5.2. Multiple Regression Results

In the next step a check of multicollinearity among the independent variables was
performed. The situation where two or more of the independent variables are highly
correlated can have damaging effects on the results of the multiple regression
analysis. Table 6 reveals a number of significant correlations between several
independent variables. For instance, size has significant correlations with leverage,
age, liquidity, innovativeness, and auditor type. Table 6 also shows a significant
correlation between the dependent variable and innovativeness. This suggests the
potential for at least hypothesis 6 to be supported. A coefficient is considered high if it
exceeds +/- 0.80 (Gujarati 1988; Shannon and Davenport 2001). Based on Table 6 the
independent variables do not suffer from the problem of multicollinearity (However,
multicollinearity can still exist even when none of the coefficients are very high. This
is the case when one independent variable may be an approximate linear function of a
set of several independent variables. Another way to assess multicollinearity is the
~749~
variance inflation factor (VIF). The variance inflation factor (VIF) quantifies the
severity of multicollinearity in an ordinary least squares regression analysis. The
highest VIF is 2.239. Hence, collinearity did not appear to be a serious problem in
interpreting the regression results.).
Table 6. Correlation Matrix with Overall Disclosure Index
Index
ALL
Index
ALL
Size
Leverage
Age
ROA
Liquid.
Innovativeness
Auditor
Size
Leverage
Age
ROA
Liquid.
Innovativeness
Auditor
1.000
0.127
0.220
0.101
0.130
0.162
0.366*
0.115
1.000
0.334*
1.000
0.470**
0.239
1.000
0.079
-0.302*
-0.434**
-0.587**
0.208
-0.034
1.000
0.220
1.000
-0.285*
-0.231
-0.187
-0.069
0.115
1.000
0.102
0.272
0.112
0.096
-0.190
0.471**
1.000
*. Correlation is significant at the 0.05 level (2-tailed).

**. Correlation is significant at the 0.01 level (2-tailed).
Multiple regression analysis was used to answer the question if there is an influence
of several firm-specific characteristics on the extent of voluntary disclosure over all
disclosure items in XBRL (the dependent variable in the analysis). Moreover,
regression analysis was performed for the three information subgroups as dependent
variables in order to assess factors explaining the extent of disclosures within the
subgroups. Thus, the study ran four regressions. Table 7 reports the model summaries
for the overall voluntary disclosures and for each of the three information subgroups.
The results are statistically significant both on an overall basis (10%-level) and by
financial information type (5%-level), whereas the statistical model of the
subcategories non-financial and general information is not significant. Table 7
indicates adjusted R2 of 16.6% (F-ratio 2.426, p=0.035), which shows that a moderate
percentage of the overall disclosure index as the dependent variable can be explained
by variations in the entire set of independent variables. Premuroso and Bhattacharya
(2008) reported in their empirical study about voluntary XBRL filers a higher
adjusted R2 of 0.333, but with a smaller sample of firms and less independent
variables. Compared to the empirical literature in voluntary disclosure, lower adjusted
R2 statistics were reported by Wallace (1988) at 0.07, whereas higher adjusted R2
statistics were reported by Wallace et al. (1994) at 0.6050, Ahmed (1995) at 0.332,
and Camfferman and Cooke (2002) at 0.193 (This value is for the Dutch sample. For
the UK sample an adjusted R2 of 0.231 was reported.). The amount of explained
variation in disclosure subgroups ranges from 18.3% in the case of financial
information to 7.3% for general information, with non-financial information in
between at 6.7%.
~750~
Table 7. Model summaries for overall disclosure items and information subgroups
Items
Adjusted R2
Sig.
DurbinWatson
0.166
2.426
0.035**
1.648
0.183
2.603
0.025**
1.697
0.067
1.513
0.188
1.655
0.073
1.564
0.172
1.460
Overall Items
Financial Items
Non-Financial Items
General Items
* significant at 10% level.

** significant at 5% level.
The results of the OLS regression for the overall disclosure index show that firm size
and the level of innovativeness are statistically significant, with the hypothesized
direction (table 8). In contrast, leverage, firm age, ROA, liquidity, and auditor type
were found not to be statistically significant. The variable firm size is significant at
the five percent level (p=0.026) with a positive coefficient (0.026). The most
significant variable in the model is the level of innovativeness, which has a p-value of
0.004. The coefficient is positive (0.954). Table 8 indicates that the same independent
variables are not consistently statistically significant across information types. Size is
an important variable explaining the voluntary disclosures of the subcategory
financial information. The variable innovativeness is statistically significant for each
of the three information subgroups, but the level of significance changes. Thus,
different factors are important in explaining the voluntary disclosures of different type
of information.
Table 8. Regression results for overall disclosures and subgroups
Model:
Disclosure Index Scores = 0+ 1Size + 2Leverage + 3Age + 4ROE + 5Liquidity +
6Innovativeness + 7Auditor + i
Independent
Variables
Exp.
Sign
Constant
Size
Leverage
Firm Age
ROA
Liquidity
Innovativeness
Auditor
Overall
Coefficient
(t-statistics)
-0.022
(-0.174)
0.026
(2.169)**
-0.052
(-0.408)
-0.028
(-1.354)
0.107
(0.587)
0.014
(0.877)
0.954
(3.023)***
0.029
(0.348)
Financial
Coefficient
(t-statistics)
-0.035
(-0.282)
0.027
(2.285)**
-0.038
(-0.304)
-0.030
(-1.472)
0.127
(0.694)
0.015
(0.969)
0.991
(3.143)***
0.025
(0.300)
** significant at 5% level.
*** significant at 1% level.
~751~
Non-Financial
Coefficient
(t-statistics)
0.005
(0.033)
0.023
(1.647)
-0.097
(-0.650)
-0.026
(-1.086)
0.078
(0.361)
0.004
(0.229)
0.872
(2.353)**
0.035
(0.359)
General
Coefficient
(t-statistics)
0.047
(0.324)
0.019
(1.384)
-0.072
(-0.486)
-0.008
(-0.329)
-0.014
(-0.067)
0.023
(1.274)
0.788
(2.141)**
0.054
(0.554)
5.3. Discussion of findings

The findings of this study are supported by the findings of some previous studies of
voluntary disclosure, but are also contrary to the findings of other previous studies.
The significant findings on firm size are consistent with most previous international
studies (e.g., Lang and Lundholm 1993; Raffournier 1995; Craven and Marston 1999;
Debreceny et al. 2002). Similar to Premuroso and Bhattacharya (2008), this study also
states a significant effect on the five percent level (p<0.05). Thus, Hypothesis 1 is
supported, which states that large firms disclose more information voluntarily. Large
firms may have a wider range of various activities that require more information to be
disclosed to reduce agency costs. A reason for this result might be that large firms
may have the resources to implement new formats in business reporting, such as
XBRL. Additionally, the variable size has a positive and statistically significant effect
on the extent of the subcategories financial and non-financial information disclosures.
Given that XBRL is a new and innovative format in business reporting, Hypothesis 6
states that the extent of voluntary disclosure in XBRL is positively related to the level
of innovativeness of the firm. The result of innovativeness is found to be significant at
a one percent level (p<0.01). As hypothesized, the coefficient for innovativeness has a
positive sign. Additionally, this variable is the most significant driver of the extent of
disclosure for each of the three subcategories. Based on their business environment
and the experiences of many research projects, innovative firms are willing to disclose
more information in an innovative format like XBRL. The relation between
innovativeness and the extent of voluntary disclosure in XBRL should be of particular
interest of future research. Contrary to prior studies, we find no evidence that other
independent variables influence the extent of voluntary disclosures.
The purpose of this paper was to empirically investigate the influence of several firmspecific characteristics on the extent of voluntary disclosure in XBRL. I define
voluntary disclosure in XBRL as being an offer of information, whether financial or
non-financial, in a new format via the SECs VFP in addition to traditional financial
reporting disclosures. Based on a sample of 51 U.S. listed firms, the results support
the expectation that voluntary disclosure in XBRL, measured by a disclosure index of
54 items, is subject to firm-specific characteristics. Consistent with previous work,
this study states that the extent of overall disclosures is significantly and positively
related to firm size at the 5%-level. Thus, the larger the company, the more extensive
the disclosure. The study also finds that companies with a high level of innovativeness
have a significant influence on the extent of overall disclosures at the 1%-level.
Moreover, voluntary disclosures by different type of information were examined. The
results of the study indicate that different factors are important in explaining the
voluntary disclosures of financial, non-financial, and general information.
The limitations of this study include a relatively small sample size of 51 firms from
the year 2008. Nevertheless, it is important to note that this is a comprehensive study,
since all voluntary U.S. filers of 2008 were considered in this study. Furthermore, the
construction of an unweighted disclosure index based on the elements, which were
voluntarily disclosed, may not be the best measurement. Studies with self-constructed
measures face the problem that the measure may not truly capture what is intended
~752~
(Healy and Palepu 2001). Finally, the empirical findings and conclusions of this study
are limited to one type of corporate communication, namely the annual report. The
annual report is not the only way that information is disseminated to investors,
analysts, and other capital market participants.
Since the spread of XBRL is worldwide, the current stage of development offers
researchers significant opportunities. It might be interesting to replicate this study
based on a larger sample size from another voluntary filing program. Therefore,
extending the study by countries that are openly advocating early XBRL adoption like
Japan, Germany, and the United Kingdom, might help to point out similarities and
differences in voluntary disclosure in XBRL. Future research could assess the extent
of disclosure of privately held and financial firms. In many countries in Europe, such
as Germany, also not-listed firms have the option to file their annual reports in XBRL
format. Furthermore, future research could incorporate other independent variables
that may affect the behaviour of management. Finally, the effect of XBRL on
corporate cost of capital issues is widely unknown.
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PS16 SMEs
Chairperson
Jiri STROUHAL, University of Economics Prague,
Czech Republic
OBLIGATION OR OPPORTUNITY FOR DRAWING

THE CASH-FLOW STATEMENT. THE CASE
OF ROMANIAN SMALL AND MEDIUM ENTERPRISES
Adina POPA, Rodica BLIDISEL, Nicoleta FARCANE, Dan STIRBU
ROMANIAN PROFESSIONAL ACCOUNTANTS

PERCEPTION ON THE DIFFERENTIAL FINANCIAL
REPORTING FOR SMALL AND MEDIUM-SIZED
ENTERPRISES
Stefan BUNEA, Marian SACARIN, Mihaela MINU
ACCOUNTING PRINCIPLES AND BOOK-TAX

(DIS)CONNECTION IN ROMANIA
Costel ISTRATE
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OBLIGATION OR OPPORTUNITY FOR DRAWING

THE CASH-FLOW STATEMENT. THE CASE
OF ROMANIAN SMALL AND MEDIUM ENTERPRISES
Adina POPA1
Eftimie Murgu University of Resia, Romania
Rodica BLIDISEL, Nicoleta FARCANE & Dan STIRBU

West Univesity of Timisoara, Romania
ABSTRACT
This paper aims to assess the extent to which Romanian SMEs are prepared for the transition
to IFRS standards. A quantitative survey addressed to the practitioners and accountants in
the small and medium enterprises from the western area of Romania is made in order to
establish the degree of perception regarding the importance and usefulness of cash flow
statement. The results show that there are differences between the views of staff specialized in
financial and accounting departments who have used this instrument and who did not use,
emphasizing difficulties encountered and illustrates the usefulness of this tool in the financial
information necessary for decision making.
KEYWORDS: SMEs in the western region of Romania, IFRS, cash flow, accountants and
management perception
1. CONCEPTUAL FRAMEWORK AND DEVELOPMENT OF
ASSUMPTIONS
The emergence of International Financial Reporting Standards (IFRS) for Small and
Medium-Sized Enterprises (IFRS for SMEs) determined us to make assessments on
the extent to which Romanian companies in this category are prepared for the
transition to this set of standards. Unlike the case of listed companies, in 2007 the
European Union stated that there is no intention for IFRS to become mandatory for
SMEs (Nolke and Perry, 2007). Before adopting IFRS for SMEs both at national and
at company level, it is very important for all parties involved to be aware of pros and
cons both in the view of users and producers of financial information.
From the perspective of our study, we were interested particularly in aspects related to
cash-flow statements. According to IFRS for SMEs, this statement is a mandatory
reporting, being part of the financial reports. The transition to the application of IFRS
for SMEs involves a different way of thinking and applying of working rules and
procedures at the level of SMEs. Therefore, the role of human resources with financial
and accounting knowledge and specialised studies is essential for SMEs in the context
of the implementation of the new accounting standards.
Correspondence address: Adina POPA, Eftimie Murgu University of Resia, Romania;

email: nicoletafarcane@yahoo.fr
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2. A NEW PERCEPTION OF THE ROMANIAN ACCOUNTING

PRACTITIONERS IDEA ON FINANCIAL STATEMENTS?
The topic of our research is structured around the main question: How prepared are
Romanian SMEs to transpose cash-flow information into mandatory financial
reporting?
Information provided by cash-flow statements can be used to increase quality and
level of financial earnings, liquidities and flexibility and they help when forecasting
cash-flows. Information on cash-flows should provide better guidance on the level of
a companys liquidity, because no other asset is more liquid than cash. According to
Carslaw and Mills (1991:63), a companys financial strength and weakness is
estimated best by using a set of cash-flow ratios combined with traditional financial
statements balance sheet and income statement.
The main purpose of this article is to study the opinion of the management of small
and medium-sized enterprises located in the western part of Romania in respect to the
importance and usefulness of cash-flow statements for this category of companies.
This results from the fact that there are no records of the views of practitioners in
finance and accounting departments in respect to this initiative.
The undertaken research focuses on the necessity, usefulness, importance and usage
level of cash-flow statements in the praxis of Romanian small and medium-sized
enterprises. Thus, the following questions are required:
1. How do SMEs perceive the costs and benefits of cash-flow statements included in
the IFRS proposed for SMEs?
2. Are there significant differences between SMEs regarding management
perceptions on cash-flow statements, depending on their size?
3. What are the difficulties of SMEs management resulting from non-preparation of
cash-flow statements?
4. How do specialised personnel who prepare financial statements perceive the
usefulness of cash-flow statements?
Currently, there are no defined records of SMEs perceptions and views on adopting
IFRS for SMEs and on the usefulness of cash-flow statements, feasibility and benefits
of its adoption and on the difficulties faced by SMEs in implementing various
accounting standards and regulations. There are significant gaps in professional
literature regarding the adequacy of IFRS proposed for SMEs. Also, there is no
evidence on accounting issues relevant for SMEs and this would have to be covered
by IFRS for SMEs. Moreover, there is a lack of empirical evidence on costs and
benefits of accounting methods based on IFRS for SMEs.
2.1. Reasons for performing an analysis of practitioners perceptions
on adopting IFRS for SMEs
According to current Romanian accounting regulations, SMEs prepare simplified
financial statements, where the statement of changes in equity and the cash-flow
statement are not mandatory.
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IFRS for SMEs provides that, besides the companys financial position, the financial
statements of SMEs have to also present fairly the financial performance and cashflows of an entity in this category. Before their implementation it is impossible to
examine directly the effects of IFRS for SMEs. Therefore, experience of those
persons with knowledge on IFRS for SMEs is useful for understanding the possible
consequences of its adoption.
In Romania, the new rules on IFRS for SMEs have been submitted to the Body of
Chartered Certified Accountants (CECCAR) in order to be analysed, and its members
will make recommendations and notes on the practical applicability of the new
accounting regulations.
According to a survey conducted by NEXIA International, although the International
Accounting Standards Board headquartered in London (IASB) has issued the
international financial reporting standard (IFRS) for SMEs in July 2009 (it is
considered that SMEs represent over 95% of all companies in the world), it seems that
companies have a poor appetite for adopting international financial reporting
standards (IFRS) for SMEs.
Due to recent completion of IFRS for SMEs (since 2009 the English version and in
2010 its translation into Romanian), there are only few case studies on the practical
difficulties of SMEs in Romania, and literature addresses this issue more from the
theoretical point of view.
2.2. Literature on the necessity and applicability of IFRS for SMEs
Eierle and Haller (2009) noted that most SMEs in Germany consider that it is
necessary only in a small extent or even unnecessary to provide internationally
comparable financial information. Based on the analysis of Belgian data, Coppens and
others (2007) have shown that adoption of IFRS for SMEs will result in a need of
separate financial reporting to tax authorities by those companies that apply IFRS for
SMEs. Moreover, both studies - Coppens and others (2007) and Haller (2003) noted
that, according to experts opinion, after adoption of IFRS for SMEs, companies
efforts for data collection and processing will probably increase considerably due to
the standards complexity.
According to Coppens and others (2007), SMEs require assistance from external
accounting specialists in order to apply IFRS, which increases implementation costs.
According to Evans and others (2005), the relative value of these costs will be high,
especially for smaller companies, but the size effect is quite rare in terms of
evaluation of costs and benefits of this particular accounting standard (Eierle and
Haller, 2009). Thus, Eierle and Haller (2009) argue that, in comparison to larger
companies, small companies overestimate the benefits of accounting standards and
underestimate their costs, probably due to the lower level of accounting knowledge in
small companies.
Many researchers confirmed the usefulness and importance of operating cash-flows in
comparison with revenues in respect to: Evolution of exchange rates for securities:
Beaver and Dukes (1972), Pattel and Kaplan (1977), Rayburn (1986), Bowen and
others (1987), Wilson (1986, 1987), Bernard and Stber (1989), Papilor (1995), Wang
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and others (1998), Sad and others (2001); - Forecast of future cash-flows: Bowen and
others (1986), Finger (1994), Krishnan and Largay (1997), Barth and others (2001),
Hussain and others, Attar (2004); Enterprise risk management and cash-flow
forecasting, Farcane N., Popa A., Caciuc L., Blidiel R., 2008; Risk management, at
the border between accounting constructions and cash-flow forecasting tools, Solle
G., Farcane N, Saglietto L., Stirbu D., 2010; Assessment of companys financial
situation, Cristea H, Pirtea M, Enache C, 2000; - Companys cash-flows under
inflationary circumstances, Pirtea M., 2000.
Both international and national professional literature demonstrates that specialized
finance and accounting personnel, who have encountered various situations in their
professional career, or have even prepared cash-flow statements, are more receptive to
implementing the new accounting standard IFRS for SMEs.
3. ASSUMPTIONS CONCERNING THE ASSESSMENT OF MENTALITY
CHANGE OF ROMANIAN ACCOUNTING PRACTITIONERS
Based on various domestic and foreign studies, which showed that the size of a
company is a factor that influences its behavior in terms of preparation and
dissemination of financial and accounting information (Hermann et. al. (1996),
Ettredge et al.(2002) , Haniffa and Cooke (2002) , Popa (2008) ), we considered that
management of small companies have different perceptions regarding cash-flow
statements in comparison with managers of medium-sized companies. Consequently,
we start from the following assumptions:
Assumption 1: There are significant size differences between SMEs in respect to
management perception on cash-flow statements.
Regardless of whether they have used cash-flows during their career or not,
specialized personnel who prepare financial statements for SMEs are aware of their
importance and of the problems faced by companies, which prepare cash-flow
statements.
Assumption 2: Specialized personnel preparing financial statements are aware of the
problems faced by companies, which prepare cash-flow statements, regardless of
whether they have used cash-flow statements during their career or not.
Moreover, it is presumed that specialised personnel in finance and accounting
departments, who prepare financial statements, consider that cash-flow statements
provide important financial information for improving decision-making at the level of
SMEs. Performance assessment, one of SMEs main objectives, caught attention of
many researchers. This led us to a third assumption:
Assumption 3: Specialised personnel in finance and accounting departments, who
have used cash-flow statements during their career, consider that managers face
difficulties in decision-making in the absence of information resulted from the
analysis of cash-flow statements, while non-users have a different perception.
Usefulness of cash-flow statements for decision-making at a companys management
level is a matter that has to be taken into account by those who prepare the companys
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financial statements. We assume that those respondents, who have not used or
prepared cash-flow statements during their careers, will have different perceptions
about the usefulness of this statement, in comparison to the group of those who have
used and even prepared it. This is the fourth assumption of our study.
Assumption 4: Specialized personnel (users and non-users of cash-flow statements)
have different perceptions regarding usefulness of cash-flow statements in providing
financial information for decision-making process.
3.1. Ways and means for testing our assumptions
Research methodology is used to obtain information for elucidating the questions
addressed in this study. Research is based on testing assumptions through logical
empiricism, which is a positive approach. Also, in order to analyse experience in
knowledge process, we have used quantitative and qualitative methods, recommended
and used by many researchers, these being the most used research methods at socioeconomical level.
In our study, quantitative data are collected by means of a questionnaire distributed to
small and medium-sized enterprises in the western part of Romania. Qualitative data
were obtained by means of open questions and direct interviews with some of the
finance managers of SMEs in this region.
The sample represents a group of people to which we apply a study which results in a
conclusion about the entire studied population. Sample methodology is used for
obtaining the opinions of finance and accounting professionals on the necessity and
usefulness of cash-flow statements in management and administration of small and
medium-sized enterprises.
The studied population consists of representatives of small and medium-sized
enterprises (according to the definition of SMEs in Romanian legislation harmonized
with European Directives) located in the western part of Romania, in Timi,
Cara-Severin, Arad and Hunedoara Counties. The sample was obtained from the
companies registered in the database of the Trade Register Offices of the 4 counties in
Region V West.
3.2. Results obtained based on statistical treatment of answered questionnaires
We have made a random selection out of the total number of 35,204 SMEs, which
were registered with Trade Register Office in 2007 in the 4 counties in Region V
West. By using a disproportionate stratified sampling technique we selected 400
companies that meet the definition of SMEs in the Romanian legislation and have an
annual turnover of not more than 43 million lei. We used stratification variables for
the companies size and headquarters. We chose the disproportionate sampling
technique for ensuring that all important subpopulations were represented in the
sample. We used the following two size groups for selecting the sample: companies
with turnover of less 8.6 million lei and companies with turnover between 8.6 and
43 million lei respectively. The clusters for headquarters were represented by the
4 counties in Region V West: Timi, Arad, Cara-Severin and Hunedoara. From each
group we selected randomly a number of 100 entities. We sent questionnaires to these
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companies and only a number of 162 companies have returned them filled out (27%).
Out of the 162 returned questionnaires, 37 were not valid because they were not
complete or the companies have a turnover exceeding 43 million lei for 2009. Thus,
there resulted a sample of 125 valid and usable questionnaires, and a response rate
of 31.25%.
Based on the received responses and validated questionnaires, we determined the
sampling error of +/- 7.28%. The sampling error or the confidence interval represents
the range of values (error) for fitting in the percentage calculated based on the sample
within total population.
One section presents descriptive data on examining the perceptions of respondents
regarding the necessity and importance of using cash-flow statements. Additionally,
we compared opinions of persons who prepared cash-flow statements in their
professional career with opinions of persons who did not use or prepare such
statements, in order to determine significant differences between the two groups
related to choice of preference, difficulties in implementing cash-flow statements and
usefulness of information in cash-flows in the decision-making process.
Out of those who have been using cash-flow statements during their career, 9.6% said
that they have only poor knowledge about its structure. Therefore, we consider that
the group of persons who have used cash-flow before is better informed than the
group of respondents who have not used it. 36.8% of the sample companies prepared
cash-flow statements, while 63.2% of them did not. We appreciate that more than half
of the SMEs do not prepare cash-flow statements.
In Romania, the General Tax Office (DGFP) is considered the main user of cash-flow
statements, followed by banks and other credit institutions, shareholders, creditors and
managers. According to respondents who used cash-flow statements, all these
categories have obtained an average around 2, partial agreement. On the other hand,
those who did not use cash-flow statements are of the opinion that banks and other
credit institutions, and shareholders are the main categories of users, while the
General Tax Office and creditors are less interested in them, with an average of
2.74, closer to not-interested level. Both groups consider that employees and
suppliers are the least interested in cash-flows.
The using respondents consider that the main purpose served by cash-flow statements
consists in filling out tax returns, while finding and obtaining financing ranks second
in the hierarchy of purposes. Non-using respondents consider that the main purpose
served by cash-flow statements consists in obtaining financing. The same group
considers that cash-flow statements are necessary for transactions with clients and
suppliers. We consider that the average obtained by this statement (average=1.65) is
the result of a misunderstanding of the question. Both groups consider that preparation
and usage of cash-flow statements does not lead to better relationships with
employees.
A comparison between respondents who have prepared and used cash-flow statements
in their professional career and those who did not use them shows that, most of those
who have used such statements (81.6%) consider it is appropriate and useful to
prepare those (76%), and only 5.6% of them chose to give up preparation of such
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statements. The group of subjects who did not use cash-flow statements represents
24% and all of them consider that it is not necessary to prepare them. The responses
suggest that those who know the cash-flow statements are aware of their importance
and necessity.
The group of those persons who did not use such statements has invoked costs with
acquisition of appropriate software and costs with financial and accounting
consultancy as the reasons that make them unwilling to use cash-flow statements.
The two statements have an average of 1.35, and 2.04 respectively, for this group.
Respondents have established that the most important problem faced in preparation of
cash-flow statements consists in a low degree of acceptance from the side of
managers and shareholders in respect to the cost-benefit ratio of preparation
compulsoriness, with an average of 1.84.
As regards the groups of users and non-users, respondents who used cash-flow
statements consider that the most important problem regarding the use of cash-flow
statements consists in the fact that managers and shareholders do not accept the costbenefit ratio in terms of compulsoriness in the preparation of such statements (an
average of 1.68). The difficulties related to how cash-flow statements are prepared
and understanding of terminology.
In terms of perception, those respondents who have not used cash-flow statements
share almost the same opinion like those who have used such statements. They invoke
especially the first problem: low acceptance degree from the side of managers and
shareholders in respect to the cost-benefit ratio of preparation compulsoriness, with
an average value of 2.57 and the second one low understanding of terminology,
with an average value of 2.57.
In order to assess the necessity and usefulness of cash-flow statements in the decisionmaking process, respondents expressed their opinions on the difficulties faced by
management in the absence of relevant information that might result from the analysis
of cash-flow statements.
3.3. Opinions on the usefulness of cash-flow statements in the decision-making
process
In this study we tested the following assumptions:
Assumption 1: There are significant size differences between SMEs in respect to
management perception in terms of cash-flow statements
Assumption 2: Specialized personnel preparing financial statements are aware of
the problems faced by companies, which prepare cash-flow
statements, regardless of whether they have used the cash-flow
statements during their career or not
Assumption 3: Specialised personnel in finance and accounting, who during their
career have used cash-flow statements, consider that managers
face difficulties in decision-making in the absence of information
resulted from the analysis of cash-flow statements, while non-users
have a different perception
Assumption 4: Specialized personnel (users and non-users of cash-flow
statements) have different perceptions regarding usefulness of
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cash-flow statements in providing financial information for the

decision-making process
After processing the data, we can say that respondents consider that in the absence of
information provided by cash-flow statements managers will not be able to
understand the causes of different cash-flow sizes and they will face the
impossibility of performing an evaluation of the companys capacity to generate cash
and cash equivalents from operating, investment and financial activities.
We concluded that respondents agree that cash-flow statements are necessary for
planning and management of future financial engagements, with an average of 1.63.
Also, they agree with following assertions: cash-flow statements provide additional
information for financial analysis and cash-flow statements serve financial
informational needs for assessing performances in a manner more close to reality,
with averages of 1.83 and 2.25.
Many of the respondents partially disagreed in respect to assertion cash-flow
statements serve for comparing operating results of various companies, because they
eliminate the effects of applying different accounting criteria for the same types of
transactions and events (average 3.68), considering that, in the absence of such
statements, operating results of various companies can be compared only based on
information included in the income statement. In the same time, respondents are
showed no interest with respect to usefulness of cash-flow statements for companys
evaluation based on forecasts for a wider time horizon and assessment of the extent
to which previous assessments correspond to cash-flows determined at a certain
moment in time, which shows that interviewed respondents did not encounter such
statements, and the two assertions obtained averages close to not-interested, of 3.25,
and 3.21 respectively.
We also highlight that respondents of the two groups do not have similar opinions in
respect to most of the assertions. Unlike the respondents who used cash-flow
statements, those who did not use them are not so decided in respect to their
usefulness, the average of the group who did not use cash-flow statements being of
only 3.74 and the standard deviation of 1.514. These respondents have an opinion
close enough to not-interested and strongly disagree, which makes us to assert
that probably they do not have sufficient knowledge and expertise for issuing resolute
judgments about subtle aspects related to cash-flow statements.
Based on various domestic and foreign researches, which showed that companys size
is a factor that influences its behavior in respect to preparation and dissemination of
financial information, we considered that small companies management have
different perceptions on cash-flow statements in comparison to medium-sized
companies managers.
The results of the Kruskal-Wallis test applied to the two groups of companies companies with turnover of less 8.6 million lei and companies with turnover between
8.6 million lei and 43 million lei - show that for certain assertions there are
differences between the two groups, and for other assertions the respondents have the
same opinions, regardless of the companys size. In order to analyse the differences
between the perception of personnel who did and who did not use cash-flow
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statements before, the questionnaire gave the opportunity to express options within
nine pre-identified advantages.
CONCLUSIONS
This study aimed to test the addressed assumptions by means of statistical parameters,
based on the fundamental theory on the debate regarding application of cash-flow
statements by SMEs. International professional literature presents different opinions
on the feasibility of applying cash-flow statements and relevance of financial
information provided by them for decision-making. A number of studies have
suggested that specialised personnel who applied cash-flow statements are more
responsive to changes implied by their application, than personnel who did not use
such statements.
Thus, we used the quantitative approach (questionnaire) in order to shape viable
research tools for examining the construction of this study. The methodological
research focused on the population in the companies finance and accounting
departments, in order to ensure collection of data required for obtaining the main
results of this study.
The results obtained by testing the assumptions are summarised in this table.
Table 1. Assumptions of comparative analysis: users and non-users of cash-flow
statements
Assumptions
Assumption 1:
Assumption 2:
Assumption 3:
Assumption 4:
There are significant size differences between SMEs in respect to

management perception in terms of cash-flow statements
Specialized personnel preparing financial statements are aware of the
problems faced by companies, which prepare cash-flow statements,
regardless of whether they have used the cash-flow statements during
their career or not
Specialised personnel in finance and accounting, who during their
career have used cash-flow statements, consider that managers face
difficulties in decision-making in the absence of information resulted
from the analysis of cash-flow statements, while non-users have a
different perception
Specialized personnel (users and non-users of cash-flow statements)
have different perceptions regarding usefulness of cash-flow statements
in providing financial information for the decision-making process
Results
Partially
confirmed
Partially
confirmed
Confirmed
Confirmed
The results show that there are differences between the opinions of specialised
personnel in finance and accounting departments who have used cash-flow statements
before and those who have not used such statements in respect to the difficulties faced
and the usefulness of financial information provided for the decision-making process.
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ROMANIAN PROFESSIONAL ACCOUNTANTS

PERCEPTION ON THE DIFFERENTIAL FINANCIAL
REPORTING FOR SMALL AND MEDIUM-SIZED
ENTERPRISES
Stefan BUNEA, Marian SACARIN1 & Mihaela MINU
ABSTRACT
2009 was an important year, internationally, for the financial reporting of small and mediumsized enterprises. First of all, the International Accounting Standards Board (IASB) published
the international financial reporting standard for the small and mediumsized entities (IFRS
for SMEs). Secondly, the European Commission started the consultations over the amendment
of Directives IV and VII with a view to simplifying them for the small entities. Moreover, the
European Commission launched a consultation over a possible adoption at the level of the
European Union of the IFRS for SMEs.
In this context, through our study, we attempt mainly, to identify the attitude of professional
accountants in our country about the financial reporting of the small and medium-sized
enterprises. Do they want a simplified financial reporting system for the small and mediumsized enterprises? Should this financial reporting system be designed starting from the
European directives or should the IFRS for SMEs prepared by the IASB be applied as such?
Should this financial reporting system be based on detailed rules or on principles and
professional reasoning? What should be the criteria for the identification of small and
medium-sized enterprises? Which is, the professional accountants view, the main user of the
financial statements prepared by the small and medium-sized enterprises?
The analysis of the 190 answers we received revealed that 52.6% of the respondents consider
that the current regulations do not provide for a reasonable level of simplification for the
small and medium-sized enterprises and, consequently, a more simplified reporting system is
needed for the SMEs. 43.2% of the respondents reckon that the accounting of SMEs should be
standardized by simplifying the Order of the Minister of Public Finance no. 30552009,
whereas only 4.2% of the respondents consider that the IASB standard could be applied as
such and 72.6% of the respondents consider that the accounting regulations for small and
medium-sized enterprises should be based on detailed rules.
87.4% of the respondents believe that the entities bound to apply the simplified financial
reporting system should be established based on quantitative criteria.. Also, 42.6% of the
respondents considered that the main user of accounting information about the small and
medium-sized enterprises is the tax authority, while 22.1% consider the management as the
main user, and 22.1% consider those who provide the funding as the main user.
KEYWORDS: Differential reporting, small and medium-sized enterprises (SMEs),

professional accountants, international financial reporting standard for small and mediumsized entities (IFRS for SMEs), European directives
Correspondence address: Marian SCRIN, Bucharest Academy of Economic Studies, Faculty of

Accounting and Management Information Systems, Piata Romana Street, No. 6, 010374; email:
sacarinm@gmail.com
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INTRODUCTION
The preparation of a standard for small and medium-sized enterprises is not a new
idea, the differential financial reporting being in the focus of several national
standardization bodies for many years. Thus, before the International Accounting
Standards Board (IASB) released the IFRS for SMEs, in many countries (Great
Britain, Australia, Canada, New Zeeland, Hong Kong, Philippines), there had already
been accounting standards for these companies. Moreover, the differential financial
reporting for individual financial statements is provided for in the European Union
Directive IV as well.
When the need for a differential financial reporting is invoked, the following are
considered amongst other things: the economic and social importance, number and
diversity of users of the financial statements, their information needs and the costbenefit ratio.
The publics interest in a company is determined by its economic and social
importance. Thus, the more an entity is economically and socially important for the
different stakeholders, the more is has to prove accountability, transparency and rigor
in its financial reporting.
It is generally agreed in the literature that the users and their information needs vary
depending on the nature of the entities. In its conceptual framework, the IASB
identifies the following categories of users of financial situations: the investors,
creditors, customers, suppliers, employees, government and its agencies and the
public. Conversely, in the international financial reporting standard for small and
medium-sized enterprises, the IASB mentions the following categories of external
users of the general financial statements prepared by the small and medium-sized
enterprises: owners who are not involved in managing the business, existing and
potential creditors and the credit rating agencies (IASB 2009). Moreover, other
categories of users were also been identified for the small and medium-sized
enterprises: tax authorities, administrators etc (UNCTAD, 2003). The financial
statements of public entities are available for an unlimited number and a diversified
category of users. The existing and potential investors are the main users of the
financials statements. These users whose economic decisions depend on the
information published in the financial statements are a heterogeneous category made
up of individuals, mutual and pension funds, insurance companies, banks etc. In the
case of small and medium-sized enterprises, however, the main users are the owners
(who most of the times are also the administrators), banks and commercial creditors.
Various studies have emphasized that in regards to the usefulness of the information
in the decision-making, the larger and diversified the user group, the more likely it is
that the entities would benefit from publishing more detailed information in the
financial statements, which is not the case of the medium-sized enterprises (Canadian
Institute of Chartered Accountants, 2001).
Moreover, one should not only consider the benefits, but also the costs incurred with
the financial reporting, such as:
costs for the preparation, printing and publication of financial information;
audit costs;
potential costs generated by the disclosure of information to a competitor;
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costs of compliance with the legal requirements;

Many such costs are fixed or do not vary proportional with the size, but in turn, they
are much more significant for the small and medium-sized enterprises.
In addition, the financial reporting is influenced by the information needs of the users
of financial statements. These needs depend, first, on the nature of the decisions. The
users of financial statements of small and medium-sized enterprises are confronted
with different decisions than those of large enterprises. Thus, while the investors of
public (large) enterprises use the financial information to decide whether to "sell or
keep the stock, for the investors of small and medium-sized enterprises the strategy
of withdrawal from an entity does not represent a realistic option (Canadian Institute
of Chartered Accountants, 2001). In addition, although the profitability and liquidity
remain important indicators, for the owners of small and medium-sized enterprises
other factors are important too, such as the independence and participation in a
business, managing their own business etc. Consequently, for the investors of small
and medium-sized enterprises, unlike those of large companies, it is not so important
to compare the information in the financial statements, and much of the information
requested for the public entities is less relevant for the small and medium-sized
enterprises.
To the same extent, the literature contains opinions opposing a differential accounting.
The main argument against the differential reporting is the need for universality.
Thus, it is believed that the existence of different accounting rules will result in
several identical images (Evans et al., 2005). Moreover, the existence of a differential
financial reporting will diminish the comparability and credibility of accounting
information (Roberts & Sian, 2006). In addition, moving from one reporting system to
another may be perceived as costly and burdensome. The opponents of differential
reporting also argue that the existence of differential standards may result in a lower
quality of some of these and, consequently, those who credit the institutions will levy
a premium to compensate for the lower quality of the financial statements. In addition,
there is even a fear of division of the accounting profession. (Evans et al., 2005).
On the other hand, there seem to be stronger arguments in favor of a differential
reporting. (Roberts & Sian, 2006). In fact, the important aspect is not the existence of
the differential reporting (big GAAP versus little GAAP), but the way in which this
shall be conceived.
If the idea of differential reporting is accepted, criteria must be decided for
establishing the different categories of reporting entities. The qualitative (public
accountability, separation between management and ownership, etc) or quantitative
(number of employees, turnover, total assets) are among the most frequently used
criteria. In practice, however, other criteria may also be used, individually or in
combinations: legal status of the business, branch of activity, listing on a stock
exchange, owners' accountability etc. In addition, it must also be decided on what
should be differential: the accounting and/or audit and/or the form of publication. A
distinction shall also be made between the individual and consolidated financial
statements.
As regards the differential accounting, a decision needs to be made as to whether the
differentiation should be restricted to the information that should be disclosed or
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should also affect the recognition and measurement. In practice, the simplifications on
the disclosure of information are accepted easier than the differentiation of the rules of
recognition and measurement, as the latter has an impact on the reported outcome,
reduces the comparability among enterprises and may lead to an increased risk of
misinterpretation by the users of financial statements. The differential financial
reporting may also target the audit requirements (the obligation to have an annual
statutory audit, requirements on the signature of financial statements by certain
persons, etc), but also the form of publication and preparation of financial statements
(detailed financial statements versus simplified financial situations, the exceptions to
the publication of financial statements, the exceptions to the preparation of financial
statements by the companies with no activity etc).
Our study is structured as follows. The first part comprises a short history of
differential reporting in our country. Then, there is an overview of the studies
published by various authors from our country on the differential reporting for small
and medium enterprises. Further on, there are presented the research methodology, the
results of the research, the conclusions and limits of the research.
We expect this research to raise the interest of the academic environment involved
both in the research and practical activity, but also the interest of those who have
anything to do with the financial reporting of the small and medium-sized enterprises:
the Romanian accounting standard setter (Directorate for accounting regulations
within the Ministry of Public Finance), the preparers, users and, last but not least, the
professional accountants, whose opinion is analyzed.
We believe that the main quality of our paper resides in the fact that, through the
empirical study presented, we go beyond the limits of descriptive research. Moreover,
to our knowledge, this is one of the few papers that test the attitude of a party
involved in the financial reporting of small and medium-sized enterprises, i.e. the
professional accountants in our country.
1. DIFFERENTIAL REPORTING: ROMANIAS CASE
After 1989, three stages can be identified in the evolution of accounting in our country
(Ionacu et. al., 2007):
a) 1990-1998: the stage of creating an accounting system suitable for a market
economy;
b) 1999-2005: the stage of harmonization with the European directives and
international accounting standards;
c) 2006-to date: the stage of compliance with the European directives and
international financial reporting standards.
In all these stages, at individual account level, to a larger or lesser extent, there have
been and still are elements of differential financial reporting. These have been mainly
aimed at the composition of the financial statements and the level of details therein.
The first accounting regulation to include elements of differential financial reporting
is the Methodological norm for the drafting and submission of the accounting balance
sheet, approved through Government Decision no. 7041993. This stated that the legal
entities that carry out economic activities shall prepare annual accounting balance
sheet (balance, profit and loss account and annexes) as follows:
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simplified system for the small and medium-sized enterprises; and

basic system, the large enterprises.
However, the small and medium-sized enterprises have had the possibility to opt for
the basic or the simplified system, and in order to move from one category to another
they had to meet the criteria set by law during two consecutive financial exercises.
Form the accounting point of view, the difference was limited to the information
disclosed in the financial statements, without targeting aspects dealing with the
recognition and assessment. In fact, the difference between the two systems of
accounting balance sheet was related to the more detailed structure of the basic system
compared to the simplified one. The accounting balance sheet, however, had the same
components, irrespective of the system: balance, profit and loss account and annexes.
In our view, this situation is explained, first of all, through the French origin of our
regulations and less through the intention of Romanian standard bodies to simplify the
financial reporting for small and medium-sized enterprises, for which there were no
identification criteria in the accounting regulations.
Moreover, the company law 311990, provided for different regulations over the
existence of the censors. Thus, in case of a joint stock company, the balance sheet and
the profit and loss account had to be accompanied by the censors report.
Between 1999 and 2005, the accounting goes through a new stage in its evolution in
Romania, which is the harmonization with the European directives and the
international financial reporting standards. In 1999 and 2001, new accounting
regulations were issued aimed mainly at harmonizing the accounting of large entities
with the European Directive IV and the international accounting standards. The
companies falling into their scope were initially established based on qualitative
criteria (trading on the stock exchange, national interest and operation on the capital
market), and later on based on quantitative criteria (turnover, total assets and average
number of employees). By enforcing these regulations, the companies have been
required to prepare new financial statements as well as a cash flows statement of
changes in equity and also to apply principles of Anglo-Saxon origin as well as the
substance over form principle and the materiality principle. Moreover, by assimilating
the IASB conceptual framework, general criteria have been introduced for the
recognition and evaluation of items in the financial statements. In addition, for the
first time in our country, the companies that applied these regulations were obliged to
audit their financial statements as well.
In 2002, the simplified accounting regulations were approved, harmonized with the
European directives. These have been applied by companies that did not exceed
certain criteria related to size, and by the companies that exceeded the size criteria but
did not fall under the scope of the accounting regulations harmonized with the
European directives and the international accounting standards. Moreover, these
regulations concerned the micro-enterprises as well. Unlike other companies that fell
under the scope of these regulations and were bound to prepare the balance sheet, the
profit and loss account and the explanatory notes, the micro-enterprises were only
bound to prepare the balance sheet and the profit and loss account. Also, in 2000, the
first regulations appeared concerning the experimental preparation of consolidated
financial statements. Although in theory the appearance of these regulations marks the
differentiation between the individual and the consolidated financial statements, the
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consolidated accounting remained in an experimental stage until 2006, when the

obligation to prepare consolidated financial statements was introduced for the first
time in Romania.
Starting with 2006, the accounting in our county has entered the stage of compliance
with the European directives and the international financial reporting standards. Thus,
by Order of the Minister of Public Finance no 9072005, the companies were divided
into those who were to apply the accounting regulations in line with the European
directives and those which, additionally, for the information needs of the users, others
than the state, had to (credit institutions) or could (institutions of public interest other
than credit institutions) apply the international financial reporting standards, starting
with the 2006 financial exercise. Moreover, in order to ensure the compliance of
national accounting regulations with the European Union regulations, the international
financial reporting standards continued to be implemented progressively. Thus,
starting with the 2007 financial exercise, the credit institutions continued to apply the
international financial reporting standards in preparing the consolidated financial
statements. But, besides the credit institutions, the companies with securities traded on
a regulated market have also been obliged to apply the international financial
reporting standards in preparing their consolidated financial statements.
At present, the small and medium-sized enterprises in Romania fall under the scope of
the accounting regulations in line with the European directives. These regulations
include several aspects of differential financial reporting, both in terms of accounting
and audit. Hence, the companies that fail to comply with certain size criteria prepare
simplified annual financial statements including: the abridged balance sheet, the profit
and loss account and the explanatory notes to the annual financial situations.
Optionally, these companies can prepare the statement on the changes in their won
capital and/or the statement of cash flows. Moreover, these companies are not bound
to audit their annual financial statements.
In our country, several studies were published, focusing on various aspects of
financial reporting for small and medium enterprises. They were developed both
before and after publication by IASB of the IFRS for SMEs, and most of them offer a
theoretical approach.
As such, the possible benefits of an international financial reporting standard for
enterprises in our country have been analyzed (Punescu, 2006). From the perspective
of our countrys accession to the European Union, the author believed that a less
complex international financial reporting standard for small and medium enterprises
would be gladly embraced by the small and medium enterprises in our country.
Moreover, the adoption at European level of the international financial reporting
standard for small and medium enterprises developed by IASB would be helpful in
improving comparability of financial reporting.
Furthermore, the difficulties that would be involved in the implementation of an
international financial reporting standard for small and medium enterprises in our
country have also been examined (Grbin & Bunea, 2007). The authors invoke the
frequent changes in the international accounting referential and, implicitly, those of a
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future international financial reporting standard for small and medium enterprises.
Under such circumstances, companies would be forced to bear various costs, on a
regular basis, which conflicts with the motivation of simplified reporting for small and
medium enterprises, namely cost reduction.
Lungu et al. (2007) have conducted a review of the specialized literature on the
possible impact of the IFRS for SMEs issued by IASB on practitioners and
professional organizations. In addition, the content of the exposure draft developed by
IASB has been reviewed.
The pros and cons of an IFRS for SMEs enterprises have also been analyzed (Tiron &
Muiu, 2008). Furthermore, the authors consider that regulation of accounting for
small and medium enterprises is a national or regional problem, in the case of the
European Union.
The advantages and difficulties of the implementation of international standards by
small and medium enterprises in Romania have moreover been addressed (Feleag et
al., 2008). The main advantages identified by the authors are the improvement of
financial communication and the enhancement of the quality of information used by
the management of entities. Difficulties would be involved by the translation of the
international financial reporting standards into Romanian and by the training of
professionals on their implementation.
Farcane & Popa (2008) have reviewed the role and objectives of IASB in developing
a standard for small and medium enterprises, but also the reasons and the
disadvantages associated to such standard.
Albu & Albu (2010), in an exploratory study, examines the context of a possible
implementation of the IFRS for SMEs in our country. The authors come to the
conclusion that the implementation of the standard for small and medium enterprises
developed by IASB is inevitable in our country, as long as the national standard setter
does not develop high quality accounting standards.
Marian Scrin (2010) attempted to identify the attitude of people who had sent
comment letters to the exposure draft to IASBs initiative of developing the IFRS for
SMEs.
Consequent to examining the 160 comment letters concerning the exposure draft of
the standard, he concluded that most of the respondents (44%) had not expressed an
explicitly favourable position to IASBs approach of developing the standard, 13%
had not agreed with IASBs approach, whereas 43% had explicitly supported IASBs
approach.
In our country, empirical studies on the need for differential financial reporting for
small and medium enterprises are almost nonexistent. However, it is worth
mentioning the study undertaken by Deaconu et al. (2009), where, among other
things, the authors also tested the opportunity in our country of adopting the standard
developed by IASB for small and medium entreprises. After questioning a certain
number of accounting professionals, it has been found that an accounting standard, or
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accounting regulations, for small and medium enterprises is (are) welcome, but the
adoption of the standard developed by IASB has not been accepted.
The differential reporting elements existing in the current accounting regulations are
not sufficient in our view, and we moreover believe that, in the case of small and
medium enterprises, financial reporting generates unjustified costs.
The purpose of our study is to identify the attitude of accounting professionals in our
country towards the financial reporting of small and medium enterprises. Do they
want a simplified financial reporting system for small and medium enterprises?
Should this financial reporting system be based on the European directives or on
international financial reporting standard published by IASB? What should be the
identification criteria for small and medium enterprises? Who is, according to
accounting professionals, the main user of the financial statements prepared by small
and medium enterprises? Should this financial reporting system be based on detailed
rules or rather on principles and professional judgment?
In order to achieve our purpose, we have developed a questionnaire consisting of
11 questions. The questionnaire has been sent to the email addresses of a number of
550 members of CECCAR (the Body of Expert and Licensed Accountants of
Romania), randomly selected from the CECCAR Table. We have received
198 responses, but 8 of them have been canceled for being incomplete (consequently,
the response rate has been 36%). The responses were collected during 1-15 March,
2011. The responses have been statistically processed with a sampling error of 7% at
a confidence level of 95% and a total population of 40,000 chartered accountants. The
sampling method is simple random sampling. The confidence level expresses the
probability that the true value of an indicator should fall within the confidence
interval. The most used confidence level is the value of 95%. It determines the
interval between the highest value and the lowest value and eliminates the percentage
of 2,5% of the extreme outliers in both directions. In other words, the confidence
interval includes 95% of the possible values of the population located at the middle of
the distribution.
The sample, consisting of 190 respondents, has the following structure by sex: women
72.1%, and men 27.9%. This gender representation is consistent with the structure of
the accounting profession in Romania, where seven out of ten individuals exercising
the profession of chartered accountant are women. Among men, most respondents are
aged between 30 and 40 years (39.6%), and over 50 years (34%). There have been
few responses of the male population aged between 20 and 30 years (5.7%).
The majority of female respondents are aged between 30 and 50 years (61.3%). The
20-30 years age group is better represented in the sample (21.2%) than the group of
women aged over 50 years (17.5%).
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Chart 1. Breakdown of sample by age
Out of the total sample surveyed, 37.4% have a professional experience of up to 10

years, 37.4% of 10 to 20 years, while the remaining 25%, of over 20 years. The
opinions have been preponderantly expressed by male respondents having an
experience of 10-20 years (50.9% of the total male population), and by those having
an experience of over 20 years (28.3%). The opinions expressed by women belong to
the group having a professional experience of up to 10 years (43.8% of the total
female population) and to the group having an experience between 10 and 20 years
(32.1% of the total female population).
Chart 2. Breakdown of sample by professional experience
4. RESEARCH RESULTS
In 2009, IASB published the IFRS for SMEs. This standard is the result of a project
that began in 2003, even against the will of some of the members of the international
standardization body, who considered that such a project strayed away from IASBs
main mission, namely that of developing standards for listed companies (Nobes &
Parker, 2008: 290).
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The standard published by IASB, in July 2009, is intended for entities not having
public accountability, but who publish, for external users, general purpose financial
statements. In order to identify the companies falling within the scope of the standard,
IASB selected qualitative criteria, yet left at the discretion of regulatory authorities
and standard setters in each country to determine the entities required or permitted to
apply the IFRS for SMEs.
Unlike the IASB, the Fourth Directive of the European Economic Community uses
quantitative criteria to determine the companies for which certain simplifications of
financial reporting are stipulated: total assets, turnover, and average number of
employees during the year (Article 27). Similarly, in our country, it is still the
quantitative criteria that are used in order to identify the companies preparing
simplified financial statements.
As such, we have included the following question (Q4) in our questionnaire:
Q4: What would be, in your opinion, the characteristics to be considered when
including a company in the category of small and medium enterprises?
After statistical processing of the responses, we have found that most respondents
(87.4%) consider quantitative criteria as more appropriate than the qualitative criteria
established by the IFRS standard for SMEs (12.6%).
Concerning the reference to quantitative criteria, opinions are divided between the
preference for the criteria under the Order of the Minister of Public Finance (OMFP)
No 3055/2009 (46.3%), and for the criteria established by the European Commission
(41.1%). Women rather prefer the criteria stipulated in the national legislation (52.6%
of the female respondents), while men are in favour of those established by the
European Commission (49.1% of the male respondents).
Chart 3. Q4 Responses
The preference for quantitative criteria is consistent with the existing trend in the
European Union, where most Member States have introduced quantitative criteria in
their national legislations, for identifying small and medium enterprises. Although
qualitative criteria are very easy to apply, their determination is not free of difficulty
(Roberts & Sian, 2006:7). For instance, the average number of employees may be
distorted by an increased number of part-time and occasional employees or by
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outsourcing certain activities, whereas the asset value is influenced by the appraisal
values used. Based on this assumption, our questionnaire included the following
question (Q5):
Q5: Do you believe that it is necessary to determine the size criteria depending on the
particularities of the sector to which the enterprise belongs?
Most respondents consider that is necessary to establish size criteria depending on the
particularities of the sector to which the enterprise belongs (60.5%). With
insignificant variations, this percentage has been found in all age groups, regardless of
gender and professional experience. As mentioned earlier, we believe that the current
regulations in our country do not contain sufficient simplification options for small
and medium enterprises and, consequently, the latter are forced to bear unjustified
costs associated to financial reporting. Therefore, by question number 6 of the
questionnaire (Q6), we have sought to identify the simplification level provided by the
Order of the Minister of Public Finance (OMFP) 3055/2009 for small and medium
enterprises.
Q6: Please rate on a scale of 1 to 5 the simplification level provided by the Order of
the Minister of Public Finance (OMFP) 3055/2009 to small and medium enterprises.
Analyzing the responses, we have found that 52.6% of the individuals surveyed
believe that the simplification level provided by the national regulation is not
reasonable, but low and very low. Out of this percentage, most respondents are aged
between 20 and 30 years (59.5% of the people in this group), and between 40 and 50
years (59.1% of the people in this group). The regulation is deemed appropriate rather
by specialists having an experience of 10-20 years (54.9%).
The responses received show that it is necessary to simplify financial reporting for
small and medium enterprises. This can be achieved by amending the Order of the
Minister of Public Finance 3055/2009 or by implementing, as it is, the IFRS for
SMEs.
By question number 7 (Q7), we have attempted to identify which would be, in the
opinion of accounting professionals in our country, the best standardization solution
for the accounting of small and medium enterprises.
Q7: What would be, in your view, the best standardization solution for the accounting
of small and medium enterprises?
The solution favoured by most accounting professionals is to amend the Order of the
Minister of Public Finance (OMFP) 3055/2009 by introducing several simplifications
for small and medium sized enterprises (43.2% of the respondents have been in favour
of this solution). The stand-out group was aged between 30 and 40 years (54.2%),
having a professional experience of 10 to 20 years (50.7%).
Conversely, very few are those who believe that the implementation of international
financial reporting standard for small and medium sized entities is an appropriate
standardization solution in Romania (4,2%).
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Nevertheless, two other standardization solutions have been considered appropriate by

some respondents. One group is represented by those who favour the development of
differential regulations, in accordance with the European directives, depending on the
size of the enterprise (20.5%), and another one believes that the best solution would
be to develop a national accounting standard converged with the IFRS standard for
SMEs, accompanied by a Chart of accounts and an implementation guide (20%).
Q8: Do you believe that, for SMEs, the accounting treatment should, first of all, take
into account the Tax Code rules?
The answer given by most respondents has been in the affirmative (65.8%). On
average, 7 out of 10 respondents, regardless of age, gender, and professional
experience, have responded affirmatively. Such a response rate confirms the
prevalence of a high degree of connection between accounting rules and tax rules. In
the case of SMEs, such connection degree is much stronger than what might be
determined by reading the national regulation. Although OMFP 3055/2009 provides
for the possibility of a reasonable disconnection, accountants of small and medium
enterprises prefer to keep the accounting policies consistent, as far as possible, with
the tax rules. The reasons are multiple: avoiding additional work arising from the
reconciliation between the accounting result and the tax result, the difficulty to
convince administrators and owners of small businesses to bear higher costs
associated with software adjustments for ensuring the implementation of accounting
rules appropriate for the business, but different from tax rules, the education level of
accountants of small businesses concerning the importance of financial reporting, the
poor enforcement of compliance with accounting rules for entities that are not subject
to auditing requirements, etc.
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Q9: Who is, in your opinion, the main user of accounting information in the case of
an SME in Romania?
Based on the responses received, the following hierarchy of users of accounting
information provided by SMEs is emerging: tax authority (42.6%), enterprise
management (22.1%), and business funders (17.9%).
Q10: Do you think that the accounting regulations applicable to small and medium
enterprises should be based on detailed rules?
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After processing the collected data, we have found that 7 out of 10 respondents
believe that accounting regulations for SMEs should be based on detailed rules.
Traditionally, Romanian accountants, and especially the accountants of small and

medium enterprises, are dependent on detailed rules, on regulations that should
provide, through the Chart of accounts, the representation of transactions and events.
Recourse to the conceptual framework and the development of professional
judgments based thereon are very scarcely present.
Q11: Do you believe that accounting regulations applicable to small and medium
enterprises should be based on principles and on the exercise of professional
judgment?
8 out of 10 respondents have answered this question in the affirmative. It is
noteworthy that most respondents, although they feel the need to exercise professional
judgment, do not give up the idea of a regulation based on detailed rules. This
situation is explained by an insufficiency and inconsistency of national regulations, a
context where recourse to professional judgment is essential.
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We have found that respondents having an experience of up to 10 years reject more

willingly the idea of detailed rules than the idea concerning professional judgment.
One explanation may be that the new generations of professionals have received
initial training where the study of IFRS and the development of professional judgment
were given an utmost importance.
Most of the respondents who had believed that the accounting treatment of SMEs
should take into account, first of all, the Tax Code rules have identified the tax
authority as the privileged user (37.6%).
Analyzing the answers, we have found that 52.6% of the surveyed people believe that
the degree of simplification provided by the national legislation is not reasonable, but
low and very low. Most of these are aged between 20 and 30 years (59.5% of the
respondents in this group), and between 40 and 50 years (59.1% of the respondents in
this group). The regulation is deemed appropriate for SMEs rather by professionals
having an experience of 10-20 years (54.9%).
44.4% of the respondents who have argued that the current form of the national
regulation is not appropriate for the needs of SMEs have believed that the best
solution of standardization is to amend this regulation by introducing simplified rules
for SMEs. The respondents who expressed this opinion are mostly persons aged
between 30 and 40 years (59.3%), and over 50 years (46.7%). 49% of the women and
34.8% of the men have supported the solution of amending the existing regulation.
Out of the respondents who do not consider the current regulation appropriate, 23.6%
have opted for the solution of developing a national accounting standard converged
with IFRS for SMEs. Proponents of this solution are mostly young people (42.9% of
respondents in this age group), as well as people aged between 40 and 50 years
(37.5%).
Among those who have argued that the current legislation is appropriate for the needs
of SMEs, 59.1% have considered that the quantitative criteria existing in the
regulation are the most appropriate. 78 out of the 190 respondents have considered
that quantitative criteria established at EU level are more appropriate for SMEs. Out
of the latter, 37.2% favour the development of separate SME regulations in
accordance with European Directives, while 16.7% support the development of a
standard converged with IFRS for SMEs.
CONCLUSIONS AND LIMITS
Our research was aimed at identifying the attitude of professional accountants in
Romania about a simplified financial reporting system for small and medium-sized
enterprises. For this purpose, we prepared a questionnaire that was sent by email to
550 expert accountants that had been randomly selected from the CECCAR Table.
The analysis of the 190 answers we received revealed that 52.6% of the respondents
consider that the current regulations do not provide for a reasonable level of
simplification for the small and medium-sized enterprises and, consequently, a more
simplified reporting system is needed for the SMEs.
87.4% of the respondents believe that the entities bound to apply the simplified
financial reporting system should be established based on quantitative criteria
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(turnover, average number of employees, total assets). As regards the size of the
criteria, most of the respondents (46.3%) expressed preference for the values stated in
the OMPF (Order of the Minister of Public Finance) 3055/2009. Moreover, 43.2% of
the respondents reckon that the accounting of SMEs should be standardized by
simplifying the OMPF 30552009, whereas only 4.2% of the respondents consider that
the IASB standard could be applied as such. In our view, this reluctance over the
IASB standard is mainly because in our country we did not experience a large scale
implementation of the international financial reporting standards, these only being
mandatory for the consolidated financial statements of publicly traded companies.
65.8% of the respondents believe that the accounting treatments for SMEs should take
into account, first of all, the fiscal rules. This indicates that although the premises for
separating the accounting and the taxation have been created in principle, in practice,
the accounting treatment is assimilated to the fiscal one. This situation, in our view, is
no surprise, because 42.6% of the respondents considered that the main user of
accounting information about the small and medium-sized enterprises is the tax
authority, while 22.1% consider the management as the main user, and 22.1%
consider those who provide the funding as the main user. 72.6% of the respondents
consider that the accounting regulations for small and medium-sized enterprises
should be based on detailed rules, which indicates that most of the professional
accountants depend on a regulation to offer them through the chart of accounts the
representation of the transactions and events.
Our study is limited because we only tested the opinion of one of the parties involved
in the financial reporting of small and medium-sized enterprises, the professional
accountants. Moreover, the generalization of the results must be made with
cautiously, one of the limits being the sampling error of 7% for a level of trust
of 95%. Despite all these limits, we believe that our study may be of interest both for
the academic environment and for those who are involved in the financial reporting of
small and medium-sized enterprises: the accounting standard setter, preparers, users
and last, but not least, the professional accountants. Moreover, we consider that this
study may be used as a reference for further research into the financial reporting for
small and medium-sized enterprises in our country.
REFERENCES
Albu, C.N. & Albu, N. (2010) The context of the possible IFRS for SMEs implementation in
Romania. An exploratory study, Accounting and Management Information Systems,
vol. 9, no 1: 45-70
Canadian Institute of Chartered Accountants (2001) Differential Reporting, Background
Information and Basis for Conclusions, Exposure Draft, available on-line at
http://www.ica.bc.ca/pdf/BasisforConclusions.pdf
Deaconu, A., Pop, I., Buiga, A., Fulop, M. (2009) Conceptual and Technical
StudyRegarding Future Accounting Regulation for SMES in Europe, Theoretical
and Applied Economics, vol. I (January): 19-32
Evans, L., Gebhardt, G., Hoogendoorn, M., Marton, J., Di Pietra, R., Mora, A., Thinggard, F.,
Vehmanen, P., Wagenhofer, A. (2005) Problems and Opportunities of an International
Financial Reporting Standard for Small and Medium-sized Entities. The EAA FRSC's
Comment on the IASB's Discussion Paper, Accounting in Europe, vol. 2: 23-45
IASB (2009) International Financial Reporting Standard for Small and Mediumsized
Entities, available on-line at http://eifrs.iasb.org/eifrs/sme/en/IFRSforSMEs
2009.pdf
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Ionacu, I, Ionacu, M., Olimid, L., Calu, D.A. (2007) An Empirical Evaluation of the Costs
of Harmonizing Romanian Accounting with International Regulations (EU Directives
and IASIFRS), Accounting in Europe, vol. 4:169-206
Farcane., N, Popa., A. (2008) Recent evolutions regarding IFRS for SMES, Accounting and
Management Information Systems, Supplement: 324-333
Feleag, L., Feleag, N., Vasile., C (2008) The Stakes in applying the International Financial
Reporting Standards (IFRS) within the small and medium enterprises, Accounting
and Management Information Systems, n. 26:43-54
Grbin, M. & Bunea, S. (2007) Les pieges de l'internationalisation de la comptabilite des
PMES. Enseignements de la reforme comptable roumaine, The Journal of the
Faculty of Economics, Economic Science Series, vol. 2: 366-370
Government Decision no. 704 1993 on the approval of measures for the enforcement of the
Accounting Law no. 82/1991, published in the Official Journal no. 303 22.12.1993
Lungu, C., Caraiani, C., Dascalu, C. (2007) New Directions of Financial reporting within
Global Accounting Standards for small and medium-sized entities, available on-line
at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1013520
Nobes, C. & Parker, R. (2008) Compartive International Accounting, Tenth Edition, Pearson
Education Limited
Order of the Minister of Public Finance no. 3055 2009, with subsequent amendments and
supplementations, for the approval of Accounting Regulations in line with the
European Directives, Official Journal no.766 10.11.2009
Order of the Minister of Public Finance no. 1121 2006 on the enforcement of the
international financial reporting standards, Official Journal no. 602 12.07.2006
Order of the Minister of Public Finance no. 1752 2005 on the approval of Accounting
regulations in line with the European directives, Official Journal no. 1080 bis
30.11.2005
Order of the Minister of Public Finance no. 907 2005 on the approval of the categories of
legal persons that apply the accounting regulations in line with the International
Financial Reporting Standards, the accounting regulations in line with the European
directives, respectively, Official Journal no. 597 11.07.2005
Order of the Minister of Public Finance no. 306 2002 on the approval of Simplified
accounting regulations, harmonized with European directives, Official Journal
no. 279 25.04.2002
regulations harmonized with the European Economic Communities Directive IV and
the International Accounting Standards, Official Journal no. 480 04.10.1999
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consolidation norms, Official Journal no. 374 11.08.200
regulations harmonized with the European Economic Communities Directive IV and
the International Accounting Standards, Official Journal no. 480 4.10.1999
Punescu, M. (2006) Good news for Romanian companies: IFRS for Small and Medium
sized Entreprises (SMES)!, Accounting and Management Information Systems,
Supplement 2006: 648-656.
Roberts, C., Sian, S. (2006) Micro-Entity Financial Reporting: Perspectives of Preparers and
Users, Information Paper, available on-line at http://www.docin.com/p53065095.html
Scrin, M. (2010) Standardul International de Raportare Financiar pentru ntreprinderile
mici i mijlocii: susinere i percepii, Contabilitate, Expertiz i Auditul Afacerilor,
no. 10:36-41
Tiron, A. & Muiu, A. (2008) Pro and contra opinions regarding a SME accounting,
Annales Universitatis Apulensis Series Oeconomica, vol. I: 71-82
United Nations Conference on Trade and Development (2003) Guidelines for small and
Medium - sized entreprises (SMEGA), Level 3 Guidance, available on line at
http://www.unctad.org/en/docs/iteteb20036_en.pdf
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ACCOUNTING PRINCIPLES AND BOOK-TAX

(DIS)CONNECTION IN ROMANIA
Costel ISTRATE1
Alexandru Ioan CUZA University of IASI, Romania
ABSTRACT
The difference between accounting and taxation is justified by their different goals. However,
referring to income tax, the starting point in the assessment of the tax base is the accounting
income. To understand the differences between accounting and taxation, an important
milestone is the manner in which accounting principles are recognized for tax purposes. Each
of the nine principles explicitly listed in the Romanian Accounting Standards could be
restricted by the tax rules. In our paper, we identified and described some of these situations:
tax implications of the lack of continuity, tax recognition of a change of the accounting
method (inventoiris and revaluation), tax regime of the provisions, tax vs. accounting timing
of revenues and charges (interests, subsequent costs), lease-back as a finance lease,
recognition of some revenues from sales of goods. The recent evolutions of the book-tax
relationship in Romania confirm the increasing deconnection de jure of the accountig and tax
rules.
KEYWORDS: book-tax differences, accounting principles, accounting recognition, fiscal

recognition
INTRODUCTION
The relation between accounting and taxation is a major topic in specific theory and
practice However, (Lamb and Lymer, 1999). The successive and rapid changes
occurring in accounting and fiscal regulations lead sometimes to spectacular
evolutions in the relation between these two aspects of company business. This
generally applies to the accounting and fiscal systems in all the countries that have a
market economy. And Romania is no exception to the rule. We may even consider
Romanias case a somewhat exemplary one, just like in all the other former
communist countries, in the sense that it is characterized by an extremely fast
evolution of the tax - accounting relationship, due to the short time elapsed from the
implementation of a set of modern accounting and fiscal systems in these countries.
Over the last 20 years, countries like Romania have gone through successive
development phases that free economies have covered over much longer periods of
time. The scientific papers of the tax accounting relation frequently refer to income
tax, more specifically to the criteria applied to measure profit/loss from the accounting
and fiscal viewpoints. However, this relation may also influence other taxes, although
less numerous and less spectacular, such as value added tax, nonresident income tax,
building tax, dividend tax
Correspondence address: Costel ISTRATE, Alexandru Ioan Cuza University of Iai;

email: istrate@uaic.ro
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Among the numerous matters that we may discuss when approaching the tax accounting relation (Mills, 1996; Langli and Saudagaran, 2004, or features such as
export orientation or involvement in activities related to new technologies; Hung and
Mo, 2002; for Romania, Fekete et al. 2009), we will focus on the way in which
accounting principles are fiscally recognized or influence taxable income, without
however aiming at an exhaustive analysis of these topics. In this paper, the term
accounting principles mean the general accounting evaluation rules listed explicitly
by the Romanian regulation and European directives.
1. METHODOLOGY
Accounting and taxation are highly regulated in Romania. The regulations that set
specific rules are numerous and they originate mostly in the same place the
Romanian Ministry of Public Finance which makes us believe in a coherent
approach both within each category of rules and between the two sets taken together.
Our approach consists of a document-based analysis of Romanian accounting and tax
regulations, which is designed to underline the manner in which tax regulations
recognize accounting principles, either by fully or partially accepting them, or by
simply rejecting them when calculating profit tax. Our analysis dwells on explicitly
recognized accounting principles. Consequently, we can only examine the accounting
of individual Romanian business entities, since any taxable income refers to
individual corporate bodies and not to groups of companies we agree on this point
with Lamb et al. (1998).
The rest of the document is organized as follows: we list the explicit accounting
principles imposed by Romanian accounting regulations (section 2), followed by
general fiscal rules that apply to taxable income (section 3), and by several
developments on the tax recognition of each principle (section 4) and, finally, by
conclusions.
2. THE LIST OF ACCOUNTING PRINCIPLES IN THE ROMANIAN
ACCOUNTING STANDARDS
The unceasing adjustment of Romanian accounting to the European and international
developments in this field, as well as to the business requirements, materialized in a
weariless set of amendments to these regulations. The creation and development of
the Romanian accounting standards have been observing all along the European
directives, international standards (IAS/IFRS) and although to a lesser extent the
accounting and tax practices imposed by Romanian practitioners. We will only focus
here on the explicitly recognized accounting principles revealed in the current
Romanian accounting regulations. Although the first version of the accounting
regulations drafted after 1990 (Governments Decision no. 704/1993 HG 704/1993)
included only the six principles proposed by the 4th European Directive, the current
regulation - order of the minister of public finance no. 3055/2009 (OMPF 3055/2009)
- lists nine principles. This evolution also brought about significant qualitative
advantages: the explanations and examples given were welcome and facilitated the
work of accounting practitioners.
Romanian regulations do not set an accounting principle hierarchy different than the
principle presentation order. Starting with 2010, the OMPF 3055/2009 renders almost
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literally several provisions of the General Framework for the Preparation and
Presentation of Financial Statements drafted by IASC/IASB. We may assume that the
IASC/IASB hierarchy is also used by the Romanian regulation (IASB and FASB are
working on a major project of improving the General framework... In the new version,
the hierarchy of quality characteristics is even more pronounced). Therefore, these
enacting terms are said to rely on basic concepts (accrual accounting and going
concern), as well as on qualitative characteristics and their components (In this
context, it is to emphasize that the use of IAS/IFRS in Romania, during 2000 - 2005,
had some tax consequences in entities bound by the Order of the Minister of Public
Finance 94/2001 on the approval of accounting regulations harmonized with the
Fourth European Economic Community and the International Accounting Standards
(Official Gazette 94/2001). Table 1 shows the regulations that imposed explicit
accounting principles in Romania.
Although it may not be representative, the principle presentation order suggests a
slight approach alteration. Thus, the principle of prudence, which ranks first in the HG
704/1993, seems to lose its importance with the diversification of the inspiration
sources used by the Romanian regulator that also relies on IAS/IFRS (Albu et al.,
2010). After 1999, for some entities (especially public entities), the regulations added
three principles: separate accounting evaluation of assets and liabilities, substance
over form and materiality. Starting with 2010, the nine principles apply to all entities,
regardless of their size or presence on the financial market.
Table 1. Accounting principles evolution in Romania
The accounting principle
Effective date
Date up to which has been
applied
Going concern
Comparability
Conservatism (evaluation on a
prudent basis)
Accrual basis
Separate accounting evaluation
of assets and liabilities
Individual recognition, without
any off-setting
The opening balance sheet for
each financial year must
correspond to the closing balance
of the preceding financial year
Substance over form
Materiality
HG
704/1993
OMFP
403/1999,
replaced
by OMFP
94/2001
OMFP
306/2002
OMFP
1752/2005
OMFP
3055/2009
1.01. 1994
1.01. 1999
1.01. 2003
1.01. 2006
ian. 2010
31.12. 2002
31.12. 2005
31.12. 2005
31.12. 2009
3
2
1
2
1
2
1
2
1
2
8
9
8
9
8
9
3. GENERAL TAX RULES, IN THEIRE RELATIONSHIPS

WITH ACCOUNTING STANDARDS
The tax code does not bring about completely new rules when it tries to set the
notional amount of profit tax. Conversely, the starting point is the accounting
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(Whitaker 2005 although the latter's proposals go in the opposite direction suggested
by Nobes 2004, Schn 2005, Walker 2007 or Desai and Dharmapala 2009), that is the
book income. The simple reading of the tax return is sufficient to convince us of this
initial recognition by the taxation bodies of the accounting income: it includes all the
accounting expenditure and revenue as such, according to their nature, i.e. the gross
accounting income. Starting from here, taxable income calculation considers several
corrections of the accounting earnings, which corrections may be synthesized as
follows:
a) items assimilated to revenue and items assimilated to expenditure;
b) tax deductions (tax-free income and other deductions);
c) nondeductible expenditure;
d) tax loss carryforward.
Yet, fiscal adjustments do not stop here. When the notional amount of profit tax has
been set and a theoretical value of this tax has been determined, the following are
deducted, if necessary (in this order): foreign tax credit, profit tax exemption, profit
tax reductions, amounts recognized as sponsorship and similar sums.
The enforcement by taxation regulations of recognition criteria different from the
accounting ones is accounted for by the different goals of taxation and accounting
(Raby and Richter, 1975; Viandier and Lauzengheim, 1993, p. 7; Rossignol, 2002;
Plesko, 2004; DAscenzo i England, 2005; Whitaker, 2005; Nobes and Schwenke,
2006 etc.). The former (taxation) mainly focuses on gathering the resources that are
needed to cover public expenditure, while the latter (accounting) is mostly designed to
gather and process data in order to collect and provide information on various entities.
4. TAX IMPLICATIONS OF THE ACCOUNTING PRINCIPLES
Considering the differences that may occur between tax and accounting, it becomes
interesting to see to what extent the effects in terms of revenue and expenditure of
accounting principles are recognized, fiscally speaking. Our approach involves both
tax recognition as such, when the revenue and expenditure are recorded in the books,
and tax timing, if different from accounting timing (Yoon, 2008). We intend to
analyze all the nine principles (Istrate 2010) shown in table 1, although some of them
do not significantly influence the relation between accounting and taxation (King et
al. 2001).
4.1. Going concern
The OMPF 3055/2009 argues that financial statements are normally drafted bearing in
mind the assumption that the business will not be interrupted in the predictable future.
This going concern does not bear special fiscal consequences the company will
calculate the taxes according to a set of general rules. Specific cases occur when, for
various reasons, the continuity is no longer possible and the company starts the
winding-up procedure. Thus, if after the enforcement of the winding-up procedures
and the payment of the debts, the company still has assets left, these assets will be
distributed to the shareholders or stockholders. In order to be able to identify the
taxation treatment applied to this transfer, we must first analyze the structure of the
equity capital left after debt payment. If one component of the equity capital
originated from different sources, one may have to deal with different taxation
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treatments. For instance, the share capital may come from the actual contributions of
the shareholder/shareholders, and also from complements consisting of profits made
by the company during its operation years or of fiscally recognized or non-recognized
revaluation surplus. The taxation treatment differs depending on the origin of each
structure. Another comment related to these possible asset reimbursements to the
shareholders focuses on whether such reimbursements should be considered or not
dividend payments. When defining dividends, the tax code explicitly states that any
money or other asset distribution performed in relation to the winding-up of a
corporate body is not assimilated to dividends. This means that the reimbursement is
not subjected to dividend taxation. One should nevertheless make a distinction
between the capacity of the shareholder, who may be either an individual or a
corporate body. If the shareholder is a corporate body, the money transferred on the
winding-up is not subjected to dividend taxation, but it will materialize in taxable
revenue of the shareholder/stakeholder. Conversely, if the shareholder is an
individual, the money that is reimbursed is subjected to 16% tax withheld at source, as
it is considered income from the winding-up of a corporate body.
Bearing in mind these remarks, we are now able to draft a fiscal classification of the
equity capital items left after the winding-up of a company:
a) equity capital coming from the actual contributions of the shareholders/
stakeholders, which is reimbursed as such, without being subjected to any
tax; we refer here to share capital components and share premiums;
b) equity capital coming from gross profits or other sums similar to gross
profits their reimbursement changes the fiscal destination, and it is hence
subjected to profit taxation (legal reserves, other reserves resulted from tax
facilities, untaxed revaluation reserves); the income resulted from the
winding-up of a company is also subjected to 16% taxation after having
withheld the profit tax, if the shareholders/stakeholders are individuals;
c) the equity capital coming from profits that were already subjected to profit
taxation is reimbursed considering the system of law applying to the
beneficiary of the amounts: if the shareholder /stakeholder is a corporate
body, no tax is withheld; if, on the contrary, the shareholder/stakeholder is
an individual, 16% taxation is applied to the income resulted from the
winding-up of a corporate body.
4.2. Comparability
According to the basic rule proposed by this principle the valuation methods and the
accounting policies must be used coherently. Yet, in special cases, changes to the
accounting policies used by the entity are also acceptable. The tax code does not set a
general rule for method changing, yet we may identify tax recognition in at least two
cases: inventories valuation and positive revaluation of tangible assets.
As concerns inventories, the tax code argues that the stock valuation accounting
methods must not be altered during the fiscal year. This means that the stock valuation
method may only be changed at the beginning of the fiscal year. This rule may very
well coincide with the accounting rule, thus almost becoming one and the same
(Hoffman and McKenzie, 2009) Any change to the stock valuation method leads to
the alteration of the stock value in the opening balance sheet of a financial year as
compared to the same stock value found in the closing balance sheet of the previous
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financial year. The tax recognition of the change makes the amount under retained
earnings to be fiscally accepted by its assimilation to deductible expenditure or
taxable revenue. Whatever the case, on the following discharge from administration of
the stocks on which the method was changed, that stock expenditure will be fully
deductible.
According to the accounting regulations, subsequent fixed asset valuation is possible
using either the cost model, or the fair value model. Switching from one model to the
other means changing the accounting method. The tax code provides that the tax value
of fixed assets also includes the revaluations performed under the law. This
accounting method change is also accepted from the taxation viewpoint. Revaluation
tax recognition has become rather a formality since, starting with May 2009, the
revaluation adjustment is taxed gradually, as the revaluated assets depreciate, which
makes the actual tax deduction to stay at the level of the depreciation that would have
been calculated if no revaluation had been performed. We should also point out that
tax recognition is limited to positive revaluations: if a depreciation that should be
recorded under expenditure occurs further to the revaluation, then this depreciation is
non-deductible expenditure, which generates deductible temporary differences.
The current version of the principle of the permanence of methods also refers to
accounting estimates, more specifically to accounting estimate changes. These are
explicitly allowed, and the examples provided by the OMPF 3055/2009 refer to
uncertain customers, to the life cycle and depreciation treatment applied to
depreciable fixed assets. Estimates on provisions, prospective cash flows or discount
rates necessary to set particular values etc may also be added to this category. If, from
the accounting viewpoint, the estimate changes are usually recognized and even
encouraged, the fiscal rule set reliable boundaries to accounting estimate drafting and
modification. For instance, the items considered when setting the fixed asset tax
depreciation must under no circumstances exceed the boundaries set by fiscal
regulations (duration, depreciation treatment, null residual value) and once set, these
landmarks are very difficult to alter. Nevertheless, we may dare to assume (without
having any empirical confirmation whatsoever) that many entities include in their
accounting records tax-based estimates, in order to avoid keeping two sets of different
books. However, it is sometimes difficult or even impossible (especially in
companies forced to audit their financial statements and/or in Romanian branches of
foreign groups) to make accounting and fiscal estimates coincide.
4.3. Accounting conservatism
Accounting prudence prohibits both revenue and asset overvaluation, and debt and
expenditure undervaluation (Givoly et al., 2007). Thus, in its pure version, accounting
prudence brings about an asymmetric probable revenue and expenditure treatment
(Watts, 2003; Pae, 2007, Iyengar & Zampelli, 2010): while probable expenditure is
always considered, probable revenue is disregarded, as its recording depends on
whether or not an event occurs that turns it into certain revenue. Among the direct
consequences of accounting prudence one may note systematic asset undervaluation
and expenditure overvaluation (Richard, 2005, Huerta de Soto, 2010, pp. 20-21). It
has also been argued that financial statements become more prudent when the
connection between accounting and taxation is more close; this statement needs
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however to be enlarged upon and also consider the evolution of the taxation levels and
of the tax deduction systems applied in each jurisdiction (Aisbitt, 2002).
Accounting standards try to discourage exaggerations when applying this principle,
stating, for instance, that prudence allows neither the constitution of excessive
provisions, or the deliberate asset or revenue undervaluation, nor the deliberate debt
or expenditure overvaluation, as financial statements would thus no longer be neutral
and hence they would stop being reliable.
Considering the impact of prudence on accounting earnings, the taxation body is
extremely careful to the consequences of prudence in terms of expenditure (Niskanen
and Keloharju 2000). As concerns Romanias case, if we only take into consideration
the depreciation adjustments and the provisions (Givoly et al. 2007), we will find in
the tax code drastic limitations applied to their tax recognition. If we focus on
business entities other than those with mostly financial activities, we notice that the
list of deductible provisions (Feleaga et al. 2010) is rather short:
a) for performance bonds granted to customers;
b) for accounts receivable depreciation;
c) for the closing and post-closing follow-up of waste deposits;
d) for land restoration, after natural deposit exploitation.
As compared to the tons of adjustments and provisions allowed by accounting rules,
the 4 categories above seem rather few. And the limitations do not stop here: tax
recognition is only achieved if additional specific requirements are met.
Another issue that relies on the principle of prudence is the treatment applied to
subsequent fixed asset-related expenditure. The rule is roughly the same from both the
accounting and fiscal viewpoints: any subsequent expenditure designed to improve
the initial technical parameters of the assets becomes fixed, provided it leads to
additional future economic benefits the taxation regulation (HG 2139/2004)
illustrates the example of buildings. Although there does not really seem to be clear
differences between the two sets of standards, the estimate according to which one
determines whether additional future economic benefits will be gained is a strongly
subjective one. Therefore, we can assume that this compulsory accounting prudence
could lead to the capitalization of a lower amount of expenditure than expected by the
taxation body.
Intangible assets may also be treated differently from the accounting and fiscal
viewpoints, which also points out the differences between the fiscal and accounting
prudence. Thus, whereas the fiscal rule explicitly recognizes the recording in the
books of patents, trademarks, copyrights or development expenditure, the same rule
stipulates that the accounting depreciation of goodwill (which is compulsory,
according to the OMPF 3055/2009) is not deductible. The opposite example is the
case of computer software: fiscally speaking, its depreciation takes three years,
although it may actually be used longer than that. This is one of the few examples
where the taxation standard is more prudent than the accounting standard.
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4.4. Accrual basis accounting

After 1990, the Romanian regulations consider accrual accounting as the basic
assumption when obtaining and providing accounting information. Our preference for
the international accounting standards (IAS/IFRS) confirms and supports this
approach, according to which transactions and events generate accounting revenue
and expenditure when they occur and not necessarily when cash flows are generated
(proceeds/payments). This basic concept (provided in the IASC General
Framework) is described as such in the OMPF 3055/2009. The description of
accrual accounting may seem somewhat ambiguous (Edwards, 2003 proposes (for the
United States) to return to a cash flows tax system; Shaviro,2009). In order to
overcome this difficulty, the standard explicitly provides an important consequence of
this principle the matching principle.
The general fiscal rule currently acknowledges the same principle, without too many
exceptions revenue and expenditure are recognized in the same way accounting
does, that is when they are earned/undertaken and not when they are actually
received/paid. One may therefore conclude that, from the principle standpoint, both
the accounting and fiscal standards rely on the same reasoning.
The tax treatment applied to installments sales enjoyed certain specific aspects related
to profit tax. Thus, before April 30, 2005, the revenue and related expenditure became
taxable/deductible (as profit tax) on the date set for installment collection.
Consequently, a clear distinction between accounting and taxation could be revealed,
although, for simplicity reasons, some accountants recorded the accounting revenue
and related expenditure on the same date set for installment collection.
The tax recognition of the accounting independence of financial years is also
supported by the following explicit provision of the tax law: the taxable profit is
calculated as the difference between the revenue earned from any source and the
expenditure undertaken in order to earn revenue, in a fiscal year One may however
notice that there are cases when the financial year of the fiscal recognition of
particular expenditure (and revenue, although less significant) differs from the
financial year when this expenditure achieves accounting recognition. Theoretically
speaking, we may include here all the differences between the taxable income and the
accounting earnings, which the international accounting standards (IAS 12 Profit Tax)
include in taxable or deductible temporary differences (see also Plesko, 2004;
Gallego, 2004; Ristea, 2008). In short, here are the possible sources of such temporary
differences:
accounting depreciation different from tax depreciation differences occurred
because of different amounts to be depreciated, different depreciation periods
or systems;
depreciation adjustments and fiscally nondeductible provisions;
interests whose deductibility is deferred until all the indebtedness and positive
equity capital requirements are met;
nontaxable revenue from value differences of long-term equity securities.
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4.5. Separate evaluation of assets and liabilities

The accounting standard provides that individual assets and liabilities must be
valuated separately. This individual identification of assets and liabilities with a view
to their valuation must be done throughout the accounting valuation process. Here are
some of the advantages of a separate valuation of assets and liabilities:
better determination of the unit values of the assets and liabilities components
when only the overall value of a set of various assets and liabilities is known;
avoidance of offsetting between possible favorable and unfavorable
differences occurred on the valuation of different assets and liabilities.
Fiscally speaking, separate valuation may trigger effects, depending on which of the
two cases described above we are confronted with. Thus, if the company acquires a
set of assets (accompanied by possible liabilities) for a unique negotiated price, the
setting of the unit values of the assets and liabilities concerned is nothing but neutral.
For instance, some quickly depreciable components or some components that are
more quickly turned into expenditure in other manner might be assigned higher values
in order to accelerate the tax deduction process. If the valuation is done on inventory
and closing, the block valuation may lead to the failure to observe other accounting
principles, such as prudence, which, as already seen, brings about the asymmetric
treatment of the favorable and unfavorable value differences.
4.6. The opening balance sheet for each financial year must correspond
to the closing balance of the preceding financial year
The most important consequence of this principle is that fact that, once published, a
set of financial statements (balance sheet, profit and loss account, cash flow
statements) can no longer be altered. The correction of the errors encountered in the
previous financial years or the changing of the accounting methods employed cannot
result into changes to the already published financial statements for those financial
years. The effects of these events are to be seen in the retained earnings of the
financial year affected by adjustment.
Fiscally speaking, the method change treatment was dwelled upon above. If it has
fiscal effects, accounting error correction will generate a possible corrective statement
where the tax is recalculated.
4.7. Individual recognition, without any off-setting
The accounting interdiction related to the offsetting between assets and liabilities, and
especially between revenue and expenditure, is a rule that has significant fiscal
implications. Accounting information would really be distorted if, for instance, a
taxable income were offset by a nondeductible expenditure item, or if a nontaxable
income were offset by a deductible expenditure item. Coming back to the case of
block assets acquisition, which are accompanied by liabilities, the possible offsetting
between an asset and a liability has effects on the tax values employed to records into
books the components of the purchased assembly.
The principle of non-offsetting proposed by the OMPF 3055/2009 brings something
new as compared to the previous standards, namely an accounting solution to assets
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changes. Until 2009 inclusive, the accounting standard made no reference to such
types of operations. Conversely, the tax standard (when referring to VAT) argued that
any exchange of goods was to be recorded as two concomitant deliveries, meaning
that each of the parties involved issues an invoice and collects VAT. We can only
assume that, when they had to record in the books an exchange of assets, accountants
employed this rather fiscal rule. The OMPF 3055/2009 provides a procedure that is
very close to the fiscal one described above: the sale/discharge from administration
and the purchase/entry in administration are recorded distinctly by the entities
involved in the transaction, which are also supposed to record the entire revenue and
expenditure related to these operations. This solution provides the accounting and
taxation compliance of the asset and service exchange transactions. Nevertheless,
please note that exaggerations are possible, that is unfounded revenue and expenditure
multiplications, when the goods and services exchanged are similar. Fiscally
speaking, such asset exchange is only interesting since it generates revenue and
expenditure (once or several times), as well as profit or loss. Revenue increase may
have some implications since tax is (also) established depending on the overall
revenue level, and profit is taxed somewhat in advance, as long as the goods received
further to the exchange have not yet been recognized as expenditure.
4.8. Substance over form
One of the consequences of Romanias embracing of the international accounting
standards (IAS/IFRS) was the introduction in the national authoritative accounting
pronouncements of this Anglo-Saxon rule. Before the passing of the OMPF
3055/2009, the application of this principle was limited to marketable entities, to other
public interest entities, as well as to entities that exceeded specific size criteria.
Starting with 2010, the substance over form principle is valid for all entities.
Substance over form is invocated when the legal form of the transaction (provided by
the drafted documents) fails to perfectly match its economic substance. Yet, the
standard suggests that such differences should be extremely rare, since, under
normal circumstances, it is the obligation of the business entities to draft documents
that reflect their economic status as accurately as possible. The accounting standard
enumerates some cases when the economic background is different from the legal
status:
the classification, by the users, of leasing contracts as operational or financial
leasing;
the categorizing of specific sales as deferred revenue and expenditure
generators;
the categorizing of securities as long or short-term securities;
the classificatin of granted and received discounts as commercial or financial
discounts.As concerns leasing contracts, their categorizing as financial or
operational is not necessarily a consequence of the substance over form
prevalence. It is true that in Romanian the distinction between the two
categories of contracts is imposed by legal regulations and not by business
usage or practice. We even find explicitly described separation criteria in both
the fiscal and accounting standards. The difference that may occur here is not
between form and substance, but between the accounting and fiscal standards:
the criteria are not exactly the same, although they are highly similar and the
perfect connection between the two sets of records is possible in practice.
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Moreover, the legal documents supporting the contracts (especially invoices)

are recorded exactly in the form they have.
There is however a significant source of differentiation between the accounting and
fiscal standards, namely the lease-back contracts. According to the OMPF 3055/2009
(sequel of OMPF 2374/2007), the procedure of recording in the books of lease-back
contracts materialized in financial leasing is limited to the accounting component
where the current account is debited and the corresponding long-term debt account is
credited. If this is the case, its accounting reflection somewhat lacks covering in the
related documents or, to put it differently, the documents drafted lack their
transposition in the books in accordance with their formal content. A lease-back
transaction is a sale followed by the reception of the asset in financial leasing
conditions it is actually a leasing contract where the user is also the supplier.
Fiscally speaking, the sale is reflected in the invoice, which includes an income equal
to the sale price, as well as the afferent collected VAT (if any). This income is taxable
on the sale date, even when no record of it appears in the company books. Also, if this
income is fiscally recognized, it should be confronted with the expense that generated
it, meaning with the net book value of the sold asset and taken over in leasing. Under
normal circumstances, this expense is deductible. Neither the income, nor the expense
is recorded in the books, but they are both fiscally recognized. After the taking over of
the asset in leasing, its book value remains the same as before, since the fixed assets
and depreciation accounts were not involved at all in the recording of the transaction
in the books. The tax value of the asset, that is the value considered when calculating
deductible depreciation is equal to the contract input value, that is the VAT exclusive
price for which the asset was sold to the leasing company.
The rule employed when recording asset sales in company books seems rather clear.
The OMPF 3055/2009 provides as such the recognition criteria of IAS 18, which
apply to such transactions. Let us not forget that IAS 18 was created in a business
environment that often employs rules that we have not yet taken sufficiently in. Thus,
the first provision states that an asset sale income is recognized by the seller if it
complies with several requirements, the first of which is the transfer to the buyer of
significant risks and benefits associated with the ownership right over that asset.
What happens if the sale is paid in installments and the ownership transfer depends on
the payment of the last installment? The accounting solution essentially depends on
the manner in which the requirements imposed by the standard are thought to be met.
If, for instance, the seller has reasons to believe that he will have difficulties in
recovering the entire amount of money, the sale is not certain and the income cannot
be immediately recognized. If this is the case, the accounting treatment could resort to
spacing out or even deferring the income (and, hence, the expense), unlike the tax
treatment, which is limited to the recording in the books of the supporting documents
(invoice). This is the difference between accounting and taxation.
The categorizing of securities as long or short-term securities does not lack fiscal
implications: as concerns long-term securities, any possible income from changes to
their value is not taxable as long as those assets are held by the company (the book
value thus differs from the tax value). Conversely, when they are categorized as shortterm, their accurate valuation may generate book income that is taxed right away (the
book value remains equal to the tax value).
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The categorizing of discounts as commercial or financial discounts is important from

the standpoint of their financial reporting, as they influence either the operating, or the
financial profit/loss, which could have specific effects on the indicators that reflect the
company business. From the fiscal point of view, the distinction between financial
and operating discounts is important, at least for two reasons:
if the discount received is categorized as financial, then it is automatically
recognized under revenue, which is immediately taxed and increases the
overall amount of revenue recorded in the books;
if the discount received is categorized as commercial, then it either diminishes
a cost of purchase, with fiscal effects when recording the purchased goods
under expenditure, or it is directly recognized as expenditure diminution
(deductible);
commercial discounts are usually invoiced, which also involves the adjustment
of the value added tax, while as concerns financial discounts the invoicing is
not implicit, which means that the VAT is not always adjusted.
9. Materiality
Rules derived from this principle were also applied before our alignment to the
European directives and to the IAS/IFRS, although this occurred in a somewhat
implicit manner. In its current official wording, the significance threshold principle
refers to information presentation in the balance sheet and in the profit and loss
account. Thus, if the information is significant, then it is presented distinctly; if, on
the contrary, it lacks significance, then it may be presented together with other pieces
of information of the same type, as a single indicator. This version of the principle
does not seem to have too many fiscal consequences, since no reference was made to
any kind of revenue or expenditure. We could nevertheless attempt to extend the
significance threshold, starting also from the text of the OMPF 3055/2009, which
provides the IASC General Framework, to the qualitative characteristics of annual
financial reports. Relevance is influenced by the nature of the information and by the
significance threshold. The information reference enables us to say that it is not only
the way in which it is presented but also the way in which it is collected that maters.
We thus come to accept significance threshold rules also when processing the data
that lead us to accounting information. Actually, this is not at all new: when recording
a transaction in the books, we sometimes apply the simplest rule, which is not always
the main one, pleading for it precisely since that transaction is insignificant. From this
point of view, fiscal implications are also possible, that the taxation body accepts or
not. For instance, on the reception of assets on which discounts were received, it is
possible to correct the cost of purchase by those discounts, or, for simplicity reasons,
they could be considered expenditure or even revenue diminution. These different
discount treatments may be caused by the difficulties related to the determination of
the reason for which those discounts were granted. To continue this reasoning, the
categorizing of subsequent expenditure related to fixed assets is not always easy to
perform, for which reason we choose the simplest solution, especially if the value of
that expenditure is not significant. All these options may also have fiscal implications,
to the extent they are included, sooner or later, in expenditure and/or revenue
structures.
Compliance with tax obligations brings about costs that tax payers must bear. The
more complex the taxation system, the higher the costs related to tax management
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(Slemrod and Blumenthal, 1996). In some countries (including Romania), the

limitation of this kind of costs for specific companies and the simplification of the
taxation procedures resulted into the replacement of profit tax by income tax, the
latter being much easier to calculate and follow (for certain companies with revenues
of less than 100,000 euros). We may even rest our argument on a sort of significance
threshold principle with fiscal applications: the profit tax is calculated only for
companies that are large enough.
The relation between company accounting and company taxation has been is a
perpetual evolution and its implications are to be identified especially in the profit tax
area, and also when calculating and declaring other taxes (value added tax, local taxes
and charges). When trying to detect the difference or superposition between
accounting and taxation, it is useful to examine the manner in which accounting
principles are fiscally recognized. We thus looked at the nine principles explicitly
listed by the OMPF 3055/2009 and we tried to identify some of their fiscal
implications, focusing especially on the instances when tax regulations differ from
accounting regulations. The result was more or less numerous fiscal consequences for
each of the nine principles.
Therefore, as concerns the going concern, the fiscal consequences occur especially
when this continuity is interrupted. Or, a lack of continuity may mean winding-up,
which is the end of the life of an entity. If, after the payment of the debts there is still
some money left, then profit tax and/or income tax is calculated for the winding-up
revenue, that is for the remaining equity capital structures. The taxation of equity
capital does not necessarily result from the differences found between the accounting
and fiscal regulations, but it is rather a natural consequence of the taxation treatments
applied to those equity capital components on their constitution.
As for method permanence, we find fiscal implications and we comment upon the
method change effects. For instance, fiscal regulations accept changes to the stock
valuation method, if these changes occur when passing from one financial year to the
next. Another method change with considerable fiscal implications is the passing from
the depreciated cost model to the fair value model. No differences between the two
sets of records occur to the extent this revaluation is fiscally recognized. As concerns
accounting estimate changes, accounting regulations have become slightly less rigid
than fiscal regulations, which may help distinguish between the two. Accounting
method changes and error corrections are also the object of the principle of balance
sheet intangibility.
Accounting conservatism is one of the principles that have important outcomes for the
accounting-taxation relation. For simplicity reasons, we may even say that the
Romanian taxation body does not fully accept the consequences of the accounting
prudence rule, thus seriously limiting the fiscal recognition of the expenditure
undertaken further to the application of this principle or simply deferring their
recognition. For instance, the tax deduction of expenditure undertaken for provisions
and depreciation adjustments is limited and conditioned rather strictly.
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The accrual accounting is also a potential source of differences between accounting

and taxation. Generally speaking, fiscal regulations recognize revenue and
expenditure as they were recorded in the books. Nevertheless, in some cases, the
moment of accounting recognition does not coincide with the moment of tax
recognition. In IAS/IFRS terms, some of these inconsistencies are considered
temporary differences. Here are the current difference sources: accounting
depreciation different from tax depreciation; adjustments for depreciation that are not
tax deductible; provisions that are not tax deductible; interests whose deductibility is
deferred; specific revenue from equity securities that is not taxable; differences
between book and tax values occurred further to restructuring and reorganization
operations. Nevertheless, unlike IAS/IFRS, Romanian accounting regulations (no
longer) require the use of the deferred tax mechanism.
Separate asset and liability valuation is important from the fiscal viewpoint, since it
prevents assigning individual values in a neutral manner, which in its turn prevents,
for instance, the offsetting between favorable and unfavorable differences, should the
fiscal treatments applied to these differences be diverging.
Given the obligation of recording all individual revenue and expenditure components,
the accounting principle of non-offsetting also has fiscal effects, since it prevents, for
instance, the offsetting between a taxable income and a non-deductible expense and
vice-versa. Also, starting with the OMPF 3055/2009, another connection between
accounting and taxation is achieved, namely the asset exchange treatment.
As it was to be expected, substance over form may also have considerable fiscal
implications. Taxation regulations focus a great deal on supporting documents (with
few exceptions). Yet, the reflection in the books of the transactions should rather
consider their economic background, which would result in some approach
differences. We identified such a suggestive example, namely lease-back operations,
where accounting regulations propose a bookkeeping method that is totally different
from the one suggested by fiscal regulations. In other cases (sales under various
circumstances), a daring accounting approach may bring about taxation advantages in
terms of deferred tax and charge payment.We agree with the idea according to which
the relation between accounting and taxation, measured by the method employed to
calculate profit/loss from the accounting and fiscal viewpoints, does not have the
same characteristics for all the categories of companies. Company size, funding
method (marketable or not), or affiliation to a group, as well as the nationality of the
major shareholders/stockholders, the interest in terms of resource mobilization from
banks or other crediting institutions are all variables that the application and fiscal
recognition of accounting principles may depend on.
REFERENCES
Aisbitt, Sally (2002), Tax and accounting rules: some recent developments in European
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PS17 Financial analysis II

Chairperson
Sotirios KARATZIMAS, University of Aegean, Greece
FUNDAMENTAL DETERMINANTS OF CAPITAL

STRUCTURE CHOICE:
A SURVEY OF ROMANIAN COMPANIES
Marilen PIRTEA, Cristina NICOLESCU, Claudiu BOTOC
IMPACT OF LONG-TERM INVESTMENT

DECISIONS ON PROFITABILITY AND COMPETITIVE
ADVANTAGE IN BUSINESS. CASE STUDY
IN THE MINING INDUSTRY IN ROMANIA
Claudia Elena SERBAN, Oana-Adelina FLORICIOIU,
Radu-Daniel LOGHIN
INCLUDING BEHAVIOURAL ELEMENTS

IN ASSET ALLOCATION PROCESS
Aurora MURGEA
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FUNDAMENTAL DETERMINANTS OF CAPITAL

STRUCTURE CHOICE: A SURVEY OF ROMANIAN
COMPANIES
Marilen PIRTEA, Cristina NICOLESCU & Claudiu BOTOC1
ABSTRACT
One of the longest-standing questions about capital structure is whether companies have
target debt ratios. The most important arguments for what could determine capital structure
is trade-off theory and the pecking order theory. The goal of this paper is to express the
linkage between financial leverage and characteristics of the company, in an emerging
market such as the Romanian one. To address this problem, we used a simple linear
regression model throughout the analysis in order to put the focus on within-company
changes in financial leverage. We consider factors related to the demand for and the supply
of debt financing. Together, the magnitude of the estimated effects of supply and demand
factors appears large enough to account the most or the entire long-term trend in emerging
market debt ratios. On the demand side, theory suggests, and prior empirical evidence of
companies, that fundamental company-level characteristics influence the degree to which
companies take on debt. In a linear simple regression model, we found a negative correlation
between financial leverage, return on operational income to total assets or growth
opportunities and a positive correlation between financial leverage, the rate of tangible assets
or turnover.
KEYWORDS: Capital structure, Trade-off theory, Pecking order theory, Financial

leverage, Company-level factors
INTRODUCTION
The capital structure of a company is basically described by the two main elements
that characterize its debt: financial leverage and maturity. Optimal leverage represents
a compromise between the nominal stream of tax benefits that debt generates, and
the probability of this stream being received.
In recent decades in emerging markets debt financing has played the role of both hero
and villain. As hero, debt financing has been viewed as an engine for growth that
enables companies to undertake profitable investments that otherwise might not have
been financed. As the villain, debt financing has been viewed as a vehicle for
companies to take excessive risks that have led to instability in emerging markets.
Although the relative costs and benefits of debt financing may be in question, it is at
least clear that debt financing has played an increasingly important part in emerging
markets finance over the past quarter century.
1
Correspondence address: Claudiu BOOC, West University of Timioara, Faculty of Economics and
Business Administration, Finance Department, 16 J. H. Pestalozzi Street, 300115, Timioara,
Romania; tel.: 0757100904; fax: 0256/592500; email: claudiu.botoc@feaa.uvt.ro
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It is standard in literature to estimate the capital structure by financial leverage. As for

the definition of financial leverage, the ratio of total liabilities to total assets is the
broadest one and used in many empirical studies. However, Rajan and Zingales
(1995) point out that this definition is inappropriate for financial leverage since total
liabilities includes items used for transaction purposes (e.g. account payable) rather
than financing. Also, Rajan and Zingales (1995) suggest that total debt to capital
probably best represents the effects of past financing decisions.
The goal of this paper is to express the linkage between financial leverage and
characteristics of the company, in an emerging market such as the Romanian one. To
address this problem, we used a simple linear regression model throughout the
analysis in order to put the focus on within-company changes in financial leverage.
We consider factors related to the demand for and the supply of debt financing.
Together, the magnitude of the estimated effects of supply and demand factors
appears large enough to account the most or the entire long-term trend in emerging
market debt ratios.
On the demand side, theory suggests, and prior empirical evidence of companies, that
fundamental company-level characteristics influence the degree to which companies
take on debt. Although numerous potential company-level determinants of capital
structure have been tested, the variables that have most consistently survived
empirical tests are company size, profitability, asset tangibility, and growth
opportunities (Rajan & Zingales, 1995).
We find that within-company trends in each of these four variables are significantly
correlated with within-company trends in debt ratios. In each case, the correlation is in
the direction consistent with previous literature: larger size, lower profitability, higher
asset tangibility, and lower growth opportunities are all associated with higher levels
of debt. Moreover, the trend in each of these four variables over the time was in the
direction that would imply an increase in leverage. On average, emerging market
companies experienced increases in size, decreases in profitability, increases in asset
tangibility, and decreases in growth opportunities in last three decades (Mitton, 2008).
Estimates of economic significance suggest that changes in these company-level
fundamentals can explain the majority of the increase in emerging market debt over
this period. Debt ratios have increased in emerging markets in large part because
companies have changed in such a way that their optimal level of debt has increased.
The increase in debt ratios may also depend on supply factors, or in other words, the
ability of companies to obtain external financing in emerging markets. If companies
are financially constrained, then increases in credit market development may lead to
higher debt ratios. Increases in stock market development (which allow companies to
substitute equity for debt) may lead to decreases in debt ratios.
This study complements and adds to Mittons (2008) survey of capital structure in 34
emerging markets (Romania was not included in the sample). We complement
Mittons work as we analyze company-level factors that affects capital structure for
Romanian companies, also an emerging market with reduced liquidity and imperfect
transactions mechanisms. According to another study realized over Romanian
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companies, we found a statistical significant negative correlation between financial

leverage and PER ratio. More exactly, one can argue that for an emergent market,
with severe restrictions on financial resources supply side, the choice of the capital
structure implies a tradeoff between external sources represented mainly by banking
credit and limited appeal to the financing opportunities through the capital market
(Pirtea et al., 2010).
The paper is organized as follows. The next section highlights theoretical
considerations regarding the main theories of capital structure, financial leverage and
value of the company. The third section briefly describes the methodological
framework, where for an empirical research we try to search for a relation between
financial leverage and main variables of the company. The data characteristics and the
results are reported in this section, whilst the last section summarizes the conclusions
of the paper.
One of the longest-standing questions about capital structure is whether companies
have target debt ratios. The most important arguments for what could determine
capital structure is trade-off theory and the pecking order theory. These two theories
are reviewed, but neither of them provides a complete description of the situation and
why some companies prefer equity and others debt under different circumstances.
These theories are conditional, not general. It is easy to find examples of each theory
at work, but otherwise difficult to distinguish the theories empirically. Large, safe
companies with mostly tangible assets tend to borrow more. Companies with high
profitability and valuable growth opportunities tend to borrow less. Each of these
tendencies is consistent with two or more of the major theories of financing.
Theoretical models developed seem to explain differently if the data is divided into
several generic groups of companies.
The trade-off theory says that companies have optimal debt-equity ratios, which
determine by trading off the benefits of debt with the costs (Graham & Harvey, 2001).
In traditional trade-off models, the chief benefit of debt is the tax advantage of interest
deductibility (Modigliani & Miller, 1963). The primary costs are those associated with
financial distress and the personal tax expense bondholders incur when they receive
interest income (Miller, 1977).
The pecking-order model of financing choice assumes that companies do not target a
specific debt ratio, but instead use external financing only when internal funds are
insufficient. External funds are less desirable because informational asymmetries
between management and investors imply that external funds are undervalued in
relation to the degree of asymmetry (Myers & Majluf, 1984). Therefore, if companies
use external funds, they prefer to use debt, convertible securities, and, as a last resort,
equity.
1.1. The trade-off theory
Jensen argues that debt is an efficient means by which to reduce the agency costs
associated with equity (Jensen, 1986). Klaus and Litzenberger show that with the tax
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advantages of debt, optimal capital structure includes debt financing. Ross argues that
debt can be valuable as a device for signaling company value (Ross, 1977). The three
main hypotheses that are used to explain differences in capital structure between
companies are the transaction-cost hypothesis, the asymmetric information hypothesis
and the tax hypothesis. According to Harris and Raviv, financial leverage increases
with fixed assets, non-debt tax shields, investment opportunities, and company size
and decreases with volatility, advertising expenditure, the probability of bankruptcy,
profitability and uniqueness of the product (Harris & Raviv, 1991).
This theory claims that a companys optimal debt constant ratio is determined by a
trade-off between the losses and gains of borrowing, holding the companys assets
and investment plans. The company substitutes debt for equity or equity for debt
until the value of the company is maximized. The gain of debt is primarily the taxshelter effect, which arises when paid interest on debt is deductible on the profit and
loss account. The costs of debt are mainly direct and indirect bankruptcy costs.
The original static trade-off theory is actually a sub theory of the general theory of
capital structure because there are only two assumptions that are broken here, the no
tax incentive assumption and the no bankruptcy cost assumption. In the more general
trade-off theory several other arguments are used for why companies might try to
adjust their capital structure to some target. Financial leverage also depends on
restrictions in the debt-contracts, takeover possibilities and the reputation of
management. Vintage companies with a long history of credits will have relatively
low default probability and lower agency costs using debt financing than newly
established companies. A common factor for all these company characteristics is that
they are proxies meant to measure some form of costs related to a principal-agent
problem. There may simultaneously be several principal-agent problems between the
different classes of securities in the company or between stockholders and managers
in the company. This multiplicity of problems can easily confuse the analyst and lend
an air of incomprehensibility to the field of corporate finance.
A construction of a positive theory of debt financing, builds on arguments on the
advantages and disadvantages of debt. First, debt is a factor of the ownership structure
that disciplines managers. Limiting control to a few agents that control the common
stock, while the rest of the capital is raised through bond sale, can reduce agency cost
of management. Second, debt is a useful signaling device, used to inform investors a
message of the companys degree of excellence. Third, debt can also reduce excessive
consumption of perquisites because creditors demand annual payments on the
outstanding loans. Debt also has its disadvantages. First, there is the problem of
agency cost of debt that includes risk substitution and under investment. Second, debt
also increases bankruptcy possibility by increasing the financial risk of the company.
Debt creation, without retention of the proceeds of the issue, enables managers to
effectively bond their promise to pay out future cash flows. Thus debt can be an
effective substitute for dividends, something not generally recognized in the corporate
finance literature (Jensen, 1986). Debt reduces management opportunity to spend
excess cash flow in non-profitable investments. Management has less control over the
companys cash flows since these cash flows have to be used to repay creditors.
Managerial incentives to allocate the companys resources to their private benefit are
larger when the company is mainly equity financed.
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The free cash flow term is the amount by which a companys operating cash flow
exceeds what can be profitably reinvested in its basic business and the emphasis is
here on the word profitably. Conflicts of interest between stockholders and managers
over payout policies are especially severe when the organization generates substantial
free cash flow (Frydenberg, 2008).
Profitability affects leverage in at least two directions. First, higher profitability
usually provides more internal financing. More earnings can be kept in the company
and hence a lower level of debt. Less debt is then needed to finance already planned
investments. Secondly, debt introduces an agency cost argument. Management will
refrain from the building of empires and excessive consumption of perquisites, when
large sums of money must be paid to creditors each year. Debt keeps the company
slim and cost efficient. Unnecessary non-profitable investments will be avoided
because creditors demand annual payments and claim any free cash flow. High
profitability should result in higher leverage according to the free cash flow
hypothesis, but a high leverage would result in high profitability on the basis of the
pecking order hypothesis.
1.2. The pecking order theory
Issuing debt minimizes the managers' information advantage. Optimistic managers,
who believe their companies' shares are undervalued, will jump at the chance to issue
debt rather than equity. Only pessimistic managers will want to issue equity. If debt is
an open alternative, then any attempt to sell shares will reveal that the shares are not a
good buy. Therefore investors will spurn equity issues if debt is available on fair
terms, and in equilibrium only debt will be issued. Equity issues will occur only when
debt is costly, for example because the company is already at a dangerously high debt
ratio where managers and investors foresee costs of financial distress. In this case
even optimistic managers may turn to the stock market for financing.
This leads us to the pecking-order theory of capital structure (Myers, 2003).
Companies prefer internal to external finance (Information asymmetries are assumed
relevant only for external financing). Dividends are "sticky", so that dividend cuts are
not used to finance capital expenditure, and changes in cash requirements are not
soaked up in short-run dividend changes. Changes in free cash flow (operating cash
flow less investment) show up as changes in external financing.
If external funds are required for capital investment, companies will issue the safest
security first, that is, debt before equity. As the requirement for external financing
increases, the company will work down the pecking order, from safe to riskier debt
and finally to equity as a last resort, when the company is sufficiently threatened by
financial distress. If internally generated cash flow exceeds capital investment, the
company works up the pecking order. Excess cash is used to pay down debt rather
than repurchasing and retiring equity. The company's debt ratio therefore reflects its
cumulative requirement for external financing.
According to the pecking order theory, the companies will prefer internal financing.
The companies prefers internal to external financing, and debt to equity if the
company issues securities. In the pure pecking order theory, the companies have no
~809~
well-defined debt-to-value ratio. There is a distinction between internal and external

equity.
The companies prefer internal financing they target dividends given investment
opportunities, then chose debt and finally raise external equity (Myers & Majluf,
1984). The pecking order was traditionally explained by transaction and issuing costs.
Retained earnings involve few transaction costs and issuing debt incurs lower
transaction costs than equity issues. Debt financing also involves a tax - reduction if
the company has a taxable profit. To give a theoretical explanation for the pecking
order phenomena several authors invoked asymmetric information. The signaling
model leads to a pecking order concept of capital structure, where retained earnings
are preferred to debt and debt is preferred to new equity. The signaling model showed
that only low profit type companies would issue equity in a separating equilibrium.
Rational investors foresee this and demand a discount in Initial Public Offerings
(IPO). This discount is a cost of raising equity that will be borne by the internal
stockholders. Debt signals to the capital market that the issuing company is a high
performance company.
Asymmetric information between old and new investors, and managers and investors
incite to signaling games where the amount of debt and the timing of new issues is
viewed as a signal of the performance of the company. The idea underlying the
signaling models is that stockholders or managers signal private information to the
security market in order to correct the markets perception of excellence.
The pecking-order theory explains why the bulk of external financing comes from
debt. It also explains why more profitable companies borrow less: not because their
target debt ratio is low in the pecking order they don't have a target but because
profitable companies have more internal financing available. Less profitable
companies require more external financing, and consequently accumulate more debt.
The pecking-order theory cannot explain why financing tactics are not developed to
avoid the financing consequences of managers' superior information. For example,
suppose that any special information available to the manager today will reach
investors within the next year. The manager cannot know today whether he or she will
view the future price as too high or too low.
Myers and Majluf consider a very simple setting, where the company's only financing
choice is debt vs. equity. The pecking order does not necessarily hold in more
complicating settings, for example when the company also chooses between straight
and convertible debt.
1.3. Tests of the trade-off and pecking order theories
The trade-off theory implies a target-adjustment model meanwhile pecking-order
theory says that the debt ratio depends on the company's cumulative financial deficit
its cumulative requirement for external financing. Shyam-Sunder and Myers tested
these time-series predictions on a panel of 157 companies from 1971 to 1989. They
found statistically significant support for both the pecking order and a targetadjustment specification of the trade-off theory. The trade-off theory, expressed as a
target adjustment model, was "consistent with" financing choices driven solely by the
pecking order. The pecking order generates mean-reverting debt ratios when capital
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investments are "lumpy" and positively serially correlated, and when free cash flow
varies over the business cycle (Shyam-Sunder & Myers, 1999).
Frank and Goyal tested Shyam-Sunder and Myers' time-series specification for the
pecking order on a much larger sample of companies from 1971 to 1998. This
specification worked reasonably well for large companies, particularly in the 1970s
and 1980s. They also find that variables motivated by the trade-off theory help
explain changes in debt financing, even after accounting for changes in companies'
financial deficits. Large companies with tangible assets borrow more, profitable
companies with high market-book ratios borrow less (Frank & Goyal, 2003).
Fama and French test the predictions of both trade-off and pecking-order models on a
large panel of companies from 1965 to 1999. They also consider modified versions of
the pecking order. (Fama & French, 1998) Both theories score some points in Fama
and French's tests, but run into serious difficulties. The trade-off theory struggles to
explain the strong inverse relationship of profitability and leverage. The pecking order
struggles to explain the heavy reliance on equity issues by small growth companies
(Fama & French, 2002).
Baker and Wurgler find that issuing companies seem to "time" the market, issuing
shares when their stock prices are high and turning to internal finance or debt when
prices are low. Consistent pursuit of timing strategies would make debt ratios depend
on paths of past stock prices as well as on requirements for external funds (Baker &
Wurgler, 2002). Ritter calls this the "windows of opportunity" theory. If investors
sometimes overprice issuing companies' shares, so that equity is truly cheap, then
equity can move temporarily to the top of the pecking order. Thus the windows of
opportunity theory could absolve the pecking order of a major empirical shortcoming,
provided that one is willing to assume systematic mispricing of new issues, at least in
"hot" issue periods (Ritter, 2003).
Most research on corporate financing decisions considers the trade-off and peckingorder theories. There are convincing examples of these theories at work. The
economic problems and incentives that drive the theories taxes, information and costs
of agency and distress show up clearly in financing tactics. Yet none of the theories
gives a general explanation of financing strategy. They are plausible as conditional
theories, but we have only a partial understanding of the conditions under which each
theory, or some combination of the theories, works (Myers, 2003). Zingales says that
we need "new foundations" for corporate finance. The foundations will require a
deeper understanding of the motives and behavior of managers and employees of the
company (Zingales, 2000).
1.4. Confronting theory with practice
How companies make their capital structure decisions has been one of the most
extensively researched areas in corporate finance, yet there is little consensus among
these studies. In a recent paper, Graham and Harvey (2001) examine the theory and
practice of corporate finance by surveying US managers. Bancel and Mittoo (2004) do
the same in the European context, but differ in its scope and focus.
Graham and Harvey (2001) test the implications of different capital structure theories
through a survey of US managers. They find moderate support that companies follow
the tradeoff theory and target their debt ratios. They also find some support for the
~811~
pecking-order theory. Their results show that companies value financial flexibility
but its importance is not related to information asymmetry or growth options in the
manner predicted by the pecking order theory. They find little evidence that other
factors including agency costs, signaling, asset substitution, free cash flow and
product market concerns affect capital structure choice.
They also report that managers use many informal criteria, such as credit rating and
earnings per share dilution, in making their financing decisions. An important issue is
whether US managers' views are influenced largely by the US institutional
environment or are also shared by their peers in other countries.
Overall, company size is positively related to the use of the discounted cash flow
method and the application of the CAPM. Smaller companies and companies less
oriented towards maximizing shareholder value are more likely to evaluate their
investment opportunities by using the payback period criterion and setting their cost
of capital at whatever level their investors tell them. For capital structure, there are
smaller disparities between corporate debt policies for US and European companies.
Financial flexibility is the key factor when determining their debt structure. In
addition, corporate financial management practices are predominantly determined by
company size, to a lesser extent by shareholder orientation, and least by country of
origin (Brounen & Koedijk, 2004).
European managers use factors similar to those used by their US peers for their
financing decisions. However, there are differences across countries on several
dimensions, especially between Scandinavian and non-Scandinavian countries. Also
the quality of the country's legal system explains cross-country variations in the
rankings of several major factors, but so do other country-specific factors such as cost
of capital. In addition, although differences in debt policy factors vary systematically
with the quality of a country's legal system, company-specific factors such as the
company's growth opportunities strongly influence the common stock policy factors
(Bancel & Mittoo, 2004). Most companies determine their optimal capital structure by
trading off factors such as tax advantage of debt, bankruptcy costs, agency costs, and
accessibility to external financing.
2. METHODOLOGICAL FRAMEWORK
2.1. Defining variables and regression model building
A company`s requests for a private loan financing should change with changing its
characteristics, over time. In this respect, we believe that the changes at the
companies` level have an impact on corporate capital structure. Among these changes,
we will consider just four factors of influence to determine the correlation with
financial leverage: the companies` size, profitability, the rate of tangible assets and the
growth opportunities, similar to other studies on financial leverage (Mitton, 2008).
The company`s size is generally positively correlated with the financial leverage,
since large companies are less likely to fail, thus generating a greater debt capacity. In
case of information asymmetry, the more a company is transparent in providing
information, the access to obtain borrowed capital is better. Investors believe that a
big company has more reliable guarantees and a better control risk. Size can be
expressed either by turnover or by the number of employees, but due to the
~812~
restructuring process of the companies in Romania will take into account the turnover
for expressing dimension.
The econometric models are linear regressions regarding the parameters, but not
compulsory regarding the variables. Logarithms of variables, those dependent or the
explanatory or both categories, allows the performance of classical linear regression
model assumptions. Thus the determination will be made using the logarithm scale
turnover.
Profitability is negatively correlated with the financial leverage, according to the
pecking order theory hypothesis, in which companies turn to borrow capital only
when internal sources are insufficient. According to the information asymmetry
theories, the financing policy is a corporate performance indicator. The higher the
financial leverage, the better the company will be perceived as more performing, and
the confidence regarding the manager will be higher. We use the return on operational
income to total assets rate (ROIA) to express profitability, calculated as follows:
ROIA =
Net operating income

Total assets
(1)
Because tangible assets can be used as collateral for obtaining loan resources, a
significant share of them may be associated with a high degree of financial leverage,
reflecting a positive correlation. Rate of tangible assets is determined as follows:
R ta =
TA IA FA
100
TA
(2)
where:
TA total assets
IA intangible assets
FA - financial assets
Companies with growth opportunities should have a low financial leverage, Myers
arguments that an excessive level of leverage may determine companies to avoid
profitable investment opportunities. Consequently, there is a negative correlation
between growth opportunities and financial leverage. (Fama & French, 2002). To
determine the growth opportunities we will consider the relationship between market
value and accounting value of shares (market-to-book ratio):
MBR =
Share price
NAS
(3)
where NAS represents the accounting net asset per share and is calculated as:
NAS =
Total assets Total debt

Number of shares
(4)
Using the above variables we can set a pool type econometric model with the
following equation:
yi,t = i + 1 x i,t + i,t
(5)
The reasons for choosing such a model were related to relatively short time span and
presentation of data, where the observations of a variable being grouped together but
presented separately from the observations of the other variables (unstacked data). For
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a more detailed approach on the influence of the four variables on financial leverage,
we have performed a sequential analysis of the model. In this regard, we have
considered possible combinations of the four variables: we analyzed those grouped
three and finally all four, the explicit form of the model being the following:
FLi,t = 0 + 1 log(CA)i,t + 2 R e i,t + 3 R at i,t + 4 MBRi,t
(6)
where:
FL financial leverage = Total debt/Equity capital
i represents i company
t represents the t moment
2.2. Description and result interpretation
To achieve a regression model that can explain the financing policy of the companies
listed on BSE, we considered a sample of 46 companies (the 22 from first category
and 24 from second category), for the period 2005-2009.
Next, we consider the analytical models under the influence of 3 of the 4 treated
factors. For the analysis model between the financial leverage (dependent variable),
the return on operational income to total assets, the rate of tangible assets and marketto-book ratio (independent variables), the results are reflected in the following table:
Table 1. Relationship between FL, ROIA, TAR and MBR
Dependent variable: FL?
Method: Pooled EGLS (Cross-section weights)
Sample: 2005 2009
Number of included observations: 5
Crossed observations: 46
Total observations: 230
Weighted variables matrix as linear estimation in a single step
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C
ROIA?
TAR?
MBR?
0.554361
-2.188050
0.382838
-0.042326
0.230297
0.735553
0.227870
0.049410
2.407161
-2.974699
1.680071
-0.856640
0.0169
0.0033
0.0943
0.3926
Weighted Statistics
R-squared
Adjusted R squared
S.E. of regression
F-statistic
Prob(F-statistic)
0.076028
0.063763
3.093244
6.198701
0.000459
Mean dependent var

S.D. dependent var
Sum squared resid
Durbin-Watson stat
3.122705
3.385150
2162.403
0.692769
Unweighted Statistics
R-squared
Sum squared resid
-0.018004
5308.495
Mean dependent var

Durbin-Watson stat
1.345409
2.278699
(Source: authors own calculations generated by using the Eviews7 soft)
Since the standard error of the coefficient value is higher, in module, than the
coefficient`s value, the impact analysis model based on return on operational income
to total assets, tangible assets and market-to-book ratio is not valid.
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For the analysis model between the financial leverage (dependent variable), rate of
return on operational income to total assets, market-to-book ratios and turnover
(independent variables), the results are reflected in the following table:
Table 2. Relationship between FL, ROIA, MBR and turnover
Sample: 2005 2009
Variable
Coefficient
Std. Error
t-Statistic
Prob.
-4.094321
0.785778
-5.210528
0.0000
ROIA?
-1.933981
0.735223
-2.630469
0.0091
MBR?
-0.066925
0.050419
-1.327371
0.1857
LOGTO?
0.614072
0.101037
6.077688
0.0000
Weighted Statistics
R-squared
0.156063
Mean dependent var
2.685130
Adjusted R squared
0.144860
S.D. dependent var
3.018797
S.E. of regression
2.962386
Sum squared resid
1983.316
F-statistic
13.93081
Durbin-Watson stat
0.571497
Prob(F-statistic)
0.000000
R-squared
0.014295
Mean dependent var
1.345409
Sum squared resid
5140.067
Durbin-Watson stat
2.350760
Consequently, the following observations can be drawn:

The standard error values of the regression function coefficients are lower, in
module, than the coefficients` values, which imply that their estimate is
correct, also reasoned by the low values of probabilities.
The correlation coefficient shows that 15.60% of the changes in ROIA,
turnover and MBR are reflected in financial leverage.
The model`s coefficients indicate that a 1% change of ER leads to a change of
-1.93% for the financial leverage, a 1% change in the MBR causes a change of
-0.06% for the financial leverage, and an amendment to 1 % of turnover
results in a change of 6.14% of the financial leverage.
Durbin-Watson test indicates a partial correlation between the residual
variables (0.57).
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For the analysis model of financial leverage (dependent variable), return on

operational income to total assets, the rate of tangible assets and turnover
(independent variables), the results are reflected in the following table:
Table 3. Relationship between FL, ROIA, TAR and turnover
Dependent Variable: FL?
Sample: 2005 2009
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C
ROIA?
TAR?
LOGTO?
-4.423280
-2.456691
0.471362
0.595256
0.774168
0.539234
0.216578
0.093495
-5.713592
-4.555892
2.176411
6.366696
0.0000
0.0000
0.0306
0.0000
Weighted Statistics
R-squared
Adjusted Rsquared
S.E. of regression
F-statistic
Prob(F-statistic)
0.190355
0.179607
3.424266
17.71151
0.000000
Mean dependent var

S.D. dependent var
Sum squared resid
Durbin-Watson stat
3.323127
3.434845
2649.986
0.547392
R-squared
Sum squared resid
0.014572
5138.623
Mean dependent var

Durbin-Watson stat
1.345409
2.345460

The correlation coefficient shows that 19.03% of the changes in ER, rate of
tangible assets and turnover are reflected in financial leverage.
The model`s coefficients indicate that a 1% change of ER leads to a change of
-2.45% for the financial leverage, a 1% change in the Tar causes a change of
0.47% for the financial leverage, and an amendment to 1 % of turnover results
in a change of 0.59% of the financial leverage.
variables (0.54).
For the analysis model of financial leverage (dependent variable), the rate of
tangible assets, market-to-book ratio and turnover (independent variables), the results
are reflected in the following table 4.
~816~
Table 4. Relationship between FL, TAR, MBR and turnover

Sample: 2005 2009
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C
TAR?
MBR?
LOGTO?
-4.479768
0.206118
-0.065353
0.615475
0.651429
0.181929
0.042456
0.079661
-6.876829
1.132958
-1.539293
7.726171
0.0000
0.2584
0.1251
0.0000
Weighted Statistics
R-squared
Adjusted R squared
S.E. of regression
F-statistic
Prob(F-statistic)
0.214896
0.204475
3.043110
20.62002
0.000000
Mean dependent var

S.D. dependent var
Sum squared resid
Durbin-Watson stat
3.070773
3.204010
2092.877
0.611174
R-squared
Sum squared resid
0.002681
5200.630
Mean dependent var

Durbin-Watson stat
1.345409
2.329926

The correlation coefficient shows that 21.48% of the changes in the rate of
tangible assets, MBR and turnover are reflected in financial leverage.
The model`s coefficients indicate that a 1% change of TAR leads to a change
of 0.20% for the financial leverage, a 1% change in the MBR causes a change
of -0.06% for the financial leverage, and an amendment to 1 % of turnover
results in a change of 0.61% of the financial leverage.
variables (0.61).
Of all the models with three variables, the greatest influence over financial leverage
belongs to the model based on the influence of tangible assets ratio, the market-tobook ratio and turnover. However, three of the four possible combinations present a
valid pattern and a positive correlation of financial leverage.
The last model takes into account all four factors as independent variables, the results
being reflected in the following table 5.
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Table 5. Relationship between LF, turnover, ROIA, TAR and MBR

Method: Pooled EGLS (Period weights)
Sample: 2005 2009
Variable
Coefficient
Std. Error
t-Statistic
Prob.
C
LOGTO?
ROIA?
TAR?
MBR?
-5.755206
0.828612
-3.465510
0.640928
-0.248395
1.741865
0.205148
1.748949
0.510407
0.128525
-3.304049
4.039082
-1.981481
1.255719
-1.932666
0.0011
0.0001
0.0488
0.2105
0.0545
Weighted Statistics
R-squared
Adjusted R squared
S.E. of regression
F-statistic
Prob(F-statistic)
0.117211
0.101517
4.047378
7.468520
0.000012
Mean dependent var

S.D. dependent var
Sum squared resid
Durbin-Watson stat
1.971556
4.279617
3685.785
1.409860
R-squared
Sum squared resid
0.011715
5153.522
Mean dependent var

Durbin-Watson stat
1.345409
2.418481

correct, also reasoned by the low values of probabilities;
The correlation coefficient shows that 11.72% of the changes in turnover, the
rate of economic return, the rate of tangible assets and MBR are reflected in
financial leverage;
The model`s coefficients indicate that a 1% change of turnover leads to a
change of 0.82% for the financial leverage, a 1% change in ER causes a
change of -3.46% for the financial leverage, a 1% change of Tar leads to a
change of 0.64% for the financial leverage and a 1% change of the MBR
leads to a change of -0.24% for the financial leverage;
variables (0.61).
Overall, the results of the study on the specified sample are consistent with the results
on companies from USA, Europe and other emerging countries: return on operational
income to total assets and growth opportunities are negatively correlated with the
financial leverage, while the rate of tangible assets and turnover are positively
correlated.
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CONCLUSIONS
There is no universal theory of capital structure, and no reason to expect one. There
are useful conditional theories, however. The theories differ in their relative emphasis
on the factors that could affect the choice between debt and equity These factors
include agency costs, taxes, differences in information, and the effects of market
imperfections or institutional or regulatory constraints. Each factor could be dominant
for some companies or in some circumstances, yet unimportant elsewhere.
Financing policy for Romanian companies is based on debt financing, with a level of
indebtedness which varies between 60-70%, except companies listed on the first
category at BSE for which the indebtedness varies between 30-40%. The explication
for these differences in results is explained by main criteria for listing at the first
category at BSE: the value of equity must be more than 30 million Euros, Romanian
capital market having a small number of companies with such volume of financial
resources.
However, the results achieved in the case study, did not show that higher borrowing
by companies in Romania was a hazardous activity very risky or undisciplined. The
existence of a high degree of financial leverage is explained by the importance of
using financial resources for the acquisition of current assets, the lack of equity and
fiscal policy.
The purpose of this study was to provide some empirical evidences on the linkage
between companys capital, as it is this reflected by the financial leverage, companylevel factors that affect capital structure. In a linear simple regression model, we
found a negative correlation between financial leverage, return on operational income
to total assets or growth opportunities and a positive correlation between financial
leverage, the rate of tangible assets or turnover.
Of course this study have several limits both on conceptual as well as on empirical
level. Among this:
1. The use of return of operating income to total assets ratio instead of EBIT on
total sales ratio. The main reason for such substitution is connected to the real
sectors prices rigidities and slow adjustments mechanism in an inflationary
environment. Thus, we had considered that the total assets reflect better the
output of the companys operational activities.
2. The short-time span considered, the limited numbers of traded companies
included the absence of split by sectors, the absence of any references to the
inter-correlation between stocks as well as between stocks and global market
dynamic, some robustness of the estimated coefficient problems revealed by
the existence of certain autocorrelations in estimation residuals etc.
Despite the resulted caveats, we are identifying the similar trends between Romanian
companies and companies from other emerging countries, regarding the financial
leverage and company-level factors and further investigation are relevant for a better
understanding of capital structure formation mechanisms.
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REFERENCES
Baker, M. & Wurgler, J. (2002) Market Timing and Capital Structure, Journal of Finance.
Bancel, F. & Mittoo U. (2004) Cross-Country Determinants of Capital Structure Choice: A
Survey of European Firms, Journal of Financial Management.
Fama, F. & French, K. (1998) Taxes, Financing Decisions and Firm Values, Journal of
Finance.
Fama, F. & French, K. (2002) Testing trade-off and pecking order predictions about
dividends and debt, Review of Financial Studies.
Frank, M. & Goyal, V. (2003) Testing the pecking order theory of capital structure, Journal
of Financial Economics.
Frydenberg, S. (2008) Theory of Capital Structure A review, NO-7005 Trondheim: Tapir
Academic Press.
Graham, J. & Harvey C. (2001) The Theory and Practice of Corporate Finance: Evidence
From The Field, Journal of Financial Economics.
Harris, M. & Raviv, A. (1991) The theory of capital structure, Journal of Finance.
Jensen, M. (1986) Agency Cost of Free Cash Flow, Corporate Finance, and takeovers,
American Economic Review, no. 76.
Miller, M. (1977) Debt and Taxes, The Journal of Finance.
Mitton, T. (2008) Why Have Debt Ratios Increased for Firms in Emerging Markets,
Journal of European Financial Management, vol. 14: 52-57.
Modigliani, F. & Miller, M. (1963) Corporate income taxes and the cost of capital: a
correction, The American Economic Review no. 53: 15-25.
Myers, S. C. (2003) Financing of corporations, Journal of Financial Economics.
Myers, S. & Majluf, N. (1984) Corporate financing and investment decisions when firms
have informations that investors do not have, Journal of Financial Economics.
Pirtea, M. & Dima, B. & Booc C. (2010) Trade Off Theory of Capital Structure Choice and
its relevance for emergent markets: the Romanian case, 5th WSEAS International
Conference on Economy and Management Transformation, Timioara.
Rajan, R. & Zingales, L. (1995) What do we know about capital structure? Some evidence
from International Data, Journal of Finance, no. 50(5): 34-42.
Ritter, J. (2003) Investment banking and security issuance, in: G M Constantinides, M
Harris and R.M Stulz, eds , Handbook of the Economics of Finance, Vol A (Elsevier,
Amsterdam) Chapter 5, this volume.
Ross, A. (1977) The Determination of Financial Structure: The Incentive-signalling
Approach, The Bell Journal of Economics, no. 8: 89-95.
Shyam-Sunder, L. & Myers, S. (1999) Testing static trade off theory against pecking order
theory models of capital structure, Journal of Financial Economics.
Zingales, L. (2000) In search of new foundations, Journal of Finance, vol. 55: 1623-1653.
~820~
IMPACT OF LONG-TERM INVESTMENT

DECISIONS ON PROFITABILITY AND COMPETITIVE
ADVANTAGE IN BUSINESS. CASE STUDY
IN THE MINING INDUSTRY IN ROMANIA
Claudia Elena SERBAN1,
Oana-Adelina FLORICIOIU & Radu-Daniel LOGHIN
ABSTRACT
Computer applications era, contemporary to us, generates the organizations management
appetite for long-term investment decision, especially since these investments, made either for
maintenance or for renewal-extension, are shown to be the path to profitability and
competitive advantage. However, are there limits to such investments? What should be the
reasoning when a long-term investment decision is taken? How could the executive identify
any faults that long-term investment decision could generate? In order to get answers to these
questions, we propose a model to reach practitioners, validated by statistical observation in
the mining industry, as organizational success depends not only on the chosen strategy and its
implementation, but on the mastery and application of quick observation techniques failures
as well.
KEYWORDS: investment decision, fixed-asset investment, economic and financial

equilibrium, business profitability, competitive advantage
INTRODUCTION
In the last decade in the U.S. have been rapidly shaped, developed and expanded
worldwide, the germs of knowledge-based economy that changes the fundamental
way to address macro and micro processes. For this type of economy knowledge
becomes a cornerstone of achieving high productivity and competitiveness for firms,
industries, national economies and world economy as a whole, says O. and L.
Nicolescu in Economia, firma i managementul bazate pe cunotine (Economy,
firm and knowledge based management). The two authors submit a concept with a
content that was developed almost simultaneously with the knowledge-based
economy, namely the concept of competitiveness. Countless international bodies and
experts put in the spotlight, during this period, competitiveness and how to get
competitive advantage at the macro and micro level.
However, as stated by the Lisbon European Council report in March 2000, now it can
be said, there were no general accepted definitions of the concept and yet has not
been developed a comprehensive model to formalize its content. Policy Board of
U.S. Competitiveness defines competitiveness as the ability to produce goods and
1
Correspondence address: Elena Claudia ERBAN, Bucharest Academy of Economic Studies;

email: claudiaserbanos@yahoo.com
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services that meet the requirements of international markets while citizens obtain a
growing and long-term sustainable standard of living. U.S. Energy Department
defines industrial competitiveness as the ability of a company or industry to meet the
challenges of foreign competitors(Havlik,2001). An interesting approach on
competitiveness is the one conducted by the Ministry of Industries in Denmark
(Nicolescu O, Nicolescu L, Economia, firma i managementul bazate pe cunotine Economy, firm and knowledge based management) who prepares a competitive
pyramid, containing seven factors considered to be relevant, but allowing the
consideration of others as well, and leaving opened the evolution to new factors
(openness is suggested by the top blank quadrilateral). The seven factors are
favourable environmental and social conditions, continuous innovation and
technological competence, building new markets and international profiles, fast
delivery, confidence in the sales, efficient manufacturing and low price.
In our opinion, any approach to measuring competitiveness and competitive
advantages must take into account, on one hand, the level at which the analysis micro, mezzo and macro is made - and on the other hand the fact they are the resultant
of many variables which are conditioned directly or indirectly. Among the variables
which determine the competitiveness and competitive advantage, regardless of the
approach, there is reflected the technological competence. This depends, at any
approach level, on the quantity, quality and reliability of the existent technique as well
as on the way the decision factors understand how to develop and conduct an
investment policy. Investment policy was and still represents a concern for all
professionals in the economic field. At a company level, financial and accounting
specialists have investigated the correlation between capital expenditures and the
volume of loans. Thus, G. Nini., D. Smith and A. Sufi showed in a study in the 90
years in Britain that over 30% of loan contracts held by companies under investigation
included limitations on capital expenditures.
The study showed the impact of these loan contracts limitations on the market value
of the business and its operational performance. Another study in Belgium conducted
by Marc Deloof in the period 1992-1996 and published in 2003 in the Journal of
Business Finance & Accounting, shows the relationship between the intensity of the
policy investment in the company, working capital levels and profitability of the
company. Since the 60s, in U.S., concerns are obvious in the investment policy and
starting with the 80s the issue of social responsibility and prudent behaviour of the
management in the investment policy at the microeconomic level has been set. The
concept of social responsibility was standardized in 2010 (ISO_DIS 26 000 Guidance of Social Responsibility) and is considered a higher level of sustainable
development approach.
In our approach to identify the competitive advantages of the extractive industry in
Romania in the context of a national funded research, an important step was
conducting a survey of the companies listed on Bucharest Stock Exchange, whose
main activity object is coal mining, in order to identify correlation between the
firm's investment policy and long-term business profitability. In the following, we
present our approach and results of the study.
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1. PRESENTATION OF THE SCIENTIFIC PROCESS

The contemporary crisis has shifted the management of companies in managerial
practices adapted to environmental turbulence, focused on competitive skills, which
lead to organizational success. Organizational success depends on the chosen strategy
and its implementation, but on the mastery and application of rapid observation
techniques failures as well. The knowledge resource is the necessary condition for
the competitiveness of the organization (Sedziuviene N., Vveinhardt J., 2010).
Economic development processes depend on the amount invested in noncurrent
assets. In a research made in China between 1979-2008, whose results are published
in the paper entitled The analysis of the composite improve models on the
relationship among Shenzens economic growth with its fixed-asset investment and
export volum, Zhang L. et al. show strong positive correlation between the volume of
investments in fixed assets and business economic growth.
In addition, the qualitative level in the economic process depends on the maintenance
of technical and technological equipments. Al-Najjar B., in the paper entitled The
lack of maintenance and not/maintenance which costs: A model to describe and
quantify the impact of vibration-based maintenance on companys business puts
under observation the role of maintenance of technical equipments and technologies
on quality production processes and determines the impact of this maintenance on
business profit and the achievement of competitive advantage desideratum, creating
the concept of vibration-based maintenance(VBM).
I. Chengalur-Smith and all, observed in a study of 149 U.S. organizations, that these
are particularly interested, in the contemporary period, in the Open Source Software
(FLOSS), due to the increase in value that is recorded by the company together with
the acquisition of this technology. The study, published in 2010, entitled An
empirical analysis of the business value of Open Source Infrastructure Technologies
shows that about 20% of the business value is due to possession of Open Source
Technologies, such as MySQL.
Computer applications era, contemporary to us, generates the organizations
management appetite for long-term investment decision, especially since these
investments, made either for maintenance or for renewal-extension, are shown to be
the path to profitability and competitive advantage.
However, in an accounting vision, are there limits to such investments? What should
be the reasoning when a long-term investment decision is taken? Do these decisions
have only positive effects? How could the executive identify any faults that long-term
investment decision could generate?
Our proposed model responds to these questions and is one useful for practitioners,
validated by statistical observation in the mining industry.
1.1. The area of the scientific correlation proposed
The correlation has as a starting point the approach of the economic-financial
equilibrium of an economic agent. The relations that arise between funding sources of
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the business and their uses determine the economic-financial equilibrium in the
business. Sources of financing (equity or liabilities) and uses of financing sources
(assets) are reported in the balance sheet and in the ownership vision; they are
considered material and financial resources for the entity. Exploitation of these
resources gives rise to outgoing or incoming economic flows to / from management,
which, from an accounting point of view are reported in the income statement. In turn,
economic flows, depending on the size, structure, and the degree of liquidity make the
resumption of the mining activity at a certain scale, in other words allow for resource
recovery designated to exploitation at a certain level or dimension. All this
mechanism is coordinated and controlled by the human capital available to business,
management and employees, capital resources that represent another category of
resources.
In this context, the level of individual skills and training of human resource is a
decisive influential factor on economic and financial equilibrium. Schematically, the
function could be presented in the following way:
Table 1. Correlation management decisions - synthesized financial statements
Management
Long-term
Investment
decisions
Assets
Economic Flows
Equity
Non-current
Assets
Depreciation and
financial expenses
Permanent
Equity
Management
Long-term
Investment
decisions
Operational Revenue
Operational
Investment
decisions
Management
Current
Assets
Assets
Raw materials, materials,

inventory, external
benefits,
employee benefits, other
expenses
Economic Flows
Current
Equity
Equity
Operational
Investment
decisions
Management
Accordingly, the enterprise has funding sources (equity) which remain at its disposal
for a period of time longer than a year (permanent equity), or a shorter period of time
than a year (permanent assets), or for a period less than an year(current equity). These
funding sources are investment-oriented either towards real estate, securities, or noncurrent assets, or in values or commodities unique to the operational cycle (current
assets).
The financial balance theory presents us, among others, with working (floating)
capital(WC/FR). Bernard Colasse, in his paper titled Gestion Financiere, mentions
that a company is financially-balanced if working capital is positive at best or null at
worst. The formula presented by Colasse for working capital is as it follows:
WC = PE - NCA,
Where: PE permanent equity (long term financial sources);
NCA -non-current assets
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The equation shows that maintaining the financial-economic balance assumes that
purchasing non-current asset, or assets with a longer operational duration than a year
must be done in the limit of available equity for the same period. Why this constraint?
We consider the balance sheet a schematic mirror for the enterprise. According to the
principle of double entry bookkeeping, the balance sheet reflects funding sources and
their uses. The framework for the balance sheet can be presented as it follows.
Table 2. Balance sheet framework, case A
WC = 0
A perfect economic and financial balance assumes perfect
dependency between the balance sheet items, according to
their duration in the enterprise
This state is practically very difficult to be achieved in
practice.
Non-current
Asset
(duration > 1 year)
Permanent
Equity
(duration > 1 year)
Current
Asset
(duration < 1 year)
Current
Equity
(duration< 1 year)
Table 3. Balance sheet framework, case B

WC > 0
This case is considered advantageous to the enterprise.
Investments comprising of long-term equity is carried out
both on non-current assets and operating assets, flow which
allows obtaining revenue or profits.
This can be observed in the asset composition through an
increase in the current assets ratio.
Many profitable companies posses this kind of balance sheet
structure.
Non-current
Asset
(duration > 1 year)
Current
Asset
(duration < 1 year)
Permanent
Equity
(duration > 1 year)
Current
Equity
(duration< 1 year)
Table 4. Balance sheet framework, case C

WC < 0
This situation is considered disadvantageous for the
enterprise. For non-current asset purchases, the long-term
equity was used, but also a part of current assets, those which
economically speaking are destined to the operating cycle. We
can see the altering trend of the asset composition, by
reducing the non-current asset ratio destined for the operating
cycle.
Enterprises in this kind of situation are challenged initially by
diminished returns, due to rescaling previous operating cycles,
after a decision has been made to invest some of the current
assets in non-current assets. Maintaining this situation for a
longer period leads inevitably to real financial losses.
Non-current
Asset
(time frame > 1
year)
Current
Asset
(time frame < 1
year)
Permanent
Equity
(time frame> 1 year)
Current
Equity
(time frame< 1 year)
Of course, in practice, financial statements like the ones previously schematically

disclosed are much more complex as there are influenced by factors such as total
receivables, total commercial liabilities, the average collection time for receivables,
~825~
the average payment time for liabilities, but we will not delve deeper since these are
out our focus for our paper.
Non-current assets are defined as that kind of asset that serves many operating cycles,
that is why its value is recovered through depreciation. Altering the total non-current
asset (non-current asset) alters economic flows in the (comprehensive) income
statement. Thus, the total depreciation expenses, regardless of method used in
determining the depreciation method (linear, accelerated, regressive) changes with the
total altered non-current asset. Moreover, operating non-current assets generates
income, which varies according to non-current asset type and its degree of use. Every
penny worth of non-current assets contribution to income can be determined using an
efficiency rate like (Vlceanu, Gh. &co, 2005):
Re venue _ per _ asset _ unit =
Re venue
* (100)or (1000)
Asset
Used revenue for calculation can be operating revenue, sales revenue or even total
revenue, including extraordinary and financial revenue. The asset unit can be
currency, 100 currency units or 1000 currency units, according to the size of the
revenue or the asset. The frequent formula uses 100 currency units worth of assets,
because the result can be further used in correlation with measures such as return
rates.
The economic correlation, which should govern every enterprises activity, is the
following:
I EFFORT I EFFECT
EN
). In our approach, total assets are the
E N 1
enterprises effort necessary for a normal operation, and the revenue represents the
effect from a normal operation. Naturally, a sharper growth of the revenue relative to
the asset would satisfy the efficiency criteria and this would be tantamount to a
sharper revenue growth per asset unit. However, revenue includes specific expenses
as well as a gross margin or profit, as:
Where I represents the base chain index (
Re venue = exp enses + profit

An activity is efficient when the revenue structure modifies to an increasing profit, or
an equal decrease in expenses. This means:
profit
profit
*100) N > (
*100) N 1 this is from a mathematical point of view
revenue
revenue
equal to
I REVENUE < I PROFIT
~826~
or
exp ense.
exp ense.
*100) N < (
*100) N 1 this is from a mathematical point of view
revenue
revenue
equal to I EXPENSE < I REVENUE

Where:
profit
*100) is the profit margin or profit levels for 100 currency
revenue
units in revenue.
exp ense
*100) is the expense rate or the level of expenses for
revenue
100 currency units in revenue
Thus, an efficient activity is governed by the following relationship:

I EXPENSE . < I REVENUE < I PROFIT
Which is equal to an increase in return rates for revenues or a decrease in expenses for
100 currency units in revenue. Disregard for this relation would thus determine a
reduction of revenue return rates, as well as increased expense levels per revenue unit.
Customizing the previous equation would follow that every type of expense should
have an inferior index compared to that of the corresponding revenue. Thus
depreciation expenses should rise slower compared to that of the operating revenue, or
I DEPRECIATION .EXPENSE < I OPERATING.REVENUE
This would entail maintaining or increasing business returns, equivalently, reduce, or
maintain in dynamic the level of depreciation expense to 100-currency unit in revenue
depreciation. exp ense

*100) .
revenu
Our reasoning leads us to believe that, as non-current asset absolute growth

determines a relative increase in depreciation expenses, increases in non-current assets
should be limited to a level, which preserves the correlation:
I DEPRECIATION .EXPENSES < I OPERATING.REVENUE
Therefore, the business returns would not be diminished over time. In this context,
we have to try preserving the asset structure, to maintain a greater ratio for noncurrent assets, or experience a diminished relative return. This is the theoretical
hypothesis we would wish to validate through statistical observation.
~827~
1.2. Research method and scope

To validate these scientific observations we chose the mining industry, or a number of
eight companies, whose main activity is coal mining, listed at the Bucharest Stock
Exchange (BVB). The sample was restricted by the main activity as well as
difficulties in gathering data. For each company we followed, over a three-year
period, the progress for the following measures: non-current assets (X1 variable AC), non-current asset (X2 variable - AI), operating revenue (X3 variable -V),
operating margin (X4 variable - PR), depreciation expenses (X5 variable - CA). The
data was partly collected from the BVB website, financial statement section and partly
from each company website from the sample. The method employed was statistical
observation. The research stages were the following:
Gathering the appropriate data;
Statistical processing for the variable to obtain a statistical average for each
variable;
According to the average for each variable we determined the average level
for the following revenue per non-current asset currency unit, revenue per 1
currency unit of non-current asset, the sum of depreciation expenses per 1 unit
of non-current assets;
According to the average level of the measures previously obtained, we
simulated an evolution of revenue, profit and depreciation expenses to identify
their trends according to the relative change of the asset structure. Likewise,
we tried to observe if the scientific hypothesis presented in the next chapter are
validated through the performed simulation.
We used software like Excel and advanced statistical calculator OpenStat.
1.3. Presentation of data and the result of statistical observation
Statistical processing the financial information gathered from the eight companies
subjected to observation generated the following report:
Table 5. Distribution parameter estimates
N=24, date
VARIAB.
MEAN
VARIANCE
STD. DEV.
STD. ERROR OF MEAN
RANGE
X1
X2
76.600
94.800
8640.267
8011.511
92.953
89.507
29.394
28.305
242.000
236.000
X3
X4
95.700
13.700
9287.789
134.011
96.373
11.576
30.476
3.661
298.000
32.000
X5
7.000
41.778
6.464
2.044
19.000
The matrix of the correlations between the variables is as it follows:

Table 6. Correlation Matrix
VARIAB.
X1
X2
X3
X4
X5
X1
X2
X3
X4
X5
12,018
12,918
13,956
11,215
1,635
13,956
7,692
11,354
12,240
19,684
12,918
10,298
7,692
12,973
10,243
11,215
12,973
12,592
12,251
12,188
13,635
10,243
19,684
12,188
13,198
t-test Values for prob. |corr.| > 0 test, with prob. > t = 0.601
~828~
As we mentioned in the previous subchapter we used the average values of the

variables to determine the revenue per current asset currency unit (V/AC), revenue per
non-current asset (V/AI), profit per revenue unit (PR/V), and total depreciation
expenses per non-current asset (A/AI). The report is the following:
Table 7. Average values of management rates
Measure
Medium value
V/AC
1.249347
V/AI
1.009494
PR/V
0.143156
A/AI
0.07384
Next, we simulated the development of the measures: operating revenue, operating

profit, depreciation expenses according to changes in the asset structure. To determine
the mentioned measures we used the rates from table no.6.
Table 8. Simulation of development for revenue, profit and depreciation
AC
100
90
80
70
60
50
40
30
20
10
AI
100
110
120
130
140
150
160
170
180
190
V
225.8841
223.4856
221.087
218.6885
216.2899
213.8914
211.4929
209.0943
206.6958
204.2973
PR
32.33659
31.99323
31.64987
31.3065
30.96314
30.61977
30.27641
29.93305
29.58968
29.24632
CA
7.383966
8.122363
8.860759
9.599156
10.33755
11.07595
11.81435
12.55274
13.29114
14.02954
The chart depicting the development of the measures is as it follows:

Graphic1. Simulation of development for revenue, profit and depreciation
250
200
150
AC
AI
V
100
PR
CA
50
CA
0
1
V
4
AC
9
10
The graph shows the evolution trends for each of the indicators taken into
consideration. For consistency reasons we also present the relative changes.
~829~
Table 9. Simulation of index deviation for revenue, profit and depreciation

Revenue
index
Profit
index
Depreciation
index
0.989382
0.989268
0.989151
0.989032
0.988911
0.988786
0.988659
0.988529
0.988396
0.989382
0.989268
0.989151
0.989032
0.988911
0.989032
0.988786
0.988659
0.988396
1.100000
1.090909
1.083333
1.076923
1.071429
1.066667
1.062500
1.058824
1.055556
Revenue
Index
deviation
Profit index
deviation
Depreciation
index
deviation
-0.000114
-0.000116
-0.000119
-0.000122
-0.000124
-0.000127
-0.000130
-0.000133
-0.000114
-0.000116
-0.000119
-0.000119
-0.000122
0.000122
-0.000246
-0.000263
-0.009091
-0.007576
-0.006410
-0.005495
-0.004762
-0.004167
-0.003676
-0.003268
Both the numbers and the chart, show that altering the asset structure, as increasing
non-current asset ratio determines a relative decrease in total revenue, total profit and
relative increases of depreciation expenses.
Practically for every 5% increase in noncurrent assets, revenue and profit register a
1% decrease, while depreciation expenses register a minimum 1% increase, which
causes the relative profit margin to reduce approximately 2%.
I DEPRECIATION .EXPENSE > I REVENUE > I PROFIT
In conclusion, this correlations appearance between the three measures is tantamount
to a reduction in the dynamic of the profit margin. The intensity of reducing relative
revenue return depends on the structural asset variation. According to the simulation,
to a 5% increase in the non-current asset ratio, the revenue return diminishes by 2%.
For the organizations management using this method would mean determining asset
structure for two consecutive periods and identifying the dynamic trend. Assuming
the non-current assets grew with x%, the relative change in revenue returns (y %) due
to structural asset alterations will be
x 2
100 100
y=
5
100
Therefore, we are talking about diminishing relative and absolute returns. The
absolute value of the percentage point of diminished returns will be determined
according to the absolute profit size.
These conclusions ware determined from a simulation, which did not consider internal
or external factors relative to the company. That is why there is a certain probability,
in a certain context, the structural asset alteration that we presented be present in the
financial statements. The management should consider this aspect and follow the
implementation of efficiency principles in management.
DISCUSSION AND CONCLUSION
In conclusion, the management tendency to invest in long-term equipment and
technologies, motivated by the desire to keep up with innovations in the field to
~830~
maintain the quality of the operating process, product quality and the differential
competitive advantages, must be limited to respecting the economic-financial balance
correlation
I DEPRECIATION .EXPENSE . < I OPERATING.REVENUE < I OPERATING.PROFIT
correlation, which is conditioned by the asset structure. This is mentionable as long as
in the asset structure, non-current assets have a greater ratio.
A proactive investment policy determines major financial imbalances. The first
consequence is the reduction of the scale from which the operational cycle resumes,
amid directing financing sources to equipment and technologies, which do not bring
important values immediately, but as an important long-term value in size. This value
divided into financial periods, short-term elaborated, fails to eliminate relative
financial losses. A second consequence would be an improved product quality, which
would contribute to customer appeal. However, even if the customers are drawn
towards the new qualitative standard, the physical volume of production diminishes
relatively due to a lack in cash-flows, consequently the company offer diminishes,
with immediate impact in the progress of the operating revenue. A third consequence
is increases depreciation expenses at a higher rate than that of the revenue, with
impact over relative returns. From a bookkeeping point of view, it is arguable that this
kind of expenses does not generate cash flows. Really, cash flows diminished now of
payment in favor of the non-current asset supplier with a higher value then current
depreciation expenses. Moreover increases of these expenses, even as a fictitious
value, affect measures such as profit, return rates, etc. and measures used as
performance and reporting measurement instruments towards shareholders and
stakeholders.
However, our explanation does not imply that we propose reducing the depreciation
expense amounts, or the non-current assets amount, as this would mean diminished, as
this would mean decreasing operations and violating the competitive advantages
principles. Our approach is for rationalization in the long-term investment decision,
meaning the following:
Preserve the asset structure with an emphasis on a larger current asset ratio;
Total non-current assets should not surpass permanent equity, and even
maintain a positive offset to finance the operating cycle;
Maintain the fundamental economic correlation between the expense, revenue
and profit evolution, as means for a relative increase in returns and obtain or
maintain competitive advantages.
REFERENCES
Aleca, O.E. and all (2010) A research profile for management information systems- case
study based on The AMIS scientific journal and AMIS international conference,
AMIS 2010 Proceedings of the 5th international conference, Accounting and
Management Information Systems, 1060-1072
Al-Najjar, B. (2007) The lack maintenance and not maintenance which costs: A model to
describe and quantify the impact of vibration-based maintenance on companys
business, International Journal of Production Economics, vol. 107, no. 1: 260-273
~831~
Chengalur-Smith, I. and all (2010) An empirical analysis of the business value of Open
Source Infrastructure Technologies, Journal of the Association for Information
Systems, vol. 11, no. 11 (SI): 708-729
Colasse, B. (2009) Gestion Financiere, Analiza financiar a ntreprindere(Companys
financial analysis), Iai, translation done by Neculai Tabr
Evangelista, R. and Vezzani, A. (2010) The economic impact of technological and
organizational innovation. A firm-level analysis., Research Policy , vol. 39, no. 10:
1253-1263
Havlik P., Landesmann M., Stehrer R. (2001) Competitiveness of CEE Industries: Evidence
from Foreign Trade Specialization and Quality Indicators, WIIW Research Reports,
No. 278, Vienna
Nicolescu O., Nicolescu L.(2005) Economia, firma i managementul bazat pe cunotine,
Sedziuviene, N. and Vveinhardt, J. (2010) Competitiveness and Innovations: Role of
Knowledge Management at a Knowledge Organization., Inzinerine EkonomikaEngineering Economics, vol. 21, no. 5: 525-536
erban, C. (2009) Riscul n activitatea agenilor economici, Bucureti
Vlceanu, Gh., Robu V., Georgescu N. (2005), Analiz economico-Financiar Economic
and financial analysis, Ed.Economic, Bucureti
Zhang, L.Y. and all (2010) The analysis of the Composite Improved Models on the
relationship among Shenzhes Economic Growth with Its Fixed-asset Investment and
Export Volume, International Conference on Management Science and Engineering,
MSE , vol. 3 : 350-354
Financial data www.bvb.ro- The Bucharest Stock Exchange website
~832~
INCLUDING BEHAVIOURAL ELEMENTS IN ASSET

ALLOCATION PROCESS
Aurora MURGEA1
West University of Timisoara
ABSTRACT
Human mind ability in understanding, processing and using large amount of information is
unfortunately limited. Confronted each day with hundreds of decisions, affective, emotional
social and cultural factors often play a more important role that the rational ones, in
contradiction with the assumption of classical finances centred on Efficient Market
Hypothesis. As Platon once said the human mind could be easily compared with a chariot
pulled on the one side by one pony the ration and on the other by one elephant the
emotions. The aim of this paper is to combine the classical financial analyses and the
behavioural elements in an allocation model which could be use by the financial consultant in
the relation with their private clients. The proposed study take into consideration both
cognitive and emotional biases, their differential presence in the case of man and women and
their influence on the investors decision. A survey on 888 participants was used in order to
be able to formulate the final conclusions.
KEYWORDS:
cognitive and emotional biases, asset allocation, investment decision,
capital markets
INTRODUCTION
Despite the late progresses, classical finances still finds hard to explain why people
act apparently irrational, managing their money. The financial markets evolutions in
the last years leaded to a new research field, Behavioural Finance, which includes
some new independent variables, the cognitive and emotional decisions determinants
into the equation.
The fusion between the classical financial analysis and the one which also considers
psychological, social, affective and emotional elements could help the investors and
financial analysts to broadly understand the markets mechanisms and the way its
participants fundament and take the financial decisions.
Understanding financial markets starts with understanding investors decisions because
investors drive markets, make them rise and fall. The human capacity to process,
understand and assimilate the huge volume of information and stimulus is limited.
The decisions and reasoning individuals daily assume are constricted by personal
circumstances, time restrictions, psychological and emotional determinants and rarely
based on strict rational economical logic. The new paradigm of behavioural
Correspondence address: Aurora MURGEA, West University of Timisoara, Faculty of Economics and
Business Administration; email: auroramurgea@gmail.com
~833~
economics tries to convince that studying the real individuals behaviour it is at least
equal interesting with the classic study of what people are suppose to do.
The investor who succeed to balance the economical rational analysis and the
behavioural analysis have a chance to understand the market and to affect less his
portfolio performance, comparing with a non-rational, hyperactive and over
influenced investor, who refuse to take into consideration the evidences. Adam Smith
(Smith,1976) said in The money game that The first thing you have to know is
yourself. A man who knows himself can step outside himself and watch his own
reactions like an observer. Discussing about investor decision and considering that
people are rational could be a limitation of the human nature which could lead to
important mistakes. This paper tries to adapt the model of asset allocation to account
for the cognitive and emotional biases present in men and women investment
decisions using the findings of the generous field of behavioural finances.
First part presents, as a starting point, the debate between the classic and behavioural
finance regarding the market efficiency and the investor rationality. In the second one
we are discussing how a financial consultant could and should act in the relation with
his partly rational client, what principles he could have in mind. The third and forth
parts are dedicated discussing the main cognitive and emotional biases included in the
study conducted in the fifth part while the next part encloses the gender influence to
the asset allocation model. The last part is dedicated to the main conclusions and
limits of the study and also to the further researches proposed to complete this work.
1. CLASSIC VERSUS BEHAVIORAL FINANCE: CAPITAL MARKET
EFFICIENCY AND INVESTORS RATIONALITY ON THE MODERN
CAPITAL MARKETS
The efficient market hypothesis (EMH) has been the central proposition of finance for
nearly forty years. During the 1970s the standard finance theory of market efficiency
became largely accepted by a majority of academics and also by a good numbers of
professionals. The basic theoretical case for EMH (Fama, 1970) rests on three
arguments: the investors are rational and as a result they value securities rationally;
assuming that some of the investors are not rational, their trades are random and
therefore cancel each other out without affecting prices; accepting a certain degree of
irrationality, this kind of investors are met in the market by rational arbitrageurs who
eliminate their influence on prices. Based on these, a series a model based on
efficiency concept have been developed, started from the initial version who defines
the efficient market as a market who rapidly adjust on the latest available information
and continuing with the modern version (Fama 1991) where the financial asset prices
reflects in a holistic manner all the available information. This implies that the
investors and the market are fully rational and the prices level is determined by the
fundamental determinants.
There are three forms of the efficient market hypothesis:
the weak form all past market prices are fully reflected in securities prices so
it is impossible to earn superior risk adjusted profits based on the knowledge
of past prices and return;
the semistrong form all publicly available information is fully reflected in
securities prices so the investor cannot gain using this information to predict
returns;
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the strong form all information is fully reflected in securities prices or in

other words, insider information is of no value.
There are mixed empirical results regarding the market efficiency but mostly non
supporting the strong form of EMH (Nicholson, 1968, Basu, 1977, Rosenberg et al.,
1985, Bechev, 2003, Moustafa, 2004, Dima et al, 2006,). Researchers have
documented numerous, persistent anomalies that contradict the EMH as the
fundamental anomalies, technical anomalies, calendar and weather anomalies. The
fundamental anomalies appear for instance because investors consistently
overestimate the prospectus of growth companies and underestimate the value of outof-favour companies Also numerous studies have shown that low price-to-earnings
(P/E) value stocks tend to out-perform both high P/E stocks and the market in general.
The technical anomalies are revealed due to the use of technical analysis which
attempt to forecast securities prices by studying past experiences. Sometimes
technical analysis finds inconsistencies with respect of efficient market hypothesis,
called technical anomalies. In the last categories one could easily include some very
well known anomalies as: January effect, Monday effect, December effect, Turn-ofthe Month effect, SAD effect.
One alternative solution, acknowledging a lot of anomalies which contest the
efficiency, information symmetry and investors rationality is represented by the
bonded rationality models, firstly promoted by Herbert Simon. He supports the idea of
a partially rational investor who takes just a part of the decisions based on
fundamental criteria and the rest based on emotional irrational factors. Starting from
his work, a series of other studies (March, 1994, Rubinstein, 1998, Gigerenzer and
Selten, 2002, Kahneman,2003, Hirshleifer et al.,2006) are using the bounded
rationality to explain the individuals decision determinants, using fundamental
methods on information analysis and understanding the information, even the
asymmetrical ones. A development of this line is represented by the so called fuzzy
logic, the neural networks and genetic algorithms. (Chiang 1996, Kim and Chum,
1998, Aiken and Bsat, 1999, Romahi and Shen, 2000) formulated decisional models
based on a postulated rational behaviour in imperfect information conditions.
Generally speaking the mentioned studies seems to try to solve two different kinds of
problems: the portfolio optimization (including the efficiency frontier) and the short
term prediction of the asset prices dynamics (Lowe, 1994)
In the last decades there been a lot of works analyzing the investor psychology and the
way it affects his decisions and the market. In their seminal work, Tversky and
Kahneman (Tversky and Kahneman, 1974) investigate heuristics that people often
employ when making decisions under uncertainty (representativeness, availability,
adjustment and anchoring). Despite the usefulness of heuristics (they could make the
probability valuation of the uncertain events much easier) they could also lead to
systematic biases. Kahneman and Riepe (Kahneman and Riepe,2003) focus on biases
in beliefs and preferences of which financial advisors should be aware: judgment
biases: overconfidence, optimism, hindsight, over-reaction to chance events; errors of
preference: non-linear weighting of probabilities, people value changes not states,
value function, the shape and attractiveness of gambles; the purchase price as a
reference point: narrow framing, repeated gambles and risk policies, short and long
views; living with the consequences of decisions: regrets of omission and commission,
regret and risk taking. In his book Shefrin presents a large number of heuristic driven
biases (representativeness bias, gamblers fallacy, overconfidence, anchoring and
~835~
adjustment, conservatism, ambiguity aversion, emotion and cognition) and framedependence driven biases (loss aversion, mental accounting, hedonic editing,
cognitive and emotional aspects, self control, regret, money illusion).
During the last years, a lot of models starting from the predominant theoretic
approach from the quoted papers were proposed. One could notice the behavioural
models based on artificial financial markets -ACE: agent-based computational
economics (Pidd,2000, Boer-Sorban et al.,2005, Tesfatsion and Judd, 2006, LeBaron,
2006, Hommes, 2006, Lovric et.al.,2008), Chan model which validated one of the
most important bias in behavioural finances called representativity (Chan et al.2002),
Mei model which tested the capital market manipulation determined by driven
heuristics biases, for the first time on the American market (Mei, 2004); Lo model
(AMH-Adaptative Markets Hypothesis)where the individual investor adapt their
decision to the environment changes using heuristics (Lo,2005), Baker and Wurgler
model which proposes a way to measure the investors feelings and test it on the main
speculative events in the last 40 years (Baker and Wurgler,2007), SAD model (Kelly
and Meschke) which tests the seasonal effects on the investors attitude.
2. INCLUDING BEHAVIORAL ELEMENTS IN THE ASSET ALLOCATION
PROCESS
There is no doubt that understanding the investors mind and emotions could improve
the relation between him and his financial consultant. The result will be a balanced
portfolio constructed for achieving the investors long term objectives.
First question raised form here could be: in what circumstances should the consultant
moderate the biased investor and in what circumstances has to adapt. Two main
principles could be formulated regarding to this problem (Pompian, 2006):
moderate biases in less wealthy clients and adapt to biases in wealthier clients
moderate cognitive biases- adapt to emotional biases
Why should a consultant adapt if his client is wealthy? The wealthy clients do not care
if they lose money? No doubt they do but the loss has a very different impact on their
general situation. For a less wealthy client an adaptation to his biases could represent
an important threat to his lifestyle but in a wealthier client case only severe market
turmoil could affect the clients daily financial security
The second principle is easily explained if we consider the potential causes of the two
biases types. The cognitive biases are derived from faulty reasoning and could be
corrected much more easily if the investor is better informed and advised than the
emotional one who is derived from the investors personality, from impulse or
intuition.
To combine those two principles one could chose to follow the next path: to adapt if
the client have a high level of wealth and shows emotional biases, to moderate and
adapt if the investor has a low level of wealth and shows emotional biases, to
moderate the cognitive biases for a less wealthy client and finally to moderate and
adapt in the last situation as one can see in the next figure.
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Figure 1. Two axis behaviour model

High level of wealth (Adapt)
Moderate and
adapt
Adapt
Cognitive
biases
(Moderate)
Emotional
biases
(Adapt)
Moderate and
adapt
Moderate
Low level of wealth (moderate)
(Source: Pompian, 2006:45)
3. COGNITIVE BIASES
A cognitive bias is a term used to describe many distortions in the human mind that
lead to perceptual distortion or inaccurate judgment. They occur because they lead to
more effective actions in given contexts or enable faster decisions when faster
decisions are of greater value or could result from a lack of appropriate mental
mechanisms, or from the misapplication of a mechanism that is adaptive under
different circumstances
A large amount of cognitive biases are mentioned in the literature. Our study will
focus on 13 of them, listed and described below:
Overconfidence bias
Anchoring bias
Illusion of control
Framing bias
Conservatism bias
Hindsight bias
Cognitive dissonance bias
Recency bias
Representativeness bias
Availability bias
Mental accounting bias
Confirmation bias
Self-attribution bias
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3.1. Overconfidence bias

Extensive evidence shows that people are usually overconfident in their judgments.
An overconfident individual overestimates his personal contribution at the successful
events with respect to capacities of other people on average and underestimates the
associated risk (Hoffrage, 2004). A potential reason for that is that people assign too
narrow intervals to their estimates of quantities. Second, people are poorly calibrated
when estimating probabilities (Barberis and Thaler, 2002). The result is an investor
who overtrades in such a way that the difference between stock he buys and those he
sells does not cover transaction costs.
In the behavioural finances overconfidence is one of the most discussed biases
because it can make the market less efficient creating the mispricing in the form of
excess volatility in return prediction (Ko and Huang, 2006). There is a strong
correlation between investors overconfidence, prices, turnover, volatility and market
bubbles because the manipulators strategic actions combined with this bias not only
bring profits to the manipulator but also brings about higher volatility, larger trading
volume, short-term price continuation and long-price reversal (Scheinkman and
Xiong, 2003, Mei et al, 2004).
Several scholars analyzed during the time the negative effects overconfidence could
impact the decisional process and how this bias affects the boys and girls (Barber and
Odean, 2001, Chira et.al, 2008).Their study pointed out the fact that due to their
overconfidence excess the boys will overtrade more and will have poorer
performances compared with girls. Girls and boys also in their study would obtain
higher performances if they would be stick at the initial investment portfolio because
the shares they decided to sell would bring higher benefits than the ones they decided
to buy (for instance in Barber and Odeans study the shares men bought generated
20% smaller returns than the one they have sold from their portfolio. The same
decrease was 17% in the womens case)
3.2. Anchoring bias
Anchoring is a cognitive heuristic in which decisions are made based on an initial
value: anchor, adjusted up or down in order to reflect the subsequent information
(Epley and Gilovich, 2006). The main problem regards the fact the adjustment is often
insufficient and the final value will heavily depend on the initial value. In financial
markets is often seen that even the data and forecast that initially appear to be far from
reality can still present an anchoring effect (Goldberg and von Nitzsch, 2001).
Because of the anchoring bias the investor tend to stick too closely to the current level
of the current level or the original estimates about a company or a financial indicator.
Also investor could become anchored in a economic state of a certain countries, sector
or companies which could negatively affect their portfolio (Pompian, 2006)
The existence of anchoring effect is relevant because help us to ask if the individuals
truly have a unique, stable and very well defined preferences or are influenced by
arbitrary anchors (Araa and Len, 2004). Trying to answer at this question Araa
and Len conducted a field experiment based on double bounded dichotomy choice
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method with the next results: anchoring effect alters the welfare estimation and put
under the question the stability of the preferences; the elicited preferences could be
considered stable or insensitive to scope even under the presence of the anchoring
effect; between the anchoring effect and emotional intensity a U form relationship
could be found.
3.3. Illusion of control bias
Ellen Lager defined the illusion of control al attributing a higher probability to the
subjective success than to the objective one (Langer, 1975). The right to chose, the
results sequence, task familiarity, competition but also active implication could
increase the individual confidence in them self and create the illusion of control.
When a person act intending to obtain certain result and the relation between this
action and the result is obvious, people usually consider that they controlled the
events. As many other heuristics this shortcut could also lead to correct judgments.
For instance when they have the power to influence the outcome the individuals
usually act deliberately to obtain it so there is a relationship between that action and
the outcome. Also people could act for a special result and could consider that there is
a connection between their acts and the outcome even in situations when they cannot
control things (Thompson, 1998).
Illusion of control could determine investors to trade more than is prudent and to
maintain under diversified portfolio because they think they can control and beat the
market. The excessive use of limit orders and other such control techniques could be
also considered a result of this illusion. The institutional investors are also committed
to this error because the task and environment faced by traders are conducive to the
development of illusions of control and that individual propensity to illusion
of control will be (inversely) related to trader performance (Fenton-OCreevy
et. al, 2010)
3.4. Framing bias
Framing refers to the way a problem is poses for the one who has to take a decision.
The first step in making a choice is to frame it but it is also the first place where
people can go wrong because the way a problem is framed influences the choice they
make.
According to the behavioral scholars if the option is presented as sure gain the result
will be a positive framing effects which will generally lead to a less-risky choice
(Twersky and Kahneman, 1981) comparing with a option presented as relative
likelihood of looses where negative framing effects will occur.
Different models have been proposed to explain the framing effect: prospect theory
which explains the framing effect starting from the differential weighting people give
to losses than to equivalent gains (Kahneman and Twersky, 1979), fuzzy-trace theory
based on the determination of the amount of cognitive processing needed to
distinguish between potential losses and gains (Reyna et.al, 2003), motivational
theories which use element as fear and wishes in order to explain what determine our
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decisions (Reiss 2004), cognitive cost-benefit trade-off theory as a compromise

between desires, correct decisions and cognitive efforts (Flyvbjerg et al, 2003).
The development of neuroimaging have linked the framing effect to the neural
activity in the amygdala (responsible for fear) and in the orbital and medial prefrontal
cortex that appears to be the part of our brain responsible for moderating the
emotions role on decision. Monitoring brain activity using functional magnetic
resonance imaging a greater activity in the prefrontal cortex of the subjects less
susceptible to framing-effects was noticed (De Martino et al., 2006).
3.5. Conservatism bias
A conservatism bias means that investors are too slow (too conservative) in updating
their beliefs in response to recent evidence. This means that they might initially under
react to news about a firm, so that prices will fully reflect new information only
gradually. Such a bias would give rise to momentum in stock market returns." (Bodie
et al.2005). In a narrow sense conservatism means that people are not perfect
Bayesian updaters (Massy and Wu, 2005).
Conservatism could cause investors to cling to a initial forecast or opinion, to react
too slow to new information and not in the last place, can be related to an underlying
difficulty in processing new information. One of conservatisms possible explanations
is that processing new information and updating beliefs is cognitively costly.
Confronted with abstract and statistical information people tends to weight them less
than the information which are easily processed and this form of base rate
underweight could be considered a form of conservatism (Hirshleifer, 2001).
Conservatism bias is present at the individual investors level but also at the financial
analysts level. James Mortier noticed in 2002 that analysts are exceptionally good at
telling what has just happened but have the tendency to underreact to fundamental
information as dividends, initiations, earnings reports because they invested in their
view and they will change it only when presented with evidences of its falsehood
(Mortier, 2002)
3.6. Hindsight bias
The hindsight bias is a psychological phenomenon which tends to occur when a
person believes that the past events were predictable and completely obvious. Investor
believe that he truly predicted what happened and they new from the beginning the
right answer, the events succession, the price evolution etc (Fischhoff, 2001) In fact,
as Keynes said the representative investor is assumed to understand the economy and
the process determining asset prices; the individual investor frequently does not .
Psychologist consider that hindsight is determined by our innate need to find a pattern
an order in the world by creating explanation that allow us believe that we could
predict future events. For investors hindsight bias is a cause for the most dangerous
mindsets that an investor can have: overconfidence. There are strong evidences for the
consequences hindsight bias could have on the investors decisions, the portfolio
allocation perception and in the final on the risk exposure (Werth et al, 2002, Monti
and Legrenzi, 2009). If this bias is present the investors will try to rewrite the history
in order to have a reason to believe their prediction was correct.
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3.7. Cognitive dissonance bias

When the newly obtained information does not match what individuals already
understood and accumulated or when a conflict between desires and self-interest and
fairness arises this generates a psychic discomfort called cognitive dissonance.
Cognitive theory proposes that the individuals will try to reduce this tension, to
harmonize what they know either by reducing self-interest behaviour or by engaging
in self-deception or by a combination (Festinger, 1957)
In order to reduce the cognitive dissonance the investors brain filters and reduce the
relevance of the negative information and concentrate son the positive information,
consonant with the former opinions. Investors who present this bias would maintain
the losing position despite the logical action just trying to avoid recognizing that he
was wrong; also the investor could continue to buy stocks just to confirm the initial
reasoning even if it is not a good idea and could neglect the new information which is
discordant with their ex ante expectation (Konow, 2000). This will lead to a
systematic overvaluation or undervaluation depending of the new information
combined with an risk assessment error (Eckwert and Dress, 2005)
3.8. Recency bias
The last events and information seem to have more importance for the investor. The
large amount of data available to the investor are not all the time cognitively available
because the investors usually have difficulties in understand, process and assimilate
large amounts of data. The recency bias could be defined as the tendency to remember
and to consider more recent information than historical information. As a result this
could cause the abandon of the long-term strategy and hinder the ability to make
rational investment decision.
In the bull market often investors are suffering by this bias considering that this bull
market will last. In fact the bull market is sooner or later replaced by a bear market. If
the investor extrapolates trends and tries to make predictions on short data series he
could buy the stocks exactly in the pick moment. Also this error could determine the
investor to consider just the last prices evolutions and ignore the fundamental value of
the assets they intend to buy or to overload the portfolio with hot stock which will
unbalance the portfolio and will determine an increase in the taken risk level.
In a paper named Irrational Pessimism and the Road to Revulsion, James Montier
(Montier, 2003) created a model using the recency bias and anchoring bias to proxy
investors expectations. Montier presents in parallel the irrational and rational
investors model noticing that between the expected return in a rational and irrational
models there is a difference of at least 3%, determined by those two biases.
3.9. Representativeness bias
Confronted with large data flow the investor tries to classify them to look for patterns
which could help him to understand the events and predict the future.
Representativeness heuristic is a judgement based on stereotypes (Shefrin, 2000) and
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it is high when an observation fits the pattern (Goldberg and von Nitzch, 2001). Some
of the most important application of this heuristic could be found in market
prediction, picking stocks, choosing mutual funds, investing in initial public offerings.
The neuronal studies found out that this bias is connected with the left side of our
cortex which is responsible for trends search even if there are no any and the
phenomenon is random. One of the most used financial example of this bias is
winner-loser effect (DBond and Taler, 1985) which could be explained from the way
the investor see the past winners (too optimistic) and past losers (too pessimistic)
which leads to an overvaluation of past winners and undervaluation of past losers.
Base rate neglect (judging the potential outcome probability investors tend to neglect
base period frequencies used to analyse the same phenomenon) and sample rate
neglect (choosing to short intervals in order to perform the needed analysis) are also
very frequent in the case of the investor confronted with this bias.
3.10. Availability bias
Availability is a heuristics in which the probability of an event is assessed on how
easy is to recall its instances- retrievability,to mentally construct its instances imaginability or how easy is to associate two instances - illusionary correlation
(Tversky and Kahneman, 1974).The individuals affected by this bias consider more
probable the events they recall and understand better comparing with the one who are
harder to imagine or understand.
What mistakes can cause availability for the investor? The main problem is that the
investor will chose the asset he wants to buy based on the cognitive available
information excluding the disciplined research. Also the investors will usually chose
investments which fit their expertise area and which resonate with their own
personality ignoring some potential good investments. In working paper called : All
that glitters: the effect of attention and news on the buying behaviour of individual
and institutional investors, Odean and Barber (Odean and Barber, 2002) pointed out
that when confronted with the need to take a decision the investor chose usually the
stocks who catch their attention not necessarily the best stocks. These glittering stocks
are signalled according to the authors by: daily abnormal trading volume, daily returns
and daily news.
3.11. Mental accounting bias
Mental accounting bias describes the human tendency to codify, categorize and
valuate the economic results by grouping them on non-fungible and noninterchangeable mental accounts. Three types of mental accounting were widely
described in the literature (Thaler, 1999). First type regards how the outcomes are
perceived and experienced and how the investments are finally valuated: ex-ante and
ex-post cost-benefit analysis. The second one involves the assignment of activities to
specific accounts. People like to separate gains and integrate losses. For example in
capital markets an investor who experienced capital gains like to separate dividends
payments and in bear markets they can use dividends to buffer capital losses.
Different types of resources and expenses are separately included in different mental
accounts: long term versus short term, incomes versus capital, poverty protection
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versus development potential. The third approach regards the frequency these
accounts are evaluated: daily, monthly, yearly and the way they are defined: narrowly
or broadly, concept called choice bracketing.
The mental accounting is a very often bias which could lead to important mistakes.
The most common is that decision makers tend to segregate different types of gambles
into separate accounts and then apply prospect theory to each account neglecting the
potential connections among them. The investors have difficulties in noticing the
interconnections between assets which leads to the pyramidal portfolio construction
where each floor is addressed to a certain investment purpose.
The house money effect (prior gains increase risk seeking for wealthy individuals)
and disposition effect (investors are risk averse over gambles for some stocks and risk
loving in gambles for others) are both determined by the mental accounting bias. The
noticed difference in attitude is driven by weather the stock has generated a paper
capital gain or a paper capital loss (Grinblatt and Han, 2005) explaining the link
between momentum and turnover (Lee and Bhaskaran, 2000)
3.12. Confirmation bias
Confirmation bias is a tendency to search for evidence which could confirm your
preconceptions, rather than for evidence that could disconfirm it (Jones and Sugden,
2000).This bias affects the decisions the investor may take in the relation with the
acquisition of information. For example the investor could search only for the
information which confirms the initial reasoning he has to choose the financial
instrument neglecting all the rest of them. The investor could also concentrate his
portfolio in shares of the company where he works or in other companies because he
emotionally connects and does not want to hear anything negative about them.
Confirmation bias could determine investors to be overconfident ignoring that in this
way they could lose money (Zweig, 2009). Several scholars have determined that the
investor would make more profit if he will resist to this bias and he will try to find
arguments for a contrary viewpoint just for the sake of argument. (Hilton, 2001)
imagining that they investment have collapsed (Krueger and Mann, 2009).
3.13. Self-attribution bias
"Self-attribution bias occurs when people attribute successful outcomes to their own
skill but blame unsuccessful outcomes on bad luck." (Shefrin, 2000).
Investors who experience a run of successful results start to develop an inflated
opinion of their own skill which could determine and exaggerated risk taking. More
than that the investor fails to learn from the mistake and in this way create o good
opportunity to repeat them. Thinking that they are infallible investors starts to
overtrade and to maintain under diversified portfolios.
4. EMOTIONAL BIASES
An emotional bias is a distortion in cognition and decision making due to emotional
factors. Emotions play the role of a pain avoiding/pleasure seeking decision factor.
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This role associated to feelings is often important and maybe more than the part
played by pure cognition.
The study take into consideration 5 of the emotional biases listed below:
Optimism bias
Endowment bias
Self-control bias
Loss aversion bias
Regret aversion bias
4.1. Optimism bias
According to the John Maynard Keynes (The general theory of employment, interest
and money, 1936) even apart from the instability due to speculation, there is the
instability due to the characteristic of human nature that a large proportion of our
positive activities depend on spontaneous optimism rather than a mathematical
expectation, whether moral or hedonistic or economic
Optimism bias, originally referred to as unrealistic optimism (Weinstein, 1980), could
be defined as the tendency of individuals to be overly optimistic about the outcome of
planned actions. This includes over-estimating the likelihood of positive events and
under-estimating the likelihood of negative events.
Hope and fear are obviously sentimental states characteristic of this form of
unrealistic optimism and they could represent the main motivational factors of a
particular way of action. The entrance of unrealistic optimism into financial world
could potential hurt if it leads to passivity and lack of interest thinking that the
problem will self solve or impulsive behaviour, taking wrong decision based on
illusions.
Kahneman and Lovallo realised a more technical description of this error. They
consider it determined by the investors inability to analyse the facts form outside,
non-passionately and comparing the current situation with the previous ones (Lovallo
and Kahneman, 2003)
The financial analysts are not exempt from this bias. Analysts are typically
overoptimistic, slow to revise their forecasts to reflect new economic conditions, and
prone to making increasingly inaccurate forecasts when economic growth declined
4.2. Endowment bias
The endowment bias is a really common feeling among the owners of economic assets
who consider that they worth more than the market because ownership increase value
in the owners mind. As a result the investor will ask for more money to sell the asset
than he will give to obtain it. The disparity between the willingness to pay for a
certain good (WTP) and the willingness to accept retribution payments in exchange
for giving up this good (WTA) cold be explained by the disutility from parting with
ones endowment and/or by an extra utility from ownership which is not anticipated
by individuals who are not endowed with the good (Bischoff, 2006).
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This bias could determine the investor to keep the inherited and bought securities even
if they worthless because this could be seen as a lack of loyalty or because they are
afraid that the selling will generate fiscal effects. Plus the investor could be afraid that
he will have to bear high trading cost if he sells those securities but in some cases the
opportunity costs leaded to their keeping is higher that the trading cost. This bias is
more frequent in the case of the investor with small experience. Experienced traders
are less susceptible to endowment bias (List, 2003)
4.3. Self control bias
Many financial decisions involve individual intertemporal choices in trying to find an
answer to the question: spend now or save for tomorrow? How do we decide? There
are two sets or answers. In the first one the answer in rational, logical based on the
careful weighting up the present value against the future, exercising the wisdom of
Solomon. Unfortunately this view does not explain how people actually behave
(Thaler and Shefrin, 1981). Nowadays amongst researchers there's much less
emphasis on peoples rationality - and more on how our self-control and emotions
interact at the actual moment of decision-making (Camerer, Loewenstein & Prelec,
2005).
In the literature there are several factors which are were found as interacting with the
self-control:
increased cognitive load based on the fact that distracted people are more
likely to spend money. Commercials, incredible offers are made to confuse the
individual and to make him open his wallet in the detriment of the investments
for tomorrow.
frequency we had to use the self control: studies show that our self-control is
undermined each time we use it (Baumeister and Vohs, 2003)
sadness could determine an increase in our spending desires because those
who are sad are more likely to want to sell at a lower price and buy at a higher
price (Lerner et. al, 2004).
disgust determine a decrease in our desires to buy things
anxiety makes us to prefer low-risk option in order to reduce uncertainty
(Raghunathan and Pham, 1999)
4.4. Loss aversion bias
The loss aversion bias could be defined as the tendency to find losses twice as painful
as we find gains pleasurable. People hate losses (and their Automatic Systems can
get pretty emotional about them). Roughly speaking, losing something makes you
twice as miserable as gaining the same thing makes you happy....Consequently loss
aversion produces inertia, meaning a strong desire to stick with your current
holdings,(Thaler and Sunstein, 2008) Nudge: Improving Decisions About Health,
Wealth and Happiness.
Loss aversion also explains a very common tendency to sell the stocks that have
increased in value and to maintain the depreciating stocks. On the long term this
strategy is exceedingly foolish because in the final the portfolio will be composed
entirely of shares that are losing money. Why does the investor do this? One of the
possible explanations could be that if they would sell their shares that have decreased
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in value this will make the loss tangible and they prefer to postpone the pain for as
long as possible, causing in this way more losses. The things seem to be also
connected with the brains activity because several studies have shown that higher
sensitivity to loss entails emotional processes recruiting structures such as the
amygdala and the anterior insula, which are parts of human cortex associated with a
some mostly negative emotions and behaviors, from the generation of fear to the
memory of painful associations (Tom et al, 2007).
4.5. Regret aversion bias
Sometimes where people are confronted with the results of a bad decision they blame
themselves considering that a different way of action would bring a different outcome.
This unpleasant feeling is the emotion of regret. Regret has serious behavioural
implication determined from the anticipation and also from the experience of this
emotion (Zeelenberg et al, 2001)
Usually individuals experience more regret for the actions they have take than for the
action they have forgone (Gilovich et al.1995, Ordonez and Connolly, 2000)
5. GENDER REALLY MATTERS?
In order to test for the described biases a questionnaire was distributed to 1000
participants, students form West University from Timisoara and Polytechnic
University from Timisoara. 888 questionnaires were declared correctly filled and were
used in the second step to determine if men and women are equally susceptible to
certain cognitive and emotional biases at the debut of their investment period.
The questionnaire encloses 38 multiple choice questions that verify the presence of
the 18th biases already discussed. The respondents were asked to state first their
gender and after to fill the form with the answers they consider correct for them. The
asked questions are presented below .The answers susceptible of the bias are market
with bold characters or/and italic characters; in the case of the biases verified by two
questions each answer susceptible of that bias counts 0.5 point. In the case of
2 answers susceptible for a bias for a question, the second susceptible answer counts
0.25 point the answer market with italics (the questions were randomly distributed in
the questionnaire)
5.1. Overconfidence
How easy you would consider predicting the price increase for a certain stock on the
stock exchange?
easy
pretty easy
pretty hard
hard
Do you think you could easily estimate what stocks will outperform the market?
absolutely not
in a very small part
yes
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5.2. Anchoring bias

You bought two years ago A companies stocks with 5 RON and now their price is
8 RON. A couple of month ago the price reached a record level of 15 RON caused by
the announcement of high past profits. You thought to sell the stocks but you havent
done it. The price dropped at 15 RON after the managers were accused by fraud.
What would you chose from the following choices?
keep the shares hoping that the price will increase again at the previous level
because now you are feeling that you would lose 7 (15-8) RON if you would
sell them
sell the shares because this increase had a conjectural reason.
Assume that you would have to sell your current house from the outskirts in order to
buy another one located in the centre of the city. You still hesitate regarding your
selling price. Your agent valuated your property at 200.000 euro. This value amazes
you because you have bought the house 15 years ago with 50.000 euro. You have
posted your selling order on market but you did not receive any offer for a couple of
month. One of the days your agents ask you an urgent meeting. He told you that
company A, that was created 8 years ago have bankrupt and 2.500 people remained
unemployed. Your agent and his co-workers concluded that this bankruptcy made the
real market to drop 10%. Your agent told you that you have to revaluate your selling
price taking into consideration this new information. You are telling him that you will
consider it and you will tell him the results. What is more probable for you to choose?
decide to keep the initial price
decide to reduce the price with 5%
decide to reduce the price with 10%
decide to reduce the price to 150.000 because you want to be sure that you will
sell it.
5.3. Illusion of control
Do you consider yourself able to better control the game output if you throw the dice
when you play games like Monopoly, dice, etc?
yes, seems that I am in control
no, this does not matter for me
If you buy a lottery ticket are you more confident when you are choosing the numbers
comparing with a randomly selected numbers?
yes, it seems more probable to win if I am choosing the numbers
no, this does not matter for me.
5.4. Framing bias
(In this case the susceptibility of this error is verified if the respondent chose different
answers to the two parts)
a. Assume that you prepare to retirement. You need 50.000 RON per year to live
comfortably but you could live with 40.000 RON and you could survive in the
extremis with 30.000 RON. In the second step, assume that there is no
inflation. Now you have to choose among two hypothetical investments. First
choice will secure you 40.000 RON/year without risk and the second one will
bring 50.000 (50% chance) or 30.000 (50% chance). What would you chose?
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first option
second option.
b. Assume that you prepare to retirement. You need 50.000 RON per year to live
comfortably but you could live with 40.000 RON and you could survive in the
extremis with 30.000 RON. In the second step, assume that there is no
inflation. Now you have to choose among two hypothetical investments.
The first choice will secure you an income able to cover your main living
expenses but you will be never able to have a high living standard. In the
second alternative you have 50% chances to have a high living standard
(50.000 RON) and 50% chance to have to live with 30.000 RON. What would
you chose?
first option
second option.
5.5. Conservatism bias
Assume that you live in Covasna and you make a prediction that sound like this: I
believe that in this winter will be a lot of snow. You are realising that you are in the
middle of February and there were no snow. What is your natural reaction to this
information?
there is still time to snow, so my prediction still can be correct
there is still time to snow but it is possible to have been mistaken
my experience tells me that my prediction is probably incorrect. The winter
almost have passed.
What your natural reaction could be when you hear some news that could negatively
affect your investments?
I am tempted to ignore them because I have already made my investment
I will revaluate the initial reasons I had but probably I will stick to the initial
decision because usually I am doing this
I will revaluate the reasons that determined me to initially buy the stock and I
will decide what to do after analysing all the determinants.
5.6. Hindsight bias
Assume you have made a bed investment. What is your natural reaction to that?
Normally I will not blame myself because it could be a misfortune. I wil sell
the shares and I will move on
I would want to know why I have failed. Usually I have a pretty good
fundament decision system and I have to realise what motivates the
performances of my investments.
Assume you have thought to include open-end funds units in your portfolio. You
analysing their performances. What is your natural approach when you are evaluating
their performances?
I am tempted to look at the historical performances comparing them with a
certain referential. I am not interested in the strategy the manager applies. I
am interested just in results. If the results are not satisfying I prefer not to
choose it.
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I am looking at the returns but I also pay attention to the managers strategy
and I am trying to realise what manager did in the analysed period of time. In
my decision coherent strategies represent an important factor.
5.7. Cognitive dissonance bias

Assume that you just have bought a new mobile phone, brand A, model B. You are
very happy with your acquisition. One day your colleague meets you and has the next
statement: This is a very nice mobile. I know this model. Did you know that for the B
brand, model D (model D is almost identical with model B) free internet is included?
You are confused initially. You did not know about it and you would also like to have
this option. Maybe you start questioning your decision and to ask yourself if you have
done the right decision. You returning back home. Which of the next action would
consider more suitable for you?
Try to find if the information is correct
You will neglect the information thinking that if you would be in the position
to buy it again you would do the same. Even if mine does not have the free
internet I am still happy with my decision
You think to further investigate the D model. Still you decide not to and you
decide to listen to your first instinct because you prefer not to discover that
you misjudged. It is better to forget about is and to enjoy it.
Assume that winter came and the entire city is full of snow. You do not have winter
tires and do not intend to buy some because believe that the winter will pass even
without them. In the evening at the news a lot of accidents due to the snow and ice are
announced and all the people are counselled to buy winter tires. What do you decide?
Even if you are confident in your driving abilities you will go and buy some
adequate tires
You are going to a tires store but because they are too expensive you abandon
the idea
You still thinking at the last years experiences and you continue to drive
without winter tires
5.8. Recency bias
Read the next names list. Without counting them answer to the next question: the list
contains more male or female names?
Sorin, Andreea, Silvia, Andrei, Ana, Maria, Eugen, Maximilian, Rodica, Octavian
Male names
Female names
5.9. Representativeness bias
George was a very good handball player in high school. After graduation George
become sport teacher. George has two sons, both very good athletes. What do you
consider more probable?
George will become the coach of the local handball small league
George will coach small league and play at the local team
~849~
Look carefully the next results from flipping a coin in the air. Which one of the next
outputs seems more probable for you?
Had
Tail
Tail
Tail
Tail
Tail
Had
Tail
Had
Had
Had
Had
First one
Second one
5.10. Availability bias

Assume that you have some money to invest and that you get a tip from a neighbour
who is known for his flair. He recommends you to buy shares of A company. What
would you do?
Probably I will buy those shares because my neighbour is usually right
Probably I will take his advice into account but I will first go home to analyse
the offer
Which one from the next two determine more deceases in USA
Lightings
Tornados
Mental accounting bias (In this case the susceptibility of this error is verified if the
respondent chose different answers to the two parts)
a. Assume that you have bought a ticket to the favourite band. When is about to
start you notice that you have lost your ticket. You have paid 100 RON for
your ticket and you are noticing that there are still available tickets for the
same price. Associate a probability to a new tickets buying.
100%
50%
0
b. Assume that you have not bought a ticket in advance but you thought that you
will buy one with 100 at the entrance. When you are there you panic because
you realise that you lost the 100 for ticket. Notice that there is an ATM near by
so you could use it to get the needed money. Please associate a probability
100%
50%
0
5.11. Confirmation bias
Assume that you bought a security after a close search. You have seen now that the
company have serious difficulties in production. In the second paragraph of the media
communicate you are reading a new product which could start to be created by the
firm, is described. What will you do?
I will notice the new product launch and I will further investigate it
I will notice the problems regarding the old products and I will try to further
investigate it
Assume that you have invested in a security. The investment value increases but not
caused by the predicted factors. What would you do?
Because there is an increase, the reason does not interest me
~850~
Even if I am very satisfied with my investment I will check it to see what

happened.
5.12. Self-attribution bias

If the total return of your portfolio increases, what is the cause for this?
Your investments talents
A combination between talent and lack
Lack
After you invested some money you hear news which will negatively impact your
investment. How probable it is that you will look for other information to confirm that
you were wrong?
Extremely improbable
Improbable
Probable
Very probable
5.13. Optimism bias
If you have to choose between investing on the next exchanges, what would you
chose
Bucuresti
Osaka
Londra
How large is the probability of something good happening to you today?
very high
high
moderate
reduced
5.14. Endowment bias
Assume that your aunt have died and left you 100 IBM stocks. Your consultant told
you that you already have too many stocks in the same field and he suggested you to
sell them. What is the most probable action you will take?
Probable I will keep those stocks because I have inherited them from my aunt
I will do what my counsellor says
Assume that you have bought some pretty profitable corporate bonds. They generated
high yields and you are very happy with them. Your financial consultant analyses
your portfolio and advice you to change them with municipal bonds, unknown for you
until now, with the same return. He explains that after all the taxes your profit will be
higher. How would you react?
You will prefer the corporate bond because they are familiar to you
You will sell the corporate bonds and buy the municipal bonds even if I am
not familiar with them
5.15. Self-control bias
How would you characterise yourself from the self-discipline point of view?
I am always reaching my goals if they are important for me no matter what
sacrifices I have to make
~851~
Most of the time I am achieving my goals but sometimes I have difficulties to

continue the battle if it seems to be too difficult
Respecting the promises to myself represent a real problem. I have very few
self-discipline and I am finding myself asking for help very often
Assume you need a new car. You had this car in the last seven years and it is the right
moment for a change. Which option seems possible for you?
Usually I do not spend too much money for my car because I am considering it
only a way of transport. I could save the money I would pay for an expensive
car and invest them
I would buy an average price car with sophisticated options because I like to
have a nice car. I cannot imagine myself buying a very extravagant car
When is about the car I like to indulge myself. Probably I will choose a special
model with luxury options. Even if buying of this car will affect my long term
saving I think for me is important the present
5.16. Loss aversion bias
Chose between the next two options:
A sure gain of 475
25% chance to gain 475 and 75% chance to gain 2000
Assume that you want to invest 50.000 RON. You have to choose between two
options:
To be sure that I will recuperate the invested money even if I do not gain
anything
To have a 50% chance to win 70.000 and 50% chance to gain 35.000
5.17. Regret aversion bias
Assume that you invested in company A and its shares increased with 10% in the
next 12 month. You are thinking to sell your shares to rebalance your portfolio but
you read an articol that states that their prices will increase further. What will you do
considering the new informations and evolutions?
I think I will keep them and I will sell them later. I would be realy sory if I
would sell them and I will notice a future increase
Probably I will sell them. But I will be sorry anyway if the price will increase
after I sold them
Probably I will sell the shares without any regret

The answers have showed some differences among the two genders, which are
described in the next graphs, grouped regarding the prevalence for the two genders
and the type of bias (cognitive or emotional)
~852~
Figure 2. Questionnaire results

Prevalent cognitive biases for women (% )
60
50
40
30
20
10
0
40
50 47
43 42
34
32 29
42 40
35
29 28
25 24
28
women
bi
as
di
ss
on
R
an
ep
ce
re
bi
se
as
nt
at
iv
en
es
s
bi
as
A
va
ila
b
M
ilit
en
y
bi
ta
as
la
cc
ou
nt
in
g
bi
as
C
on
fir
m
at
io
n
bi
as
Fr
am
in
g
of
co
nt
ro
l
si
on
C
og
ni
tiv
e
Illu
A
nc
ho
rin
g
b ia
men
Prevalent emotional biases for women(% )

80
72
70
62
60
49
50
43
women
40
men
30
20
10
0
Endowment bias
Regret aversion bias
Prevalent cognitive biases for men(% )

60
50
50
37
40
30
23
29
25
women
24
20
11
men
13
12
14
10
0
Overconfidence
bias
Conservatism
bias
Hindsight bias
Recency bias
Self-attribution
bias
Prevalent emotional biases for men (%)

60
50
55
50
40
30
women
19
20
men
20
7
10
0
Optimism bias
Self-control bias
Loss aversion bias
As one can see the results shows gender differences regarded to susceptibility to
certain biases, especially in the case of some of them:
Recency bias men are more susceptible to be affected by this bias (13%
diference)
Regret aversion bias women are more susceptible to be affected by this bias
(10% diference)
Mental accounting bias- women are more susceptible to be affected by this
bias (7% diference)
Why these differences? Trying to explain the first difference one potential explanation
could be represented by the memory differences between the two genders. According
to some specialists (Knox et al, 2001;Sinha, 2005, Washburn, 2005) women have
better multi-tasking skills than men which involve the use of memory. Women were
~853~
more likely to come up with a creative way to remember the events or values, a better
ability to adapt and respond to uncertainty that could improve their results in recency
bias.
Women are more pessimistic (see the result in optimism bias), realist (see the results
in overconfidence bias), risk adverse and regret adverse that men. The thinks are
connected because the higher proportion of regret aversion is somehow determined of
the general differences between man and women in those aspects (Zeelenberg et
al.,1996; Ben Zeev, 2000; Seiler,j.M., Viccky, l.S., Traub, S., Harrison, D.M.,
2008). The differences between genders could be explained using the knowledge of a
new field of cellular biology called epigenetic. The scientists promote the idea that the
main characteristic of a cell (in our case of our investor, man or woman) could be
better explained by the environment they live (the neighbour cells, their state and
local processes) than by their genetic determinants. The creation of sub-conscious
memory in the first year of life as a basis for 95% of our futures actions could make
us believe that the different environment we create for children, the different approach
in raising them could be a determinant of the differences we are noticing in their adult
life. The permanent encouragement for boys to be courageous, not to fear anything
and not to show their emotions could be seen in the action of the potential men
investors.
As one can see in mental accounting women seem to be again more biased than men.
One could say that it is normal to see this in the financial field too because it is really
common in the real non-financial life. Women are more used and more capable that
men to solve multi-task problems (Sinha, 2005) using the mental acocounting to
separate the career and different fields of the personal life in order to try to reach their
goals in both.
6. GENDER INFLUENCES IN ASSET ALLOCATION MODEL
The classic finance proposes portfolios build on the rule of return/risk optimization. It
is certain from what we have already discuss that men and women investors are not
alike and a common strategy for both could not be appropriate.
More, a portfolio who does not account for the biases the investor could be
susceptible to, based on the idea of investor rationality could not hold if we are aware
of the multiple examples of human irrationality and capital market lack of efficiency.
That is why sometimes the proposed portfolio should depart from the efficiency
frontier incorporating gender differences and the susceptibility to a specific set of
biases. For instance if the general mean-variance output recommendation would be
65% bonds and 35% shares it is more than possible to increase the proportion of riskfree asset in portfolio for women or to decrease it for a man, after analysing the biases
he is susceptible of. One should see the portfolio as a tailor-made one, specific to each
investor and to accept a departure from the classical optimum because the optimum
portfolio is the one which brings the expected return but also allows the investor to be
able to sleep.
~854~

The main conclusion of this paper is that men and women both are susceptible to
different cognitive and emotional biases but in different proportions and that those
biases affect their investment decisions. Constructing a portfolio based on the
assumption of investors rationality could be considered a non-realistically approach
as one could easily see from the results obtained from this questionnaire and from the
existing literature in behavioural finance. Including behavioural finance in the asset
allocation and taking into consideration the differences between genders in the
decision processes could be by far a more efficient solution.
One of the possible limitations of this study could be represented by the small number
of respondents and by their representativeness for the investor sample. This limit
could be overwhelmed by increasing the number of participants and by trying to find
a better representative sample.
A future direction is to try to create a neuronal network capable to generate clusters of
individuals who are susceptible to a specific set of biases, on gender criterion or/and
by other. This approach could help a potential consultant to know the investor better,
to create a portfolio that perfectly suits to the investors gender and personality.
ACKNOWLEDGEMENTS
This paper received financial support through the project, Post-Doctoral Studies in
Economics: training program for elite researchers - SPODE" No finance contract.
POSDRU/89/1.5/S/61755, European Social Fund project funded by Human Resources
Development Operational Programme 2007-2013
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Zeelenberg, M., Beattie, J., Van der Pligt, J., de Vries, N.K (1996), Consequences of regret
aversion: effects of expected feedback on risky decision making, Organizational
behaviour and human decision processes, vol.65, no.2:148-158
Zweig, J (2009), How to ignore the yes-man in your head Wall Street Journal (Dow Jones
& Company), available on-line on http://online.wsj.com/article/SB100014240527
48703811604574533680037778184.html
~859~
PS18 Education
Chairperson
Alain BURLAUD, INTEC Paris, France
ACCOUNTING STUDENTS ACADEMIC

PERFORMANCE: A BATTLE BETWEEN
PERCEPTIONS? A ROMANIAN RESEARCH NOTE
Carmen Giorgiana BONACI, Razvan V. MUSTATA,
Alexandra MUTIU, Dumitru MATIS
PERCEPTION OF THE ROMANIAN ACCOUNTANTS

REGARDING THE FINANCIAL ACCOUNTING
EDUCATION
Paul DIACONU, Vasile GORGAN, Catalina GORGAN,
Nicoleta COMAN, Codrina Sandru
MANAGEMENT VIEW RELATED TO HIGHER

EDUCATION AN ANALYSIS OF THE ROMANIAN
BUSINESS PERCEPTIONS
Mihaela STET, Alexandra ROSU
SOCIAL NETWORKING IMPACT ON EDUCATIONAL

PROCESSES IN ROMANIA
Florin MIHAI, Andrei STANCIU, Ofelia Ema ALECA
THE BEGINNINGS OF TRANSYLVANIAN CLUJ

ACCOUNTING SCHOOL
Teodora Viorica FARCAS, Adriana TIRON TUDOR
~860~
ACCOUNTING STUDENTS ACADEMIC

PERFORMANCE: A BATTLE BETWEEN
PERCEPTIONS? A ROMANIAN RESEARCH NOTE
Carmen Giorgiana BONACI1, Razvan V. MUSTATA,
Alexandra MUTIU & Dumitru MATIS
ABSTRACT
Our paper contributes to the body of literature dealing with accounting students academic
performance. Since any method used in measuring students academic performance will
generate results that bear the evaluators fingerprint, we focus our analysis on examination
performance. We therefore look at students self-acknowledged grades and their final grades
as assessed by the educator. The educator in assessing students final grades uses blooms
taxonomy of educational objectives. We further analyze and discuss students ability to
acknowledge their academic performance and the components of their final grade in
accordance to Blooms taxonomy. The analysis is performed on a sample of 3rd year
accounting students and considers the Controlling course. Cluster analysis is also employed.
The findings offer useful insights for accounting educators.
KEYWORDS: accounting students, examination performance, Blooms taxonomy, selfacknowledgement
INTRODUCTION
Accounting students academic performance represents an important component of
the educational process since it should represent a reflection of students knowledge,
but also an indicator of their intellectual abilities and skills. Chia (2005) even
documents that graduates academic performance represents a significant indicator of
future initial job interviews. We must also make reference to Vrooms (1964)
expectancy theory, which provides a useful conceptual framework for understanding a
student's motivation to strive for academic success (Harell, 1985). Furthermore, by
using the within-persons decision modeling approach Stahl and Harrell (1981)
documented that a student's motivation to strive for academic success is positively
correlated with the student's actual behavior (academic performance). The manner in
which educators through the evaluation process are assessing students academic
performance is therefore extremely important in motivating their future behavior.
Moreover, we believe that students should also develop the ability to selfacknowledge their academic performance and make them aware of their actual status.
As a saying goes we almost always get what we measure, the assessment process of
students academic performance should be very carefully considered.
1
Correspondence address: Carmen Giorgiana BONACI, Babes-Bolyai University,

Faculty of Economics and Business Administration, Cluj Napoca, Romania;
email: carmen.bonaci@econ.ubbcluj.ro
~861~
As it is also said that beauty lies in the eyes of the beholder it might be a difficult task
to reconcile students self-acknowledged academic performance with that assessed by
the educator. Our paper therefore analyzes and compares the two reflections of
students academic performance by considering a sample of 3rd year accounting
students and the Controlling course. Students self-acknowledged grades were
obtained with the help of the questionnaire while their final grades as assessed by the
educator were those attributed to them through the final exam for the Controlling
course. Blooms taxonomy was used in developing the examination process that
generated students final grades as assessed by the educator, after previously being
used within the teaching-learning process during the semester. Other students
characteristics obtained through the questionnaire were used in order to develop
cluster analysis.
The question therefore being posed by our study is what would be the best manner in
which we could approach the examination process of accounting students academic
performance? In order to find a suitable answer we must first think about the outcome
and that would be a true and fair view of students academic performance. Correctly
reflecting accounting students knowledge, and their intellectual abilities and skills
would represent useful input when considering their future behavior which can
represent better academic performance for the following academic years (when
considering undergraduates) or a suitable career orientation (when considering
graduates). Our paper proposes the use of Blooms taxonomy within the evaluation
process based on its role of providing the classification of the goals for the
educational systems, which we think should also be considered when assessing the
output of the educational process in terms of students academic performance. We
further analyze how students final grades are formed based on the taxonomys levels.
Our paper proposes the use of Blooms taxonomy in order to asses accounting
students academic performance. Since the taxonomy is supposed to provide the
classification of the goals for the educational systems, it would only be natural for us
to also use it when assessing the results of the educational process.
Students self-acknowledgement is also a component of their behavior that can be
analyzed and considered within the educational process. Analyzing and comparing
accounting students self-acknowledged grades with those assessed by the educator
can bring some insights in this direction. The results of our paper are useful for
accounting educators when considering the evaluation process.
Our paper further develops a review of literature on accounting students academic
performance in order to acknowledge the state of the art when it comes to this
significant component of the educational process. A distinctive component of the
paper explains the research design, which was used in its development. Within the
following part of the paper, we perform the proposed research design and interpret the
obtained results. Some concluding remarks, which synthesize our findings, are
presented within the final part of the paper together with some research perspectives.
~862~
1. ACCOUNTING STUDENTS ACADEMIC PERFORMANCE:

REVIEW OF LITERATURE
Up-to-date literature considering academic performance in accounting rarely focuses
on the examination performance by itself, while in most of the cases emphasizing its
correlates. If we look at studies being developed few decades ago we can find support
for multiple choice testing as an alternative to the traditional problem or essay test
used for evaluation of academic achievement in accounting courses (Collier and
Mehrens, 1985), while also encouraging the development of objective test items for
use in the classroom. We must nowadays mention Guneys (2009) study discussing
the idea of examination structure, noting that students do care about the way the
examination questions are asked, and pleading for a rigorous and pedagogic
preparation of examination questions in accounting. Guney (2009) documents that
some students show their ability and intellect better in multiple-choice examinations,
while some on essay-type examinations. That is why he argues for the use of various
formats of examinations that should have the role of mitigating the adverse
consequences of a typical exam structure on a specific group of students.
If we are to make a review of how academic performance is being measured within
literature and emphasize the exact term being used we can conclude that it is through
marks (Jones and Wright, 2010; Guney, 2009), grades (Schleifer and Dull, 2009;
Ramburuth and Mladenovic, 2004; Gracia and Jenkins 2003; Lewis et al. 1983),
scores (Fordham and Hayes, 2009; Gardner et al. 2005; Koh and Hoh 1999), points
(Kealy et al., 2005) and examination results (McDuffie and Smith, 2006; Chia, 2005;
Duff, 2004; Paisey and Paisey, 2004; Hartnett et al., 2003; Lane and Porch, 2002;
Lancaster and Strand, 2001; Naser and Peel, 1998; Tho, 1994; Barlett et al, 1993).
Jones and Wright (2010) use marks on two questions on the final examination dealing
with consolidation accounting, Ramburuth and Mladenovic (2004) use aggregate final
grades, Lewis et al. (1983) grade point average and Schleifer and Dull (2009) use a
grade-point average scale (4 for an A, 3 for a B, 2 for a C, 1 for a D, and 0 for an F).
In accordance to the purpose of each study, authors may consider students academic
performance for one or more years, while looking at one or more subjects (accounting
or others). Fro example Gracia and Jenkins (2003) use total grade points achieved in
all modules studied by each student in the previous academic year, while Koh and
Koh (1999) use scores obtained in all the subjects for each of the three years of an
accountancy degree programme in order to capture a better assessment of their overall
academic ability than one or two subjects, and to track their performance over time.
Other studies using examination results make reference to the common final exam
(Lancaster and Strand, 2001), module performance (Paisey and Paisey, 2004),
assessment task (Hartnett et al., 2003), assessment test (Barlett et al., 1993) and quiz
scores (Fordham and Hayes, 2009) or percentage of total points earned on three
interim tests and on the final exam (Kealy et al., 2005).
A significant number of studies that were developed over time can be included in the
body of literature considering the determinants of academic success in accounting.
Therefore, academic performance is most of the times analyzed as being the
dependent variable for literature considering correlates of academic performance in
accounting. Once again studies vary in accordance to their main objective, looking at
~863~
a particular accounting subject or more, at academic performance for different periods

and taking into consideration a series of determinant factors (Barlett et al., 1993; Tho,
1994; Phillips ,1998; Naser and Peel, 1998; Koh and Koh, 1999; Lancaster and
Strand, 2001; Gracia and Jenkins, 2003; Hartnett et al., 2003; Duff, 2004; Paisey and
Paisey, 2004; Ramburuth and Mladenovi, 2004; Gardner et al., 2005; Kealey et al.,
2005; McDuffie and Smith, 2006; Watson et al., 2007; Guney, 2009; Schleifer and
Dull, 2009; Fox et al., 2010; Jones and Wright, 2010).
First explanatory variables of accounting students academic performance to be
considered in literature comprised educational, demographic and/or financial
characteristics variables (Barlett et al., 1993; Tho, 1994). Primarily developed in the
USA, the substantial literature considering the determinants of academic success in
accounting focused on gender, prior knowledge of accounting, academic aptitude, and
mathematics, producing largely inconclusive results (Duff, 2004). Phillips, 1998 notes
that in accounting education research, cognitive style and ability have received the
greatest attention when assessing performance. A review of accounting education
literature by Watson et al. (2007) includes a discussion of learning styles and
technology (Tho, 1994). For example, McDuffie and Smith (2006) address the
particular use of an audit reporting system as a teaching aid and its impact on
students performance. Koh and Koh (1999) investigate the impact of six variables
(namely, gender, prior accounting knowledge, academic aptitude, mathematics
background, previous working experience and age) on the performance of students in
a three-year accountancy degree programme. Lancaster and Strand (2001) investigate
academic performance and student perceptions regarding the cooperative learning
format. Further studies consider a blend of data from demographic, attitudinal and
behavioural sources, effectiveness of accounting students' approaches to learning
being often considered (Gardner et al., 2005; Paisey and Paisey; 2004; Gracia and
Jenkins, 2003; Hartnett et al., 2003, Byrne et al., 2002; Booth et al., 1999; Duff, 1997;
Tan and Choo, 1990).
We will furthermore mention a few particular approaches and factors considered
when analyzing accounting students academic performance. Paisey and Paisey
(2004) focus on two aspects of student attendance, namely the reasons why some
students do not attend classes, and the issue of whether attendance improves academic
performance, documenting a clear positive relationship between attendance at classes
and subsequent academic performance. Gardner et al. (2005) look for associations
between levels of communication apprehension and students abilities to advance in
their studies or average levels of academic performance, but fail to document it.
As previously mentioned, studies can also be grouped by considering a certain
accounting subject when analyzing academic performance. This is the case for Naser
and Peel (1998) and Kealey et al. (2005), who focused on determinants of student
performance in a Principles of Accounting course. Naser and Peel (1998) examined
the impact of a number of new attitudinal variables on examination performance,
documenting that student perceptions of factors associated with class size, the
attributes of the lecturer, student effort and the complexity of the course are associated
with student performance in a first level principles of accounting course. Meanwhile,
Kealey et al. (2005) document that critical-thinking skills contribute significantly to
explaining the cross-sectional variation in student performance in an accounting
~864~
principles class. A more particular factor such as paper colour was also considered by
Michael and Jones (1955) and further analyzed by Fordham and Hayes (2009).
Another classification of the significant number determinants of academic
performance in accounting currently being used in literature is done by Guney (2009),
employing student-oriented endogenous factors (e.g. age, gender) as well as studentexogenous factors (e.g. quality of teaching, examination structure). And finally we
will refer to the latest studies on accounting students academic performance.
Schleifer and Dull (2009) consider metacognition as an important aspect of selfregulated learning and therefore having potential as a learning skill or attribute that
can serve to improve accounting education and performance. Fox et al. (2010)
consider the impact of a student peer-mentoring programme on first-year
undergraduates academic performance, while Jones and Wright (2010) extend
previous work by combining the effect of cognitive style and the use or non-use of
two versions of a hypertext learning aid and their interaction on student performance
in advanced financial accounting.
While considering literature on accounting students academic performance we must
also mention those cases when academic performance represents an explanatory
variable or a determinant factor for another considered dependent variable. It is
mostly the case of studies in job search, such as Chia (2005) and Lewis et al. (1983).
Chia (2005) investigates the effects of academic performance, extracurricular
activities and emotional intelligence of potential accounting-major graduates on the
outcomes of their respective interviewing activities and the number of final job offers
given by the multinational Big 5 public accounting firms. His results document that
the number of initial job interviews is affected by both a graduates academic
performance and level of participation in extracurricular activities.
Overall, the above presented studies approach academic performance even though the
criterion of success being defined differently in each case, as Gammie et al. (2003)
also comment on previous academic performance that was documented to be a
statistically significant indicator of university performance. Therefore, in many cases,
due to the limited information supplied in the studies in relation to the precise
specification of the independent variables, it is difficult to compare the predictor
variables.
Our study proposes the use of Blooms taxonomy in assessing accounting students
academic performance. Blooms taxonomy has received considerable international
recognition within the evaluation community (Lewy and Bathory, 1994). This was
mainly due to the fact that the taxonomy was soon after its introduction used within
seminars at the United Nations Educational, Scientific, and Cultural Organization
(UNESCO) and the Organization for Economic Cooperation and Development
(OECD) (Athanassiou et al., 2003, p.535). A review of literature indicates a growing
awareness of the taxonomys potential usefulness and richness among college and
university level educators (Athanassiou et al., 2003, p.537). The taxonomy can be
used in developing the curriculum design process, students assessment process and
instruction evaluation. Until recently the taxonomy has been largely used within the
teaching process, Stokes (2008) documenting how authors of 24 accounting textbooks
used verbs at the lower levels of the cognitive domain.
~865~
2. RESEARCH DESIGN
Developing the analysis of our research project involves the use of two distinctive
instruments: a questionnaire and the examination process that will further be
described.
In order to develop the analysis that was aimed through our study we implemented a
questionnaire on a sample of accounting students. Choosing the students was done
based on our intention of continuing our research in the area of accounting students
academic performance by considering the same group of students that were
investigated a year ago when considering a different course (Financial Accounting).
This group comprises students within a three years accounting programme of BabesBolyai University in Cluj-Napoca, Romania. We therefore aimed a group of 389
students in their 3rd university year, at the end of the first semester. The questionnaire
was only administered to a number of 367 students that took the final exam in
Controlling during the 2009 winter exam session period. We finally ended up in using
a number of 316 questionnaires for this study. We eliminated those questionnaires that
either were missing a significant number of filled questions (which we considered to
be 10 out of a total of 29), either had no response for the last question of the
questionnaire. This last question required students to self-acknowledge their grade for
the Controlling final exam, which they have just been taken.
The questionnaire was implemented after a 14 weeks period of educational activities
comprising courses and seminars. Controlling courses and seminars were structured
during the semester based on Blooms taxonomy. Students were required to read the
materials assigned for the classes and to do not more than 3 problems or exercises per
week as homework. The scope of the seminar was to check the comprehension of the
material assigned to be read and to apply the theory to a specific situation. Courses
were designed to exercise students abilities to analyze, synthesize and evaluate a
given case study. The courses preceded seminars, the learning process therefore
following the presented order of the taxonomy.
A particularity of our study is that implementing the questionnaire was correlated with
students actual examination through written final exam during the exam session
period. Students attending the final exam in Controlling were presented with two sets
of documents. Each set was het-up and comprised A4 format white paper and a cover
page. The cover page presented a series of distinctive elements such as name of the
course, research project, date etc. One set comprised the exam questions and its cover
page included a small red square (20 cm side). The other set comprised the
questionnaire and its cover page included a small blue square (20 cm side). The cover
page for the exam questions required students to fill in their personal information
(name) in a particular designed space, while the cover page for questionnaire did not
ask for students name. Moreover, students were instructed that the questionnaires
were anonymous in order to ensure the objectivity of their answers. Students were
allocated separate time required for responding the exam questions and for filling in
the questionnaire. This information was clearly explained to them after handing the
two sets of documents. At the end of the allocated time, students were asked to place
their questionnaires in a distinctive set that was separated from that of the exam
documents.
~866~
As previously mentioned, the questionnaire was formulated in such a manner that did
not allow for the identity of the respondent to be reviled. Still, in order for is to be
able to develop our analysis we needed to correlate each students questionnaire with
its corresponding exam documents, which reflected the academic performance. This
had to be initially done without students acknowledgement with the purpose of
maintaining their objectivity. That is why we posted a particular code on the cover
page of students exam documents in a manner that would not receive students
attention. The same code was posted on the questionnaire set of documents. When
distributing the two sets of documents to students, each student received the two sets
bearing the same code. This allowed us to match each students questionnaire with the
corresponding exam documents. The information obtained through the questionnaire
was not used until the beginning of the next semester when students were told about
the used code system and asked for their written acceptance in order for us to use the
information they therefore provided within our research project. All students within
our sample gave their approval in order for us to use the information they provided
through the questionnaire and also their examination information for Controlling.
Questions within the questionnaire were formulated in relation to a series of
determinants of accounting students academic performance as identified through
literature. The questionnaire was structured on two distinctive components. The first
components comprised a number of 11 questions that had a general character. The
second component comprised 18 specific questions asking students to relate to the
particular Controlling course. The final question within the questionnaire asked
students to self-asses their grade for the Controlling final exam they had just taken
and express it in accordance to the Romanian grading system (grades ranging from 0
to 10, where 10 represents the maximum possible grade). Their answers to this final
question actually represented Students Self-Acknowledged Grade (SSAG), which we
used in developing our study.
As previously mentioned, Controlling courses and seminars were structured during
the semester based on Blooms taxonomy. It was the taxonomy that also helped us
structure the exam questions for the above mentioned Controlling final exam.
Students examination process was therefore in deep correlation with the way
students learned during the semester. Our arguments for using Blooms taxonomy
refer to its structure that offers a very clear tool of testing students knowledge and
abilities on a continuous basis, while generating clear feedback on what they have to
do further in order to develop their learning process. We also consider that grounding
the teaching and evaluation process on Blooms taxonomy gives educators a basis of
comparison between the effective level being achieved during the semester and the
goal of the educational system. We will further outline some main aspects related to
Booms taxonomy.
In 1956, a committee of College and University examiners published the Classification
of Educational Goals under the name of Taxonomy Educational Objectives: The
Classification of Educational Goals. Handbook 1. Cognitive domain. The editor of the
material was Benjamin S Bloom from University of Chicago. The committees scope
was to build a taxonomy of educational objectives, which would provide the
classification of the goals for the educational systems. It is expected to be of general
help to all teachers, administrators, professional specialists, and research workers who
deal with curricular and evaluation problems. It is especially intended to help them
~867~
discuss these problems with greater precision (Bloom, 1956, p.1). This is referred to
as the original taxonomy. 45 years after, the taxonomy was revised. We developed our
research based on the original taxonomy.
The original taxonomy of educational objectives related to cognitive domain is
structured on two levels: Knowledge and Intellectual abilities and skills. The first
level, Knowledge, involves the recall of specifics and universals, the recall of
methods and processes, or the recall of a pattern, structure, or setting (Bloom, 1956,
p. 201).
The second level, Intellectual abilities and skills, refer to organized modes of operation
and generalized techniques for dealing with materials and problems (Bloom, 1956,
p. 201). Materials and problems can have different natures: some of them may require
special information and techniques but some may require general information, which
can be assumed to be part of the individual's general fund of knowledge. This level
refers to the mental process of organizing and working with the materials and
problems in order to achieve a purpose. In order to be able to work with information,
this level is based on 5 sub-levels:
Comprehension of material and problem; comprehension represents the lowest
level of understanding. It is related with the ability of understanding what is
being communicated and conveying the idea further without necessarily
connecting it with other ideas or materials.
Application; this refers to the ability and skills needed to apply general rules,
procedures, and methods called abstractions to a specific situation. To be
applied, abstractions need to be remembered first.
Analysis, which implies to break the material and problem into parts and to
analyze them separately and then in correlation with other factors. The scope of
this phase is to understand how the initial material was build.
Synthesis represents the process of combining the materials parts using a new
structure, clearer than before.
Evaluation represents the process of judging the materials for a given purpose.
Usually, this phase requires quantitative and qualitative judgments and very
often the given purpose is not indicated by the material ad has to be identified
by the evaluator.
Our study assesses accounting students academic performance by using an evaluation
grid that was structured based on the above presented taxonomy. The content of the
discipline was divided into four main parts: marginal analysis, cost-volume-profit
analysis, budgeting and activity based costing. We tested each parts content based on
students knowledge and their ability to comprehend, apply, analyze and synthesize.
We used closed and open questions and also multiple choice questions therefore
applying various formats of examinations, as advised within literature (Guney, 2009).
Open questions approached theoretical aspects and problems whose calculation
needed to be detailed by students in order to be graded. The last level within Blooms
taxonomy was tested by using a case study where students had to reach a certain
conclusion, which also had to be presented in writing and argued. The maximum
grade that could be obtained (10 points) was structured by considering the taxonomys
five levels (comprehension 2.25 points, application 2.25 points, analysis
2.25 points, synthesis 2.25 points, and evaluation 1 point).
~868~
After developing the two methodological instruments that were described above we
proceeded with implementing our analysis. Descriptive analysis was performed for
the whole sample of students. Correlation analysis was used when considering the two
reflections of students academic performance (students final grade as assessed by
the educator and students self-acknowledged grade). Both descriptive analysis and
correlation analysis was also performed on clusters in order to obtain more insights on
students academic performance. The obtained results are presented within the
following part of our paper.
3. DEVELOPING THE ANALYSIS AND INTERPRETING RESULTS
Based on previous mentioned methodological aspects we have further implemented
the analysis aimed through the development of this study. This analysis is based on
two distinctive dimensions. The first one refers to students academic performance
and the other to a series of answers that were offered by students through the
questionnaire that was implemented after their examination process through the final
exam for Controlling. It was based on these answers that we developed cluster
analysis, which allows us to look at students academic performance more coherently,
and in a more detailed manner.
Therefore, the answers that were provided by students through the implemented
questionnaire represent the basis for our developing of seven distinctive clusters. The
first cluster actually comprises our entire population of students participating in our
research project that includes 316 cases (students) being observed. The following
clusters are built based on a series of factors that are considered by literature as
determinants of students academic performance and therefore were used in
formulating questions within the implemented questionnaire. We will further present
the factor determining each of the considered clusters. The second cluster can be
called the Gender Cluster based on the fact that it groups respondents based on their
gender. Results point the fact that our sample population is mainly formed out of
females, representing 86% of the respondents. Another cluster considers students
previous high school characteristics, separating students that went to a high school
with economic profile, therefore having previous encounters with accounting
disciplines. We therefore separated students which went to a high school with
economic profile from those who did not based on the answers they provided. The
results being obtained based on this separation show a relative balance between the
two sub-clusters.
Students' Assessed Final Grade
40
Students' Self-Acknowledged Grade

120
30
100
80
20
60
40
10
Std. Dev = 2,20
Std. Dev = 1,30
20
Mean = 7,5
Mean = 4,93
N = 316,00
N = 316,00
0
2,0
50
9, 0
0
9, 0
5
8,
00
8, 0
5
7, 0
0
7, 0
5
6, 0
0
6, 0
5
5, 0
0
5,
50
4, 0
0
4, 0
5
3, 0
0
3, 0
5
2,
00
2, 0
5
1, 0
0
1,
0
,5
NREALA
4,0
3,0
NSPERATA
~869~
6,0
5,0
8,0
7,0
10,0
9,0
Table 1. Students Academic Performance Analysis
Clusters
Bloom Comp.
Correlations
Min
Values
Max
Mean
Std.
Min
Percentage
Max Mean
Std.
Cases
No.
0.110
0.122
0.113
0.127
0.043
316
316
316
316
316
316
316
316
316
Panel
A
Pearson
Spearman
SAFG
SSAG
Comprehension
Application
Analysis
Synthesis
Evaluation
0.567**
0.589**
0.250
2.000
0.000
0.000
0.000
0.000
0.000
9.450
10.000
2.250
2.250
2.250
2.250
1.000
4.934
7.487
1.084
1.266
1.306
1.095
0.181
2.203
1.303
0.683
0.632
0.690
0.580
0.202
0.00
0.00
0.00
0.00
0.00
0.63
1.00
0.75
1.00
0.32
0.20
0.26
0.25
0.23
0.03
Notes: Panel A comprises the whole sample of students being analyzed; SSAG - Students SelfAcknowledged Grade, SAFG - Students Assessed Final Grade; ** Correlation is significant
at the 0.01 level (2-tailed)
Table 1. Students Academic Performance Analysis (continued)
Clusters
Bloom Comp.
Panel B
Gender
Male
Gender
Female
Correlations
Pearson
Spearman
SAFG
SSAG
Comprehension
Application
Analysis
Synthesis
Evaluation
0.365*
0.351*
Pearson
Spearman
SAFG
SSAG
Comprehension
Application
Analysis
Synthesis
Evaluation
0.608**
0.617**
Min
0.250
3.000
0.000
0.000
0.000
0.000
0.000
0.250
4.000
0.000
0.000
0.000
0.000
0.000
Values
Max
Mean
8.470
10.000
1.875
2.250
2.250
2.070
1.000
9.450
10.000
2.250
2.250
2.250
2.250
1.000
3.953
7.238
0.875
1.019
1.047
0.842
0.169
5.132
7.561
1.120
1.312
1.367
1.143
0.188
Std.
2.091
1.494
0.552
0.656
0.736
0.482
0.212
2.211
1.235
0.705
0.628
0.671
0.589
0.204
Min
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Percentage
Max Mean
0.63
1.00
0.50
0.71
0.32
0.59
1.00
0.75
1.00
0.23
0.21
0.27
0.23
0.23
0.04
0.20
0.26
0.26
0.23
0.03
Notes: Panel B groups respondents based on their gender; SSAG - Students Self-Acknowledged
Grade, SAFG - Students Assessed Final Grade;
*,** Correlation is significant at the 0.05, 0.01 level (2-tailed)
~870~
Std.
Cases
No.
0.133
0.158
0.136
0.153
0.068
42
42
42
42
42
42
42
42
42
0.106
0.114
0.109
0.123
0.038
262
262
262
262
262
262
262
262
262
Clusters
Bloom Comp.
Panel C
Prior
Economic
High
School
Pearson
Spearman
SAFG
Correlations
Pearson
Spearman
SAFG
Std.
Min
Percentage
Max Mean
Std.
0.250
8.770
4.705
2.156
2.000
0.000
0.000
0.000
0.000
0.000
10.000
2.250
2.250
2.250
2.250
0.900
7.465
1.056
1.166
1.276
1.050
0.156
1.303
0.651
0.628
0.709
0.566
0.178
0.700
9.450
5.131
2.230
3.000
0.000
0.000
0.000
0.000
0.000
10.000
2.250
2.250
2.250
2.250
1.000
7.505
1.109
1.351
1.332
1.134
0.203
1.306
0.710
0.625
0.673
0.591
0.219
Cases
No.
146
146
146
0.00
0.00
0.00
0.00
0.00
0.59
1.00
0.61
1.00
0.32
0.20
0.26
0.26
0.23
0.03
0.108
0.142
0.120
0.132
0.045
0.616**
0.635**
SSAG
Comprehension
Application
Analysis
Synthesis
Evaluation
Notes:
Values
Max
Mean
0.509**
0.408**
SSAG
Comprehension
Application
Analysis
Synthesis
Evaluation
No Prior
Economic
High
School
Min
146
146
146
146
146
146
170
170
170
0.00
0.00
0.00
0.00
0.00
0.63
0.67
0.75
0.81
0.23
0.20
0.26
0.25
0.22
0.04
0.113
0.101
0.108
0.123
0.041
170
170
170
170
170
170
Panel C divides students into two categories as follows: the first category comprises students that went to
a high school with economic profile previous to university, and the second comprises the other students;
SSAG - Students Self-Acknowledged Grade, SAFG - Students Assessed Final Grade;
** Correlation is significant at the 0.01 level (2-tailed)

Clusters
Bloom Comp.
Correlations
Min
Values
Max
Mean
Std.
Min
Percentage
Max Mean
Std.
Cases
No.
0.090
0.104
0.096
0.091
0.034
73
73
73
73
73
73
73
73
73
0.116
0.127
0.118
0.136
0.045
243
243
243
243
243
243
243
243
243
Panel D
Prior
Professional
Experience
No Prior
Professional
Experience
Pearson
Spearman
SAFG
SSAG
Comprehension
Application
Analysis
Synthesis
Evaluation
0.524**
0.621**
Pearson
Spearman
SAFG
SSAG
Comprehension
Application
Analysis
Synthesis
Evaluation
0.573**
0.578**
Notes:
0.700
2.000
0.000
0.250
0.000
0.000
0.000
0.250
3.000
0.000
0.000
0.000
0.000
0.000
9.450
10.000
2.250
2.250
2.250
2.250
1.000
9.225
10.000
2.250
2.250
2.250
2.250
1.000
5.274
7.863
1.117
1.379
1.408
1.177
0.191
4.832
7.374
1.074
1.231
1.276
1.070
0.178
2.047
1.283
0.605
0.589
0.647
0.559
0.217
2.241
1.290
0.705
0.641
0.700
0.585
0.198
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.42
0.62
0.50
0.56
0.14
0.63
1.00
0.75
1.00
0.32
0.20
0.27
0.26
0.22
0.03
0.20
0.26
0.25
0.23
0.03
Panel D considers weather students have previous working experience in the field of accounting; SSAG Students Self-Acknowledged Grade, SAFG - Students Assessed Final Grade; ** Correlation is
significant at the 0.01 level (2-tailed)
~871~
Clusters
Bloom Comp.
Panel E
No Future
Professional
Accounting
Activity
Future
Professional
Accounting
Activity
Correlations
Pearson
Spearman
SAFG
SSAG
Comprehension
Application
Analysis
Synthesis
Evaluation
-0.030
0.018
Pearson
Spearman
SAFG
SSAG
Comprehension
Application
Analysis
Synthesis
Evaluation
0.600**
0.616**
Min
0.250
5.000
0.000
0.000
0.000
0.000
0.000
0.250
2.000
0.000
0.000
0.000
0.000
0.000
Values
Max
Mean
7.970
10.000
1.875
1.950
2.075
2.070
0.300
9.450
10.000
2.250
2.250
2.250
2.250
1.000
3.342
6.906
0.712
0.885
0.820
0.820
0.103
5.114
7.552
1.126
1.308
1.361
1.12
0.190
Std.
1.736
1.201
0.600
0.577
0.563
0.493
0.112
2.180
1.299
0.680
0.624
0.682
0.582
0.209
Min
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
Percentage
Max Mean
0.63
1.00
0.61
0.51
0.14
0.59
1.00
0.75
1.00
0.32
0.19
0.28
0.23
0.25
0.03
0.20
0.26
0.26
0.22
0.03
Std.
Cases
No.
0.151
0.188
0.141
0.131
0.039
32
32
32
32
32
32
32
32
32
0.105
0.112
0.110
0.127
0.043
284
284
284
284
284
284
284
284
284
Notes: Panel E groups students based on their intention of pursuing a future career in the field of
accounting after graduation; SSAG - Students Self-Acknowledged Grade, SAFG - Students
Assessed Final Grade; ** Correlation is significant at the 0.01 level (2-tailed)
Clusters
Bloom Comp.
Panel F
Personal
Option
for
Accounting
Specialization
No Personal
Option
for
Accounting
Specialization
Pearson
Spearman
SAFG
Correlations
SSAG
Comprehension
Application
Analysis
Synthesis
Evaluation
Notes:
Values
Max
Mean
Std.
Min
Percentage
Max Mean
Std.
0.544**
0.584**
SSAG
Comprehension
Application
Analysis
Synthesis
Evaluation
Pearson
Spearman
SAFG
Min
0.250
9.450
5.157
2.167
2.000
0.000
0.000
0.000
0.000
0.000
10.000
2.250
2.250
2.250
2.250
1.000
7.622
1.145
1.312
1.388
1.118
0.191
1.253
0.670
0.623
0.662
0.586
0.213
257
257
257
0.00
0.00
0.00
0.00
0.00
0.59
1.00
0.75
0.59
0.32
0.21
0.26
0.26
0.21
0.03
0.105
0.114
0.111
0.108
0.044
0.542**
0.584**
0.625
8.820
4.122
1.987
3.000
0.000
0.000
0.000
0.000
0.000
10.000
2.050
2.250
2.250
2.070
0.400
6.862
0.864
1.131
0.989
1.005
0.131
1.280
0.665
0.598
0.703
0.546
0.110
257
257
257
257
257
257
51
51
51
0.00
0.00
0.00
0.00
0.00
0.63
0.76
0.42
0.71
0.11
0.19
0.28
0.21
0.26
0.03
0.131
0.151
0.109
0.138
0.030
Panel F considers weather students are part of the accounting specialization as a result of their own
choice or as a consequence of other determinant factors (the influence of their environment or the result
of the faculty distribution process); SSAG - Students Self-Acknowledged Grade, SAFG - Students
Assessed Final Grade; ** Correlation is significant at the 0.01 level (2-tailed)
~872~
Cases
No.
51
51
51
51
51
51
Clusters
Bloom Comp.
Panel G
Negative
Attitude
for
Accounting
Specialization
Positive
Attitude
for
Accounting
Specialization
Pearson
Spearman
SAFG
Correlations
SSAG
Comprehension
Application
Analysis
Synthesis
Evaluation
Notes:
Values
Max
Mean
Std.
Min
Percentage
Max Mean
Std.
0.035
0.044
SSAG
Comprehension
Application
Analysis
Synthesis
Evaluation
Pearson
Spearman
SAFG
Min
0.250
6.875
2.965
1.475
4.000
0.000
0.250
0.000
0.000
0.000
10.000
1.725
1.950
2.000
1.525
0.500
6.931
0.527
0.793
0.822
0.704
0.117
1.412
0.519
0.488
0.593
0.479
0.158
29
29
29
0.00
0.11
0.00
0.00
0.00
0.37
1.00
0.67
0.56
0.27
0.15
0.29
0.26
0.24
0.04
0.118
0.174
0.176
0.165
0.068
0.599**
0.614**
0.250
9.450
5.133
2.168
2.000
0.000
0.000
0.000
0.000
0.000
10.000
2.250
2.250
2.250
2.250
1.000
7.543
1.141
1.313
1.355
1.135
0.188
1.28
0.673
0.626
0.681
0.575
0.206
29
29
29
29
29
29
287
287
287
0.00
0.00
0.00
0.00
0.00
0.63
1.00
0.75
1.00
0.32
0.21
0.26
0.25
0.22
0.03
0.108
0.115
0.106
0.123
0.040
Panel G considers students grouping into two categories based on their satisfaction degree related to the
accounting specialization they are part of;
SSAG - Students Self-Acknowledged Grade, SAFG - Students Assessed Final Grade;
** Correlation is significant at the 0.01 level (2-tailed)
Another aspect that was analyzed through one of our questionnaires components is
weather students already have some previous working experience in the field of
accounting. Two sub-clusters have therefore been created, the first comprising
students with previous working experience in the field of accounting. This time results
show a major unbalance, the number of students having no previous working
experience in the field of accounting being significantly higher. Considering the same
topic of accounting practice, students were also asked weather they intend to develop
a career in the field of accounting after graduating. This time almost 90% of our
respondents declared they have this intention for their future development.
The following two clusters refer to students attitude towards the accounting
specialization to which they currently belong. The first cluster looks at how students
became part of the accounting specialization and separates those students who became
accounting students as a result of their own wishing, as opposed to those who were
determined by their close company or even victims of the faculty distribution
process. We can notice that 257 students out of the total 316, meaning 83.44% of
them declared to have chosen the accounting specialization based on their own
wishing. Our last cluster looks at students satisfaction related to the accounting
specialization at the moment of the questionnaires implementation. Results show that
those declaring to be unsatisfied with the accounting specialization they currently
belong to only represent 9.71%. This value is lower than that representing students
who did not initially wish to become accounting students (16.56%), pointing that
some of the students have come to be satisfied with the accounting specialization even
~873~
Cases
No.
287
287
287
287
287
287
if this was not their first option when faced with choosing their future specialization,
as they were in the past.
We should also mention the fact that out of the total 367 questionnaires that were
implemented we only ended up using 316. This was due to some questionnaires being
incompletely filled and eliminated from the analysis, as explained within the research
design part of the paper. Moreover, as Table 1 shows, the number of cases being
analyzed when considering different clusters might also differ from the total number
of questionnaires finally being kept for analysis within the study. We refer here to
clusters comprising less than the 316 students due to eliminating those students who
did not answer the question that actually represented the factor that helped us establish
a certain cluster. For example, 12 students forgot to mention their gender when
answering the questionnaire. As a consequence, Panel B only comprises a number of
304 students.
Moving forward, another aspect that should be discussed is students academic
performance. We have appealed within our study to using two distinctive instruments
in order to measure academic success or performance. One on hand we used students
final grade as assessed by the educator (the SAFG variable) and on the other their
self-acknowledged grade (the SSAG variable). We meanwhile consider that both
instruments being used in measuring students academic performance actually
represent two distinctive perceptions upon the same reality. Therefore, the main
objective of our study would be to question and analyze these two perceptions on the
evaluation process while also making use of Blooms taxonomy. The obtained results
are interpreted in correlation and based on variables obtained through the
implemented questionnaire.
A first step of our study would be to analyze the correlation degree between the two
grades used in measuring accounting students academic performance while also
considering cluster analysis. We furthermore analyzed the manner in which students
final grades as assessed by the educator were formed when considering the levels of
Blooms taxonomy. We therefore calculated the Percentage representing the weight
of each level of Blooms taxonomy in generating students final grade (SAFG).
We might say that some of the obtained results are unexpected and reflect
particularities of the analyzed environment. First, when referring to the whole group
of students being analyzed (Panel A) we maybe expected a high level of students
subjectivity in assessing their self-acknowledged grade to make it difficult to establish
a correlation between their assessment (SSAG) and that of the educator (SAFG).
Obtained results document that such a correlation exists and records a medium level.
The analyzed correlation could not be documented for the group of students that were
not planning on pursuing a future career in the field of accounting (Panel E) and also
for the group of students that presented a negative attitude towards the accounting
specialization as being unsatisfied with it (Panel G). When looking at the graph that
reflects grades distribution for the two considered measurement instruments of
accounting students academic performance (SAFG and SSAG) we can conclude that
students expectations for their grades as based on their self-acknowledgement is
higher in comparison to the actual grade being granted by the educator. This for sure
we kind of expected as a result of the comparison. When considering students final
grades as assessed by the educator our sample records a mean grade of 4.93, while the
mean for students self-acknowledged grades is 7.50. We consider the difference
~874~
between the two calculated means to be significant since the evaluation process
measures grades on a scale from 0 to 10. The obtained results therefore identify a
significant need for educators to work on improving students ability to acknowledge
their own academic performance.
When analyzing students final grades as assessed by the educator we notice that
neither one of the students received the maximum grade (10). Meanwhile, 12 students
responded they were expecting to obtain a 10, as mention through their selfacknowledged grade. The highest grade being granted by the educator was 9.45 and
belonged to a female student. Cluster analysis points the fact that the highest grade
being granted by the educator to a male student was 8.47, with almost 1 point lower.
As also documented within literature, the presence of gender differences with respect
to performance may have implications on students career choices, course enrolment,
and the use of knowledge, etc (Guney, 2009). While accepting the fact that gender can
affect the degree of motivation and thus performance, various studies considering this
variable generated mixed evidence. Some studies cannot detect any meaningful
relation between gender and accounting performance (Gammie et al., 2003a; Jackling
and Anderson, 1998). Tho (1994), reports that female students outperform male
students in accounting, as they are believed to have higher work needs. De Lange and
Mavondo (2004) also show that gender may induce different learning strategies for
female and male students which can affect their academic performance.
One of the results that contradict our expectations refers to the fact that the maximum
grade obtained by students having no previous economic background is higher than
that of students who went to a high school with economic profile. This is also true
when considering the two groups mean grade for both SAFG and SSAG. Moreover,
the mean final grade as assessed by the educator when considering the group of
students who went to a high school with economic profile (4.705) is beneath the grade
required for passing an exam in accordance to the Romanian grading system (5). This
once again raises some question marks. Under these circumstances we consider we
should analyze to what extent are the high school and university education systems
correlated and is the first one less efficient than the latter so that it affects students
academic performance? Of course that another explanation could lay in the fact that
maybe students having no previous economic knowledge work and study harder than
those who already do (Panel C).
Students who already have some working experience in the field of accounting seem
to outperform those who dont (Panel D). This can be an indicator of the importance
of accounting students involvement in practice. This is also the case when analyzing
students cluster based on their choosing of the accounting specialization and pursuing
of a future accounting career. Therefore, those becoming accounting students as a
result of their own wish outperform those influenced by other factors (Panel F) and
students pursuing a future accounting career outperform those who dont (Panel E).
Results also document the fact that students that are unsatisfied with them being a part
of the accounting specialization record lower chances of passing the exam (Panel G).
Another dimension of our study focuses on analyzing how students final grades as
assessed by the educator are being constructed based on the levels within Blooms
taxonomy. When analyzing the whole sample of 316 students, results show that
students obtain higher points based on analysis (Panel A). Students seem to receive
few points when it comes to comprehension and evaluation. If we were expecting
students to do worst on the evaluation level questions, them having difficulties on the
~875~
comprehension level questions was unexpected. As an overall conclusion, students

earn their grade based on the first four levels in Blooms taxonomy, evaluation
problems solving being less accessible for them.
When considering gender clusters we notice that male students base their grade
mostly on questions belonging to the application level while female students equally
rely on questions belonging to the application and analysis levels (Panel B). These
results proving that female students find it easier to reach the analysis level questions
are consistent with them outperforming male students.
Students who went to high schools with an economic profile seem to rely on
application and analysis also, while students with no economic background prefer the
application level question (Panel C). These is no longer consistent with the later
outperforming the former.
Previous working experience in the field of accounting doesnt seem to differentiate
students when it comes to forming their grade, questions belonging to the application
level being preferred by both students who have it and those who dont (Panel D).
This is also the case when considering students satisfaction related to the accounting
specialization (Panel G).
Some differences are also found when considering students intention of developing
future careers in the field of accounting and their status of accounting students. More
precisely, students planning on pursuing an accounting career and those who became
accounting students as a result of their own desire equally rely on questions belonging
to the application and analysis levels (Panel E and F). Meanwhile, students who do
not plan on pursuing an accounting career and those who became accounting students
due to other factors than their own desire mostly rely on questions belonging to the
application level (Panel E and F).
Overall, the obtained results show that students mostly base their final grade in
Controlling on questions belonging to the application and analysis levels, while
evaluation questions are rarely correctly solved. The mean percentage recorded for the
evaluation level is only 3%, while the maximum points that could be obtained on this
level represent 10% out of the total final grade.
CONCLUDING REMARKS
We will further synthesize the main findings of our study while also identifying some
research perspectives.
Results being obtained when comparing students self-acknowledged grades with
those assessed by the educator, even though correlated, represent an indicator showing
that further work could be done in order to enhance students ability to better assess
their real academic performance. This of course is based on the consideration that
grades being assessed by the educator, which are not considered to represent the
supreme truth either, should be less biased than those self-acknowledged by students
who for sure tend to be subjective. Developing students ability to better assess their
accounting knowledge as well as abilities and skills might be helpful for them when
searching for a job that optimizes their characteristics and expectations.
~876~
Cluster analysis being performed within the previous part of the paper was also
interpreted by reference to findings of studies dealing with similar aspects. Some
question marks are raised upon the Romanian high school education system in the
case of economic profile high schools since results document that students with no
economic background seem to outperform those who went to a high school with
economic profile.
Our paper proposes the use of Blooms taxonomy in order to asses accounting
students academic performance. Since the taxonomy is supposed to provide the
classification of the goals for the educational systems it would only be natural for us
to also use it when assessing the results of the educational process. When analyzing
how students final grades as assessed by the educator are being constructed based on
the levels within Blooms taxonomy an unexpected situation is documented, students
actually receiving lower points for the comprehension level questions than for the
application, analysis and synthesis level questions. Since comprehension represents
the lowest level of understanding, the determinants of the obtained results should be
further investigated. Overall, questions belonging to the application and analysis
levels seem to be preferred by students when analyzing their percentage within the
final assessed grade in Controlling, while evaluation questions are rarely correctly
solved.
We once again relate to Stahl and Harells (1981) within-persons decision modeling
approach, which we consider, emphasizes the importance of students examination
process. Examination performance as assessed by the educator is considered to be a
relevant reflection of students academic performance and used by the majority of
studies within research literature. This represents an argument for its consideration
and analysis aiming for the improvement of students examination process. On the
other hand, students self-acknowledged performance may motivate students
behavior. Considering the fact that there must be a fair representation of students
academic performance, the relationship between students and educators perceptions
on academic performance should also be considered.
ACKNOWLEDGEMENTS
Authors would like to acknowledge the participants to the Audit and Accounting
Convergence 2009 Annual Convention for their helpful comments and suggestions.
Special thanks go to our colleague Vasile Cardos for his inspiring ideas that helped us
develop this paper. This work was supported by CNCSISUEFISCSU, project
number PNII IDEI 2476/2008, Study regarding the development process of the
Romanian educational accounting system toward a global economic environment.
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PERCEPTION OF THE ROMANIAN ACCOUNTANTS

REGARDING THE FINANCIAL ACCOUNTING
EDUCATION
Paul DIACONU1, Vasile GORGAN,
Catalina GORGAN & Nicoleta COMAN
Codrina SANDRU
University of Transilvania Brasov, Romania
ABSTRACT
In the past twenty years the Romanian economy has undergone profound transformations.
The fall of communism in December 1989 followed by the transition to a market economy has
produced a series of major changes in the economic, political and social environment.
Accounting higher education has faced constant need to adapt to frequent changes in recent
years accounting system and the whole higher education system was reorganized in
accordance with the Treaty of Bologna. On the other hand there are worldwide studies that
confirm the differences between what is expected of a professional accountant and what he
acquired during university studies. Given that, our empirical study aims to outline the
perception of professional accountants on the Romanian accounting educational system. In
this approach, we tried to capture the relationship between theoretical and practical
knowledge in terms of importance assigned to each category by professional accountants, to
establish the role that the accounting professional bodies play in permanent training and
creating a hierarchy of skills required for professional accountants by IES 2 (International
Education Standard -Content of professional accounting education programs) from the
perspective of the accounting professionals from Romania.
.
KEYWORDS: Professional education, higher education accounting, professional

accounting bodies
INTRODUCTION
The fall of communism in December 1989, followed by transition to a market
economy has produced a series of changes in accounting in Romania. The French
accounting model served initially as a model of inspiration for the Romanian
accounting system. Between 1990 and 1993 the French accounting system was taught
in Romanian universities. In this time the Romanian accounting system consists of a
combination of soviet accounting and an accounting system of French inspiration
(Albu, Alexander, & Albu, 2010).
Accounting model applied as of 1 January 2004 was a French-inspired one although
traces of the communist accounting model seemed to continue to manifest (Feleaga,
1999). Analyzing the conditions under which an accounting system can change,
1
Correspondence address: Paul DIACONU, Bucharest Academy of Economic Studies, Romania;

email: pauldiaconu74@yahoo.com
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Nobes and Parker (2008) argue that neither country has completely broken with the
past and the influences left from the pre-communist and communist period.
Following the conditions imposed by the World Bank in the late 90s, Romanian
accounting system focuses on international accounting standards while not forgetting
about European Directives. OMFP (Order of the Ministry of Public Finance) no.
94/2001 was issued for the harmonization with the European Directives and
International Accounting Standards. Jermakowicz and Grnik-Tomaszewski (2006)
deemed that the implementation of international accounting standards might affect a
country's reputation, transforming it into a "modern business environment, organized
and well regulated, especially in ex-communist countries that have gone through
several reforms.
Later, as Romania moved towards becoming a member of the European Union OMFP
no. 1752 was issued in 2005 for the enactment of the 4th and 7th European Directives.
This was replaced with OMFP no. 3055 in 2009.
Accounting higher education in Romania has been influenced by the changes of the
Romanian economy, suffering a continuous process of adjusting to economic
conditions, often being a step ahead.
On the other hand, since 1993 Romania has made major steps towards the European
Higher Education Area by reorganizing the entire higher education system (MECT,
2005). The new legislation of June 2004 (law no. 288/2004) stipulates the
reorganization of university studies in three cycles (Bachelor, Master, and Doctoral).
Starting with the academic year 2005-2006, Romanian higher education is structured
as follows:
First cycle (180-240 ECTS) Bachelor degree;
Second cycle (90-120 ECTS, exceptionally 60 ECTS) Master degree;
Third cycle (3 years and in special situations 4 or 5 years) - Doctoral degree.
As Romania became member of EU starting with 2007, the transition has brought a
number of important changes in the higher education system, the reform being
accelerated.
Over time there have been signals sent to higher education regarding its capability to
meet the requirements of the accounting labor market.
The Bedford Report of the American Accounting Association states: there is little
doubt that the current content of professional accounting education, which has
remained substantially the same over the past fifty years, is generally inadequate for
the future accounting professional. A growing gap exists between what accountants
do and what accounting educators teach (American Accounting Association, 1986).
Cheng Kai-Wen (2007) assess that: under the influence of globalization and the
ongoing expansion of technology, many scholars believe that there is an obvious
discrepancy of expectation between the providers of accounting education (i.e.
teachers and students) and the demanders of that education (i.e. accounting firms and
business enterprises).
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Likewise Tanyel, Mitchell, & McAlum (1999) conducted a quantitative study

involving 129 faculty and 151 potential employers of economic studies graduates.
They investigated the perceptions of the attributes required by an employer from a
fresh graduate at the start of his career.
The most important characteristics nominated by the employers were interpersonal
skills, ethics and graduate accountability. Faculties on the other hand nominated the
following: interpersonal relations at the same level with ethics, the second nominee,
followed by attitude accountability and managerial skills. In turn, Baker & McGregor
(2000) conducted a study on the importance of accounting student characteristics in
the employment process. The report concluded that the most important group of
features is the one that regards candidate's personal honesty.
Lowry & Yap (1997) conducted a study on the usefulness of skills acquired in school
learning process by management accountants. General knowledge skills were
classified as having a very high priority, and in their communication skills were rated
as most important.
Teaching process involves two categories of actors, teachers on one hand and students
on the other, adequate preparation of the latter activity not solely depending on
activity of the first category. Tanner, Totaro i Wilson (1998) conducted a study on
the perception of students' abilities and motivation. Study results show that teachers
are dissatisfied with students oral and writing communication skills, no sign of
improvement being noticed in the last ten years.
Howieson examines the skills required of professional accountants in the context of
existing trends in business environment at the beginning of the 21st century, and their
implications for accounting education. One of the conclusions states that the objective
of preparing students for ongoing training cannot be limited to university level.
Predictions concerning the rapid change in knowledge and technology, as well as
practitioners desire to improve their career, suggest that continuous training is another
area where the activity will become more significant than it is now. Universities may
be able to position themselves as high quality training 2.offerer but they will have to
face competition from employers and professional associations.
Our study addressed the majority of financial and accounting professionals of the
accounting professional bodies from Romania: CECCAR (The Body of Expert and
Licensed Accountants of Romania), CAFR (Chamber of Financial Auditors of
Romania), CCF (Chamber of tax consultants) and ANEVAR (National Association of
Romania Evaluators), seeking to capture both their perceptions about the current
system of access to the profession and issues related to learning and lifelong selection.
seeking to capture both their perceptions about the current system of access to the
profession and issues related to training throughout life.
The objectives of our research are the following:
Establishing the relationship between theoretical and practical knowledge in
terms of importance assigned to each category by professional accountants
Establishing the role of professional bodies in the financial accounting training
throughout life
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The creation of a hierarchy of skills required by IES 2 (International Education

Standard-Content of professional accounting. Education programs) for the
accounting professionals, from the perspective of the professional accountant
in Romania.
The data gathering process involved an online questionnaire with closed and open
questions. Most of the questions were closed or fixed-choice response. The
questionnaire structure followed the research objectives. The questionnaire was sent
to a number of 1435 members of professional organizations (CFAR, CCF, ANEVAR,
and CAFR) whose email addresses were extracted from the official websites
of the organizations mentioned above. A total of 78 responses were received in
October 2010.
The sample structure by age and by level of academic education is as it follows
Table 1. Sample structure by age
Age
25-35 years
35-45 years
45-55 years
Above 55 years
Percent
25,64%
34,62%
25,64%
14,10%
Table 2. Sample structure by education

Academic education level
Bachelor degree
Master degree
Doctoral degree
Percent
37,18%
41,03%
21,79%
The questionnaire was organized into four sections which :

a. Statistical positioning of the interviewed
b. The importance assigned by accounting professionals to theoretical and
practical activities
c. The role of the accounting professional bodies (CAFR, CECCAR,
ANEVAR, CCF) in professional training
d. The hierarchy of skill acquired through educational process in universities
The first category of questions allow the positioning of the respondents according to
age and academic training. Given the relatively heterogeneous population covered by
the study, we divide it after the main descriptors of the respective populations: age
and academic education. Depending on this we can establish the level of academic
education and age of respondents and will be able to make our opinion on the level of
awareness of issues by those interviewed.
The second section of questions tries to identify the perception of accounting
professional on the theoretical and practical training in relation to the demands of
employers on the accounting labour market.
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The third category of questions tries to outline the perception of the interviewed on
the transition from academic education to education offered by professional bodies,
the way these two broad categories of professional trainers interact (through the
perception of members of professional bodies), and to assess the need of evaluation
and control of the educational process.
The last category of questions tries to assess importance of discipline recommended
by the IES educational standards issued by IFAC in the activity of accounting
professionals.
A five points semantic differential scale was used for most of the questions to assess
the opinion of those interviewed. Values between 1 and 5 in correspondence with the
importance stated by the respondents were assigned to the responses (5-important,
1-not important).
To determine the hierarchy of skills a weighted average was calculated based on the
scores obtained by each skill, the resulting average being used to rank the skills.
We applied Chi-square procedure to test the significant difference between groups
using as differentiation criteria the age of the interviewed and their level of academic
education. Data processing was performed with Microsoft Excel spreadsheet and
XLSTAT add in.
2. RESEARCH RESULTS
2.1 The importance assigned by accounting professionals to theoretical
and practical activities
.
In order to assess the importance assigned by accounting professionals to theoretical
knowledge acquired during university studies on one hand and solid practical skills
acquired through practical work experience on the other hand, respondents were asked
to give scores on a scale of 1 to 5 according to their importance (1 not important,
5 important). The distribution of responses is shown below:
Table 3 The importance assigned by accounting professionals to theoretical
and practical activities (response distribution)
Theoretical knowledge
acquired during university
studies
Solid practical skills
acquired through practical
work experience
not important
1
2
important
2 (2,56%)
8 (10,26%)
15 (19,23%)
19 (24,36%)
34 (43,59%)
0 (0,00%)
0 (0,00%)
5 (6,41%)
15 (19,23%)
58 (74,36%)
By analyzing the frequency series we can conclude that accounting professionals find
theoretical knowledge acquired during university studies important, but to a lesser
extent than solid practical skills acquired through practical work experience. This
could confirm what some of studies cited above, namely that there is an obvious
discrepancy of expectation between the providers of accounting education and the
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demanders of that education (American Accounting Association, 1986) (Cheng,

2007). In what follows we try to detect if there is any link between the age and level
of academic education on one hand and the way they appreciate the theoretical
knowledge acquired during university studies and practical skills acquired through
practical work experience on the other hand. To do that we use chi-square analysis to
test some hypothesis.
Hypothesis 1
There is a link between the age of the interviewed persons and the importance level
they attaches to the theoretical knowledge acquired in school.
H0: There is no association relation.
Ha: There is an association relation
Given the small sample size the recoding of variable was required. To safely use the
Chi-square test based on the Chi-square approximation, a maximum of 20% of the
cells of the contingency table should have values lower than 5 (number of cases). To
overcome this limitation we arbitrarily grouped scores lower than 3 and those greater
than 3. We also regrouped ages categories obtaining two of four: 25-45 years and
45-65 years. The effect of the re-codification is the occurrence of the possibility that
certain correlations existing between subgroups might have been lost.
Table 4. Chi-square results for Hypothesis 1
Chi-square (Observed value)
Chi-square (Critical value)
DF
p-value
alpha
6,685
5,991
2
0,035
0,05
As the computed p-value is lower than the significance level alpha=0,05, one should
reject the null hypothesis H0, and accept the alternative hypothesis Ha.
The risk to reject the null hypothesis H0 while it is true is lower than 3,54%.
Hypothesis 2
There is a link between the academic education level of respondents (bachelor degree,
master degree, doctoral degree) and the importance level they attaches to the
theoretical knowledge acquired in school
Because of the restrictions imposed by the Chi-square contingency table, scores lower
than 3 and greater than 3 were grouped. The chi-square results are listed below:
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7,768
9,488
DF
p-value
0,100
alpha
0,05
As the computed p-value is greater than the significance level alpha=0,05, one cannot
reject the null hypothesis H0. The conclusion is that there is a link between the
education level of respondents (bachelor, master, doctorate) and the importance level
they attaches to the theoretical knowledge acquired in school.
Hypothesis 3
There is a link between the age of the interviewed and the importance level they
attaches to the solid practical skills acquired through practical work experience
The results of chi-square test applied on the distribution of responses associated with
scores 3,4 and 5, because the number of responses for scores 1 and 2 is zero, is shown
below:
1,114
5,991
DF
p-value
0,573
alpha
0,05
reject the null hypothesis H0. The conclusion is that there is no link between the age
of the interviewed and the importance level they attaches to the solid practical skills
acquired through practical work experience
Hypothesis 4
There is a link between the academic education level of the interviewed and the
importance level they attaches to the solid practical skills acquired through practical
work experience
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The results of chi-square test applied on the response distribution of associated with
scores 3,4 and 5, because the number of responses for scores 1 and 2 is zero, is shown
below:
1,103
5,991
DF
p-value
0,576
alpha
0,05
reject the null hypothesis H0. The conclusion is that there is no link between academic
education level of the interviewed and the importance level they attaches to the solid
practical skills acquired through practical work experience
2.2 The role of the accounting professional bodies (CAFR, CECCAR, ANEVAR,
CCF) in professional training
To assess the opinion of the interviewed on The role of the accounting professional
bodies (CAFR, CECCAR, ANEVAR, CCF) in professional training, we asked them
to give their views on the Romanian university system's ability to meet the needs of
accounting professionals who tries to get access to the Romanian qualified labour
market. Responses to questions are summarized in the table below.
Table 8. The response distribution to questions used to assess the role
of role of the accounting professional bodies
Yes
No
Question
Number of
responses
Number of
responses
Do you find the current three year bachelor degree

cycle adequate for young graduates to satisfy the
demands of labour market from Romania and
European Union?
25
32%
53
68%
Do you find the graduation of a two year master,

which contains the disciplines required to gain access
to profession, adequate to offer access to training
stage for auditor, chartered accountant or tax
consultant?
44
56%
34
44%
Do you think that there is a need for a mechanism to

monitor the education process of universities masters
in order to offer access to training stage of
professional bodies without an admission exam?
59
76%
19
24%
Do you consider necessary an institutional dialogue

mechanism between existing professional bodies and
the Romanian higher education system for monitoring
educational curricula of faculties ?
75
96%
4%
Do you find the current training programs conducted

by professional bodies useful?
63
81%
15
19%
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Most of those interviewed (68%) believe that three years cycle is not sufficient for
training graduates for the labor market requirements, while 32% say that the cycle of
three years is enough. Generally, accounting professionals agree to assimilate a master
program which contains the disciplines required to gain access to profession to an
admission exam that offer access to training stage. Most of them find the current
training programs conducted by professional bodies useful (81%). Likewise, most of
them consider that there is a need for a for a mechanism to monitor the education
process of universities masters and find necessary an institutional dialogue
mechanism between existing professional bodies and the Romanian higher education
system for monitoring educational curricula of faculties (96). These responses outline
the important role the professional bodies play in the ongoing training and educational
curricula and also highlight the need to adapt the educational curricula to market
demands.
Our study has also detect a link between the academic education level (bachelor
degree, master degree, doctoral degree) and how they estimate that three year
bachelor degree cycle is adequate for young graduates to satisfy the demands of
labour market from Romania and European Union?
The response distribution is shown below:
Table 9. The response distribution used the detect the link between academic
education level and accountants opinion on bachelor degree cycle
Academic education level
Yes
No
14
5
6
Bachelor degree
Master degree
Doctoral degree
15
27
11
Table 10. Results of chi-square test

DF
p-value
7,552
5,991
2
0,023
alpha
0,05
As the computed p-value is lower than the significance level alpha=0,05, one should
reject the null hypothesis H0, and accept the alternative hypothesis Ha according to
which there is no link between the academic education level and the perception of the
bachelor degree cycle.
The study has not found other links between categories of respondents constituted on
the basis of age or academic education level and the response distribution to questions
of this section.
2.3 The hierarchy of skill acquired through educational process in universities
In order to highlight the opinion of accounting professionals on the on the
competences acquired during the current bachelor degree cycle, they were asked to
give scores from scores from 1 to 5 (1 unimportant, 5 important) to competences
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recommended by IES 2 (Content Programs of professional accounting education) and

IES 3 (Professional skills and general education) issued by IFAC. To determine the
hierarchy of skills a weighted average was calculated based on the scores obtained by
each skill, the resulting average being used to rank the skills. The resulted hierarchy is
presented below
Figure 1. Hierarchy of competences as seen by accounting professionals
In order to make a comparison we created a hierarchy of competences associated to

disciplines taught during the bachelor degree cycle of the Faculty of Accounting and
Management Information Systems from the Academy of Economic Studies of
Bucharest. To create the hierarchy we used the number of ECTS (European Credit
Transfer and Accumulation System) points allocated to each discipline. The score
final score obtained by a competence is the sum of ECTS points of the disciplines that
make up that competence. Professional judgement of the authors was used to classify
the disciplines.
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The resulted hierarchy is shown below:

Table11. Hierarchy of competences order by ECTS points
Competences
Financial accounting and reporting
Finance and financial management
Quantitative methods
Business and commercial law
Economics
Audit
IT control competences
Financial markets
One of, or a mixture of, the competences of, the roles of manager
Management and strategic decision making

Management accounting and control
General knowledge of IT
Taxation
IT user competences
Marketing
Interpersonal and communication skills
ECTS points
31
24
18
16
15
11
9
9
9
8
6
5
5
4
4
2
It may be noted that there is a discrepancy between the importance of skills acquired
through education system and the assessment of professional accountants. These ones
focuses on competences which rather belong to human quality (professional values,
ethics, attitude, intellectual skills). Surprisingly, skills that exclusively belong to
finance and accounting field appear to be less valued by those interviewed.
CONCLUSIONS
Given the changes that the Romanian higher education has to face, our study aims to
highlight the perception of the professionals on the Romanian accounting education.
One of the first conclusions is that accounting professionals find theoretical
knowledge acquired during university studies important, but to a lesser extent than
solid practical skills acquired through practical work experience. This choice may be
explain by the fact that most of them find the current three year cycle inadequate to
fulfill the demands of labour market from Romania and European Union. A two years
master seems to offer an adequate level of education to gain access to profession if
there is monitoring mechanism for those masters.
The study highlights the role that professional bodies play in ongoing training, the
education programs of these ones being appreciated by the respondents. An
institutional dialogue mechanism between existing professional bodies and the
Romanian higher education system for monitoring educational curricula of faculties is
also recommended.
The hierarchy of skills based on responses received highlights the important role
played by practical knowledge, ethical values, intellectual skills in the work of the
professional accountant confirming studies cited in firs part of this paper.
~890~
REFERENCES
The Academy of Economic Studies Bucharest. (2010). Planuri de invatamant Contabilitate si
Informatica de Gestiune. Available at http://www.ase.ro/site/pentru/Planuriinvatamant/ plan_inv/plan_cig.asp (2011)
Albu, N., Alexander, D., & Albu, C. N. (2010). Accounting change in Romania- A historical
analysis. The 31st Congress of the Association Francophone de Comptabilit, Nice,
France
American Accounting Association. (1986). The Bedford Report- Future Accounting
Education:Preparing For The Expanding Profession. Available at, http://aaahq.org/
aecc/future/prologue.htm (2010)
Baker, W. M., & McGregor, C. C. (2000). Empirically Assessing the Importance of
Characteristics of Accounting Students. Journal of Education for Business, 149-157.
Cheng, K.-W. (2007). The Curriculum Design in Universities from the Perspective of
Providers in Accounting Education. Education, 581-590.
Feleaga, N. (1999). Comparative accounting [Sisteme contabile comparate]. Bucharest:
Editura Economic.
IFAC. (2008, 8). International Education Standard IES 2 Content of Professional Accounting
Education Programs. Available at http://web.ifac.org/media/publications/d/handbookof-international-e/ies-2-content-of-professi.pdf
IFAC. (2008). INTERNATIONAL EDUCATION STANDARD IES 3 PROFESSIONAL SKILLS
AND GENERAL EDUCATION. Available at: http://web.ifac.org/media/publications/d/
handbook-of-international-e/ies-3-professional-skills-1.pdf
Jermakowicz, E., & Gornik-Tomaszewski, S. (2006). Implementing IFRS from the
perspective of EU publicly traded companies. Journal of International Accounting,
Auditiong and Taxation, pp. 170-196
Lowry, J., & Yap, C. (1997). Management Accounting: What Skills? Australian Accountant,
pp. 50-51.
MECT Towards the european higher education area. Bologna process. National Reports
2004-205. Available at: http://www.edu.ro/index.php?module=uploads&func=
download&fileId=6393 (2005)
Nobes, C., & Parker, R. (2008). Comparative International Accounting-Tenth Edition,
Prentice Hall
Tanner, J. R., Totaro, M. W., & Wilson, T. E. (1998). Accounting Educators' Perceptions of
Accounting Students' Preparation and Skills: A 10-Year Update. The Journal of
Education for Business, pp. 16-17.
Tanyel, F., Mitchell, M. A., & McAlum, H. G. (1999). The skill set for success of new
business school graduates: Do prospective employers and university faculty agree?
Journal of Education for Business.
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MANAGEMENT VIEW RELATED TO HIGHER

EDUCATION AN ANALYSIS OF THE ROMANIAN
BUSINESS PERCEPTIONS
Mihaela TE 1, & Alexandra ROU
Vasile Goldi, Western University Arad, Romania
ABSTRACT
The main objective of this paper consists in revealing the business environment expectations
regarding the competences and capabilities offered by the universities. It aims also to give
indications about the strengths and weaknesses of higher education regarding the changing
requirements of business environment. The researches are founded on the surveys on
graduates from different specialties in economics and interviews realized in Romanian
business environment. On the basis of collected information there has been realised analysis,
interpretation and drawing inferences. This methodology puts into evidence some indicators
that can be used to measure the customer satisfaction regarding the higher education, both
from individuals and business environment points of view. Starting from an analysis of
customers perceptions, the paper offers indications about how can universities improve their
economics curricula in order to respond at the requirements of our present business
environment.
KEYWORDS: management, business, university, satisfaction, globalization

INTRODUCTION
In those days of crisis that Romania, as most of countries, around the world found on
XXI century's (Breban, L. et al., 2010) scaffold are passing through, we must be
aware that any rational modern enterprise is becoming more oriented towards two
major directions: first to give up a greater share more or less substantial of employees
by reason of the impossibility of paying wages and to employ the graduate students
because of the advantages that the government offers to the employers. But in this
second case, becomes noticeable a neo-trend positioned at the level of management
know-how that a university graduate can inject in an organization, upstream and/or
downstream of its value creation chain.
In fact, from interviews with Romanian managers, one of the indicators that we
wanted to analyze with priority it was the level of satisfaction of both students and
graduates of the Bologna cycles, in parallel with the feed-back existing at the level of
business men. In fact, all these steps follow one thing in common: profit and return on
investment realized. Namely: the profit of university graduates initially confined to
recognized diplomas obtained and thus will absorb the costs of fees for university
studies and in the second phase and not only the material advantages which would
1
Correspondence address: Mihaela STET, Vasile Goldi, Western University Arad, Romania;
email: mihaelastet@yahoo.com
~892~
naturally succeed on the organizational ladder. From the perspective of managers

(Kotler, P., 2003) it is clear that profit will be strictly linked to the contribution of
knowledge brought by the graduate employee that should be much higher as the
investments in salary, payments to state and/or other benefits that results from its
employee status in accordance with policy organization.
We appreciate that this phenomenon should not and can not be analyzed from an
isolationist perspective, being necessary to create a IQMS (Integrated Quality
Management System) which is existing both in the state and/or private national
universities and in the business area as long as possible to ensure a regular self-control
designed to adjust its own methods, theoretical and practical of both analyzed levels
by this work.
1. METHODS AND MATERIAL RESOURCES
To be able to provide objective monitoring of HE-MB ratio (higher education modern organization) we propose another pragmatic and dynamic indicator
generically called OKIE (Object Key Interest in Education), capable to permit a
relevant insurance of quality system in their own HE area (Sderqvist, M., 2001). We
consider that this measure will ensure that costs incurred for the benefit of knowledge
will get quality education, own skills, information and proper management NPE
(needs-preferences-expectations). We also consider that this neo-parameter can be
addressed from the perspective of KPIs (Key Performance Indicator), which explains
the fact that the scope of MUs (modern universities) found under the incidence of
micro-macro directions imposed by the chaotic pace of the third millennium has to
ensure real commissions of intellectual know-how in order to be easily decoded,
implemented and related to the specific management environment of the workplace.
In this context, we also appreciate that we can speak about an IHES (Implicit Higher
Education Sustainability) who actually understand the importance that the
globalization throws on the world micro-macro-global economic stage (Dumitra, C.,
Rou, A., 2010): prevention of the lack of educational opportunities for both daily and
distance higher education. This can be accomplished by monitoring, analysis and
interpretation of SSFR (Student Satisfaction Feedback Request). At this level it will
be generate informational windows in the form of a real MDB (modern database),
able to reflect in the management analysis the concrete action of RVHE type
(Rethinking the Values of Higher Education). The proposed indicator can actually
demonstrate the linearity shaken by the environment that changes with steps that are
more harder forecasted (Oliver, HM et al., 2000).
Yet any analysis undertaken at the level of HE - business area ratio needs to
demonstrate clearly whether it exist or not CWF (competing worries and Fears) on the
reference market, especially for the two axes that are analyzing in this work. The
CWF is actually locates at the level of the known collocation "value for money",
which acquires new connotations in the current EFS (economic, financial and social)
crisis that brings on LRI (local-regional-international) stage another paradox:
although high school graduates no longer have the financial resources necessary to
continue studies degree (mainly due to a drastic minimization of income from families
and on the other hand the impossibility to be engaged because of the lack of
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experience), and are put in a position to accept a job that doesn't requires HE and even
less management skills.
So, we are in situation to ask ourselves if the Romanian society and not only will be
satisfied with a low level of management skills and knowledge, truncated by the sap
of superior knowledge and not with an intelligence certificated through well known
Bologna process that Romania has already aligned as an EU member (anta C. et al.,
2010). Actually, obtaining a better grade in business life becomes now just an
approach totally devoid of a fully justification that is necessary and reasonable if we
take into consideration the discrepancy and injuriousness of the salaries of those who
own the HE and those who remain anchored in unknowledge. And since we get here,
what can we say about the basic curriculum that it involves national universities
today? How fast can it be adapted to an unstable market from the dynamic behave
point of view (Blackwell, R., Engel, AM, 2002), to which social challenges must
respond and how its performance can be measured? To all this questions we are trying
to answer further.
National universities and not only should first focus on creating its own internal
structures in order to be in making a proper reorientation of the curriculum in parallel
with the evolution and the specific NPE at the active market level. In other words, it is
necessary that a redefinition and repositioning of its outputs (learning outcomes,
management knowledge, abilities, skills acquired by students and/or graduates), while
keeping the specific and traditional academic fingerprints (Parker, C, Mathews, BP,
2001). The universities contribution should be fully correlated with the state suport in
order to reach the stage for underline QNR (National Qualifications Register) able to
provide a transparent approach on HE quality for to correctly compensate the quantity
of HE anchored to the level of credit awarding, which measured the volume of
students work during the years of study. But in our opinion, all this effort calls for a
neo-cooperation of all forces of responsabile for the entourage specific to HE:
national universities, ARACIS responsible representatives of the Romanian
government.
Further, in our opinion, we must consider that we have to take into consideration with
priority also the effects of the EFS crisis towards the current market, extended from
the end of 2009 until present, if we think to the mutations that are operating in a
century of chain crisis. And we continue to ask: is there an optimal rate of intellectual
adaptation to a globalize present environment?
And if so, then that would be the anti-crisis intellectual ingredients and/or spices that
Romania can afford? In an open dialogue with national entrepreneurs we obtained an
apparently interesting information, located in a nodal point: the potential today's
students represent a niche of HE threatened by declining birth-rates garnished with
increasing lack of revenue needed to cover the costs claimed by the current private
education system and fewer places for the scholarship offered by the public
universities.
2. RESULTS AND DISCUSSIONS
If this seems to be the landscape of our world then it means we can easily associate
the university services with the trade negotiation field, where the partners face at a
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negotiation table, where they are the common stake. This easily implies that all it is
essentially just a game of will and desire to win. Well, in our case who will have the
advantage of slightly higher: the universities or the future graduates?
And we also ask: what academic entrepreneurship manager is able to analyze and
resolve this issue? On first examination, we appreciate that the neo-business people
optics is directly positioned in the pattern shown in the figure 1.
Figure 1. A business pattern directly concerned to HE
Providing new task/work
Goal
Knowledge
Knowing
single
mind
exploring
mind
improved
mind
Studying this pattern of relationship we are in position to appreciate that were

moving increasingly towards an educationcracy (democratic education) able to absorb
with a fantastic speed more varied PIs (Performance Indicators) that constantly focus
on outputs, which is characteristic to HE. And if this complex curriculum researchers
usually resort to various methods more or less adapted to the evolving nature of OKIE
(Likert scale, different methods such as ASSIST, AEQ, LSQ, ETQL), our research
was conducted and configured in two distinct phases.
The first was the interviews realization with graduates of HE as well as
representatives directly responsible for HEOs (Higher Education Organizations)
found at national level. Then, this process was accompanied by the organization of
focus groups from where data were collected and processed both by univariate and
multivariate analysis.
If we refer to the 60 universities currently existing on the Romanian market, then we
can say that high school graduates have provided a solid bunch of alternatives but the
key question appears to follow when evaluating it is made for the quality of
educational services provided by them. The course here will be extended an issue
related to the decision to continue or not the masteral and/or PhD studies under the
umbrella of the same university that granted the bachelor degree in the particular
study. This unknown field could be resolved in a view already expressed that "people
should understand that Frontline They are the ones who bring success to Their
moments of truth, and everyone else should understand Their first job is to support the
people as They Frontline do it"(Carr, C., 1990).
We believe that we can naturally extend this explanation by addressing in terms of
TQM (Total Quality Management) (Ahlberg, M., 1995) in order to understand the fact
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that the neo-student (McCulloch, A., 2009) of XXI century has increasingly the regard
such approach HOME (How the Opportunities Must Be Experimented) thinking.
Certainly here we consider including proximity parameter to the centre of HE and
particularly the possibility of replacing students' home or rental pay by own incomes
with personal and/or family home. Here is just a step required to understanding that
CST (Customer Satisfaction Theory) should be incorporated in the circumstances as
the following relational model:
Figure 2. Pattern transposed on CST principle
SST
Students
Satisfaction
Theory
Fig
SSI
SSI
Students
Satisfaction
Ideas
Students
Satisfaction
Aplications
In such an equation it becomes very simple a refocusing of national universities

positioning, which will claim an obvious reconfigure of placement and the systemic
way of perception by potential and/or current customers (Emery, C. et al., 2001)
found in their academic record book.
For this we found that it is necessary to achieve even a design of what we understand
from the initially discussions in order to obtain a sketching of this scientific material
that should be finally a parameter of SS (Student Satisfaction) type, played in figure 3,
specific to the time we cross on the uncertainties EFS scale imposed by the current
intangible barometer of globalization.
Figure 3. The model of 10 forces with direct incidence on SS management
materialization
University
world
perception
University
goals
University
world
ranking
University
promotion
University
performance
SS
University
access
University
relationships
University
culture
University
mentality
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University
behaviour
It is relatively easy to observe that among these 10 distinct channels, own by any
academic entity (Garbarino, E., Johnson, MS, 1999) may not be omitted a proactive
CRM (Customer Relationship Management) template so that it can be outlined as
accurately as possible the opportunities offered by the graduates to managers with
their hiring in the organization and the opportunities that university can provide them
as a corresponding feedback towards school fees directly payable (if private university
entities).
Actually the modern academic environment (Umbach, PD, Porter, SR, 2002) should
be able to provide a customized and personalized educational pattern, watering,
concentrated and focused on increasing the number of students, able to acquire
successful career in duly elected academic training and / or associated and / or
completely separate.
To compact all the presented elements in a normal way, concerning the academic
intelligence stage, then we should look misplaced idea that instead of wasting of time
in order to identify the corresponding university for the NPEs high school graduate
parameters (Slater, D., 1998), and so this would certainly be more normal to be
wasted energy in the quality of higher education itself, so throughout higher education
to become a continuous quality summum.
It should be understood that the society has no current practical needs of graduates
and/or bachelor degrees/masters/PhDs graduates over disagreements that have
somehow acquired the same skills and/or theoretical and practical knowledge related
graduate who has a simple high school diploma. Today, Romania and so the other
countries needs elites, which completely reverses the quality training priorities for HE
quality and against HE quantity.
Sure it would be necessary lot of efforts for to create a revival national business
infrastructure to prevent national brain drain but also in parallel to this step should be
based on synergistic pattern of business consulting career that the Romanian state
should be aware and to assume, in order to obtain a desaturation of the educational
guidelines for curriculum areas that can not be absorbed at the present job market
level.
We appreciate also that this approach will be able to extract the country from state
paying the irrational unemployment benefits as a response to a proper undistributed of
the present HE outputs. So we state that Romania currently must understand that
many organizations that have not yet entered into specific stages of insolvency and/or
bankruptcy in particular can increase no longer databases with graduates with higher
education.
It is necessary an orientation more judicious, balanced and rational of eager HE in
relation to a momentary lack of optimal absorptions and we appropriate the existing
jobs integration in the current market as a national priority. In fact, an effective
national CRMs should be able to profitable translate HES (Higher Education
Services) in order to be able to positively and proactively influence perceptions,
satisfaction and HE results in order to obtain in the end reports exclusively focused
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towards the quality of cost-benefits axe. Thus, new challenges overlap task university
sites, which are able to explain a national opened competitive behaviour.
The strength of the educational act itself on domestic market is actually a correct
democratic struggle (Needham, C., 2003), justified by the competition law so that the
SS currently receives an even broader sense conceptually, as we can see in the next
figure.
Figure 4. Materialization of relations found at the SS level
SS
SPQ
(student perception quality)
SPV
(student perception value)
SG
SH
SL
SR
SK
SP
student
goals
student
hired
student
life
student
renoun
student
knowledge
student
performance
Based on the SPE and SPQ the Romanian state should implement sustainable
benchmarking efforts of specific type so that the NPEs with bachelor/master/PhD
graduates to be as realistic and possible to be translated in the near future into reality
of a painful viral SWOT suffocation characteristic to the EDC (contemporary Digital
Economy) pattern, expanded due to widespread ICT interfaces, upstream or
downstream of the national economy.
However, regardless of which option will be pursued at the management study level,
we note that virtually progress is irreversible and the Internet market is very firmly
embedded in a future which overlaps with a hologram seemingly unimaginable at
present so that the universities can no longer afford not to fully digest and absorb the
whole information without transforming it into business advantages and management
durable niches for the entire society.
REFERENCES
Ahlberg, M., (1995) TQM for University Level Needs Attention to Neglected Processes of
Quality Learning and Quality Research, Proceedings of the Seventh International
Conference on Assessing Quality in Higher Education, July 1995. Indianapolis, Indiana:
Planning and Institutional Improvement, Indiana University/Purdue University
Indianapolis, 1995
Blackwell, R., Engel, P.M., (2002) Consumer Behaviour, Piter, St. Petersburg
Breban, L., Borlea, S., Rou, A., anta, C., (2010) Management pulse of the XXI century
towards the responsible enterprise, 5th International Conference Accounting
and Management Systems AMIS 2010, Academy of Economic Studies Bucharest,
June 16-18, 2010
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Carr, C., (1990) Front-line Customer Service: 15 Keys to Customer Satisfaction, USA:
John Wiley & Sons, Inc.
Dumitra, C., Rou A., (2010) Bazele comerului, Ed. Risoprint, Cluj-Napoca
Emery, C., Kramer, T., Tian R., (2001) Customer vs. Products adopting an effective
approach to business students, Quality Assurance in Education, volume 9, number 2,
pp. 110.115
Garbarino, E., Johnson, M.S., (1999) The diffrent roles of satisfaction, trust, and
commitment in customer relationships, Journal of Marketing, volume 63, pp. 70-87
Kotler, P., (2003) Marketing Management, Prentice Hall
McCulloch, A., (2009) The student as co-producer: learning from public administration
about the student university relationship, Studies in Higher Education, vol. 34, no. 2,
pp. 171-183
Needham, C., (2003), Citizen Consumers: New Labours Markeplace Democracy, London:
Catalyst Working Paper
Oliver, H.M. et al., (2000) Is relationship marketing for everyone?, European Journal of
Marketing, volume 34, number 9/10, pp. 1111/1127
Parker, C, Mathews, B.P., (2001) Customer satisfaction: contrasting academic and
consumers interpertations, Marketing Intelligence & Planning, volume 19, number 1,
pp. 38/44
Slater, D., (1998) Consumer Culture and Modernity, Cambridge: Polity Press
Sderqvist, M., (2001) The Internationalization and strategic planning of Higher/Education
Institutions - An analysis of Finnish ERP strategies, Helsinki School of Economics and
Business administration
anta C., Rou A., Breban L., Bochi L. (2010) EU Intelligent steps to maintain in the race
of the 3rd millennium, Conferina internaional Integrarea european noi
provocri, ediia a-VIa, Facultatea de tiine Economicea Universitii din Oradea,
28-29 mai 2010, TOM XVII, ISSN 1582-5450, steconomice.uoradea.ro/
pdf/sesiune_com/2010/programme.pdf
Umbach, P.D., Porter, S.R., (2002) How do academic departments impact student
satisfaction? Understanding the Contextual Effects of Departments, Research in Higher
Education, Volume 43, number 2, pp. 209-234
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SOCIAL NETWORKING IMPACT ON EDUCATIONAL

PROCESSES IN ROMANIA
Florin MIHAI1, Andrei STANCIU & Ofelia Ema ALECA
ABSTRACT
The main purpose of the research is to analyze the impact of social networks on educational
process in Romanian higher education. Considering these aspects, based on a theoretical
frame regarding the educational value of the social networking web sites, a model of
implementing Facebook usage in higher education leaning processes was proposed. The data
required to validate the model were gathered through a survey on students at the Bucharest
Academy of Economic Studies. The survey has revealed that social networking sites have
become very popular among students and could be considered as valuable potential for
education. The study opens a wide perspective on students availability to use social
networking sites, but also other web based technologies.
KEYWORDS: On line social network, e-Learning, Educational context, Facebook,

Computer Supported Collaborative Learning
INTRODUCTION
Due to the continuous increase of using new IT&C technologies in everyday life, the
implementation of these technologies in learning activities becomes a necessity.
Though the e-learning platforms are implemented in universities all around the world,
the educational methods, techniques and educational software tools do not have
always keep the pace with the new information technologies, an example being the
social networking sites which are very popular, being accessed regularly by most
students and teachers, but not yet considered an instrument for learning and teaching.
Kleiner at all (2007) conducted a study regarding the development of educational
technologies and found that the reluctance of teachers is the key of non-integration of
new technologies in teaching.
For example, many Romanian teachers still consider social networking sites as a kind
of virtual playground for teenagers. But there evidence that social networking is a
more complex phenomenon and, there are the politicians who prove that
social networks are not just a funny places on the web and are worth to pay attention
(Figure 1).
Correspondence address: Florin MIHAI, Academy of Economic Studies, Piata Romana, nr. 6, Sector
1, Bucharest, Romania; email: fmihai@gmail.com
Figure 1. Social networking became a more complex phenomenon
Though some negative aspects could be also emphasized and Flynn (2009); Stansbury
(2009); Young (2009) identified specific issues, there are already several educational
institutions which are using social networking establishing relationships with
students accounts. For example University of Cambridge and University of Oxford
are very keen on promoting their Facebook pages (Figure 2).
Figure 2. Several educational institutions are using social networking in order
to establish relationships with students accounts
These models could be useful to eliminate teachers reluctance and to demonstrate

that social networking sites are basically a solution for teachers to be constantly in
touch with students (Roblyer et all, 2010).
The key of success consists not only in a prompt response regarding the evolution of
support technologies for teaching, but also in reengineering educational processes
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through developing and implementing new concepts as Computer Supported

Collaborative Learning (CSCL) which encourages collaborative development of
knowledge. From this point of view, modern e-learning platforms have radically
changed students and teacher's role in learning activities and are promoting the
concept of social learning by using social software tools (such as blogs, online
encyclopaedias and virtual worlds). In scientific papers, this tendency to transform
e-learning process and to convergence with social networking is referred by some
authors as Long Tail Learning (Karrer, 2008).
E-Learning 2.0, unlike systems not based on CSCL, involves the accumulation of
knowledge as a social phenomenon which can be socially constructed and is based on
effective learning through conversations and various types of interaction in the virtual
environment (Casquero et al. 2010). In recent years, a massive increase in the number
of virtual classes or delivered live online presentations was recorded in high education
all around the world. Complementary to virtual classes, accessing social networks as
learning environments has become a basic concept for E-learning 2.0 frameworks.
The main role of social networks is to coagulate virtual learning communities within
the scope of discussions on topics such scientific subjects, virtual experiments or other
various themes as exams preparation.
A major impact in promoting these activities focused around the concept of "social
networking" is provided nowadays by the development of client applications for
mobile devices which enhances their accessibility. Moreover, the development of
technologies needed to implement e-learning software on the latest generation
telephone devices and other mobile devices has led to the shaping of new concepts
such as mobile-learning or, in learning foreign languages, Mobile Assisted Language
Learning (MALL).
In the area of social networking, recent surveys highlighted that 30% of Facebook
users and 37% of Twitter are using the networks from mobile devices (Figure 3).
Figure 3. Social networking web sites: Login via mobile devices
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Formerly designed on communication purposes and for improving information
exchange among small groups of users, social networking sites have become quickly
very popular, and the number of users from a wide geographical area joined the
groups and became regular clients.
In general, the social networks sites provide users with a private virtual space where
each one could build his own public profile and manage a list of links to other users
profile (Boyd and Ellison, 2007).
1.1 Facebook (facebook.com)
Founded in 2004 by Mark Zuckerberg, was formerly named thefacebook.com and was
designed as a closed online social network, available only for Harvard University staff
and students. Subsequently, network access has been extended to other universities
and companies like Apple or Microsoft. Since 2006, Facebook provide free access
regardless the membership in a university or company.
The network is based on Web 2.0 technology and is available from any computer with
Internet access, providing support for other several device types, including mobile
devices, benefiting from optimized software interfaces, especially designed.
Users can look up for their friends from around the world and can build their own
profile that can be public or private. The profile could be changed at user will or,
public profiles could be blocked by the administrators if other users are reclaiming the
content. Each user is allowed to post messages or photos which, also, could be public
or could be addressed to a specific group or users. More recently, Facebook also
provide different types of games for the users entertainment.
The main controversy which Facebook has been facing since the beginning concerns
about the respect for private life, given that information about users privacy can be
gathered for advertising purposes, by placing ads on the each users page and several
analyses are made by Facebook for his commercial partners in order to study the
social behaviour of each user. Undoubtedly, at this moment, in Romania
facebook.com is one of the most popular social networks and is estimated that
approximately 1.5 million Romanians are using Facebook (Negrila, 2010). Despite the
worldwide spread of Facebook users, there are still countries in the Middle East (or
even China) where Facebook is banned or limited.
In terms of educational impact on higher education institutions, at the moment, there
are several institutions registered on Facebook, but also students, parents and many
groups specially created for finding school or university colleagues. Practically, on
Facebook, we find all forms of interaction between educational services providers,
direct beneficiaries of education services, and why not, parents of students as
stakeholders. These interactions can take several educational approaches for Facebook
users:
(a) Learning for using Facebook
(b) Using Facebook for learning
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(a) Learning for using Facebook could be consider a strange approach, but is a
concept which emerges from the users incontestable interest in own information
security and privacy in order to answer to questions such What could happen when a
student make public their information on Facebook ?
On the facebookforparents.org web site tips and good practices are available for
parents, in order to keep safe the children while they are surfing on Facebook pages.
Things have gone further and there are software applications designed for data
security which provide the option to deny access to Facebook to specific users of a
given computer. However, a proper understanding of social networking concept and a
proper evaluation of knowledge spreading potential could be an important step for
decision makers in network security for many institutions.
(b) Regarding from the Using Facebook for learning point of view, teachers
seems to be less convinced than students to use Facebook. The teachers reluctance
on using Facebook to communicate with students is not resulting from their
conviction that using Facebook would not produce beneficial effects on learning, but
from their concerns about security of information conveyed in social networking and
high exposure on the Internet for teachers privacy.
There are many possible uses of Facebook in education, some authors
(Onlinecollege.org, 2009) stating about 100 ways to use Facebook in the classroom, in
order to provide value to the educational process.
The main features which recommend Facebook as a valuable tool which could be
used in education are:
Teachers can create custom list of students and manage groups of students on
custom topics related to courses;
Exchanging information through links, photos or multimedia content related to
specific subjects;
Creating surveys and quantifies the feedback.
Using the on line chat for direct communication between students and
teachers.
Publishing news on tests, exams or face to face meetings.
Integrating Facebook with other collaborative services provided by other
application (like Google docs).
Using Facebook as a complement for an eLearning platform
1.2 Twitter (twitter.com)
Twitter is a micro blogging service based on WEB 2.0 technology. The main
characteristic of Twitter is the feature of transmitting short messages like SMS, up to
140 characters. Formerly, many users considered Twitter an alternative SMS service
in the Internet.
Being two years younger than Facebook, Twitter is online since 2006 at
www.twitter.com. In the online community, the short messages transmitted through
twitter are known as tweets and the users of Twitter tweeters. In order to transmit
a message, a user could directly access the twitter web site or could use a dedicated
interface such: Twitpic, Digsby, Tweetdeck, etc. Several mobile phone operators from
different countries allow the transmission of messages on Twitter network through
SMS, using your mobile phone.
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The base concept for Twitter is to allow the users to publish their own notes on a
personal Twitter account and, in the same time, to let them read messages posted by
other users on their accounts.
Each person could define a custom list of Twitter users and is allowed to follow notes
posted by these people. Starting from these premises, the virtual space provided by
twitter for micro blogging is used nowadays in many activities:
Publishing news by newspapers or media agencies. There are several TV
stations (like CNN or PROTV) which publish the latest news on Twitter,
allowing users to be informed in the shortest time via mobile phone
notifications.
Promoting blogs. Many Twitter users have personal blogs and are using
Twitter in order to promote their activity on a personal blog and to attract new
visitors. Meanwhile on blog pages could be inserted Twitter widgets which
foster the micro blogging.
Promoting political activities. In recent years Twitter started being used
extensively for political action: elections, protests, etc. There are countries
(Barry, 2009), where large protests were coordinated on Twitter, when local
authorities tried to censor the calls to protests in local media.
Promotion of projects by institutions
Promotion of cultural events.
Launch of book or web sites.
Set up surveys.
Marketing.
Although at first glance, using a micro blogging service in the educational process
may seem cumbersome and inefficient and the features that could be used in the
educational process are not as complex as in the case of Facebook, micro blogging
network offers certain advantages that can be emphasized in the educational
processes:
Tracking news about books, journals or treaties available in the libraries of
educational institutions
Rapid spread of information about scheduled face to face meetings, exams, or
seminars.
Rapid spread of solutions to exercises, problems or specific controversies
Posting bibliographical notes or hyperlinks to scientific references by teachers
and students.
Facilitate the solving of specific problems which may be easily solved in a
group.
Teachers can set also up surveys and collect feedback information
Short messages of 140 characters offer a high degree of conciseness and
develop the ability of teachers and students to communicate in a more efficient
way.
However using a micro blogging platform in the educational process, whether it's
Twitter or other platform, because of the specific environment for conversations,
some controversial situations could arise. Regarding Twitter few negative aspects
could be mentioned:
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Twitter does not allow users to define groups in order to design a structure of
courses on topics of interest or to define specific groups of students as targets
for messages. If a teacher coordinates several courses for different groups of
students, spreading messages only on certain groups is difficult and
information could become irrelevant.
Rapid propagation of rumours (intentionally or not intentionally).
Because of limited message size to 140 characters, users can get to make gross
errors of expression.
Messages could become a source of spam.
Some students could prefer just to take advantage of others' work, posting
notes from time to time just to look like they are working.
We also found interesting, the latest demographic statistics which prove that social
networking is sharing a large segment of users with schools and universities. For
example around 50% percent of Facebook & Twitter users are people under 35 years.
Figure 4. Facebook & Twitter Facts - 2010
(Source: Data provided by Digital Surgeons, www.digitalsurgeons.com)
The same statistics reveal that 49% percent of Facebook users and 55% of twitter are
involved I educational activities in high schools or universities. And another quarter
has already graduated (Figure 5).
Figure 5. Facebook & Twitter Facts - 2010
(Source: Data provided by Digital Surgeons, www.digitalsurgeons.com)
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2. STUDY METHODOLOGY
Lee and McLoughlin (2008) consider social networking sites as educational tools
because students users can use them for communication and social support as well as
for discovering and sharing knowledge.
Based on previously proposed models in the scientific literature (Mazman & Usluel,
2010) a model for educational use of social networking sites was designed (Figure 6).
In this model the authors proposed to develop the usefulness of social networking
sites for learning and teaching in terms of six components: communication with
teachers or peers, collaboration in a particular group of learning, sharing resources
through interchange of documents and multimedia resources, the usefulness in the
educational process and the frequency of access.
Figure 6. A model for using social networking sites in educational context
(Source: adapted from Mazman & Usluel, 2010)
Communication with teachers

Communication with teachers through social networking could be considered an
extension to face to face classroom communication.
H1: Communication has a significant influence on the potential use of social
networking sites for educational purposes
Collaboration
Several scientific papers (Ajjan & Hartshorne, 2008, Lockyer & Patterson, 2008)
emphasize that social networking sites provide support for collaborative learning.
Users of social networking sites can join study groups corresponding to a certain
school, class or group they belong to and can share educational resources and
knowledge in an easier way.
H2: Collaboration has a significant role in using social networking as a support for
educational activities.
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Resources and knowledge sharing

Using social networking sites allows sharing multimedia resources like photos, videos
or hyperlinks to other web resources. One of the main advantages in using social
network sites as a tool for education consist in a unique approach which involves
collaborative group work and sharing of knowledge.
H3: Resource sharing has a significant influence on the use social networking sites in
educational purpose.
Usefulness
The utility factor concerns about the the degree to which a person believes that using
a particular system would enhance his or her job performance (Davis, 1989). The
usefulness of social networking sites is provided by facilities offered to users, such as
communication, interchange of information and resources that could be achieved
through a public or semi-public profile accessible to other users.
H4: The usefulness has a significant influence on the use social networking sites for
educational purpose
Frequency of access
Some authors believe that using social networking sites in everyday life (Mazman &
Usluel, 2010) and the fact that most users spend a lot of their time online provide a
good support in the context of education.
H5: Frequency of hits has a significant influence on the use of social networking sites
in educational purpose
Use of flexible technologies
The technological boom in IT&C technology allows access to web sites anytime,
anywhere through mobile communication devices.
H6: Flexibility of access provided by new technologies has a significant influence on
the frequency of accessing social networking sites
In order to examine how students perceive the use of social networking sites for
educational purposes a questionnaire-based survey was developed (presented in
Annex 1).
3. STUDY RESULTS AND IMPLICATIONS
In the questionnaire-based survey were involved 64 persons, students at the Bucharest
Academy of Economic Studies, the large majority being young people aged between
21 and 31 years.
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Figure 7. Structure of the survey participants by age
Social networking sites

According to the survey we found that Social networking is common among young
people in Romania and only 16% of participants do not have an account on a social
networking site. The most used social network is Facebook with over 87% of
participants at the survey being registered on Facebook. The survey also reveals that
Twitter is not so popular among students from Bucharest Academy of Economic
Studies.
Figure 8. Preferences on social networking sites
Another target of our survey was to find why students are joining social networks.
Nowadays, social networking sites are mainly used for keeping in touch with
colleagues and friends (over 60% of respondents saying that they have registered for
this purpose). Communication for educational purposes has a smaller percentage of
respondents (around 28%).
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Figure 9. Why are students using social networking?
Frequency of access
In terms of frequency of access, most users (around 67%) are accessing social
networking sites from 1 to 5 times a day and around 6s% could be considered pretty
addicted to social networking. They are doing over 20 logins per day.
Figure 9. Frequency of access (social networking sites)
Another highlighted point in the study is the link between the frequency of hits on
social networking sites accounts and e-mail services as means of communication.
According to the survey results, it seems that the trend of registering on social
networking web sites and email accounts is the same (t = 0.31, p = 0.76). All the
survey participants are using email and 92% access their accounts at least once a day.
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Figure 10. Frequency of access (email accounts)
Flexibility
Technological flexibility involves use of electronic mobile devices to access the sites
for social networking anywhere and anytime". Regarding flexibility of access, most
of survey participants are using laptops (62%) while 25% are using mobile phones.
Very few said they have used other devices (like tablet PC or IPad), this kind of
devices tends to become popular in our country but they are still quite expensive for
students.
Figure 11. Devices used to access social networking sites
Prospects for social networking sites as support for educational activities

At a more specific question regarding the prospects for social networking sites as a
support for educational activities, most of the respondents (about 62%) consider using
social networking sites an opportunity for communication between students and
teachers and around 25% consider that online social networking does not fit for
education. (Figure 11).
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Figure 12. Use of social networking sites for educational purposes
Communication, collaboration and sharing of learning resources and knowledge

In terms of use social networking sites for educational purposes, most of students who
responded to the survey (around 50%) believe that sharing resources, collaborating
through online social networking and communicating with teachers are very important
in using social networking sites for learning and only around 20% of the students
found one of these less important.
Figure 13. Communication, collaboration and sharing of learning resources
and knowledge

Tools for education provided through social networking sites offer specific
advantages especially for distance learning, using an affordable and popular
environment. Currently, online social networks are used by heterogeneous groups
with different ages which tend to integrate more and more facilities offered by these
networks in their daily lives. There is no doubt that, with the unprecedented expansion
of social networks, personal data security policies must to be improved and users are
~912~
have to be better trained to protect themselves. In recent years several social

networking users have been victims of hackers, spam, malware or phishing.
One of the most popular social networks in Romania is Facebook, which is gathering
many visitors, especially young people, from different backgrounds and continues to
expand rapidly in all age groups. The rapid development of technology in the field of
mobile devices is opening new opportunities for knowledge transfer and social
networks are the first to benefit. Student are very receptive to the development of
technologies for mobile devices and implementing e-learning software on the
telephone devices or other mobile devices is already leading to the shaping of new
concepts (as M Learning or mobile-learning )
According Facebook Statistics, there are more than 250 million active users currently
accessing Facebook through their mobile devices and people that use Facebook on
their mobile devices are twice as active on Facebook than non-mobile users. Also,
there are more than 200 mobile operators in 60 countries working to deploy and
promote Facebook mobile products. As regards the support of these networks for
educational processes, as we noted in the above analysis, there are users of social
networking, whether students or teachers who do not realize the benefits of certain
features of these networks educational purposes. The percentage of Romanian
students who show reluctance to communicate on networks like Facebook for
educational purposes is still pretty high. Of course, this could be also interpreted as an
issue of social culture on student- teacher relationship in Romanian universities.
In 2007 Facebook officially published some statistical data regarding users activity
on the network. The data revealed that the visitors spend a lot of time interacting with
other integrated applications in Facebook (at that time were estimated 88 million
visits with an average duration of 4 minutes and 30 seconds and not less than 14
millions unique visitors). Facebook applications are custom functionality that works
within the Facebook environment. The code runs on a separate server, but the
applications interface plays back inside Facebook.
A great challenge for e-learning solutions developers is related to the integration of
collaborative tools in education. For social networks web sites, but also for the
educational system, a very important step would be to develop additional features
geared towards the development of social learning concept, and to develop and foster
tutorials on how these networks could be used to socialize at school and home.
REFERENCES
Ajjan, H., & Hartshorne, R. (2008) Investigating faculty decisions to adopt Web 2.0
technologies: theory and empirical tests, The Internet and Higher Education, Vol. 11,
No. 2: 71-80
Barry, E. (2009) Protests in Moldova Explode, With Help of Twitter, N. Y. Times, available
on-line at http://www.nytimes.com/2009/04/08/world/europe/08moldova.html?_r=1,
accessed at 07.04.2009.
Boyd, M. D., & Ellison, N. B. (2007) Social network sites: definition, history, and
scholarship. Journal of Computer-Mediated Communication, 13(1), 210-230.
Casquero, O., Portillo, J., Ovelar, R., Benito, M., Romo, J. (2010) iPLE Network: an
integrated eLearning 2.0 architecture from a university's perspective, Interactive
Learning Environments, Vol. 18, No. 3
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Davis, F. D. (1989) Perceived usefulness, perceived ease of use, and user acceptance of
information technology, MIS Quarterly, Vol.13, No. 3:319-340
Flynn, N. (2009) Facebook, take 2: Cyberbullying, Education week, available on-line
at
http://
blogs.edweek.org/edweek/LeaderTalk/2009/05/facebook_take_2_
cyberbullying.html?qs=facebook
Karrer, T. (2008) Corporate Long Tail Learning and Attention Crisis,
Elearningtech.blogspot.com, available on-line at http://elearningtech.blogspot.com/
2008/02/corporate-learning-long-tail-and.html
Kleiner, B., Thomas, N., & Lewis, L. (2007) Educational technology in teacher education
programs for initial licensure (NCES 2008040). Washington, DC: National Center for
Education Statistics, Institute of Education Sciences, U.S. Department of Education
Lee, M. J. W., McLoughlin, C. (2008) Harnessing the affordances of Web 2.0 and social
software tools: can we finally make student-centered learning a reality?, Paper
presented at the World Conference on Educational Multimedia, Hypermedia and
Telecommunications
Lockyer, L., Patterson, J. (2008) Integrating social networking technologies in education: a
case study of a formal learning environment, Proceedings of 8th IEEE international
conference on advanced learning technologies : 529-533
Mazman, S. G., Usluel, Y. K. (2010) Modeling educational usage of Facebook, Computers
& Education, No. 55: 444-453
Negrila, S. (2010) Cum comunica mall-urile pe Facebook, wall-street.ro, available on-line
at http://www.wall-street.ro/slideshow/Real-Estate/91365/Cum-comunica-mall-urilepe-Facebook.html, accesat la 25.08.2010.
Onlinecollege.org (2009) 100 Ways You Should Be Using Facebook in Your Classroom,
http://www.onlinecollege.org/2009/10/20/100-ways-you-should-be-using-facebook-inyour-classroom/, accessed at 10.01.2011.
Roblyer, MD, McDaniel, M., Webb, M., Herman, J, Witty, J.V. (2010) Findings on
Facebook in higher education: A comparison of college faculty and student uses and
perceptions of social networking sites, Internet and Higher Education, No. 13:
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Stansbury, M. (2009) Coach sued for requesting Facebook logins. eSchool News:
Technology news for today's K-20 educator, eSchool 20News, Vol 19, No. 9 :4
Young, J. R. (2009) How not to lose face on Facebook, for professors, The Chronicle of
Higher Education, Vol.55, No. 22, A1
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ANNEX 1
Questionnaire on the impact of social networks on educational process in Romania
1. What social networking sites do you use?
FaceBook
MySpace
Twitter
Hi5
Others
I do not
access social
networks
2. How often do you visit social networking sites?
I do not access websites Less than 1
Between 1 and 5
for social networking
time per day
logins per day
Between 6 and 20
logins per day
3. How often do you access other online communication technologies (email)?

I do not have an Less than 1 time
Between 1 and 5
Between 6 and 20
email account
per day
logins per day
logins per day
More than 20 times

daily
More than 20 times

daily
4. Do you use social networking sites to:

Very
much
A lot
A
little
Not at
all
Im not using social networks

Communicating with people whom I've not seen recently
Keep in touch with colleagues
Communication in educational purposes
Personal presentation
Others (please specify)
5. If you are a member of one or more social networks *:
desktop pc
laptop
Mobile phone
Other devices ( Ipad, tablet pc,

etc)
Access social networks using:

* You can specify multiple variants
6. To what extent do you consider the following elements in the use of social networking sites for teaching and
learning?
Very important
Important Less
Not at all
important
important
Communication with teachers or colleagues, links
to topics, resources or training
Collaboration (within a particular group based on
the sharing of educational topics, resources,
projects, ideas, etc.).
Resource sharing (interchange of documents and
multimedia resources)
Others (please specify)
7. What do you think about the prospects of using social networking sites as a support for classroom activities?
An opportunity for communication
Online social networks are not
Others (please
I dont
between students and teachers
for education
specify)
know
8. You are:
Male
9. Your age:
Less than
20 years old
Women
Between 20 and
30 years old
Between 30 and
40 years old
Between 40 and
50 years old
Between 50
and 60 years old
Over 60 years
old
THE BEGINNINGS OF TRANSYLVANIAN CLUJ

ACCOUNTING SCHOOL
Teodora Viorica FARCAS1 & Adriana TIRON TUDOR
ABSTRACT
Our contribution in this paper is to identify the main influences that have an effect on the
beginnings of school of accounting from Cluj Transylvania, in XIX century and first part of
the XX century, connected with the political and socio economical changing contexts of that
historical period. We focus our attention mainly on the accounting school created in the
institutional environment of the Academy of High Commercial and Industrial Studies. This is
due to the excellence of this school of accounting, taking into considerations the follows
arguments: the ancientness of the school, the school reputation, professors' fame, the ideas
presented in school research journals, the activity of professors association, the excellence of
this school of accounting.
KEYWORDS: Accounting School, The Academy of High Commercial an Industrial

Studies, Transylvania, Cluj, history, educations
INTRODUCTION
The history of accountancy is, in a large measure, the history of civilization.(Woolf
(1986) .There is a strong emphasis on attempting to study accounting in the contexts
in which it operates (Hopwood, 1983;Napier, 1989).
Our aim is to demonstrate the strong connections between the history of the
foundation of the main schools of accounting from Romania and the social
economical and political context in which was created.
The accounting education started in her incipient form in XIX century in Romanian
territories.
The evolution of economy and merchandise commerce required the appearance of
education forms, which developed in various ways on the territories inhabited by
Romanians.
From all the Romanian territories, Transylvania was the first territory where the
institutions of economic and accounting sciences appeared, having Germanic and later
on Austro-Hungarian influences. Tiron-Tudor A and Mati D (2010) emphasize that
the accounting system in 19th century in Transylvania was influenced by German
models.
1
Correspondence address: Teodora Viorica FARCAS, Babes-Bolyai University, Romania;

email: teodorafarcas@yahoo.com
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The first works in Romanian, in the field of accounting, appeared on the

Transylvanian territory, as here there was an education form intended for the training
of the population in the field of commerce.
The organization of the higher education in Romanian language, in Transylvania,
more exactly in Cluj Napoca, had several attempts and restraints, but eventually,
they succeeded in setting here a higher education institution, with a major in
economy, which represents today the precursor of the greatest Faculty of Economic
Sciences from Romania.
One of the first higher education Institution in the field of economy, and particularly
in the field of accounting in Romanian language, was settled in Cluj, in 1919, after the
Great Unification. This was called the Academy of High Commercial and Industrial
Studies from Cluj and it can be considered the first form of higher education in the
accountancy field from Transylvania. The institution carried out its activity for 20
years in the town of Cluj, and then it was entirely moved to Brasov due to political
changes.
Our attention will be focused on Cluj first form of higher education in the
accountancy field. There are some reasons for taking a particular institutional focus,
as well as for selecting specifically the Cluj Accounting School as the purview of
interest. Firstly, the specific choice of the Cluj Accounting School for an exploration
of the interrelations between its beginning and the social, economical and political
context at that period is because it is an institution with a rich cultural and social
history, which has and continues to have, a marked influence on the accounting
research and opinions at national level. Secondly, the specific of the period in which
the First Romanian accounting school was set up in Transylvania. Thirdly, as on of
the oldest accounting educational institution in Romania, with over 90 years of
activity deserve an institutional history. Institutional history works commonly appear
in celebration of a key anniversary, as part of accounting historys role in enhancing
the status of accounting and those who practice it (Carnegie, Napier 1996).
The article is divided into three major parts. The first briefly introduces the reader into
the subject of research by presenting the subject importance and the reasons for
choosing this subject. The methodology used is presented in the second part, the third
part provides the heart of analysis and is structured in three sections one for each
period of time. For each period, the social economical and political context is
explored in the beginning and we continue with capturing the determinant elements of
the evolution of Transylvanian accounting school.
Finally, the concluding section summaries the article as well as presents some wider
implication of the analysis.
We develop a qualitative, explanatory study involving a contextual analysis with the
intention to elucidate the contingent nature of the Transylvanian accounting school
evolution by describing events as they occur, with the goal of capturing all of the
richness of everyday behaviour and with the hope of discovering and understanding
~917~
phenomena that might have been missed if only more cursory examinations have been
made.
The purpose of our historical writing is:
to tell the story in the present of something happened in the past (Munslow,
2001)
to explain why certain things in the past happened as they did (Rampolla, 2004)
to became aware of, appreciate and judge perspectives others than ones own
both through historical data and through interpretation of what other historians
have said (Marius & Page, 2009)
Under Parker (1993) criteria, our study should be classified as being written from the
inside due to the authors affiliation at this school. We follow in our research the
model of historical works on accounting bodies used by Brown (1905), Garrett
(1961), Institute of Chartered Accountants of Scotland (1954), Institute of Chartered
Accountants in England and Wales (1966) and Carey (1969) as examples of works
which had been written from the inside.
From a methodological point of view, it was conducted a thorough study of relevant
(mainly Romanian) literature available (textual analysis). We have studied primary
and secondary data of information about the Transylvania history, accounting
education in Romania, and about the Academy of High Commercial and Industrial
Studies written in Romanian language, English and French in order to become
familiarized with the process of accounting education in Transylvania changes
through time.
Furthermore, in order to get an understanding of accounting literature in different
periods of time, and of the development of an accounting literature (and thought) in
Romania, there were been studied older (beginning of the 20th century) and newer
Romanian accounting books.
The analyzed period was split into three distinct periods with the reason of capturing
the events chronology:
the development phase - before the 1918, when modern Romania was formed
the mature phase of Transylvanian Accounting School in Cluj - between 1918
and 1940
the decline phase of Transylvanian Accounting School in Brasov between
1940-1950
We analyzed individually each of the three periods because accordingly with the
Punctuated equilibrium theory, there were three stasis (- long period of relatively
unchanged form) and three punctuation (radical change over a short duration):
1918 the year when all Romanian territory were unified, and the modern
Romania was formed
1940 the year when the Academy of High Commercial and Industrial Studies
was refugee in Brasov, due to the Vienna Diktat 30 august 1940,
1950 the year when the Institute of Economic sciences and forecasting (the
transformed name of the Academy) was dissolved.
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However, after 10 years, the Transylvanian accounting school was reborn like
Phoenix bird. In 1961 was founded in Cluj, The Faculty of Economic Sciences in the
framework of Babes Bolyai University who continued the tradition of Academy of
High Commercial and Industrial Studies.
The punctuated equilibrium theory was used for the first time in accounting research
by Alexander and Servalli (2010), to investigate the complex process of accounting
change. The model of Alexander and Servalli was used by Albu, Albu and David
(2010) to analyses the processes and causes of change in history of Romanian
accounting. The main objective of the study was to explore the Romanian accounting
histories in the context of the model as proposed by Alexander and Servalli (2010), in
order to critically examine Romanian attitudes and perceptions today and suggest a
number of rational predictions of likely future developments in an EU/IFRS
environment, in a world where accounting seeks to serve organizations of vastly
different sizes, with vastly different user needs, in vastly different attitudinal contexts.
Tosh (1991:12-13) explained the fundamental premises of historicism as follows:
,,Each age is a unique manifestation of the human spirit, with its own culture
and values. For one age to understand another there must be recognition that
the passage of time has profoundly altered both the conditions of life and the
mentality of men and women even perhaps human nature itself and that an
effort of the imagination must be made to relinquish present-day values and to
see an earlier age from the inside.
For this reason, in our research we consider important to analyze the coordinates of
the Transylvanian accounting school evolution linked with the economic
environment, the historical context at the national level. In this respect well try to
look at the main defining moments of the accounting history marked by the evolution
of capitalism and implicitly the development of Transylvanian accounting school.
We apply the contextual analysis, that helps us to assess the text within the context of
its historical and cultural setting. A contextual analysis combines features of formal
analysis with features of cultural archaeology, or the systematic study of social,
political, economic, philosophical, religious, and aesthetic conditions that were (or
can be assumed to have been) in place at the time and place when the text was
created. While this may sound complicated, it is in reality deceptively simple: it
means situating the text within the milieu of its times and assessing the roles of
author, readers (intended and actual), and commentators (critics, both professional
and otherwise) in the reception of the text.
Our contribution in this paper is to identify the main influences that have an effect on
the beginnings of school of accounting from Cluj Transylvania in XIX century and
first part of the XX century connected with the political and socio economical
changing contexts of that historical period. We focus our attention mainly on the
accounting school created in the institutional environment of the Academy of High
Commercial and Industrial Studies. This is due to the excellence of this school of
accounting, taking into considerations the follows arguments: the ancientness of the
school, the school reputation, professors' fame, the ideas presented in school research
~919~
journals, the activity of professors association, the professors' role in national

accounting profession organisation.
2. TRANSYLVANIAN ACCOUNTING SCHOOL-THE DEVELOPMENT
PHAS BEFORE 1918
2.1. The Romanian territories social, historical and economic context before 1918
Before 1918 the Romanian territories were considered individual countries. In history,
Romanian principalities existed mainly independently of one another (at least in a
formal manner), due to mainly external pressures.
Transylvania is one of the Romanian historical territories situated in the North West
part of Romania. In ancient times it was part of the Dacia Kingdom and Roman Dacia.
Since the 10th century, Transylvania became a province of the Kingdom of Hungary.
After the Battle of Mohacs in 1526, it was part of the Eastern Hungarian Kingdom,
out of which the Principality of Transylvania emerged. Most of the time, in the 16th
and 17th century, this Principality was vassal to the Ottoman Empire, and in some
periods to the Habsburg Empire. At the end of the 17th century, Transylvania came
under the control of the Habsburg Empire.
From 1437 to 1848, medieval political power in Transylvania was shared between the
mostly Hungarian nobility, German burghers, and the seats of the Szkely people (a
Hungarian ethnic group), while the population was made up by Hungarians, Szeklers
and Germans and Romanians) Starting then, Transylvania was in name attached to
Habsburg-controlled Hungary, though it had a separate status, being subjected to the
direct rule of the emperors governors. In practice Transylvania was severed from
Hungary until 1867 when, after the Austro-Hungarian Compromise, the separate
status of Transylvania ceased and it was incorporated into the Kingdom of Hungary as
part of Austrian-Hungarian Empire.
Transylvania became part of Romania only after the First World War, and at that time
the country was represented by Moldavia and Wallachia, other two Romanian
territories, unified in 1859, and gained their independence in 1878 (recognized at the
international level).
Because all of these historical conditions, in Romania capitalism imposed rather late
in comparison with West European countries, which generated a slower development
of accounting in our country. If in the western countries the industrial revolution
started at the beginning of the 17th century, Romania had been until the beginning of
the 19th century a country still in late Middle Ages.
Romanias economy was still based on a feudal agriculture, the industry almost didnt
exist, the manufacturers, in classical view, appearing only in the middle of 18th
century. The trade, which was the main economic factor contributing to the
development of capitalism had a lot to suffer in the Romanian historical provinces,
being strongly influenced in the second half of the 16th century by the instauration of
Turkish and Austro Habsburg Empires monopoly (Muresan, 2007). Consequently,
due to the change in international context (in our influence sphere the Turkish Empire
starts losing ground in favour of the Russian empire), until the beginning of the 19th
~920~
century when the economic life starts developing, accounting hadnt been a necessity
in the Romanian economic life (Dobroteanu, 2004). The main factors which
influenced directly the economy of Romanian provinces in the 19th century are: the
degree of industrial development, the trade development, the degree of economic
autonomy, capital availability, national independence, etc. (Ionascu, 1997).
2.2. The early beginning of Transylvanian trade and accounting school
Prior to the late 1800s, the terms bookkeeping and accounting were often used
interchangeably because the recording/posting process was central to both activities.
There was little need for financial statements (e.g., income statements) because most
owners had direct knowledge of their businesses and, therefore, could rely on
elementary bookkeeping procedures for information.
For example, in 14th century during the time of crafting organizations, we can find
proof that incomes and expenses accounts were kept, registers and exchanges
document were used, different stories of economic activities ( Hrisoave) were found
in towns like Sibiu, Brasov, Rasnov, giving evidence that accounting in its primary
form was quite developed (CECCAR).
Double-entry accounting manifested certainly in the 17th century, in factories in
Sibiu, Brasov and Bucharest (Demetrescu et al., 1979, cited in Ionascu, 1997: 176).
Althought there were proofs that forms of accounting were used in the Romanian
territories long before, considering the registers and accounting books found for
several very old estates of the time, but a significant development was only visible
starting the second half of the 18th century, when commerce began developing.
There were some towns from Transylvania: Sibiu, Brasov and Rasnov, that were
situated in the eastern border of Habsburgic Empire, and had the majority of the
citizens Saxons. These people were brought in by the Hungarian king to repel the
Turks and they came in the area with their habits, traditions, knowledge and
mentalities. The cities flourished with trade, being coveted by its neighbors. These
towns were important trading centers, acting as intermediaries in the long-distance
trade between Western and Central Europe and the Ottoman Empire.
For this reason at the beginning of XIX century Transylvania, the eastern part of
Habsburgic Empire had an economy more developed if we compare with other parts
of Romanian territories (Moldavia and Wallachia).
The Transylvania economy was characterized by a developed structure of trade and
industry, and have bequeathed to us accounting records.
The fact that accounting has invariably been associated with societies where business
has flourished was to Hatfield "so obvious that I offend by explanation. Wherever
trade flourished, the practice of double-entry could be found, lending color to the
views that trade followed double entry, or that double-entry followed trade.
(Hatfield, 1950)
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As Bedford (1970) explains historically the process by which accounting procedures

and thought has been transmitted from one country to another has been by the
physical transfer of accountants.
The invention of accounting was vital to the development of the capitalistic enterprise.
In particular, double-entry bookkeeping permitted the full representation of the flow
of capital through a business.
However, in the late 1820s the numbers of corporations rapidly increased and to
operate successfully, were needed cost reports, production reports, financial
statements, and operating ratios that were more complex than simple recording
procedures could provide.
Referring again to Transylvania and trade, we can give as an example the spices, that
were a major element in the transit tradeoff oriental goods. Pakucs studied the subject
using data available from the beginning and from the fifth decade of the sixteenth
century: the customs registers as primary sources for reconstructing commercial
traffic. Using a comparative approach the author presents the amounts of different
spices that reached Transylvania through the customs of Brasov and Sibiu. Although
Brasov attracted a far larger amount of goods and number of traders than Sibiu, the
latter surpassed Brasov in the trade with saffron and other spices. Apart from pepper,
the quantities of spices brought to the Saxon towns via Wallachia are not very
impressive.(Pakucs 2002)
For centuries, the city of Brasov was (and still is) Transylvania's gateway towards the
South and East. As the renowned Harvard professor Samuel Huntington shows in his
work "The Clash of Civilizations", this is where (ideologically) Europe ends. The
fault line between the western and the eastern civilization runs indeed through Brasov,
separating Transylvania from the rest of Romania (Huntington, 2003).
Due to its geographical position, at the crossroads of Moldavia and Wallachia, Brasov
has had a fast economic growth, becoming one of the most important markets in
Transylvania. On the 14th century Brasov became one of the most economical and
political strongholds in the Southeast of Europe and on the 16th century also a cultural
center. Johannes Honterus, a great German humanist, worked most of the time in
Brasov and Deaconu Coresi printed the first Romanian book also in Brasov.
2.2.1. Books
The first trade book, who precede the Romanian accounting literature is considered to
be the paper "Izvod pentru lucrurile de obste si dechilin n scrisori de multe chipuri"
(Sibiu, Petre Bart printing house), a translation from Slavonic language made in 1792
by Dimitrie Evstatievici, who was a school director. The book contents models for
contracts, receipts, accounts, trade bills etc.
In 1837, in Brasov, is published the first double entry bookkeeping in Romanian
language, Pravila comerciala under the signature of the well known teacher from
Brasov Emanoil Ioan Nechifor that offers in this way a good example for other
accounting teachers and practitioners. It is worth saying that Nechifor creates his own
terms, in Romanian, which was very important and hard to do at that moment. The
~922~
first accounting manual written in Romanian includes procedures and economic

calculus, principles of commercial moral and ethics, notions of administration and
commercial law. The Nechifor accounting book was a translation from the German
language Practical usage of double entry accounting. Some other translations of that
period, published in the 1830s and 1840s were adapted from French - J. J. Jaclot, La
tenue des livres enseigne en vingt et une leons - and German (CECCAR, 2006;
Drgnescu-Brate, 1941). Some time later, in 1844, in Bucharest was published by
Dimitrie Jarcu the paper Scriptura Doppia or the bookkeeping.
Allowing for the difference in context, Rusu et al. (1991: 52) compare the
contribution of Nichifor for Romania with that of Luca Pacioli at the international
level, as they consider fundamental Nichifors work of disseminating in Romanian a
first treatise of accounting and commerce, using mathematics and economic
philosophy, religious and laic literature in order to influence merchants and
accountants.
Due to the economic growth, accountancy also has a significant rise: there appeared a
series of works about accountancy, such as those belonging to Honoriu Warta
(Tinerea registrelor n partida simpla si n partida dubla Single and double entry
bookkeeping in 1873), Ion Ionescu de la Brad (Mic tratat de contabilitate
Accounting small book in 1870), Dimitrie Iarcu (Contabilitatea casnica House
Accounting in 1863 and Contabilitatea agricola Agricultural accounting in 1870),
Theodor Stefanescu (Contabilitate n partida dubla Double entry accounting in
1873) and other.
Only in the second part of XIX century we can speak about the beginning of
Romanian accounting thinking. The writings of the time prove that until 1888 there
hadnt been an official organization of a guild of accountants in Romania. Until that
moment there had been only the distinction between an accountant and a bookkeeper.
In this sense, Stefanescu (1874: 93) believes that an accountant needs economics,
finance, math knowledge, the difference between the two professional categories
being like the one between an architect and a mason (Zelinschi).
In 1874 Professor Theodor Stefanescu published The course of double entry
accounting. Even if his source of inspiration were mainly French authors, we must
say that his study can be considered the first study that was no longer a simple
translation of compilation. It opened a new way for the Romanian accounting thinking
and practice.
Up to the end of XIX century we can observe that a great number of translations and
original works regarding accounting are published in the important centers of culture
and economy such as Brasov and Cluj in Transylvania, Bucharest, Iasi and Galati in
other Romanian territories.
2.2.2. Influence of European practices
Transylvanians movements derived their inspiration from the eighteenth-century
European Enlightenment. Younger were students of the French Enlightenment and
of German classicism. Samuil Micu, the founder of modern Romania, was deeply
influenced by the contemporary Austrian Enlightenment as a student at the
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University of Vienna. Other examples abound. It is conclusive that the common

heritage of movements included a keen assimilation of the Enlightenment and a
strong desire to improve Transylvanian society.
XIX century in Romanian accounting is a period that may be characterized by the
adoption of the best European accounting practices. (Tiron, Mutiu) In the context of
the advanteges of the Romanian territories position (a bridge between Central Europe
and the Far East), Rusu et al. (1991: 50-51) show the possitive infuence of tranzit
commerce on accounting development.
In XIX century, the numerous theories of accounts aimed at finding the basic rules
of keeping books, sough to disentangle the mystery of double-entry. Among the
most frequently mentioned authors dealing with two and four series theories were
several Italian scholars: Cerboni Giuseppe (1827-1917 and Tuscan school with his
logismografi, Francesco Villa and the lombardian school and Fabio Besta and the
Venetian school with their materialistic theory of accounts. These theories was
developed in time by Edmond Degranges- the father.
Given the presence of Venetian or Genovese merchants (starting 1200) on Romanian
territories, there can be no doubt that Romanians learned accounting and bookkeeping
principles from them.
At the beginning of the nineteenth century the former glory of Italian accounting was
overshadowed by its decline during the eighteenth century, and accounting literature
from France, England, and Germany took centre-stage.
Concerning the influence of foreign literature, Demetrescu underline that the French
literature was used in the south part of Romanian territories ( Muntenia), while the
Italian literature was used in Moldavia and the German literature in Transylvania.
There were also some theories in the accountancy field at that time. Theories of
accounts (rather than accounting theories) dominated not merely the early but also
the later part of this century when Italian accounting had regained a prominent
position beside other countries. The relation of those theories to the charts of
accounts-which later became so prominent in Continental Europe is historically
important.
Different authors of XIX century support theories based on individual study or
materialistic theories. The former (theories based on individual study) tried to
identify every account with a person responsible for it, while the materialistic
theories derided such an attempt. Another dispute was how many classes of accounts
were used. Their numbers originally ranged from one to about five. Many
combinations of these criteria existed. In XIX century another scientific dispute was
between entity versus proprietary theories, as well as the emergence of other
theories. (Mattessich, 2003)
Schar developed materialistic theories with two classes of accounts, the most
successful category. He was the father of one version of the basic equations (A-L) =
OE which was to indicate that the accounts of assets and liabilities form one single
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category, and those of owners equity form the other. This theory was advanced by
Hugli and above all Schar.
In XIX century in Transylvania was used the most successful theory of that times, a
developed theory of Venetian school. Huglis materialistic theory of two accounts
classes. This was further developed by another Swiss Schar whose closed accounts
system was regarded by Scherpf (1955:8) as the fist chart of accounts in the proper
sense.
2.2.3. Accounting personalities
Accounting is a human construction. Contemporary accounting cannot be
understood without reference to the key personalities who have contributed to
accounting development (Millerson, 1964, p. 50; Parker, 1993). Recent studies on
the formation of the accounting profession may present pitfalls to historians who
choose to undertake explanatory biographical investigations of accountings past. In
an article Napier (1989) refers to these studies and their authors. These studies
propose different factors such as social class (Macdonald, 1984), gender (Kirkham
and Loft, 1993; Roberts and Coutts, 1992), political acuity (Willmott, 1986),
relations with the State (Chua and Poullaos, 1993; Chua and Sinclair, 1994;
Poullaos, 1993) and links with other professions (Kedslie, 1990a; Macdonald, 1984)
as determinants of the professionalization of accounting.
Emanoil Ion Nikifor the first author of an accounting book in Romanian language
was teacher at Trade School in Brasov. His book printing cost was sponsored by
Gheorghe Nica, a great trader who was in the sale tile the supervisor of Trade
School, founded by Gheorghe Baritiu, in 1837 in Brasov. In introduction, Nichifor
present his good intention to help his colleagues with a book wrote in Romanian
language following the Austrian model of accounting. Also in the book were used as
well a lot of Germans words: Weksselgeschaft, Gericht, Kommission-Buch., etc.
Another important personality for the Romania and Transylvania was I. C. Pantu. He
was born in Brasov in 1860, and after the high school, in 1879 he went to Vienna to
continue his studies at Trade Academy. In parallel he was student at Philosophy and
Polytechnic University. At his return in Brasov in 1882 he start to teach accounting
and business correspondence at Commercial school Andrei Birseanu till his
retirement in 1921. In 1898 Pantu published his firs double entry accounting book
and some others after 1900. In his books introduction Pantu mentioned that he was
inspired by German literature of Kurtzbauer, Augspurg, Ziegler,Schar, Hugli, Reisch
, Kreibig and French literature of Leautey, Guilbaut, Granges, Andoyer and Mertens.
He declared himself to be pro for the materialistic theory with three series of
accounts and a supporter of mathematical concept of accounting.
2.2.4. Accounting vocational schools
C. G. Demetrescu considers that including accounting as a study object in the
teaching system had an important impact in the development of the accounting used
in the Romanian states. In this respect, after 1831, the teaching curricula for the
secondary schools, included subjects with a profound commercial character,
accounting included.
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In Transylvania, the roots of accounting schools start up in Cluj and Brasov. In 1837
the Trade School from Brasov curricula contents accounting discipline, and the
course book was Pravila Comerciala writed by Emanoil Ioan Nichifor.
Also, in other Romanian territory, like Iasi in 1838, Braila in 1843 and Bucharest in
1844, accounting discipline was included in trade schools curricula.
In XIX century the economic development requests qualified employees in
industrial, agricultural and trade activities. For this reason, Trade and Industry
Chambers from Transylvania (founded by law in 1850) supported the foundation of
commercial schools for trade and other business activities. In Transylvania were
14 commercial schools with a three years study curricula including discipline like:
trade history, accounting, business correspondence, commercial mathematics,
economics principles, and commercial law. In parallel, there were some projects
concerning the foundation of higher studies in economics.
In 1835, in Cluj was founded the Normal Trade School and in the second part of XIX
century was founded the High School of Trade and in 1902, at the Trade and industry
Chamber of Cluj, was founded the Trade Academy of Cluj. The two years curricula of
the Academy consist theoretical and practical knowledge combined with economic
legal framework. The management, the pedagogical activities and the curricula were
influenced by that time models from Vienna, Budapest, Prague and Bratislava, but
taking into consideration the Transylvanian economies needs.
The elementary schools of commerce, where courses lasted three years, accepted
candidates with a primary education diploma, while the high schools provided four
year courses and accepted graduates from lower secondary schools or elementary
schools of commerce. The courses taught in the schools of commerce were primarily
practical and accounting was concerning only the facts of commerce. The graduates
enjoyed good career opportunities, especially in accountancy, banking, education
and public administration. They predominantly filled positions as accountants in the
private or public sectors (Zelinschi).
In our opinion the educational institutions (trade schools) which create, transmit and
legitimize the body of knowledge, are a key part of the accounting history in any
country. These institutions also play another role in that they establish a social
network and a community which share the same formal education and professional
interests in the early 20th century. The schools of commerce in Romania were the
primary institutions which diffused accounting knowledge, in addition, the alumni of
these schools formed a well developed network that provided a basis for building the
accounting profession (Zelinski).
2.2.5. Accounting academic school
As professor Walker says in his work, the national contexts set the conditions for the
development of accounting in universities (Anderson-Goughin, Edwards and Walker,
2009). The first academic studies in Cluj were started in the mid of XVI century. In
1565, it was established to set-up a Calvin College in Cluj Napoca; but this was
achieved only in 1581, once Prince Stefan Batory started to reign the territory; so on
12 May 1581, a University with the office in this town was set-up. The University of
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Cluj, also called College, was organized and managed by the Jesuit monks sent from
Poland, and this University raised at the level of the Western Universities.
The first University of Cluj had a religious background; its main purpose being that of
drawing young people to Catholicism. In 1603, because of denominational debates,
the University was dissolved.
In 1698, a new University was set-up in Cluj, this time by the Habsburgs, but its
purpose was also religious. At this moment, the teaching language at Universities was
Latin. Although they tried to draw young people to Catholicism, this did not happen;
instead, young people had access to learning, which was very difficult to get at that
time.
Because State intervention was stronger and stronger, in 1776, the Emperors in
Vienna agreed that the Catholic University of Cluj would become interdenominational. On this occasion, the Piarists, who were more permissive, replaced
the Jesuits. This may be noticed in the increased number of students from that period.
In 1784, the number of Universities from the Empire was reduced to only three, in
Vienna, Lowen and Buda, the rest of the education institutions being transformed into
high shcools. The University of Cluj was transformed in the Academic Royal High
School (Dana Pop, 2005).
The teaching languages in these schools were Latin, German, Hungarian, but not
Romanian. The attempts of the Romanians from Transylvania were countless, they
wrote many appeals and sent them to Vienna, requesting to set-up a University for
Romanians, where the teaching language would be Romanian and the teachers would
be Romanians.
Thus, following the Gathering of Blaj, in the 19th century, a Juridical Faculty was setup in Sibiu, but the teaching language was German. The Romanians wished to set-up
a University in Cluj, where the teaching language would be Romanian. The
publications of that period, Gazeta Transilvaniei [The Gazette of Transylvania], as
well as the Romanians from the other territories supported the cause of the Romanians
from Transylvania.
After the annexation of Transylvania to Hungary in 1867, in 1872 it was decided to
set-up a University in Cluj, where the teaching language was Hungarian. The
University had four Faculties: Law; Medicine; Philosophy, Literature and History;
Mathematics and Natural Sciences. At that time, the University had several
shortcomings, beginning with the teachers and continuing with the material resources.
At the same time, the access of the Romanians to education was modest, and the fact
that the Romanian language and literature were taught in Hungarian was very difficult
to accept for the Romanian population.
Economics disciplines were included in Law Faculty curricula (economy, public
finances and corporate finances, statistics, commercial law, commercial
correspondence, and accounting) but also in the curricula of other faculties
(economic history, economic geography, statistics and mathematics of economics).
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2.3.
Conclusion about the before 1918 period
In Europe, once with the increase in the number of corporations, there arose as well
a demand for additional financial information. With no direct knowledge of a
business, investors had to rely on financial statements for information, and, to create
those statements there were required more complex accounting methods. Therefore
the accountants responsibility expanded beyond simply recording entries to include
the preparation, classification, and analysis of financial statements.
As John L. Carey (1969) wrote in The Rise of the Accounting Profession, the
nineteenth century saw bookkeeping expanded into accounting. Additionally, as
the development of the corporation created a greater need for the services of
accountants, the study of commerce and accounting became more important.
Although there had been trade business schools and published texts on
accounting/bookkeeping, traditional colleges had largely ignored the study of
business and accounting. When a lot of major universities decided to create schools
of commerce, the accounting started to secure a significant place in the curriculum.
Once with the separation between management and ownership in corporations, there
arose as well a need for an independent party to review the financial statements.
Someone was needed to represent the owners interest and to verify that the
statements accurately presented the financial conditions of the company. Moreover,
there was often an expectation that an independent review would discover whether
managers were violating their fiduciary duties to the owners. Additionally, because
the late nineteenth century was a period of major industrial mergers, someone was
needed to verify the reported values of the companies. The independent public
accountant, a person whose obligation was not to the managers of a company but to
its shareholders and potential investors, provided the knowledge and skills to meet
these needs.
Even though Romanian society developed a lot during the 19th century, this is more
an appearance than a reality. The development of western nations was more
significant for the same period, because a strong obstacle in the development of the
capitalist society was in the Romanian countries the suzerainty, even formal,
towards the Turkish Empire. Only after the War of Independence from 1877-1878,
the basis of a modern economy could be establish in the real sense of the word,
because of the political and legal freedom that was obtained. This moment marks the
beginning of the Romanian accounting thinking.
Certainly, in Romania, the development of accounting depended to a large extent on
economic development, on the concrete conditions in which both the social and the
economic field evolved.
After reviewing the accounting and history literature, we could identify the different
impact of the foreign influence. Major factors which are contributing to the way of
Romanian accounting evolutions are as follows:
the influence of economics, characterized by: the industrial development rate,
the trade evolution, the economical autonomy rate, the available capital, the
financing system, the management system of enterprises.
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the political influence and the domination of Austro Hapsburg Empire in

Transylvania and Ottoman Empire in other Romanian regions.
Cultural influences: the Austro Hungarian Empire has left on the Transylvania
a large number of habits regarding the administrative organization as well the
German influence of the accounting school can be found in the accounting
theory. In the same period, in others Romanian territories, not part of the
Austro Hapsburg Empire, the Latin origins of the Romanian people and the
similarities with the French culture have influenced the legal system based
on laws and the accounting.
Historians of accounting will of course have disparate interests and agendas, and
their research may well be used by others of different standpoints. Through all of
this, the words of Haskins, asserting that accounting history helps us to understand
our present andforecast or control our future (Haskins, 1904:141), return as a
challenge to current accounting historians.
3. THE MATURE PHASE OF TRANSYLVANIAN ACCOUNTING SCHOOL
IN CLUJ BETWEEN 1918 AND 1940
3.1. The Romanian territories social, historical and economic context after 1918
Internationally, this period was marked by two important events: the Second World
War (1939-1940) and the Great Depression (1929-1933). These events have had
negative economic consequences, but subsequently led to the formation of the
Common Market.
The 1918 is for Romanians the Unification year, the year of the formation of
Greater Romania, when Moldavia and Wallachia were joined by Transylvania,
Bukovina and Bessarabia. This unification and the end of the First World War had
brought lots of changes in the economic, politic and cultural context.
First World War ended on 11 November 1918 by the defeat and capitulation of
Germany and the signing of the armistice from Retondes. On December 1, 1918 in
Alba Iulia proclaimed the Grand Union of all the Romanian. This Union was all that
the Romanian wanted for ages.
In the interwar period - 1918-1938 - Romania has undergone several phases:
a) 1919-1922 the stage characterized by the destructions of the First World
War,
b) 1922-1928 period of relative development, when Romania restore the
economic, industrial and agrarian production and completed its political and
economic unification;
c) 1929-1933 economic crisis, characterized by: high inflation, unemployment,
poverty;
d) 1934-1938 Romania's economic boom period due to the protectionist
policies and intervention state in the economy.
Romania between Wars is an agricultural-industrial country. Peasants are now the
subject of the biggest land reform in postwar Europe and the industry knows an
accelerated growth. Romania, in terms of energy is independent and manufactures
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locomotives, buses, airplanes, various electro-technical articles, features and

important chemical industries, food, textiles. Oil production situates Romania first in
Europe, gas and gold Romania ranking second in the same tables. National income of
110 dollars per capita was higher than the Balkan states.
In the accounting plan, this period is marked by existing global concerns to create a
chart of accounts (in Western countries especially Germany) and those on Improved
financial communication. Romania was sharing the ideas existing at the European
level.
3.2. Romanian Academy of Higher Commercial and Industrial Studies, Cluj
After the Great Union of 1918, the new Romanian University of Cluj was organized.
For this organization, there was taken into consideration the opinion of the Bucharest
University and the Iasi University. In the mean time, for the beginning, teachers from
the Old Kingdom were brought to this University, and only 8 out of 20 teachers were
from Transylvania. The University had four Faculties, namely Letters and Philosophy,
Sciences, Law and Medicine.
The need of having a higher economy education was felt even at the beginning of the
19th century. Thus, once with the setting up of the University teaching in Romanian in
1919, only after an year, in 1920, there was set up the first form of higher economy
education, namely the Commercial Academy (which in 1922 was called the
Academy of High Commercial and Industrial Studies).
3.2.1. Books
During the First World War there were no writings in the accountancy field in
Romania, the war interrupted all the work that was made before in the second part of
the 19th century. However, after 1921, the accounting literature begins to develop
a lot.
Between 1925-1927 the accounting courses appear in three volumes compiled by
professor C. G. Demetrescu, who was teaching at the Higher Commercial School in
Iasi. They have been used for three decades by all business schools in the country,
including students of the Academy of Higher Commercial and Industrial Studies
from Cluj.
In 1932, D. Voina, Professor at the Academy of Higher Commercial and Industrial
Studies from Cluj, has published his PhD paper: Phases in the evolution of
accounting. In this paper, the author has study the evolution of the accountancy in
Italy, France and Germany.
The period of the Academy of Higher Commercial and Industrial Studies from Cluj is
characterized by a large number of writings, articles in the accountancy field, that
were written and published by the professors of the Academy.
For this reason, in 1930, there was founded an important economic magazine Observatorul Social Economic, which became the most important and wellknown in our part of the country and one of the best in the whole country. (Victor
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Jinga, 1943:1). During its 14 years of existence, all the important writings including
a large part of the professors and students works - were published in this magazine
(222 articles and studies, and many notes, book presentations and reviews).
In the period when the Academy functioned at Cluj, (for 10 years, until 1940), in
Observatorul Social-Economic there were published two papers in the accountancy
field, both written by Iosif Grbacea. One of this was referring to the control
problematic in the companies, and the other one was about the Romanian currency
(this is more an economic paper).
In addition to published works by teachers, the accounting literature in Romania in the
period after 1918, was enriched by the published works of the ones who were working
in the field of accounting. For example Aug. Dorwagen has published the works:
Agricultural Accounting (1921) and Analytical studies related to agricultural
technical accounting, economics and agricultural policy, as well as livestock and
zooeconomics (1913).
3.2.2. Accounting personalities
In the first year of Academy activity, its courses were taken by 35 students, followed
by a group of professors made of six personalities of the Cluj academic environment:
Gheorghe Moroianu (Political Economy), Ion Mateiu, Octavian Prie (Romanian
Language), Aurel Ciortea (Commercial Mathematics), Constantin Leca (German
Language) and Ion I. Lapedatu (Financial Science and Legislation).
The founding professors, besides the above-named ones, were Gheorghe Bratu
(Commercial Arythmetics), Silviu Dragomir (History of Commerce); Ion Evian and
Dumitru Voinea (Accounting), Dumitru B. Ionescu, Victor Jinga (Political Economy).
Some of them worked as professors at the Cluj University, others came from the preuniversity environment and from the business environment from Transylvania.
At the same time, personalities of the accounting history, well-known people, who left
important works in the field of the Romanian accounting, worked as professors at the
Academy. In the table below, the most important experts of those times are identified:
Table 1. Accounting professors of the Academy of High Commercial and Industrial
Studies
Ion Evian
Dumitru Voina
Iosif Ioan Grbacea
Ioan Tara
Dumitru Haiegan
Octavian Lungu
Accounting
General Accounting
General Accounting
Financial Accounting
Statistical Accounting
Accounting
3.2.3. Accounting vocational schools

As we said in the first chapter the number of commercial schools was hight since the
19th century, and the tradition will continue in the next century too. So on 1
September 1918 has been founded in Brasov the State Higher School of Commerce.
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During the school year 1921-1922 the School of Commerce was reorganized after the
similar model of schools of those times, turning into commercial school for 4 years.
At the end of the 1928 the number of medium comercial schools has increased in
Transylvania at the number of 54.
After the 1918 in Transylvania and Cluj, there was an important number of schools
that were teaching commerce. Here are few of those: The Commercial Academy in
Cluj (1878-1923), Apprenticeship commercial school in Cluj (1882-1961), The
Commercial High School for girls ,,Marianum (1896-1948), Commercial practice
school Cluj (1924-1931), Turda middle commercial technique school (1928-1955),
The Superior commerce School from Dej(1929-1931), The Superior Commerce
School for boys ,,Great Prince Mihai from Cluj (1931-1954) .
3.2.4. Accounting academic school
As we have already mentioned, the Academy of High Commercial and Industrial
Studies was set up in Cluj in 1920. In 1922, the Academy was structured in two
sections:
Commerce, Bank, Insurance Section
Industrial Section
After a while, a new re-structuring of the sections took place, this time in three
specialization groups:
Economic Sciences
Financial Sciences
Social Sciences
Based on the above, it can be noticed that at the Academy was no Accountancy
section, in spite of this in the university environment, it is very important to
understand the relationship of the accountancy with economics and also the
accounting itself through educational practices. However, accounting itself was to
become increasingly distanced from a very theoretical mathematically oriented
economics (Sanderson 1972: 202). Solomons (1974) identifies the McNair Report
(which instigated the Universities Scheme) as the source of a problematic relationship
with economics. In Solomons view this scheme maintained accounting in a
subordinate position within universities. (Anderson Goughin J.R., Edwards and
Walker, 2009)
In the first ten years of existence, approximately 2000 students attended the academic
courses, then until 1948, the number of students exceeded 10.000. As of 1 January
1930, the academic and research activity of the higher economic education institution
from Cluj was organized through a special law, namely the Law of the Academy of
High Commercial and Industrial Studies.
3.2.5. Conclusion about the period
This period was one of a new beginning. The Unification contributed to a high
development of the superior economic education. In this context it was founded the
first form of higher education in Romanian language in Transylvania, the Academy of
High Commercial and Industrial Studies from Cluj.
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The accounting literature is rich after 1918, a large number of professors and students
from Transylvania and from the other Academies from Romania published important
papers in the accountancy field. Also there were few accountants that were not
professors who published some works in the accounting field.
There was an important review of the Academy, were all the works of the professors
and students were published. The name of this review was ,,Observatorul socialeconomic. The period of the Academy in Cluj was one of organization and beginning
of academic work in all the economic fields including accountancy.
4. THE DECLINE PHASE OF TRANSYLVANIAN ACCOUNTING SCHOOL
IN BRASOV BETWEEN 1940-1950
4.1. The Romanian territories social, historical and economic context after 1940
The Second World War broke out on 1 September 1939 in the contradictions between
the imperialist powers because of the desire for territorial expansion and domination
of Nazi Germany.
In the spring begins the great German offensive in the West, which leads on the one
hand, to the occupation of Denmark and Norway, and on the other to the dissolution
of French military power. Marshal Petain called a truce (17 June 1940), and not only
the France collapsed, but the entire European political system including Romania. On
26 June, after the Romanian government's ultimatum presented by the Soviet
government, the territory between the Prut and Dniester, and northern Bukovina came
into the Soviet Union.
Romania had been part of the beneficiaries of peace of the World War, Germany
claimed the former losers, who, encouraged by her great military successes, now
openly calling for the revision of borders. Romania was forced to accept so-called
"arbitration", in fact the Vienna Dictate (30 August), decided before the two foreign
ministers, the Germany and Fascist Italy, and to give an area of 42,243 km square in
Transylvania, including Maramures, Crisana and northern Transylvania, including
Cluj. In this context the Academy of High Commercial and Industrial Studies will
move to Brasov.
After a short period of neutrality, Romania joined the Axis Powers in June 1941
during the government of Ion Antonescu. In 1944, after Antonescu was removed,
Romania joined the Allies powers. Romania's participation in the Second World War
was characterized by the two campaigns: one in the East for the liberation of
Bessarabia and Bukovina, and Western for the liberation of Transylvania.
4.2. Transylvanian Accounting school decline
After the Vienna Dictate, more precisely in September 1940, as we said before, the
Academy of High Commercial and Industrial Studies of Cluj had to find a new
location in Transylvania. The University of Cluj was moved to Sibiu and Timisoara,
and the Academy of High Commercial and Industrial Studies was moved to Brasov, a
town with tradition for the Romanian economic and accounting education.
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During the first years of activity in Brasov, conditions were quite harsh, because
nothing was prepared for the receiving of the new University in town. First of all there
was not a building of the Academy; the courses were held at a high school and even at
cinema Astra. Thus, the professors and the students from Cluj needed to rebuild the
Academy in Brasov.
4.2.1. Books and accounting personalities
During over 25 years, a significant series of papers with a didactic character were
published. Some of them included important historical references and dealt with the
fundamental topics of a discipline.
The professors I. N. Evian and Dumitru Voina with their writings broght into the
heritage of accounting new elements of thinking. The first one developed the
economic conception above the accountancy in two fundamental books, and the other
one has created the economic and legal theory.
Although the prevalence of substance over form was set out as a principal relatively
late in Romania, there were "voices" to refer to an "economic outlook" of accounting
in contrast to a "legal concept". Thus I. Evian in "Industrial Accounting" published in
1947, makes clear that the accounting technique would have the objective to follow
the economic phenomena that occur in companies, not the registration of their
patrimony.
Between the two opposite approaches of accounting, the patrimonial one, sustained by
professor Spiridon Iacobescu, and the economic one, sustained by Ion Evian, has
made its way the economic and legal thinking of Dumitru Voina. The economic and
legal conception of Voina brings new elements in the judgment of fundamental
problems of the accountancy. In his writing, "General Accounting", Voina, presents
the following definition of accounting: "Accounting observe the movements of values
that are causing economic phenomena and legal relationships, describe them and
represent their numerical , groups them into categories and then reconstituted by the
synthesis calculations, the entire life of the organism that falls within its research
area (Voina, 1947).
The professor Ion Evian, also wrote "Theories of accounts", in which will try to
remove legal elements from accounting, the author being an adept of German
literature. His belief consisted in the fact that accounting is only an arithmetic
supplement of economic science.
Accounting professors and specialist were at that time at the Academy, also: Garbacea
Iosif, Hasiegan Dumitru, Lungu Octavian, Lupas Semproniu, Manolache Mihai, Tarta
Ion V., Rusu Dumitru, Turdeanu Lucian. They also published their work in the
Academy review ,Observatorul social-economic.
Beside the publication of the Academy from Cluj-Brasov, in Romania there were
other few reviews with accounting specific. The most important was The General
Review for Commerce and Accountancy (1908-1916 and 1921-1946), replaced from
1937-1955 with The Accounting Newsletter.
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4.2.2. Influence of European practices

The influences from the outside in the period of the Academy in Brasov were the one
that influenced from the beginning the writing in the accountancy field in this part of
the country. Thus first of all there was the German influence, very well ilustrated by
Iosif Garbacea, who published in the review of the Academy two papers having a
German example: Hans Scherpf: Handelsbilanz-Steuerbilanz and Dr. W
Shroder:Bilanzverglich mittels Bewegungs-Bilanz und Kennziffern, Hamburg, 1942.
The French influence was expressed by Ioan Tarta, the professor that wrote about
Henry Fayol in a paper, published in the review of the Academy.
Concerning the Italian influence, Iosif Garbacea wrote three papers about this
influence in the accountancy field: Nello celio la contabilita nel nuevo codiceberna
1939, Gino Zappa: Le volutazioni di Bilancio con particolare reguavdo ai bilanci
delle sicieta per azinoni. Milano and The Italian influence in the accountancy field.
This influence can be seen very important because in Italy the accountancy was taught
in the Universities since the nineteenth century, so that it was a very strong tradition
already there (Anderson Goughin J.R., Edwards and Walker, 2009).
4.2.3. Accounting vocational school and accounting academic school
As well as in the other two periods, there can be identify some schools of accounting
and commerce in Transylvania area: The Commercial High School for girls
(1940-1953), The Economic High School from Odorheiul Secuiesc (1943-1975),
Trading technique middle school for boys Cluj (1945-1955), Hungarian trade school
(1945-1948).
There will be identified a growth of university accounting education in this period,
that can be seen as the continuing story of the dynamic of the credentialing and
licensing practice. The initial exporting of the practice of credentialing and licensing
(as in accounting) beyond the university was one thing. People recognised the
universities as the experts in expertise in general and were willing to see the
qualification in general as a sign of expertise. However, trying to use this new
knowledge identity to establish a different set of rules about the nature of expertise
(one dominated by technique, by teaching not research) within the university was
quite a different matter (Anderson Goughin J.R., Edwards and Walker, 2009).
Given the conditions, the Academy carried out its activity in Brasov till 1948, and was
a real form of higher education in which the accountancy was an important subject of
study. The professors and the students that were learning here wrote important papers
that influenced the way of thinking in the accountancy field in Romania.
The relocation of the Institute to Iasi was made under the pressure of political factors
and it was the result of a debatable decision, taking into consideration that, afterwards,
Brasov asked that a higher education economic establishment be restored to this
centre of rapid industrial and commercial growth. This request was accomplished
after exactly 40 years by the foundation, in 1990, of the Faculty of Economic Sciences
within TRANSYLVANIA University of Brasov.
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4.2.4. Conclusions about the period

Due to the existence and activity of the Academy of Higher Commercial and
Industrial Studies in Brasov for a decade, the city became a real university centre.
Nevertheless, the citys academic claims can be traced back much earlier: The idea
of a Romanian university in Ardeal preoccupied our predecessors as well. When the
dwellers of Brasov started building the secondary school from Groaveri, they made a
strong foundation for sturdy walls which could support other floors. These would later
be the home of the university (Puscariu, 1978).
The Commercial Academy in Brasov imparted an academic flavour to the city due to
an increasing number of scientific and artistic activities, public conferences, research
institutes, journals and other publications and intense activities carried out by
students.
This phase of the Academy of High Commercial and Industrial Studies was
characterized by the efforts to maintain the scientific and didactic requirements, the
requirements for the extension of the social and education spaces, the requirements for
didactic works, specialty magazines and books for the library, the requirements to
organize the student life in the best conditions.
CONCLUSIONS
The development of the economic education as a whole, and specifically in Romania,
followed the evolution of the economy. Thus, because of the development of the
commerce with merchandise, at the end of the 19th century, and the beginning of the
20th century, in the territories inhabited by Romanians, the effort to disseminate
economic knowledge through commercial schools, was intensified.
There were a series of factors which contributed to the way Romanian accounting
evolved, as folows:
the influence of economics, characterized by: the industrial development rate,
the trade evolution, the economical autonomy rate, the available capital, the
financing system, the management system of enterprises.
the political influence and the domination of Austro Hapsburg Empire in
Transylvania and Ottoman Empire in other Romanian regions.
cultural influences: the Austro Hungarian Empire, the German influence of the
accounting school can be found in the accounting theory, the French culture
have influenced the legal system based on laws and the accounting, and the
Italian influence.
The Transylvanian territory lived a different historical experience than the other
Romanian territories, this is the reason why their wish to create a Romanian higher
education could be reached only after the Great Union.
In 1919, the University of Cluj was founded, and in 1920 the first form of higher
economic education was set up, namely the Academy of High Commercial and
Industrial Studies of Cluj. This Academy is considered the first form of higher
education in the accountancy field in Cluj and in Transylvania.
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Due to the foundation of the Academy, the accounting literature is rich after the 1918,
a large number of professors and students from Transylvania and from the other
Academies from Romania published important papers in the accountancy field.
Through the study of the papers written by the professors of the Cluj Academy
(moved to Brasov in 1940) we could identified the special interest for the scientific
research in the field of accounting. The most part of their works, made of articles,
chronicles and reviews, were published in the magazine of the Academy of High
Commercial and Industrial Studies, called Observatorul social-economic, which
was founded in 1930 and functioned until 1947.
The period of the Academy in Cluj was one of organization and beginning of
academic work in all the economic fields including accountancy. During the period
when the Academy carried out its activity in Brasov, an important number of works in
the field of accounting was written, especially in the field of financial accounting.
These works represent the manifestation of accounting maturity in the evolution of
accounting on the territory of our country. These are basic works, which present the
principles used today in the field of accounting.
The Academy of High Commercial and Industrial Studies of Cluj is one of the most
important period of the accounting school in Transylvania and it represents the
evolution of the accounting thinking in Romania and accounting higher education.
This is not an exhaustive paper, some more arguments for the accounting education
and accounting school can be found and we will try to found.
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Carey, J. L. (1969) The Rise of Accounting Profession, American Institute of Certified Public
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Demetrescu, C. G. (1930) Istoria contabilitatii. Antichitatea, Bucuresti
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Dobroteanu, L. and Dobroteanu, C. (2002) Audit, Concepte si practici. Abordare nationala si
internationala, Ed. Economica, Bucuresti
Draganecu Brates, P. (1941) Precursori romni n contabilitate, Bucuresti
Dumitrescu, St. (1947) Elemente si principii de stiinta contabila, Bucuresti
Dumitrescu, St. and Toma, D. (1973) Principii ale contabilitatii, Ed. Didactica si Pedagogica,
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Evian, I.N. (1946) Contabilitatea dubla, Bucuresti
Haskins, C. W. (1904) Business education and accountancy, Harper & brothers
Hatfield, H.R. (1950) A Historic Defence of Bookkeeping, WT Baxter Press, London
Hopwood, A. G.(1983) ,,On trying to study accounting in the contexts in wich it operates,
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Huntington, S. (2003) The clash of civilizations and the remaking of world order, Simon
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Napier, C. J. (1989) ,,Research directions in accounting history, The British Accounting
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Parker, R. H. (1993) ,,The scope of Accounting History: A note, ABACUS, Vol. 29,
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Rampolla, M. L. (2004) A Pocket Guide to Writing in History, St. Martins Press, Boston
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Ristea, M. (1994) Noul sistem contabil din Romnia, Ed. Cartimex, Bucuresti
Rusu, D. et all (1991) Fra Luca di Borgo i doctrinele contabilitii n cultura economic
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Tiron Tudor A , Mutiu A (2007) ,,Important stages in the development of Romanian
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Tosh, J. (1991) The Pursuit of History: Aims, Methods and New Directions in the Study of
Modern History, Longman Press, New York
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Voina, D. (1947) Contabilitate generala, Ed. Academiei, Brasov
Woolf, A. H. (1986) A short history of accountants and accountancy, Garland Pub., New
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Zelinschi D. (2009) ,,Legitimacy, expertise and closure in the Romanian accountants
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JOURNALS:
Buletinul contabililor, 1937-1955.
Colectia Revista Finante, Credit, Contabilitate
Colectia Revista Generala de Comert si Contabilitate, 1908-1916.
Contabilitate si expertiza, 1998-1999.
Evidenta contabila, 1956-1969.
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Revista Generala de Contabilitate si Expertiza, 1996-1997
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PS19 Financial markets

Chairperson
Andrei FILIP, ESSEC Paris, France
FINANCIAL MARKET EFFICIENCY

AND PERSPECTIVES ON IFRS ADOPTION.
CASE STUDY FOR THE UNITED KINGDOM,
Stefana DIMA (CRISTEA), Bogdan DIMA, Otilia RMT
PROPERTIES OF ANALYSTS FORECASTS

FOR ROMANIAN LISTED COMPANIES:
HOW MUCH DO FIRM-SPECIFIC FACTORS MATTER?
Mihaela IONASCU
NET INCOME VERSUS COMPREHENSIVE INCOME

FOR PROFESSIONAL INVESTORS
Iulia JIANU, Ionel JIANU, Ionela GUSATU
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FINANCIAL MARKET EFFICIENCY

AND PERSPECTIVES ON IFRS ADOPTION.
CASE STUDY FOR THE UNITED KINGDOM,
tefana DIMA (CRISTEA) 1
Vasile Goldis Western University of Arad, Romania
Bogdan DIMA & Otilia RMT

West University of Timioara, Romania
ABSTRACT
This paper examines the random walk behavior of three major capital markets, namely
United Kingdom, United States of America and Japan. Results are obtained for DJI, FTSE
100 and NIKKEI 225 indexes, over a time span from 1995 to 2010. Our analysis uses the so
called Lo-MacKinlay (1988) Variance Ratio Tests and some unit root tests in order to
estimate if the corresponding Hurst exponents of these indexes evolve as random walk
processes. The results suggest that the Hurst exponents for the prices series can not be
described as random walk processes. The unit root analysis suggest that overall, the trend
stationarity hypothesis can be rejected in the favor of unit root with drift processes. We are
viewing such outcome as an empirical proof for the difficulty of validating the weak form of
markets informational efficiency. However, we are considering that the intensification of
IFRS adoption can contribute to further improvement of this efficiency.
KEYWORDS: informational efficiency, random walk, IFRS adoption, financial market

INTRODUCTION
Efficiency of capital markets has important implications for the investors policy of
investment. In efficient markets, all fundamental information about the intrinsic value
of traded assets and information related to market characteristics should be reflected
in prices, without any distortions or omissions. So, prices of the assets will reflect
markets best estimate for the risk and expected return of the asset, taking into account
what is known about the asset at the time. Therefore, there will be no undervalued
assets offering higher than expected return or overvalued assets offering lower than
the expected return. All assets will be appropriately priced in the market offering
optimal reward to risk.
In general terms, market efficiency means that prices fully reflect all the available
information (Fama, 1970: 383). The accepted view was that when information arises,
the news spreads very quickly and is incorporated into the prices of securities without
delay. Thus, neither technical analysis, which is the study of past stock prices in an
1
Correspondence address: tefana DIMA (CRISTEA), Vasile Goldi Western University of Arad,
Faculty of Economic Sciences, Address: 15, Mihai Eminescu St., Arad, Romania ; email:
stefana_cristea@yahoo.it
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attempt to predict future prices, nor even fundamental analysis, which is the analysis
of financial information such as company earnings, asset values, etc., to help investors
select undervalued stocks, would enable an investor to achieve returns greater than
those that could be obtained by holding a randomly selected portfolio of individual
stocks with comparable risk (Malkiel, 2003).
Based on such views, the goals of this paper are: 1) to empirical evaluate the
informational efficiency for three major financial markets the United States of
America, Japan and the United Kingdom in the context of current real and financial
turbulence; 2) to debate over the implications of IFRS adoption on the respective
market informational efficiency.
The paper is structured as follows: the next section review the conceptual framework
of Efficient Market Hypothesis, discussing some recent critics as this are synthesized
by so called Adaptive Market Hypothesis. Section 2 debates the implications that
IFRS adoption might have on market efficiency. Section 3 describes the data and the
methodology. Section 4 reports the results. Some conclusions are drawn and some
further research directions are suggested in section 5.
1. A CRITICAL ASSESSMENT OF THE EFFICIENT MARKET
HYPOTHESIS
In regard to the assessment of market efficiency there are two main approaches: the
first is represented by the efficient market hypothesis (EMH) as it was initially
defined by Fama (1965; 1970; 1991): information is perfect and the rational
economic subjects collect and use in a systematic and logic manner this information,
the prices of the financial assets are based on fundamentally efficient mechanisms.
The second one refers to the adaptive market hypothesis (AMH) when information
is imperfect and the economic subjects make portfolio management decisions in a
partially rational manner (Lo [2004; 2005]).
For a long time EMH has represented a dominant model in explaining the asset price
formation (Beechey et. al., 2000), among others because until AMH emerged there
was no viable alternative (Zhang, 1999). According to EMH since the information is
perfect, it is assumed that there are no significant cases of informational asymmetry,
non-uniformly distributed, costly and partially relevant information. Grossman (1976)
and Grossman and Stiglitz (1980) argue that perfectly informational efficient markets
are an impossibility, because if markets are perfectly efficient, the return to gathering
information is nil, in which case there would be little reason to trade and markets
would eventually collapse.
The EMH for common stocks has received significant empirical support in the past,
and as noted by Jensen (1978: 95), there is no other proposition in economics which
has more solid empirical evidence supporting it than the Efficient Market
Hypothesis.
Lo and McKinlay (2001) argue that EMH by itself is not a well-defined and
empirically irrefutable hypothesis. To make it operational, one must specify additional
structure, e.g. investors preferences, information structure, business conditions, etc.
But then a test of EMH becomes a test of several auxiliary hypotheses as well, and a
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rejection of such a joint hypothesis tells little about which aspect of the joint
hypothesis is inconsistent with the data.
Hence, when EMH is not empirically validated, an alternative solution is the
adaptive market hypothesis (Lo and MacKinlay, 1988; Lo, 2004). This approach is
consistent with the concept of bounded rationality as understood by Simon (1955).
According to Simon, the decision making people have a limited analytical ability and
the information analysis algorithms are inherently imperfect. Thus, instead of
pursuing an optimal solution, the economic subjects are frequently preferring to select
a solution which can be seen as satisfactory, whether this is optimal or not.
Thus, the market is seen as a diversified ecology populated with various species of
investors (investment funds, retirement funds, individual investors and so on)
unequally adapted to the decisional environment. When a diversified number of such
species of investors compete on the market in attracting high quality financial assets,
the market is highly efficient. However, if a reduced number of investor species
attempt to incorporate in their portfolios low quality financial assets, the informational
efficiency of the market decreases.
In consequence, the market evolution is characterized by an alternation of the areas in
which a significant fraction of the investors has the adequate decisional methods and
the informational efficiency of the market is maximal, with areas in which an
important number of the market participants use decisional methods insufficiently
adequate and the market presents a reduced informational efficiency. From this
perspective AMH does not necessarily excludes the possibility of EMH being locally
feasible, however it represents a significant generalization of this by taking into
account of certain evolving mechanisms which set new trajectories to the market
dynamics.
In regard to the forms of market efficiency, Fama (1965) identifies:
weak form efficiency: financial assets prices instantly and completely reflect
any information from the past. This means future prices cannot be predicted by
analyzing past prices.
semi-strong form efficiency: financial assets prices adjust to publicly available
new information very rapidly and in an unbiased fashion, such that no excess
returns can be earned by trading on that information. Thus, any information
will be automatically reflected in prices, in the shortest time possible. So, the
semi-strong form has a more general nature than the weak form.
strong form efficiency: financial assets prices fully reflect all public and
private information available. Therefore, no one c can earn excess returns
since there is no piece of information that would provide additional value to
the investors.
These forms of efficiency are included in one another, thus the semi-strong form
includes the weak one, while the strong form includes both.
Out of these three forms of informational efficiency we consider that the most capable
of influencing the IFRS adoption is the weak form, given that in this case, the
financial assets prices reflect any information from the past (Fama, 1970, p. 383).
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In the context of IFRS adoption, the empirical evidences which can support this
hypothesis are obtained by testing the weak form using two sets of methods:
a) in a direct manner by determining the degree in which the financial assets
prices evolution can be described as martingale and respectively, as randomwalk;
b) in an indirect manner, by analyzing the statistical characteristics of the
temporal series formed by the efficiency of owning and trading financial
assets.
In regard to the tests for market efficiency, there is voluminous literature on the topic
(Bollerslev and Hodrick, 1992). The ideas discussed include standard auto-correlation
tests, multi-period regression tests and volatility tests. Due to the extensive literature,
we will make reference to those sources related in some extend to the tree countries
we are addressing in this paper Japan, the USA and the UK.
Thus, the weak form market efficiency of Asian capital markets was studied by
Whorthingthon and Higgs (2006). They examined for random walks daily returns for
ten emerging (China, India, Indonesia, Korea, Malaysia, Pakistan, the Philippines, Sri
Lanka, Taiwan and Thailand) and five developed markets (Australia, Hong Kong,
Japan, New Zealand and Singapore), using serial correlation coefficient and runs tests,
augmented Dickey-Fuller, unit root tests and multiple variance ratio tests. The results
for the tests of serial correlation were in broad agreement, conclusively rejecting the
random walks in the daily returns of all the markets studied. The results from the
more stringent variance ratio tests indicated that the developed markets in Hong
Kong, New Zealand and Japan were consistent with the most stringent random walk
criteria.
Cooray (2003) tested the random walk hypothesis for the stock markets of the USA,
Japan, Germany, the UK, Hong Kong and Australia, using unit root tests and spectral
analysis, which is a method of testing for oscillatory movements in a time series and
enables identifying any cyclical or seasonal patterns in stock prices. For this study
were used monthly data of stock market indices of these six countries mentioned
above, during April 1991 to March 2003. The results based upon the augmented
Dicky-Fuller (1979) and Phillips-Perron (1988) tests and spectral analysis find that all
markets exhibit a random walk. While the multivariate cointegration tests based upon
the Johansen Juselius (1988, 1990) methodology indicates that all six markets share a
common long run stochastic trend, the vector error correction models suggest a short
run relationship between the US, Germany, Australia and the rest of the markets
implying that these countries can gain in the short run by diversifying their portfolios.
Taylor (2000) investigated the predictability of long time series of stock index levels
and stock prices, by using both statistical and trading rule methodologies. The trading
rule analysis used a double moving-average rule and the methods of Brock,
Lakonishok and Le Baron (1992). Thus, he studied the FTA, FTSE-100, DJIA and
S&P-500 indices, prices for twelve UK stocks and indices derived from these stock
prices. From the statistical analysis resulted that the index and price series were not
random walks, and the trading rule analysis generally confirmed this conclusion.
Borges (2008) studied the weak-form market efficiency applied to stock market
indexes of France, Germany, UK, Greece and Spain. The used data were daily closing
values of stock markets, chosen as representative for each of those markets. The
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period observed was between 1 January 1993 and 31 December 2007, during which
the markets were very volatile, especially in the case of Greece. Overall, it found
convincing evidence that monthly prices and returns follow random walks in all six
countries. It concluded that France, Germany, UK and Spain meet most of the criteria
for a random walk behavior with daily data, but that hypothesis is rejected for Greece
and Portugal, due to serial positive correlation.
Chan et al. (1992) studied the relationships among the stock markets in Hong Kong,
South Korea, Singapore, Taiwan, Japan and the United States, by using unit root and
co-integration tests. In this study, all the stock prices were analyzed both individually
and collectively to test for international market efficiency. They found unit roots in
stock prices and the higher-order co-integration tests indicated that there is no
evidence of co-integration among the stock prices. Their finding suggested that the
stock prices in major Asian markets and United States were weak-form efficient
individually and collectively in the long run.
Worthington and Higs (2003) have tested random walks and weak-form efficiency in
European equity markets. They have studied the daily returns for sixteen developed
markets (including the UK) and four emerging markets (Czech Republic, Hungary,
Poland and Russia). Their results shown that among the developed markets, only
Germany, Ireland, Portugal, Sweden and the UK satisfy the most stringent random
walk criteria with France, Finland, the Netherlands, Norway and Spain meeting at
least some of the requirements of a strict random walk. Among the emerging markets,
only Hungary satisfies the strictest requirements for a random walk in daily stock
returns. The results of their analysis are consistent with the generalization that
emerging markets are unlikely to be associated with the random walks required for the
assumption of weak-form market efficiency. The evidence regarding developed
markets is less conclusive with some markets following random walks while others
do not.
Overall, this literature depicts a non-conclusive picture of the current status of various
markets informational efficiency. Supplementary, the current financial and economic
turbulence has affected markets mechanisms and, presumably, has increased the
heterogeneity of markets evolutions.
2. PERSPECTIVES FOR IFRS ADOPTION
Due to the growing interdependence of economies around the world, the global
economic and financial crisis had influenced greatly the general publics perception
on financial sector issues. The role that financial reporting plays in the contemporary
society has been largely debated over the last three years as a wide range of key
organizations such as UNCTAD, G-8 Finance Ministers, G-20 Summit, the European
Council of Ministers and the United States Congress paid more attention to the need
for a sound accounting language able to ensure financial and economic stability.
The main purpose of the accounting convergence process is to provide reliable,
transparent and comparable financial information required by the globalized financial
markets. The core element of this process is represented by the standards issued by
IASB (International Accounting Standard Board). In order to respond to the needs of
these markets, IASB and US FASB have established in 2009 a Financial Crisis
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Advisory Group (FCAG) which comprises around 20 senior leaders experienced in

international financial markets related aspects. The role of FCAG is to advise the two
Boards in regard to the implications that the financial crisis alongside the possible
changes in the global regulatory environment might have on standard-setting. In
relation to this, IASB has launched a number of projects (such as fair value
measurement and financial instruments). Moreover, IASB: had amended requirements
on the reclassification of some financial assets from fair value categories to amortized
cost categories; issued additional technical guidance on the determination of fair
values of financial assets in illiquid / inactive markets.
The literature seldom considers that IFRS adoption lead to an increase in the
understandability of financial statements for investors, financial analysts and other
users, these standards already representing the financial reporting framework
accepted for the issuers admittance on the main stock exchanges in the world (Mueller
et al., 1997).
In this context, the question that arises is the following:
Does the adoption of IFRS contribute to an increase in the informational efficiency of
the financial markets?
There are certain advantages of IFRS adoption such as greater comparability of the
financial information and better disclosure to stakeholders which may lead to a
decrease in the investors risks and uncertainty, leading to an increase in the
informational efficiency of the market and eventually minimizing the cost of capital
(Prather-Kinsey et al., 2008; Fogarty, 2008; Bova and Pereira, 2010). Comparability
contributes to the general objective of trust in the information given (Epstein and
Mirza, 2005). Thus, the IFRS intrinsically attempt to comprehensively respond to
investors needs in terms of information and economic guidance based on accounting
information (Rosenfield, 2005).
The literature review reveals that there are a few studies addressing directly the link
between the financial information provided by IFRS-based financial reports and
informational efficiency as defined by the Efficient Market Hypothesis - Fama
(1970; 1991) or the Adaptive Market Hypothesis - Lo (2004; 2005). Such an
example is represented by Lambert et al. (2006) which investigated the way in which
the voluntary adoption of IFRS before 2005 has contributed to the semi-strong form
of the European financial markets informational efficiency; and provided interesting
evidences regarding the potential use of IFRS in the investment decision making
process. However, we consider that the respective paper does not provide sufficient
empirical evidences which validate the semi-strong form on those markets. Thus, the
respective research direction remains open for further development.
With the aim of responding to our question it is essential to have first a complete and
stable set of financial reporting standards, condition which will probable be met not
prior to 2012. However, the issuance of a coherent set of standards is not the only
condition, another one may reside in extensive adoption of these standards on the
global financial markets. At the moment, more than 120 jurisdictions from around the
world permit or require IFRSs for domestic listed companies. Besides, the IFRS
adoption depends greatly on the status of the convergence process between IASB and
US FASB and on the standpoints of the US Securities and Exchange Commission
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(SEC) and of the European Union; since these are the trend setters for companies
planning to get listed on the most developed financial markets in the world.
Consequently, in this paragraph we shall address the issue of IFRS adoption in the
UK, USA and Japan focusing on the time span 1995-2010, whereas in the following
paragraph we will be testing the weak-form market efficiency of these financial
markets; a discussion regarding the perspectives of the influence of IFRS adoption on
market efficiency being included in the last paragraph of the paper.
2.1. IFRS adoption in the USA
The United States of America started to show interest in the elaboration of the
international accounting standards in a 1980s series of joint meetings between the
International Accounting Standards Committee (IASBs predecessor), the US
Securities and Exchange Commission, New York Stock Exchange and International
Bar Association. Soon after, the US FASB (Financial Accounting Standard Board)
has joined IASC as an observer.
However, through the Norwalk Agreement in October 2002, FASB and IASB
committed for the first time to eliminate the differences in the accounting treatments
stipulated by international accounting standards and US GAAP. In addition, the two
Boards decided to co-ordinate their future activities in order to ensure that, once
achieved, compatibility is maintained. Moreover, in February 2006 (and updated in
2008), the Boards released a new Memorandum of Understanding (MOU) identifying
short-term and long-term convergence projects and setting the steps and milestones
towards achieving convergence. Recently, as reaction to the pressure exercised by
international groups and organizations, IASB and FASB reaffirmed their commitment
to convergence by issuing a statement outlining steps for completing the major joint
projects by 2011.
To this decision contributed in certain extend the standpoint of US SEC in regard to
IASB-FASB convergence process, since right at the beginning of the economic and
financial crisis, the SECs decision to drop the reconciliation requirements for foreign
registrants that adopt IFRSs came as a surprise. Till November 2007, the foreign
companies had two choices: either to prepare US GAAP based financial statements or
to fill a reconciliation form of net income and net assets to US GAAP (Form 20-F).
Thus, this was the case for more than 1.100 non-US companies of the approximately
15,000 companies registered with SEC. The cost of such reconciliation for European
companies was between 1 and 10 million Euros annually depending on their size and
field of activity (McCreevy, 2005).
However, due to the progress of the convergence process, SEC dropped these
requirements and allowed the use of IFRSs as issued by the IASB; by this, meaning
the full set of standards including the carve-out made by the European Union and the
continuous amendments to IFRSs.
Moreover, in August 2007, SEC launched a public debate on whether or not to allow
US domestic issuers to prepare IFRS financial statements for the purpose of
complying with the rules and regulations of the SEC. To show its clear intentions, in
November 2008, SEC published for a proposed IFRS roadmap, which outlines the
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milestones that, if achieved, may lead to mandatory transition to IFRS starting

December 2014; certain entities are allowed to adopt IFRS in advance.
Figure 1. Timeline of IFRS adoption in the USA
Launched
debate over the
use of IFRS by
US issuers
SEC and IASC

joint
conference
80s
FASB becomes
an observer at
IASC meetings
2002
MoU2
MoU1
2006
2007
!!! SEC drops
reconciliation
requirements
SEC
proposes
IFRS
roadmap
2008
Update
MoU2
Workplan
regarding
the decision
over the use
of IFRS by
US issuers
2010
???
2015/2016
Prospective
mandatory
use of IFRS
by US
issuers
In addition, in February 2010, the SEC published a Statement in Support of

Convergence and Global Accounting Standards aiming at facilitating the development
and execution of a Work Plan that will enable SEC to reach a decision regarding the
use of IFRSs by US issuers by 2015 /2016.
2.2 IFRS adoption in the United Kingdom
The financial reporting principles of the United Kingdom influenced in a great extend
the development of the international accounting standards and the financial reporting
within the European Economic Community and, implicitly, the European Directives.
In fact, the euro-harmonization process coincided with UKs joining the EEC.
Meanwhile, at London, IASC was being founded, with UK being one of the nine
accounting organizations supporting the initiative.
As member of the EEC, UK was part of the European Unions decision to sign the
1995 protocol, EU offered guidance to the Member States in adopting IAS, whereas
these standards were compatible with the European Directives. The Directives do
not, however, provide answers to all the problems facing the preparers and users of
accounts and accounting standard setters in the 1990s. Some issues are not addressed
at all in the Directives.
Also, in 2000, Commission announced the plan to require IAS for group accounts of
listed companies by 2005. A year later, the Commission adopted a fair value directive,
which requires/allows fair value measurement of certain financial instruments.
Financial reporting standards in the UK are set by the Accounting Standard Board
(ASB) of the Financial Reporting Council (FRC). Since the end of 2000 and
beginning of 2001, ASB addressed the issue of convergence between the UK GAAP
and IAS. The publication of The Convergence Handbook was expected to help the
ASB to identify and prioritize the areas where national standards should be changed.
Moreover, on 15 May 2002, the Accounting Standards Board (ASB) published seven
Financial Reporting Exposure Drafts (FREDs) as part of the first stage of a three
phase programme to align UK GAAP with IFRS.
~947~
In response to the issuance of the IAS Regulation by the European Union, on July
2003 UK Department of Trade and Industry (DTI) has approved a regulation that
permits, starting January 2005, all UK companies to use IFRS as an alternative to UK
GAAP, in addition to the European law requirement for listed companies to use IFRS
from 2005 in preparing their consolidated statements.
Figure 2. Timeline of IFRS adoption in the UK
UK
joined
EEC
1995
70s
IASC
founded
at
London
EU
protocol guidance
to IAS
adoption
EU
announces
plan to
require IAS
for listed
UK
government
uses IFRS
ASB
launched
convergence
with IAS
???
2008
2001
2000
2005
All UK
companies
permitted
to use
IFRS
Standard on
convergence
Standard on 2012
convergence
UK GAAP is
expected to
be replaced
by IFRS for
2010
SMEs
The status of the UK convergence process with IFRS had been reconsidered on March
2004 in a Discussion Paper UK Accounting Standards: A Strategy for Convergence
with IFRS. The starting point was the impossibility to maintain on long run the use
of two sets of different accounting standards in the UK (UK GAAP and IFRS) so
alignment in necessary.
In addition, at the end of 2008, the ASB issued a UK standard on Improvements to
Financial Reporting Standards in order to maintain the convergence between UK
GAAP and IFRS. Overall, as indicated in the 2008/2009 Financial Reporting Council
Annual Report, the ASB remains committed to convergence; however, the strategy
for achieving this remains under consideration. The ASB continued its efforts to
ensure that UK converged standards remain in line with their IFRS equivalents,
responding to circumstances arising from the current crisis as appropriate. (FRC,
2009: 5). Also, late last year, ASB issued Improvements to Financial Reporting
Standards 2010 in order to maintain converge with IFRS.
However from 2012, UK GAAP is expected to be replaced with the IFRS for SMEs
and the Financial Reporting Standard for Smaller Entities (FRSSE) will remain in
place for those entities choosing to do so and subject to threshold criteria.
2.3 IFRS adoption in Japan
For almost 30 years, Japanese entities prepared consolidated financial statements
according to Japanese GAAP and submitted those to the Japanese securities
commission. Until the foundation of Accounting Standards Board of Japan (ASBJ), a
governmental council was setting accounting standards. The use of US GAAP in
consolidated accounts, instead of Japanese GAAP is allowed for domestic companies
registered with the US SEC. US GAAP consolidated financial statements of the
current 35 companies can be used for Japanese reporting as well. Around
~948~
250 Japanese companies are listed on EU exchanges, using Japanese GAAP, whereas
approximately 10 companies from IFRS countries are listed in Japan.
The road towards the adoption of IFRS has started in October 2000 when an advisory
body of the Ministry of Finance (Business Accounting Deliberation Council - BADC)
decided to make Japanese GAAP more compatible with IAS. However, in 2001, a
newly created organization was entrusted with the accounting standard setting
function - ASBJ - and an oversight foundation similar to IASB Foundation was
created as well - Financial Accounting Standards Foundation (FASF).
Four years later, ASBJ and IASB launched a joint convergence project between
Japanese GAAP and IFRS. In addition, the Committee of European Securities
Regulators (CESR) completed its review on the equivalence of Japanese, American
and Canadian GAAPs with IFRS and recommended the European Commission to
declare the three sets of GAAP equivalent to IFRS, subject to limited changes, which
were considered significant by CESR. As a response to the CESR report, in October
2006, the ASBJ released its Project Plan Concerning the Development of Japanese
Accounting Standards, which identified 26 accounting issues to address in order for
the EU to permit Japanese companies to trade on European securities markets.
In 2007, with the signing of the "Tokyo Agreement", ASBJ and the IASB laid out
short term convergence projects to be completed by 2011. As part of the agreement
the two boards will seek to eliminate by 2008 major differences between Japanese
GAAP and IFRS (as defined by the July 2005 CESR assessment of equivalence), with
the remaining differences being removed on or before 30 June 2011. As a
consequence, revisions were made to Japanese GAAP and at the end of 2008; the EC
established that Japanese GAAP are equivalent to IFRS.
Figure 3. Timeline of IFRS adoption in Japan
BADC
decides on
compatibility
with IAS
2001
2000
ASBJ +
IASB
launched
joint
convergence
project (CP)
ASBJ is
founded
2005
FSA allows
voluntarily
CPs
use of
designate
d IFRSs
2010
Tokyo
Agreement
2006
ASBJ
released
JGAAP
development
plan with IAS
2007
2009
2008
EU announces
JGAAP
equivalence
???
2012
2011 FSA decision

on the
mandatory
CPs adoption of
IFRS
On 11 December 2009, the Financial Services Authority of Japan (FSA) issued an

order allowing certain listed domestic companies voluntarily to start using
designated IFRSs in their consolidated financial statements starting from the fiscal
year ending 31 March 2010. The designated IFRSs are all approved by the FSA and
the list includes all IFRS and Interpretations issued before 30 June 2009. Those
companies not choosing to adopt designated IFRSs, must use Japanese GAAP. The
domestic companies using US GAAP must cease to do so after 31 March 2016.
~949~
An updated Project Plan aligned with the IASBs work plan was released by ASBJ in
April 2010, focusing on eliminating the remaining differences between Japanese
GAAP and IFRS by June 2011.
In this context, the decision of the mandatory adoption of IFRS for Japanese listed
entities in 2015 or 2016 is still subject to the FSAs final decision expected in 2012.
In March 2011, ASBJ has released its latest summary of standards development and
its project plan, discussing issues related to the projects of IASB and FASB. The
project plan states: "2011 is the year for significant change in the IASB's leadership.
Accordingly, the IASB's Work Plan does not show the timetable for 2012 and beyond.
In Japan, market participants expect that within this year the uncertainty about the use
of IFRSs would be eliminated. The Business Council of Financial Services Agency
will also resume its deliberation. The convergence efforts by the ASBJ including the
MoU projects need to be carried on taking account of the direction of the discussions
at the Council. Consideration is needed about the pace and the expected effective
dates for the development of standards and we need to extensively listen to views
from market participants."
Also, in the latest meetings between the ASBJ and the FASB in February 2011, the
two boards discussed the future of global convergence of accounting standards. Since
the final decisions regarding the mandatory use of IFRS are expected to be made
during 2011 for the USA and in or around 2012 for Japan, the ASBJ and the FASB
updated each other with the recent developments in their respective convergence
projects with the IASB and exchanged views on the a number of IASB projects.
3. DATA AND RESEARCH DESIGN
For drawing the sample study, we obtained data from three developed capital markets,
namely the United Kingdom, the United States and Japan, on the DJI indexes, the
FTSE 100 and NIKKEI 225 over the period 1995-2010.
The main statistic characteristics of the indexes are reported in Table 1. It can be
noticed that the indexes display a non-normal distribution with clear fat-tails effects.
More exactly, the distribution of DJI and FTSE 100 indexes is left tailed while Nikkei
225 is right tailed. In the meantime, DJI have a peaked distribution (leptokurtic)
relative to the normal one, while for FTSE 100 and Nikkei 225 this is flat (platykurtic)
relative to the normal.
Table 1. Main statistic characteristics of major indexes
Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis
Jarque-Bera
Probability
Observations
DJI
9486.69
10110.02
14093.08
3832.08
2219.10
-0.65
3.05
265.02
0.00
3732
FTSE100
5103.81
5203.75
6930.20
2954.20
967.71
-0.22
1.94
204.63
0.00
3732
~950~
NIKKEI225
14154.51
14156.87
22667.00
7054.98
3799.44
0.15
1.92
196.88
0.00
3732
Graphic 1. Recent evolutions of DJI, FTSE 100 and NIKKEI 225 markets
24,000
20,000
16,000
16,000
12,000
12,000
8,000
8,000
4,000
4,000
0
500
1000
1500
DJI
2000
FTSE 100
2500
3000
3500
NIKKEI 225
A series is said to be (weakly or covariance) stationary if the mean and autocovariances of the series do not depend on time. Any series that is not stationary is
said to be non-stationary.
A common example of a non-stationary series is the random walk:
y t = y t 1 + t
(1)
Where is a stationary random disturbance term. The series y has a constant forecast
value, conditional on t, and the variance is increasing over time. The random walk is a
difference stationary series since the first difference of y is stationary:
y t y t 1 = (1 L ) y t = t
(2)
A difference stationary series is said to be integrated and is denoted as I(d ) where d is
the order of integration. The order of integration is the number of unit roots contained
in the series, or the number of differencing operations it takes to make the series
stationary. For the random walk above, there is one unit root, so it is an I(1) series.
Similarly, a stationary series is I(0).
Standard inference procedures do not apply to regressions which contain an integrated
dependent variable or integrated regressors. Therefore, it is important to check
whether a series is stationary or not before using it in a regression. The formal method
to test the stationarity of a series is the unit root test.
Unit root tests can be used to determine if trending data should be first differenced or
regressed on deterministic functions of time to render the data stationary. Moreover,
economic and finance theory often suggests the existence of long-run equilibrium
relationships among non-stationary time series variables.
Various unit root tests suggests that overall the evolutions of the considered
developed markets indexes can be fairly described as unit root with drift processes
~951~
(Table 2). Among these, Kwiatkowski et al. (1992) and Bierens and Guo (1993) imply
as null trend stationarity against unit root with drift, while Bierens (1993) and
Breitung (2002) assume that the series are unit roots with drifts.
With some notable exceptions, especially for Bierens-Guo tests (Type 6) and, in a
certain measure for Nikkei 225, these are converging to depict the image of all the
markets indexes being I(1) variables.
Table 2. Unit roots tests (trend stationarity against unit root with drift)
KPSS
Null:Trend
stationarity
against unit root
with drift
DJI
0.97
(reject / reject)
BIERENS-GUO
(Type 5)
Null:Trend
stationarity
against unit root
with drift
1560.49
(reject / reject)
FTSE 100
0.68
(reject / reject)
1882.12
(reject / reject)
27.74
(reject / reject)
NIKKEI
225
0.76
(reject / reject)
181.67
(reject / reject)
10.65
(accept / reject)
BIERENS-GUO
(TYPE 6)
Null:Trend
stationarity
against unit root
with drift
24.05
(reject / reject)
BIERENS DHOAC
Null:
Unit root with drift
against trend stationarity
BREITUNG
NULL:
Unit root with
drift against trend
stationarity
DHOAC(1,1)=0.42
DHOAC(2,2)=0.45
(accept/accept)
DHOAC(1,1)=0.39
DHOAC(2,2)=0.56
(accept/accept)
DHOAC(1,1)=0.58
DHOAC(2,2)=0.68
(accept/accept)
0.42
(accept/accept)
0.26
(accept/accept)
0.31
(accept/accept)
Notes: Bierens DHOAC and Breitung tests computed based on 100 replications with the
errors draw from the normal distribution with zero mean and variances the squared
OLS residuals (bootstrapping); The conclusions are drawn for 5% and 10% critical
regions.
3. RESULTS AND COMMENTS

Our evaluation of the Efficient Market Hypothesis for the considered markets consists
in testing the indexes in order to estimate the possibility to describe them as random
walk processes. This involves the appliance of the so-called Lo and MacKinlay (1988;
1989) overlapping Variance Ratio Test. This test examines the predictability of the
time series by comparing variances of differences of data computed over different
intervals. If the data are assumed to follow a random walk, the variance of a q period
difference should be q times the variance of the one-period difference. Evaluating the
empirical evidence for or against this restriction is the basis of the variance ratio test.
More exactly, if there is a time series {Yt}= {Y1, Y2,,Yt} satisfying:
Yt = + t
(3)
where is an arbitrary drift parameter then the key properties of a random walk that
are of interest for the test can be described as E(t)=0 for all t and E(tt-j)=0 for any
positive j.
The estimators for the mean of first difference and the scaled variance of the q-th
difference are defined as:
~952~
1 T
(Yt Yt 1 )
T i =1
2 (q ) =
1 T
(Yt Yt q q )2
Tq t =1
(4)
and the corresponding variance ratio:

2 (q )
VR (q ) = 2
(1)
(5)
The variance estimators may be adjusted for bias, as suggested by Lo and MacKinlay,
by replacing T in equation (4) with (T-q+1) in the no-drift case, or with (T-q+1)(1q/T) in the drift case.
Lo and MacKinlay (1988) show that the variance ratio z-statistic:
z (q ) = (VR (q ) 1) s 2 (q )
1 / 2
(6)
is asymptotically N(0,1) if the estimator s2 is properly chosen.

Under the i.i.d. (independent identically distribution) hypothesis we have the
estimator,
s 2 =
2 (2 q 1)(q 1)
3qT
(7)
while under the m.d.s. assumption we may use the kernel estimator,
2(q j )
j
s (q ) =
q
j =1
2
q 1
(8)
where:
T
T
j = ( y t j )2 ( y t )2 / ( y t j )2
t = j +1
t = j +1
(9)
The test is first performed for homoskedastic random walks using the wild bootstraps
distribution to evaluate statistical significance. Such an approach is based on the
strong assumption that t is i.i.d. Gaussian but the normality assumption is not strictly
necessary. Three different alternatives are considered:
1) The Hurst exponent series are random walks so that variances are computed
for differences of the data;
2) These series are assumed to follow an exponential random walk so that the
innovations are obtained by taking log differences or, alternatively,
3) The series contains the random walk innovations themselves.
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Table 3. Lo and MacKinlay Variance Ratio Tests

A) Random walk
JOINT TESTS
VALUE
DEGREE OF
FREEDOM
PROBABILITY
DJI
Max |z| (at period 8)

Wald (Chi-Square)
3.35
29.84
3731
15
0.00
0.01
FTSE 100

Wald (Chi-Square)
4.14
35.14
3731
15
0.00
0.00
Nikkei 225

Wald (Chi-Square)
2.74
15.95
3731
15
0.02
0.39
B) Exponential random walk

JOINT TESTS
VALUE
DEGREE OF
FREEDOM
PROBABILITY
DJI

Wald (Chi-Square)
3.02
31.15
3731
15
0.00
0.01
FTSE 100

Wald (Chi-Square)
4.00
37.90
3731
15
0.00
0.00
Nikkei 225

Wald (Chi-Square)
2.62
15.34
3731
15
0.03
0.43
JOINT TESTS
VALUE
DEGREE OF
FREEDOM
PROBABILITY
DJI

Wald (Chi-Square)
200.99
50787.63
3732
15
0.00
0.00
FTSE 100

Wald (Chi-Square)
200.84
50617.52
3732
15
0.00
0.00
Nikkei 225

Wald (Chi-Square)
203.79
52794.16
3732
15
0.00
0.00
C) Random walk innovations
Notes: Null Hypothesis: A) The index is a random walk; B) The (log) index is a random
walk; C) The cumulated index is a random walk; Computed using: Rank scores;
Included observations: 3731 (after adjustments); Standard error estimates assume
no heteroskedasticity; Lags specified as grid: min=2, max=16, step=1; Test
probabilities computed using permutation bootstrap: 10000; Random generator:
Knuth; Tie handling: Random
Kim (2006) offers a wild bootstrap approach to improving the small sample properties
of variance ratio tests, as it was found that the wild bootstrap tests have desirable size
properties and exhibit higher power than their alternatives in most cases. The
approach involves computing the individual (Lo and MacKinlay, 1988) and joint
(Chow and Denning, 1993) variance ratio test statistics on samples of observations
formed by weighting the original data by mean 0 and variance 1 random variables,
and using the results to form bootstrap distributions of the test statistics. The bootstrap
~954~
p values are computed directly from the fraction of replications falling outside the
bounds defined by the estimated statistic. Kims simulations indicate that the test
results are generally insensitive to the choice of wild bootstrap distribution.
Wright (2000) proposes modifying the usual variance ratio tests using standardized
ranks of the increments, Yt. Letting r(Yt) be the rank of the Yt among all T values,
he defines the standardized rank (r1t) and van der Waerden rank scores (r2t):
T +1
r1t = r (Yt )
/
2
(T 1)(T + 1)
12
r2 t = 1 (r ( Yt ) / (T + 1))
(10)
(11)
In cases where there are tied ranks, the denominator in r1t may be modified slightly to
account for the tie handling.
The Wright variance ratio test statistics are obtained by computing the Lo and
MacKinlay (1988) homoskedastic test statistic using the ranks or rank scores in place
of the original data.
Under the i.i.d. null hypothesis, the exact sampling distribution of the statistics may be
approximated using a permutation bootstrap.
Wright (2000) also proposes a modification of the homoskedastic Lo and MacKinlay
(1988) statistic in which each Yt is replaced by its sign. This statistic is valid under
the m.d.s. null hypothesis, and under the assumption that = 0, the exact sampling
distribution may also be approximated using a permutation bootstrap.
The unit root analysis suggests that, overall, the trend stationarity hypothesis can be
rejected in the favor of unit root with drift processes. In the mean time, the failure of
describing the Hurst exponent as a random walk, suggests that the indexes are
imperfectly adjusted under the impact of informational shocks and displays some
rigidities in their formation mechanisms.
CONCLUSIONS AND FURTHER RESEARCH
One of the primary goals of this study is to evaluate the weak-form of three major
financial markets informational efficiency. Our results suggest that the Hurst
exponent for the prices series can not be described as random walk (with different
versions) processes.
We interpret such results as rejecting the Efficient Market Hypothesis for the
considered markets. Of course, there can be identified some limitations of our
proposed analysis. Among these, the estimated levels of the Hurst exponent are
sensitive to the choice in methodology; the Lo and MacKinlay approach is a test of
the long run variance and so it allows the treatment of the short run adjustments in the
series. The data set is limited and no structural break-points are identified in the
behavior of indexes during different sub-periods of the observed time span; the
interactions between indexes are ignored; the Adaptive Market Hypothesis is just
~955~
mentioned, but no analytical developments are considered. Thus, some possible

further research directions can be developed by: evaluating the results robustness to
the changes of the methodology evaluating the Hurst exponent; considering a longer
data set and performing sub-periods evaluations; developing a sounder framework,
able to explain in greater details the mechanisms of markets partial informational
inefficiency.
Meanwhile, it is necessary to provide a description for the underlying mechanisms of
the potential impact that extending the IFRS adoption might have on the informational
efficiency of the considered markets; by taking into account both the effects on
information quality as well as the induced changes in investors behavior.
Despite this caveats, we consider that such results can better highlight the intrinsic
markets adjustments mechanisms to the various informational shocks and allows a
better understanding of transactional decisions in the context of an uncertain business
environment.
ACKNOWLEDGEMENT
This article has benefited by financial support through the project ,,Studii PostDoctorale n Economie: program de formare continu a cercettorilor de elit
SPODE, financing contract no. POSDRU/89/1.5/S/61755, project financed by the
European Social Fund Sectoral Operational Programme Human Resources
Development 2007-2013.
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PROPERTIES OF ANALYSTS FORECASTS

FOR ROMANIAN LISTED COMPANIES:
HOW MUCH DO FIRM-SPECIFIC FACTORS MATTER?
Mihaela IONASCU1
ABSTRACT
This paper seeks to explore the properties of analysts forecast accuracy for companies listed
on Bucharest Stock Exchange (BSE). Based on a sample of 266 firm-month observations
(predictions made in 2008 for 2009 and 2010), the paper investigates several firm-specific
factors documented by the literature to have a significant impact on forecast accuracy, and
shows that for Romanian listed companies, forecast errors for earnings per share reported
under local GAAP are negatively correlated with the size of the firm and the corporate
governance policies. The results are convergent with those documented in international
contexts, showing that larger firms as well as those which are better governed are more likely
to provide additional disclosures, and thus increase forecast accuracy.
KEYWORDS: properties of analysts forecast, corporate governance, information

environment
INTRODUCTION
There is a large amount of literature investigating various factors affecting analysts
forecast accuracy. The drivers of forecast accuracy can be both analyst-specific (such
as analysts skills and behavior), and firm-specific (such as firm characteristics and
actions) (Ernstberger, Krotter and Stadler, 2008). Among the firm-specific factors, the
information environment of a company is a key driver of forecasts accuracy, as more
information reduce uncertainty about a companys future prospects and thus leads to
smaller forecast errors. And the literature documents factors such as corporate
governance policies and financial reporting standards and disclosure to lead to a better
information environment, and consequently to increase analysts forecast accuracy.
In Romania, several steps were taken in order to improve the quality of financial
disclosure and that of corporate governance polices of listed Romanian companies. In
2006 Companies Law was amended to improve board composition by including
independent directors and to allow for a dualist governance system comprising a
Supervisory Board and a Management Board (Olimid et al. 2009). And starting in
2001, several requirements were gradually issued to ensure companies adherence to a
Corporate Governance Code. At the same time, there were gradual requirements
aimed at improving the financial disclosures of firms listed on BSE, and starting with
Correspondence address: Mihaela IONASCU, Bucharest Academy of Economic Studies;

emal: mihaela.ionascu@gmail.com
~959~
2005, listed Romanian companies prepare mandatorily financial statements in

compliance with IFRS, while others apply IFRS for internal information needs.
In this context, the purpose of this paper is to investigate the properties of analysts
forecasts for listed Romanian companies, trying to expose the effect of firm-specific
factors, especially those that are reasonably expected to affect the quality of the
information environment, and thus enhance or decrease forecast accuracy.
There is a large amount of literature showing that both analyst-specific and firmspecific factors are driving forecasts accuracy. For instance, rather optimistic analysts
tend to have upward biased forecasts (Easterwood and Nutt 1999), while more
experienced analysts tend to have more accurate forecasts (Clement, 1999). Among,
the firm-specific factors, the literature documents company size, industry, corporate
governance policies or financial reporting standards and disclosure as drivers of
forecasts accuracy.
For instance, larger firms are expected to provide additional disclosure than smaller
firms, which may lead to a decrease in forecast errors. However, larger firms may also
have more complex activities which may decrease forecast accuracy. (Brown, Preiato
and Tarca, 2009).
There is also a recent stream of research showing that better quality corporate
governance is associated with an increase in the overall quality of information
possessed by financial analysts, which can reasonably be expected to lead to more
accurate analysts forecasts. Bhat, Hope and King (2006), using country level proxies
for corporate governance transparency, showed that differences in transparency across
21 countries affect forecasts accuracy, when controlling for financial transparency. In
addition, their results showed that the effect of corporate governance transparency on
analyst forecast accuracy is larger when financial disclosures are less transparent. The
argument supporting these findings is that governance-related disclosure plays a role
in improving the information environment of companies which leads to smaller errors
in analyst forecast.
This rationale is backed by other research results, such as the ones provided by
Karamanou and Vafeas (2005), who documented that effective corporate governance
is associated with higher financial disclosure quality. Karamanou and Vafeas (2005)
showed that more effective corporate boards and audit committees structures lead to
more accurate management earnings forecasts, which can reasonably lead to a
decrease in analysts forecast errors.
Byard and Weintrop (2006) have also discussed the association between corporate
governance and the quality of information available to financial analysts. Their
findings proved that the quality of corporate governance increases the quality of
financial analysts information about upcoming earnings.
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Several recent papers have showed that financial reporting is an important source of
information used by financial analysts for predictive purposes (Peek, 2005).
Consequently, there was an increase in the body of research investigating the
relationship between financial disclosure and analysts forecast accuracy. Authors
such as Vanstraelen, Zarzeski and Robb (2003) or Hope (2004) proved that increased
disclosure leads to increased analysts forecast accuracy. Hope (2002), for instance,
relates the CIFAR index of the level of annual report disclosure to forecast accuracy
for a sample of 1,553 firm-years from 22 countries, showing that a high volume of
financial information made available to financial analysts enhances their forecast
accuracy.
IFRSs are allegedly high-quality financial reporting standards, with extensive
disclosure requirements and evolved recognition and valuation procedures, expected
to increase transparency, diminish information asymmetry, and, consequently,
facilitate predictions in order to support investment decisions on capital markets.
Starting with the adoption of IFRS in the EU, several papers tried to investigate the
impact of IFRS adoption on the analysts forecast accuracy. For instance, Brown,
Preiato and Tarca (2009) showed on a sample of 40.123 monthly observations for
companies operating in 13 European countries during 2002-2007 that forecast errors
were significantly lower after the IFRS mandatory implementation. Ernstberger
(2008) has also showed that on the German capital market analysts forecast accuracy
improved after the IFRS adoption. Tan, Wang and Welker (2009) obtained similar
results on a sample of 38 countries, several European countries included.
Furthermore, Tan, Wang and Welker (2009) documented empirically, that the IFRS
adoption attracts foreign analysts, especially those with experience in IFRS, or whose
countries make IFRS implementation compulsory at the same time.
However, the literature has not yet reached common grounds on the role plaid by the
quantity of financial disclosure in enhancing analysts forecast accuracy, authors such
as Pope (2003) arguing that it is not clear whether financial disclosure is a
fundamental determinant or just a complement of the recognition rules operating in
different accounting regimes. At the same, a higher volume of financial disclosure due
to preparing two sets of financial statements under two types of standards (usually
local GAAP and IFRS) might have a negative impact on the information environment
of a company which may lead to a decrease in analysts forecasts accuracy.
This paper investigates the effect of firm-specific factors on analysts forecasts
accuracy for Bucharest Stock Exchange, trying to expose those that are reasonably
expected to affect the quality of the information environment, and thus enhance or
decrease forecast accuracy.
2. METHODOLOGY
The sample was comprised of 19 companies listed on the Bucharest Stock Exchange
followed by financial analysts according to Thomson Reuters I/B/E/S data base. We
used monthly predictions made in 2008 for 2009 and 2010. The sample was reduced
to 266 firm-month observations by the following: lack of actual earnings for 2010,
absolute analyst forecast error in the corresponding month of the previous year cannot
be calculated due to missing consensus forecast, eliminating financial entities.
~961~
The following regression model (firm, month and year subscripts omitted for
convenience) are used to investigate the properties of analysts forecasts:
ERROR = 0 + 1 IndGOV + 2 LOG _ SIZE + 3 IFRS + 4 FOLLOWING +
5 HORIZON + 6 PREV _ ERROR +

Where:
ERROR The absolute difference between actual EPS computed under local
GAAP and the monthly median consensus forecast scaled by stock
price at the middle of the month.
IndGOV An aggregate index for corporate governance computed by Olimid
et al. (2009) for listed Romanian companies based on three
characteristics of the board of administrators (board size, proportion
of non-executive directors, duality for the Chairman and Director
General).
LOG_SIZE Natural log of the market value of equity at the middle of the
month.
IFRS An indicator variable equal to 1 for companies with double reporting
(both IFRS and local GAAP), and 0 otherwise.
FOLLOWING The number of analyst earnings forecasts included in the
median consensus forecast.
HORIZON The number of months between the announcement of the median
consensus forecast and the earnings announcement date.
PREV_EPS The absolute value of last years forecast error scaled by price,
measured at the corresponding month in the previous year.
We expect the coefficient on IndGOV and LOG_SIZE to be negative, consistent with
a reduction in analysts forecast errors, and the coefficient on IFRS to be positive, as
double reporting may lead to confusion and a decrease in forecast accuracy.
The model used three control variables: FOLLOWING was used, as the literature
documents that more competition between analysts makes them forecast future
earnings more accurately (Hodgdon et al. 2008). We also controlled for the number of
months between the announcement of the consensus forecast and the announcement
of actual earnings (HORIZON) to control for the fact that earnings forecasts tend to
become more accurate near the announcement of actual earnings date (Clement 1999;
Brown et al. 1999). And we also controlled for the previous errors effect
(PREV_ERROR), as the current periods forecast error is expected to be positively
correlated with the previous periods forecast error (Brown et al. 1999).
3. RESEARCH RESULTS
The values obtained after the operationalization of the variables are presented in Table
1 below.
Table 1. Descriptive statistics
ERROR
IndGOV
SIZE
Observations
266
266
266
Minimum
,0088
,2222
15,6529
Maximum
15,0796
1,0000
24,0965
~962~
Mean
,502168
,661785
19,364842
Std. Deviation
1,5841630
,2695070
1,8554278
IFRS
FOLLOWING
HORIZON
PrevERROR
Observations
266
266
266
266
Minimum
0
1
13
-,9625
Maximum
1
7
41
19,7236
Mean
,47
1,73
24,91
1,736109
Std. Deviation
,500
1,341
6,760
4,8418358
We used stepwise regression analysis to avoid eventual collinearity problems and to

find the best fitted model to explain forecasts errors.
Regression results are summarized in Table 2 below.
Table 2. Regression results
Model 1
Variables
(Constant)
LOG_SIZE (-)
Model 2
Coefficients
6,989
t
7,433
Sig.
,000
-,335
-6,930
,000
IFRS (+)
Model 3
Coefficients
10,518
-,556
t
11,425
-11,244
Sig.
,000
,000
Coefficients
9,818
t
10,776
Sig.
,000
-,528
-10,872
,000
1,613
8,785
,000
1,695
9,440
,000
4,061
,000
PREV_ERROR (+)
Observations
Adjusted R square
F statistic
,067
266
266
266
,151
,341
,378
48,024 (sig. ,000)
69,534 (sig. ,000)
54,583 (sig. ,000)
As expected, company size is negatively correlated with forecasts errors, as larger

firms are more likely to disclose more information and thus reduce forecasts errors.
Contrariwise, companies preparing financial statements in compliance with both local
GAAP and IFRS tend to have lower forecast accuracy. We were only able to control
for previous errors effect, which are positively correlated with current period forecasts
errors. Overall, the model accounts for 37,8% of the analysts forecast errors
variations.
The other control variables, FOLLOWING and HORRIZON, were not significantly
associated with forecast errors. However, IndGOV was found to be negatively
associated with forecasts errors, when analyzed as a single independent variable (see
Table 3 below):
Table 3. Regression results
Model 4
Variables
(Constant)
IndGOV (-)
Observations
R square
F statistic
Coefficients
1,900
-2,112
t
Sig.
7,877
,000
-6,255
,000
266
,129
39,123 (sig. ,000)
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CONCLUSIONS, LIMITATIONS AND FURTHER RESEARCH

The paper investigated several firm-specific factors expected to affect analyst forecast
accuracy for listed Romanian companies. The results confirmed the international
trends, as larger Romanian listed companies and those that are better governed tend to
have more accurate forecasts. However, companies preparing two sets of financial
statements incur bigger forecast errors, as double reporting seems to have a negative
impact on the information environment of a company.
The main limitation of the paper comes from the small number of listed companies
followed by financial analysts and the limited period covered. Furthermore, there was
no data available on forecasted earnings per share reported under IFRS to compare
their properties with those for earnings per share reported under local GAAP.
Consequently, research is needed in order to further clarify the effect of the
information environment on analysts forecast accuracy for Romanian listed
companies with an emphasis on the role plaid by financial reporting.
ACKNOWLEDGEMENT
The authors gratefully acknowledge the financial and logistic support offered by the
Project Performance and Excellence in Postdoctoral Research in the Field of
Economic Sciences in Romania, grant POSDRU/89/1.5/S/59184.
REFERENCES
Bhat, G., Hope, O.-K. and Kang, T. (2006), Does corporate governance transparency affect
the accuracy of analyst forecasts?. Accounting & Finance, 46: 715732
Brown, P. R., Preiato, J. P., Tarca, A. (2009). Mandatory IFRS and Properties of Analysts
Forecasts: How Much Does Enforcement Matter? UNSW Australian School of
Business Research Paper No. 2009 ACCT 01
Byard, D., Li, Y. & Weintrop, J. (2006). Corporate Governance and the Quality of Financial
Analysts Information. Journal of Accounting and Public Policy, 25, 609-625.
Clement, Michael B. (1999): Analyst Forecast Accuracy: Do Ability, Resources and
Portfolio Complexity Matter?, Journal of Accounting & Economics, 27 (3): 285303.
Easterwood, John C. and Stacey R. Nutt (1999): Inefficiency in Analysts Earnings
Forecasts: Systematic Misreaction or Systematic Optimism?, Journal of Finance, 54
(5): 17771797.
Ernstberger, J, Kroter, S., Stadler, C. (2008) Analysts Forecast Accuracy in Germany: The
Effect of Different Accounting Principles and Changes of Accounting Principles,
Business Research, 1(1):26-53
Hope, Ole K. (2004): Variations in the Financial Reporting Environment and Earnings
Forecasting, Journal of International Financial Management and Accounting, 15
(1):2143
Hope, O-K. (2002). Disclosure Practices, Enforcement of Accounting Standards and
Analysts' Forecast Accuracy: An International Study, Available at SSRN:
http://ssrn.com/abstract=353160 or doi:10.2139/ssrn.353160
Karamanou I., Vafeas N. (2005) The Association between Corporate Boards, Audit
Committees, and Management Earnings Forecasts: An Empirical Analysis, Journal of
Accounting Research, 43(3): 453-486
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Olimid. L., Ionacu M., Popescu L., Popescu V. D. (2009), Corporate Governance in
Romania. A Fragile Start, Proceedings of ECMLG 2009, the 5th European Conference
on Management, Leadership and Governance, held at the ATExcelixi Training and
Conference Centre, Athens, Greece, 5-6 November 2009, 151-156.
Pope P. (2003). Discussion of Disclosure Practices, Enforcement of Accounting Standards,
and Analysts' Forecast Accuracy: An International Study, Journal of Accounting
Research, 41(2), 273-283.
Peek, Erik (2005): The Influence of Accounting Changes on Financial Analysts Forecast
Accuracy and Forecasting Superiority: Evidence from the Netherlands, European
Accounting Review, 14 (2): 261295.
Tan, H., S. Wang, S., Welker, M. (2009). Foreign Analysts Following and Forecast
Accuracy around Mandatory IFRS Adoptions, in progress, http://www.bus.wisc.edu/
accounting/faculty/ documents/PaperMikeWelker4-17-09.pdf
Vanstraelen, Ann, Marilyn T. Zarzeski, and Sean W.G. Robb (2003): Corporate
Nonfinancial Disclosure Practices and Financial Analyst Forecast Ability across Three
European Countries, Journal of International Financial Management and Accounting,
14 (3): 249278.
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NET INCOME VERSUS COMPREHENSIVE INCOME

FOR PROFESSIONAL INVESTORS
Iulia JIANU1& Ionel JIANU
Ionela GUSATU
University of Medicine and Pharmacy "Carol Davila", Romania
ABSTRACT
This paper tries to grasp the importance given by professional investors to comprehensive
income in relation to net income. The question around which this study circumscribes is the
following: Which of the indicators: the net income or comprehensive income is more relevant
to professional investors in making investment decisions? To answer to this question, based
on data collected from financial statements of 62 companies listed on the London Stock
Exchange, we calculated on the one hand, Pearson correlation coefficient, between the basic
earning per share and price per share, and on the other hand, between the comprehensive
income per share and price per share. The results reflected similar values of the Pearson
coefficient in both cases, suggesting that in making investment decisions, professional
investors give almost equal importance to both net income and comprehensive income. The
results were supported also by simple regression functions constructed which showed very
similar changes in size of the price per share due to the influence of the net income or of the
comprehensive income.
KEYWORDS: comprehensive income, net income, price per share, professional investors
INTRODUCTION
The net income is considered the main indicator for measuring the financial
performance of an economic entity. By the method of its calculation, the net income is
oriented towards the past, serving as a measure of the progress of an economic entity
during a past period of time. According to Olimid (1998), the net income may have
other uses: a guide of dividend policy and of entity acquiring; a means of predicting
future results to make investment or disinvestment decisions; a means of evaluating
the capacity of management to lead the economic entity; a means of estimating the
value of other groups decisions related to the entity; a management tool in a number
of areas within and outside the company (pricing policy, wage negotiations, credibility
in front of credit agencies, price regulation in monopoly conditions.
The net income is the difference between revenue realized in transactions and related
historical cost occurred in a designated period of time, based on the accrual basis,
realization principle and matching principle. The calculation of the net income, taking
into account the mentioned principles, involves two stages:
recognizing revenue when it is realized;
1
Correspondence address: Iulia JIANU, Faculty of Accounting and Management Information

Systems, Bucharest Academy of Economis Studies, Romania, email : jianu.iulia@cig.ase.ro
~966~
recognizing expenses in three possible ways:

o associating cause with the effect, as it is the case of different components
that make up the cost of sold goods which are recorded as expenses along
with recording revenue from the sale of those goods;
o a systematic and rational allocation when it is required to obtain economic
benefits over several financial years and the correlation with income can
be made generally or indirectly, as the case of property depreciation;
o an immediate recognition when they do not produce future economic
benefits or when such benefits do not have the necessary characteristics to
be recorded as assets on the balance sheet. It is the case of administrative
or sales expenses, as well as research expenses.
Lately, due to the evaluation of a growing number of items at fair value, the principle
of revenue recognition when it is realization is more often violated by the recognition
of unrealized gains (for investment property, biological assets, financial instruments
measured at fair value through profit and loss account, derivatives). Thus, the net
income in the profit and loss account tends to reflect not only the current income and
expenditure but also those expected to occur in the future.
An economic entity gains profit by carrying out two types of activities: those that
combine or transform inputs into goods whose sales value is greater than the value of
factors and activities that lead to achieving growth in earnings due to factors of
production that are in entitys possession. Since 1961, Edwards & Bell have claimed
that the decisions involved by the two activities are so different that their separation is
inevitable for assessing the fairness of management decisions and that there must be a
clear distinction between the change in value resulting from the production and the
change in value resulting from over time. Currently, this distinction is less obvious.
More and more elements are measured at fair value, and the gains obtained from asset
appreciation, as the case of real estate investments and biological assets, are presented
in the income from ordinary activities, thus violating the principle of achieving
revenues. Instead, the fair value measurement for other types of assets (revalued
tangible and intangible assets, assets held for sale) requires recognition of gains by
directly affecting the equity.
Chambers (1994) stated that only the comprehensive income can be used to assess the
performance of the company and of its managers. In his view, the acquisition of any
asset is considered a good investment as long as the present value of future cash flows
generated by its use exceeds the present value of future earnings generated by
alternative use of the amount that would currently be obtained from the sale of the
asset. No matter how fixed would be the intention to use an asset over a long period of
time, it is wise that when a superior profitability opportunity is found, the asset should
be sold and we should invest in another one. Thus, goods are not purchased solely for
the gross profit, but also to benefit from the expected price changes, the general or
relative ones.
In France, in 1998, Bernheim predicted a two-pronged approach of the outcome:
addressing the economic entity's performance based on transactions that it achieved
during the period, translated by the difference between its revenues and expenses and
addressing its patrimonial enrichment measured by the difference between its net
assets at the beginning and at the end of the period. This dual approach aims to answer
~967~
two types of different needs of users, to measure the performance of activities, current
operating concept, and to measure enrichment, in a patrimonial conception of the
economic entity, all inclusive concept. According to current operating concept, in
profit and loss account are included only the consequences of operational, normal
activities of the period, and there are reported on equity, the activities that do not
affect the operational activities. These activities are considered as normal, recurring
and allowing to provide the economic entity's future performance. Proponents of
performance assessment based on the result of current operating concept, tend to
measure the managerss performance, retaining in a restrictive manner, only the
elements controlled by them. According to all inclusive concept, all elements that
affect the increase or decrease in equity during the period, except for the distributions
of dividends or capital decrease through distribution to shareholders or partners, from
their respective contributions, enter in the field of financial performance
measurement. The indicator which allows the calculation of the financial performance
in terms of all inclusive concept is the comprehensive income.
The comprehensive income takes into account both realized gains and losses and
unrealized gains and losses that are directly recognized in equity as being the
consequence not only of factors that can be controlled by the entity through its
management team but also of market factors such as the evolution of market prices, of
the interest rate, of the exchange rate or of the stock market of shares. The category of
gains and losses recorded directly in the equity under IFRS includes: gains and losses
from the revaluation of tangible and intangible fixed assets, gains and losses from the
evaluation of financial instruments that are available for sale, gains and losses from
the risk hedging associated with cash flows and investment in a foreign entity,
exchange differences from the conversion of foreign operations, gains and losses
relating to defined benefit plans, deferred tax relating to items recorded directly in
equity.
The financial statements of an economic entity are important for a wide range of
users: investors, financial lenders, suppliers, customers, employees, the state, and the
general public. We must admit the truth:that the vast majority of information is used
by investors to predict financial statement and the future performance of the
economic entity. This is the reason why investors are first appointed by the IASB as
users of accounting information. In other accounting referentials, such as U.S. GAAP,
investors are the only users, the others being considered auxiliary users who use the
information provided to investors to meet their own needs. Investors who "play" on
the stock exchange by speculating the price variation are considered professional
investors.
Longevitaty of the net income, as main indicator for measuring the financial
performance of an economic entity on the one hand, and the "novelty" of the concept
of comprehensive income that tends to take the place of the net income in measuring
the financial performance of an economic entity, on the other hand, were the
prerequisites for testing the relevance of the two indicators in making decisions on the
sale or on the purchase of shares by professional investors. Consequently, the question
around which this study circumscribe is the following: Which of the indicators: the
net income or the comprehensive income is more relevant to professional investors in
making investment decisions?
~968~
This study is structured in the following way: the first part carries aut a brief history
on the comprehensive income since the emergence of the concept up to present, the
second part summarizes the literature review focused on the statement of
comprehensive income, the third part explains the research methodology, and the
fourth part focuses on presenting the results obtained from the data collected and the
discussions that are appropriate. The paper concludes with the authors' conclusions
regarding the importance given by professional investors to net income versus
1.
BRIEF HISTORY CONCERNING THE STATEMENT

OF COMPREHENSIVE INCOME
The term comprehensive income appeared for the first time in 1980 in the American
legal texts (SFAC 3). Five years were necessary so that the term comprehensive
income should be defined for the first time in 1985 in Concepts Statement 6 Elements
of Financial Statements as:
"the change in equity of a business enterprise during a period from transactions
and other events and circumstances from nonowners sources. It includes all
changes in equity during a period except those resulting from investments by
owners and distributiond from owners.
If the definition of this concept required five years, its implementation required 12
years, SFAS 130 Reporting Comprehensive Income applied to financial years
beginning after December 15, 1997.
In the U.S., SFAS 130, requires companies to disclose the comprehensive income in a
primary financial statement, but allows the disclosure of the comprehensive income
either in a performance or nonperformance statement. The comprehensive income
includes the effects of all performed operations and of all acts that occurred during the
year, relating themselves to the current operation or not and having contributed to the
increase or decrease in equity (excluding the shareholders contributions or their
associates contributions and the distributions to them). Any gains or losses recorded
in the year, realized or not, exceptional or extraordinary, contribute to the economic
entity's performance and should be included in the statement of comprehensive
income. By adopting the comprehensive income, the FASB abandons the concept of
profit and loss account and directs its attention to the balance sheet. This does not
mean that the American standards give a greater importance to the balance sheet (it
belongs to users and not to regulators) but that translates a conceptual shift with such
important consequences that FASB felt obliged to foresee compromises and steps to
ensure the transition.
The U.S. format of comprehensive income statement was the consequence of heated
debates between two different points of view: on the one hand, the FASB that
supported the disclosure of the comprehensive income statement as reflecting the
performance of the entity and on the other hand, board members who indicated that
the presentation of comprehensive income in a performance statement would enhance
its visibility, thereby increasing investors' use of this information, which is why they
supported the disclosure of comprehensive income statement as a change in equity. As
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a result of diverging views between the two representatives, FASB and board
members, the solution found was to choose the option between the two preferences:
the presentation of comprehensive income as a statement of performance, in
two possible options: either as a financial statement that is different from
profit and loss account that includes two items: the net income shown in the
income statement and other comprehensive income. The category of other
gains and losses includes changes in fair values of financial instruments
available for sale, the gain or loss from derivatives, adjustments to the pension
plans, the differences arising from translating the financial statements of
foreign entities, or drawing a single statement of financial performance that
includes both the evidence presented in the profit and loss and other gains and
losses component.
presentation of comprehensive income as part of the statement of changes in
equity.
ASB in the UK was the first regulator that in 1992 adopted the concept of
comprehensive income by FRS Rule 3 Statement of Total Recognised gains and
losses. The publication of the Statement of total recognised gains and losses is
justified by the ASB in that British accounting rules or statutory provisions allow the
direct observation in equity of gains and losses as well as the revaluation of property,
differences in conversion, latent gains or losses on financial instruments, gains and
losses arising from pension funds. Statement of total recognised gains and losses is
specific to British accounting being seen as a situation that facilitates forecasting,
ASB arguing this:
The disclosure of these components is designed to facilitate understanding of
the performance achieved in a period and to assist users in deciding on the
extent to which past results are useful in helping to assess potential future
results. (ASB, 1992, FRS 3)
FRS 3 also states the preparation of a statement reconciliation of the net income
obtained under conditions in which the economic entity has revalued the tangible
outcome with the net income that would have been obtained in historical costs. The
role of this statement is to allow comparability between the financial statements of
entities which have opted for the revaluation of tangible and financial statements of
entities which have remained at historical cost. This must be presented in the notes to
financial statements and it has no equivalent in international practice. Information
should be presented only if the differences between the two results are
significant. Differences may be due to:
if assets are revalued, depreciation is based on the revalued amount, if assets
had not been revalued, the depreciation would have been based on historical
cost;
if assets are sold, profit is the difference between the selling price and the
revalued carrying amount, while for the assets valued at cost, the profit is
higher because it represents the difference between the sale price (the same)
and the historical book value (lower).
Introducing this reconciliation statement between the historical costs and the net
income in fair values provides very relevant information, especially for users of
accounting information who are skeptical on the fair value determined after
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reassessment, it is easily to make it, thus respecting the qualitative cost-benefit

constraint. We recommend this statement to be part of a set of financial statements
and not to be just a certain note in the annexes.
IASC revised the IAS 1 standard in 1997, to introduce a second statement of the
results regarding the changes in equity which may reflect either all changes in equity
or changes in equity other than transactions with owners. We believe that the
objective of the two statements is so different that the IASB would not have asked the
economic entities to make a choice. The statement of comprehensive income, called
by the IASB The statement of gains and losses, was a statement that reflects the
overall performance of the economic entity, while the situation of changes in equity,
as the title suggests, was a statement that presented changes in equity and was quite
complex to present relevant information.
In 1998, ASB in Australia published an expos-survey (ED 93), which proposed a
unique statement to reflect performance, with an overview presentation in a separate
statement of changes in equity which are not attributed to owners. The need for a
unique statement to reflect the performance has become increasingly evident
worldwide. In this regard, in 1998, the representatives of the Council of Accounting
Rules in Canada belonging to ICCA attended, with the representatives from the U.S.
standardization bodies, New Zealand, Australia and Britain, as well as with the
representatives of the IASB (this group of regulators is known as the G4 +1) the
publishing of a special report on a new presentation of the performance
statement. The G4 +1 proposals have focused mostly on presenting the performance
components and not on establishing and measuring the performance. In other words, it
was about the way in which specific performance items were grouped and presented
in such a way as to serve the objectives of financial statements. The unique statement
of the performance proposed by the G4+1 distinguished the elements specific to
operating activities from other elements specific to other gains and losses, according
to four basic criteria: operating activities/activities outside operation, recurring/nonrecurring items, items that are not owned/held items, internal/external events.
Currently, the IASB calls that both net income and unrealized holdings gains or losses
(other comprehensive income) will be included in a single comprehensive income
statement. In this sense, art. 81 of IAS 1 Presentation of Financial Statement allows
economic entities to choose between two ways to present all items of income and
expense recognised in a period:
(a) a single statement of comprehensive income, or
(b) two statements: a statement displaying components of profit or loss
(separate income statement) and a second statement beginning with profit or
loss and displaying components of other comprehensive income (statement of
comprehensive income).
IAS 1 defines the notion of other comprehensive income as:
income comprises items of income and expense (including reclassification
adjustments) that are not recognised in profit or loss as required or permitted
by other IFRSs.
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The components of other comprehensive income include: changes in revaluation

surplus; actuarial gains and losses on defined benefit plans; gains and losses arising
from translating the financial statements of a foreign operation; gains and losses on
remeasuring available-for-sale financial assets; the effective portion of gains and
losses on hedging instruments in a cash flow hedge.
Smith & Reither (1996) consider that the comprehensive income is higher than the net
income because, by its components (other comprehensive income) there can be made
easier comparisons between entities in the same sector and moreover, these elements
must be known for evaluating overall performance because they result from a
companys economic decisions and activities.
Based on prior research in accounting and psychology, Laureen & McDaniel (2000)
developped a psychology-based framework that evaluates how presentation format of
comprehensive income affects nonprofessional investors' information acquisition,
evaluation, and weighting processes. In order to test these predictions, ninety-five
M.B.A. students participated in an experiment by analysing the insurance company's
financial statement. The results of the study showed that the financial-statement
format for presenting comprehensive income did not significantly affect
nonprofessional investors' acquisition and evaluation of that information, but
generally did significantly influence their information weighting and resulting
performance judgments. Moreover, the authors showed that the nonprofessional
investors' judgments of corporate and management performance reflect the volatility
of comprehensive income only when it is presented in a statement of comprehensive
income.
Gordon & Niles (2005) on a case study for students, inspired by the practical reality
of two technology firms: Lucent Technologies and Microsoft, in order to reflect the
effect of timing on accounting reporting decisions and the role of auditors in
deternining fair financial reporting, demonstrates that the comprehensive income
statements, unlike net income, are relatively stable and difficult to manipulate.
In a survey of 202 U.S. commercial banks in 1996-2004, Hodder et al (2006) have
pointed out that result volatility in an accounting that would allow evaluation of all
financial instruments at fair value, is 90 % higher than the volatility of net income and
77% higher than the volatility of comprehensive income which would result in a
higher stability of comprehensive income in relation to net income. Hunton et al
(2006) in an experiment involving 59 financial executives and 3 chief executive
officers shows that a greater transparency of comprehensive income statement reduces
the likelihood for the managers to recommend selling available-fot-sale securities that
increase/decrease current income when projected earnings are below/above consensus
forecast. Liu & Liu (2006) consider that the comprehensive income reporting will
provide more useful and related information, and satisfy the users with comprehensive
financial information in future, recommending that other comprehensive income
should be reported separately from other equity items.
Following the analysis of 46 annual reports of the 2008 financial year published by
European industrial companies which apply IFRS, Dumitrana et al (2010) noticed that
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only 9 companies have written out the statement of comprehensive income (the
standard IAS 1 provided for the year 2008 the option to choose between the
preparation of the statement of losses and gains and the statement of changes in
equity). For the analysed entities other comprehensive income recognised directly in
the equity represent on an average, 27,8% of the total comprehensive income. Within
other comprehensive income, the most considerable items are owned by gains and
losses arising from translating the financial statements of a foreign operation.
Although most investors prefer reporting comprehensive income as a separate
statement of performance due to the more transparent provided information, in a study
of 440 companies, Bamber et al (2010) showed that 81 percent of the sample S&P
500 firms do not follow policymakers preference, and instead report comprehensive
income in the statement of equity. Only 19 percent the sample (85 firms) reports
comprehensive income in a performance statement. The absolute value of other
comprehensive income is 12.7 percent of the absolute value of net income. The most
important component of the other comprehensive income is unrealized gains and
losses on foreign currency translation reported by 81 percent of the sample firms (this
component represents 55,4 percent of other comprehensive income). The next
component of other comprehensive income are: unrealized gains and losses on AFS
securities reported by 60 percent of the sample firms (this component represents 30,9
percent of other comprehensive income); a pension component reported by 39 percent
of the sample firms (this component represents 11,3 percent of other comprehensive
income); and a derivatives component reported by 4 percent of the sample firms (this
component represents 2,2 percent of other comprehensive income). However, based
on this survey, the authors have shown the comprehensive income is 32 percent more
volatile than net income. It is also important to highlight the assumptions that have
been validated by the authors following the survey they conducted: managers with
more powerful equity-based incentives are more likely to avoid performance
reporting, and CEOs whose jobs are less secure are more likely to avoid performance
reporting.
Barton et al. (2010) estimated and compared the value relevance of a comprehensive
set of performance measures commonly disclosed in the financial statements of
almost 20,000 firms from 46 countries during 19962005. The performance measures
analysed were operating cash flows, sales, EBITDA, operating income, income before
taxes, income before extraordinary items and discontinued operations, net income,
and total comprehensive income. The autors find that the value relevance of the
performance measures varies substantially across line items on the income statement
as well as across countries. The results of the survey have shown that, subtotals near
the center of the income statement, such as operating income, have the strongest
association with contemporaneous stock returns than subtotals at the top or bottom of
the income statement, such as sales and total comprehensive income, which have the
weakest association with stock returns. Also, the survey has shown the weak value
relevance of net income and comprehensive income mostly in common-law countries.
Taking into account the results of the survey, we could see the superiority of the net
income towards the comprehensive income from the value relevance point of view,
both in common-law countries and in code-law countries.
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3.
RESEARCH METHODOLOGY
For data collection we have chosen as a sample of 100 economic entities listed on
London Stock Exchange (FTSE 100) those which had submitted the annual report on
www.orderannualreports.com site, thus obtaining a total of 71 annual reports. Out of
the 71 economic entities, we have removed 9 because: an entity did not present the
financial statements in the annual report, 4 entities presented financial statements
prior to 2009 in their annual report, an entity applied the U.S. GAAP referential in its
financial reporting, an entity did not apply the amendments to IAS 1 for the financial
year 2009 regarding the statement of comprehensive income, and for two entities the
data on the price per share was not available. Therefore 62 entities were surveyed.
Regarding the analyzed entities, the balance-sheet date was the end of 2009 for 42
entities and 06/30/2009 for two entities. The remaining 18 entities had the closing
date of the balance sheet in 2010 as follows: in January, 4 entities; in February 1
entity; in March 12 entities; in April 1 entity. Therefore, in order to show to what
extent net income and comprehensive income influence the price per share, we took
for analysis the price per share of closing balance. Since 15 economic entities had
financial statements which was different from GBP (14 entities in USD and one entity
in EUR ), in order to achieve the price correlations of these entities, we converted the
GBP in USD then in EUR taking into account the rates in effect of the stock market.
To convert, we used the converter on the XE website (http://www.xe.com/
currencycharts/?from=GBP&to=USD). The entities participating in the study, the
reporting currency of the financial statements, the date for balance sheet and the price
per share for the analysed entities are presented in Annex 1.
In order to determine which of the indicators between net income and comprehensive
income influences more the price per share, we calculated the correlation degree
between basic earning per share and price per share, on the one hand, and
comprehensive income per share and price per share, on the other hand. In order to
calculate the correlation degree, the Pearson correlation coefficient was used. This
coefficient serves three function (Smith, 2005, p. 69):
it establishes the direction of any relationship which should be intuitively
correct and which must correspond whith the sign if this variable in any
regression equation;
it suggests those varables which are likely to be useful explanatory variables
because they are highly correlated with the dependent variable;
it highlights potential multicollinearity problems by quantifying the strenght
of association between competing explanatory variables
Pearson correlation coefficient may take values between -1 (for a perfect inverse
relationship) and +1 (for a perfect positive correlation). In the present study, the
calculation of the coeficient was automatically done by Pearson function in EXCEL.
To this purpose, two data were used:
for calculation correlation degree between net income and price per share, the
independent variable is the basic earning per share and the dependent variable
is the price per share (Annex 2).
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for calculation correlation degree between comprehensive income and price

per share, the independent variable is the comprehensive income per share
and the dependent variable is the price per share (Annex 3).
The price per shares for the entities under study was taken from the site of the London
Stock Exchange (www.londonstockexchange.com). Basic earning per share for the
2009 financial year was taken from income statement. Total comprehensive income
per share was calculated by relating total comprehensive income to the number of
shares. The values for total comprehensive income, net income, total other
comprehensive income and for each element of other comprehensive income (changes
in revaluation surplus, actuarial gains and losses on defined benefit plans, gains and
losses arising from translating the financial statements of a foreign operation, gains
and losses on remeasuring available-for-sale financial assets, the effective portion of
gains and losses on hedging instruments in a cash flow hedge, tax relating to
components of other comprehensive income) were taken from the statement of
In order to show how much the change of the basic earning per share or the
comprehensive income per share influences the stock market we used the simple
regression model. The simple regression analysis which assesses the possibility of a
link between two variables, we make by Regression fonction in EXCEL.
In order to show to what extent the change of the basic earning per share influences
the price per share we named the function:
YNI= a + bXNI
where:
YNI price per share (dependent variable)
XNI basic earning per share (independent variable)
a, b parameters for the simple regresion between market stock and basic
earning per share
In order to show to what extent the change of the comprehensive income per share
influences the price per share we named the function:
YCI = + XCI
where:
YCI price per share (dependent variable)
XCI comprehensive income per share (independent variable)
, parameters for the simple regresion between market stock and
comprehensive income per share
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4. RESULTS AND DISCUSSIONS

4.1.
Correlation analyse between basic earning per share or comprehensive

income per share, on the one hand, and the price per share, on the other
hand
The way in which each of the performance indicators, net income and comprehensive
income, affect the decisions of professional investors, to keep or sell the shares they
hold or to acquire new ones, is reflected through price per shares. To show which of
the two indicators gives better information to professional investors, by a comparative
way, we calculated the degree of correlation between, on the one hand, the basic
earning per share and price per share, and on the other hand, comprehensive income
per share and price per share. For the analysis of the correlation, Pearson index was
calculated through EXCEL.
The degree of correlation between the basic earning per share and price per share
(Person's correlation coefficient) based on data presented in Annex 2 is 0.56. The
degree of correlation between comprehensive income per share and price per share
(Person's correlation coefficient) based on data from Annex 3 is 0.47. The results
obtained show that the degree of correlation is stronger between net income and price
per share than between the comprehensive income and the price per share. One reason
for this result may be that the comprehensive income is a new concept which is not
given due importance by the bodies that should promote it among the main indicators
in assessing the economic entity's financial performance. We refer here to the
supervisory body of the London Stock Exchange, which among the basic indicators
under the heading "summary" in the presentation of companies, does not have the
comprehensive income. In addition, under the heading "fundamentals" is presented
only the balance sheet and profit and loss account, the comprehensive income is not
presented.
The financial year 2009 was the first year in which entities that apply IFRS can
choose to present the economic entity's financial performance in a single statement of
comprehensive income (here, it will be presented the income and expenses which are
now reflected in the profit and loss account, as well as gains and losses recognized
directly in equity), or in two situations: first, the profit and loss account, and then, the
statement of comprehensive income (here, it will be presented only the total of the
accounting income that is calculated in profit and loss account , as well as gains and
losses recognized directly in equity). As seen in Figure 1, regarding the economic
entities under study, we found that only 5 entities present a single statement of
performance, while the remaining 57 entities prepare two statements of reporting
performance: profit and loss account and the statement of comprehensive income.
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Figure 1.The distribution of financial statements reporting the number

of performance
Thus the traditional in reporting financial performance seems to take priority over the
new changes that tend to present an unique performance reporting. However, the
values that are high and near the Pearson coefficient for both the analysis of net
income correlation with the price per share (0.56), and for the analysis of the
comprehensive income correlation with the price per share (0.47) suggests that
professional investors take into account in making investment decisions both the net
income and the comprehensive income. To validate this hypothesis we considered
important to show to what extent the modification of basic earning per share and
comprehensive income per share influence the price per share. For this, we used the
simple regression model, having already shown that the basic earning per share or
comprehensive income per share, and the price per share, are linked.
4.2 The simple regression model to calculate the price per share in relation
to earning per share
Based on data from Annex 2 and on the results obtained by applying the Regression
function presented in Table 1, we defined the following simple regression function to
express the price per share in relation to basic earning per share:
YNI = 512,22 + 8,91 XNI
(Formula 1)
The b coefficient in Formula 1 shows that in the case of a change with a pound/cent of
basic earning per share, the price per share changes by 8.91 pounds/centimes.
Table 1. Summary output for simple regression between price per share
and comprehensive income per share
Regression Statistics
Multiple R
0,56005749
R Square
Adjusted R
Square
Standard
Error
0,313664392
0,302225466
1180,733454
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Observations
62
ANOVA
df
SS
MS
Significance F
38228184,72
38228184,72
27,42079
0,00000221166
Residual
60
83647889,32
1394131,489
Total
61
121876074
Regression
Coefficients
Intercept
X Variable 1
Standard
Error
t Stat
P-value
Lower
95%
Upper
95%
Lower
95,0%
Upper
95,0%
512,2206
190,3024
2,6916
0,0092
131,5590
892,8821
131,5590
892,8821
8,9158
1,7026
5,2365
0,0000
5,5100
12,3216
5,5100
12,3216
Since Multiple R has a positive value which is greater than 0.5, shows that between
basic earning per share and price per share there is a direct correlation of medium
intensity. R Square shows that 31.36% of the variation of the price per share is
explained by the basic earning per share. Since Significance F has a very small, far
below the threshold limit of 0.05, and F has a high value (27.42), we can accept the
simple regression model presented in Formula 1, and validated by Figure 2.
Figure 2. X Variable 1 Line Fit Plot
4.3 The simple regression model to calculate the price per share in relation
to comprehensive income per share
Based on data from Annex 3 and on the results obtained by applying th Regression
function in Table 2, we defined the following simple regression function to express
the price per share in relation to basic earning per share:
YCI = 729,47 + 5,37 XCI
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(Formula 2)
The 2 coefficient in the formula 2 shows that in the case of a change with a
pound/centime of comprehensive income per share, the price per share changes by
5.37 pounds/centimes.
Table 2. Summary output for simple regression between price per share and basic
earning per share
Regression Statistics
Multiple R
0,472184425
R Square
Adjusted R
Square
Standard
Error
0,222958131
0,210007433
1256,336024
Observations
62
ANOVA
df
SS
MS
27173261,72
27173262
17,215916
Residual
60
94702812,33
1578380
Total
61
121876074
Regression
Coefficients
Intercept
X Variable 1
Standard
Error
Significance F
0,00010679
t Stat
P-value
Lower
95%
Upper
95%
Lower
95,0%
Upper
95,0%
729,4754
185,9590
3,922776
0,0002278
357,5021
1101,4488
357,5021
1101,4488
5,3719
1,2946
4,149207
0,0001068
2,7821
7,9616
2,7821
7,9616
Since Multiple R has a positive value close to 0.5, this shows that between
comprehensive income and price per share there is a direct correlation of medium
intensity. R Square shows us that only 22.29% of the variation of the price per share is
explained by the comprehensive income. Since Significance F has a low value,below
the threshold limit of 0.05, and F is a high value (17.21), we can accept the simple
regression model presented in Formula 2 and validated by Figure 3.
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Figure 3. X Variable 1 Line Fit Plot
4.4. Discussion concerning the power of net income and comprehensive income
for profesional investors
From the comparative analysis of the two simple regression models, it is noted that
the price per share is influenced to a greater extent by the net income than by the
comprehensive income. Thus, in the case of a change with a pound/centime of basic
earning per share, the price per share changes by 8.91 pounds/centimes, while in the
case of a change with a pound/centime of comprehensive income per share, the price
per share changes by 5,37 pounds/centimes. However, we consider that the difference
between the b coefficient in Formula 1 (8.91) and the coefficient in Formula 2
(5.37) is insignificant since the amounts are expressed in pounds/centimes. This close
relationship that is, on the one hand, between basic earning per share and price per
share, and on the other hand, between comprehensive income per share and price per
share, was confirmed by the analysis using Pearson coefficient which showed the
correlation values of 0.56 for net income and 0.47 for comprehensive income.
Therefore, we consider validated the assumption that in making investment decisions,
professional investors take into account both the net income and the comprehensive
income. To support this idea, we present the interpretation of the results obtained by
collecting data from the 2009's financial statements for entities under study.
As seen in Table 3, most economic entities obtain a positive result, for both net
income and comprehensive income. Four out of the eight entities for which
comprehensive income registered a negative value, was generated by other
comprehensive income (net income for these entities being positive) while for the
remaining four entities, the negative value of comprehensive income was generated
both by the negative net income and by the negative value of other comprehensive
income. The remaining two entities had a negative result, in the end they had a
positive comprehensive income as other comprehensive income were higher than net
income. We can note that for 60% of entities surveyed, total comprehensive income
has a negative value.
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Table 3. Differences between net income and comprehensive income
Entities
nomber
62
Total comprehensive
income
positive
value
54
Total other comprehensive

income
Net income
negative
value
positive
value
8
56
negative
value
positive value
6
25
negative value
37
Therefore, only for six of the entities reviewed, other comprehensive income was at
the basis of changing the sign of the obtained result (positive net income and negative
comprehensive income, or, negative net income and positive comprehensive income), which
represents less than 10% of the total number of entities reviewed. An argument to
support the importance of comprehensive income in making investment decisions is
the significant amount of total other comprehensive income related to the value of the
net income.
Figure 4. Proportion of value of total other comprehensive income in value of net
income
As seen in Figure 4, less than 10% of the total number of entities present values that
are insignificant for total other comprehensive income (<5% from net income), for the
remaining 90% of the entities reviewed, the value for other comprehensive income is
significant, ranging from values > 5% of net income to levels > 100% of the net
income.
According to IAS 1, the components of other comprehensive income include:
(a) changes in revaluation surplus (IAS 16 Property, Plant and Equipment and
IAS 38 Intangible Assets);
(b) actuarial gains and losses on defined benefit plans recognised in accordance
with paragraph 93A of IAS 19 Employee Benefits;
(c) gains and losses arising from translating the financial statements of a foreign
operation (IAS 21 The Effects of Changes in Foreign Exchange Rates);
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(d) gains and losses on remeasuring available-for-sale financial assets (see IAS
39 Financial Instruments: Recognition and Measurement);
(e) the effective portion of gains and losses on hedging instruments in a cash
flow hedge (see IAS 39).
As seen in Figure 5, gains and losses arising from translating the financial statements
of a foreign operation is the element that is found in 85% of the reviewed entities,
followed by, the effective portion of gains and losses on hedging instruments in a cash
flow hedge (77%), gains and losses arising from translating the financial statements of
a foreign operation (73%), actuarial gains and losses on defined benefit plans (71%).
The element with the lowest weight represents changes in revaluation surplus which is
only represented at the level 3 of the economic entity, which suggests the trend of
economic entities to be evaluated at historical cost, avoiding the fair value
measurement when it is not required by regulations (IAS 16 provides only the option
of revaluation of tangible and intangible assets at fair value).
Figure 3. The number of companies that present other comprehensive income
Along with the 5 components of the other comprehensive income, the amount of
income tax relating to each component of other comprehensive income, including
reclassification adjustments shall be disclosed, either in the statement of
comprehensive income or in the notes. According to IAS 1, the economic entities may
present components of other comprehensive income either: net of related tax effects,
or before related tax effects with one amount shown for the aggregate amount of
income tax relating to those components. In the case of the reviewed entities, 40% of
them, representing 25 entities, presented in statement of comprehensive income
components of other comprehensive income net of related tax effects.
CONCLUSION
For a long time and even today net income continues to be considered the main
indicator for measuring economic performance of an entity. Along with the net
income, the comprehensive income starts to gain the status of leading indicator in
reflecting the entity's financial performance. The close values of the Pearson
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coefficient, for both the correlation of the net income with the price per share and for
the correlation of the comprehensive income with the price per share, suggests that
professional investors take into account in making investment decisions both the net
income and comprehensive income. By analysing the regression function on the one
hand between the basic earning per share and the stock market of the share, and on the
other hand between comprehensive income per share and the stock market of the
share, it came out that both net income and comprehensive income influence in the
same way and with almost equal intensity the stock market of the share.
By analyzing the financial statements of entities under study, we could fiind that most
entities present two financial statements to report performance (income statement and
statement of comprehensive income) although IAS 1 recommends as basic treatment
the submission of a single statement of performance reporting. The appeal, however,
to two cases involving financial reporting of performance, has an inconvenient, at all
insignificant: a greater importance can be given to a statement over the other. The fact
that professional investors give the same importance to both comprehensive income as
well as net income, this represents a prerequisite for supporting the need for unique
statements in performance reporting.
Although it is stated that the net income includes only revenues and expenses, in
recent years, due to the use of fair value in evaluating a large number of items in the
financial statements, the difference between net income and comprehensive income
tends to diminish. What distinguishes the comprehensive income from the net income
is other comprehensive income, which includes five components: changes in
revaluation surplus, actuarial gains and losses on defined benefit plans, gains and
losses arising from translating the financial statements of a foreign operation, gains
and losses on remeasuring available-for-sale financial assets, the effective portion of
gains and losses on hedging instruments in cash flow hedge. But, although in small
numbers, these five components together, have presented significant value for the
analyzed entities; more than 45% of the entities had the value for other comprehensive
income over 50% of net income. Of the five components, gains and losses arising
from translating the financial statements of a foreign operation, were found in most
organizations. This is normal, given that the analyzed entities are multinational and
the exchange differences arise inherently from the consolidated financial statements.
It should be noted, however, the low number of entities which have opted for the
revaluation of property, (3 entities). It is a definite proof of the superiority of
historical cost over fair value.
The results of this study represent a balance between the conflicting results of
researches that have been done so far in terms of comparison of the comprehensive
income and the net income. We state that they are contradictory because, as seen in
the literature review, some studies have reflected the superiority of the net
income,while others reflected the superiority of the comprehensive income. This
study represents only a link in the multitude of researches that will probably be made
in the future in thisarea; and this because only in 2009, the statement ofcomprehensive
income became a single reporting statement of performance for entities that apply
IFRS.
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This study is not without limits, among which we may include: the small number of
entities under study, limiting the analysis solely to information collected from a single
stock exchange, the authors' subjectivity in interpreting the results.
ACKNOWLEDGEMENTS
This work was supported from the European Social Fund through Sectoral Operational
Programme Human Resources Development 2007-2013, project number
POSDRU/89/1.5/S/59184 Performance and excellence in postdoctoral research in
Romanian economics science domain
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Financial Analysts Journal 52(6): 14-19
~984~
ANNEX 1
COMPANY NAME
Balance
sheet date
Stock
market data
Reporting
currency of
Stock
market data
Reporting
currency of
COMPANY NAME
Balance
sheet date
32. KINGFISHER PLC
30.01.2010
01.02.2010
Million
31.12.2009
04.01.2010
Million
31.03.2010
04.01.2010
Million
03.04.2010
06.04.2010
Million
31.01.2010
01.02.2010
Million
31.03.2010
04.01.2010
Million
1. 3I GROUP PLC
31.03.2010
01.04.2010
Million
2. AMEC PLC
31.12.2009
04.01.2010
Million
3. ADMIRAL GROUP PLC
31.12.2009
04.01.2010
Million
4. AGGREKO PLC
31.12.2009
04.01.2010
Million
5. ALLIANCE TRUST PLC
31.01.2010
01.02.2010
Million
6. ASSOCIATED BRITISH
FOODS PLC
12.09.2009
14.09.2009
Million
7. ASTRAZENECA PLC
31.12.2009
04.01.2010
Million $
38. NEXT PLC
30.01.2010
01.02.2010
Million
8. AVIVA PLC
31.12.2009
04.01.2010
Million
39. OLD MUTUAL PLC
31.12.2009
04.01.2010
Million
9. BG GROUP PLC
31.12.2009
04.01.2010
Million
31.12.2009
04.01.2010
Million $
10. BP PLC
31.12.2009
04.01.2010
Million $
31.12.2009
04.01.2010
Million $
11. BARCLAYS PLC
31.12.2009
04.01.2010
Million
31.12.2009
04.01.2010
Million
31.03.2010
06.04.2010
Million
31.12.2009
04.01.2010
Million
30.06.2009
02.07.2009
Million
31.12.2009
04.01.2010
Million
14. BUNZI PLC
31.12.2009
04.01.2010
Million
31.12.2009
04.01.2010
Million
15. BURBERRY GROUL

PLC
31.03.2010
06.04.2010
Million
46. RIO TINTO PLC
31.12.2009
04.01.2010
Million $
31.12.2009
04.01.2010
Million $
31.03.2010
01.04.2010
Million $
12. BRITISH AIRWAYS

PLC
13. BRITISH SKY
BROADCASTING PLC
33. LLOYDS BANKING

GROUP PLC
34. LONDON STOCK
EXCHANGE PLC
35. MARKS AND
SPENCER PLC
36. MORRISON (W M)
SUPERMARKETS PLC
37. NATIONAL GRID
PLC
40. PETROFAC
LIMITED
41. RANDGOLD
RESOURCES PLC
42. REXAM PLC
43. RSA INSURANCE
GROUP PLC
44. RECKITT
BENCKISER PLC
45. REED ELSEVIER
PLC
16. CENTRICA PLC
31.12.2009
04.01.2010
Million
47. ROYAL DUTCH

SHELL PLC
17. COMPASS GROUP PLC
30.09.2009
02.10.2009
Million
48. SABMILLER PLC
18. DIAGEO PLC
49. SMITH & NEPHEW

PLC
50. SMITHS GROUP
PLC
51. STANDARD
CHARTERED PLC
31.12.2009
04.01.2010
Million $
31.07.2009
03.08.2009
Million
31.12.2009
04.01.2010
Million $
30.06.2009
01.07.2009
Million
31.12.2009
04.01.2010
Million $
31.12.2009
04.01.2010
Million $
31.12.2009
04.01.2010
Million
52. TUI TRAVEL PLC
30.09.2009
04.01.2010
Million
31.12.2009
04.01.2010
Million
53. TESCO PLC
27.02.2010
01.03.2010
Million
31.12.2009
04.01.2010
Million
31.12.2009
04.01.2010
Million
30.09.2009
02.10.2009
Million
31.12.2009
04.01.2010
Million
31.12.2009
04.01.2010
Million
30.09.2009
02.10.2010
Million
31.12.2009
04.01.2010
Million
31.12.2009
04.01.2010
Million
27. INVENSYS PLC
31.03.2010
01.04.2010
Million
58. UNILEVER PLC
31.12.2009
04.01.2010
Million
28. INVESTEC PLC
31.03.2010
01.04.2010
Million
59. VODAFONE
GROUP PLC
31.03.2010
04.01.2010
Million $
29. J SAINSBURY PLC
20.03.2010
22.03.2010
Million
60. WPP GROUP PLC
31.12.2009
04.01.2010
Million
30. JOHNSON MATTHEY

PLC
31.03.2010
01.04.2010
Million
61. WHITBREAD PLC
04.03.2010
04.01.2010
Million
31. KAZAKHMYS PLC
31.12.2009
04.01.2010
Million $
62. XSTRATA PLC
31.12.2009
04.01.2010
Million $
19. EURASIAN NATURAL

RESOURCES PLC
20. FRESNILLO
MANAGEMENT SERVICE
21. G4S PLC
22. GLAXOSMITHKLINE
PLC
23. HAMMERSON GROUP
PLC
24. IMPERIAL TOBACCO
GROUP PLC
25.
INTERCONTINENTAL
26. INTERNATIONAL
POWER PLC
54. THE CAPITA

GROUP PLC
55. THE ROYAL BANK
OF SCOTLAND GROUP
56. THE SAGE GROUP
PLC
57. TULLOW GROUP
SERVICES LTD
ANNEX 2 (amounts in pounds or centimes)

COMPANY NAME
COMPANY NAME
1. 3I GROUP PLC
17,20
293,00
32. KINGFISHER PLC
16,50
216,60
2. AMEC PLC
52,42
805,00
33. LLOYDS BANKING GROUP PLC
7,50
52,26
59,00
1.174,00
34. LONDON STOCK EXCHANGE PLC
33,80
733,50
4. AGGREKO PLC
62,67
938,00
35. MARKS AND SPENCER PLC
33,50
377,90
9,14
314,00
36. MORRISON (W M) SUPERMARKETS

PLC
22,80
291,30
45,50
850,00
37. NATIONAL GRID PLC
152,38
647,50
519,00
4.744,83
38. NEXT PLC
188,50
1.984,00
8. AVIVA PLC
37,80
394,50
-7,80
111,40
9. BG GROUP PLC
64,50
1.161,00
104,78
1.671,42
10. BP PLC
88,49
989,95
41. RANDGOLD RESOURCES PLC
86,00
8.271,59
11. BARCLAYS PLC
86,20
280,60
42. REXAM PLC
-3,70
288,30
-38,50
243,30
43. RSA INSURANCE GROUP PLC
12,20
119,70
13. BRITISH SKY BROADCASTING PLC
14,90
454,80
44. RECKITT BENCKISER PLC
198,90
3.351,00
14. BUNZI PLC
46,40
672,50
45. REED ELSEVIER PLC
17,20
512,50
15. BURBERRY GROUL PLC
18,80
724,00
46. RIO TINTO PLC
276,20
5.598,29
16. CENTRICA PLC
16,50
281,30
47. ROYAL DUTCH SHELL PLC
204,00
45,48
31,70
377,60
48. SABMILLER PLC
122,60
2.986,65
18. DIAGEO PLC
64,60
897,00
49. SMITH & NEPHEW PLC
53,40
1.051,90
81,00
1.533,96
50. SMITHS GROUP PLC
72,40
735,50
44,90
1.284,54
51. STANDARD CHARTERED PLC
167,90
2.603,93
14,40
267,20
52. TUI TRAVEL PLC
-2,30
253,40
22. GLAXOSMITHKLINE PLC
109,10
1.340,00
53. TESCO PLC
27,50
433,00
23. HAMMERSON GROUP PLC
-54,10
412,20
54. THE CAPITA GROUP PLC
30,76
751,00
24. IMPERIAL TOBACCO GROUP PLC
65,50
1.809,00
55. THE ROYAL BANK OF SCOTLAND

GROUP PLC
-6,40
32,10
25. INTERCONTINENTAL HOTELS

GROUP PLC
74,70
904,50
56. THE SAGE GROUP PLC
14,46
224,00
26. INTERNATIONAL POWER PLC
65,50
309,90
57. TULLOW GROUP SERVICES LTD
1,87
1.331,00
27. INVENSYS PLC
296,00
345,90
58. UNILEVER PLC
121,00
2.246,32
28. INVESTEC PLC
44,00
539,50
59. VODAFONE GROUP PLC
16,44
244,74
29. J SAINSBURY PLC
32,10
329,20
60. WPP GROUP PLC
35,90
617,00
30. JOHNSON MATTHEY PLC
77,60
1.786,00
61. WHITBREAD PLC
92,37
1.486,00
104,00
2.210,28
62. XSTRATA PLC
25,00
1.861,79
4.266,68
69.798,64

6. ASSOCIATED BRITISH FOODS PLC
7. ASTRAZENECA PLC
12. BRITISH AIRWAYS PLC
19. EURASIAN NATURAL RESOURCES

PLC
20. FRESNILLO MANAGEMENT
SERVICE LTD
21. G4S PLC
31. KAZAKHMYS PLC

TOTAL
39. OLD MUTUAL PLC

40. PETROFAC LIMITED
ANNEX 3 (amounts in pounds or centimes)

COMPANY NAME
COMPANY NAME
1. 3I GROUP PLC
45,46
293,00
32. KINGFISHER PLC
11,40
216,60
2. AMEC PLC
21,96
805,00
33. LLOYDS BANKING GROUP PLC
11,92
52,26
57,01
1.174,00
8,77
733,50
4. AGGREKO PLC
58,46
938,00
35. MARKS AND SPENCER PLC
18,49
377,90
9,14
314,00
36. MORRISON (W M)
SUPERMARKETS PLC
20,47
291,30
47,99
850,00
37. NATIONAL GRID PLC
140,21
647,50
515,28
4.744,83
38. NEXT PLC
155,82
1.984,00
9,54
394,50
73,37
111,40
51,99
1.161,00
40. PETROFAC LIMITED
116,33
1.671,42
106,99
989,95
41. RANDGOLD RESOURCES PLC
123,50
8.271,59
11. BARCLAYS PLC
86,20
280,60
42. REXAM PLC
-14,67
288,30
12. BRITISH AIRWAYS PLC
18,12
243,30
43. RSA INSURANCE GROUP PLC
-5,71
119,70
13. BRITISH SKY BROADCASTING PLC
22,61
454,80
44. RECKITT BENCKISER PLC
161,59
3.351,00
14. BUNZI PLC
46,40
672,50
45. REED ELSEVIER PLC
17,02
512,50
15. BURBERRY GROUL PLC
18,53
724,00
46. RIO TINTO PLC
487,43
5.598,29
5,98
281,30
47. ROYAL DUTCH SHELL PLC
311,07
45,48
29,13
377,60
48. SABMILLER PLC
249,21
2.986,65
18. DIAGEO PLC
42,90
897,00
49. SMITH & NEPHEW PLC
63,70
1.051,90
-11,59
1.533,96
50. SMITHS GROUP PLC
17,54
735,50
50,42
1.284,54
51. STANDARD CHARTERED PLC
193,30
2.603,93
5,96
267,20
52. TUI TRAVEL PLC
-19,45
253,40
22. GLAXOSMITHKLINE PLC
96,15
1.340,00
53. TESCO PLC
23,75
433,00
23. HAMMERSON GROUP PLC
-62,58
412,20
54. THE CAPITA GROUP PLC
21,82
751,00
24. IMPERIAL TOBACCO GROUP PLC
83,01
1.809,00
-16,97
32,10
25. INTERCONTINENTAL HOTELS GROUP PLC
83,78
904,50
56. THE SAGE GROUP PLC
25,45
224,00
26. INTERNATIONAL POWER PLC
60,69
309,90
57. TULLOW GROUP SERVICES LTD
-14,38
1.331,00
27. INVENSYS PLC
560,84
345,90
58. UNILEVER PLC
138,16
2.246,32
28. INVESTEC PLC
78,59
539,50
59. VODAFONE GROUP PLC
16,30
244,74
29. J SAINSBURY PLC
28,15
329,20
60. WPP GROUP PLC
24,05
617,00
30. JOHNSON MATTHEY PLC
60,49
1.786,00
61. WHITBREAD PLC
12,24
1.486,00
168,51
2.210,28
62. XSTRATA PLC
143,18
1.861,79
4.574,00
69.798,64

6. ASSOCIATED BRITISH FOODS PLC
7. ASTRAZENECA PLC
8. AVIVA PLC
9. BG GROUP PLC
10. BP PLC
16. CENTRICA PLC
19. EURASIAN NATURAL RESOURCES PLC

20. FRESNILLO MANAGEMENT SERVICE LTD
21. G4S PLC
31. KAZAKHMYS PLC

TOTAL
34. LONDON STOCK EXCHANGE PLC
39. OLD MUTUAL PLC
55. THE ROYAL BANK OF SCOTLAND

GROUP PLC
PS20 Environmental accounting

Chairperson
Massimo POLLIFRONI, University of Turin, Italy
EXPLORATORY STUDY ON SOCIAL

AND ENVIRONMENTAL REPORTING OF EUROPEAN
COMPANIES IN CRISES PERIOD
Camelia Iuliana LUNGU, Chirata CARAIANI,
Cornelia DASCALU, Raluca Gina GUE
A COMPLEX APPROACH TO CLIMATE CHANGE

EXTERNALITIES
Florian COLCEAG, Cornelia DASCALU, Chirata CARAIANI,
Camelia Iuliana LUNGU, Raluca Gina GUE
DIFFERENCES REGARDING ENVIRONMENTAL

REPORTING: THE CASE OF ROMANIAN
ORGANIZATIONS
Ionel-Alin IENCIU

Massimo POLLIFRONI

ON THE FINANCIAL STATE OF THE COMPANY
SECTOR STUDY
Petru STEFEA, Cristina CIRCA

CORRELATIONS FOR SUSTAINABLE PERFORMANCE
BUDGETING
Violeta CIMPOERU, Maria RADU, Valentin CIMPOERU
~988~
EXPLORATORY STUDY ON SOCIAL

AND ENVIRONMENTAL REPORTING OF EUROPEAN
COMPANIES IN CRISES PERIOD
Camelia Iuliana LUNGU1, Chirata CARAIANI,
Cornelia DASCALU & Raluca Gina GUE
ABSTRACT
The present study promotes arguments for reporting improvement to support stakeholders
confidence and proposes possible policies and strategies for social and environmental
reporting, resulting from European companies activity. We examined the information
disclosed in annual reports and corporate social responsibility reports from a sample of the
companies listed on the Euronext Stock Exchange over a three-year period. The purpose of
the research is to support the idea that the quality of social and environmental information
provided by companies is increasing as time passes and in relation to the present economic
conditions. We conducted an exploratory study whose results are analysed and discussed in
terms of financial and economic evolution within the present world crisis. They give us the
possibility to design a new facet of the overall framework for reporting social and
environmental information by combining theoretical requirements of the Global Reporting
Initiative (GRI) standards with their implementation in the reporting practice of European
companies.
KEYWORDS: social, environmental, reporting, corporate responsibility, companies

practice.
INTRODUCTION
Concerns with the current state of knowledge in the area of corporate social and
environmental reporting have moved beyond their initial stage in the research
community and most certainly needs further encouragement (Milne and Gray, 2007).
There are genuinely complex and difficult issues to be confronted in reporting on
corporate actions in regard to the society and the environment (Hopwood, 2009). The
challenges resulting from this, both financially and related to sustainability issues
have been reported by an increasing number of businesses. Many companies have
board committees that take responsibility for and oversee sustainability, supporting
compliance with a voluntary social and environmental reporting framework and
disclosing adequate adherence to sustainable development principles.
Corporate social responsibility (CSR) is gaining more importance in todays business
life, and its different approaches emphasise its contribution to sustainability. The core
idea sustains that the business sector should play a proactive role in society, in
addition to its economic purpose of making profits. These issues have led the industry
1
Correspondence address: Camelia Iuliana LUNGU, Academy of Economic Studies, Bucharest;

email: camelia.lungu@cig.ase.ro
~989~
to engage in a sustainability debate and initiate strategies for responding to the

challenges of sustainable development, in the spirit of Brundtland Commission Report
(UN, 1987). More and more companies provide concise and focused sustainability
information in their annual report, as proof of reliable disclosure, accompanied by full
sustainability reports on their websites, reflecting a growing maturity on CSR
disclosures (Lungu et al., 2010).
The development of social and environmental accounting and reporting over the last
40 years has resulted in a wide range of actual and potential accounts of (typically)
organisational interactions with society and the natural environment (Gray, 2010).
Since the mid 1970s, a number of studies (most of them of qualitative in nature) have
investigated the nature and frequency of social and environmental disclosures, their
patterns and trends, and their general relationships to corporate size and profitability.
Nevertheless, the voluntary nature of sustainability reporting explains the variations in
content and the lack of expected assurance for the disclosed social and environmental
information. This gap raises concerns regarding accuracy and reliability and has to be
considered by companies for their future reports.
In this study we examine the Corporate Social Reports, but also Annual Reports in
terms of social and environmental information disclosed by European companies. The
main objective of this study is to determine the degree to which social and
environmental reporting requirements included in Global Reporting Initiative (GRI)
standards are considered for publication by European companies, as proof of reliable
and high quality disclosure. The target period for our study is 2007-2009, as it is the
most recent period for which companies have published information for stakeholders.
It is also the period during which companies have struggled through the deepest
global crisis. The study population in this article consists of European companies
listed on Euronext Stock Exchange. We seek to design a pattern for reporting social
and environmental information and for highlighting a trend in the evolution of the
content of financial and non-financial published reports during the crisis period.
The central research proposition of the study is: The quality of social and
environmental information provided by companies is increasing in relation to the
amount of time passing and the present economic conditions. Based on our previous
research, both theoretical and practical, we analyse the content of reports published by
the companies in our sample, in terms of implementation of GRI requirements. As we
argue in the following paragraph, GRI standards may be considered the most relevant
because they are applied by a considerable number of companies interested in
extending reporting for stakeholders. We support the idea that providing qualitative
disclosures is increasingly necessary once the users upgrade from shareholder to
stakeholders. Thus, information needs have become increasingly complex, and they
now rank at a more complex level of analysis. In order to put up with the current
economic context, entities must overcome the simple reporting of financial
information and extend the reports to include integrated value and descriptive
presentations to give confidence in their activity.
We conducted an exploratory study whose results are analysed and discussed in terms
of financial and economic evolution within the context of the present world crisis.
This analysis give us the possibility to design a new facet for the overall framework of
reporting social and environmental information, by combining theoretical
~990~
requirements with their implementation in the practices of European companies.

Therefore, it will be an important contribution not only for interested companies, but
also for national standard setters. The studys originality also rests on the conclusions
and debates discussed, based on the obtained results that refer to connecting the
disclosure patterns to policies and strategies for social and environmental reporting in
time and space.
1. REPORTING SOCIAL AND ENVIRONMENTAL ISSUES IN EUROPEAN
COMPANIES - RESEARCHERS' AND PRACTITIONERS' VIEWS
Integrating principles of sustainable development into general business accountability
structures opens up new business opportunities and helps companies create value, not
just avoid destroying it (WBCSD, 2006). At the company level, discussions of
sustainability reporting (SR) are focused on the idea that environmental or social
concerns may affect the ability to expand operations or may damage the reputation
and brand value. New codes of corporate governance have increasingly begun to
highlight the attention they must pay to risks associated with sustainability concerns
on the management agenda. Thus, organisations must redefine their essential business
objectives by aligning them with the sustainability strategy of the company.
Additionally, they must be coherent with the changes in organisational culture implied
by corporate responsibility.
Reporting is an important communication tool which can ensure greater corporate
transparency and enable better engagement with stakeholders. Moreover,
sustainability reporting is largely voluntary and appears to be driven by market
pressures (Golob and Bartlett, 2007). Since the beginning of the 2000s, the demand
for disclosure from the most important listed companies has dramatically increased.
The failures of large companies listed on the most important stock exchanges have
placed extra pressure on them and standards setters for the increase in the quality of
corporate reporting (Beretta and Bozzolan, 2004). A study by Mammat et al. (2010)
shows that as of 2008 there has been an increase in the quality and effectiveness of the
social and environmental information reported. However, debates still continue on the
quality of information presented, based on the fact that some companies report large
volumes of data that is difficult for the reader to digest. Even more so, other
companies report so little that it merely raises questions regarding their commitment
to sustainability and stakeholder reporting overall.
The stakeholder approach to strategic management, first proposed by R. Edward
Freeman in 1984, is used today in an extensive body of research, including social and
environmental disclosure. Investors and stakeholders in continental Europe are
becoming increasingly concerned about corporate social and environmental policies.
As a result, many companies are voluntarily increasing the extent of social and
environmental disclosures in their annual report. Cormier et al. (2005) identified
determinants of corporate disclosure using multi-theoretical lenses that rely on
economic incentives, public pressures and institutional theory. Results show that risk,
ownership, fixed assets age, and companys size, as well as routine, determine the
level of environmental disclosure by German companies for a given one year period.
Although determinants have been identified, mixed findings are presented in prior
studies for some commonly examined variables such as size, industry classification
and ownership structure. Gray et al. (2001) suggest that larger, more profitable
~991~
companies and those in more socially and environmentally sensitive industries can be
expected to make greater use of the (typically voluntary) disclosure of information
about their social and environmental. Lynn (1992) found no relationship between
company size and the level of social and environmental disclosures, while Hackston
and Milne (1996) show that there is no relationship between profit measures and
social and environmental disclosures. Brammer and Pavelin (2006) found that larger,
less indebted companies with dispersed ownership characteristics are significantly
more likely to make voluntary environmental disclosures, and that the quality of
disclosures is positively associated with companys size and corporate environmental
impact. Some studies suggest that, in addition to companys size, proprietary costs,
information costs and media visibility determine corporate environmental reporting
(Cormier and Magnan, 2003).
Surveys of social and environmental reporting practice tend to show that both the
quantity and the overall quality of reporting are increasing (WBCSD, 2003; Holland
and Foo, 2003; Gray and Milne, 2002). We support the idea that, in areas such as
scope of reporting, consistency of methodological approaches to recognition and
measurement policies, and timeliness of reporting, improvements in quality are
required. Similarly, we see the need for better focused stakeholder related reporting.
Preparers of social and environmental reports, in particular, would like confirmation
that their reports are effective. Additionally, users of such reports, especially the
increasingly environmentally aware financial community, are demanding more
consistency in the ways in which social and environmental issues are measured and
reported.
The latest studies refer to the recent accounting scandals that appear differently when
viewed from the perspectives of the political/regulatory process and of the market for
corporate governance and financial reporting (Ball, 2009). For the most part,
governments have maintained a distance from the reporting and CSR movements,
considering them voluntary private initiatives (Brown et al., 2009). There have
recently been several professional associations and other initiatives that have
responded to these concerns; therefore, a range of tools and guidelines for social and
environmental reporting are available (see www.enviroreporting.com).
Corporate Social Responsibility is part of the Europe 2020 strategy for smart,
sustainable and inclusive growth. In March 2010 the European Commission made a
commitment to renew the EU strategy to promote Corporate Social Responsibility
(CSR) as a key element in ensuring long term employee and consumer trust. More
and more issues concerning voluntary social and environmental standards as
introduced by the Global Reporting Initiative are included in todays compulsory
reporting. Thus, in addition to existing International Financial Reporting Standards
(IFRS) regarding accounting and reporting of social and environmental aspects, the
International Accounting Standards Board (IASB) has published a proposed nonmandatory framework to help entities prepare and present a narrative report. This
publication is referred to as the Management Commentary (IASB, 2010) and helps
users of the annual reports, among others, to understand how non-financial factors
have influenced the information presented in the financial statements.
In EU countries there are government initiatives and requirements to enlarge the
scope of conventional reporting to include non-financial information. Some actions
~992~
are motivated by national environmental and social policy goals, others by external
users pressures to obtain a reliable view on companies actions. All indications point
to continuing expansion of governmental reporting initiatives to new countries and
regions over the next few years. The European requirements on sustainability
reporting, included in the EU Accounts Modernisation Directives, define and describe
Key Performance Indicators (KPIs) that provide businesses with a tool for
measurement. They are quantifiable metrics that reflect the environmental
performance of a business in the context of achieving its wider goals and objectives.
KPIs help businesses to implement strategies by linking various levels of an
organisation (business units, departments and individuals) with clearly defined targets
and benchmarks (DEFRA, 2006). The EU Accounts Modernisation Directives also
introduce requirements for companies to include a balanced and comprehensive
analysis of the development and performance of the business in their Directors
Report. The requirement for an expanded Directors Report, which came into effect
for EU companies in January 2005, is not a completely new idea. The concept of nonfinancial reporting and in particular, the recognition, measurement and disclosure of
environmental issues in the annual accounts and annual reports of companies, was
recommended by the European Commission. The analysis should include both
financial and, where appropriate, non-financial key performance indicators relevant to
the particular business, including information relating to environmental and employee
matters (EU, 2003).
Complementary to European Union specific requirements, there is evidence that the
majority of European companies use the Global Reporting Initiative Guidelines for
reporting social, environmental and economic aspects of their activity. Social and
environmental reports based on the GRI Reporting Framework, disclose outcomes and
results that occurred within the reporting period in the context of the organisations
commitments, strategy and management approach. Its purpose is to communicate
clearly and openly about sustainability and to be used by organisations of any size,
sector, or location (GRI, 2006). GRI Framework defines the principles of preparing a
sustainability report (materiality, stakeholder inclusiveness, sustainability context, and
completeness) and underlines a number of principles for qualitative disclosure
(balance, comparability, accuracy, timeliness, clarity, and reliability). Report makers
choose the guidance and indicators contained in the various Framework components
to suit their needs and their stakeholders interests. GRI framework emphasises the
importance of extensive interaction with stakeholders to determine appropriate
reporting boundaries. Reporting organisations are encouraged to follow GRI structure
in compiling their reports, however, other formats may be chosen. A content index is
provided for entities reporting on GRI Framework in order to identify information by
referring to page numbers the standard disclosure can be found.
According to Brown et al. (2009), GRIs major contribution to the field of reporting,
and its own source of legitimacy, has been to popularise a multi-stakeholder process.
This allows participants to articulate their principal concerns with regard to
sustainability performance and incorporate emerging issues, facilitating a broadly
based societal dialogue and indirectly contributes to the policy agenda. Lozano and
Huisingh (2011), in their analysis on various sustainability reporting frameworks,
concluded that GRI guidelines have the broadest scope, and it tends to be the most
frequently used set of guidelines for SR reporting.
~993~
There are also critical approaches to social and environmental reporting, considered
just an increment of corporate social responsibility, with limited amount of
disclosures (Solomon and Lewis, 2002). The idea that some organisations label
themselves as corporate social reporters but do not behave in a responsible way
concerning sustainability matters is also discussed (Moneva et al., 2006). At the same
time there are organisations that often have good intentions in sustainability matters,
but they cannot transform those intentions into actions and results. Reporting
corporate social and environmental information has matured over the past decades,
but there still remains a lack of adequate standardisation. Equally significant is the
growing movement by the major accounting organisations to become involved in the
development of standards for corporate social reporting, auditing and verification.
Triggered by the financial crisis, issues of comprehensive risk management, long-term
performance and ethics are rapidly gaining relevance and consideration. Restoring
confidence and trust in markets will require a shift to long-term sustainable value
creation, and corporate responsibility must be an instrument towards this end.
2.1. Sample and data collection
Our focus on the reporting practices of European companies led us to construct our
sample based on companies listed on the European stock exchange. There are the two
pan-European stock exchanges: OMX Exchanges, which operates eight stock
exchanges in the Nordic and Baltic countries, and Euronext, based in Amsterdam and
with subsidiaries in Belgium, France, Netherlands, Portugal and the United Kingdom.
For this study, the Euronext stock exchange is the most suited because it is highly
representative for the practices of European companies, due to its declared objective:
to take advantage of the harmonisation of the European Union financial markets.
According to their website presentation, Euronext has successfully integrated local
markets across Europe to provide users with a unified market that is broad, liquid and
cost effective. Euronext is the largest central order book cash market in Europe and
the second largest derivatives exchange in the world, by value of business traded.
Following the initial three-way merger of the local exchanges of Amsterdam, Brussels
and Paris, Euronext acquired the London-based derivatives market LIFFE and merged
with the Portuguese exchange in 2002.
The evidence from prior studies (Hackston and Milne, 1996; Gray et al., 2001)
supports the argument that larger companies are subject to stronger pressure from
stakeholders and consequently, they are expected to find more persuasive arguments
to disclose social and environmental information. These assertions led us to determine
our sample structure. Thus, we included companies from 16 different industries as
follows: one company per industry having the highest market capitalisation on 31st of
July 2010 and one company per industry having the smallest capitalisation, all
extracted from compartment A (includes Issuers with a market capitalisation of which
is superior to 1 billion Euro) of Euronext Stock Exchange. Thus, we arrived at a
sample of 32 entities. For the companies included in our study, we searched their
websites and analysed their annual reports and corporate social responsibility reports
in accordance with the research objective, formerly described, over a period of three
years, between 2007 and 2009.
~994~
We created a database containing information related to the importance attributed by

each company to environmental and social aspects, measured by existence or absence
of elements such as: distinctive corporate responsibility links disclosed on a
companys website; existence of a published CSR report and its volume; compliance
with GRI Guidelines; appliance of G3 requirements; key performance indicators
(KPI) disclosure; social and environmental external certification supported by an
assurance statement; existence of a CSR section on published annual reports and its
volume; presentation of GRI compliance in annual reports; and disclosure of social
and environmental elements in financial statements. The volume of CSR reports, CSR
section in annual reports and of the annual reports are measured in number of pages.
This information was gathered using the Euronext database. In order to achieve our
objectives, the information included in the database was sorted and filtered using MS
Excel and we created sub-databases with companies classified on size (large/small
capitalisation) and according to European market affiliation established by the
Euronext Stock Exchange (presently there are functional markets in Paris,
Amsterdam, Brussels and Lisbon).
2.2. Research method: Content analysis and its appliance for the study
In order to develop patterns of social and environmental disclosure, we carried out a
thorough content analysis of the corporate social responsibility (CSR) reports
published by the companies in our sample. Content analysis is defined as a method of
codifying text into different groups depending on selected criteria (Weber, 1990). This
research method has been used extensively to investigate CSR reporting, and is
considered a technique for gathering data that consists of codifying qualitative
information in anecdotal and literary form into categories in order to derive
quantitative scales of varying levels of complexity (Abbot and Monsen, 1979). By
definition, content analysis is both a qualitative and quantitative technique, employing
qualitative data which are subsequently quantified, and concentration on either
approach may lead researchers to overlook the challenges arising from the methods
multifaceted nature (Gephart, 2004).
The extent of disclosure can be taken as an indication of the importance of a CSR
topic to the reporting entity (Krippendorf, 1980). In content analysis, several
alternatives have been proposed in order to measure the amount of CSR reporting
(Unerman, 2000). Gray et al. (1995) suggest that the amount of disclosures (number
of words, sentences or pages) provides richer data and automatically encompasses the
number of disclosures. Generally, studies measure the number of words (Deegan and
Gordon, 1996; Zghal and Ahmed, 1990), sentences (Hackston and Milne, 1996) or
pages (Gray et al., 1995; Patten, 1992) used to address the different CSR topics.
Advocates of the number of words, such as Deegan and Gordon (1996), have argued
that this method can record the level of disclosure in greater detail, while, those of the
number of sentences (Hackston and Milne, 1996; Milne and Adler, 1999) argue that
these units, rather than words, convey meaning. It seems now widely accepted that the
number of pages is the preferred method for computing the amount of disclosure.
Because the number of pages reflects the total space given to corporate issues, the
importance attached to that theme can be contingent.
Considering all this information and correlating them with our study objective, we
established the research unit to be CSR and annual reports published by the European
~995~
companies, listen on compartment A of Euronext Stock Exchange and the unit for
measuring the extent of social and environmental disclosure to be the number of
pages. Elements tracked in the content analysis of company reports are chosen in
order to assess the quality of information presented and are expressed as research
questions, such as:
Does the company publish the social and environmental disclosure through
distinguished corporate social reports, other than information offered on the
company website?
Does the company provide a web link to particular areas designed to inform the
stakeholders of the company's corporate responsibility?
Does the company report in either the CSR report or annual report the
compliance with the GRI requirements in general, and with GRI G3 Guidelines,
in particular?
Does the company include special presentations on Key Performance Indicators
(KPIs), which would increase the quality level of non-financial information?
Is auditing of social and environmental information presented in corporate
social reports, which provides presentations assurance?
What social and environmental information is presented within financial
statements?
3. RESULTS AND DEBATES OF THE EXPLORATORY STUDY
This exploratory study based on the content analysis of reports published by European
companies concerns the evolution of social and environmental information volume
and quality provided by reference to GRI requirements, during the global crisis period
of 2007-2009. For this research, we defined the quality of corporate information in
compliance with GRI standards by inclusion of measurable information along with the
descriptive one. This is illustrated by presenting the key indicators of global
performance (KPIs) but also by ensuring external credibility, relevance and assurance
of the information presented in corporate social and financial reporting. We also
consider that using new tools available on a companys website is one aspect defining
the increasing quality of information provided to the interested stakeholders.
3.1. Social and environmental informations evolution in time (three years)
provided by category of market capitalisation
Through analysing the websites of the companies included in the sample, we noticed
that all top European companies (classified by mid-2010 capitalisation level) provide
information on corporate responsibility and on the effort to support the principles of
sustainable development. This information is either classified by category,
summarised in correlative tables, or detailed using descriptions of social and
environmental issues overviewed throughout the business activity. Among companies
with smaller capitalisation, 63% provide such information on their websites, a rather
high percentage, in our opinion.
The awareness process of environmental and social responsibility by economic
entities can be monitored by analysing corporate social reports published by these
companies. The voluntary presentations in these reports provide identification of the
degree of awareness that economic and financial society has now come to. The data
resulting from the content analysis of reports of European companies in our sample
show that publishing independent rather than compulsory reports is still a difficult
~996~
process to implement at an extended level. Companies with a market capitalisation of

less than 3,500 million Euros publish such reports in a very small proportion and with
an insignificant extent and details. However, we find it encouraging that there is a
significant percentage of the above mentioned companies which give a great
importance to informing the stakeholders by using their websites and creating
designated areas for social responsibility. These are companies that in the future may
publish more and more complex corporate social reports.
The percentages of corporate social reports published, shown in Table 1 should be
debated so as not to leave a false impression on the reader. It is true that at first sight
the social and environmental information disclosure through CSR reports are
characterised by decreasing during the period under review, but we did not jump to
the conclusion that companies have lost their interest in such reporting. We detailed
our analysis and noted that some companies, such as Faurecia, in the manufacture of
automobiles, or Vinci, in the construction industry, went from ignoring social and
environmental information in 2007 to providing the data in distinct sections in their
annual reports or in their reference documents (as required by French law) by 2009.
While others, like Air Liquide, in the chemical industry, Renault, in the vehicle
constructions, or Societe Generale, in banking, waived the presentation of CSR
reports, choosing to integrate them into the reference documents or presenting them
interactively on their website. From the above discussion we see that large European
companies show an important interest in providing complex information that includes
environmental and social aspects, in addition to financial ones.
The current economic environment, determined by the global crisis that companies
are now experiencing, led us to analyse and discuss the quality of information
provided by companies, referred to in terms of GRI compliance, KPI disclosure and
assurance statements. The data collected for our sample indicates that the GRI
standards are a reference point for corporate social reporting especially for large
companies, and the percentage of GRI reporting was 88% in 2009, up from 2007,
after a decrease recorded in 2008.
Table 1. Social and environmental information in CSR reports size classification
mNoP***
MNoP****
GRI Com-pliance
G3 Guide-lines
KPI
Assu-rance in
CSR Report
High
capitalisation
companies 2009
High
capitalisation
companies 2008
High
capitalisation
companies 2007
Small capitalisation
companies 2009
companies 2008
companies 2007
ANoP**
Grouped sampled
companies
Existence
CSR Report
100%
75%
91
26
229
88%
44%
50%
81%
100%
81%
64
26
116
69%
50%
44%
63%
100%
88%
68
34
94
75%
63%
56%
50%
63%
13%
62
16
68
13%
13%
19%
13%
63%
13%
44
28
57
13%
6%
6%
13%
63%
19%
48
41
56
19%
19%
6%
13%
SEI* on
web site
*SEI social and environmental information

**ANoP average number of pages
~997~
***mNoP minimum number of pages

****MNoP maximum number of pages
In 2009, Sodexo was the only company that declined to show compliance with GRI.
In an attempt to find a plausible explanation, we also analysed the 2010 Corporate
Citizenship Review Progress and noticed that the company specified the compliance
with GRI guidelines, presenting social, environmental and economic indicators
required by the standards. Also, the presentation of key indicators of global
performance declined in 2008 (Societe Generale, Sodexo and AbInBev) and had a
return in 2009. Although we have no other information, the decline of details
presented in 2008 and the return to detailed presentation in 2009 may also be
explained by the critical moment of the economic and financial crisis, believed to be
in 2008. Companies had to face this period with a negative impact on financial results
that affected the interest of companies in providing detailed information on social
responsibility.
Contrary to the volume and details characterising the social and environmental issues
reporting, external assurance by one of the Big Four was on an upward trend. In this
case we consider that the economic and financial crisis had a strong impact. To find
resources to overcome the negative effects of the crisis, European companies have
turned to external assurance for corporate reports to increase stakeholders
confidence.
The companies whose capitalisation is less than 3,500 million Euros are not yet
interested in reporting social and environmental information. In our view, they are in
an intermediate stage of the implementation of integrated economic, social and
environmental reporting as a response to stakeholders requirements. These
companies have a low interest in providing information to comply with certain
reporting standards. By complying, they would have an impact on stakeholders by
providing valuable data on global performance or external assurance of such
information. However, the trend is still not exponentially increasing as we had
expected.
We also analysed the trend of companies which incorporated social and
environmental information in annual reports (results in Table 2).
Table 2. Social and environmental information in annual reports size classification
Grouped sampled
companies
High capitalisation
companies 2009
High capitalisation
companies 2008
High capitalisation
companies 2007
companies 2009
companies 2008
companies 2007
Annual
report (AR)
CSR section
in AR
ANoP* in
CSR section
GRI reference
in AR
Environmental
aspects in Financial
Statements
100%
88%
12
13%
50%
100%
88%
10
13%
44%
100%
88%
13%
31%
100%
88%
0%
19%
100%
88%
6%
19%
100%
88%
0%
13%
*ANoP average number of pages
~998~
We noticed that an important percentage of companies developed a separate section in

their annual reports, incorporating information on corporate social responsibility.
While it is an important step in the direction of company responsibility to ensure a
high quality of life, it is just the beginning. We are witnessing an increasing number
of entities which agree to assume social responsibility and begin to act according to its
principles. However, the information in the annual reports considered as reference
documents for the companys relationship with the stakeholders is minimal.
The data included in Table 2 shows that the companies in our sample still offer a
small space in annual reports to sections detailing social and environmental
information. Thus, large capitalisation companies have an average of 10 pages
describing social and environmental issues, from a total average of 215 pages of the
annual report, (5% of all information provided). References to GRI reporting
standards are very rare in the annual reports (13% of large companies, insignificant
for small capitalisation companies). The most common details presented in the Notes
to financial statements are related to environmental provisions, the references to
environmental costs and social costs. Information on employee benefits, other than
mandatory social contributions is presented in a descriptive form rather than as
measurable indicator.
The volume of social and environmental information provided by European
companies through annual reports differs according to their market capitalisation.
Thus, whether corporate social reports for large capitalisation companies are
comprehensive, including up to 229 pages, with an average of 91 pages in 2009,
corporate social reports of companies with capitalisation up to 3,500 million Euros, do
not exceed a volume of 68 pages. Analysing the evolution over three years, we
identified an upward trend for both types of companies, supporting our research
proposition that the quality of social and environmental information reported by
European companies is increasing over time.
3.2. The evolution of social and environmental information presentation by
financial market between 2007 and 2009
The second aspect of the content analysis of the reports included in our sample refers
to the trend in social and environmental reporting that could be influenced by the
financial markets within Euronext Stock Exchange. Results are presented in Table 3.
Due to a highly different number of companies on each market covered by our sample
(Paris 21, Brussels 4, Amsterdam 5, and Lisbon 2), we could not extrapolate proposals
to improve social and environmental reporting for other countries in the European
Union.
We limited our debate regarding the changes over time to each listed market.
Companies listed on Euronext Paris and Amsterdam markets give the highest
importance to providing social and environmental information through their website.
On a large proportion, (about 60%) companies develop and publish reports on
corporate social responsibility. If the number of companies publishing corporate
social reports did not varied significantly during the period 2007-2009, representing
the first part of the global crisis, in terms of average volume (measured in number of
pages) of such reports we noticed interesting developments. Thus, European
~999~
companies from all four Euronext markets have diminished interest in the qualitative
social and environmental information reporting in 2008 compared to 2007, suddenly
rethinking corporate reporting aspects in 2009. A more nuanced situation occurred for
the companies listed on the Lisbon market: although they reported social and
environmental issues in 2007, they completely abandoned them in 2008 and did not
reconsider them in 2009.
Table 3. Social and environmental information in CSR reports Euronext market
classification
Existence
mNoP***
MNoP****
GRI Com-pliance
G3 Guide-lines
KPI
ANoP**
Assu-rance in CSR
Report
CSR Report:
PARIS 2009
PARIS 2008
81%
81%
57%
52%
93
65
26
26
229
116
57%
43%
29%
29%
38%
19%
57%
48%
PARIS 2007
81%
57%
72
48
94
48%
38%
29%
43%
BRUSSELS 2009
BRUSSELS 2008
75%
75%
25%
25%
99
40
99
40
99
40
25%
25%
0%
25%
0%
25%
0%
0%
Financial markets of
Euronext by year
SEI* on
web site
BRUSSELS 2007
75%
25%
40
40
40
25%
25%
25%
0%
AMSTERDAM 2009
AMSTERDAM 2008
100%
100%
60%
60%
57
47
50
44
68
50
60%
60%
60%
60%
60%
60%
60%
40%
AMSTERDAM 2007
100%
60%
49
34
71
60%
60%
60%
20%
LISBON 2009
LISBON 2008
50%
50%
0%
0%
0
0
0
0
0
0
0%
0%
0%
0%
0%
0%
0%
0%
LISBON 2007
50%
50%
47
47
47
50%
50%
0%
50%
*SEI social and environmental information

**ANoP average number of pages
***mNoP minimum number of pages
****MNoP maximum number of pages
Entities listed on the Lisbon market have dropped for the time, the presentation of
social and environmental aspects and entities listed on the Amsterdam market
maintained their high level of quality for social and environmental information.
Moreover, the entities listed on the Brussels market registered a regression in
presentation beginning with the financial year ending on December 31, 2008, while
those listed on the Paris market followed the global economic and financial trend: a
decline in 2008 and a return on an upward trend in 2009. The declarations of external
assurance for social and environmental information provided by corporate social
reports are still growing and becoming more prominent from 2007 to 2009. The
number of companies addressing external assurance aspects increased by 5% in 2008,
and by 10% in 2009, compared to the year 2007.
Formalising the presentation of expanded economic, social and environmental
information in the annual report as the main credible and transparent instrument of
economic entities activity is gaining ground slowly but surely. Thus, the volume of
~1000~
CSR sections in the annual report increased from year to year, as well as the various
presentations of social and environmental factors in the financial statements.
Table 4. Social and environmental information in Annual Reports (AR) Euronext
markets
CSR section
MNoP***
Environ-mental
aspects in
Financial
Statements
mNoP**
GRI
reference in
AR
ANoP*
AR ANoP*
in AR
Financial markets of
Euronext by year
2009 PARIS
2008 PARIS
216
221
90%
90%
12
10
1
1
38
28
10%
10%
38%
33%
2007 PARIS
204
95%
10
32
10%
29%
2009 BRUSSELS
2008 BRUSSELS
120
108
75%
75%
10
11
2
2
23
22
0%
0%
25%
0%
2007 BRUSSELS
98
75%
14
0%
0%
2009 AMSTERDAM
2008 AMSTERDAM
131
136
80%
80%
4
6
2
2
7
10
0%
0%
40%
40%
2007 AMSTERDAM
133
60%
13
0%
20%
2009 LISBON
2008 LISBON
215
172
100%
100%
10
10
5
2
14
14
0%
50%
0%
50%
2007 LISBON
179
100%
15
0%
0%
*ANoP average number of pages

**mNoP minimum number of pages
***MNoP maximum number of pages
The figures summarised in Table 4 demonstrate a poor representation of social and

environmental information included in the annual reports and an even lower one in
financial statements. These results correspond to the reality that we are presently
facing today: climate changes, reaching the margin in natural resources, the ecological
footprint of companies, waste management, human rights, improving labour relations,
and ensuring reasonable social protection.
4. DISCUSSIONS AND RECOMMENDATIONS
Based on the exploratory study debated in this research, and also from our previous
research experience, we support the implementation of corporate social reporting in a
company through a series of steps:
Provide additional social and environmental information for a competitive
advantage;
Redesign the companys website in order to present descriptive information on
corporate responsibility;
Redesign the companys organisational structure by creating a department or
appoint a manager responsible for corporate social reporting;
Prepare and publish corporate social reports complying to a set of standards;
Obtain an external audit of social and environmental information presented in
the corporate report;
~1001~
Include social and environmental information in separate sections of the

annual report;
Integrate social, environmental and economic indicators in the financial
statements.
To develop their social and environmental reporting practices, European companies
should consider focusing on key issues of the sustainable development agenda,
demonstrating relevance and transparency in reporting. The increasing pressure from
stakeholders in relation to the corporate accountability disclaimer offers incentives for
understanding corporate responsibility as the right thing to do. Additionally, this
pressure guides companies to adopt strategic management and global information
reporting collaboration in order to develop sustainable, healthy and stable products
and services.
Issues that support our recommendations for increasing European companies
interests in the preparation of social and environmental reports complying with
European and internationally applicable standards are: the global trends of moving
from efficiency to cleaner and more sustainable activity; improving stakeholders
evaluation, risk management, engagement and research; the leadership among large
companies in science and innovation; greater risks for those with a global footprint,
that depend on natural resources; a better collaboration among industries for finding
the best solutions to ensure sustainability; the transfer of power back to the hands of
customers who ask for environmentally friendly products and services; and the need
for governments to take action and not ignore social and environmental policies and
taxes.
The financial and economic crisis of 2007 to the present contributed to the failure of
key businesses, declines in consumer wealth, substantial financial commitments
incurred by governments, and a significant decline in economic activity. Even if both
market-based and regulatory solutions have been implemented or are under
consideration, significant risks remain for the world economy over the next periods.
The global financial crisis started to show its effects in the middle of 2007 and into
2008. Around the world, stock markets have fallen, large financial institutions have
collapsed or been bought out, and governments in even the wealthiest nations have
had to come up with rescue packages to restore their financial systems. During
periods of crisis economics are rethinking.
The results and discussions presented in this study lead us to conclude that the impact
of economic and financial crisis on reporting social and environmental information is
extremely powerful, both in voluntary non-financial reports and annual reports. The
use of corporate social reporting as a tool for providing social and environmental
information is still limited. Even though, the references in the annual reports on the
description and presentation of measurable social and environmental aspects gains
more and more importance and a higher percentage of companies consider necessary
to provide details on the social responsibility they assume and created special links on
their web pages. The evolution of corporate social reporting has been modelled
according to the development of the economic crisis, and signals an upward trend of
pushing companies to provide comprehensive, integrated, and certified information on
their activity.
~1002~
CONCLUSIONS
The qualitative aspects of the information presented in our analysis, including the
compliance with GRI Guidelines, the new generation of GRI G3 standards, key
performance indicators of global performance and external assurance by publishing an
assurance statement, are those that differentiate companies in European Union
countries. The findings presented in our article give us hope that in the future the
quality of information provided by entities will be presented in terms of the impact of
their actions on the environment and society, and given an equal role in the financial
impact. This approach will help companies to overcome the negative effects of the
global crisis but also the disadvantages in the very near future: natural resources
reaching the limit. Therefore, saving through recycling efforts, environmental
protection, environmental-friendly products and the awareness of necessity for their
presentation in the annual reports are mandatory actions for economic recovery on an
upward trend.
Thus, we assert once more that a formal set of recognised reporting principles and a
standardised reporting framework, not dissimilar in principle to those adopted in the
EC 4th Directive on Company law or to IASB framework, should help overcome any
perception that reporting of social and environmental information lacks credibility.
All these issues lead us to the conclusion that a base for discussion on corporate
economic, social and environmental reporting is necessary for European entities. In
our future research we intend to enlarge the present study in order to propose
guidelines for an integrated reporting.
Our research is aimed through its scope to encourage companies to expand their
financial reporting on corporate social and environmental information. The findings of
this paper will help formulate government policy decisions that promote corporate
social and environmental reporting and thereby make entities more responsive to
changes in the natural and social environments. We consider this a useful contribution
in entities efforts to integrate quality information in their annual reports.
ACKNOWLEDGEMENTS
This work was supported by CNCSIS - UEFISCDI, project number PNII - IDEI ID
1819/2008, titled Research regarding reassessment of financial reporting in the light
of risks and uncertainties generated by contingent social and environmental factors.
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~1005~
A COMPLEX APPROACH TO CLIMATE CHANGE

EXTERNALITIES
Florian COLCEAG1
IRSCA Gifted Education, Romania
Cornelia DASCALU, Chirata CARAIANI,

Camelia Iuliana LUNGU & Raluca Gina GUE
ABSTRACT
This paper analyzes the current state of the externalities in the field of climate change. The
objective of our scientific study is to provide a conceptual framework for the complex analysis
of phenomena with a destructive environmental impact, offering emerging economies a
decision alternative. Through qualitative-correlative research, based on complexity sciences,
this paper approaches the issue of climate change externalities from the perspective of
environmental feedback controlled by triangulated Source Sensor Decision-maker
structures. The main result of the research is the complex analysis model of externalities,
adapted to Triple Bottom Line reporting, convergent with the requirements of corporate
social responsibility.
KEYWORDS: climate change, externalities, Source Sensor Decision-maker,

performance, sustainability
INTRODUCTION
Interactions between human factors and the natural environment are pervasive and
manifest in various forms, without any possibility for direct communication of
accurate and coherent reporting of causes, actions and effects. Due to environmental
phenomena, which can directly and implicitly affect the economy, the need to
understand the rules of the game is becoming increasingly important. At the
present, the global crisis is intensified by global climate change, with deep
implications for the environment, society and economy. The expression "climate
change" is increasingly used instead of global warming to describe the materialization
of cumulative environmental changes and not only the rising temperatures (Staudt et
al., 2008). The general term of climate change means any form of climate deviation
that has no physical cause or statistical nature. The reasons for this complex
phenomenon are natural (changes in solar activity, long-term changes related to the
Earths orbit, and natural internal climate system processes) and anthropogenic
(increasing atmospheric concentration of carbon dioxide and other greenhouse gases).
In a narrow sense, climate change shows significant adjustments of climate elements
during a given period, within economic, social and environmental effects. Climate
change is an environmental issue, which creates risks in the development process
(European Commission, 2009). Food crises, water shortages, the spread of diseases
1
Correspondence address: Florian COLCEAG, IRSCA Gifted Education, Bucharest, Romania;

email: florin.colceag@gmail.com
~1006~
into new territories, destruction caused by floods, forced migration of populations

caused by land desertification, and rising levels of seas and oceans are only a few
effects of climate change that all countries must recognize.
While studies are underway on the main cause of global warming (Le Treut et al.,
2007; Solomon et al., 2009), there is a scientific consensus that the greenhouse effect
is the main item in the hierarchy of causal factors. Although it is a natural
phenomenon consisting of a partial retention of the Earths radiation in the
atmosphere, the greenhouse effect is caused by greenhouse gases, which reflect
radiation. Greenhouse gases are the effect of human activities, currently supported by
objects, equipment, machinery, etc., all generating major environmental impact.
The lack of complex tools to address this issue, as well as linear-thinking trained to
operate without a complex understanding of the dynamics and the evolutive structure
of the environment, are problems which may jeopardize humanity in the future.
Despite warnings from climatologists, economists and other specialists, the world is
not yet sufficiently aware of the dangers of climate change. Wright and Erickson
(2003) are concerned about the incorporation of possible catastrophic consequences in
the integrated models developed to assess global climate changes. Studies by
Rokityanskiy (2007) discuss the regulatory aspects concerning greenhouse gases
(carbon and methane) which have a potential to destroy the Earths energetic balance
and trigger a catastrophic event. Le Kama et al. (2010) agree that environmental
destruction caused by economic activities may be irreversible and that the level when
environmental degradation becomes irreversible is unknown. There is no perception
of complexity, dynamics, exponential growth, or the momentum of changes in climate
change. This leads to the preservation of traditional social structures, and a slow
response to current problems, that are still assessed using a quantitative approach,
with similarly low efficiency, precision and adequacy. Although catastrophic and very
uncertain, variations in climate changes may generate a butterfly effect starting from
insignificant quantitative data, with qualitative changes in information, relationships,
direction, data structure etc. (Olmstead, 2011).
The perception of ecological crises is directly correlated with social and cultural
values. The currently enforced polluter pays principle is bound to the culture of
using financial values as an assessment tool for any product, although the amount paid
does not often compensate the damages done to biodiversity. Additionally, the ethical
approach in regard to the environment is the total prohibition of pollution. Otherwise,
it becomes obvious that manufacturers are allowed to pollute, provided they pay ecotaxes. The tendency of the political and economic environment to approach
environmental problems in economic terms is clear. The issue of externalities is
broader than the assessment and measurement for the prevention of pollution. It is
bound to the environmental impact of a corporate activity, and where regulations are
consistent with sustainability principles, the companys ability to generate profits is
severely affected. The mechanisms of taxes that will ultimately benefit stakeholders
through specific policies fail to simultaneously cover the social and sustainability
needs. Therefore, there is a pressing need for an initial assessment of the complex
relationships between the environment and humanity, as well as the relationships
between the economic and financial mechanisms, before designing political decisions
and fund allocations.
~1007~
This research endorses the idea from Tol (2009) that climate change, more
comprehensive, more complex and more uncertain than any other environmental
issue, is the origin of all externalities. The research hypothesis is:
With climate change, sustainability may be achieved through a qualitative-correlative
approach, characteristic to complexity science.
To support the research hypothesis and to create a real image of the knowledge limits,
the first section of the paper presents representative models developed thus far for
recognition and analysis of externalities in the context of severe global climate
change. The second section presents the qualitative-correlative modeling in terms of
global climate change events. Qualitative analysis can be balanced by classical
quantitative analysis methods incorporated into the accounting models, in order to
establish the extent of information flow, with directions determined by commutative
circuits and diagrams. The resulting reference scheme represents the sustainability
model in the context of global climate change.
1. THE ANALYSIS OF CLIMATE CHANGE EXTERNALITIES
The manufacture and consummation have effects that ascribe costs and benefits to
third parties, without affecting the prices of goods or services; these are externalities.
The externality arises when the manufacturing cost of a good or the benefits
associated with its consumption are allocated to someone other than the manufacturer
or the consumer, respectively. Environmental externalities represent the negative
(cost) or positive (benefit) impacts of manufacturing and consumption on the
environment, which are not recognized, but affect consumer satisfaction and entity
value, avoiding the market mechanisms.
Neoclassical economics failed to provide a consensus regarding solutions to remedy
external effects. Pigou (1920) finds that taxes and regulations can spontaneously
correct the prices of ecosystem-generated services. Coase (1960) believes that a
market response generated during the development process leads to a spontaneous
reaction, associated with externalities. In Coases approach, the monetary
measurement is the result of demand and supply of environmental services,
constituting an active economic factor. Costanza et al. (1997) support the necessity of
a financial measurement of services created by the natural environment, as well as the
measurement of collateral damages created by affecting these environmental services.
They believe that in the case of externalities, any evaluation is better than no
evaluation at all.
Externalities causing damages to the environment and community generate costs that
appear, for example, when a company releases a pollutant into the natural
environment without an economic transaction taking place (Antheaume, 2003). An
entity involved in the monetary measurement of costs for goods and services may take
into account clean air and unpolluted water, or raw materials, but it does not take into
account the multiple effects of its economic activity on biodiversity. Therefore, an
inadequate understanding of environmental mechanisms prevents a correct financial
assessment of environmental impacts and of the way they subsequently affect the
economic environment and health.
~1008~
Attempts by economists to describe the relationship between the economy and the
natural environment in terms of costs have resulted in a number of modeling theories
(Azar and Schneider, 2002; Nordhaus, 2007; Faber and Frenken, 2008). These
theories currently allow a quantitative assessment, covering the stability interval of
the relationship, but are unable to characterize its internal structure. The global
warming phenomenon, caused not only by industrial and domestic pollution, but also
by the discretionary intervention of economic society on the balance of biodiversity,
has intensified and diversified the relationship between the economic and natural
environment, emphasizing externalities of an exhaustive nature.
A considerable amount of economic literature has approached the issue of climate
changes, their causes and potential impact, and also the costs to mitigate the process
(Edmonds and Reilly, 1983; Nordhaus, 1991; Pearce, 1991; Cline, 1992;
Schmalensee, 1993; Weyant, 1994). From the perspective of economic analysis,
recognizing the irreversible nature of pollution caused by economic activities induces
the hypothesis that the natural environment has the capacity to absorb pollutants at a
constant rate (Keeler et al., 1972; Gradus and Smulders 1993). Other researchers
(Forster, 1975; Dasgupta 1982) have formalized the assimilation function of nature,
correlating the level of pollution and the absorption capacity of the environment: the
more intense the pollution, the lesser the level of environmental assimilation. These
works are deterministic in nature. Attempts to optimize the balance between the wellknown business interests and the not yet fully configured or understood environmental
interests, have created compromise models hoped to generate valid solutions.
Reductionist approaches specific to the twentieth century have permitted the
accumulation of a massive amount of information, multifaceted and in all areas. This
information must be integrated through the vision of complexity sciences into
aggregated models, holistic, dynamic and on multiple layers of complexity to
understand the nature of complex crises generated by climate change.
At the end of the twentieth century, policies to reduce the destructive effects on the
environment were shaped to reflect sustainable development and economic growth;
the optimal emissions policy leads to uncertainty about the occurrence of
environmental events, which may lead to a continuous decline in wealth. The resource
of air purity is renewable due to the natural process of eliminating carbon dioxide
and other gases form the atmosphere through, for example, photosynthesis or the
dissolution of pollutants into the ocean, in conditions we hope to be stable, but have
an unclear dynamic because of the disappearance of species. Similar processes have
been considered by Clarke and Reed (1994).
The description and recognition of these change processes allows managers to decide
at any time if it is desirable to keep emissions below the natural rate of purification.
Additionally, it is important to see if it is possible to maintain the probability of
occurrence or restriction of emissions at or below the purification rate, avoiding the
risk for the occurrence of severe environmental events. These decisions are currently
ignoring the issue of alleged stability of the natural environment and primarily
consider the economic factor in terms of profitability. The possibility to avoid risks,
originating in the nature of environmental events considered here is unique for our
research and has important consequences. On the other hand, the policy of pollution
allowances does not solve the problem of natures ability to intervene, but gives way
to risks for unpredictable biological and ecosystem catastrophes.
~1009~
Clarke and Reed (1994) emphasized the importance of continuous and discontinuous
damage effects on accumulated pollution. Similarly, we explain the recognition of
direct costs associated with air pollution, caused by the hazardous effects of pollutants
(other than greenhouse gases). These direct costs manifest themselves in the form of
increasing healthcare costs, reducing agricultural crops, degraded values of
recreational areas and advanced corrosion of materials and buildings; examples of
such costs are identified in the works of other authors like Hohmeyer (1988),
Nordhaus (1991), Ottinger et al. (1991), Cline (1992) and Curtiss et al. (1995). The
main characteristic of such procedures is the recognition of the external effects of
pollution. Typically, profit-based economic and financial effects do not take into
account the irreversible degradation of the balance of biodiversity. We consider that
these events are not necessarily irreversible: there is life after the event. Therefore, we
assume, for any event, that it is partially reversible and that there is a possibility to
recover from the impact with the help of remediation activities. The cost of such
remediation activities, once it is identified, may have a profound effect on the
optimization of policies regarding pollution. Furthermore, the remediation of natural
balances is uncertain as long as the biodiversity equilibrium which currently allows
an efficient intervention to reduce pollution through specialization of species is
destroyed.
The catastrophic environmental effects covered by the Cropper model (1976), and the
effects of catastrophic environmental collapse risks on the optimal and equitable
consumption/pollution tradeoffs presented by Clarke and Reed (1994), are generated
by random environmental processes whose probability of occurrence depends on the
concentration of pollutants. Therefore, the risk of occurrence of such events depends
exclusively on the current level of pollution, and not on the history of pollution or the
actual trends. In this case, uncertainty results from the lack of information regarding
the critical point of pollution, which triggers these events, rather than the real
stochastic environmental processes. In our opinion, the profound lack of knowledge
regarding the pollution phenomenon and the pollution levels are endogenous risks.
This includes internal causes which may be manipulated if there is a coherent global
framework to reduce uncertainty and the hazard of destructive effects on the natural
environment. The hypothesis of Cropper (1976) and Clarke and Reed (1994)
determine that the pollution levels and the hazard of environmental effects are
external to the system (exogenous). This different approach leads to specific actions
with important implications for optimal policy formulation and analysis. Stochastic
analyses ignore qualitative relationships, treating dynamic and complex structures in
numerical terms, which make it unsuitable for understanding relationships that
maintain the equilibrium of the planet.
When viewed through the lens of history, this reality is revealed in the form of
endogenous uncertainties the critical conditions must be kept below the pollution
levels achieved in the past (if such an event has taken place before). For example, in
the case of endogenous uncertainties, the probability of hazard occurrence is
diminished by applying a policy to not increase pollution, in which case the planner
can avoid the risk of occurrence by prohibiting emissions exceeding the natural
purification rate. Returning to a pollution level below a certain threshold value,
however, cannot recreate extinct species or lost balances. Therefore, the objective is
sensitive to the upward or downward trend of pollution and to the natural mechanisms
to reduce pollution, which are generally ignored or unknown. For this reason, it is
~1010~
essential to establish a monotony property of the state of the variable pollution must
neither be increasing nor decreasing along the optimal plan before the problem is
correctly formulated. The equilibrium implies that the optimal emissions form an
interval whose limits attract the pollution process outside the interval, from any initial
level. This is an optimistic point of view if the process is regarded from the
perspective of increasing variability of responses from the natural environment,
caused by the degradation of biodiversity. Considering the response of the natural
environment as a constant, induces an unjustified optimism underlying the economic
policies regarding the emissions of pollutants. In comparison, the exogenous events in
the Clarke and Reed (1994) study generated isolated equilibriums.
A similar structure was determined by Tsur and Zemel (1995) in the context of
renewable groundwater in aquifers under threat of salt water intrusion. The event of
salt water intrusion occurs when the state of the aquifer a body of underground
water filtered through a water-permeable rock, but not salt water reaches an
unknown threshold. In the aquifer, salt water intrusion is irreversible and terminal (the
damages cannot be repaired). The initiative of reversible events analysis provides an
opportunity for participative attitudes (Tsur and Zemel, 1995). Considering, for
example, the probability of polar glaciers to disappear and change the state of the
water, we find that the aquifer and water purity are dependent variables which are not
yet accounted for, and that conventional reporting does not reflect the complexity of
processes. The analysis takes place in terms of comparing decision problems where
the hazardous events cannot be ignored. For this type of problem, there is a single
point of equilibrium in which the optimal condition (concentration of air pollution)
converges from any initial level. When the environmental protection costs are high,
the equilibrium interval extends beyond the relevant levels of state variations,
implying that it is never optimal to keep emissions over the level of natural
purification rates (Tsur and Zemel, 1996).
Even if the severity of global warming is a threat to the existence of humanity, the
problem is still approached from the carbon variable. The carbon in the carbon
dioxide implicitly affects the oxygen equilibrium of the planet, with similarly
irreversible effects. According to Lovelock (2009), a 2% increase or decrease could
result in burning the entire vegetation through auto-combustion or the impossibility of
respiratory processes. For this reason, there is a need for complex and correlative
approaches, of a metabolic type, which consider the effects of economic activities in
the phenomenon of global warming.
The indicator currently used to assess the environmental component in Triple Bottom
Line evaluations is the Global Reporting Initiative (GRI) system. It includes reporting
indicators structured in accordance with the information requirements of stakeholders:
Core indicators, which are relevant to most reporting entities and of interest to
the majority of stakeholders;
Additional indicators, which are the result of emerging practices or show
interest to some organizations. These are currently tested and may become
core indicators.
The GRI reporting framework for environmental issues is presented in Table 1.
~1011~
Table 1. Environmental Performance Indicators

Environmental
aspects
Materials
Energy
Core indicators
Additional indicators
EN1 Materials used by weight or volume.

EN2 Percentage of materials used that are
recycled input materials.
EN3 Direct energy consumption by primary
energy source.
EN4 Indirect energy consumption by primary
source.
EN8 Total water withdrawal by source.
Water
Biodiversity
EN11 Location and size of land owned, leased,

managed in, or adjacent to, protected areas and
areas of high biodiversity value outside protected
areas.
EN12 Description of significant impacts of
activities, products, and services on biodiversity
in protected areas and areas of high biodiversity
value outside protected areas.
EN16 Total direct and indirect greenhouse gas

emissions by weight.
EN17 Other relevant indirect greenhouse gas
emissions by weight.
Emissions,
effluents, and
waste
Products and
services
Compliance
Transport
Overall
EN19 Emissions of ozone-depleting substances

by weight.
EN5 Energy saved due to conservation and efficiency

improvements.
EN6 Initiatives to provide energy-efficient or
renewable energy based products and services, and
reductions in energy requirements as a result of these
initiatives.
EN7 Water sources significantly affected by
withdrawal of water.
EN9 Water sources significantly affected by
withdrawal of water.
EN10 Percentage and total volume of water recycled
and reused.
EN13 Habitats protected or restored
EN14 Strategies, current actions, and future plans for

managing impacts on biodiversity.
EN15 Number of IUCN Red List species and national
conservation list species with habitats in areas affected
by operations, by level of extinction risk.
EN18 Initiatives to reduce greenhouse gas emissions
and reductions achieved.
EN24 Weight of transported, imported, exported, or
treated waste deemed hazardous under the terms of the
Basel Convention Annex I, II, III, and VIII, and
percentage of transported waste shipped internationally.
EN25 Identity, size, protected status, and biodiversity
value of water bodies and related habitats significantly
affected by the reporting organizations discharges of
water and runoff.
EN20 NO, SO, and other significant air

emissions by type and weight
EN21 Total water discharge by quality and
destination.
EN22 Total weight of waste by type and disposal
method.
EN23 Total number and volume of significant
spills.
EN26 Initiatives to mitigate environmental
impacts of products and services, and extent of
impact mitigation.
EN27 Percentage of products sold and their
packaging materials that are reclaimed by
category.
EN28 Monetary value of significant fines and
total number of non-monetary sanctions for
noncompliance with environmental laws and
regulations.
EN29 Significant environmental impacts of
transporting products and other goods and materials
used for the organizations operations, and transporting
members of the workforce.
EN30 Total environmental protection expenditures and
investments by type.
(Source: Global Reporting Initiative, 2006)
~1012~
There is an observable prevalence of quantitative reporting, while qualitative aspects

such as the direct influence of the individual human factor or behavioral issues are
summarily reported. However, these issues are studied by economic sciences and
allow the use of other reporting practices, present in quantitative approaches, even if
they reflect qualitative processes.
Sustainable development encompasses a wide range of social, environmental and
cultural dimensions complementary to economic issues. Issues are multidisciplinary
in nature, and complexity and uncertainty are the norm. Sustainable development is
also an ideologically laden concept. The conflicts of interests dissipate from the usual
business approach to adapting to the current system and making radical changes. The
conventional cost-benefit considerations solve many of the sustainability problems.
Sustainability assessment models are used to demonstrate the features and potential of
participative environmental protection alternatives.
Discussions on global warming have led to the emergence of the carbon market,
where the negotiation of the trading price for atmospheric carbon is essential. In the
carbon market, the benefits of pollution remediation generated by abandoning
polluting industries are translated into degrowth programs, according to the economic
vision for financial benefits. This pseudo-technique to reduce the effects of global
warming emphasizes the possibility to increase carbon emissions in one country,
caused by industrial pollution in another country. Therefore, there is still a tendency to
provide a reductionist approach to a complex problem, with catastrophic-type
behavior. The measures taken to reduce energy and materials consumption, decrease
industrial pollution, and enforce taxes on polluters, do not address the issue of
restoring biodiversity, which would be the only guarantee that nature can eliminate
pollution through its own means and reinstate the natural balance. These types of
studies and measures require complex approaches to biodiversity and systemic
equilibriums, as well as complex analysis instruments.
The recognition and measurement of global climate change effects is a new challenge.
The biggest issue is the shift from a model with a small number of quantitative and
measurable variables to more complex models, qualitative and/or correlative in
nature. However, the current models allow estimations for short-term or long-term
financial effects on companies. These companies are permitted a certain allowance of
carbon dioxide emissions annually, but those which exceed the established levels of
pollution are fined. From this point of view, the ecological solution would be to
discontinue the emissions of carbon dioxide and other pollutants creating a
greenhouse effect and, implicitly, global warming. In the current technological
conditions, this solution means discontinuing the activity of all oil and coalconsuming organizations and generating social and economic crises associated with
this decision. The carbon problem is still approached in a business to business manner
and without sufficient consideration for the possibility to support nature in
remediating pollution, or to create non-invasive technologies using the reporting and
analysis methodologies based on complexity sciences. Changes in seasons affect the
life-cycle of all living organisms, with direct effects on the survival of species.
Among others, destroying the species cooperation chains by their extinction occur a
reduced capacity to produce food and, profound economic crises that directly affect
the social and environmental environments. An incomplete understanding of these
~1013~
causal chains (which may only be fully comprehended through complexity sciences)
results in insufficient reporting of relevant data. Moreover, inefficient policies are
employed to solve climate change related problems.
Managerial accounting approaches are encumbered by the inherent subjectivity of
political and cultural influences, the limits of understanding, and social mechanisms
of decision-making. The measurement of environmental externalities based on the
theory of economic welfare is built on restrictive behavioral foundations. This can
only model moral values to some extent, although such values are an essential part of
peoples preferences towards the environment. In addition, many externalities are new
and complex. In these cases, the initial challenge lies not in discovering private
preferences, but in specifying the conditions for public discourse over common ways
of understanding the pertinent issues. This implies that research on the environmental
externalities, in addition to refining the theory and the applications of existing nonmarket valuation techniques, must also address the instruments and content of
political and moral debate (Frame and Cavanagh, 2008).
2. RESEARCH METHODOLOGY AND RESULTS
Due to complexity sciences, explorations that generate accounting analyses and
reports benefit from the presence of a component which analyzes the structure and
equilibrium of information flows. The equilibrium is given by the number and
structure of cycles and commutative diagrams. This is relevant to not only
understanding the information dynamics and identifying the control or accumulation
centers, but also in understanding the command circuits or control mechanisms.
The cybernetic approach given by sustainability or chaos schemes allows for an
understanding of relationships, generating factors, and information structures that may
lead to changes, regardless of the size or direction of information flows. Therefore,
the qualitative approach becomes useful in understanding the mechanisms of
informational relationships between the human structure, social and economic
structure, technological structure and natural environment structure. This cybernetic
approach is specific to the analysis models that result from complexity sciences,
allowing an intimate understanding of the complex and dynamic structures and
mechanisms for interrelationship. In terms of economy and accounting business
processes, this approach allows both the analysis of organization schemes and
organization efficiency, and the analysis of complex human relations or relations with
the components of the social and natural environment, technological impact or
organizational policies, regardless of the complexity of the studied processes and
structures.
2.1 Description of research method
To address complex modeling of climate change externalities, this research focuses on
commutative cycles and diagrams. At the base of the primary structure lies a
triangulated feedback structure containing a Source, a Sensor and a Decision-maker,
and a portfolio of possible relationships between the three components. In terms of
externalities, the cost is the main instrument for decisions on resource allocations,
production volume and structure, supply side, and technological innovations. The
cost is also the most important feedback realized through variations that identify the
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source and detect the sensor, giving the decision-maker the possibility to describe
future self-stimulating (increasing the amplitude of variations) or self-inhibition
(decreasing the amplitude of variations) behaviors. The unlimited manifestation of the
two behaviors can lead to the destruction of the system equilibrium or to the evolution
to another level of existence (Dasclu et al., 2010). Through the triangulated feedback
structure, the decision-maker can act through successive iterations until the objective
is met.
Figure 1. Triangulated structure for the complex analysis of externalities
Source S
Sensor &
Decision-maker D
Audit
Commitmen
What If
Analysis
Consumer
behavior
Decision
efficiency
Cause
determinatio
Decision
making
Conformity
assurance
Effects
determinatio
(Source: Adaptation from Colceag et al., 2010)
Primary behaviors given by the sense of the arrows that establish the relationships
between the Source, Sensor and Decision-maker are refined by the time factor, with
the possibility of self-stimulation or self-inhibition for each behavior. In the cycles of
complex analysis of climate change externalities, the game of triangulated structures
leads to behaviors that describe and offer a potential decision portfolio.
These fractal patterns generate simple schemes, corresponding to cycles, and contain a
minimum of three items A, B, and C, integrated in a perpetual relationship of
transmitting information, such as:
A B C A B......
If between A, B, and C there is a Source, Sensor, Decision-maker relationship or
function attached, we can identify:
A growth cycle: Source Sensor Decision-maker Source...
A degrowth cycle Source Decision-maker Sensor Source
Therefore it can generate behaviors that modify the overall entropy of the system or
its components.
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Considering A as the starting point, the resource base, and C, as the accumulation
base, we obtain a commutative diagram with B as an intermediate point, and the
following relationship between the three:
A B and B C A C
The model is specific to the command control structures and allows quantitative
measurements in point C, validated by B as an intermediate point.
This study is based on qualitative-correlative approaches to self-stimulating and selfinhibiting cycles as described by Prigogine (1976) in dissipative systems. Therefore,
this study uses the notions Source (S), Sensor (&), Decision-maker (D) and the
relationships between two triangulated structures that are interfering. Using this
research method, we assess the qualitative characteristics of interrelations specific to
the composite structure Source Sensor Decision-maker, generating costs that
entities are (internal or conventional costs) or are not (external costs or negative
externalities) responsible for and committed to.
Designing this model of complex analysis for climate change externalities can be
represented by attributing financial and non-financial information to the Decisionmaker element of the model. Here the Sensor is represented successively or integrated
through social and environmental factors that influence the measurement and
recognition of environmental externalities. In both cases, the behavior of cycles can
be self-stimulating or self-inhibiting. Self-stimulating behaviors increase the
amplitude, while self-inhibiting behaviors decrease the amplitude, in both growth and
degrowth cycles. There may be polygonal commutative diagrams, some having two
accumulation points and two starting points for the arrows representing the flows. The
research has revealed a vast array of dynamic life phenomena: individual and
organizational behavior, team work, and even social, economic and environmental
behavior, showing a fractal evolution (Malik, 2004).
Our previous work (Dasclu et al., 2008; Gu e et al., 2010), as well as numerous
research papers on environmental externalities (Little, 2000; Herbohn, 2005;
Vogtlnder, 2010), show that quantitative measurements on the product life cycle
made for environmental accounting systems involve assigning a value (quantitative,
measurable) to the environmental impact while achieving a certain objective. This
approach involves self-regulating cycles and commutative diagrams built on the
composite structure Source Sensor Decision-maker:
Drawing up a list of relevant energy and material consumption and discharges
in the natural environment (Source);
Estimating the potential social and environmental impact, in correlation with
the identified inputs and discharges (Sensor);
Interpreting results in terms of adopting a correct and well-documented
decision (Decision-maker).
2.2. Discussions and results
The theory of dissipative structures finds its place in the complex analysis of climate
change externalities through a complex model of open systems with the ability to
continuously generate changes or innovative transformations. A dissipative system is
formed when there are three minimal components: a Source (e.g. a source of heat), a
Sensor (e.g. a thermometer), and a Decision-maker (e.g. a thermostat). A self-
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stimulating system is manifesting, for example, when the temperature rises, and the
Decision-maker gives the order to continue increasing the temperature. The selfinhibiting system is present when, in the case of a drop in temperature, the Decisionmaker gives the order to continue decreasing the temperature. In all the other cases,
we find a self-regulatory system (Gregor, 2005).
Projecting the principles of dissipative systems onto sustainable economy reveals,
through parallelism, the following essential points:
The Earth is a complex dissipative structure made up of other dissipative
systems linked by complex interdependencies;
The lack of knowledge and compliance with dissipative structures can be
observed as the increased entropy of the natural, economic and social
environment;
observed as the destruction of species caused by global warming;
observed as financial, economic and productivity crises;
observed as the decline of public confidence in governmental structures
followed by manipulative and centralizing attempts by the state to monitor and
insure control; and the violation of basic human rights;
The dissipative approach of complex relationships that allows the
identification of energy and financial flows, or other types of flows, depends
on the scope of the theory;
Sustainable management decisions require an understanding of systemic
complexity and dynamics;
There is a possibility to transfer the behavioral patterns between various
dissipative systems, for example, between the cycles from the economy of the
living cell to the global economy.
Dissipative systems, characterized by entropy and synergy, stimulation and inhibition,
commutative circuits or diagrams, flows or accumulations, information or functional
structure, behaviors or adapting portfolio, are adequate instruments for the qualitative
approach of various phenomena generated by internal structuring rules and
interactions with the environment.
Physical considerations from the theory of dissipative systems are perfectly adaptable
to the unbalanced and crises-generating social, economic and environmental
phenomena, which must be controlled in the context of a real sustainable
development. Adaptation involves a quantitative analysis of the phenomenon,
according to the changes in entropy. Additionally, a qualitative-structural analysis and
a complex, dynamic analysis of internal mechanisms generated by the interferences
and interactions of dissipative systems is needed. This is achieved not only through
geometric homological or algebraic modeling (triangulated structures), but also
through quantitative vector models.
The involvement of civil society in environmental and social issues is considered and
characterized by two dissipative systems, the natural/social environment and civil
society. A triangulated approach to the two dissipative systems identifies each
benchmark composite structure, with real correspondents presented in Table 2.
~1017~
Table 2. Dissipative systems involved in environmental issues

Dissipative systems
Natural/social
environment
Civil society
Composite structure
Source
Sensor
Decision-maker
Source
Sensor
Decision-maker
Real possible correspondents

Stability of the social and natural environment
Temperature/degree of agitation and tension
Pollution/loss of cultural, economic, political equilibrium
Public policy crises management/ response to abuses
Reactivity/response to imbalances
Organized action/response to emergencies
The interaction between the two systems generates eight other systems which are
structured according to the characteristics and functions in growth and degrowth
cycles and commutative diagrams.
In Table 3, we summarize the eight triangulated structures as a result of complex
analysis of climate change externalities, identifying the action on the emitting system,
with results captured by the receiver.
Table 3. Complex approach for climate change externalities by cycles and diagrams
A. Growth cycles
Interfering structures
Source = Stability of
natural and social
environment
Emitting system
Natural/ social
environment
Action
Volunteer work
Result
Response reactivity to
imbalances = Sensor
Receiving system
Civil society
Sensor = Response
Civil society
reactivity to imbalances
Maintaining
values
Reactions against pollution,

loss of cultural, economic,
political balance = Decisionmaker
Natural/ social
environment
Decision-maker =
Natural/ social
Pollution, loss of
environment
cultural, economic,
political balance
Source = Crises
Civil society
management/ response to
abuse
Penalty
Stability of the natural and

social environment = Source
Natural/ social
environment
Alternative
planning
imbalances = Sensor
Civil society
Urgent actions
Actions organized according Civil society

to the emergencies =
Decision-maker
Crises management/ response Civil society
to abuse = Source
Sensor = Response
Civil society
2 reactivity to imbalances
Decision-maker =
Organized actions/
response to emergencies
B. Degrowth cycles
Source = Stability of
3 natural and social
environment
Actions organized
according to the
emergencies = Decisionmaker
Sensor = Temperature/
degree of agitation and
tension
4 tension
Civil society
Cooperation
Natural/social
environment
Organization
Civil society
Transparent
cooperation
Natural/social
environment
Warning
Stability of natural and social Natural/ social

environment = Source
environment
Natural/social
environment
Responsibility
Crises management/response
to abuse = Source
Cooperation
Organized actions in response Civil society

to emergencies = Decisionmaker
Source = Crises
Civil society
management/response to
abuse
~1018~
Actions organized according Civil society

to the emergencies =
Decision-maker
Control of temperature and
Natural/ social
degree of agitation and tension environment
= Sensor
Civil society
Decision-maker =
Civil society
Transparent
Organized
cooperation
actions/response to
emergencies
C. Commutative diagrams starting from Decision-maker
Source = Crises
Civil society
Involvement
management/ response to
abuse
Control of temperature and

Natural/ social
degree of agitation and tension environment
= Sensor
Alternative
planning
Sensor = Response
reactivity to imbalances
Civil society
Source = Stability of the Natural/social

natural and social
environment
environment
Civil society
imbalances = Sensor
Urgent actions
Organized actions in
Civil society
= Decision-maker
Decision-maker =
Organized
actions/response to
emergencies
8 degree of agitation and
tension
Decision-maker =
Organized actions/
imbalances = Sensor
Volunteer work
D. Commutative diagrams starting from Source

Natural/social
Decision-maker =
Previsions
Pollution, loss of cultural, environment
economic, political
balance
Maintaining values
tension
Natural/ social
environment
Maintaining values Stopping pollution,

Natural/social
cultural, economic and environment
political imbalances =
Decision-maker
Organization
Organized actions in
Civil society
= Decision-maker
Sensor = Reactivity of
response to imbalances
Stopping pollution,
cultural, economic and
political imbalances =
Decision-maker
Civil society
Control of temperature
and degree of agitation
and tension = Sensor
Natural/social
environment
Stability of the natural

and social environment =
Source
Stability of the natural
and social environment =
Source
Natural/social
environment
Natural/social
environment
Warning
Natural/social
environment
Civil society
Transparent
cooperation
Control of temperature
and degree of agitation
and tension = Sensor
Natural/social
environment
Natural/social
environment
Responsibility
Civil society
Civil society
Cooperation
Crises management/
response to abuse =
Source
Crises management/
response to abuse =
Source
Civil society
This complex approach provides flexibility to the decision-making process and it is

consistent with the Triple Bottom Line reporting model, in the context of social
corporate responsibility. Our future research proposes a component designed to
correct errors through systems with four points of support.
~1019~
CONCLUSIONS
Complex and dynamic approaches have the potential to cover the gaps generated by
the traditional linear quantitative approaches by introducing new instruments to
approach issues and design solutions. These approaches cannot always be translated
into financial or quantitative terms. Translation in financial terms is possible in the
case of interference between the economic factor and another factor, but it is not
feasible for phenomena connected with the economic environment. Biodiversity has
emerged independently from the economic human factor, and therefore it cannot be
assessed either in financial terms, or through economic, financial or political measures
of intervention. In the case of biodiversity, the influence of the economic factor is
invasive. The social and economic environment consumes the same resources as
biodiversity and generates entropy, as opposed to biodiversity which generates
synergy.
Understanding how best to relate the organization performance and the
macroeconomic issues is an evolving process. Global Reporting Initiative
recommends reporting entities to explore ways in which to include these aspects in
their sustainability reports directly; doing so would accelerate the process of
understanding these links, both by themselves and with their users (GRI, 2006).
To create projections of reality that can be studied by integrated analysis, the complex
approach to global climate change externalities provides a solution. It validates the
need to create an integrated framework to "reduce complexity" so that it becomes
predictable, controllable and responsive to the actions of correcting the destructive
effects caused by natural or human forces. This framework should allow integrating a
variety of areas relevant to sustainability, including both natural and social sciences
and using a system of values that are recognizable, identifiable and quantifiable. The
framework should be accessible to decision-makers, combining different effects of
options in various areas. Lastly, it calls for the development of human abilities, which
are now limited to monitoring a small number of dimensions of reality (Huppes and
Ishikawa, 2009).
ACKNOWLEDGMENT
This work was supported by The National Council for Higher Education Research
Executive Board for Financing Higher Education and University Research (CNCSIS
UEFISCSU), project PN II IDEI 1825/2009: Researches, developments and
innovations in social environmental accounting from the policies and procedures
perspective for global warming eco-costs recognition in Romania.
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DIFFERENCES REGARDING ENVIRONMENTAL

REPORTING: THE CASE OF ROMANIAN
ORGANIZATIONS
Ionel-Alin IENCIU1
ABSTRACT
Since environmental reporting remains voluntary at international level, there are major
differences in terms of the quality and quantity of the environmental information reported by
organizations in different sectors and countries. The main objective of the study is to analyze
the corporate environmental behavior and to suggest factors that explain the quality and
quantity of environmental disclosure within Romanian organizations. The results show that
the environmental information provided by the Romanian organizations is incomplete and
irrelevant for stakeholders. The statistical analysis has demonstrated that environmental
reporting in the case of Romanian organizations is influenced by the size of the entity, by
public exposure and by the structure of the shareholders.
KEYWORDS: environmental reporting, Romanian organizations, performance, public

exposure, size
INTRODUCTION
Since the environmental reporting is a voluntary fact at international level, there are
major differences in terms of the quality and quantity of the environmental
information reported by entities in different sectors and countries. Many studies have
investigated various determinants of companies voluntary disclose practices, but most
of all have been inducted in developed countries such as Germany (Cormier et al.,
2005), UK and US (Holland and Foo, 2003); Australia (Frost, 2007; Deegan and
Rankin, 1996), Spain (Larrinaga et al., 2002; Criado-Jimenez et al., 2007), Canada
(Buhr and Freedman, 2001), Nordic Counties (Nyquist, 2003). Only a few studies
have analyzed environmental reporting within developing countries: Malaysia
(Sumiani et al., 2007), India (Chatterjee and Mir, 2008), Kenya (Dulacha, 2006),
Zimbabwe (Owusu-Ansah, 1998).
The study adds to the literature that analyzes factors that influences voluntary
disclosure in developing countries such as Romania. In the absence of a regulatory
framework regarding environmental reporting the paper analyze the quality of
environmental information disclosed by Romanian organizations and suggest factors
that determine companies from a developing country such Romania to report
environmental information.
Correspondence address: Ionel-Alin IENCIU, Babe-Bolyai University, Faculty of Economics and

Business Administration, Cluj-Napoca, Romania; email: alinienciu@yahoo.co.uk
~1024~
1. ENVIRONMENTAL REGULATION IN ROMANIA

As many other countries from Central and Eastern Europe, Romania inherited heavy
environmental problems from the communist period. These problems were caused by
the industrial policy based on high productivity that did not take into account the
impact on environment and public health. The biggest issues concern sectors like:
water quality, waste disposal, and air and soil pollution. In Romania the
environmental policies were born during the 90s once with the former Ministry of the
Environment. The national objectives regarding the environmental field were
elaborated in 1992, The National Strategy for Environmental Protection being
revised in 1996 and 2002. Starting from 1999, Romania has adopted a National
Strategy for Sustainable Development, in accordance with the area regulations in
Europe and worldwide. Since 2000 the national environmental policies try to assess
the European standards and objectives, the environmental aspects becoming an
important component for Romanias general policy. The year 2007 marks the
integration of Romania into the European Union, the implementation of European
environmental policies and the introduction of new European funding programs for
environmental protection activities (structural funds). Since 2008, Romania has a new
National Strategy for Sustainable Development, characterized by a new philosophy of
development of the European Union and worldwide shared. The strategy sets actual
targets for the transition to a generating value added development model, aimed at a
continuous improvement of the quality of people life and their relations in harmony
with the natural environment.
However, there is, so far, no legislation in this area, requiring organizations from
Romania, listed or not at the capital market to provide stakeholders separate reports or
specific information relating to the environmental impact. Providing such information
would be useful, especially for listed companies and for those operating in industries
considered highly polluting. In other words, the entitys commitment regarding the
environmental impact or environmental issues remains voluntary in the case of
Romanian companies.
The study accomplished by Lee and Hutchison in 2005 (Lee and Hutchison, 2005: 86)
provides a current state of the factors that could influence environmental reporting
and categories them in three types: external factors (laws and regulations, the
legitimacy of the entity, rising public, public exposure); factors related to the entity
(features, the cost/benefit report, other tests); Individual factors (culture, attitude). In
this study we take into consideration:
1 External factors such as public exposure (expressed by section or category on
the stock exchange or the share of sales for export);
2 Factors related to the entity such as the entitys characteristics (size expressed
by the turnover and by the number of employees);
3 Individual factors related to the capital structure (the origin of capital, the type
of capital, the number of shareholders);
4 Factors related to environmental performance (fines from Environmental
Guard; if the entity pollutes the environment as stated in negative press
articles, environmental performance indicators);
~1025~
5 Factors related to the entitys financial performance (financial performance);

6 Factors related to the entitys membership in various environmental programs
(PANP membership carbon emission, the coming out in the Register of the
Romanian Polluters appeared in 2007).
In order to check the existence of these links, I formulate the following assumptions
that I tried to validate through statistical analysis:
H1: The level of environmental reporting for a publicly traded organization from
Romania depends on the entitys public exposure. In formulating this hypothesis was
started from the following consideration: the more an organization is exposed to the
public (investors, users, media, etc.), the more it would be willing to provide all
possible information on various aspects, including environmental information. This
hypothesis was tested in studies such as those of Brown and Deegan (1998), Patten
(2002) etc. The public exposure of an entity was quantified by turn by three variables:
the section on the Stock Exchange (the organization may be traded on capital markets
BVB or RASDAQ), the category at the Stock Exchange (the organization may be
listed in Category I, II or III) and the sales percentage intended for export (here was
analyzed especially the opening of the organization outdoors).
H2: The size of the entity determines the level of environmental reporting. The size of
the entity, in particular the intensity of the work carried out, would represent, from our
point of view, an essential factor of environmental reporting. Pattern (1991) and
Milne and Hackston (1996), Cormier and Magnan (2003), Cormier et al. (2005),
Belkaoui-Riahi (2001), Watson et al. (2002) are some of the researchers that have
demonstrated over time the correlations between the size of the entity and the level of
environmental reporting. Ahmed and Courtis (1999) found that size, listing status and
financial leverage influence voluntary disclosure. The size of the entity is expressed
by two variables: turnover and the number of employees.
H3: The capital structure determines the level of environmental reporting for the
Romanian entities. Cormier and Gordon (2001) showed that the status of the capital
(public or private) influences environmental reporting. Cormier and Magnan (2003)
showed that the dispersion of the capital (national/foreign) positively affects
environmental reporting in the annual report. The following variables were examined:
the status of the capital (public or private), its dispersion (Romanian or foreign) and
the number of the shareholders.
H4: The level of environmental reporting is closely linked to the environmental
performance for the Romanian entities, environmental performance of an organization
being expressed by three indicators: whether or not appeared press articles related to
the negative environmental performance for a particular entity; whether an entity has
been fined or not by the Environmental Guard for not complying with the related
legislation; environmental performance expressed in financial terms as being equal to
the total number of emissions in the environment related to turnover (we considered
the polluting level reported to the intensity of the work performed). In the study
conducted in 2002, Dennis Patten (2002) demonstrates, using as indicators for
environmental performance the level of emissions in the environment related to the
turnover, the existence of a negative link between the environmental performance and
the level of environmental reporting.
~1026~
H5: The financial performance of en entity determines the quality level of

environmental reporting. In formulating this hypothesis, we assumed that an
organization with positive financial performance (profit) gives greater importance to
environmental issues. There have been previous studies that sustain this hypothesis
(Wallance and Naser, 1995; Belkaoui-Riahi and Karl, 1978; Cooke, 1989), but also
there are some studies that argue that organizations with low profitability might
disclose more voluntary information to justify their status (Wallace et al., 1994).
H6: Belonging to different environmental programs, determines the level of
environmental reporting. Since 2007 Romania is part of the EU ETS European
Program regarding the trading of CO2 emissions to European level. There are a
number of entities in Romania taking part to this program in order to reduce
emissions. This program membership was considered to be a factor that would
determine organizations to give greater importance to environmental protection and
also to report more information on environmental impact. Also, in 2007, was
published The Registry of Polluters in Romania, where a series of organizations and
the amount of emissions into the environment for 2005 are present. Thus, we
considered that the entities that are present in this registry are determined in the future
to provide more conclusive information on the environmental impact.
I selected only organizations listed at Bucharest Stock Exchange, because they
provide annual reports, financial statements and other categories of reports (The
Managers Report, environmental reports, sustainable reports) which are publicly
available, while for unlisted organizations, the access to information is restricted. As
indicated in the previous subsection, there is a variety of studies that analyses the level
of environmental reporting in different countries, taking as a sample, particularly
listed entities (Gamble et al., 1995; Deegan and Rankin, 1996; Walden and Schwartz,
1997; Cormier and Magnan, 1997; Brown and Deegan, 1998; Larrinaga et al., 2002;
Deegan et al., 2002; ODonovan, 2002; Burritt, 2002; Al-Tuwaijri et al., 2003;
Comier et al., 2005; Frost, 2007; Taylor, 2007; Sumiani et al., 2007). Thus, were
taken into account 101 organizations from 22 areas of activity that may impact the
environment (Table 1).
Table 1. Areas of activity included in the study
No.
Area of activity
Symbol
Number of
entities
Agriculture, forestry and fishing
Ag
Mining industry
IE
Production and supply of electricity, thermal energy, gas, water
EE
Water distribution, sanitation, managing waste, recyclable materials

ti iti
Construction
14
Transport and storage
Tr
Food industry
IA
10
The manufacture of beverages
FB
The manufacture of textiles
FT
10
Wood processing, the manufacture of wood and cork products, except

f it
PL
~1027~
No.
Area of activity
Symbol
Number of
entities
12
The manufacture of coke products and of products resulted from

t manufacture
l
i substances and chemical products
The
of
PC
IC
13
14
The manufacture of basic pharmaceutical products and pharmaceutical
PF
15
ti
The manufacture
of rubber and plastic products
FPC
16
The manufacture of other non-metallic mineral products
PNM
17
Metallurgy industry
IM
18
Metallic construction industry
CM
19
The manufacture of electrical equipment
FEE
20
The manufacture of vehicles
FMT
18
21
The repair, maintenance and installation of machinery and equipment
22
Printing and reproduction of recorded media
RIIME
TRSI
Total number of entities
101
(Source: accomplished by the author)
For all the organizations selected I conduct a content analysis regarding the
environmental information provided in various types of reports and published
statements for the year 2007. Se I create a reporting model (Table 2) comprising four
categories of environmental information that an organizations should provide to give
users a clear and comprehensive picture of the environmental impact. This model
includes categories of environmental information that GRI Guidelines 2006 suggests.
Moreover, such models on different categories of environmental information are used
for content analysis of environmental reporting in countries such as Germany (Comier
et all, 2005), Spain (Larrinaga et al., 2002; Criado-Jimenez et al., 2007), Canada (Neu
et al., 1998), Ireland (ODwyer, 2001), Great Britain (Stray, 2007), USA (Holland and
Foo, 2003), India (Chatterjee and Mir, 2008) or in the entities listed on major
international exchanges (Davis-Walling and Batterman, 1997; Jose and Lee, 2006).
Table 2. Reporting model of environmental informational
No.
1
1.1
1.2
1.3
1.4
1.5
2
2.1
2.2
2.3
2.4
2.5
3
3.1
Environmental information detailed on categories and subcategories

Information regarding general aspects of environmental management /corporate policies
Environmental policies (information on environmental activities, the undertaken products and processes,
managements commitment to environmental issues, the responsibility to the environment, sustainability,
sustainable development)
The structure and organization of environmental management (monitoring of the environmental issues,
environmental management system, the existence of pollution control departments, ISO 14001/EMAS
certification, training and employee involvement, investments, awards)
Targets and objectives for environmental management (future investments, targets, objectives, purpose)
External initiatives regarding environmental protection (the participation in the development of
environmental standards, awards, research and development on environmental management, local
community initiatives, joint projects with other entities on environmental management, support for
environmental organizations, environmental investments)
Information regarding Environmental Audit
Information regarding environmental regulations and legislations
Actual or potential litigation for breaching environmental legislation
Fines received for violations of environmental legislation
Environmental pollution (water pollution, air, soil, noise, waste discharge)
Corrective, remedial or improvement actions, undertaken or to be taken
Present or future environmental legislation
Information on environmental pollution and resource consumption, water and energy
Carried pollution (emissions in air, discharge to waters, soil emissions the level of emissions,
discharges, information on initiatives to prevent and reduce emissions and discharges)
~1028~
No.
3.2
3.3
3.4
3.5
4
4.1
4.2
4.3
4.4
4.5
Environmental information detailed on categories and subcategories

Information on material consumption (used materials, material recycling, material recycling efforts)
Information on energy consumption (energy used, reducing energy consumption, investments and
initiatives to reduce energy consumption)
Information on water consumption (amount of water used, water recycling activities)
Information on the produced pollution on products and activities (product life cycle analysis, products or
processes impact on the environment , on the local community, on biodiversity, current or future actions
regarding the improving of the environmental performance for products or processes)
Information on environmental risk/ environmental costs/environmental obligations
Past, present or future environmental investments (details of investments, the way they contribute to
improving environmental performance)
Past, present or future operating environmental expenses (details of investments, the way they contribute
to improving environmental performance)
Environmental savings and avoided costs (cost reductions of emissions, waste, gains on recycling,
savings on energy consumption)
Environmental externalities (information on environmental externalities, the way the entity recognizes
environmental externalities in the category of environmental costs, measures to reduce environmental
externalities)
Environmental obligations (environmental liabilities, environmental provisions, environmental contingent
liabilities, accounting treatment of environmental obligations, assessment, estimation, the probability of
the resources outflow , detailing of obligations)
In order to achieve a qualitative analysis of environmental information reported by the

organizations in the study, for each subset of environmental information contained in
Table 2 it was used a scale of 0 to3 as follows:
1. If the organization does not provide information.
2. If the organization provides general information. General information refers to
information that is not specific to an activity conducted by the entity. This
information is usually standard sentences or phrases used by different entities,
not being specific to the carried activities.
3. If the organization provides information specifically described. Specific
information represent non-financial information that are specific to some
activities, industries and entities;
4. If the organization report quantitative information regarding environmental
issues. If specific issues are presented in monetary or quantitative terms, the
entity will receive the maximum score because it provides comprehensive
environmental information.
This way of coding was used in the studies conducted by Wiseman (1982), Cormier
and Magnan (2003), Comier et al. (2005) and offers the following advantages
(Comier et al, 2005:15):
allows integration of various types of information in a single figure
comparable between entities in terms of relevance;
allows the implementation of a qualitative scoring of environmental
information provided by each entity;
Although this process has its subjectivity, it eliminates irrelevant information,
taking into account only relevant information.
5. ANALYSES AND RESULTS
On a first analysis of the environmental information provided by the 101 surveyed
organizations, I select only entities providing certain environmental information
which have impact on the environment through their work. It was found significant
~1029~
the reduction of the sample to the 46 entities because it would be relevant to quantify
the environmental reporting for the entities that have environmental impact. It was
found that there are two entities (SC Albalact SA and SC Romimplent SA) who have
claimed to have no significant impact on the environment and have not provided
relevant information on the environmental impact, being thus fined by The
Environmental Guard because of the violation of the laws of the environment. This
trend highlights that the entities avoid the presentation of negative aspects (such as
fines, penalties), being thus violated the principle of true image on environmental
impact, trying to maintain its legitimacy by not providing information that could strike
its reputation. Appendix 1 (at the end of the paper) presents the descriptions of the
variable and appendix 2 (at the end of the paper) reflects the values of variables for
the 46 entities included in the sample.
Checking the first assumption I analyzed the variation of environmental reporting
related to the public exposure of the organization. As stated earlier, the public
exposure of an organization was quantified by the following variables:
1 The Stock Exchange section
2 The Stock Exchange category
3 The percentage of export sales
Table 3. The coefficient of the correlation between variables
The level
of environmental
reporting
Pearson Correlation
The Stock
Exchange
section
Sig. (2-tailed)
N
Kendall's tau_b
Spearman's rho
-.581(**)
-.623(**)
.488(**)
.000
.000
.001
45
45
45
-.549(**)
-.546(**)
.428(**)
.000
.000
.000
46
45
45
45
-.656(**)
-.654(**)
.593(**)
.000
.000
.000
45
45
45
Sig. (2-tailed)
N
The percentage
of sales export
46
Sig. (2-tailed)
N
The Stock
Exchange
category
46
** The correlation is significant for a level of the coefficient equal to 0.01.

(Source: calculations made by the author in SPSS)
The correlation between the dependent variable and the three independent variables is
reflected in table 3:
1 Pearsons coefficient (ranging between -1 and 1), for the first independent
variable (the Stock Exchange variable) is negative (-0.581 different from 0),
which demonstrates a link inversely proportional, of average intensity,
between the level of environmental reporting and the Stock Exchange section.
In other words, the entities traded on BVB have a higher level of
environmental reporting than the RASDAQ traded entities;
2 For the second independent variable (the Stock Exchange category) the
Pearsons coefficient is negative (-0.623 different from 0), which demonstrates
a link inversely proportional, of average intensity, between the level of
environmental reporting and the Stock Exchange category. In other words, the
entities that are traded in the first category present a higher level of
~1030~
environmental reporting than the entities traded in the second category,

respectively the entities traded in the third category which present the lowest
level of environmental reporting;
3 Pearsons coefficient for the percentage of export sales is positive (0.488
different from 0) which demonstrates a link directly proportional, of average
intensity, between the environmental reporting and the percentage of export
sales. In other words, the entities that export more, are publicly exposed both
in the national country and abroad, are entities more opened to the
international level ( must provide a good image both in the national country
and abroad), thus being tempted to report more information.
From the statistical analysis conducted it can be concluded that the public exposure of
the Romanian entities has a significant influence on the level of environmental
reporting, which allows us to accept the first assumption and to bring publicly
exposed as a factor that determine the quality of environmental information.
Checking the second assumption: the variation of environmental reporting depending
on the entitys size, expressed in turn by two variables: turnover and number of
employees.
Table 4. The correlation coefficient between variables
The level
of environmental
reporting
The level of
environmental reporting
Pearson Correlation
Sig. (2-tailed)
N
Kendall's tau_b
Spearman's rho
.535(**)
.000
.000
45
45
.362(**)
.383(**)
.001
.000
46
45
45
.477(**)
.530(**)
.001
.000
45
45
Sig. (2-tailed)
N
.623(**)
46
Sig. (2-tailed)
N
Number
of employees
Turnover
46
** The correlation is significant for a level of the coefficient equal to 0.01.

Pearsons coefficient reflects in both cases a direct link, of high intensity between the
level of environmental reporting and the turnover (0.623**), respectively between the
level of environmental reporting and the number of employees (0,535**). R Square
Coefficient shows that between the two independent variables (turnover and number
of employees) turnover best explains the variations of environmental reporting
(0.388%). The value of Sig. coefficient is 0, if the link is there in all three cases with a
probability of 99% (Sig. <0.01). The statistical analysis has demonstrated the
existence of a direct link, of high intensity between the size of the entity and the level
of environmental reporting, which allows us to conclude that the more intense is the
activity carried out by an entity, the more it is exposed to the polluting risk, to the risk
of appearing more in the forefront of the establishment and the media, being thus
determined to provide as much information to users as possible regarding its impact
on the environment.
~1031~
To see if capital structure determines the level of environmental reporting we analyze

the existence of statistical correlations between the level of environmental reporting
and the type of the capital (private capital/state capital), the origin of the capital
(Romanian capital/foreign capital) and the dispersion of shareholders (the number of
shareholders).
Table 5. The correlation coefficient between variables
The level of
environmental
reporting
Pearson
Correlation
Sig. (2-tailed)
N
Kendall's tau_b
Private capital/
state capital
Spearman's rho
.337(*)
.435(**)
.184
.022
.003
.226
46
46
45
.242
.353(**)
.134
.052
.005
.245
46
46
46
45
.289
.421(**)
.175
.051
.004
.250
46
46
45
Sig. (2-tailed)
N
Number of
shareholders
46
Sig. (2-tailed)
N
Romanian/fo
reign capital
46
* The correlation is significant for a level of the coefficient of 0.05.

** The correlation is significant for a level of the coefficient of 0.01.
The correlation between the dependent variable and the three independent variables
which expresses the entitys capital structure is reflected in Table 5:
1 The Pearsons coefficient (can range between -1 and 1) for the first
independent variable (private/state capital) is different from 0, and Si. Is
<0.05, which demonstrates a link directly proportional, of low intensity,
between the level of environmental reporting and the type of capital
(private/state). However, this correlation is not well defined because there are,
in the 46 entities reviewed, only 2 state entities;
2 As for the second independent variable (Romanian capital/Foreign capital),
Pearsons coefficient is positive (0.435** different from 0), Sig.<0.01 which
demonstrates a link directly proportional ,of average intensity between the
level of environmental reporting and the origin of capital. In other words, the
entities with foreign capital present a higher level of environmental reporting
than Romanian owned entities, which can be explained either by the entities
opening to outward, their membership to large international groups, either
through the more difficult access of the shareholders to internal information.
Thus the entities must provide as more information as possible on the entitys
site or in annual reports;
3 As for the third correlation, it can be noticed that the number of shareholders
does not affect the level of environmental reporting (Sig>0.1), which shows
that a large number of shareholders does not determine the entities to report
information on their impact on the environment.
~1032~
It can be thus concluded, that the only variable regarding the capital structure, which
would explain the quality level of environmental reporting for listed entities in
Romania, is the origin of the capital, the foreign owned entities representing a higher
level on environmental reporting.
Checking the fourth hypothesis: the level of environmental reporting varies according
to the environmental performance in the entities, environmental performance that we
tried to express in different forms, namely:
1 environmental performance through the media (press negative information);
2 environmental performance through the Environmental Guard (fines from the
Environmental Guard)
3 Environmental performance based on the emissions released into the
environment (total emission in the air, water, soil in 2005/turnover in 2005),
published in the Register of Polluters in Romania in 2007.
Table 6. The Correlation Coefficient between Variables
Pearson Correlation
The level of
environmental
reporting
1
Sig. (2-tailed)
N
Kendall's tau_b
Spearman's rho
Environmental
performance
(emissions/turnover)
.112
.879
.260
.742
46
46
11
-.004
-.122
.278
.973
.329
.240
46
46
46
11
-.005
-.146
.479
.973
.334
.136
46
46
11
Sig. (2-tailed)
N
Fines from
the
Environme
ntal Guard
-.170
46
Sig. (2-tailed)
N
Negative
aspects
appeared in
press
-.023
46
If we analyze the coefficients in Table 6 it can be noted that there is no correlation in

any of the three cases, implying that the environmental performance does not affect
the level of environmental reporting. A number of factors such as the negative image
as a result of newspaper articles or receiving fines from the Environmental Guard
have not determined entities to increase environmental reporting, most of these
unfavorable issues being raised in annual reports, other documents or summary
reports. It can thus be affirmed that this hypothesis cannot be validated.
Table 7 is analyzing the variation of environment reporting depending on the financial
performance (profit/loss).
~1033~

The level of
environmental
reporting
The level of environmental

reporting
Pearson Correlation
Financial
performance
.232
Sig. (2-tailed)
.125
N
Kendall's tau_b
46
45
.190
Sig. (2-tailed)
.132
N
Spearman's rho
46
45
.227
Sig. (2-tailed)
.134
46
45
Following the statistical analysis, it can be concluded that there is no link between
financial performance and the level of environmental reporting, the fifth hypothesis
being rejected.
The entitys membership in various environmental programs determines the level of
environmental reporting for the entities in Romania. Thus it will be analyzed the
variation of environmental reporting depending on:
1 Membership of PNAP carbon emissions;
2 The presence in The Registry of Romanian Polluters from 2005 issued in
2007.
The level of
environmental
reporting
Pearson Correlation
The entity is part of

PNAP carbon
emissions
Sig. (2-tailed)
N
Kendall's tau_b
Spearman's rho
-.242
.344
.105
46
46
-.086
-.150
.489
.230
46
46
46
-.103
-.179
.495
.235
46
46
Sig. (2-tailed)
N
-.143
46
Sig. (2-tailed)
N
The entity is present in

the Registry of
Romanian Polluters
46
** The correlation is significant for a level of the coefficient of 0.01.

Following the statistical analysis, it can be concluded that the entitys belonging to
various environmental programs (PANA, The Registry of Romanian Polluters) does
not determine them to provide more information on the environmental impact.
~1034~
CONCLUSIONS
The level of environmental reporting in the case of Romanian entities is very low. The
average report in 2008, the highest of the three periods analyzed is 0,78 thus resulting
a low interest manifested by the Romanian entities towards these aspects. Because
0,78 comes close to the qualitative level 1, which shows that an entity offers general
information about a certain category of environmental information, we could say that
the entities of Romania offer only general information regarding their impact on the
environment, incomplete and irrelevant information for its users;
The environmental information category which got the highest score or the
environmental aspects most often offered by the Romanian entities is the information
regarding general aspects of environment management / corporative politics, and the
less tackled aspects consist of the information regarding the environmental risks /
costs / obligations. Although the latter is the most relevant information for a detailed
analysis of the entities' impact on the environment, these aspects are neglected or
hidden by the Romanian entities. They stick to general aspects regarding the
environmental management, politics, targets and objectives, without mentioning any
details.
The main source of environmental information is represented by annual reports. 44
environmental informational cases were presented in the annual reports of the entities
(generally in section 1.1.6), which shows that annual reports are the main sources of
information of the entities of Romania. Also, the entities' sites (for those that have
one) and the explaining notes to the financial situations represent relevant sources of
information regarding the environmental impact. We could also see that no entity of
Romania listed on the BVB emits a separate environmental reporting or sustainable
reporting, which have become a regular aspect for numerous entities of European
countries, both developed and in course of development.
The factors best explaining the variation of environmental reporting in the case of
Romanian listed companies are the public exposure of the company (by means of
variables like stock exchange tier and the export sales percentage), the size of the
company (by means of turnover variable), respectively the type of capital (by means
of the Romanian / foreign capital variable), explaining 64,7% of the environmental
reporting variation in the case of Romanian listed companies. The exposed
environmental information are positive information fact representing an advantage for
companies in their relations with users, and environmental reporting is not correlated
with environmental performance, which raises again the issue of objectivity regarding
these information.
ACKNOWLEDGEMENTS
This paper is part of the research project POSDRU/89/1.5/S/59184 Performance and
excellence in postdoctoral research within the field of economic sciences in
Romania, Babe-Bolyai University, Cluj-Napoca being a partner within the project.
~1035~
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~1037~
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~1038~
APPENDIX 1
Description of the variables used
Variable
Company
Symbol
Company
Source
www.bvb.ro
Environmental reporting
level
The Stock Exchange section
ER_level
SB_E
Determine by the authors

www.bvb.ro
CB_E
www.bvb.ro
Annual report 2007
The Stock Exchange

category
The percentage of sales
export
PExp_E
Annual report 2007
Turnover
Number of employees
Financial performance
Negative aspects appeared
in press
Fines from the
Environmental Guard
The entity is part of PNAP
carbon emissions
The entity is present in the
Registry of Romanian
Polluters
Environmental performance
(emissions/turnover)
Private capital/ state capital
Turnover
Emp
PF_E
Annual report 2007

Annual report 2007
Pres_Neg_E
www.google.com
Amz_E
www.gnm.ro
National plan of
emissions allocations
PNAP_E
RegPol_E
Perf_mediu_E
Romanian Pollution
Register 2005
Romanian Pollution
Register (RPR 2005)
Annual report 2007
TC_E
Annual report 2007
Romanian/foreign capital
CRS_E
Number of shareholders
Nr.Act_E
Annual report 2007
Coding
Name of the company
Can bring value
between 0 (minimum)
to 3 (maximum)
1 - BVB; 2 - RASDAQ
1 first category; 2
second category; 3
third category
Total exports / Total
sales
Turnover (RONnational currency)
Number of employees
1 - profit; 2 - loss
1 - appear; 2 not
appear
1 were amended; 2
were not amended
1 part of; 2 not part
of
1 part of; 2 not part
of
Emissions /Turnover
1 private capital ; 2
state capital
1 Romanian capital;
2 foreign capital
Number of
shareholders
~1039~
Type
dependent
independent
independent
independent
independent
independent
independent
independent
independent
independent
independent
independent
independent
independent
independent
independent
APENDIX 2
Values of the variables used
PF
_E
Pres
_N_
E
Amz
_E
PNAP_
E
RegPol
_E
Perf_
mediu_
E
TC_
E
CRS
_E
Nr.Act
_E
26397
0,177
294954903
1269
87354241
320
102475892
625
50
2314303549
2184
ER_
level
SB
_E
CB_
E
PExp_
E
Petrom
2,35
54
12284378408
Dafora
0,25
Rompetrol Well
Services
Foraj Sonde
0,45
0,25
Transelectrica
1,9
Company
Turnover
Emp
Vest Energo
0,15
26167224
75
Impact
Developer&Cont
Pentaco
0,25
108645733
166
20029345
176
Condmag
0,45
214701853
907
Transgaz
1,4
1038866794
4869
Alro
0,85
79,93
2045525398
4306
0,253
Mechel
9,33
809910584
4012
0,19
T.M.K. Artrom
0,9
72
522572481
1325
Nutricom
0,3
98957828
556
MNP
0,95
0,2
238925170
920
Ves
0,85
43169285
727
Amonil
0,95
80
87082133
406
0,666
Azomures
Oltchim
Sinteza
1,25
1,5
0,8
1
1
1
1
1
2
69,48
74
0
820607363
1749871975
13753903
2659
4836
182
1
2
1
1
1
2
1
1
2
1
1
2
1
1
2
10,732
0,099
.
1
1
1
2
1
1
3
5
3
Victoria
0,35
25189238
158
Siretul Pascani
0,9
38
15979583
445
Sef Petroforest
0,3
44,94
16954411
378
Rompetrol
Rafinare
Antibiotice
2,05
35
5429312435
879
0,056
0,85
61
229415602
1565
0,004
Biofarm
0,8
64,87
62344059
317
Zentiva
0,95
193996640
821
Romcarbon
0,55
6,86
90588846
761
Teraplast
0,4
Carbochim
0,6
32225111
386
Helios
0,25
0,6
26500787
282
Vulturul
6316451
168
Electroputere
1,3
47,83
142819099
2550
Grupul Industrial
Electrocontact
1,55
1,7
14241340
197
Armatura
0,4
31,47
30573774
402
Comexip
0,8
6654754
147
Comelf
0,6
87,29
108922175
1113
Titan
Echipamente
Nucleare
0,9
5186698
114
~1040~
Compa
77
301563792
1860
Uamt
0,4
0,7
70416635
572
Aerostar
0,8
37
139190732
1679
Santierul Naval
Orsova
Vae Apcarom
1,45
100
87376230
723
1,5
38,59
77972560
237
Avicola Iasi
0,1
32072516
409
0,052
Protan
0,15
42911182
356
0,018
Agrana Romania
0,15
441474213
679
0,001
~1041~

Massimo POLLIFRONI1
University of Turin, Italy
ABSTRACT
The aim and topic of the paper is to formulate a theoretical accounting model for the
measurement and the inclusion of a new intangible asset in the financial statements related to
environmental sustainability and social responsibility. To achieve this goal the central part of
the paper presents an accounting approach that follows an Italian research project entitled
POLIED(RO) (POL Pollenzo, I index, E environmental and economics Design). The
accounting model proposed in the study tries to accommodate the main suggestions of the
International Accounting Standards and the final result tries to propose an accounting model
oriented towards the overcoming of the current neutrality between the results of the
traditional accounting models and those derivable from social and environmental reports
realised by companies, in which is possible to assume an ideal bidirectional connection
between the different accounting approaches.
KEYWORDS: Accounting Methodology, Environmental Sustainability, Financial

Accounting, Green Accounting, International Accounting Standards, Corporate Social
Responsibility.
INTRODUCTION
The scientific objective of the project is to create an index based on a range of
different criteria, combining the various aspects of sustainability with current market
demands. The index, entitled POLIED(RO) (transl. POLYHEDRON)[POL Pollenzo
(note: Pollenzo is the town which houses the headquarters of the unit research leader,
the University of Gastronomic Sciences; for more information see at www.unisg.it;
the project period was started in December 2009 and will end in December 2011), I index, E
environmental and economics Design] is based on a variety of different aspects, all of
which possess the same scientific weight in the index, and all of which have at least
one thing in common with the others (Piedmont Region, 2009). The general aim of
the index is based on three observations:
1. the fact that existing standards can be difficult to interpret, and the presence of
an increasing range of certification without adequate consumer knowledge,
has generated confusion for consumers;
2. the demand for a return to the past, namely consumers desire to rediscover
historic products connected to the traditional cuisine of a given area,
representing an innate tourist attraction for the area, but also a cause for
1
Correspondence address: Massimo POLLIFRONI, University of Turin;

email: pollifroni@econ.unito.it
greater attachment to the area among those who live there and exhibit an
increasing desire to rediscover time-honoured traditions and products;
3. safeguarding the environment and landscape. With reference to the most
widely used voluntary certification systems, and product standards in
particular, often these are only relatively successful, due to bureaucratic
problems and a poor market response.
In order to tackle these demands, which can become pressing in view of the fact that
in some cases they prevent the certification mechanism from being effective, and in
order to forge a closer bond with the local area by means of feedback, we underline
various aspects (Piedmont Region, 2009):
the culinary and historic traditions of the products area of origin. As the work
programme shows, using the Piedmont region as an example, this unit will be
responsible for supplying basic tools for studying Regional gastronomyeconomic aspects and sociological aspects: these aspects will be analysed by
means of two sets of indicators, that will form one side of our polyhedron.
The first set is based on the relationship between production/distribution and
the local community (acceptance, sharing, participation, collective decisionmaking), while the second refers to the final consumers expectations and
frames of reference;
the environmental sustainability of the product in according to the LCA (life
cycle analysis) approach, throughout the entire production chain, and by
means of the flexible environmental management system specially designed to
take into account the various areas that the index intends to include;
the environmental sustainability connected to design and packaging, which
strongly influences the image and eco-efficiency of the entire production
chain, even more so in the case of food products;
the aspects regarding the interaction between business activities and the local
area, analysing the environmental/landscape-related sustainability of strategies
adopted by the farming and food processing industries.
The methodology applied is the system of environmental/landscape management that
was created in the context of a three year project funded by the Environment
Department of the Piedmont Regional Council. This system combines the classic
priorities of an environmental management system with the landscape issues
championed by the European Landscape Convention. This methodology will enable
us to start out from the local area and its products, identify the tasks of each partner in
the project, and construct an index capable of leading the surrounding area towards a
wide-ranging concept of sustainability first introduced in 1987 by the World
Commission on Environment and Development (WCED) as () the economic and
social development that doesnt compromise the environment and the natural
resources the continuation of human species and the future development depend on
() (WCED, 1987). The potential impact of the project consists in fostering
increasing attention to product and local area sustainability among the institutions and
the population (Piedmont Region, 2009). The aforementioned bureaucratic problems
that standards encounter have often prevented them from being adopted by producers,
and even when a certification process is initiated and completed, the widespread lack
of knowledge, and sometimes also the costs involved, have prevented the general
spread of these standards. The idea is to connect these virtuous, often isolated
examples to the local area, by means of a mechanism based on a system to manage the
~1043~
organization of research and resources (which are complementary yet diversified) to

arrive at the creation of the index in question (Piedmont Region, 2009).
This will then be returned to the local area, with the application of at least some of the
aspects of the environmental/landscape management system. The joint use of these
tools, the high degree of flexibility planned for the index, and the multidisciplinary
nature of the project from its outset should represent a sort of guarantee of results, in
view of the fact that in the organizational process and at the various stages of the
project, nothing is left to chance. Moreover, the planned trial of the index in the
Piedmont region could come to represent an exemplary point of departure, and a
model for other regional areas, in Italy and elsewhere, interested in the index. The
accounting approach followed in the research is explained in the following paragraph.
1. THE ACCOUNTING APPROACH FOLLOWED IN THE POLIED(RO)
RESEARCH PROJECT
During the last years, the topics of innovation and measurement of the results is
assuming a progressively higher relevance with perspectives of sustainable promotion
of the local and regional development and the updated approach oriented toward a
sustainable system has produced many world-wide experimentations, starting working
on a deep reflection on how to incorporate macroeconomics by environmental and
social parameters (Stiglitz et al., 2009; European Commission, 2009). The increasing
debate over the process of globalization (and of glocalization) (McLuhan, 1989;
Nederveen, 2004; Robertson et al., 2003) and, at the same time some others drivers,
like as the awareness of the important role that the innovation can assume in the
economic and social development of Italy and the new demands shown by
stakeholders (Freeman, 1984; Jones, 1995), have stressed the need, for what pertains
the activities related to the food and agricultural compartment, to develop and to use
evaluating tools more precise and shared. In this way, the experience of other
Countries and the related literature on the aforesaid issues underline that the
substantial activation of both evaluating and innovative tools generally bring
interesting benefits. Nevertheless it is to underline that such processes, when not
properly developed, addressed and understood, can bred distortions on the same
assessment activities. Moreover these evaluating activities can shape interesting
opportunity to stimulate both the link with the paradigms coming from other
disciplines and the process of internationalization of the business studies related with
the issue of food and agricultural compartment. In the light of the general objectives
of the project, the contribution priority focuses on the economic evaluation
sustainability in general sense applied on food and agricultural compartment
through the work out of a cause-effect analysis model of the processes of
production, distribution, sale and consumption of the food and agriculture
commodities, directed on two profiles of analysis (Piedmont Region, 2009):
1. the sustainability of the process, in different configurations that characterize it:
social, environmental, etc.;
2. the responsibility for the action of players (accountability) and the results
policy asseveration related (assurance engagement policy).
Under the first profile of research, in an wider and above all in a much more
sustainable vision of the food and agricultural compartment, the main purpose of
the present contribution is, therefore, to identify, systematize and implement into the
~1044~
process of the compartment the informative tools pertaining the model of the
Corporate Social Responsibility (CSR) (Carroll, 1979; Sethi, 1975). Under the second
aspect of research the main purpose of the model is to define a matrix of common
valuing elements, related to the accountability and assurance engagement policies,
that can be taken as reference in the sector of the integrated food and agricultural
compartment.
Therefore the present model wants to represent one aspect (the one purely business
economics oriented), of the wider scientific objective of the whole project, that is to
create a multi-criteria index that gathers in its own lay-out the aspects of the
sustainability applied to the processes of production, distribution, sale and
consumption of the food and agricultural commodities (Piedmont Region, 2009).
The POLIED(RO) index results in fact constituted by manifold field of study, all
pertaining to the index with the same scientific weight, all interconnected and having
at least one side in common. The aim of the present theoretical study is related to a
theory concerning accounting model that can farther reinforce the connection between
the different accounting models defined by a mutual exchange process of information
flow in which:
the environmental and social reports can, on one hand, acquire the economic
information they need to edit their own documents from the traditional reports;
on the other hand they can be in a position to reallocate the environmental and
social performance previously got in the traditional final statement,
influencing in a direct way the accounting results.
In this case the financial statement should become an independent governance
instrument used by the company (public or private) to be accountable to its
stakeholders of the results of its environmental and social policies realized in a
sustainable development perspective: at the present moment several companies use
dedicated documents regarding the environmental and social communications, such as
e.g., social reports, environmental reports and sustainability reports.
The International Accounting Standards mentioned above present an accounting
model where the financial, economic and patrimonial information enclosed with the
traditional final statement isnt directly influenced by the one enclosed with the
environmental and social reports: the main link is that the environmental and social
reports use the data produced by the traditional reports. In the environmental report
models applied to the private companies (Mathews, 1997; Lehman, 1999) or to the
public institutions (CLEAR, 2003; ISPRA, 2009), two different cluster of accounts
are expected to be used (Giovanelli et al., 2000):
the first cluster is called Physical Accounts: e.g. the set of 10 European
Common Indicators (ECI) (European Commission, 2001) is the most common
cluster used at European level and it has the focus of having indicators capable
of measuring not a specific phenomenon, but the overall sustainability at a
local level;
the second cluster is called Monetary Accounts: it concerns the money that a
company has to invest in the environmental protection.
Only the Monetary Accounts have an accounting derivation because the company
fixes them toward a reprocessing of balance (budget plan and/or final balance): this
reprocessing is the only one-way link between the two types of reports; equally it is
~1045~
not possible to have a parallel (and opposite) process where the final statement results
could be directly conditioned by the performance got from the environmental
report in a positive way (eco-efficiency) or negative trend (eco-inefficiency).
Similar consideration can be made with reference to the traditional social report
models related to the public company (G.B.S., 2005) or to the private sector (G.B.S.,
2001): during the last years the Italian Accounting Standards have used the Added
Value as a referential quantitative indicator.
For the Italian Accounting Model the Added Value is considered very important in the
social report field (Gabrovec Mei, 2002): the Added Value measures the wealth
produced by the company with reference its shareholders that participate to the
distribution of the wealth itself. Added Value is represented in two different tables
(G.B.S., 2001): the table for the calculation of Added Value, identified by comparing
interim revenues and costs (see Figure 1.); the table for the allocation of Added Value
being the summation of the remuneration received by stakeholders within the
company and the donations (see Figure 2.).
Figure 1. Schema for the calculation of Added Value
(Source: G.B.S., 2001: 21)
~1046~
Figure 2. Table of the allocation of Added Value
(Source: G.B.S., 2001: 24)
In the document of the G.B.S., mentioned above, the table for the calculation of
Added Value the articulated opposition between the positive and the negative
elements involved in the working capital that come directly from the economic
financial accounting system of the company. In both examined cases the assessment
of the Monetary Accounts in the environmental report and the Added Value
determination in the social report a common accounting derivation of the values is
recorded: both of them are determined by a data reprocessing of the final statement of
the company, but they can not able to reallocate the environmental and social
performance previously found in the final statement of the company.
The central part of the study has the aim of suggesting a theoretical accounting model
able to go beyond the informative limit (definable now as one-way informative flows)
and where it can be possible to create a bi-directional link between the report models
(an environmental and social one on one hand and a traditional one on the other
hand): this model should have a reciprocal exchange of the informative flow where
the environmental and social reports can acquire the economic information they need
from the traditional report, and then they can reallocate the environmental and
social performance they got in the final balance, directly influencing the accounting
results. The most virtuous companies from the point of view of environmental
sustainability and social responsibility should deserve an award: a new intangible
asset, a new social-green goodwill (Andr et al., 2009; Johnson, E.R., 2010) having
in return a net equity increase of the company (Kristrm et al., 2003).
The present accounting model, that introduces a new intangible asset in the balance
sheet as a reward to the most virtuous companies from the point of view of
environmental sustainability and social responsibility (Laufer, 2003), presents the
following issues:
1) determining the composition of the board responsible for evaluating;
2) defining the evaluation process phases;
3) evaluating of environmental and social performances.
The aspects mentioned above are outlined below.
1) Determining the composition of the board responsible for evaluating.
About the first point, determining the composition of the board responsible for
evaluating, the board may be: a) an internal board; or b) an external board
(recommended choice). In the case of an internal board the components are
represented by internal employees (or consultants) of the company subject, while in
the second case (external board), the model would require:
to chose an external and independent board in order to avoid the self
reference risk of the process realised by the company;
to find the auditors in the professional categories having more ability both in
the field related to the accounting profession [accountants have to have the
Certification (or Asseveration) of the accounts], or in the field related to the
environmental audits, that is () activities intended to quantify
environmental performance and environmental position () (CLEAR,
2003) [auditors have to check the Environmental Management System (EMS)
of a company (public or private) to see if it has the mandatory requirements
asked according to the international standards EMAS or ISO 14001].
The auditors opinion should be independent, according to two aspect of the problem.
The first aspect concerns the choice of the target in charge of the evaluation, that
shouldnt be the responsibility of the company, but in order to limit the discretion
should be the responsibility of the central administration (such as the Ministry of
Economy or the Ministry of Environment) or of a local administration (such as, e.g.,
the Court that has territorial jurisdiction, or the local office of the Court of Auditors,
etc.). The second aspect regards the ways of payments of the auditors: instead of a
direct payment between the company and the auditor, it should be used an indirect
way between the central (or local) administration and the auditor (in this case the
environmental fiscal system adopted by the single nation should provide for a correct
~1048~
reallocation of the resources needed to assure the correct payments of the auditors
activities). In both cases mentioned above (evaluation by an internal board or an
external board), the model would require a national or regional coordination achieved
by a public institution (a central or local administration).
2) Defining the evaluation process phases.
This point concerns the freedom of joining the evaluation process in the early on: the
freedom of choice should be limited to the years after the first evaluation accession in
order not to enforce the budget policies of the environmental and social
performances (see Figure 3.).
Figure 3. Theoretical framework of the evaluation process phases
~1049~
The adhesion to the evaluation process should be guaranteed by pre-emptively

definite cycles (for example three-year cycles or five-year cycles) and the choice of
exiting the evaluation process after a cycle should be at least as long as the length of
the attended cycle in order to avoid a periodicity adhesion which is convenient to the
evaluation process: once the minimum exclusion period is over, the company should
be able to join the next evaluation processes of its environmental and social
performance, following the same rules above described.
3) Evaluating of environmental and social performances.
The final point Evaluating of environmental and social performances can produce,
respectively, two kinds of outcomes: a qualitative result or a quantitative result.
A qualitative result as a qualitative assessment of the company may be achieved
by administering a questionnaire: it is the case realised by an internal board above
mentioned (this part of the research is in working progress and is not available at the
present moment).
The second case concerns the analysis of the companies from the point of view of
environmental sustainability and social responsibility that should deserve an award, a
new intangible value, above mentioned as social-green goodwill. This quantitative
value can be analysed alternatively as:
a non-accounting value (to say not included in the annual balance sheet);
or an accounting value, a new accounting asset included in the annual balance
sheet.
The methodological path to evaluate this new value (like a non-accounting value not
included in the annual balance sheet, or like an accounting value included in the
annual balance sheet) is shown in the following two paragraphs.
2. THE METHODOLOGICAL PATH FOR EVALUATING THE SOCIAL
PERFORMANCE
Looking for a precise methodological path for evaluating the social performance, the
model has selected the Value added distribution plan mentioned before, created by the
G.B.S., an Italian scientific no profit organisation () having the aim of developing
and promoting the scientific research on social balance and the topics related to the
stewardship of the companies in order to advance the social responsibility of the
company and its use in national and international spheres (...).
The plan suggested by the G.B.S. divides the value added remuneration in:
a) human resources remuneration;
b) civil service remuneration;
c) payment of loan capital;
d) non distributable value assigned to the preservation and the increase of the
asset.
What needs to be rewarded more could be found as a real social dynamic
charactering the company that has to be evaluated only in point a) called human
resources remuneration. This happens because:
point b), civil service remuneration,
point c), Payment of loan capital, expresses the outcome of certain fulfilments
to contract regulations that connect the company to its financiers;
~1050~
point d), Non distributable value assigned to the preservation and the increase
of the asset, ultimately, relates to the observance of particular statutory or law
obligations.
So the only winning factor (in case of socially virtuous behaviours) could be
represented by destining the value added to the employees that according to the
model proposed by G.B.S. are subdivided into: Members of the Administrative
Institutions (politically or administrative eligible); subordinate employees (with short
term or long term contracts) and non-subordinate employees and co-workers, whereas
the relative salaries are included in two classes:
Direct salaries: they include all those financial and natural components that
contribute to quantify the immediate or delayed economic benefit, that the
employee excerpts from the relation with the company. Examples of direct
salaries of the employees are: direct payment (including natural payments and
excluding refunds); severance pay or other types of funds; company provisions
(food, crche, scholarship, etc.);
Indirect salaries: they include social contributions at expense of the company
(costs defrayed for the employees are not part of the salary of the interlocutor,
because they convert in benefits obtained in a indirect way for the company
that manage the social service) (G.B.S., 2005).
That being stated, in continuing the discussion, the components we need to isolate in
order to quantify social policies (Carroll 1991; Levitt, 1958) that are actually virtuous,
and therefore winning from the social point of view, should be referable to direct and
indirect salaries of the subordinate employees with a long term contract: in the other
circumstances, particularly in short term jobs, flexible jobs, etc., the nature of contract
relations includes a priori that medium-long term planning so much wished most of
all for new generations in the contemporary debate about the optimization of
welfare models (Carter, 2006). This argument finds solace in the definition made by
the European Commission of social responsibility, as: () the voluntary decision of
contributing to the progress of society and to the protection of the environment,
combining social and ecological concerns in company dealing and in interactions
with stakeholders () (European Commission, 2000): the increasing appeal to
flexible job instruments, also in Public Administration and in our specific area of
interest, the university, unfortunately doesnt embody that spirit of cohesion and
social welfare mentioned several times in the Community document cited before. The
reflections done before have the purpose of bringing the attention to a delicate and
complex theme, the flexibility in job market, that in our model depicts itself more and
more like a physiological board towards a system structurally oriented on
precariousness. A thorough reflection about the phenomenon and about related
corrective actions is therefore appropriate, but is beyond the aim and the contents of
this contribution: parallel reflections concern the coupling of these reflections to a
model of management control oriented on the fundamental principles of efficiency,
efficacy and company inexpensiveness: so the values of the social actions are to be
isolated from those made voluntarily, in adherence to the definition of social
responsibility realised by the European Commission and above mentioned (E.C.,
2000; McWilliams et al., 2001).
After having indentified the voluntary social expenditures from those required by law
(note: in the model are relevant only the voluntary expenses), it is necessary to share
~1051~
the voluntary social expenses between current management and asset management:
this process is explained in the following points.
1) Assessment of Intangible Value Created by the Relevant Social Performance
for Current Management (IVCRSPcm(t;s)).
Taking up our approach, the formula related to the quantification in the year (t) of the
reward acknowledged for a social relevant behaviour, defined as Intangible Value
Created by the Relevant Social Performance for Current Management (IVCRSPcm(t;s))
placed under the assets of Immaterial Immobilizations with counterpart a net equity
revaluation (in the case of an accounting asset included in the annual balance sheet)
could be written as:
n
i=1
i=1
IVCRSPcm(t;s) = (SCi(s) * r(t s)) (SBi(s) * r(t s))
(1)
where:
IVCRSPcm(t;s) = Intangible Value Created by the Relevant Social Performance
for Current Management (IVCRSPcm(t;s)), quantified in the year (t) (year when
the evaluation of social performances is realized) and related to the accounting
year (s) (year when the Social Costs are paid and the Social Benefits are
obtained);
SCi(s) = Sum of Social Costs (i) concerning the year (s);
SBi(s) = Sum of Social Benefits (i) concerning the year (s);
r(t-s) = monetary revaluation rate (r) concerning the period between the
accounting year (s) (year when the Social Costs are paid and the Social
Benefits are obtained) and the year (t) (year when the evaluation of social
performances is realized).
The monetary revaluation rate (r) used in the model, should be defined directly by the
related set of rules, or indirectly referring to specific Prices Indexes for monetary
revaluation produced by official national institutions (e.g. in Italy the Italian National
Institute of Statistics Istat) or by official internationalones (e.g. in Europe Eurostat).
2) Assessment of Intangible Value Created by the Relevant Social Performance
for Asset Management (IVCRSPam(t;s)).
The same reflection concerns the social investments (Burke et al., 1996) to isolate in
order to quantify social policies actually virtuous, always referable to subordinate
employees (like, for example, the capitalization of the costs of education and research,
the construction of kindergartens and company refectories, etc.): also in this case,
these accounts should be purified from possible subsidies collected in capital accounts
for this purpose. In this last case the formula of the quantification in the year (t) of the
reward acknowledged for a social relevant company behaviour, definable as
Intangible Value Created by the Relevant Social Performance for Asset Management
(IVCRSPam(t;s)) could be written as:
n
i=1
i=1
IVCRSPam(t;s) = (SAi(s) * r(t s)) (SCBi(s) * r(t s))
~1052~
(2)
where:
IVCRSPam(t;s) = Intangible Value Created by the Relevant Social Performance
for Asset Management (IVCRSPam(t;s)), quantified in the year (t) (year when
the evaluation of social performances is realized) and related to the accounting
year (s) (year when the Social Assets are paid and the Social Capital Benefits
are obtained);
SAi(s) = Sum of Social Assets (i) concerning the year (s);
SCBi(s) = Sum of Social Capital Benefits (i) concerning the year (s);
accounting year (s) (year when the Social Assets are paid and the Social
Capital Benefits are obtained) and the year (t) (year when the evaluation of
social performances is realized).
In conclusion, the quantification of the Total Intangible Value Created by the
Relevant Social Performance (IVCRSPT(t;s)) in the year (t), is determined by the
following formula:
IVCRSPT(t;s) = IVCRSPcm(t;s) + IVCRSPam(t;s)
(3)
where:
IVCRSPT(t;s) = Total Intangible Value Created by the Relevant Social
Performance (IVCRSPT(t;s)), quantified in the year (t) (year when the
evaluation of social performances is realized) and related to the accounting
year (s);
IVCRSPcm(t;s) = Intangible Value Created by the Relevant Social Performance
for Current Management (VCRSPcm(t;s)), quantified in the year (t) and related
to the accounting year (s) (year when the Social Costs are paid and the Social
Benefits are obtained);
IVCRSPam(t;s) = Intangible Value Created by the Relevant Social Performance
for Asset Management (VCRSPam(t;s)), quantified in the year (t) and related to
the accounting year (s) (year when the Social Assets are paid and the Social
Capital Benefits are obtained).
3. THE METHODOLOGICAL PATH FOR EVALUATING
THE ENVIRONMENTAL PERFORMANCE
Even in this case the values of the environmental actions are to be isolated from those
made voluntarily, in adherence to the above definition of social responsibility realised
by the European Commission (E.C., 2000): for individualizing the areas of analysis it
is possible to follow national standards [e.g. an Italian standard is the framework
realised by ISPRA (ISPRA, 2009)] or international standards [e.g. an international
standard is the COFOG (Classification of the Functions of Government) classification
realised by United Nations (Eurostat, 2007)].
With reference to the last classification, COFOG classification, it includes for
environmental analysis these functions: 01 - General public services, 02 Defence,
03 - Public order and safety, 04 - Economic affairs, 05 - Environmental protection,
06 - Housing and community amenities, 07 - Health, 08 - Recreation, culture and
religion, 09 - Education, 10 - Social protection; then for the function n. 05 Environmental protection - there are included the following sub-sectors of financial
~1053~
analysis: 05.1 - Waste management, 05.2 - Waste water management, 05.3 - Pollution
abatement, 05.4 - Protection of biodiversity and landscape, 05.5 - R&D
Environmental protection, 05.6 - Environmental protection n.e.c. (residual division).
Our research suggests to use COFOG classification, because the fixed structure
proposed by United Nations is more preferable to the IASone and defines clearly (not
discretionary) the areas of environmental analysis making it easier to compare several
results across different cases studies: this represents a competitive advantage for
applied environmental research (Rouse et al., 1999).
Also in this case the next steps are:
identifying the voluntary environmental expenditures from those required by
law (note: in the model are relevant only the voluntary expenses);
sharing the voluntary environmental expenses between current management
and asset management: this process is explained in the following points.
1) Assessment of Intangible Value Created by the Relevant Environmental
Performance for Current Management (IVCREPcm(t;s)).
After we having individualized the environmental values on which we can apply the
model, the formula of quantification in the year (t) of the reward to acknowledge, in
these case, for an environmental relevant behaviour, defined as Intangible Value
Created by the Relevant Environmental Performance for Current Management
(IVCREPcm(t;s)) placed under the assets of Immaterial Immobilizations with
counterpart a net equity revaluation (in the case of an accounting asset included in the
annual balance sheet) could be written as:
n
i=1
i=1
IVCREPcm(t;s) = (ECi(s) * r(t s)) (EBi(s) * r(t s))
(4)
where:
IVCREPcm(t;s) = Intangible Value Created by the Relevant Environmental
Performance for Current Management (IVCREPcm(t;s)), quantified in the year
(t) (year when the evaluation of environmental performances is realized) and
related to the accounting year (s) (year when the Environmental Costs are paid
and the Environmental Benefits are obtained);
ECi(s) = Sum of Environmental Costs (i) concerning the year (s);
EBi(s) = Sum of Environmental Benefits (i) concerning the year (s);
accounting year (s) (year when the Environmental Costs are paid and the
Environmental Benefits are obtained) and the year (t) (year when the
evaluation of environmental performances is realized).
Also in this case the monetary revaluation rate (r) used in the model, should be
defined directly by the related set of rules, or indirectly referring to specific Prices
Indexes for monetary revaluation produced by official national or international
institutions.
2) Assessment of Intangible Value Created by the Relevant Environmental
Performance for Asset Management (IVCREPam(t;s)).
~1054~
The same reflection concerns the environmental investments (Nehrt, 1996) to isolate
in order to quantify environmental policies actually virtuous: these accounts should be
purified from possible subsidies collected in capital accounts for this purpose.
In this last case the formula of the quantification in the year (t) of the reward
acknowledged for a environmental relevant company behaviour, definable as
Intangible Value Created by the Relevant Environmental Performance for Asset
Management (IVCREPam(t;s)) could be written as:
n
i=1
i=1
IVCREPam(t;s) = (EAi(s) * r(t s)) (ECBi(s) * r(t s))
(5)
where:
IVCREPam(t;s) = Intangible Value Created by the Relevant Environmental
Performance for Asset Management (IVCREPam(t;s)), quantified in the year (t)
(year when the evaluation of environmental performances is realized) and
related to the accounting year (s) (year when the Environmental Assets are
paid and the Environmental Capital Benefits are obtained);
EAi(s) = Sum of Environmental Assets (i) concerning the year (s);
ECBi(s) = Sum of Environmental Capital Benefits (i) concerning the year (s);
accounting year (s) (year when the Environmental Assets are paid and the
Environmental Capital Benefits are obtained) and the year (t) (year when the
evaluation of environmental performances is realized).
The quantification of the Total Intangible Value Created by the Relevant
Environmental Performance (IVCREPT(t;s)) in the year (t), is determined by the
following formula:
IVCREPT(t;s) = IVCREPcm(t;s) + IVCREPam(t;s)
(6)
where:
IVCREPT(t;s) = Total Intangible Value Created by the Relevant Environmental
Performance (IVCREPT(t;s)), quantified in the year (t), year when the
evaluation of environmental performances is realized;
IVCREPcm(t;s) = Intangible Value Created by the Relevant Environmental
Performance for Current Management (VCRSPcm(t;s)), quantified in the year
(t);
IVCREPam(t;s) = Intangible Value Created by the Relevant Environmental
Performance for Asset Management (VCRSPam(t;s)), quantified in the year (t).
In conclusion the new immaterial asset can be defined as Global Intangible Value
Created by the Relevant Social and Environmental Performance (IVCRSEPG(t;s)) and
can be determined by the following formula:
IVCRSEPG(t;s) = IVCRSPT(t;s) + IVCREPT(t;s)
~1055~
(7)
where:
IVCRSEPG(t;s) = Global Intangible Value Created by the Relevant Social and
Environmental Performance (IVCRSEPG(t)): the value is determined in year (t)
and refers to the activities supported in year (s);
IVCRSPT(t;s) = Total Intangible Value Created by the Relevant Social
Performance (IVCRSPT(t;s)), quantified in the year (t);
IVCREPT(t;s) = Total Intangible Value Created by the Relevant Environmental
Performance (IVCREPT(t;s)), quantified in the year (t).
The last formula concerns the Global Intangible Value Created by the Relevant Social
and Environmental Performance (IVCRSEPG(t;s)) determined in year (t) and refers to
the activities supported in year (s). At this point it is possible to extend the formula for
social and environmental activities supported in a defined year cycle (w) (e.g. a three
years cycle or a five years cycle, etc.), with w = 1 (s) m. In this case the Global
Intangible Value Created by the Relevant Social and Environmental Performance
(IVCRSEPG(t;w)) determined in year (t) and referred in a defined year cycle (w)
can be determined by the following equation:
m
IVCRSEPG(t;w) = IVCRSPT(t;s) + = IVCREPT(t;s)

s=1
s=1
(8)
where:
IVCRSEPG(t;w) = Global Intangible Value Created by the Relevant Social and
Environmental Performance (IVCRSEPG(t;w)) determined in the year (t) and
referred to the activities supported in a defined year cycle (w), with w = 1
(s) m;
IVCRSPT(t;s) = Sum of Intangible Values Created by the Relevant Social
Performance (IVCRSPT(t;s)), quantified in the year (t) and referred to the social
activities supported in a defined year cycle (w);
IVCREPT(t;s) = Sum of Intangible Values Created by the Relevant
Environmental Performance (IVCREPT(t;s)), quantified in the year (t) and
referred to the environmental activities supported in a defined year cycle (w).
In the central part of the study we tried to prove theoretically the determination of the
new intangible asset attributable to companies virtuous from the standpoint of
environmental sustainability and social responsibility (Orlitzky et al., 2011): this new
intangible asset can be considered as a new social-green goodwill having in return a
net equity increase of the company that would work as a revaluation reserve (or
revaluation surplus reserve) that is created when the value of an asset becomes
greater than the value at which it was previously carried on the balance sheet,
increasing shareholders funds.
Adhering to the evaluation process, taking up what we said before, should be
guaranteed for defined year cycles (for example three years cycles or five years
cycles), and the possible choice of leaving at the end of the cycle should be confirmed
for a period at least of the same duration of the one expected for the adhesion, in order
to avoid an adhesion in alternation and for the convenience of the evaluation process.
Consequently the counterpart created as a revaluation reserve (net equity value) has
~1056~
the function to compensate possible future company losses and it should be used for
this aim only just for the part that corresponds to the revaluation related to the current
management. All this in order to avoid the creation of potential negative values of this
net equity fund showed previously (that, for example, in the case of asset divestment):
the potential connection between the new intangible asset [Global Intangible Value
Created by the Relevant Social and Environmental Performance (IVCRSEPG(t;w))] and
the related reserve is explained in Table 1.
Moreover the Global Intangible Value Created by the Relevant Social and
Environmental Performance (IVCRSEPG(t;w)) is not subject to problems of
amortization because the conditions are lacking (like, for example, the use of the
economic good, the useful duration defined of new tangibility, etc.), whereas in
adherence to the following International Accounting Standards: a) for the Private
Sector the main IAS/IFRS documents are:
IAS 36 Impairment of Assets (it deals with impairment testing for all tangible
and intangible assets, except for assets that are covered by other IFRS) (IASB,
2010);
IAS 38 Intangible Assets (IASB) (IASB, 2009) [for the Public Sector the
similar standards are: IPSAS 21 Impairment of Non-Cash-Generating Assets
(IPSASB, 2004); IPSAS 31 Intangible Assets (IPSASB, 2010)].
The present contribution in its essential parts proposed a purely theoretical model
oriented towards the overcoming of the current neutrality, previously defined, in the
connection-conditioning (reciprocal or bidirectional) between the results of the
traditional accounting and those derivable from social and environmental accounting
of the company, in which is possible to assume an ideal bidirectional connection
between the different accounting models (Griffin et al., 1997).
Table 1. Connection between the new intangible asset and the related reserve
New intangible asset
Level 1
(IVCRSEPG(t;w)) =
Global Intangible Value
Created by the Relevant
Social and
Environmental
Performance
Level 2
IVCRSPT(t;s) =
Sum of Intangible
Values Created by
the Relevant Social
Performance
+
IVCREPT(t;s) =
Sum of Intangible
Values Created by
the
Relevant
Environmental
Performance
Level 2
IVCRSPcm(t;s) = Intangible Value
Created by the Relevant Social
Performance for Current Management
+
IVCRSPam(t;s) = Intangible Value
Created by the Relevant Social
Performance for Asset Management
+
IVCREPcm(t;s) = Intangible Value
Created
by
the
Relevant
Environmental
Performance
for
Current Management
+
IVCREPam(t;s) = Intangible Value
Created
by
the
Relevant
Environmental Performance for Asset
Management
~1057~
Related Revaluation
Reserve
Potential use for
future coverage of net
equity losses
Yes
No
Yes
No
Therefore is evident that the aspects analyzed and the consequent solutions, need a
natural consolidation obtainable through the realization of a comparative
benchmarking between the actors of the system (scientific community, public
companies, interested professional orders, guarantee institutions of the process, etc.),
oriented towards the determination of a scientific method to evaluate a model that is
commonly shared by all the subject interested in the process (De Moor et al., 2005).
In conclusion it is meaningful to obtain that if the debate about how to individualize a
model of accounting that combines more the traditional accounting evaluations with
social and environmental ones, is quick, it is also nowadays a far off target: the
final wish is that this contribution can, in some ways, stimulate the common interest
towards the definition of an accounting system in which the traditional accounting
analysis are more integrated with the complementary ones (social and environmental
analysis) (Hooghiemstra, 2000; Laufer, 2003).
Further arguments and widening, combined with an experimentation on the field, will
be able, therefore, to allow a useful consolidation of this proposal and favour at the
same time a formation process of a new vision of the concept of sustainable
development referred to the accounting disciplines.
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~1060~

ON THE FINANCIAL STATE OF THE COMPANY
SECTOR STUDY
Petru STEFEA1 & Cristina CIRCA
ABSTRACT
The present article approaches the relationship between the financial objectives and the
environmental sustainability restrictions in three industrial sectors with major environmental
impact: the water and wastewater sector, the production of heating and electricity from
conventional sources and the production of electricity from wind energy. Starting from the
specific features of each sector, we shall debate the impact of the current and long-termed
financing needs on the companies performance and consistency of operations.
KEYWORDS: sustainable development, financing needs, performance, energy supply,

water supply
INTRODUCTION
The integration of the sustainability principles into the economical development has
lately turned into a strongly promoted challenge. Nevertheless, its accomplishment
requires a common effort of all the actors performing on the market: the producers of
goods and services are often bound to redefine their technological process, according
to the environmental restrictions, while the consumers of goods and services may
accept or refuse price increases generated by the improvement of the companies
ecological performance.
In the present article, we decided to illustrate this assumption, by analyzing the
specific features of three sectors with a major environmental impact: the water and
wastewater sector, the production of heating and electricity from conventional sources
and the production of electricity from wind energy. Talking about sustainable
economic development, all of them are currently in the public spot-light. The two
traditional ones the water supply and the energy supply from fossil fuels are
associated to environmental risks, mostly generated by still unsolved pollution
problems, especially in countries where the environmental protection policies are in
an inception stage. On the other hand, the use of renewable resources in the supply of
electricity represents a business opportunity per se, born from the environmental
concerns.
Correspondence address: Petru Stefea, West University of Timisoara, Romania;

email:petru.stefea@rectorat.uvt.ro
~1061~
Besides their relevance in the context of sustainability, we chose the three sectors due
to the size and diversity of their markets. Water and energy are basic products,
procured by any individual. As common topics, we chose to debate the financing
sources of the investment and operating process, as well as the influencing factors of
the performance in each sector. As for the format of the paper, we shall start by
shortly describing the specific features of the debated fields, as well as the common
sustainability restrictions; finally, after drawing the general picture, we shall conclude
the article by detailing their impact on the companies financial indicators. In our
research, the theoretical premises were supported and confirmed in the financial
statements analysis of several sample companies.
1. THE WATER AND WASTEWATER SECTOR
1.1 The state of affairs
According to the World Commission on Water, the world population tripled in the last
century, whereas the world water consumption increased six times. 70% of the total
amount of water extracted in this period was used in the agriculture, 20% was used in
the industry and 10% was consumed by households. For the next 30 years, the water
consumption is estimated to increase with about 50%.
Many of the present water allocations proved to be inefficient, as a consequence of the
centralized control over the water companies, imposed by the current legislation, of
the lack of cost control and of the incomplete evaluation of the benefits. This is the
reason why, according to the current trends, the allocation of the water should be
governed to a greater extent by market rules.
As for Romania, only 52% of the total population is connected both to water and
sewage services, while 71% of the wastewater is untreated or insufficiently treated.
Until now, most of the water and wastewater companies have been operated often
inefficiently by city companies, with little access to additional financial resources.
1.2 Financing the investments
Considering the fact that the water operators use to be state controlled companies,
investments are frequently financed by means of subsidies granted by local, national
or European public authorities, as well as by loans granted rather by financial
institutions like the European Investment Bank, the European Bank for
Reconstruction and Development, or the World Bank. Given the current concerns
regarding the EU grants, we shall further on detail several of their potential additional
problems.
The amount of such a subsidy equals that part of the investment which cannot be
covered by the company from the net revenues generated by the investment. The
future net revenues are forecasted at their present value, in order to take into account
the time value of the money, whereas the discount rate is set by the European
Commission and adjusted, if necessary, by the beneficiary state. This mechanism may
generate problems in times of economical insecurity, like the crisis we are
experiencing nowadays, when the given discount rate seen as an opportunity cost of
the capital may be not realistic. In this context, if the rate proves to be too high or
~1062~
too small, the revenues and, as a consequence, the subsidy may be over- or
underestimated.
Further on, an extremely important, but seldom analyzed implicit cost, imposed to
subsidized companies, is the obligation of the beneficiary company to reach certain
performance standards, which means to continue the investment process and finance it
from own resources.
The performance indicators imposed to the company can be reached if the forecasts
included in the cost benefit analysis were realistic. These are influenced both by the
level of the discount rate and by the precision of the tariffs fixed for the services
rendered. In this context, water operators must also consider two antagonistic
principles, detailed in the next paragraph: the polluter pays principle and the
affordability principle. A high level of the tariff, according to the polluter pays
principle, will apparently increase the forecasted profitability of the company, i.e. its
net revenues, whereas the direct consequence will be the decrease of the subsidy
granted. In fact, it is possible that the predicted income, given by the amount invoiced,
is reduced by a high level of accounts receivable which remain unsettled. In the eyes
of the financer, the incapacity of the company to collect its receivables is considered a
sign of bad financial management.
In order to respect its future investment commitments, a good solution could be the
acceptance of private companies in the water and wastewater sector, in order to grant
the access to more financing sources.
1.3 Financing the operations
For the operations of companies in the water and wastewater sector, significant
balance sheet and income statement positions are the following:
in the balance sheet, the most important current assets are the accounts
receivable, as the activity of such companies doesnt need important
inventory; the most significant current obligations recorded regard the energy
suppliers and the personnel;
in the income statement, the most important revenues are given by the services
rendered, while the most significant expenses come from the energy
consumption and the personnel costs paid usually with constant (fixed)
monthly wages.
Based on these circumstances, we shall mainly discuss further on the premises and
conditions governing the collection of the accounts receivable, depending on the
number of customers (or the amount of billed services) and the level of the tariff.
Considering the monopoly position and the certain and constant demand for water and
sewage services, the number of customers is high and constant. The possible
difficulties to overcome do not regard the number of the customers, but their structure
on income levels.
The water demand is mainly determined by two elements:
the number of households, the areas to be irrigated and the number of
industrial entities to be supplied by one water company and
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the amount of water which is supplied or needs to be supplied in a certain

period of time.
With regard to the amount of supplied water, an important parameter to be considered

is the elasticity of the water demand to the water price, calculated firstly for certain
geographical areas and then in each area for several income stages, respectively for
small and big consumers. Moreover, the demand must be estimated for a defined
period of time, within which one has to consider the demographic forecasts, as well as
the agricultural and industrial development on the considered territory.
The most important factor in assuring the current financial resources is the collected
tariff. Fixing the tariff for water supply and sewage is a delicate matter, as its level
should fulfill at the same time several antagonistic conditions:
from the standpoint of the customers, the price of the supplied water should be
sufficiently low, so that it doesnt raise any affordability problems, as water is
a primary good and the access to it should be granted to anyone;
from the standpoint of the environmental authorities, the price of the supplied
water should be sufficiently high to cover the environmental costs of the water
use, according to the polluter pays principle;
from the standpoint of the water company, the price of the supplied water
should be sufficiently high to cover the suppliers current obligations (given
by operational costs, the share of the investment cost to be paid in the current
year, as well as a share of the investments replacement cost at the end of their
useful life) and to grant a certain profit, but in the same time sufficiently low
to assure a satisfactory collection of the accounts receivable.
In the context of the above described matters, the level of the tariff must be set
considering three main restrictions:
The polluter pays principle
According to one of the basic premises of the sustainable economic development - the
polluter pays principle the level of the tariff should be sufficiently high to cover the
cost of the already produced pollution, as well as the prevention cost of the future
pollution. The water companies usually have a monopoly status, nevertheless the tariff
increase as a consequence of the lack of competition will not necessarily lead to the
turnover increase. Though the elasticity of the water demand to the price is small, it
increases with the decrease of the consumers income. As a consequence, the
principles of the sustainable development will be observed if the water consumption
decreases, but the company will face the risk of reducing the profitability of its
operations, as the most operational costs are fixed costs.
The willingness to pay
The willingness to pay is a second essential factor to be considered when fixing the
water and sewage tariff, especially when the tariff is about to increase in order to
cover the cost of recent investments in specific assets. The upgrade or the extension of
the existing water infrastructure of a city doesnt necessarily change the quality of the
supplied water, as perceived by the consumer. Such investments usually lead to the
decrease of the companys operational costs, the decrease of the pollution or a certain
improvement of the services rendered, like the elimination of the water supply
breakdowns. In any of these situations, the consumer will not perceive an
improvement of the water quality, able to justify a tariff increase; as a consequence,
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the customers might refuse to pay or might delay the payment of the bills, thus
affecting the collection of the companys accounts receivable.
Remark. An average collection period in the water and wastewater sector covers 70
days.
The affordability level
In order to be affordable, the water and wastewater tariff should not exceed certain
generally accepted levels. In order to make sure that the tariff remains affordable on
the target market, the company shall take into account the capacity to pay of the
households with the lowest incomes, i.e.:
it shall estimate the average household income for all tariff paying households;
it shall estimate the number and the income of all low income households,
based on the lowest income decile;
the general affordability will be assured, if the total amount billed monthly to
the lowest income households, for water and wastewater services, including
direct taxes, does not exceed 4% of the households available income
(generally accepted level, for an average consumption of 75 l per capita),
respectively 1,2-2,5% for average income households (for an average
consumption of 110 l per capita).
In this context, there are voices saying that conditioning the tariff level by the
affordability of the consumers breaks the rules of the market economy, as the tariff
may no longer reflect the real value of the service rendered. As a consequence, the
water operator should not be concerned with the affordability matter when fixing the
tariff, while the water and sewage availability to the lowest income households should
be approached by the social protection authorities.
1.4 The performance
In the water and wastewater sector, investments are made in long-term assets, with
high procurement/construction and maintenance costs. Though the water industry is
not affected by fashion or trends, it is influenced by following variables:
the expectations of the consumers with regard to the quality of the services
rendered;
the technological progress, recorded both inside and outside the water sector
(devices meant to reduce the water consumption, used both by industrial
entities and by households);
the increase of the demand, based on the demographic increase, the
improvement of the life quality and the industrial development;
the environmental protection restrictions: the water industry has a major
environmental impact, both in the management of the water reserves and in the
treatment and disposal of the wastewater.
Considering the need to fulfill both the economic performance and the social
performance criteria, the profitability of the water companies is usually moderate or
small.
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2. THE PRODUCTION OF HEATING AND ELECTRICITY

FROM CONVENTIONAL SOURCES
One of the major causes of the air pollution in the urban area is given by the steam
power plants, responsible for most urban SO2 and NOx emissions, especially when the
applied technology is old. The impact of the firing plants on the environment is
significant: climate changes induced by the greenhouse gas emissions, wide
dispersion of the polluting substances, as well as alterations of the air quality.
As chemical sources of energy, steam plants usually burn energetic coal (pit and
brown coal), pit gas, or oil fuel. Considering the outcome, steam power plants can be
either electricity suppliers - with an additional production of heating for internal
(own) use, or electricity and heating suppliers, operating as an urban heating plant.
According to the National Strategy for Energy, the supply of heating and electricity in
Romania is still highly dependent on the use of fossil fuels, among which the most
important are the coal and oil fuel (46%), followed by natural gas (39%). Natural gas
is a source of energy with a higher energetic performance and a lower pollution level.
Nevertheless, due to its high procurement price, all recent economical forecasts in the
European energy sector point out to coal as a base fuel for the next period.
In Romania, the energy sector is characterized by:
low efficiency in the use of the energy sources;
ageing equipment and facilities, leading to important energy losses, ultimately
paid for by the final consumers;
poor technical and economical performance;
high operating and maintenance costs.
Under these circumstances, complying with the Kyoto Protocol requires the
implementation of important investment projects in firing plant technology, aimed at
the decrease and sweetening of the emissions. Other major goals are the partial use of
renewable fuel in the firing process (biomass), as well as the cogeneration of heating
and electricity, raising the efficiency in the consumption of basic resources.
We find here the problems already pointed out in the water sector: the centralized
(urban) heating systems have a three-sided social-economical impact, reaching the
energy, the environmental and the public services sector. On the one hand, they need
to satisfy the energy demand, without harming the environment and the health of the
population; on the other hand, the tariff of the services rendered must remain
affordable.
Investments in the technology of urban firing plants are financed mostly from loans or
subsidies, given the prevailing state ownership of such companies and subsequently
their low profitability. Loans are usually granted by financial institutions supporting
the development, like regional development banks, multilateral development
institutions and development agencies.
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Among other financing sources, we can mention international funds aiming the
development of the energetic sector and the decrease of its impact upon the
environment, like:
structural instruments, supporting the investment without explicit financial
costs, though inducing the obligation that the investment is efficiently
operated, in order to assure not the reimbursement of the funds, but the
steadiness of the investments operation;
financing mechanisms promoted by the Kyoto Protocol: the Joint
Implementation Mechanism JTI, , the Clean Development Mechanism
CDM and the International Emission Trading IET.
Similar national sources are the following:
the Romanian Fund for Energetic Efficiency, administering funds grated by
the Global Environmental Fund and the International Bank for Reconstruction
and Development, allocated to the projects of energetic efficiency;
the Environmental Fund, administered by the Ministry of Environment and
allocated to projects aiming the control and decrease of the air, water and soil
pollution (including the implementation of clean technologies), the waste
recycling and the treatment and disposal of hazardous waste;
funds of the Romanian Agency for Energy Conservation, allocated to
investment projects in the production, transport and distribution of heat
energy.
The declared non reimbursable funds also carry implicit costs with regard to the cofinancing, later investments or operations detailed in the next paragraph.
2.3 Financing the operations
Just like in the water sector, the tariff collected for the rendered services is the point
where the economical, the social and the environmental concerns come together, as it
has to fulfill at the same time several conditions:
it has to cover the operating and maintenance costs of the equipment (existent
and new);
it has to be affordable;
it has to be an incentive for the decrease of energy consumption.
The synchronic fulfillment of the three conditions is currently assured by a subsidy
system, assigned both to the producer and to the consumer. Out of social reasons, the
tariff is fixed by public authorities as an exogenous variable, independent of the
production cost, while the liquidity of the supplier is assured by subsidizing the
difference between the tariff and the cost. At times, the production cost is seen as a
net cost, computed as the difference between the production cost of the heating and
electrical energy and the selling price of the electricity, where the produced electricity
exceeds the own needs. The consumer subsidies are added up to the producer
subsidies and address only households.
The fixing of the tariff in connection with the average household income allows tariff
increases with the increase of the standard of living. Nevertheless, the positive impact
of the tariff increase upon the producers cashflow may be cancelled by another trend
accompanying a better standard of living and promoted by the public authorities: the
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improvement of the buildings energetic efficiency, which reduces the necessary

heating to be supplied.
Besides assuring the affordability, subsidies are meant to encourage a more efficient
fuel consumption and reduce the impact on the environment, whereas one of the ways
to reach these goals is the promotion of heat and electric energy in co-generation. The
effects of the co-generation are well known in Romania, as the national energetic
system includes several co-generation plants with high-duty steam turbines, covering
ca. 40% of the annually produced energy. To keep this trend, the producer subsidy is
thought to be replaced with a bonus for efficient co-generation, based on the sold
electricity, for which the market and the price will be guaranteed by the public
authorities. Other bonuses could be granted for the use of renewable fuel in the
burning process.
2.4 The performance
The forecasts regarding the future demand of heating energy are based on following
parameters:
the trends of the energy consumption in households, public institutions,
industry etc;
the development of the market, with regard to the surface to be heated;
the heat losses from the networks.
The last parameter is the only one that can be controlled by the producer, as the heat
losses from the networks can be diminished by means of investments, meant to renew
the infrastructure; the first two parameters are exogenous, i.e:
The development of the market, with regard to the surface to be heated, depends on
the general economic conditions, as they determine both the development of the
building market and the connection/disconnection rate of the consumers. The
voluntary disconnection of the consumers from the central heating system, out of
affordability reasons, is a specific problem of the sector. In the water sector,
disconnections from the public network are extremely rare, as consumers usually do
not have an alternative source of water. In the heating sector, the affordability must be
accompanied by the willingness to pay, defined as the part of the income that an
individual is willing to allocate to a certain service rendered. The willingness to pay is
reflected in the collection rate of the accounts receivable, as well as in the
disconnection rate of the consumers from the public heating network. The latter is
usually induced by two main reasons:
the wish to pay less for the heating characterizing low income households;
the capacity to use individual heating sources, of a better quality
characterizing high income households.
The consumption depends on the price of the heating (starting from the premise that
the consumption is metered and the customer always pays for exactly what he has
consumed), as well as on the efforts to save heat energy. This is the point where the
elasticity of the demand to the price should be debated. A rising fuel price will lead to
rising costs of the individual heating systems and these will become more expensive
than the centralized (urban) heating system. It means that the elasticity of the heated
surface to the price of the fuel is positive, leading to the extension of the market for
the centralized heating systems, due to the increase of the heated surface. In the same
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time, a rising fuel price will also increase the cost of the centralized heating,
encouraging the individuals to cut back their consumption. In this case, the elasticity
of the demand to the price is negative, leading to the decrease of the market due to the
decrease of the consumption. As a consequence, the effects of a rising fuel price on
the size of the market depend on which one of the above described effects is
prevailing.
With regard to the costs, the most important financial effort goes to the fuel
procurement, as the main variable cost. For the plants working on natural gas, the fuel
cost requires future efforts to decrease the consumption, given the high price of the
imported gas. Moreover, the price of the inland procured gas is also on the rise, as the
intention of the governing authorities is to level out the price differences between the
inland and the imported fuel.
As important fixed costs, worth mentioning are the personnel and the maintenance
costs. Similar to any other enterprise, personnel costs are given by the number of
employees and their competence. A specific feature of the heating sector is the fact
that the number and the features of the personnel also depend on the type of fuel
powering the plant, which prescribes the complexity of the equipment to be operated.
As an example, gas plants need relatively few but highly qualified employees, while
coal and oil plants are operated by more, though less qualified employees. Also worth
mentioning is the fact that the operating costs can be significantly decreased if the
plant equipment is operated at the working capacity it was designed for, whereas the
working capacity can be affected by the occasional heat losses in the installation.
3. THE PRODUCTION OF ELECTRICITY FROM WIND ENERGY
The production of clean energy is not the object of one, but of several industry
sectors: wind energy, solar energy, geothermal energy, wave energy, biomass energy
etc, different with regard to the growth factors, technology, competition and
profitability. None of these sectors is currently able to produce enough clean energy
as to satisfy the global demand, at a convenient price. Nevertheless, their parallel
existence and development balance the shortcomings of the conventional energy
production with fossil fuels.
The development of the renewable energy sectors is supported by extremely
convincing reasons, given in fact by the faults and current trends of the global
economy: the negative side effects of the fossil fuel consumption (the soil, air and
water pollution, the pools built in the oil sector, the rising fuel prices), the increase of
the global energy demand, the development of the clean energy production
technology, the need to diversify the current energy sources, as a result of the
overload of the existing networks, the rising electricity prices etc.
The global production of wind turbines has important annual growth rates, as the wind
energy is an important electricity source in several European countries, like Denmark,
Spain, Portugal and Germany. As a matter of fact, most important wind energy
companies are European.
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The most significant advantage of this energy source is given by the fact that it allows
the production of electricity with absolutely no greenhouse gas emissions, while the
main resource used is inexhaustible, the operating and maintenance costs are low (as a
no fuel is burnt), the turbines can be built both by land and by sea and the
surroundings of the wind farm can also be used to other purposes. On the other hand,
the main disadvantage consists in the fact that the production is discontinuous,
depending on the wind intensity. Moreover, the operation of the wind farms is highly
dependent on public subsidies, the installation costs of the turbines are high, the
turbines can be installed only on certain regions, where they will also produce noise
and alter the landscape.
In this context, the wind power sector is operated by three types of companies:
a. wind turbine producers, whose profitability has been continuously increasing
during the last years, as a consequence of the increasing demand for wind energy.
A recent trend among the turbine producers is the high number of mergers, in
order partly to increase the market shares, partly to take control over the turbine
subsystem suppliers;
b. wind turbine subsystem suppliers usually including companies producing
turbine subsystems as a part of their current activity;
c. wind turbine operators consisting partly in electricity producers from different
sources and partly in independent operators, selling their production to local
distributors.
The activity of the three is strongly interdependent, as they all contribute to the final
production price of the wind electricity.
Investments in the production technology of clean energy are financed both from
public and from private funds. The public financing generally comes as:
loans granted by the World Bank, the United Nations Development Program,
the United Nations Environment Program, the European Bank for
Reconstruction and Development, the Inter-American Development Bank;
public underwriting of loans granted by commercial banks;
subsidies;
tax abatements.
Private capital is brought into listed companies either as direct investments, or as
investments in specific funds: mutual funds interested in environmentally sustainable
companies, as well as listed energy investment funds.
3.3 Financing the operations. The performance
The financial sustainability and the performance of the operations are influenced by
different factors, depending on the profile of the company: wind turbine producer or
operator. The main difference between the two is given by the dependence on public
subsidies, whereas the operators are directly and the produces indirectly dependent on
the public support.
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Subsidies are granted in order to promote the sustainable economical development, as

the connection key between the ecological and the economical development. Unlike
the support granted to public water and heat suppliers, the wind energy is subsidized
not in the investment, but in the operating process, assuring the latters continuity.
The clean energy is produced by means of new technology, whose research and
development process is far from being completed; as a consequence, the costefficiency ratio is still not optimal. The cost of the competition, i. e. of the fossil fuel
energy producers, is generally lower than the production cost of the clean energy.
Therefore, public authorities try to balance the relationship between the ecological
and the financial performance, by taking specific measures:
the taxing of the greenhouse gas emissions, which increases the production
cost of the fossil fuel energy producers, in order to cut their cost advantage;
the coercion of the electricity suppliers to procure a part of the necessary
energy from renewable sources;
the fixing of a minimum selling price for the clean energy producers (an
important condition when investments are financed from loans granted by
commercial banks, as a certain selling price guarantees a certain profitability
and return on the investment).
The production cost of the wind electricity includes all costs of the project
(investment costs - land procurement, turbine procurement and assemblage, as well as
operating costs); further, the costs are returned on the electricity amount estimated to
be produced during the equipments useful life. As a consequence, the economical
sustainability of the sector depends on the economical efficiency both of the turbine
producers and of the turbine operators. As a general premise, the wind electricity
involves high investment costs, balanced by low operating and maintenance costs.
The wind turbine producers are generally governed by market rules, whereas the
public financing has an indirect influence upon their activity, by means of its impact
on the demand for clean energy. The (unlikely) abandonment of the support granted to
the turbine operators will lead to the decrease of the demand for turbines.
Nevertheless, the turbine production is currently experiencing such a spectacular
growth, that its main problem has become the insufficient working capacity of the
turbine subsystem suppliers. This potential blocking is determined by three main
types of factors: political, technological and economical factors. Politically seen, the
problem consists in the irregularity of the granted investment subsidies. The
subsystem producers need to increase their working capacity in order to be able to
satisfy the demand, whereas the necessary investments are usually financed from
public funds. The funds are not granted with a regular frequency, which means that
the producers delay the investment process, in order not to spend their own funds. The
technological factors involve the constant demand for better technological
performance, whereas not all the suppliers are able to keep the rhythm. The
economical factors regard the constantly rising prices of the raw materials (steel,
copper and carbon), affecting both the planning of the production and the subsystem
selling prices.
As already mentioned, the market of the wind turbine producers is dominated by
relatively few companies (mostly European), while the current market trend is given
by the vertical and horizontal integration of the activity, justified by the need to get
the subsystem supply problem solved.
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As anticipated, we shall conclude the present paper by shortly summarizing, in the
three sectors described, the impact of the general state of affairs, as well as of the
financing characteristics of the investment and operating process, upon their main
financial analysis indicators.
It is firstly obvious that the environmental sustainability efforts are generally
supported by means of public funds, oriented either towards the investment, or
towards the operating process. Without the public support, the sustainable
administration of the conventional resources would not be affordable for the
consumers, while the renewable resources could not represent a competitive
alternative.
As subsidies are recorded as a part of the capital, they will have a direct positive
impact on the financial sustainability and autonomy indicators and an indirect positive
impact on the solvability indicators, as they allow the completion of the total assets
with no debt costs. Nevertheless, subsidies are usually accompanied by several
implicit costs, given by restrictions regarding the future performance of the subsidized
activity; such restrictions can increase the working capital needed and create shortterm liquidity problems. We talk mainly about the tariff setting restrictions, where the
environmental component (the polluter pays principle) conflicts with the social
component (the affordability principle), possibly leading to delays in the collection of
the accounts receivable. A further threat on the short-term financial equilibrium is
generated in the subsidy granting period, if the financing principle is the
reimbursement of already paid expenses. The time lag between the own cash outflows
and the subsidy cash inflows can be financed by means of short-term bank loans,
whereas the cost of the debt can be considered a collateral cost of the subsidy.
If the subsidy is oriented towards investment costs, it rarely covers all investment
needs of the company. The public funds are granted either for a part of the initial
investment need, either for the entire initial investment, though conditioning the
company to continue the renewal of the technology in future, from own sources. If the
water or heating supplier is a public company, then its low profitability limits its
access to regular, unsubsidized loans, meaning that a public support granted today
might affect the performance and solvability of the company in the future.
The ecological and economical principles are rarely complementary, at least in the
described sectors. The profitability of the operations (with effects on the return on the
investment) increases when the renewal of the technology leads to the decrease of the
resource losses, out of technical reasons. In the same time, the decrease of the billed
water or energy, as a consequence of the tariff increase required by the polluter pays
principle, will increase the ecological performance of the population, but decrease the
financial performance of the water or energy supplier. In this context, water suppliers
will be quite strongly affected, as most operating costs they record are fixed costs.
With regard to the energy suppliers, the principles of the sustainable economical
development will be respected if the conventional and alternative energy sources will
become real competitors. For the moment, as both are strongly subsidized, the clean
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energy comes to complete the conventional one, representing an option either for the
middle and high income consumers.
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~1073~
www.acciona.es
www.fin-apa.ablog.ro
www.gamesacorp.com/es
www.repower.de
www.vestas.com
www.wassernet.at
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CORRELATIONS FOR SUSTAINABLE PERFORMANCE
BUDGETING
Violeta CIMPOERU1 & Maria RADU
Valentin CIMPOERU
University Politechnica Bucharest, Romania
ABSTRACT
The purpose of this paper is to emphasize that there is no economic growth without
sustainable performance, leading to medium and long term improvement of the public and
private sector management, while maintaining environmental quality and sustainable use of
natural resources. Green strategies for economic development bring up the concerns about
social and environmental issues as a source of economic recovery and long-term growth. The
study is based on the deepening of quantitative analysis tools, using a model of simple linear
regression, being an useful tool for a specialist to help explain economic phenomena, while
putting forward work hypotheses and quantitative relations between the two variables used in
our investigation: Environmental Performance Index (EPI) and Gross Domestic Product
(GDP) per capita, calculated for the year 2008. This paper evaluates the recorded ecological
progress, measured by the environmental performance indicator, dependent variable, related
to economic growth measured by GDP per capita, independent variable, and seeks to present
the strategic planning and sustainable performance as a source of inspiration for managers,
leading them to change their practices and to experiment with new devices.
KEYWORDS: sustainable performance, budgeting, social and environmental reporting,

environmental performance indicator, simple linear regression.
INTRODUCTION
Sustainable development policies and practices have generated numerous violations in
the past 20 years, and the approach and the involvement of specialists in this field
have evolved exponentially over the years. Practice suggests that drawing attention to
the reporting of economic, social and environmental information provides
considerable advantages in various fields such as finance, insurance, marketing,
normalization etc. The rapid evolution of global market requires the existence of
common rules to facilitate trade. Competition created by global market entails
streamlining and improving the resources and processes within the entities (Caraiani
et al., 2010). As the economic and financial crisis is being generated by the current
market model, the global economy requires a perspective change in the business and
government area. The solution could come from a sustainable model, oriented towards
the long-term progress of human society. Expedient and necessary, the sustainable
development measures are being applied by more and more worldwide entities. The
1
Correspondence address: Maria Violeta CIMPOERU, Bucharest Academy of Economic Studies,

Romania, email: violetacimpoeeru@yahoo.com
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sustainable performance can represent a 3 in 1 solution for the economic, social and
environmental issues. The entities oriented towards green strategies must comply in
the future with mandatory regulations for each activity, and managers plans will be
targeted to sustainable budgets models. This reflects that the budgetary annual
approach may undermine the budgetary performance, leading to incorrect allocation
and inefficient use of resources and also to fiscal instability. In the late 1980s and the
beginning of 1990, many countries of the Organisation for Economic Co-operation
and Development (OECD) have launched reforms in the public sector which included
new budgetary approaches to significantly reduce large fiscal deficits. Gradually, they
abandoned the traditional budgeting, line - element, and applied a sustainable topdown (vertical) budgetary model. This modern approach of public finance
management seeks to structure the budget around large programs, which are defined
along the goals of governmental policy and they are linked to specific outcomes in
order to integrate policy, planning and annual budgets. (Petkova, 2009). The
transition, from initiation to performance-oriented budgeting, is extremely difficult
because appropriate approaches are needed for the political and institutional contexts
within the Ministry of Finance and the sectoral ministries. It also means that the
budgets are structured on a program with very stable allocations from one year to
another, replacing the budgets based on a traditional line, where the sectors used to
forecast the current budget on the one of the previous year, plus a small increase. In
other words: "the priorities of the policy determine the funding and not vice versa"
(Holmes & Evans, 2003). By planning their activities, managers learn to anticipate
potential problems and how they can be avoided. Therefore, representatives of
environmental ministries and other relevant governmental agencies having
responsibilities for managing environmental and natural resources, struggle to
introduce into the medium-term budgets this useful analysis for green strategies.
However, the cross - sectoral nature of many environmental problems requires a
specific action, coordinated by a wide range of public sector institutions and
represents a major challenge. It is remarkable that countries that have successfully
introduced such budgeting models, which also included social and environmental
programs, have started from a strong base in terms of public sector capacity and
public finance management, and have done so for a certain number of years.
Exploring a wider area of decision making situations of public and private entities in
the developed countries involves a special focus on accounting informing needs of
stakeholders (Bebbington et al., 2007). Recent research refer to numerous motivations
regarding the social and environmental reporting (O'Dwyer et al., 2005, Cormier et
al., 2005, Solomon & Lewis, 2002). Cormier et al. (2005) propose that sustainable
reporting of potential costs should be understood in the context of benefits for the
humankind. Hassel et al. (2005) examined the relevance of environmental
performance and finds that investors do not appreciate the true value of this
performance increase as a result of environmental protection activities in terms of
overall green performance. Sustainable reporting is often known as the Triple Bottom
Line Reporting (TBL) and forms the basis of shares within companies that lead to
environmental performance and technological development together with social
contribution. In practice, public and private agencies of environmental management
use environmental indicators to summarize and assess the ecological processes
(environmental performance, the allocation of restoration efforts and to establish the
benchmarks of social and environmental criteria). Yale Center for Environmental Law
and Policy (YCELP) and the Center for International Earth Science Information
Network (CIESIN) at Columbia University in collaboration with the World Economic
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Forum and Joint Research Centre of the European Commission have elaborated and
calculated the Environmental Performance Index as a response to information
technology developments and data-driven decisions that have transformed every
corner of society, from business to the green environment. EPI includes a set of
environmental indicators, which are calculated for areas with problems and which
should become factors of great interest in political decisions in every country.
Since everybody is talking about the economic crisis in negative terms only, we
believe that there can be some positive aspects, and one of them may be a greater
attention of the public, for the community in which they live, regarding to exacerbate
consumption of resources, which can also represent a starting point to sustainable
programs. Our study emphasizes that, although growth represents "the right hand" and
the ecological growth "the left hand", the right cannot work without the left and vice
versa. Thus, we made a comparative analysis between the environmental performance
indicator, calculated for the year 2008 for 149 countries, with GDP per capita,
calculated for 2008 using a statistical-econometric methodology.
1. BUDGETING FOR SUSTAINABLE PERFORMANCE THE CONNECTION BETWEEN ENVIRONMENTAL PROGRAMS
AND ECONOMIC AND POLITICAL PROGRAMS
Most countries are moving towards a form of sustainable performance-based budget,
where the medium-term expenditures with a focus on politics are included in program
budgeting. The translation of political priorities in results for the citizens requires that
the budget structure be supported by a programmatic approach. At the same time it is
important for the budgetary structures to not be so restrictive, as they may limit the
ability of administrative agencies to mobilize available resources to maximize
efficiency and effectiveness.
Australia has the most sophisticated performance-based budgeting system, but studies
have pointed out that this is not a criterion for cost-effectiveness (Petroka, 2009).
A gradual process would be more cost-effective because it combines expenditures
regarding policy development and program objectives, but also performance
indicators, establishing monitoring and evaluation systems. Most studies suggest that
monitoring and evaluation are the weak links in the chain for a sustainable budgeting,
because very often, there is a direct link between indicators, results and resource
allocation. From these essential parts of the process of understanding of what actually
works and what doesnt, we will enrich the analysis basis which should support not
only the decisions regarding the fiscal space, but also the decisions regarding the
reallocation within the existing base, so going from underperforming to the green
performance through the implementation of environmental budgeting programs.
In the Netherlands, promises made by politicians during the electoral campaign,
represents the basis for assessing the government at the end of his four-year term. As
a consequence, the Dutch politicians are very careful in preparing the political
programs and therefore seek the help of the technocrats or the economic research
institutes, to prepare macro-economic projections and the estimated cost of electoral
programs they are proposing. The aggregated results are published before the
elections and environmental agencies make assessments regarding the impact of the
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economic activities on the environment, but also the environmental investments. Such
a situation gives great credibility to budgeting for sustainable performance and is fully
supported by politicians and then is internalized to the sectoral ministries. There are
some similarities also in Australia, where, under the state budget honesty, Finance and
Treasury are required to disclose the estimated cost of electoral programs of the
government and the opposition before the elections (Van Helden, 2008). Experiences
from developing countries showed that the sectoral strategies for environmental
programs, if they do exist, are usually prepared without much consideration to the
actual costs and budgetary implications of planned policies. There is an abundance of
documents related to policies and strategies, but they often remain on paper. The
problem of these countries is the lack of reliable data that could support credible
monitoring systems. Thus, environment ministries need information and
methodologies for setting targets and measures for evaluating the results of
environmental programs both financially and socially. However, this is a good
practice, because these documents regarding the policies and strategies are available
to the general public, making the first step in improving transparency and reporting
Triple Bottom Line (TBL).
2. SUSTAINABLE PERFORMANCE - THE NEED FOR TBL REPORTING
On an international scale, there is growing number of entities reporting on
environmental and social impact of organizational activities. However, traditional
financial and reporting accounting do not provide adequately data for measuring
environmental and social impacts and, therefore, require a more detailed reporting
within organizations (Yongvanich & Guthrie, 2006). Recent years have experienced a
substantial increase in reporting on environmental and social problems by big
corporations (Gray, 2006).
According to a survey by Deloitte and Touche, 90% of the respondents believe that
the economic, social and environmental reporting is an important element in the
listing entity in terms of reputation and brand value. The survey also shows that 42%
of financial managers consider that companies with a good social and environmental
performance can successfully overcome weaknesses (Deloitte & Touche, 2002).
Depending on specific circumstances such as industry, location or business model,
environmental issues found in most corporate reports of entities relate to: climate
change, energy, water, biodiversity and land use, chemicals, heavy metals and toxic
air pollution, management loss, rarefaction of the ozone layer, the situation of the
oceans, fishing and deforestation (Esty & Winston, 2006). Cormier et al., (2005)
proposed an understanding of environmental reporting for the potential costs based on
the benefits to mankind. Hassel et al. (2005) examined the relevance of the
environmental performance and found that investors do not appreciate a performance
increase, as a consequence of environmental protection activities. The supporters of
the phrase:one must pay to be green" say that there is a causal link between
environmental performance and financial performance (Hassel et al., 2005). The
attempts - to isolate the effects of pollution control in the process of determining the
net cash flow, and to assess the environmental impact that their environmental efforts
have on the entity, - proved to be challenges for the accounting research. Based on
studies conducted in order to examine the evolution of investment funds, sustainable
methods of investment, sustainable development indicators, the accounting regulators
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institutions show that investors tend to give increasing importance to the green
reporting (Koellner et al., 2005). Thus, social and environmental reporting provide
complete reasoning for incorporating environmental and health issues in the decision
making process.
In order to achieve the objectives, the team used a fundamental research based on
specialized literature and a quantitative method of data collection, based on an
econometric regression model. In presenting a linear regression model are important
aspects related to identification of the two variables and specification of regression
model parameters. The simple linear regression model is defined by its linear
relationship between the two economic variables and through a set of assumptions
made on the data series, on the residual variable and two variables of the model and
also on the linear relationship between them.
In 2008, EPI was calculated for 149 countries and 146 countries used the model
because for the three of them the GDP per capita for 2008 was not found, and they
were eliminated. The endogenous or explained variable within the EPI model is the,
and the exogenous or independent variable is GDP per capita.
First, we created a database with two variables in MS Excel, by analyzing the data
using EViews 7, and second, we tested their linear dependence and obtained a
stochastic dependence, because the endogenous variable is auctioned by a series of
factors, which are not specified within the regression model. This opens up
opportunities for new approaches regarding the analysis of a multiple regression
model, taking into account other factors approaching in a new way the economic,
political and environmental context.
4. GREEN INDEX - EPI 2008
4.1. A brief overview
EPI 2008 based itself on a team of researchers and experts to identify the most
suitable indicators in each policy category and, in some cases, to assist the data
processing activity, making a truly collaborative effort with the world of science.
EPI focuses on two important environmental objectives:
reducing stressors for environmental health;
promote the strengthening of the ecosystems and the healthy management of
natural resources.
These broad objectives reflect the priority policy of the environmental authorities
around the world and of the international community, which aims to ensure
environmental sustainability.
The two goals were analyzed using 25 performance indicators in six well-established
policy categories that have then been combined to create the final result. In order to
make the 25 indicators comparable, each measure was converted to a measure of
proximity-to-target with a range from 0 to 100. Initially, they examined the
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distribution of each indicator to identify whether the extreme values reach the
aggregations of some indicators. Consequently, outliers were removed using a
statistical technique called winsorization which selected 95% of the distribution for
the analysis, and, by using a simple arithmetic transformation, EPI 2008 was
determined for 149 countries and the observed values were placed on a scale from 0 to
100. EPI is a work in progress, and thus EPI 2010 was also determined. Given the fact
that the GDP values per capita for 2010 have not been made public yet, the
econometric model was developed by using the indicators calculated for 2008.
4.2. Econometric Model
Research focused on a comparative analysis using a statistical-econometric
methodology used by a wide range of authors of specialized literature. The statistical
parameters measuring the symmetry, the normality of distribution and the
correlation between various statistical data, - are obtained by the regression function.
Data processing for the analyzed indicators was performed with the help of EViews 7
application. The quantitative data allowed the drawing up of a simple regression
model showing the dependence between the EPI indicator and the analysis factor,
GDP per capita.
The linear regression model is as follows:
y i = b + a x i + i , i = 1,..., n
where:
y i represents the EPI SCORE, calculated for the year 2008
x i represents GDP per capita, calculated for the year 2008
n represents the number of countries taken into account for the analysis
We will consider next the GDP per capita influences the EPI indicator for a number of
146 countries, alphabetically grouped.
The necessary series of data, necessary to estimate the values of the model, are crosssectional data (collected for a set of statistical units):
Index EPI (2008) marked as EPI / Source: Environmental Performance Index
2008- www.yale.edu.epi
GDP per capita (current U.S. $) (2008) - marked as GDPC / Source: World
Bank and OECD national accounts on National Accounts data files
http://data.worldbank.org/index/NY.GDP.PCAP.CD
Units of measurement and transformations on data series:
The EPI: values between 0 and 100 (100 - the country with the highest score EPI)
GDP per capita: GDP per capita is gross domestic product divided by midyear
population. GDP is the sum of gross value added by all resident producers in the
economy plus any product taxes and minus any subsidies not included in the value of
the products. It is calculated without making deductions for depreciation of fabricated
assets or for depletion and degradation of natural resources. Data are in thousand
current U.S. dollars for comparability.
We study, in a comparative manner, the data series related to this model. In this case,
the series of the EPI indicator has a Mean of 71.87, the values ranging from a
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Minimum of 39.1 to a Maximum of 95.5. Standard Deviation of 12.83, shows that the
data are relatively homogeneous. Skewness is -0.59, Kurtosis 2.61, Jarque-Bera 9.63,
which are values close to those of a normal distribution (0 and 3, respectively) (Figure
1). For data series describing the GDP per capita Mean is 13.22, the values ranging
from a Minimum of 0.14 and a Maximum of 117.95. Standard Deviation of 20.06,
suggests a wider range of values for this series of data. Skewness is 2.29, Kurtosis
9.05, Jarque-Bera 351.83 (Figure 2), indicating that the normal distribution of data
series is missing.
The Skewness indicator is a statistical parameter measuring the lack of symmetry (the
symmetry of a distribution requires that this latter has be symmetrical to the central
point). The value of this indicator close to 0 indicates the existence of a normal
distribution of the analyzed data series. Values significantly different from 0 (positive
or negative) reflect the degree of remoteness from the normal distribution.
The Kurtosis indicator measures to see if the elements of a series are close or far from
the normal distribution. A high value of this indicator (in our case for our series GDP
per capita) indicates that the data series has a distinct peak from the average.
A "link" between these two indicators is shown by the Jarque-Bera statistics test,
which measures the degree of closeness to normality. The normal distribution
measures the extent to which a statistical model fits with the observed data series.
Testing the null hypothesis with the help of the Jarque-Bera test indicates null values
of the Skewness and Kurtosis parameters.
Figure 1. Data analysis for EPI series (Histogram and stats)
20
Series: EPI
Sample 1 146
Observations 146
16
Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis
12
8
4
71.87466
74.60000
95.50000
39.10000
12.83647
-0.599122
2.615645
Jarque-Bera
Probability
0
40
50
60
70
80
9.633055
0.008095
90
Figure 2. Data analysis for GDPC series (Histogram and stats)

90
Series: GDPC
Sample 1 146
Observations 146
80
70
60
50
40
30
20
10
0
0
20
40
60
80
100
Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis
13.22144
4.215000
117.9500
0.140000
20.06073
2.298092
9.058982
Jarque-Bera
Probability
351.8367
0.000000
120
The deterministic relationship between the two data series expresses the dependency
between the dependent variable EPI - at the macroeconomic level and the
independent variable - GDP per capita (Figures 3 and 4).
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Figure 3. The importance of GDPC for EPI determination (Excel)
Figure 4. The importance of GDPC for EPI determination (EViews)

120
100
80
60
40
20
0
25
50
75
100
125
GDP PER CAPITA (THOUSAND US $)

EPI
The graph "cloud points" includes both coordinate points (EPIi, GDPCi) i = 1.146 and
the GDPC regression line used to quantify the GDPC effect on EPI (Figure 5). From
this graph we can notice a positive linear dependence between two variables: the
higher the GDPC level gets, the higher EPI is.
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Figure 5. Scatter with regression

100
90
80
EPI
70
60
50
40
30
0
20
40
60
80
100
120
GDP PER CAPITA (THOUSAND US $)
As, in reality, the dependence between the dependent variable Environmental

Performance Index at a macroeconomic level and the independent variable GDP per
capita is a stochastic one, and in determining the EPI was taken into account only one
factor (although the dependencies are more numerous), the econometric model is
given by:
y i = b + a x i + i , i = 1,..., n
where is the error of meaning (specification), which is a random variable
(stochastic) that has some probabilistic properties, being given by the inexact
relationships between the variables.The variance of the two data series as a group is
shown in Tabel 1, by applying the test for Equality of Variances.
Table 1. Comparison of variances for the two series as a group
Test for Equality of Variances Between
Series
Date: 03/27/11 Time: 11:26
Sample: 1 146
Included observations: 146
Method
F-test
Siegel-Tukey
Bartlett
Levene
Brown-Forsythe
df
Value
Probability
(145, 145)
1
(1, 290)
(1, 290)
2.442319
0.879505
27.89582
8.866492
0.485026
0.0000
0.3791
0.0000
0.0031
0.4867
Std. Dev.
12.83647
20.06073
33.84723
Mean Abs.
Mean Diff.
10.57504
14.43154
12.50329
Mean Abs.
Median Diff.
10.46644
11.63322
11.04983
Category Statistics
Variable
EPI
GDPC
All
Count
146
146
292
Bartlett weighted standard deviation: 16.84054
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Mean TukeySiegel Rank

150.8493
142.1507
146.5000
Estimating the parameters for the proposed model, the relationship between the
dependent variable Environmental Performance Index (marked as EPI) and
independent variable GDP per capita (marked as GDPC), we obtain the following
form for the regression equation (Table 2):
EPI = 67.51565+ 0.329693* GDPC
Table 2. The estimation results for the regression model parameters
Dependent Variable: EPI
Method: Least Squares
Date: 03/26/11 Time: 22:30
Sample: 1 146
EPI=C(1)+C(2)*GDPC
Coefficient
Std. Error
t-Statistic
Prob.
C(1)
C(2)
67.51565
0.329693
1.095368
0.045701
61.63743
7.214194
0.0000
0.0000
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)
0.265473
0.260372
11.03957
17549.58
-556.7750
52.04459
0.000000
Mean dependent var

S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat
71.87466
12.83647
7.654453
7.695324
7.671060
2.102390
Testing some assumptions made on the parameters of the regression model

We are testing to see whether the variable GDP per capita coefficient is significantly
different from 1.
We define the hypotheses of the statistical test:
H0 : a = 1
H1 : a 1
We calculate the test statistics using the formula:
t=
a 1
a
Obtaining: t = -14.68 .
The tabulated value for this test, with 145 degrees of freedom and significance level of
0.001, is 3.291. The calculated value is less than the tabulated value, so we accept null
hypothesis and the GDP per capita coefficient is not significantly different from 1.
Econometric Interpretation
For this model, GDP per capita increase by $ 1,000 (for this data series were divided
by 1000), leads to an improvement in the 0,329 Environmental Performance Index.
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The determination rapport (R-squared) has a small value, almost 26.54% of the
variance of EPI and is explained by the variance of the GDP per capita factor.
Statistical relationship between the endogenous variable and exogenous variable is
weak, which shows that besides the GDPC variable, used to test a causal relationship
between the EPI and GDPC, we also include other variables as the composition of this
indicator includes a number of 25 other influential factors.
The validity of this model can be sustained on the account of low values of probability
and standard error values. The probabilities associated with the t-Student test for
independent variable coefficient is below 5% (0%), thus rejecting the null hypothesis
that the slope of the regression line is insignificantly different from zero, thus
obtaining a properly specified model. Similar results for free term (free term is
significantly different from zero). Between the value of t and F statistics, which
corresponds to the regression slope, we can verify the relationship t = F. DurbinWatson test, with a value of 2.10, indicating that the residual variables are not auto
related.
Forecast
In order to make a forecast of the EPI variable we have resized the data series by
using a sample of observations from 1 to 120, and starting with the observation 121,
we considered the prediction (Figure 6). The forecast is accurate enough because
RMSE is low (11.33) taking into account that the sample taken into consideration is
quite high, and the Theil coefficient is less than 1 (0.078).
Figure 6. Forecast for EPI variable based on current values
130
Forecast: PREVIZIUNI_EPI
Actual: EPI
Forecast sample: 1 120
Root Mean Squared Error
Mean Absolute Error
Mean Abs. Percent Error
Theil Inequality Coefficient
Bias Proportion
Variance Proportion
Covariance Proportion
120
110
100
90
80
70
60
11.33958
9.242842
14.55307
0.078198
0.000001
0.333530
0.666469
50
40
10
20
30
40
50
60
PREVIZIUNI_EPI
70
80
90
100
110
120
2 S.E.
Economic Interpretation
The regression model results obtained by using the application EViews, showed that
GDP per capita influences to a large extent the EPI indicator. By analyzing the
determination ratio (R-squared = 26.54%) we can observe that its amount is quite high
considering the fact that 25 variables are included into the composition of EPI. Given
that developed countries have a very high GDP per capita, an increase of $ 1,000
means (by refering to our average) an increase of the EPI Score by 0.329.
Extensions of the above- used regression model Environmental Performance Index is
a variable depending not only on the classical indicators such as GDP per capita, as
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shown above, but also by sizes which approach in a new way the economic and
political context such as Government Effectiveness.
The form-model is defined as follows:
yi = b + a xi + c zi + i , i = 1,..., n
Where
y i is EPI, for 2010
x i GDP per capita, for 2010
z i is the Government Effectiveness
n represents the number of countries taken into analysis

The econometric model is a multiple regression model and opens another path for
future research.
CONCLUSIONS
Environmental issues and over-exploitation of natural resources can be largely
explained by the lack of clearly defined property rights and other causes of market
failure in combination with inadequate policies and weak institutions. Linking
environmental concerns with economic arguments in decision-making process can be
an important step towards better achieving the Millennium development policies.
Thus, technical and economic arguments for policy reform argue that the allocation of
budgetary resources based on well-designed programs can contribute to sustainable
development. Environmental programs are more credible if they are developed and
budgeted for professional entities (eg. Australia and the Netherlands). The
introduction of medium-term budgeting is particularly favorable for environmental
ministries and agencies with responsibility for environmental management, because
the programs are long-term and investment in infrastructure is also for long periods.
Budgeting for sustainable performance force weaker ministries such as environment
to think strategically and to develop policies and financial planning in order to obtain
a convenient budget compared to other budgets of the stronger ministries. If they are
well-conceived, the environmental programs can provide a strong link between
policies, strategic budgeting and TBL reporting.
Based on specialization literature review, we can affirm that more and more
companies conduct a reporting of the sustainability, by including the social,
environmental and economic impact, not only as an accounting tool, but also a
strategic one, in order to highlight the new sources of income and economic growth.
Our research argues that countries that take environmental issues into the economic
and governmental policies are more competitive and more innovative than others.
They have access to a range of information before others and are better prepared to
deal with unpredicted issues that may adversely affect people's lives. By rethinking
products and services to meet market-oriented needs, the environmentoriented
countries ensure themselves environmental and ecological growth. This hypothesis
results from the empirical model presented, showing that the environment results can
be quantitatively determined, facilitating a detailed analysis of environmental policy.
In order to improve these goals, politicians should invest in collecting more data and
monitoring a set of key indicators over time.
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Environmental challenges come in many forms, which vary with material wealth and
development. Developed countries and developing countries raise the question of
pollution impacts and undeveloped countries are threatened by the lack of basic
environmental facilities, such as access to potable water and sanitary facilities.
AKNOWLEDGEMENTS
This work represents the partial results of doctoral research, which was realized with
the support of the doctoral scholarship, within the project Doctorate in economy at the
Europes knowledge standards (DoEsEc), POSDRU/88/1.5/S/55287 contract,
financed from European Social Fund and from the European Social Fund through
Sectoral Operational Programme Human Resources Development 2007-2013, project
number POSDRU/107/1.5/S/77213 Ph.D. for a career in interdisciplinary economic
research at the European standards and with the support of the doctoral scholarship
within the project Doctoral and post doctoral programs supporting research contract
no POSDRU/107/1.5/S/76813.
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ODwyer, B., Unerman, J. and Bradley, J. (2005) Perception on the emergence and future
development of corporate social disclosure in Ireland, Accounting, Auditing &
Accountability Journal, vol 18, no.1: 14-43
Petkova, N. (2009) Integrating Public Environmental Expenditure within Multi-year
Budgetary Frameworks, OECD Environment Working Papers, no. 7, OECD,
Publishing doi: 10.1787/224138120533
Solomon, A. and Lewis, L. (2002) Incentives and discentives for corporate environmental
disclosure, Business Strategy and the Environment, vol 11, no.3: 154-169
Van Helden, F. (2008) Medium term expenditure frameworks and environmental spending:
the case of the Netherlands, OECD background case studies
Yongvanich, K. & Guthrie, J. (2006) An extended performance reporting framework for
social and environmental accounting, Business Strategy and the Environment, vol. 15,
no.5:309-321
Environmental Performance Index (2008) Yale Center for Environmental Law & Policy
available on-line at http:// www.yale.edu.epi
Gross Domestic Product (2008) available on-line at http://data.worldbank.org/indicator/
NY.GDP.PCAP.CD
~1088~
PS21 Management information systems IV

Chairperson
Felicia ALBESCU, Bucharest Academy of Economic Studies,
Romania

AN APPROACH INSIDE AND OUTSIDE
THE ORGANIZATIONAL
Georgiana Andreea CIOAN, Ilinca HOTARAN

Irina Bogdana PUGNA, Felicia ALBESCU, Robert SOVA
~1089~

AN APPROACH INSIDE AND OUTSIDE
THE ORGANIZATIONAL
Georgiana Andreea CIOAN1& Ilinca HOTARAN
ABSTRACT
The management information system can be a powerful weapon for the business environment,
if it is well managed and if we have acknowledgments about its hidden aspects. For this, we
must understand how we can collect appropriate data, what are the methods used for
managing the databases and how we can combine traditional with modern methods for
developing the picture of a whole. This is essential because only in an integrated business
environment we can act as change and improvement agents, we can see the priorities, the
restrictions and we can establish an order in what first seems to be chaos. We chose a
double approach because one of the key for success is managers ability to see the trees as
much as the forest.
KEYWORDS: information system, organization, priorities, extended supply chain,

integration, performance
INTRODUCTION
In the representation of reality, the concept of system highlights the interaction,
correlation, relationship between all elements. In some sense, the concept of system is
the opposite of the term chaos. The intention of the general theory of systems is to
disclose property, principles and laws that are characteristic of systems in general,
regardless of their variety or type of their components. The extended supply chain is a
system, and its main objective is to reach out to the highest goals trough collaboration.
In a collaborative relationship, we must understand that the information flow is a
necessity, an opportunity, a chance for development but also it can be a great
disadvantage if the companies miss the essential elements of its integration.
The organization is an open and adaptive system if we take into account the fact that it
is a component of larger systems with which it has harmonized links, trough the
management process. An organization can be understood, only if you research it as an
open system, whose internal processes are in relation to the environment, and also are
depending to the quality of information systems.
Systemic analysis of organizations offers a new perspective on the information
exchange between humans and between humans and the environment. We consider
that is essential to analyze the management of information systems situated inside an
organization and also the information system that reveals the extended supply chain,
taking it from the chaos to the next step, to the whole future.
1
Correspondence address: Georgiana Andreea CIOAN, Management Faculty, Bucharest Academy

of Economic Studies, Bucharest; email: georgianacioana@yahoo.com
~1090~
1. INFORMATION
The information assures an interface between companies trough the implementation
of different information software. A barrier difficult to overcome over the time was
the lack of integrated applications. The use of information resources brought
extraordinary improvements
1.1. Cooperation at the information flows level
It is linked to a shift from transaction marketing to relationship marketing, in which
complete and reliable information exchange between actors in the distribution channel
is essential. This has proved to be the key to the success of a partnership. Indeed, a
successful partnership depends on the quality of communication, on the information
exchange, on the register of shared information and also on the active participation of
partners in the process. The interchange of electronic data (EDI) is both quantitative
(helping to sales forecasting and also to production management and physical
distribution) and qualitative (as a valuable support in launching new product or
supporting marketing activities). Cooperation at the level of products flow has led to
developments in terms of "supply chain management (SCM)".
1.2. The role of information
There are four major fundamental mistakes when we delineate the need for
information:
We consider systems as individual features and not cross-functional elements
We interview managers individually and not jointly
We are not allowing trial and error in the detailed design process
We ask the wrong questions during the interview
2. THE FIRST APPROACH - THE ROLE OF INFORMATION
AND THE COMMUNICATION PROCESS INSIDE ORGANIZATIONS
In order to do their work effectively, the personnel inside organizations need to have
access to information in a timely manner and accurately. Business functions are better
integrated, the link between organization and its suppliers and stakeholders is
stronger, internal processes are more efficient if organizations have information
systems that can provide this type of information. In nowadays business environment
there is a higher need for managers to focus on the quality of the information systems
they implement in their companies. One should not jump to the conclusion that it is
the IT experts duty to make sure that the clearness of information is ensured. They
are only responsible for designing the systems. It is managements task to ensure that
the systems developed serve the needs of people and of the business (Boddy et al.,
2004). As information systems have become more and more crucial in the process of
organizational development, moving from behind the curtains directly on stage,
managers should seek to actively involve in the their customization which will have
great impact on firms performance.
Organizations are mainly constituted as open environments, where information flows
between all the interested parties. People select the data they need, make changes on
~1091~
it, transform it in order to get the necessary results, or as the literature states, the
resources (inputs) are worked upon and transformed into outputs which affect
organizations environment and which, at their turn, generate new sources of inputs
and information. If we analyze a production process for instance, one good example
for the flow of information inside the process would be that of the shop-floor
supervisors and operators who use information about the raw materials available,
inventory, warehouses, machinery in order to help them in planning production;
furthermore, they transform this information with the use of other pieces of
information regarding the degree of capacity utilization, efficiency and process
quality, delivery schedules and deliver orders to the final customers, generate
information about customer satisfaction to the marketing department, prices, sales and
other incoming orders to the financial department, thus creating a continuous
information flow, adding value to all the processes.
Firms nowadays operate by combining two types of activities: physical - the transport
of materials from suppliers, the actual production, the handling of work-in-process
throughout the facilities, the delivery to the customer etc. and electronic - online
orders, products catalogue and offers, payment systems, scheduling of operations,
online meetings, the communication in the supply chain and many more (Boddy et al.,
2004). Even if the IS are well development and wide-spread, there is still the need for
direct human contact - face-to-face reunions, telephone calls, brainstorming, which
usually are most efficient when unusual problems arise or solutions are unclear.
However, in situations or cases where the exchange of information has become a
routine, IS enable the communication to be done almost only electronically, through
the means of company-wide databases, interrelating different parts of the organization
to have access to updated information. It is not only a consequence of the fact that
technology rushes to provide new and non-conformist means of communication in the
competition for growing progress. It is a solution for the necessities of businesses that
have developed and operate globally, in different environments. As a consequence of
globalization and instant access to information, new products and services have
transformed the way customers influence businesses (Petcu & Drghici, 2010).
Corporations transfer their knowledge and their operational functions worldwide,
creating a network of information sharing that has to be accessible from every corner
of the international business arena; emerging firms want to promote themselves and to
enter the market with a modern approach of doing business, going online and getting
in contact with their clients and partners by all means.
Figure 1. Increase of information intensity in manufacturing
Dynamic business
environment
elec-s
aero
auto
cement
food
(Source: Coronado Mondragon et al, 2004:1223)
~1092~
Information intensity
2.1. The benefits of information

Information is tradable - it may be considered as a resource, the issuer of the
message can sell it many times and transferring it to the buyer may give birth to
another sale. The latter could sell it for a higher price, sometimes increasing its
value through the knowledge that comes with it. (Fattahi & Afshar, 2006: 134)
Information can be used and reused - we can state that information is
something that can be recycled.
Information can be shared - it can be used by several users at the same time
without being depreciated, especially if it is in electronic format. Thus it allows the
creation of databases and their continuous expansion.
Information can be transferred - in the physical form, for example written
documents, reports, files; it is hard to transfer information from one user to another,
sometimes involving time delays and loss of some of its value. Thus, technological
innovation provides solutions to make the transport of information easier through
electronic means, which involve lower costs and less effort. E-databases, e-mail, ebooks, intranets, the Internet and other products of the great IT progress allow
information to be accessible in all parts of the world, with minimum efforts. (Fattahi
& Afshar, 2006: 135)
Information can be processed - since technology made it possible in the first
place, it also provided ways of managing information, designing in this way new
sources of information which add value to the communication process and require
very few investments, as compared to the benefits resulted.
Information can be reproduced - information from databases can be copied on
legal conditions, electronic sources on the Internet can be translated and shared with
different other users, online documents can be compiled and reused.
Information can be refined - as they use several pieces of information and they
come in contact with widely spread resources, users reach to the conclusion that
information needs revising because sometimes it is loaded with useless items. This
characteristic permits adding value to information and making it more useful to the
persons accessing it. By deleting unnecessary data, information becomes more useful
and hence users spend less time in analyzing it and retrieving what they need.
Information can be interpreted, inferred and adapted - users have the
opportunity to give different interpretations to information, creating and delivering
new sources and adding value through their work. (Fattahi & Afshar, 2006: 136)
Information can be synthesized and converted into knowledge - new
information is generated through analyzing, synthesizing and extracting whats most
valuable out of it. (Fattahi & Afshar, 2006: 137)
2.2. The relationship between information systems and companys priorities
In the current business context, companies are striving more and more for continuous
improvement and more integrated processes. Globalization, increased competition,
increased customer demands, fast changing wants (Cioan & Ohot, 2010: 613) and
the recent economic crisis impact a lot the business environment. In this context, the
advanced information technology solutions and ERP implementation have become a
major strategic issue. The relationship between implementing ERP systems and
establishing their organizational strategies is critical, therefore the management of
companies has a decisive role in this process. The success of this resides mainly in the
~1093~
efforts of the top management, in providing training to employees and to all the
personnel involved, a very good communication of the objectives, a fully supervised
project management as well as an adaptation to the resistance to change and an
employment of results measures.
Another key aspect in this respect, and one that turned into an impediment when
different firms enrolled in adopting such kind of IT tool, is the good understanding of
the business, the organizational goals and needs, the relationships inside the firm and
firms connections with the business environment. Under these circumstances, due to
its integrative approach of managing businesses, ERP has become lately more like a
new style of management (Yen & Sheu, 2004). At the same time, in order to produce
the discounted results, the ERP systems should be customized according to the
companys necessities and to its processes.
It is more that obvious that the implementation of ERP systems engages an effect on
the companys position as compared to its competitors. Unfortunately, until now a
procedure to guide the implementation of ERP in straight connection with companys
competitive strategy is yet to be developed. Therefore this chapter investigates the
strategic issues of ERP systems and of their customization for firms requirements.
Different studies throughout the years have discussed the competitive priorities of
companies and refined them according to changes in the evolution of the business
environment. Some included differentiation, competitive costs, response to customers
needs, and as competition rose, other priorities where emphasized like quality,
delivery, flexibility, service, innovation. The further step in the enforcement of
companys strategy is the segmentation of priorities at lower levels in the organization
into structural and infrastructural plans (Yen & Sheu, 2004). These decisions refer to
long-term concerns such as processes, facility location and capacity and their
interaction with the organizational structure, the planning and control systems, the
quality issues and employees skills and leadership.
ERP implementation has a very significant impact on the business functions and
companys performance, affecting numerous elements like planning, scheduling and
control systems (Yen & Sheu, 2004) at the operational level, and tactical and strategic
decisions in terms of integrated business plans. According to this assumption, we can
state that it is an integrative solution that puts together firms resources and delivers
the most effective results out of their most efficient utilization. It acts on a horizontal
basis, at the level of operations, employing at the same time the entire organizations
plans and strategies in a global perspective, gradually attracting all the organizational
structures as we move along the vertical scale and reach the top management level.
It is the characteristics of firms operations that influence the ERP implementation
steps the management should approach. The most influential steps in this process are
those related to managements actions (process analysis and diagnose, process
standardization, package customization, information sharing and accessibility,
centralization, team selection, training) even though technology related actions should
not be overlooked (software acquisition, adaptation, tests). Therefore managements
role in the implementation process is crucial: it is the decision making structure on
which the success and the effectiveness of the implementation steps reside. Further in
this article we will discuss in detail the ERP systems as a method.
~1094~
2.3. How line managers use information systems to increase the efficiency
of processes
The are a lot of definitions of the concept of line manager in the literature, but the
most appropriate one to the scope of the research would be the person who is
responsible for the day-to-day tasks and for the people under his supervision,
mediating the communication of companys objectives from the upper levels down to
the employees, being at his turn under the guidance of a middle manager. Mainly,
their role is that of linking top management with workers and operators, by taking the
overall strategies and figuring them out into operational activities, performing the
functions of planning, organizing, leading and controlling. None of these functions
could be performed efficiently without putting all the resources of the company
together (human and physical) and no results could be obtained effectively without
the support of the sharing of information, communication, motivation and coaching.
In this respect, line managers rely very much on the benefits provided by different
information systems to undergo activities in a timely, qualitative and cost-effective
manner.
We will furthermore analyze the way in which line managers contribute to
performance improvement through the means of information systems by resuming the
results of a study (Malmqvist, 2008) undertaken by Chalmers University of
Technology, Gothenburg, Sweden. The study had in view Volvo Information
Technology AB, a global company owned by Volvo AB, which offers support and IT
solutions for all activities at Volvo AB. It is one of the six business units that sustain
the eight business areas which constitute Volvo Group (Volvo Group, 2010). As it is a
very large business area and the view upon the big picture could hinder more specific
results that actually represented the aim of the analysis, the focus was centered upon
Volvo Infrastructure and Operations (I&O) Site Gteborg, the managerial issues faced
by line managers and the relationship with the information systems they have
enforced.
In order to gather data regarding the position and the tasks of I&O inside the
organization, the work and the role of line managers in I&O, the problems they incur
in their day-to-day work, the way they handle the large panel of responsibilities they
have and whether or not they have to leave aside some of them because of the lack of
time, three preliminary semi-structured interviews were conducted where interviewees
expressed their ideas and points of view on the specified issues. In the second part of
the study, six final interviews provided information on the way line managers
prioritized their tasks and on the conflicts that arose when trying to rank these
priorities. The managers were also enquired about the way in which information
systems enhanced the ease of doing their work more accurately and having access to
necessary information. Other important aspects were the ways in which information
systems could be better designed, implemented and improved to help people use
resources at full potential and provide the best results.
The observations were made according to the principles of Soft Systems Methodology
which focuses on the study of phenomena and on treating systems as flexible entities,
taking into account the fact that reality is built by humans in a continuous way. It
assumes that organizational systems are changing on a permanent basis, thus all the
~1095~
norms, roles and values residing in it should be looked at from a subjective point of
view (Jacobs, 2004: 140). It all stands in analyzing the organizational environment
from the soft perspective and applying it to the hard procedures, understanding
the change-related issues rather than seeing it as a collection of static processes, tools
and people. Checkland and Pouter (2006: 196), referring to this method of
observation, say that it can be used in human situations when there is a feeling that
this could/should be improved, or when something needs to be done about this.
In figure 2 we presented a visualization of the mnemonic CATWOE (the abbreviation
stands for Customer, Actors, Transformation process, Worldview, Owner and
Environmental constraints) (Malmqvist, 2008) adapted to the information flow and
processes at Volvo I&O Site Gothenburg, which better illustrates the relationship with
all departments involved in the decision making and with all interested parties
(stakeholders), as well as their interaction with companys information systems.
There were seven semi-structure interviews and discussions with some of the most
influential people in the process at the I&O Site, among which the Site Manager, a
Manager for Managers, a line manager, two employees and two process owners - one
representing the HR department and another from the Finance department
(Malmqvist, 2008). As a brief presentation, we are going to describe in short the main
responsibility of the interviewees: the Functional Manager controls the process in
terms of efficiency, quality of the products, establishing goals or more specifically,
performing the long-term planning, being a customer of the sites resources; the Site
Manager is concerned with daily activities; the HR department is responsible for all
employees working at the site; the line manager is in charge of the daily activities,
who and what task performs each employee, in other words he is making sure that his
team meets the objectives set by the Functional Manager, as well as of product
economy, quality, and it also has economic and HR responsibility, which refers to
planning the budget and forecasting the needs in terms of resources, and also
supervising the work of the employees, their performance and development. Some of
the interviewed people underlined the fact that at Volvo there is a great highlight on
employees, it is the idea of knowledge-based company who cares for its people
mostly because its them who carry out most of the tasks and commit to the actual
realization of strategic goals.
From the opinions of some of the people interviewed we could agree upon the fact
that most of the time, economic issues and daily activities get more priority due to
their apparent urgency and tactical impact, hence the focus on employees is hindered
and it comes off second best. The general point made refers to the need of line
managers to be responsible for HR activities also, as they are more long-term issues.
There is also the impression and it may at the same time be not just that, that line
managers are facing a lot of pressure from all directions, making it very difficult to
prioritize between what the function requires from a line manager and how he deals
with daily activities. Therefore the exact and fair description of the role of a line
manager would solve all ambiguities, as well as a better planning of his duties and a
good structure of his work
~1096~
Figure 2. CATWOE illustration of information flow between parties impacting

the manufacturing process at Volvo I&O Site Gothenburg
DEMANDS
FOR
RESOURCES
Top management
GOALS
Sales
Department
PERFORMANCE
RESULTS
RESOURCES
Finance
Department
DEMANDS FOR
RESOURCES AND
COMPETENCE
Functional
manager
RESULTS,
REPORTS,
QUESTIONS
Site
Manager
OBJECTIVES
QUESTIONS,
RESULTS
HR
Department
OBJECTIVES,
SUPPORT,
CONTROL
Manager
for managers
Marketing
Department
ORDERS
PERFORMANCE
APPRAISAL,
RESULTS
RESULTS
SUPPORT,
CONTROL
CUSTOMER
SUPPORT
Customers
Line
manager
OBJECTIVES
TRAINING
GUIDANCE
CONTROL
ASSESMENT
Information Systems
RESULTS
APPRAISAL
EMPOWERMENT
QUESTIONS
PAYMENT
I&O
Manager
Operators/employees
In their position, having to deal with a lot of activities and coming in contact with a
lot of people, whether they are employees or site, finance or marketing manager, line
managers must handle a lot of information that they must look for in a lot of different
places. For financial facts and figures, as well as other data regarding the daily work,
the planning of employees time or budgeting, they can get a great deal of reports
from the SAP they have implemented. For HR activities there are some modules of
the SAP that provide useful information on how to better manage the workforce and
to value it accordingly. To serve this purpose, a handbook is available on the intranet,
there is a service center that can provide help for many types of problems regarding
the HR policy, and another level is designed for HR policies. There are also other
means of transmitting information like Outlook, where managers can plan their time
and employees time if they want, or getting information from, like Faros, through
which someone can order programs or other services he/she needs to do their work.
And last but not least, there is an IT solution that Volvo IT offers to enable a more
lean flow of information and communication, a virtual workplace presented as a
website that provides open or secure access, where collaboration is made possible
through forums, news, lists of contacts or tasks - TeamPlace (Volvo IT AB, 2011).
In addition to these computerized means of communication, some interviewees
stressed out that there are pieces of information they normally get in traditional ways,
like discussing with their colleagues, receiving feedback from coaches or mentors,
sometimes in informal situations, not necessarily during meetings or reunions. This
has, needless to say, its advantages and disadvantages, like for instance the fact that
the novice gets the information easier and in a facile manner, but he/she can actually
not get it the right way, he/she cannot learn how to deal with a new method the way it
~1097~
is designed. But not all issues are solved in the traditional way. Line
their computers depending on the activity they need to undertake, if
create reports, to analyze results of different projects or tasks. Some
assistants who perform this work for them, but it depends again on
information is needed or what kind of analysis has to be done.
managers use
it is either to
of them have
what kind of
Even though they benefit of a lot of IT support, there is still the feeling that
information is spread all over the place (Malmqvist, 2008: 25). This may lead to
creating difficulties in finding information in a timely manner, and also having access
to the right kind of information mainly because there seems to be a lack of
effectiveness in the structuring process. The company has tried to adapt all other
information systems they introduced which were basically created for the general
management purpose, like SAP, sometimes even to the needs of the line managers, in
order to make available the right information to certain categories of users.
Interviewees agreed that they had problems using all the applications and in getting
the requested information from the systems, partly because these applications were
very difficult to work with and it took a long time to learn it, but they pursued because
they acknowledged that in this way their effectiveness will increase considerably.
The challenge for line managers is and will continue to be the overall picture and how
to get a general overview of the situation in your area of interest with so much
information that one has access to. Putting together data from the financial reports,
inventory systems, HR system, demand forecasts etc. is not enough. Learning how to
manage information and how to make better use of information systems helps only in
theory; in practice, we all have the same behavior and instead of reading the
instructions manual, we simply try to see how a device works. In reality, the
advantages of these systems are far beyond ones acknowledgement. They have a lot
of functions that could make easier a line managers work, but they cannot spend too
much time in seeing how all these things work, they are trying to prioritize and time is
not really their best friend. The systems are not by far used at their full extent, a lot
more could be done with them, but it is users choice to how much he/she can
dedicate to learning all the functionalities and relationships beyond the interface and
his/her background that support or impedes the learning process.
Another gap in implementing information systems and making them accessible to
employees is the approach of the training that needs to be done. This is the case for
many companies worldwide, when the experts provide the users with some basic
training, but as things get more and more complicated, there are still questions left
without answer. Its the now you have the application, here is your password, ask if
there is anything you need to know (Malmqvist, 2008: 28) type of approach, as one
of the interviewed line managers states. Since line managers have a lot of crossfunctional responsibilities, they should probably receive a more in-depth training
which should be done on a continuous basis. With all the many tasks they are
requested to perform, they are entitled to have the necessary conditions to do that.
And as previously mentioned, the solution to this issue would be to develop training
for general purpose and then to allocate each line manager and each decisional staff a
training that is focused on the particularities of his/her work, to adapt it to the needs of
the user.
~1098~
We can assume that the problems enumerated here are probably not only the case of
Volvo, other companies who have embraced the challenges of information systems
are facing the same situation: systems are not exploited at their maximum,
information is not appropriately put at disposal, there are too many tools and functions
the users are trying to make themselves familiar with but which they never actually
implement in their work and thus become more of a counterproductive mean.
Other surveys, some of which presented in the research of Coronado Mondragon et al.
(2004), have revealed the limited advantages that investment in information systems
can provide, underlining the fact that despite the great amount of support software and
techniques developed, productivity and effectiveness have seldom increased, in most
cases stagnating.
3. SECOND APPROACH THE ROLE OF INFORMATION
AND COMMUNICATION SYSTEM OUTSIDE THE ORGANIZATIONAL
BOUNDARIES
3.1. Methods for data collection in the extended supply chain
Data collection involves the use of several methods. Business system planning (BSP)
is a structured interview technique developed by IBM. It focuses on identifying
problems and decisions related to an organizational process and it determines what
information is required for a correct approach.
Table 1. Business System Planning
BSP- PROBLEMS/ SOLUTIONS/ INFORMATION
Problems
Solutions
Reducing the order processing cycle The need to understand the lead
among members of supply chain time cycles between the chain
while maintaining or even reducing members and logistics costs vs.
total performance.
overall costs.
BSP - Decision
How to transport the X product.
Information
Performance to
each organization
The total cost
logistics
Historical data
chain members
Travel costs
times
fulfill orders for

of supply chain
on orders from
and
processing
BSP - Information
Comisionarul i modalitatea folosite de competiie
Costurile de transport i performanele comisionarului i a modalitilor
Commissioner and the method used by competition
Transportation cost and the performance and the methods used by the
commissioner
Critical Success Factors (CSF) focuses on areas of high performance that must
function effectively for the organization to succeed and meet the information
requirements.
Table 2. Critical Success Factors
CSF
The performance measurement
system of integrated supply
chain
Information
Measurement for the integrated supply chain performance
Performance measurements for individual members of the organization
Effective performance of supply chain and of organizational measurement
Goals to measure
Performance over time
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Traditional systems do not allow trials and errors regarding information systems.
Following these methods have resulted systems that must be changed every time and
because of this they become completely unnecessary. To meet this great challenge, a
new prototype was built. The prototype was introduced to overcome these obstacles
through the validation of the systems requirements due to experimentation, refining
and testing. To achieve the performance standards, certain information must be
automated. There are three interrelated streams: value stream, informational stream
and material stream. To the extent that they can be automated, they can be included in
the ERP. It is a process that can be a standard, but also a freeze of the factors included
in the ERP.
3.2. Information systems and supply chain management
When computers first appeared in 1960, those displays filled an entire room with
tubes and wires. With the development and evolution of the integrated circuit, the cost
of a computer decreased significantly and its power increased exponentially. With the
emergence of personal computer, fiber optic networks and the explosion of Internet
and World Wide Web, the cost and availability of the information, all that led to the
elimination of delays caused by the informations transmission in any supply chain
network. Computer and telecommunications technology have led to simulation of
work in real time and on-line communication throughout the entire chain.
Managers that create information systems should not view them as a set of repetitive
transactions between different entities, customers and suppliers, or distributors or
retailers. An ideal system should include all functions and all organizations that go
through the chain. Given the explosion of Internet, of intranet systems inside the
companies, future systems will have the following characteristics:
A centralized coordination of information flow
Total logistics management - the integration of all transport systems, control
and production systems
Signs of change orders that triggered a series of changes in the program of
production, logistical or planning storage operations
Global visibility in terms of resources transport across business units within the
boundaries
Overall management of stocks - the ability to locate and track the movement of
each element
Global procurement - Strengthening procurement functions across
organizations, facilitating the rigging components for purchasing and also the
standardization
Inter-company access of information - clarity of information on production and
demand is identified at the top and also at the bottom of the value chain
Data capture - the ability to capture data on a command from its point of
departure, and to track products throughout their road, when their properties are
modified.
Transform the image from the inside - managers can see the "big picture"
In the ideal informational supply chain, the information is available to any party in the
chain and also the number of feedback loops that characterize a fully integrated
supply chain. These links are critical because they allow the appearance of just-in-
~1100~
time deliveries between each link of the chain. They also assure that the inventories
can be minimized and entities may respond to fluctuations in an appropriate manner in
terms of time and quality.
4. SOLUTION FOR INTEGRATING THE INFORMATION FLOW
4.1. Computer system for the optimization of an extended supply chain using
electronic commerce
E-commerce means, in traditional way, the use of applications such as electronic
transfer of documents (EDI), fax communications, bar code, file transfer and email in
networks, along with adding value. The extraordinary development of the
interconnectivity of computers through the Internet, in all segments of society, led to
an obvious increasing trend for companies to use these networks in the area of a new
type of commerce, electronic commerce. Besides the old services mentioned, this type
of commerce, also uses new ones. It is, for example, the ability to make purchases
over the network, electronic "on" web catalogs consultation or off web catalogs
consultation on a CD-ROM and the possibility of paying via credit card or some
electronic purses. For others, trade business on the Internet is the business network
that runs between suppliers and customers as an alternative option for "traditional"
communication by fax, dedicated communication lines or EDI on value-added
networks. Finally, another form of Internet commerce involves the transfer of
documents - from contracts and orders pro forma, to photos or voice recordings.
4.1.1. E-commerce system architecture
To build an e-commerce system, the architectural need is to collaborate with four
components (electronics / computer subsystems) for the following roles:
(a) Client. The first component is a classic equipment, a PC connected directly (via
an ISP) or indirectly (a corporate network) to the Internet. The buyer uses this
equipment to browse and shop.
(b) Trader. The second component is a computer system (hardware & software),
usually located at the dealer, which also hosts updated electronic catalog of products,
available to be ordered online on the Internet.
(c) Transactional system. The computer system (hardware & software) responsible
for processing orders, taking payment, records and other business aspects involved in
trading.
(d) Payment Gateway. A computer system which is responsible for the routing of
payment instructions within the financial and banking networks, including credit card
verification and authorization of payments. This system acts as a gate linking the
global network and Internet-banking financial subnet, it is the gate through which
access is controlled by a gatekeeper, based on specific credit card information (card
type, card no.). From the payment instructions, the "goalkeeper" redirects the
information to central card information (CC - a server certificate to this purpose and
approved by the issuing bank). In this place the card issuing bank is identified and the
payment instructions are forwarded to the bank server that connects networks interbank. Once the information reached the bank network which is working with the
buyer, a series of checks regarding the authenticity of the card and available credit are
made (automatically). Depending on the outcome of these checks, the bank decides
either payment (bank transfer - the trader's account can be opened in any bank), or
~1101~
refuses this payment. In both cases, the outcome of the decision (payment
confirmation or refusal) is sent in real time, following the chain of servers in reverse
to the customer (Jacobs & Whybark, 2000).
4.1.2. Models of e-trade
The most widely implemented models for e-trade are:
B2B transactions. B2B is an e-trade model in which all participants are companies or
other organizations. B2B field is a very promising, due to Internet involvement at the
corporate level. Recent studies show that there are more than 1.1 million Internet
users from their work place (including schools and universities) and over 42,000 toplevel domains registered.
B2C transactions. This type of transaction is made between individual buyers and
sellers from the large companies. In this case, the human factor is more important and
the interactivity is the basic characteristic of the purchasing decision. Customers buy
from people they know and they trust. Clients trust the brand firstly because they trust
the managers of the company, its specialists and / or its employees. That is why the
companies should treat very carefully the public image of its employees. An online
community has as main objective to get into contact persons with common concerns.
(Canda et al., 2010)
B2G transactions. Governments use the channels of e-trade to increase efficiency of
operations and to improve customer service. One area of concern for governments in
the area of business is wide-scale use of the Internet and WAN networks, to
disseminate information, opportunities, quotations received from vendors/suppliers of
goods and services. Government involvement in e-trade has a catalytic effect on local
business, in a particular country. Governments are the biggest purchasers of goods
and services from the private sector. Building a critical mass of online shoppers to
assist the emergence of an e-trade business community, requires the active
involvement of governments, not only from a legal perspective but also as a
participant in electronic trade as an ideal source of training and technical assistance to
new firms, just born in e-trade. (Jacobs, 2004)
4.1.3. The benefits of electronic commerce
With the support of the Internet and the use of specific software packages, electronic
commerce had and still has advantages and benefits for firms, individual consumers
and society.
Benefits for business:
Extension to international markets by providing services and performance;
Decrease of the costs for design, processing, distribution, storing and finding
paper-based information, by creating an attractive web page for a virtual shop.
The customized web sites, purchase suggestions and tailored special offers can
substitute for face to face interaction;
Lower communication cost;
~1102~
Reliability and safety. Parallel servers, hardware redundancy, fail-safe

technology, information encryption and firewalls sites can meet this
requirement;
Construction of an electronic value chain in which to focus on a limited
number of core competencies - the opposite of a one stop shop (electronic
stores can be specific or general, if properly programmed).
Benefits for consumers:

The possibility for consumers to purchase or make transactions 24 hours a day,
all year round, from almost any location;
Give consumers more choices of products and prices;
Consumers have certainty about the value. Vendors can achieve this by
offering a product or a product line that attracts potential customers through
competitive prices;
Consumers can receive relevant information in seconds, not days or weeks;
Makes it possible to participate in virtual auctions;
Urging consumers to buy. Traders on the internet can provide such help
through ample comparative information and good search facilities;
Allows consumers to interact with other buyers in electronic communities and
to compare experiences;
Benefits for society:
Providing a sense of community through chat, forums that require the
involvement of customer, loyalty schemes and affinity programs;
Allows more people to work from home and buy from home and hence less
traffic on the streets and low air pollution;
Allow certain goods to be sold at lower prices, with advantages for those with
lower incomes;
Increase efficiency and/or improve quality;
Provides an organization careful and agile enough to respond quickly to any
changes in the economic, social and physical environment. (Jacobs & Whybark,
2000)
4.2. ERP: Enterprise Resource Planning

Systems for enterprise resource planning (ERP) have emerged as a way to keep track
of companys inventory and developed trough the integration of traditional
management functions, such as the financial, payroll and human resources, with other
functions, including production and distribution. Currently, ERP systems continue to
evolve and already we can observe acronyms, such as extended ERP, ERP II,
enterprise business applications EBA, enterprise commerce management ECM, or
comprehensive enterprise applications EBA. (Hotran & Horga, 2010). In 1960, the
main objective of an ERP was the inventory control systems. In the '70s, the midsized companies could afford to buy computers, leading to the revision of the
traditional cycle of production and resource allocation. We have developed systems
for material requirements planning (MRP) to ensure that the company has in stock the
required quantity of material. Determining the amount of components needed,
however, was not sufficient. To improve efficiency, companies have to plan their
production based on materials, equipment and priorities. Thus, we have implemented
~1103~
capacity requirements planning (CPR). But computers with reduced capacities didnt
allow adding in the calculation of CRP equation, variables such as downtime or
maintenance. As a result, each work station was modeled as having infinite capacity
and the planning still remained unclear. The next step was the development of
manufacturing resource planning (MRPII), which integrated business planning, sales,
support activities and other functions, so that they can be coordinated.
In the '90s, each functional department of the company benefited from computer
support. Programs and departments' databases were not connected, repeated
introduction of the same data meant loss of time, data arising from individual
applications were inconsistent and attempts to analyze them only lead to chaos at the
decisions level. In addition, consumers increasingly required reduced delivery times.
All this, combined with the Japanese philosophy of the production process, have led
Western businesses to reassess the production process. "Just in time" (JIT), which was
aimed at eliminating wastage and unproductive time, required the development of
much closer relationships between suppliers and manufacturers. On the one hand,
producers had to know the cost of materials when an order was settle. On the other
hand, those who dealt with the supply had to know the sales plan in advance. There
was the need to develop a common database and this is the moment that can be
considered the birth of ERP systems.
When we talk about ERP, we rarely think about planning how to spend resources.
Rather we think of a company's vision on business, in other words, the company and
all the components seen as a unified whole, rather than isolated segment of activity.
On the one hand, ERP refers to software infrastructure that provides internal cohesion
in a company, and on the other hand, it supports external business processes in which
the company is involved.
4.2.1. How can ERP improve business performance?
An ERP system enables decision makers to achieve full analysis of a business plan, to
achieve better communication within the company, to improve cooperation and
interaction between various departments. Through the option of simulation and trough
the flexible and dynamic nature of applications, we can make forecasting plans,
assessments, pre-definitions of the evolving trends for the industry which includes the
company, qualitative analysis, all this integrated with e-business technologies and
communication on-line.
Figure 4. Conceptual diagram of an ERP system
Reports for
management
C
L
I
E
N
T
S
Financial
Accounting
Sales and
distribution
After-selling
Services
Unic data
base
Production
Stocks
Front-office
Applications
Staff
payroll
~1104~
Back-office Applications
S
U
P
P
L
I
E
R
S
From the customer perspective an ERP can facilitate management of current

operations, improve order fulfillment, improve cash flow, integrate financial
information, improve customer services, improve production control, raise the
efficiency in production scheduling and can adapt quickly to changing market
conditions. Also, an ERP ensures the compliance with reporting requirements
imposed by law, and documents provided by internal procedures, eliminating
inconsistencies and redundancies in companies. (Hotran & Horga, 2011)
4.2.2. Disadvantages of an ERP system
Many of the problems that organizations have with ERP systems are due to
inadequate investment in training of personnel, including those implementing and
testing changes, and the lack of a policy of protecting the integrity of data in ERP
systems and also its use.
Limitations of an ERP system include:
Success depends on the skills and employment experience, including training
on how to use the system correctly.
Customizing the ERP software is limited.
Redesigning business processes to fit the industry standards set by the ERP
system, may lead to a loss of competitiveness.
ERP vendors can charge sums of money for annual license renewal, which is
not related to the size or profitability of the company which uses ERP software.
ERP systems are seen often too rigid and too difficult to adapt to specific
production flows of companies - this is one of the main causes of their failure.
Refusal to provide internal confidential information between departments can
reduce the efficiency of the software.
There are often compatibility issues with older systems used by different
partners.
4.2.3. ERP costs
Many companies classify the ERP solutions as expensive. The costs of an ERP
solution may vary depending on many factors and are, in fact, a plurality of other
costs. So, in the price cost of an ERP, we include the software licenses, the cost of
implementing the solution, maintenance costs, costs of integration with external
applications and the maintenance of those interfaces and also hardware and
telecommunications infrastructure costs. All these elements depend on the specifics of
the solution in a particular company: the processes that need to be implemented, the
number of users, duration and purpose of implementation.
Many users complain about the cost overruns from the initial budget approved for
purchasing an ERP system. The emergence of these hidden costs is caused by lack of
consistency between the position during the negotiation and implementation. In other
words, at the negotiation level, the customer requirements are at the minimum level
because they want to decline the purchase price, but during implementation, there
requests go to a maximal level, in disagreement with the initial negotiation. Secondly,
it is the cost of licenses, and this means also the cost of service configuration that
requires additional software (network, database, etc.) and also the need for
modernization of hardware that ERP providers believe that there are included in the
ERP price. Third, during implementation, with deeper understanding of the
~1105~
application for the beneficiary, it reveals other solutions or necessities that attract
additional costs.
Underestimated costs:
Training represents, on the unanimous opinion of those who have implemented
ERP systems, one of the most underrated aspects of the budget.
Integration and testing of ERP package with other software tools used by the
company is often an activity whose cost is underestimated.
Conversion of data from the format required by the old applications to the
format required by the ERP systems is an activity that proves to be very costly
and difficult to estimate quantitatively.
Maintenance. Developing such a solution actually does not stop, ever.
Customers always have special requirements to change, but there are also
requirements that arise from changes in the law.
4.2.4. ERP II
The evolution of technology is subject to the laws of nature, and is subject to "natural
selection" and "adaptation to environment." These laws express a simple principle: the
things that do not adapt do not survive environmental change. Business is business
and that information systems that support them, are no exception to the law of
evolution. ERP II represents the next stage of development of enterprise resource
planning systems. Technology has entered into the communication era, particularly
with the growth of the Internet. ERP II is actually an ERP adapted to the reality of the
Internet, through changes in functionality, technology and architecture. The most
obvious change is the shift in emphasis from activities focused on the internal
workings of the company, to the integration and external collaboration.
Table 4. ERP applications versus ERP II applications
ROLE
ERP
Optimizing enterprise
FUNCTION
Production, sales and distribution, financial

processes
PROCESSES
Internal, hidden
ARCHITECTURE
DATE
Web-aware, closed, monolithic

Internally generated and consumed
ERP II
Integrating
the
value
chain,
collaborative-commerce opportunities
Vertical
processes,
horizontal
processes,
custom
industrial
applications
External connection including suppliers
and customers
Web-based, open, modular
Published and shared internally and
externally
(Source: Gartner Research)
4.2.5. ERP solution - Microsoft Dynamics Nav

This software was purchased in 2002 by Microsoft. It passed successive stages of
integration into Microsoft's Navision portfolio of solutions from The way to grow,
to Microsoft Business Solutions Navision and then to its current name Microsoft
Dynamics Nav. Microsoft Dynamics NAV is an application on two or three layers.
The two layer architecture is the most used. The three layer architecture means that
between the client and server, business logic is taken by Navision Application Server,
which performs operations without user interface (eg. barcode reader).
~1106~
There are two methodologies for implementation:

standard methodology
Sales
Diagnosis
Analysis
Design
Development
rapid implementation methodology
A reliable platform for development. Microsoft Dynamics NAV provides the

functionalities needed to run a business. Thus, the open architecture of Microsoft
Dynamics NAV, allows to Microsoft certified partners to transform the standard
technological platform, into a solution adapted to the specific way of doing business.
They are the only global software provider from the middle market sector which
offers complete freedom to local partners searching to meet specific needs. Their
partners have access to the entire source code for business logic.
Open and secure platform. Object-oriented development environment of Microsoft
Dynamics NAV and compact source code, make this solution easy to customize,
maintain and connect to other systems.
Reliable database. Whether it chose Microsoft SQL Server or Database Server for
Microsoft Dynamics NAV, you can count on a reliable way of storing data. The
security system controls not only the users and applications accessed, but also ensures
that there will never be inconsistencies. Even if, during a post process, the computer
stops, the recorded transactions will not be un-synchronized.
Easy to learn. Familiar look of Microsoft Outlook makes the employee training
quicker. For example, in the general accounting section, the screen will show the
same interface whether it is viewed a balance, created a new account or something it
is posted on a journal to an existing account. Surfing is more familiar because the
interface is based on Microsoft Windows standards. Complete online support is
available, on which you can even add your own suggestions.
Accessing information in any language. This software provides better service to
customers and suppliers. It offers them the inventorys descriptions, printed reports
and invoices, in their own language and currency.
In our opinion, a supply chain of the future will be more:
Instrumented: the information that was created before by human resource
will be increasingly more handled by computers. Stocks will self-count. Containers
will detect their own content. Pallets will report if they have reached the wrong
location.
Interconnected: the whole chain will be connected - not only the customers,
suppliers and IT systems, but also the elements, the products and other small objects
~1107~
used to monitor the supply chain. Extensive connectivity will enable supply chain
networks worldwide to plan and make decisions together. The quality and
performance management of companies to manage economic risk, social and
environment can be measured today and the information can be sent to investors so
they can track and choose the top companies. (Ciora, 2010)
Intelligent: decisions taken within the supply chain will also be more
intelligent. Advanced modeling will help decision makers to revue their options
before heading to a dynamic set of risks and restrictions. Intelligent systems will be
capable to automatically make decisions, increasing response and reducing the need
for human intervention.
Thus, we can say that the future supply chain will be eager for change, will have a
capacity for innovation beyond customer imagination, will be integrated globally, will
withstand environmental perturbations and will be authentic. In all this characteristics
we can see clearly the involvement of evolved information flows at different level.
Regarding the trend companies are following to adopt information systems, we would
recommend first an in-depth analysis of strategies and business plans, an alignment
with short-term priorities and only afterwards should the actual implementation be
considered. Otherwise, the investment could not lead to the desired benefits.
Management information systems can be seen also as an offensive and defensive
weapon in a changing environment. In our opinion, the perfect integration can be
made if you look closely at both approaches. It is important to stay with one eye at the
detail and one eye at the system, explaining in this way why some managers from the
biggest companies are not able to see the forest for the trees.
REFERENCES
Boddy, D., Boonstra, A. & Kennedy, G. (2004) Managing information systems: an
organisational perspective - second edition, London: Prentice Hall/Financial Times.
Canda, A., Rusescu, M. & Pantea, C. (2010) Revealing the people who empower the social
networks an exploratory research of the Romanian market, 17th International
Economic Conference IECS 2010, Sibiu: 30-36, ISBN 9789737399878
Checkland, P. & Poulter, J. (2006) Learning for Action: A Short Definitive Account of Soft
Systems Methodology and its use for Practitioners, Teachers and Students, Chichester:
John Wiley & Sons, Ltd.
Cioan, G. & Ohot, A.A. (2010) Romanian Quality Seen by an American Group, 5th
WSEAS International Conference on Economy and Management Transformation,
24-26 October, 2010, Timioara, Selected Topics in Economy and Management
Transformation, vol. 2: 610-614
Ciora, C. (2010) Value creation through sustainable development, Suplimentul revistei
Calitatea - Acces la succes, year 11, no.111, ISSN 1582-2559
Coronado Mondragon, A.E., Lyons, A.C. & Kehoe, D.F. (2004) Assessing the value of
information systems in supporting agility in high-tech manufacturing enterprises,
International Journal of Operations and Production Management, vol .24, no. 12:
1219-1246
Fattahi, R. & Afshar, E. (2006) Added value of information and information systems: a
conceptual approach, Library Review, vol.55, no.2: 132-147
Hotran, I. & Horga, G. (2011) ERP Software The Opportunity to Bypass the Time of
Crisis, International Journal of Education and Information Technologies, issue 2,
vol. 5: 242-249
~1108~
Hotran, I. & Horga, G. (2010) Leadership - crucial element in implementing ERP systems,
WSEAS International Conference on Economy and Management Transformation, West
University of Timisoara, October 24-26, vol 2: 388-393
Jacobs, B. (2004) Using soft systems methodology for performance improvement and
organisational change in the English National Health Service, The Journal of
Contingencies and Crisis Management, vol.12, no.4: 138 149
Jacobs, F.R. & Whybark, D.C. (2000) Why ERP A Primer on SAP Implementation, New
York: Irwin/McGraw-Hill
Malmqvist, M. (2008) First Line Manager Role and Information Systems: A Case Study at
Volvo IT of how Information Systems Can Help the First Line Manager Better Balance
the Soft and Hard Tasks They Face, thesis work in Informatics, report no.2008:019,
Gothenburg: Library of Chalmers University of Technology
Petcu, A.J. & Drghici, M. (2010) Confluences and interferences between TQM and Lean
Six Sigma, 17th IGWT Symposium and 2010 International Conference on Commerce,
Facing the Challenges of the Future: Excellence in Business and Commodity Science,
21 25 September 2010
Yen, H.R. & Sheu, C. (2004) Aligning ERP implementation with competitive priorities of
manufacturing firms: an exploratory study, International Journal of Production
Economics, no.92: 207-220
Volvo
Group
(2010)
Volvo
IT
Company
Presentation,
available
at
http://www.volvoit.com/SiteCollectionDocuments/Volvo%20IT/documents/other/Volv
o%20IT%20company%20presentation%202010%20en.pdf (accessed 19.03.2011)
~1109~

Irina Bogdana PUGNA1, Felicia ALBESCU & Robert SOVA
ABSTRACT
We are witnessing a new shift in business intelligence: the move from traditional analytics to
predictive analytics, as a distinct new software sector. In this paper, we try to present some
aspects regarding predictive analytics and their role in providing a deeper insight of data, in
adding intelligence to BI applications. After presenting some notions about predictive
analytics what it means and how it differs from terms like data mining or business
intelligence itself, we discuss about the process of predictive modeling, about different types
of business users and analytical tools that we can integrate in the BI platform of an
organization. At the end, we propose a BI cycle that should be extended to cover all the
decision making process, including the decision itself, the action generated by it and to
provide feedbacks in order to update it accordingly with the changes of business environment
as both as a way and as a mean to a predictive performance management.
KEYWORDS: predictive analytics, business analytics, data mining, analytical modeling,

analytical tools
INTRODUCTION
Companies are increasingly turning to a new management discipline called predictive
analytics to compete and thrive. Rather than relying on intuition when pricing
products, maintaining inventory or hiring talent, managers are using data, analysis and
systematic reasoning to improve efficiency, reduce risk and increase profits.
In simple terms analytics means using quantitative methods to derive insights from
data, and then drawing on those insights to shape business decisions and, ultimately,
improve business performance. Thus predictive analytics is emerging as a gamechanger. Instead of looking backward to analyze "what happened?" predictive
analytics help executives answer "What's next?" and "What should we do about it?.
Business analytics are accessible for managers only through business intelligence. But
is there a difference and, if so, which is it, between business intelligence and business
analytics?
Business intelligence (term coined in 1989 by Howard Dresner, researcher at the
Gartner Group) is considered more and more as being an umbrella term to cover a
number of methodologies and ideas designed for the increase of efficiency and
profitability in the corporate workplace. Some consider it as being primarily data
reporting and visualization, others include business performance management. For
1
Correspondence address: Irina Bogdana PUGNA, PH.D, Academy of Economic Studies,

Bucharest; email: irina.bogdana@yahoo.com
~1110~
database vendors, is mainly about data extraction, transformation and integration,

while for the analytics vendors is mainly about statistical analysis and data mining.
Figure 1. Intelligence through analytics
Optimization
C
o
m
p
e
t
i
t
i
v
e
A
d
v
a
n
t
a
g
e
Whats the best

that can happen?
Predictive
modeling
Forecasting
What will happen next?
Statistical analysis
What if these trends continue?
Alerts
Why is these happening?

What actions are needed?
Query drilldown
Ad hoc reports
Standard
reports
Where exactly is the problem?
How many, how often, where?

What happened?
Degree of intelligence
(Source : SAS, 2008:5)
For many years, BI was limited to assist and support the process of extracting
valuable information and knowledge from large collections of data via sophisticated
analytic and statistical tools. Traditionally, BI could be broken in three components:
information sources, or the database and software applications where data
resides;
integration the act of compiling data from various and heterogeneous sources
before it was analyzed;
analysis and reporting of the data itself.
In other words, it is all about collection, integration, analysis and presentation of
business information using analytic applications.
Business analytics is the analytical process of reasoning, forecasting and measuring
business actions and processes based on extracted patterns in collected business data
and business plans. The analytic applications offer feedback about the status of the
organization; they adapt to the business model, answer questions about the business
and are optimized to answer to the user questions.
Lately, business analytics is the new term embraced on the market. The term business
intelligence has been watered down so much that seems to be less attractive to
business users. Its enough to compare the interest on those two terms in the last years
as it is shown by the volume search relatively to each of them on the Google.
~1111~
Figure 2. Google Trends on business intelligence slow decline
Figure 3. Google Trends on business analytics rising sharply
(Source Google st, 2011: 16)
But, in the end, which is the difference between business intelligence and business
analytics? For example, one of the most important vendor on BI market consider that
business analytics is an umbrella term including data warehousing, business
intelligence, enterprise information management, enterprise performance
management, analytic applications, and governance, risk, and compliance. But other
vendors use business analytics to indicate some level of vertical/horizontal domain
knowledge tied with statistical or predictive analytics.
Generally, when a new term is introduced (at least in information technologies field),
people are tempted to dismiss the old one as just technology driven and backward
looking while the new term is business oriented and actionable.
There are two things worth differentiating:
~1112~
The first is the business aspect of BI the need to get the most value out
of information. This need hasnt really changed in over fifty years
(although the increasing complexity of the world economy means its ever
harder to deliver). And the majority of real issues that stop us from getting
value out of information (information culture, politics, lack of analytic
competence, etc.) havent changed in decades either.
The second is the IT aspect of BI what technology is used to help
provide the business need. This obviously does change over time
sometimes radically.
There are still some BI professionals that equate reporting or monitoring with
analytics, and may be is not entirely inaccurate to do so. Business people can use
reports to understand the business, analyze root causes and guide future activities. For
some users, such as executives and managers, reports and dashboards are optimal
analytical tools; for others, such as business analysts or analytical modelers there is a
need to move beyond reporting to analytical and predictive technologies with richer
functionality.
Still, at the end of the date, nobody important cares how we call it. If we are in charge
of a project, what really matters is working out the best way to leverage the
information opportunity in the organization, and putting in place appropriate
technology to meet that business need.
Nevertheless, its true that we are witnessing an unprecedented shift in business
intelligence (BI), largely because of technological innovation and increasing business
needs. The latest shift in the BI market is the move from traditional analytics to
predictive analytics. Although predictive analytics belongs to the BI family, it is
emerging as a distinct new software sector.
1. PREDICTIVE ANALYTICS - the science that makes decision smarter
How we can define predictive analytics? Analytics is defined as being the science of
analysis and analysis the tracing of things to their source, and the resolving of
knowledge into its original principles. From a business perspective, analytics is about
understanding the root causes of business events and conditions. Typically, business
people identify root causes by asking a series of questions in a heuristic fashion (the
answer to each question sheds new insights and generates new questions, and the
process continues until one discovers desired insights).
Predictive analytics is a broad term describing a variety of statistical and analytical
techniques used to develop models that can be used to predict future behavior and
events. The form of those predictive models varies, depending on the behavior or
event that they are predicting. The core element of predictive analytics is the
predictor, a variable that can be measured for an individual or entity to predict future
behavior. Multiple predictors are combined into a predictive model, which, when
subjected to analysis, can be used to forecast future probabilities with an acceptable
level of reliability. In predictive modeling, data is collected, a statistical model is
formulated, predictions are made, and the model is validated (or revised) as additional
data become available.
~1113~
Predictive analytics combine business knowledge and statistical analytical techniques

to apply with business data to achieve insights. These insights help organizations
understand how people behave as customers, buyers, sellers, distributors and so on.
Multiple related predictive models can produce good insights to make strategic
company decisions, like where to explore new markets, acquisitions, and retentions;
find up-selling and cross-selling opportunities; and discovering areas that can improve
security and fraud detection. Predictive analytics indicates not only what to do, but
also how and when to do it, and to explain what-if scenarios.
1.1 Predictive analytics versus business intelligence and data mining
BI tools fall into the following categories:
Report and visualize what has happened most of the currently available tools
fall into this category
Understand why it has happened some tools are available at the moment,
while more and more tools will be available in the next years
Predict what will happen few tools available today, more will start to appear
in the next years
Figure 4. BI technologies
HIGH
BI technologies
Predictive analytics
COMLEXITY
What might
happen?
Why did it
happened?
OLAP and
visualization tools
Whats
happening
now?
Query,
reporting
and search
tools
What
happened?
Reporting
LOW
Dashboards, scorecards
Prediction
Analysis
Monitoring
BUSINESS VALUE
HIGH
(Source: W.Ekerson, 2007: 5)
The other BI technologies query and reporting tools, online analytical processing
(OLAP), dashboards and scorecards are deductive in nature, as they examine what
happened in the past. Business users must have some sense of the patterns and
relationships that exists within the data based on their personal experience. They use
query, reporting, and OLAP tools to explore the data and validate their hypotheses. As
for dashboards and scorecards, they take deductive reasoning to a step further by
presenting to the users a de facto set of hypotheses in the form of metrics and key
performance indicators (KPIs) that users examine on a regular basis.
Predictive analytics works the opposite way: it is inductive. It doesnt presume
anything about the data; it rather lets data lead the way. Predictive analytics employs
statistics, machine learning, neural computing, computational mathematics and
artificial intelligence techniques to explore all the data, and not only a narrow subset
~1114~
of it, to dig out meaningful relationships and patterns. It is important to note that
predictive analytics is more than statistics some call it statistics on steroids (W.
Eckerson, 2007). Its true that nearly all analytical modelers use descriptive statistics
to understand the nature of data that has to be analyzed, but there are a lot of
predictive techniques (neural networks, decision trees, genetic algorithms) that take
advantage of increased computer processing power to perform complex calculations
that often require multiple passes through extremely large volumes of data.
At that point, we can ask: whats the difference than between predictive analytics and
data mining? Because the term data mining has been used - especially by the software
companies, while academics and researchers have used the term knowledge
discovery instead - to describe the techniques and processes involved in creating
predictive models. Both data mining and predictive analytics apply sophisticated
mathematics to data in order to solve business problems. But when we talk about data
mining, we are usually referring to an analytical toolset that automatically searches for
useful patterns in large data sets. On the other side, predictive analytics is an analyst
guided (not automatic) discipline that uses data patterns to make forward looking
predictions by evaluating multiple data patterns. Data mining searches for clues, while
predictive analytics delivers answers that can guide to a what next action.
Figure 5. Data mining versus predictive analytics
Data
mining
Predictive
analitics
Answers
What next?
Explore
Data mining is often one stage in developing a predictive model; its automated
techniques are used to isolate the most data variables within a vast field of
possibilities. These variables are used to build a mathematical model that predicts the
future behavior consistently.
The term data mining its so out of fashion that vendors and consultants now
embrace the term predictive analytics or advanced analytics or just analytics to
describe the nature of tools they offer. But not all the analytics are predictive! In fact,
there are only two major types of predictive analytics: supervised learning (the
process of creating predictive models using a set of historical data that contains the
results we want to predict) and unsupervised learning (previously known results are
not used to train its models).
~1115~
Figure 6. Types of predictive analytics
Supervised
learning
Unsupervised
learning
Classification
Regression
Time series analysis
Clustering
Association
Analytic model
We can predict that the future of data mining lies in predictive analytics. Although
the terms data mining and data extraction are often confused with each other, data
mining is more than data extraction It is the extraction of hidden predictive
information from large databases or data warehouses. Data mining, also known as
knowledge-discovery in databases, is the practice of automatically searching large
stores of data for patterns. A predictive analytical model is built by data mining tools
and techniques.
Traditional business intelligence (BI) tools extract relevant data in a structured way,
aggregate it and present it in formats such as dashboards and reports. Like data
mining, BI tools are more exploratory than action-oriented, but the exploration is
more likely driven by a business user than an analyst. BI helps businesses understand
business performance and trends. It focuses on past performance, while predictive
analytics forecasts behavior and results in order to guide specific decisions.
Predictive analytics also focuses on distilling insight from data, but its main purpose
is to explicitly direct individual decisions. Many BI suites now include some
analytics, ranging from report-driven analytics that synthesize past performance data
to predictive analytics used in forecasting.
Figure 7. Business intelligence versus predictive analytics
Business
intelligence
Predictive
analytics
Whats happened?
INSIGHT
What to do?
ACTION
~1116~
Traditional analytical tools claim to have a total integrated view of the enterprise or
business, but they analyze only historical datadata about what has already
happened. Traditional analytics help gain insight for what was right and what went
wrong in decision-making. Todays tools merely provide rear view analysis.
However, one cannot change the past, but can prepare better for the future and
decision makers want to see the predictable future, control it, and take actions today to
attain tomorrows goals.
Predictive analytics employs both a microscopic and telescopic view of data allowing
organizations to see and analyze the minute details of a business, and to peer into the
future. Traditional BI tools cannot accomplish this functionality. Traditional BI tools
work with the assumptions one creates, and then will find if the statistical patterns
match those assumptions. Predictive analytics go beyond those assumptions to
discover previously unknown data; it then looks for patterns and associations
anywhere and everywhere between seemingly disparate information.
1.2 The business value of predictive analytics
Predictive analytics can help companies optimize existing processes, better
understand customer behavior, identify unexpected opportunities and anticipate
problems before they appear. There is no doubt that predictive analytics can yield a
substantial ROI. Nevertheless, there are many organizations that have yet to employ it
- according to a survey conducted in august 2010 by TDWI (The Data Warehousing
Institute) only 30% of organizations have fully or partially implemented predictive
analytics, while more than 50% were still exploring or have no plans about it.
We can list a lot of reasons to justify that a company needs predictive analytics; these
are only some of them:
Get a higher return on data investment
Find hidden meaning in data
Look forward, not backward
Deliver intelligence in real time
Discover unexpected opportunities
See assumptions in action
Empower data-driven decision making
If thats so, why we dont find predictive analytics wide spread in most of the
organizations? Many IT managers and some business managers understand the value
that predictive analytics can bring, but most are still wondering where to begin.
Analyzing data is not easy. Finding people who have sufficient knowledge of the
business processes, underlying data structures, and data access and analysis tools is
challenging. Also, preparing organizational data so that business people can access
and trust it is difficult, time-consuming and expensive. The analytical tools like
spreadsheets, desktop databases, reporting tools are not so evolved and havent
changed much in the past years. But there are many new analytical tools (like visual
discovery and workgroup BI tools) and technologies designed to improve the
productivity of business analysts and preserve information consistency throughout an
organization.
~1117~
2. THE PROCESS OF PREDICTIVE MODELING

The process of predictive modeling requires great skill and is so important that it must
be integrated in a clear methodology ( in fact, in 1996 was created the first industry
standard methodology called CRISP Cross Industry Standard Process for Data
Mining). So most analytic modelers adhere to a methodology to create predictive
models. But, whatever which methodology, explicit or implicit, is followed, the
processes of creating predictive models integrate the following steps:
Project definition define the business objectives and desired outcomes and
translate them into predictive analytic objectives and tasks. That requires a
close interaction between the business and analytic modeler.
Exploring the data analyze source data to determine the most appropriate
data and model building approach.
Data preparation select, extract and transform data upon which to create
models.
Model building create, test and validate models and evaluate whether they
will meet project goals.
Deployment apply model results to business decisions or processes.
Deploying analytical models can be achieved in more than one way : share the
model (share insights with business users via a presentation), score the model (
transform the model in a SQL statement or programming code and then apply
it to every record in the database ), embed the model in a business intelligence
report or in an application (so it drives business actions automatically).
Model management manage models to improve performance, control access,
promote reuse and minimize overhead. Even if now few organizations are
concerned about model management, the demand for that particular activity
will increase to comply with new compliance regulations.
Figure 8. The process of predictive modeling
Operational data
Data cleaning and organizing
Data
Mining
External data
Predictive
model
development
Predictive model
Deployment : SHARE / SCORE /EMBED IN APPLICATIONS
Model Management
~1118~
2.1 Analytics get more embedded into business applications

Business intelligence traditional tools are not an ideal environment for creating
sophisticated models with complex algorithms. But there is sometimes a fine line
between BI tools - that can create reports and support any department or domain - and
analytic applications, which are solutions that consist of a set of predefined reports
that enable business users to manage a variety of integrated processes within a single
domain. Many BI and application vendors are delivering packaged analytic
applications that embed predictive models, which are easy to use as the user is not
required to create analytical models - he needs only to know how to interpret the
results.
According to a research conducted by TDWI (The Data Warehousing Institute) in
2009 the MAD (Monitor, Analyze and Drill to detail) framework represents the
optimal way to design a BI environment to meet the analytical needs of casual
business users.
Figure 9. MAD framework
Executives/
Managers
Monitor
Graphical
KPIs
Analyze
Drill
Dimensional views and

filters
Managers/
Analysts
Operational queries and reports
Analysts/
Workers
(Source: W. Eckerson, 2009:9)
The monitoring layer consists of graphical KPIs (Key Performance Indicators) that
enable business users to asses the status and trend of KPIs at a glance. If a KPI value
is out of order, they can drill down to the analysis layer to explore the KPI from
multiple perspectives or dimensions using filters. Once they discover the root cause of
the problem, they can drill to atomic-level data in the data warehouse or source
system to identify the customers or products affected by the problem and take action.
The monitoring layer is usually supported by a portal or dashboard interface, the
analysis layer by an OLAP tool, and the drill-to-detail layer by dynamically generated
queries into a data warehouse or source application. BI applications based on MAD
framework address 60 to 80% of the questions asked by casual users (according to the
study quoted before).
Vendors are starting to expand the MAD framework to extend the analytical reach of
casual users. Rather than giving casual users separate analytical tools that they likely
~1119~
wont use, a MAD solution embeds analytical capabilities into the application so that
users hardly recognize that theyre crossing the boundary from casual user to
analytical modeler.
Figure 10. The double MAD framework
Current
Future
Monitor
Graphical
KPIs
Analyze
Drill
Modeling
WHAT-IF
Dimensional views and

filters
Advanced
Analytics
Operational queries and reports
Do
Collaborate and
Act
The monitoring layer of a double MAD application enables users to perform what-if
analysis. They can change variables in their KPIs (by moving interactive slides) and
view the impact on current and forecasted results. The analysis layer embeds more
sophisticated visualization and analytical functions that make it easy to spot patterns
and relationships in data. The bottom layer incorporates collaboration and closed-loop
capabilities so users can share ideas about data trends and issues, update or interact
with operational applications.
2.2 Analytical tools
With the new analytical trend in BI, there are a lot of analytical tools now on the
market from the traditional ones like spreadsheets and reporting tools to the
modern ones like visual discovery or graphical modeling. The problem is how those
tools can be implemented in which BI framework and, even more important, who
are their users. First of all, we have to identify and classify different kinds of users;
and there are at least two types of users that we can distinguish: the casual users
(executives, managers, some business analysts) and power users (IT developers,
business analysts, analytical modelers). Its very important to understand their roles,
capabilities and information requirements when it comes to business analytics (or to
business intelligence). Usually, we find in organizations BI tools that are too complex
for casual users but not sophisticated enough for power users. Thats why there are
different types of analytical tools on the market: analytical tools for casual users and
analytical tools for power users (the newest ones).
~1120~
The most spread analytical tools for casual users are BI platforms and search and
exploration tools. A BI platform is an integrated suite of BI modules built on a
unified, services-based architecture.
SOURCES
SERVICES
BI
MODULES
DELIVERY
CHANNELS
Figure 11. A BI platform

WEB
Production
Reporting
DESKTOP
Ad-hoc
queries
MOBILE
Dashboards
Scorecards
OLAP
PORTAL
End user
reporting
PRINTER
SOCIAL
MEDIA
Proactive
detection and
alerts
Disconnected
and mobile
analytics
COMMON SEMANTIC LAYER
Security
Data
access
OLTP and
Operational
systems
Data warehouse /
Data mart
Metadata
Query
engine
OLAP
Calculation
engine
Packaged and
custom apps
User
access
Caching
Files/
Excel/XML
Business
Processes
From a casual user perspective, a BI platform should only expose the BI capabilities
they need using role-based access control; from there, BI platforms should parcel
information on demand using the MAD framework.
The analytical tools for business analysts a category of super users are OLAP tools
and visual discovery tools that provide speed of thought analysis, conforming to the
way the user wants to interact with data.
There are also other new types of analytic tools, for more specialized super users
like IT developers and analytical modelers. Among them: workgroup BI, analytical
workbenches and functions (text analytics, graphical modeling), in-database analytics
(user-defined functions, sandboxes), high performance analytical platforms.
So, we have different kind of users - from manager to IT developer of business
analytics and its important to provide to each type the user the right analytic tool for
his information and analysis needs and competencies. Business intelligence must be
customized to users roles and personalized to their individual tastes.
~1121~
3. ANALYTICS FOR ADAPTIVE BUSINESS INTELLIGENCE

AND AGILE ENTERPRISE
2011 is the year of breakthrough analyticsAcceleration of analytics will support
the agile enterprise. Agility is a concept that incorporates the ideas of flexibility,
balance, adaptability and coordination under one umbrella in business. Analytics
technologies will help businesses be more agile and will become a key business
differentiator in 2011 and beyond (Maria Ketan, CMO and vice president, Ingres
Corporation, 2011).
The future of business intelligence lies in the development of systems that can
autonomously and continuously improve decision making within a changing business
environment, rather than tools that just produce more detailed reports based on current
static standards of quality and performance. It must incorporate techniques that build
autonomous learning, with feedback loops that generate prediction and optimization
scenarios to recommend high-quality decision outcomes; but also with an in-built
capacity to continuously improve future recommendations. To answer to that demand,
developers are focusing on new-generation information infrastructures that will be
more intelligent.
In our vision, the BI cycle should be extended to cover all the decision making
process, including the decision itself, the action generated by it and to provide
feedbacks in order to update it accordingly with the changes of business environment
(figure 12).
Figure 12. BI cycle
GOALS and METRICS
Data
warehouse
DATA
INFORMATION
(transformed data)
OLAP
DM
Actionable
KNOWLEDGE
MODELS
(output
patterns)
Business
plan
AI
!
Distribute
Collect
Integrate
Synthesis
Aggregate
Analyze
Act
Measure
Interpret
Business
analytics
Changes
impact
AI
Environment
ADAPT
These feedbacks should be covered by adaptive modules, that can automatically

adjust the action to the new reality in order to optimize its result. Those adaptive
modules use business analytics (measuring, forecasting and optimizing if its the case
business actions and processes based on available knowledge and on goals and
metrics established in business plans) and AI technologies. They are supposed not
only to change the action (or at least to offer new actionable knowledge for that) but
also to detect the change itself. This involves a shift towards predictive performance
management moving beyond simple metrics to a form of artificial intelligence based
software analysis and learning.
~1122~

Data continues to grow, and it seems that is happening somehow out of control. But
all this impressive amount of data (even if we assume that we can access and trust it,
so its already structured an d organized in data warehouses or even analytical data
marts, which is usually difficult, time-consuming and expensive) that doesnt
necessarily mean bigger or deeper insights for business. The only way for that is
through powerful analytics and interactive reporting tools that deliver high
performance results.
Analytical tools enable greater transparency, and can find and analyze past and
present trends, as well as the hidden nature of data. However, past and present insight
and trend information are not enough to be competitive in business. Business
organizations need to know more about the future, and in particular, about future
trends, patterns, and customer behavior in order to understand the market better. To
meet this demand, many BI vendors developed predictive analytics to forecast future
trends in customer behavior, buying patterns, and who is coming into and leaving the
market and why.
As Nigel Rayner noted in his speech at the annual Gartner Business Intelligence
Summit in 2009: The business intelligence market is a perennial evergreen. While it
has seen ups and downs in the past decade, its growth vector remains strong, and
aggregate revenues should exceed $ 12 billion by 2014. New categories continue to
emerge and be absorbed into core BI. The current crop includes business
performance solutions, text analytics, predictive analytics and data mining and
complex event processing. By 2012, 33% of analytic applications applied to
business processes will be delivered through course grained application mashups.
In our opinion, business analytics, operational business intelligence, the agile
enterprise, the need for powerful insight tools are the most important trends connected
to business intelligence today. Its future lies in systems that can guide and deliver
increasingly smart decisions in a volatile and uncertain environment. In this context,
its extremely important both for business managers and BI professionals to cooperate
in order to implement in organizations the right analytical tools, that respond to each
particular user needs: from ad-hoc report navigation to ad-hoc report creation and
develop of predictive models. An information and intelligence insights partnership
should function between business people of different competencies and roles
regarding business intelligence. And that is where the future research must be focus
on (together with attempts to define a more widely accepted methodology for the
process of predictive modeling itself), as we have the tools for predictive analytics, we
recognize the need and its business value but still we are sitting on a mountain of
gold but were not mining it as effectively as we could (M. Masciandro, director of
BI at Rohm & Haas: 2011).
REFERENCES
Albescu F., Pugna I. and Paraschiv D (2008)., Business Competitive Intelligence the
ultimate use of information technology in strategic management, 4th International
Conference of ASECU Development, Cooperation and Competitiveness, Bucharest
Azvine B., Cui Z., Majeed B and Spot M (2007) Operational risk management with real time
business intelligence. BT Technology Journal vol. 25, nr. 1 :154-167
~1123~
Azvine B.Cui Z.Majeed B and Nauck D.D. (2006) Real time business intelligence for the
adaptive enterprise in Proceedings of the IEEE Joint Conference on E-Commerce
Technology (CEC 06) and Enterprise ComputingE-Commerce and E-services
(EEE06) San Francisco :222-229
Blasum R. (2006) Operational BI available on line at www.business-code.de
Davis J. (2006) Right-time business intelligence: optimizing the business decision ycle
available on line at www.B-EYE-network.com
Economist Intelligence Unit (2006) Business Intelligence: Putting information to work
available on line at www
Ekerson W.W.(2007) Best practices in operational BI Converging analytical and
operational processes available on line at www.tdwi.org/
Ekerson W.W.(2007) Predictive Analytics: Extending the value of your data warehouse
environment on line at www.tdi.org
Ekerson W.W.(2009) Beyond reporting: delivering insights with next generation analytics
on line at www.tdi.org
FICO (2010) Understanding predictive analytics available on line at www.fico.com
Gartner Group (2009) Business intelligence summit, interviews available at
www.gartnergroup.com
Heizenberg J. (2009) BI predictions 2009: The paradox between demand and supply
available on line at www.bi-guru-nhm.com
IBM (2009) Get more from BI by understanding your analysis needs, available online at
www.informationmanagement.com
Imhoff C. (2007) Faster must go faster available on line at www.paraccel.com
Ketan M., (2011) 11 Big-data analytics predictions for 2011, available online at
http://tdwi.org/Articles/2011/03/16/Big-Data-Analytics-Predictions.aspx?Page=1
Michalewicz M., Schmidt M. and Chiriac C. (2006) Adaptive Business Intelligence, Springer
Books
Pugna I., Albescu F. and Paraschiv D.(2009) Adaptive and right-time business intelligence,
AMIS International Conference, Bucharest
Pugna I., Albescu F. and Zaharie D.(2008) Business Intelligence for strategic performance
measurement BPM, 4th International Conference of ASECU Development,
Cooperation and Competitiveness, Bucharest
Sandu D.I. (2008) Operational and realtime Business Intelligence, Revista Informatica
Economica nr. 3 (47):33-36
Tapscott D.(2008) Business Intelligence: Actionable insights for business decision makers:
available on line at www.newparadigm.com
White C. (2007) Become more agile: put operational BI to work available on line at
www.bi-research.com
~1124~
PS22 Management accounting

Chairperson
Mathew TSAMENYI, University of Birmingham, UK
SURVEY OF THE PRODUCT COSTING METHODS

USED IN CZECH REPUBLIC
Boris POPESKO, Petr NOVAK
THE ROLE OF COSTS AND CONTROL IN ENSURING

A SUCCESSFUL MANAGEMENT IN THE DECISIONAL
PROCESS
Stefania-Eliza BANA (PANCIU), Florinel Marian SGARDEA
THE CHANGE IN MANAGEMENT ACCOUNTING

IN ROMANIA
Madalina DUMITRU, Daniela CALU, Gorgan CATALINA,
Adriana CALU, Georgiana TOADER
~1125~
SURVEY OF THE PRODUCT COSTING METHODS

USED IN CZECH REPUBLIC
Boris POPESKO1& Petr NOVAK
Tomas Bata Univerzity in Zlin, Czech Republic
ABSTRACT
This paper presents the results of the survey focused on the usage of the different types of
product costing methods in Czech enterprises performed in the years of 2004, 2007 and 2009.
Results of individual surveys are compared with one another, in order to prove the expected
tendencies of higher usage of modern costing methods such as Activity-Based Costing, in
recent years. First part of the paper refers to previous studies of the enterprise cost structure
presented by other authors and illustrates the most important reasons of the individual
costing system utilization. Following part of the paper defines the basic research
methodology and expected limitation of the study. In final part of the paper, results of the
survey are introduced and properly discussed.
KEYWORDS: cost management, costing system, overhead cost, Activity-based costing

INTRODUCTION
Field of the product costing techniques is one of the important features of cost
management and management accounting. While the method used for product costing
purposes are usually not an object of the any regulations, companies could use any
method of product costing and any tape of cost allocation technique. This fact causes
a high variety of used costing methods. According to traditional management
accounting (Drury 2003, Garrison et al. 2010, Weygandt et al. 2010, Shim and Siegel
2009) product costing methods could be divided in two major categories: job order
costing and process costing. These systems differ in the object of the cost assignment.
While in job order cost system, the company assigns costs to each job or to batch of
goods, in process cost system companies apply costs to similar products that are massproduced in similar fashion (Weygandt et al. 2010). It is therefore unnecessary to
assign costs to individual units of output (Drury 2001). Based on this definition we
can expect, that choice to use either job order costing system or process costing
system will be more determined by the characteristics of the company production
process than by desired way of cost assignment.
Objective of the study was to identify the product costing method according to used
method of cost allocation. Traditionally, two different product costing systems are
defined, the traditional absorption costing and alternative variable costing (Drury
2001). These two major costing approaches differs from one another, by the degree of
costs assigned to the cost driver. Many other methods of product costing are defined
1
Correspondence address: Boris POPESKO, Tomas Bata University in Zln, nm. T. G. Masaryka
5555760 01 Zln Czech Republic; email: popesko@fame.utb.cz
~1126~
in traditional management accounting. Special category of product costing method is

the Activity-Based Costing, which was designed in 1980s and became more natural
part of enterprises costing system in recent years. One of the objectives of the study
was to identify the level of Activity-Based Costing utilization in Czech Republic.
1. PRODUCT COSTING METHODS
Various types of the product costing systems are defined by the academics and
practitioners. As mentioned above, product costing methods are not object of any
regulation which lead in situation, where users of these systems are free in design,
construction and use of the product costing system. Shields (1998) has speculated that
there will be an increasing divergence in management accounting practices across
industries. Classification of the product costing methods is not general. Product
costing methods could be classified in different ways. As mentioned above the costing
methods could be classified into job order costing and process costing based on the
type of production process. More important classification of the product costing
systems is based on cost allocation principles. In this field we can distinguish the
traditional absorption costing, variable costing and Activity-Based Costing.
Product costing methods used in organizations went through the relatively important
changes in last decades. Al Omiri and Drury (2007) suggests that a need to improve
the sophistication of product costing systems has been driven by changes in
manufacturing technology, global competition, information costs and customers
demands for greater product diversity. These changes prompted criticisms of the
ability of traditional management accounting systems to report sufficiently accurate
product costs and ABC systems were promoted as the solution to overcome the
distortions in the product costs reported by traditional costing systems (Cooper, 1988;
Kaplan, 1994).
Many studies had been performed in order to analyse the level of utilization of
individual costing methods. Most of these studies are focused on the individual
segments of the business (Brierley et al, 2007). Many surveys into product costing
practice identify the industries making up their sample (e.g. Bright et al., 1992; Drury
et al., 1993; Lamminmaki and Drury, 2001) and others have identified industries
making up their samples in Activity-Based Costing (ABC) research (e.g. Cobb et al.,
1993; Gosselin, 1997).
Performed studies had the focus on different industry segments and used different
structure of questions, which make even more difficult to declare any common results.
Brierleys (2007) study performed in England shows that 20.7% of companies do not
include overhead costs in product costs, while 33.6% of companies uses or is open to
use ABC. Similar study made by Al Omiri and Drury (2007) in 1000 UK companies
showed very similar result: 35% of companies use traditional absorption costing
system, 23% of companies use variable (direct) costing system and 29% of the
companies use ABC system.
Many studies have been reported in field of ABC extent. Cokins (2003) suggest that
significant variations in usage of ABC both within the same country and across
different countries have been reported. These differences may arise from the difficulty
to define precisely the difference between traditional costing systems and ABC
~1127~
systems and the specific time period when the surveys were actually undertaken. The
same limitations could play role in distinguishing other types of costing systems such
as absorption and direct costing.
Drury (2003) suggests that performed survey evidence points at an increasing interest
in ABC over the last two decades. In the UK, surveys in the early 1990s reported
adoption rates around 10% (Innes and Mitchell, 1991), similar adoption rates of 10%
were found in Ireland (Clarke, 1992) and 14% in Canada (Armitage and Nicholson,
1993). In the USA Green and Amenkhienan (1992) claimed that 45% of firms used
ABC to some extent. More recent studies suggest higher ABC adoption rates. In the
UK reported usage was 29% (Al Omiri and Drury, 2007). In the USA Shim and
Stagliano (1997) was reported usage rate 27%.
Large surveys related to the ABC adoption had been performed in mid 1990s. Report
usage rates from mainland Europe are 19% in Belgium (Brugemann et al, 1996), and
6% in Finland in 1992, 11% in 1993 and 24% in 1995 (Viertanen et al, 1996). Low
usage rates have been reported in Denmark (Israelsen et al, 1996) in Sweden (Ask et
al, 1996) and Germany (Scherrer, 1996). Activity-based techniques do not appear to
be adopted in Greece (Ballas and Venieris, 1996), Italy (Barbato et al., 1996) or Spain
(Saez-Torrecilla, 1996).
Along with the relatively strong differences between used product costing methods in
different surveys, many authors points at the dependence of the used method of
product costing on the type of the organization and organization cost structure. Study
performed by Lawson et al. (2009) showed very strong relation between indirect cost
portion and cost management methods used. Study proves the fact, that best-practice
organizations have a much higher level of indirect costs, requiring them to have a
costing system that can more accurately allocate these costs in a relevant, reliable, and
reasonable manner. The greater use and appreciation of Activity-Based Costing by the
best practice companies can be attributed to their greater need for better costing
system. Strumactickas and Valanciene (2009) proved that the applicable instruments
of management accounting depend on an organization type. Their study indicates that
Market Creators use the least tools and Value Creators have most of them on an
average. Market creators are strategically oriented young companies, which reach
their blossom phase and start to stabilize, while value creator is mainly related to
the getting out of stabilization phase.
Another reason which drives the selection of the product costing system is the
structure of the products, customers and performed activities. Many authors (Cokins,
2001; Stanek 2003) refer that application of more sophisticated product costing
method, such as Activity-based costing, is most effective in enterprises with complex
structure of the products, customers and activities. Abernethy et al.(2009) shows how
product diversity and cost structure influence the design of costing systems.
1.1. Specifics of the product costing in Czech perspective
Use of the management accounting techniques in Czech Republic in the second half
of 20th century had several specifics caused by political environment. Orientation on
central planned economy led to the establishment of integral system for company
management. Methodology of the product costing was regulated by the statutory rules
~1128~
in order to fulfil the needs of central planned economy. This costing technique was
based on traditional absorptions costing principles and used three different types of
overheads (production, administrative and sales). In 1966, the regulations of the
unified costing rules were accepted and in 1971 act of unified social-economic
information system finished the complex regulation of the management accounting
techniques in state owned enterprises (Lana and Sedlek, 2005).
Change of the politic system in 1989 caused the transformation from central planned
economy into free market economy. In this situation no regulations related to the
system of the management accounting were furthermore demanded. The change of the
political system doesnt mean radical change in the management accounting practices.
Companies started very slow process of adoption of diverse costing techniques.
Anyway, many companies keep in use the traditional techniques known from 1970s.
2. RESEARCH OBJECTIVES AND USED METHODOLOGY
Research focused on the product costing method application in Czech enterprises had
been performed in years 2004-2009. Three individual surveys had been performed:
first in 2004, second in 2007 and last in 2009. The performed researches has been
focused on the more aspects of the management accounting practices such as cost
structure, used methods of product costing, budgeting practices etc. This paper reports
the results of the research focusing on used product costing techniques. Performance
of the similar researches in different periods of time allows the analysis of the product
costing method utilization trends. The expectations, based on the foreign studies, were
in increasing usage of the sophisticated costing methods such as Activity-based
costing and decreasing use of traditional absorption costing methods. Foreign
experience shows, that relative use of modern costing systems is gradually increasing
in long term period. Expectation about absolute portion of use of different costing
methods was different than in foreign studies. Because of the above mentioned
specifics of the costing process before 1989 and slower adoption of progressive
managerial techniques, considerably lower usage of ABC was expected in the study.
The hypothesis about the low usage of ABC techniques and about their increasing use
in Czech enterprises was tested by the questionnaire survey and by the statistical
comparison of the data gathered from different time periods.
Data from three questionnaire surveys has been analyzed in the research in order to
get better and more accurate results and also because of a need to compare the
evolution of the researched indicators. First questionnaire survey was made in 2004,
when 116 questionnaires had been evaluated (Popesko 2005). Similar research was
made in 2007. The structure of the questionnaire was focused on the same objectives
as in 2004. 96 questionnaires have been gathered and analyzed (Popesko & Novak
2008). Final questionnaire survey was performed in 2009 as a part of extended
research focused on costing methods use in Czech enterprises (Novak 2009). Finally
77 questionnaires have been processed. Enterprises of different sizes have been
researched within the individual surveys. Table 1 shows the structure of statistic file.
~1129~
Table 1. Structure of the researched enterprises

YEAR/ENTERPRISE CATEGORY
TOTAL
RELATIVE
2004
Small
7,76%
Medium
55
47,41%
Large
52
44,83%
Small
38
39,58%
Medium
32
33,33%
Large
26
27,08%
Small
10,39%
Medium
42
54,55%
Large
27
35,06%
2007
2009
3. RESULTS
As mentioned above, first research survey has been made in 2004 where 116
manufacturing enterprises have been investigated. The objective of the survey was an
identification of the used product costing methods in Czech enterprises. Results of the
survey are depicted in table 2. Total sum of answers doesnt give the number of
surveyed enterprises, because some of the respondents use more than one method.
Table 2. Product costing methods used in 2004
USED PRODUCT COSTING METHOD
TOTAL
RELATIVE
Do not use any product costing method
5.98%
Division costing
4.27%
Traditional absorption costing
36
30.77%
Joint and by-product costing
1.71%
Standard costing
50
42.74%
Variable costing
35
29.91%
ABC/M
5.13%
Other
11
9.40%
(Source: Popesko, 2005)
The survey proved relatively high use of traditional absorption costing (over 30%)
and high use of variable (direct) costing method (30%). Relatively surprising was the
use of the standard costing method. Because this method in not pure allocation
method, but rather cost control method, it was mostly marked along with the other
costing methods. Use of the Activity-based costing and management techniques were
identified by 5.1% enterprises.
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Very similar research had been performed in 2007. The performed research, which
was primarily oriented on the complex management accounting techniques used by
Czech enterprises, contained the same questions related to the used product costing
methods as research performed in 2004, in order to allow the comparison with 2004
research. Results of the survey are depicted in table 3.
TOTAL
RELATIVE
5.21%
Division costing
9.38%
30
31.25%
4.17%
Standard costing
39
40.63%
Variable costing
23
23.96%
ABC/M
5.2%
Other
2.1%
(Source: Popesko and Novak, 2008)
Despite relatively different structure of the researched enterprises (table 1), survey
performed in 2007 showed very similar results as the study performed in 2004. This
similarity could support the relevance of the performed studies based on the relatively
low number of respondents. Two major product cost techniques showed similar
utilization as in 2004, the traditional absorption costing (31.5%) and variable costing
little lower volume (24%). The study showed again relatively high usage of the
standard costing method very often used along with other costing methods. Utilization
of ABC is almost the same (5.2%).
Similar data were gathered in questionnaire survey performed in 2009. Results of the
survey are depicted in table 4.
TOTAL
RELATIVE
3,90%
Division costing
2,60%
31
40,26%
0,00%
Standard costing
10,39%
Variable costing
5,19%
ABC/M
7,79%
Other
30
38,96%
(Source: Novak, 2009)
Result of the survey is relatively different form previous studies. Most common
product costing method is again the traditional absorption costing. Survey showed
relatively low use of variable costing. Some of the users of variable (direct costing)
could be in the category other because of various description of this type of product
~1131~
costing method in practice. The use of ABC/M was very similar to the expectations.
Result showed that use of this method is slightly increasing.
Above described results qualify the authors to several statements. Most used type of
product costing method in Czech manufacturing enterprises is traditional absorption
costing. Surprising result was the relatively increasing use of this type of product
costing, together with the relative lower use of variable (direct) costing. Explanation
of this could be tendencies of manufacturing companies to adopt the full costing
method in order to better support of pricing decisions. The variable costing method
seems to be relatively popular in Czech enterprises in 1990s. Temporary adoption of
the absorption costing method could be accepted as the interpretation of the survey
results.
Expected results have been indicated in the Activity-based methods utilization.
Survey showed relatively low use of these methods with comparison to other
European countries. The study also proved increasing use of ABC/M in Czech
manufacturing enterprises. The study also showed that the utilization of Activitybased techniques is relatively more frequent in large enterprises, than in small and
medium enterprises. The large companies were ABC users in 5 out of the 6 cases in
2004, in 4 out of the 5 cases and in 2 out of the 6 cases in 2009.
The study could have limitations in number of researched enterprises, in
understanding of question by the respondents or in ability of respondents to provide
undistorted answers in the survey. Despite that fact it provides the actual overview of
the used product costing methods in Czech manufacturing enterprises during 2000s.
The comparison of the individual survey results could also depict the tendencies in
product costing method utilization.
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~1134~
THE ROLE OF COSTS AND CONTROL IN ENSURING

A SUCCESSFUL MANAGEMENT IN THE DECISIONAL
PROCESS
Stefania-Eliza BANA (PANCIU)1& Florinel Marian SGARDEA
ABSTRACT
Knowing the costs represents an important factor when taking decisions or planning future
activities. The analysis and registration of data regarding the costs of past activities is only
part of the cost accounting. Managers are preoccupied both by the future costs - their level
influences production and supply decisions and by price politics. Considering that all firms
are preoccupied with continuous cost reduction, in this material we want to debate on this
subject that is of major importance for any manager, regardless of his or her field of activity.
We will try to answer to the following questions:
How can we effectively reduce business costs?
What should be the priorities of the management of companies in 2011?
The strategy of an enterprise is the art of selecting and optimizing the resources and the
means of all type that are available, in order to reach one or more goals of progress,
imposing to the competition the place, time and conditions of the competitive struggle
Maria Niculescu (2003). From here we can understand the important role that the resources
consumption analysis has, the analysis of costs when evaluating the results obtained. Between
cost analysis and the enterprise strategy is a double connection. On the first hand the results
obtained from cost analysis and accounting are important for strategic decisions of the
enterprise, and on the second hand management accounting provides us information
regarding the costs of products, services and activities. By comparing them with the turnover
obtained by a product or service, we can calculate the margins and profitability for every
level of analysis. Comparative analysis of the profitability of products is important when
deciding the product portofolio of the firm. Choosing a method for calculating the costs is
determined by the tight relationship between the type of production and the type of
corresponding evidence of the consumption. In general, the specific of the manufacturing
technique determines the method of calculating the cost which suits it best. The principles of
organizing [Clin O., Crstea Gh., 2002, p.76-80] modeled the structure, management and
results of the enterprises along the XIXth and XXth century. It is time to renounce to these
principles in order to adopt new ones. Contemporary enterprises must engage themselves in a
radical mission of reinventing the working arrangements.
KEYWORDS: support costs, strategic management, Target Cost, fixed costs, variable
costs
Correspondence address: Stefania-Eliza BANA (PANCIU), Bucharest Academy of Economic

Studies, Romania; email: elizabana@yahoo.com
~1135~
INTRODUCTION
To calculate, monitor and control the costs represents just one of the aspects of the
performance of which we will consider in this study. To manage costs implies
organizing a managerial accounting which will allow the calculation, analysis and
reporting according to the needs of the management. The economists from transitional
countries try to introduce modern approaches in the calculation of costs with strategic
management purposes, known and utilized in the countries with well developed
economies. Unfortunately they paid little attention to the modalities of applying the
new international approach to cost management in a new competitive environment.
This practice raises interest both in theory and in application and it necessitates a
more ample research, which determined the actuality, objective and purpose of the
present paper.
1. THE UTILIZATION OF THE MODERN METHODS AND TECHNIQUES
OF COST CALCULATION. A PLEAD FOR THE TARGET COSTING
METHOD
The cost of production represents an economic indicator, which expresses the value of
the utilized resources in order to complete a concrete process which is finalized with a
product or service.
The calculation method is the path to be followed by using some specific calculation
processes with the purpose of achieving the mail objective of the managerial
accounting, and the determination of the product unit cost.
The classical methods of production cost calculation belong to the integral or
absorbent cost concept, bringing together within the price of fabricated products,
portfolios and services provided the sum of the production expenses usually grouped
in direct, indirect expenses and calculation articles.
These methods involve making two rows of calculation regarding the costs of
production, namely pre-calculation and post-calculation. Through these calculations
two rows of indicators are elaborated, pre-calculated and effective, with their help the
periodic control over framing the effective cost in the level pre-calculated is done.
Through the comparison between the two rows of indicators the deviation from the
pre-calculated costs can be determined.
The utilization of the traditional cost calculation methods have the following limits:
Calculates the periodic cost and compares the products that are not in the same
stage of the life cycle;
Traditional methods measure the cost as it is created, at which point he can no
longer act on it;
Traditional methods correspond to an optics of fixing the selling price
according to the cost; this logic is not valid in the sectors in which the
competition is high and where the price is market oriented.
In order to respond to these criticisms, we need calculation methods that take into
account the product life cycle, the market-driven price and that allow cost
management from the design of the product is needed.
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Performance optimization is translated through optimization of the life cycle that

becomes a management object. The cost is obtained as a measure of value, or what
the client is willing to pay for the product. As a result, the enterprise doesnt have to
manage the cost reduction, but the optimization between cost and value. The switch
from cost management to strategic cost management represents the actual step in the
concept development. In the product life cycle there are three important phases:
planning phase, production phase and abandon phase.
Figure1. LIFE CYCLE
Cost
Decided cost
80%
Cost carried out
Abandon
20%
20% of the carried out cost is similar with 80% of the decided cost
In the 70`s, following the methods previously used in the USA, a new cost
calculation method is developed in Japan which meets the following requirements:
Target-Costing (TC) developed at Toyota
The target cost represents a negotiation basis between the different functions of the
enterprise in order to assure the long term viability of the new product and also it
represents the products competitiveness. The target-costing method is part of a global
approach, which targets cost reduction along the process of continuous improvement
of technology and fabrication process implying, in the same time, a new human
resources management and better competencies. Specifically, we are talking about the
following issues:
mastering different phases of the product life cycle;
cost analysis starting with the birth of the products, according to the
characteristics and the selling price;
assuring, progressively that the new products will be profitable during their
life cycle;
reducing the time it takes to conceive products;
diminishing the development costs and assuring a faster depreciation;
assuring a better relationship organization between the company and the
suppliers and collaborators;
mobilizing and motivating all competencies from within the enterprise through
an transversal approach which favors an enhanced competitiveness.
~1137~
The TC method allows the design of new products according to the market
expectation (price) and of the shareholders (profit margin) resulting the target cost
also according to the firms competencies and technical options (estimate cost).
The general calculation formula is:
Target Cost = Competitions selling price Expected margin
In the case of the TC method, the market price represents the independent variable
and the costs for design, manufacturing, marketing and other functions are depending
on it.
The variable that the enterprise cant control is the selling price. It results from the
actual or predicted state of the competition forces that are pressuring the targeted
market segment.
This price is the result of a compromise of examining the different restrictions: needs
and income of the potential client, particularities of the product, long term production
capacity, competitors prices. Analyzed as a closed unitary concept of cost
management, TC is characterized through the estimation of values as functions of the
selling price, the complete costs and of the beneficiary on the whole life cycle of the
product.
Such a management is characterized by the following:
It is maintained on the whole life cycle of the product;
It focuses on costs even from the developing phase of the product;
It is based and uses the price information from the target and starts from the
market-orientated cost information;
It is based on the budgeting of the products functions;
The evaluation basis is represented by the complete costs.
The objective that TC has represents the improvement of the situation for the results
related to the product through a reduction of standard costs in the direction of some
targets costs according with the competition.
Theoretically, the objective of TC is based on the following six principles:
1. The costs of future products to evaluate the mass production of internal
marketing projected revenue;
2. The necessary target costs, based on the complete costs formula are evaluated
through cutting out from the selling price the profit margin desired, taking into
account a certain degree of risk (cost component);
3. Overall costs are determined by the relationship between the selling price
desired margin + risk rate and it is distributed on the different components of
the product corresponding to the utility function needed by the clients;
4. Costs of product components serve as the task for the entire value creation
chain, starting from research & development and continuing with supplying,
production and selling;
5. Through the analysis of the difference between target costs and standard costs
and through benchmarking we can identify, on a product component level, the
optimization potential;
~1138~
6. The value adding chain must assure, through plans of selling the product,
terms of sales by optimizing both material and processing costs, and by value
analysis, to determine measures to be taken and implemented to achieve the
objectives required for each product.
I. Stages of TC method are the following:
Stage I. Setting the target price
Usually, target price is set by market research techniques and concerns the life of the
product. Therefore, it has a strategic determination, a dynamic character and assumes
many forms and levels in relation to market segments and over time supply and
demand.
Market research for the design product resulted in determining a sale price and the
forecast sales volume. It forecast price that will evolve throughout the product
lifecycle.
The steps of the target setting strategy:
For what target markets or market segments should be aimed?
Target markets (national, international, global);
Target market segments (price, depending on use);
The attractiveness of those target markets and market segments.
How does the competition develop?
The structure of competition (market volume, market share, scope of interest
of competition);
Structure of cost and quality standards;
Prices and future pricing policy.
How do the target client groups evolve and what claims will them have regarding the
products?
Development of target customer groups (segments developments);
Future claims from customers, for example with regard to price;
Characteristics of products which highlight the performance;
Operating characteristics;
Delivery, service, etc.
Which is the clients opinion regarding the prices of the future products.
What is the strategy that the product manufacturer seeks?
Strategic projects on markets and customers (products, markets, product life);
Strategies in terms of timing and choice of product depending on which will
calculate the cost and price target.
What purposes related to domestic policies seeks the producer?
What is expected in terms of return on capital?
Cash flow;
Operational results.
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Which are the final purposes of the producer?

Future prices;
What does the produces want to achieve taking into consideration the quantity
of products that reached the market, the life of these products and market
share;
The necessary time in order to enter on the market with a new product.
This presentation of strategy, on steps, shows that the process of determining the
target cost should be included in the strategic plan of the producer over several years.
Target pricing is always uncertain, considering how the market evolves, how does the
competition react and the monetary relations. In the event that the assumptions about
the planning are changed, this can have a high impact and effects over future market
prices.
Example 1:
ALFA enterprise studies the project of a new microwaves oven. The sales for this
product were predicted for a period of five years; after this period the pressure from
the competition and the technical innovations will force the enterprise to change this
product with a modern one.
A study made by the enterprise shows that the price could be set at 1500 ron for the
first three years. This price is relatively high, but the device will have a modern
design, which proposes advantage over competitors who have older models. Starting
with the forth year, the price will be adjusted to 1300 ron in order to resist to the
competitors new products. Sales forecast are as follows: 4000 units in the first three
years, 2000 units for year four and five.
Table 1. Turnover forecast for five years
Explanations
Quantity
Price of
Turnover
Year 1
4,000
1,500
6,000
Year 2
4,000
1,500
6,000
Year 3
4,000
1,500
6,000
Average selling price target is = 23,200,000

16,000
Year 4
2,000
1,300
2,600
Year 5
2,000
1,300
2,600
Total
16,000
23,200
= 1,450 lei/unit
The latest concern to management is to determine the level and the structure of the
cost of a product that it can afford. Often it has to give up the previous fabrication
prescriptions in order to reach the new cost structures and level. Global target prices,
along with the others predictions, must be included both in the planning of the current
and future years in order to:
offer security to the product profitability,
establish the maximum value that the price of the product can reach
motivate this maximum value
Stage II. Estimated profit margin target
This stage results from the strategic middle-term planning of the firm and from its
portfolio of products.
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This is why the size of the target price is not a fix sum, but a profit curve which
stimulates, with the help of the financial analysis, the expected profitability of the
product, taking into account the assumptions on the volume of business. Together
with the planning and the presentation of the allowed market prices, it is important to
study the costs and its structure, this being done by the project managers and internal
control.
For different rates which are estimated for five years, the gross profit margin is
calculated in Table 2.
Tabele 2. The calculation of profit margins
Explications
Year 1
Year 2
Year 3
Year 4
Year 5
Total
Turnover
Profit rate
la C
6,000
6,000
6,000
2,600
2,600
23,200
11%
10%
8%
6%
6%
8.84 %
Margin
Profit (mii lei)
660
600
480
156
156
2,052
ALFA enterprises has as objective a profit rate calculated using the turnover.
(a) is the average target profit
2.052.000 = 8.84 %,
23.200.000
from here results that the share of the cost in the price is of 100% - 8.84% = 91.16%.
The objective margin for a washing machine is equal to the average price multiplied
by the average profit margin, meaning: 1.450 X 8.84% = 128.18 lei /unit.
Stage III. Determining the target cost
The target cost is derived from the previous calculations by a simple substraction. The
evaluation is not made globally, but in an analytical way, using partial target costs,
depending on the product components and subassemblies. In our case, the objective
cost of a product is equal to the difference between the selling price and the objective
margin. The two terms (price and margin) cover all product life cycle. The objective
cost is then broken down in parts cost objective in each product.
Example: The objective cost of the washing machine is 1.450 lei 128.18 lei =
1.321,82 lei. The global objective cost is broken down by the relative importance of
the sub-assemblies, as we can see in the following table:
Table 3. Target costing benchmarks
Name of benchmark
Magnetron
Metal case
Electric lamp
Programmer
Command system
Total
Share on cost
30%
20%
10%
25%
15%
100%
~1141~
Target costs on parts

396.54 lei
264.36 lei
132.18 lei
330.46 lei
198.27 lei
1.321,82 lei
The evaluation is not done global, but analytical, on different types of partial target
costs, depending on the product components and subassemblies. The breaking down
can be done using:
Organic break down: of the product in subassemblies, taking into account its physical
structure. This method is based on the knowledge of the current costs of the
components and the ability of the enterprise to produce them. It implies a continuity in
the preservation of existing techniques, but also an adaptation through innovation,
considering the product features.
Functional break down: is based on the analysis of the product, taking into
consideration the clients needs: each function is a customer need that a product must
meet. This method is based on customer and market needs; by target cost we
understand what customers are willing to pay for all services expected from their
product.
The estimated cost is a cost built the whole lifecycle of the product.
Target cost method is part of a global approach, which aims at reducing costs along
the continuous process of improving the technologies and manufacturing processes,
assuming in the same time a new style of human resources management and greater
powers.
Continuous cost reduction has to concern all the enterprise, which requires an adapted
management style. We take into consideration the following:
Overcoming different stages of product life;
Cost analysis starting from the product concept, depending on their
characteristics and possible selling prices;
Ensure progressively, that the new products will be profitable during their life
cycle;
Reducing the time of conception of products;
Minimize development costs and ensure faster depreciation;
Example 2:
Gama enterprise studies the launch of a new type of metering and protection for niche
block (BMPT) with two counters, used in low voltage networks to supply electricity
to small consumers, which should provide increased tolerance to gauge and mounting
shares. The forecast amount to be produced is 10,000 units/month. After a market
analysis it has been determined that for the target segment the acceptable sale price is
of 60,000ron/box. The accepted margin by shareholders is 10% of the selling price.
From the production activity we known these costs:
direct costs for a carton: 2,000 RON / niche by niche, niches in block 24;
direct costs per carton: 20,000 lei;
costs for customers (advertising): 10,000,000/month
After interviewing distributor clients to final consumers is seems that it is not very
important that these blocks have this specific gauge (meaning 24 niches / block),
reason why the firm will reduce them to 20. In this way the acquisition cost will be
reduces with 3,000 lei/unit. From the direct costs, 1700 represents the raw material
which gives the product its quality. This represents 50% of the client value.
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To establish:
1. target cost and estimated cost
2. 2. new estimated cost. Can you manufacture the product?
Solution:
1. CT/BMPT = Price Profitability = 60,000 60,000*10% = 54,000 lei/box
CE/BMPT = 24*2,000 + 20,000 + 10,000,000/10,000 = 69,000 lei
Deviation from the target cost (CT) = 69,000-54,000 = 15,000 lei
Optimal cost for raw material = 50%*54,000 = 27,000 lei/box
2. Optimal cost for raw material /BMPT = 27,000/20 = 1,350 lei
Initial cost for raw material/BMPT = 1,700
From here it results that we have to lower raw material cost for one unit with
350 lei.
CE/BMPT = 20*(2,000-350) + (20,000-3,000) + 1,000 = 51,000 lei
Deviation from the target cost = 54,000 51,000 = 3,000 lei
Conclusion: Considering that the deviation is relatively large from the target cost, is
not recommended to start manufacturing the product.
II. Steps and implications to ensure cost objectives in the TC
Orienting the costs toward the market and planning target costs in relation to the
product functions require some changes in the company structure and technology,
starting from the market.
In this way production leans on interoperable sales plans which ensure the
conjunction between potential improvements on products, production costs by product
and functional requirements. The estimated cost is a cost built on the whole lifecycle
of the product. The estimated cost is based on the following formula:
production cost
+ research and development cost
+ distribution cost
+ overall cost of administration
= Complete estimated cost
From the client point of view, the estimated cost of possession is based on the
following formula:
purchase price
+ ancillary costs of acquisition
+ cost of use (operating)
+ maintenance costs
+ residual cost
= Possession cost of the user
By summing the two costs, the producer and the user, we get the overall cost of the
product life cycle. The rapid pace of competition obliges the enterprise to have an
appropriate approach based on a forestall thinking for production lines. The whole
issue regarding the chain of value creation and related service functions have to be
resolved at latest until the beginning of series manufacture.
To achieve or obtain a transparency of costs and outcomes is necessary to provide a
procedure for combining, oriented towards the responsibility sectors. This allows a
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cost management oriented towards sectors and thereby a clear delineation of

performance at this level. Goals and deviations are structured as follows:
Change in design - Technical development
Changing prices Purchasing
Changing Purchasing - Purchasing / Production
Change in Technology Production
Volume mix - Price - Quantity disposed - Sales
The core of this new organization is delegating responsibility concerning results,
down, to the professional levels; using design teams are separated the bearers of skills.
The results are not driven by the controlling, but by team members in those sectors,
occasion on which controlling collaborators offer support in the decisions field.
Benefits of the controlling new conception must be seen in:
Clear demarcation of responsibility by sector;
Support operational decision-making processes in areas of product design;
Increasing efficiency of the management corporation and the divisions;
Increased capacity to adapt to environmental changes;
Avoiding the loss of the lack of correlation, by organizing the projects for
sectors and clear delegation of liability for each man;
Shortening the time of design and development, and avoid modification costs
by an early engineering knowledge of design teams.
To apply a consistent cost management, target oriented, considering the current
market situation and environment, there is no rational alternative. By the new
organizational structuring of the information systems which are oriented towards the
procedural chain which has to be created and by orientation towards the market
determined objectives, we will be able to better adapt in the future to strategic needs.
2. HOW CAN WE EFFECTIVELY REDUCE BUSINESS COSTS?
In order to answer to this question it is necessary to know some useful information, as
follows:
Fix costs (FC) are those whose size remains relatively unchanged, or changes
depending on the increase or decrease of the production obtained in insignificant size.
For example: depreciation costs, costs with rent, costs with salaries. Fix costs are
generated from consumption of material, human, informational, financial resources,
resources used in various activities of the firm with the purpose of obtaining income
and benefits, in accordance with the objectives, strategies and company policies.
Variable costs (VC) are those which modify their volume according to the
modification of the volume of production. For example: consumption with raw
materials, consumables, energy and water.
When the economy is rising, the companies are concerned with reaching objectives
that refer especially to the growth of the market share and income and use
development strategies by further investments in upgrading or acquisition of new
storage, sale and production capacities. This expansion of company activities
automatically generates an increase in fixed costs related to the use of new resources.
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When the business opportunities are stagnating or decreasing, companies give more
attention to reducing fixed and variable costs of the company, taking in consideration
the objectives of maintaining the profitability and financial stability in an unstable and
unpredictable business environment.
Identification, classification, calculation and control of fixed costs become a priority
for managers of any company daily. The analysis and control of costs requires
awareness and understanding of general characteristics of the company's activity and
understanding the interdependencies relation between business and the environment in
which it operates (economic, politic, technologic, social etc.).
Cost managerial accounting is the main source of information for the analysis and
control of fixed costs. For the analysis and efficient reduction of fix costs we can take
into consideration the following:
cost approach must begin first at the company level (global approach) and then
by components (types of activities and cost centers, types of expenses);
identify the activities which generate fix costs and analyze then the two basic
options: the activities will be decreased and reorganized or the activities will
be eliminated;
identify resources that generate the highest consumption within each cost
center;
approaches to reduce fixed costs are determined by each category of fixed
costs;
benefits of cost reduction measures must be maintained on long term in order
to ensure business competitiveness on the short, medium and long term.
The best way to reduce costs is to change the way of thinking on the use of resources.
Conventional methods of cost reduction focus on reducing staff. They give short term
results but fail in the long term because staff reduction does not necessarily mean
reduction of the related activities.
Turney has five basic ideas related to cost reduction by administrating the activities,
as follows:
a) reducing the time and effort required to perform a task. This is usually done by
improving the process or product;
b) eliminating the activities that are unnecessary, not appreciated by clients and
not essential for the well-functioning of the firm;
c) where is possible the choosing and selecting the activities with low cost since
the design phase;
d) business must meet several requirements, unless it is necessary only in one
purpose;
e) elimination of unused resources. Costs can be reduced only if resources that
can be saved are spread in another place of the firm or eliminated. Cost
savings based on these data become re-allocation bases.
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3. WHICH SHOULD BE THE PRIORITIES OF THE ENTERPRISES

MANAGEMENT IN THE YEAR 2011?
Enterprises will focus their attention especially on:
restructuring the product and service portfolios towards the actual target client
needs;
revising selling price policies, promotion and distribution of products, in a way
in which clients may understand the characteristics, advantages and benefits of
each product and by doing this stimulating the demand for consumption;
implementing a system of measuring performances on a company level and
based on activity types;
resuming investments that sustain the re-launch of the firms activities;
Sales priorities: more or better?
Most of the businesses recorded declines in sales in 2009 and 2010 compared to 20072008. And still, some businesses are also doing well in 2011. Why is that?
Because in these businesses, managers and specialists have acted with priority in the
following directions:
they re-evaluated the opportunities and risks of the market;
they restructured and diversified the product and services based on the needs
and the power of paying customers portfolio ;
they monitored the financial efficiency of each sale and focused on cashing and
commercial profit.
Changing the strategic position of enterprises
This is due to changes in the environment of the enterprise. These changes occurred
due to the essential contributions of developments in computer technology. Along
with the introduction of CIM systems (Computer Integrate Manufacturing) came
important modification in all fields and sectors of the enterprise.
Within decision-making of the enterprise we find new aspects on a high level such as:
Preparing information about costs referring to a multitude of objects of cost
calculation.
Reduction of the size of the fabrication lots;
Determining an optimal number of production variances;
Determining costs for specific orders;
The economic efficiency control in the ever-growing and important sectors of
common indirect costs.
The necessary information is referring to the whole value adding chain within a
company, including production sectors and auxiliary activities that help indirectly.
Knowing the mode of action of each of the factors of profit optimization
It is necessary the knowledge about the mutual influences of those factors (sales price,
volume of production and distribution, variable costs, fixed costs, production structure
and dissolution), because only in this way we can take rational decisions to optimize
profit:
modification of the production and sale structure of the products and
assortments, stimulating the product with the highest coverage factor,
promoting the sale of differentiated products and assortments which will lead to
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an increase in profit equal to the difference between the amount by which the
production and sale of certain types has increased (with high coverage factor)
multiplied with the gross contribution per unit and the reduced amount of
production and sale of certain products and assortments (with lower coverage
factor) multiplied by the gross contribution per unit.
reducing variable costs as a result of actions to redesign the products, to use
substitutes, to streamline work etc. with a certain percentage or amount to each
individual product, which will result in an additional profit equal to the product
between the quantity sold and the reduction of variable costs.
finally, reducing fixed costs, either by dissolution of a retail store, of a
warehouse, downsizing staff, with a certain percentage or amount, leading to
the obtaining of additional profit equal to the reduction of fixed costs.
CONCLUSIONS
By monitoring movements of the market share for most products, a company can see
if she gains or loses its market position, and the examination of relative market shares
will indicate the strength of different competitors. Cost management has to be well
informed in order to determine the strategic positioning in the market. Depending on
the chosen strategic position, firms put more emphasis on particular techniques of cost
management.
Conceptual conditions that must be met by current methods of calculation of the costs
in terms of future company engineering, are:
Technology costs should be allocated directly to products
Significant costs should be entered directly in the objectives of management
reporting
Costs of activities that bring or dont bring added value should be separately
identified
Support costs will be recognize as costs that dont bring added value and that
should be to be oriented directly to the product
Each homogeneous group of activities, products, etc.. should be organized in
the centers of responsibility
Calculating the cost of activities will enhance the efficiency of storage and
operational control
To determine the cause - effect relationships between the costs of activities
and objectives of management reporting separate criteria for allocating should
be developed
The costs must be aligned to support the requirements of the product life cycle
The cost of production is an economic quality and quantity indicator, which occupies
a central position in the indicator system of a company and it is used for the
measurement and assessment of economic growth. The cost of production expresses
the value of the resources used for realising a process, which ends with the creation of
a product or service and is meant to assist the efficiency evaluation of the production
activity conditioned by the production technology and organization, and to assist the
process of managerial decision making with the purpose of selecting the best and the
most rational way of business development.
The concept according to which traditional accounting-based systems are useful tools
for strategic analysis of costs is wrong; companies must implement new systems of
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modern strategic management of costs. Today, the competitive environment requires a

modern architecture of the cost system, which should be based on the conceptual
principles of strategic management: to allow multidimensional cost management and
performance measurement of the company.
Knowing the production cost structure, knowing its change in time and space, is
particularly important in guiding actions to reduce costs, acting preferably on costs
with the largest share of expenditure.
REFERENCES
Briciu Sorin, Burja Vasile, 2004, Contabilitate de gestiune. Calculaia i analiza costurilor,
Editura Ulise, Alba Iulia;
Dumitru Corina Graziella, Ioan Corina, 2005; Contabilitatea de gestiune i evaluarea
performanelor, Editura Universitar, Bucureti;
Ebbeken Klaus, Possler Ladislau, Ristea Mihai, 2000, Calculaia i managementul costurilor,
Editura Teora, Bucureti;
Epuran Mihail, Bbi Valeria, Grosu Corina,1999, Contabilitate i control de gestiune,
Editura Economic, Bucureti;
Ion Cucui, Vasile Horga, Mariana Radu (2003) Control de gestiune, Editura Niculescu,
Bucuresti
Ionacu Ion, Filip Andrei Tiberiu, Stere Mihai, (2003), Control de gestiune, Editura
Economic, Bucureti.
Yoram Eden, Boaz Ronen, Activity Based Costing (ABC) and Activity Based Management
(ABM), Financial and Management Accounting Committee, Articles of Merit
2002,(http://www.ifac.org./bookstore/Professional Accountants in Business)
Oprea Calin (2000). Contabilitatea de gestiune, Tribuna Economic, colecia Metode,
tehnici, instrumente nr. 145, Bucureti
Sorin Briciu, Vasile Burja (2004), Contabilitate de gestiune. Calculaia i analiza costurilor,
Editura Ulise, Alba Iulia, p. 199
Sgardea Florin, Sendroiu Cleopatra (2007),Contabilitatea de gestiune-sursa de informatii
pentru adaptarea deciziilor, Gestiunea si contabilitatea firmei, vol. 10, nr. 4, pp. 28-41
~1148~
THE CHANGE IN MANAGEMENT ACCOUNTING

IN ROMANIA
Madalina DUMITRU1, Daniela CALU, Gorgan CATALINA,
Adriana CALU & Georgiana TOADER
ABSTRACT
The change in management accounting is a topical issue in international research in
management accounting. We want to see which the situation in Romania is. In order to
analyse it, we followed two approaches. First, we made a brief presentation of the situation of
management accounting in Romanian companies, relying on a few empirical researches
published previously. Secondly, we studied the articles published in four top journals in
Romania and classified them according to the issues studied.
KEYWORDS: management accounting, change, journals

INTRODUCTION
One way to study the nature of change is exploring the stability and continuity of the
inherent continuous processes of life. Veblen was the first to build a parallel with
biology, emphasizing the pass of the relevant information in time (Veblen, 1898,
1919). The same parallel was used by Hodgson (1993) and Calu (2005) in their
studies. Stability and change are not independent: even though the biggest part of life
is stable, people are characterized by a curiosity searching for alternatives to the
present situation. So, there is always potential for change. The change in this area is a
continuous process, of interest in the international research (Scapens, 2006). The
recent social, economical and juridical changes forced the appearance of innovations
in the management accounting. These changes sent the old theories into the shadow,
questioning their opportunity, but also the capacity of the new ones to succeed in
difficult moments. The analysis of the change in management accounting supposes
the analysis of the way in which a theory is chosen instead of another.
We ask ourselves which the factors are determining the change in the management
accounting of the entities in the public and private area, at international level, but
especially in Romania, where taxes frequently prevents the decision making persons
to focus on other aspects of the entity they work in. Even more, in Romania the
application of the management accounting was poorly understood in 1990 (as being
optional), which stopped its progress.
The social and economical environment, including culture, have a collateral impact in
the change appearance in the financial accounting, the immediate impact being
1
Correspondence address: Mdlina DUMITRU, Academy of Economic Studies of Bucharest;

email: madidumitru2007@gmail.com
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managed by the financing system of the firms, to which the political factor is added.
By observing through time the political-economical-accounting correlation in
Romania, we can distinguish the following general ideas: the enforcement of
socialism has generated the incitement of an accounting which uses adequate
mechanisms, and the globalization is currently generating the aggregation of standards
regarding the convergence, concluded between IASB and FASB (Baker and Barbu,
2007). In the management accounting, the elements which determine the changing are
represented by external factors (such as, normalized factors in the case of Romania, in
the nineties) but mostly by the internal factors the culture of the firm, the
management, the size of the firm, the activity area, the form of ownership of the
capital etc. (Burns, 2000; Scapens, 2009).
We live in a changing world! But do we live in a changing country? At least from
the point of view of the management accounting. Lets see an example. A study
published in 2010 (Jinga et al., 2010) showed that as far as the cost methods employed
by surveyed managers, 20.51% apply the global absorption method, 25.64% apply the
job costing, 7.69% apply direct-costing, 12.82% use ABC costing, 5.13% use targetcosting and 17.95% do not know the name of the method or they do not use any
method for cost computation.
However, global absorption and job costing methods (the two most used costing
methods in Romania according to the previous study in 2009) were the ones used
more than thirty years ago. That is, before the Relevance lost of the management
accounting.
Nowadays, the continuous change has become a constant, the organizational
environment being constrained to align to the new trends and technologies, and even
to a whole redefining as an organization. In order to survive, the entities must change,
must reinvent their operation of dependence towards the movements and trends of the
market. For a considerable period of time, the management was regarded as true art,
an acquired talent through the practice of attempts and errors. A variety of individual
techniques, often based on creativity, human reasoning, intuition and experience were
used for solving problems of the same type and this against the quantitative methods
and the scientific approaches. The complexity of businesses and their activity
environment has increased considerably in the last decades (Quattrone and Hopper,
2001).
The international researchers admitted the need for a change in management
accounting. In this article we try to assess the situation in Romania. In order to do this,
we organize the rest of this research paper as it follows:
We analyze the change in the management accounting from the international
perspective;
We analyze the change in the management accounting in Romania identified
at the level of the companies;
We analyze the change in the management accounting in Romania from the
point of view of the research works published;
We analyze the change in the management accounting in a future perspective.
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1. THE ANALYSIS OF CHANGE IN THE MANAGEMENT ACCOUNTING

THE INTERNATIONAL PERSPECTIVE
Management accounting change in organizations has to be seen as an evolutionary,
path dependent process in which existing ways of thinking (institutions), circuits of
power and trust in accountants can all have an impact on the way in which the actors
within the organization respond to external institutional and economic pressures. It is
this complex process of inter-related influences which shapes management accounting
practices and explains the diversity we see in the practices of individual companies.
Understanding management accounting change requires an understanding of various
organisational and historical contingencies (Scapens and Roberts, 1993; Hopper et al.,
2004). In the last thirty years there has been a change in the management accounting
research topics: from explaining the diversity of practices in a population, to making
sense of the practices in individual companies. In management accounting research
the 1970s was an era of economic oriented mathematical models. Going into the
1980s, management accounting researchers began to recognise that there was a gap
between theory and practice, and that research to describe practice was urgently
needed. Into the 1990s a variety of theories and a number of different methodological
approaches started to be used to study management accounting practices. This change
is reflected in the shift in the research methods from quantitative survey work to
qualitative case studies (Scapens, 2006). But the challenge for current (and future)
work is to use the theoretical perspectives which the researchers have developed to
provide insights that are relevant and helpful for practitioners. This is the case
especially when academic works theorise issues closer to managers daily lives such
as accounting change (e.g. Burns and Scapens, 2000), and accounting in interorganizational relationship (e.g. Mouritsen and Thrane, 2006).
The success of the changes in the accounting system depends on the manner in which
the behavioural and organizational implications are managed (Shields, 1995). The
appropriate implementation of these changes is less successful if they are seen as
simple technical innovation. Most of the studies are focused especially on the users
perceptions (managers), while the perceptions of information providers were often
ignored (Pierce and ODea, 2003).
The recent financial crisis and corporative scandals without precedent, the markets
globalization and the competitiveness without precedent, the continuous change of the
national and international regulations together with the opportunities offered by the
informational advanced technologies have forced the appearance of innovations in the
management accounting. In the specialized literature, we can find many
understandings of the term innovation (Alter, 2000; Rogers, 1995; Moisdon, 1997).
This problem was studied also in the past by the specialty authors for the entities from
the public sector (Lapsley and Wright, 2004; ter Bogt and van Helden, 2000) and the
private sector (Albu, 2008; Alcouffe, 2002; Alcouffe s.s.,2003; Wolfe, 1994). A
relevant feature is that when a product which solves a practical problem with a
theoretical interest is obtained and that product works, that means we have
constructed a theory in the management accounting (Malmi s.a., 2004). When it
comes to innovations, the following have to be described: the theoretical framework
of the research, the methodology used, the causes of implementing the innovation, the
elements which have influenced the implementation and further on the process of
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implementation for different innovations will be analyzed by comparison, the degree

of spreading for these innovations in Romania will be discussed, the results obtained
will be synthesized and proposals will be interpreted and defined for running the
innovations in the management accounting.
After the seventies, the research in the international management accounting has been
characterized through an obvious disciplinary opening (Bollecker & Azan, 2009). It is
known that the theoretical borrowings are meant to diversify the analysis and enlarge
the research. From this point of view, Rojot (2005) was highlighting that in the
current status of the management sciences, the capacity of conservation of the
plurality of approaches must be supported, in an independent manner from the
disciplinary frontier and to be chosen depending on the needs. A researcher has great
chances to innovate, by moving away from the traditional cores of its discipline, in
order to advance towards the frontier areas, because the progress appears in a greater
degree at the meeting point of the disciplines (Dogan and Pahre, 1991). By studying
the international specialized literature, we can see that the articles are influenced more
by the management sciences (43.39% from citations) than by sociology (33.96%).
The management accounting system, as a way of organizational control being at the
disposal of managers, is by its nature dependent of the organization (Bouquin, 2004).
By analyzing the specialized literature, we have identified features of the entities from
the private sector which operate in production, services, distribution, constructions,
agriculture (Bavita et al., 2008; Maurel, 2008) etc. In the last years, with the advent of
the philosophy New Public Management, the research of the entities from the public
sector grew considerably. Concerning the public sector, in the specialized literature,
we have identified organizational features for education, health, public administration
etc. (Nor-Aziah and Scapens, 2007; Brignall and Modell, 2000; Lapsley and Pllot,
2000). As well, we may identify the features of those who activate as freelancers
(notary Cappellatti and Kouthra, 2008, individual offices of accounting etc.).
Nowadays, the accounting activity is automated. The main issues of the accounting
system from the point of view of the management are not technical or structural but
refer to the need of an efficient management accounting from the managements point
of view. The IT system is at the basis of this process, supplying the information.
Caglio (2003) was stating that usually the external factors are significant for those
who work in the domain of management accounting. Other studies cannot provide
such an assurance and state that the impact is collateral, through control (Scapens and
Jazayeri, 2003; Granlund and Malmi, 2002). As influences of the informational
technologies upon the management accounting, we mention the following: the joint of
the management accounting systems to strategy and action (Boitier, 2007); the
transition from the management accounting system based on numbers generated by
accounting to a system based on nonfinancial, operational numbers (Dechow and
Mouritsen, 2005); the remodelling of the mission of the management accountants,
which focus mostly on analytical duties (Davis and Albright, 2000); the remodelling
of the knowledge which the management accountants must acquire (Azan, 2009); the
increase of the flexibility of the information processing, in this way integrating the
accounting information. In the last three decades the role of the management
accountant was to improve the competitiveness and the profitability of the firm
through a speech of logical analysis and a rational decision-taking process. Still, the
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manner in which the speech is designed has been modified through time from the
presentation of the relevant information in the 1980s, to the working with the
managers for finding the information needed in the 1990s, to disciplining the
organization through the measurement systems of performance in 2000 (Balvinsdottir
et al., 2009).
THE NATIONAL PERSPECTIVE
In Romania the concerns are still early. Glavan et al. (2007) conducted a research on
the relevance and quality of accounting information in management decisions. The
conclusion of their study was that accounting information is used in management
decisions (83% of managers consider it significant and 67% deemed necessary). Yet,
the most important elements are taken from the financial accounting (66%). This
answer can be explained by the fact that 83% of the entities surveyed organize
financial accounting and only 17% management accounting. 17% of the responding
managers cannot assess the role of the accounting information in the decision-making
process. 17% of the managers consider that the support for the managerial decision is
the information offered by the market and mass-media. In the same time, most of the
accountants fully trust the accounting information (67%), which they consider it is
available in time (67%).
One reason for lack of relevance of information provided by management accounting
is that despite changes in economic environment accountants continue to use the same
tools and traditional techniques (Almasan and Grosu, 2008; Dumitru, 2007).
Albu managed in 2007-2008 a research contract based on the contingency theory. The
team studied the influence of the cultural factors, contingency factors on types of
instruments, innovations in management accounting in Romania and the process of
hybridization in the accounting profession and the identification of the contingency
factors for this phenomenon.
In a study analysing the job advertisements for the management controllers, Albu and
Albu (2007) notice that: the instruments focusing the actions and behaviours of the
actors are mostly represented by the budgets and are used mostly in the subsidiaries
and the foreign capital companies; the modelling of the relationships between the
resources and the aims of the decision making processes; there is a bond between the
strategy and the daily issues.
Jinga et al. (2010) analysed in an empirical survey the situation of the management
accounting in Romania in this moment in different activity domains. The conclusion
is that there would be a gain in the modernization of the management accounting if
the registration of the expenses according to their destination and evolution would be
ruled. The use of the three criteria offers unlimited informing opportunities. The legal
change would determine the entities to form a database with multiple uses.
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3. THE ANALYSIS OF THE RESEARCH IN MANAGEMENT

ACCOUNTING IN ROMANIA
Many studies have chosen to investigate the role of academic journals in the
dissemination of accounting knowledge because they have proven to be the primary
means for the diffusion of research knowledge in the social sciences (Nederhof, 1985;
Nederhof and van Raan, 1993; Gray et al., 2002, quoted by van Campenhout and Van
Caneghem, 2010, pag. 837). Even though Schneider (1995) argues that it is not only
the publication of a piece of research that matters, but also its ability to boost further
research, current evaluation methods still mainly focus on the former.
For individuals, publications are crucial because their number and quality are
generally the main criteria for hiring, tenure and promotion decisions (Brinn et al.,
1996; Stone, 1996; Mathieu and McConomy, 2003), even in institutions which have
little interest in research (Hopwood, 2008, p. 89). For universities, recognition as a
research-intensive institution creates a favourable image that may attract the best
postgraduate students and provide financial resources, especially since several
governments have undertaken research assessment exercises to guide the allocation of
public funds Raffournier and Schatt, 2010, pag. 2).
In Romania, the term of quality ratio was introduced to include in the universities
financing methodology a stimulating and corrective component. The National Council
of Research in Higher Education (CNCSIS) computes IC6 since 2006, using the data
from 2005 (previously, IC8 was computed). This quality ratio, involved in the
assessment of the performances level in the university scientific research, has a
complex structure and a distinct computation formula as to other quality ratios. It
allows the budgetary allocations covering the basic needs of the universities in
students preparation (wages and materials) to be correlated with the way in which
they are satisfied, both from funds allocated from the state and from other revenues
(http://www.cncsis.ro/Public/cat/25/Prezentare.html).
The criteria imposed on the universities by this quality ratio have as effect requests
regarding the research results of the academics. The relevance and visibility of the
results of the scientific research activities is measured according to:
1. a) Articles, proceedings paper, review published in ISI indexed journals;
b) Scientific papers published in foreign journals in the main journals stream,
indexed in international databases;
c) Scientific papers published in the volumes of the international conferences
ISI indexed and/or the ones organised by international professional bodies
2. Articles published in journals recognised at a national level, by CNCSIS B
and B+ categories
3. Books published by national printing houses recognised by CNCSIS or
prestigious international printing houses (on paper or electronic).
Raffournier and Schaff (2010) study the content of 18 major academic journals in
accounting over five years (20002004) and the set of papers presented at the EAA
congress in 2003, 2004 and 2005. We notice in their study that no paper of a
Romanian author appears in any of the journals and only 2 papers are presented at
EAA congresses. However, these papers are not part of the evaluation process in
Romania. Thus, we consider that the researches of the Romanian authors are mainly
~1154~
published in Romanian journals. The result is convergent with the one of Popa et al.
(2009).
We base our research on the study of the articles published in Romania on this topic.
In order to analyze the research in management accounting in Romania, we establish
four periods in time:
1908-1948: in 1908 the first accounting journal was published in Romania,
Revista general de comer i contabilitate (RGCC). In this time range the first
articles on management accounting issues appear;
1949-1989: in 1949 Romania switched to a soviet accounting system. As this
domain is less affected by the new rules of the economic doctrine, the number
of articles on this topic is increasing;
1990-2004: it is the period in which Romania started to implemented a new
accounting system;
2005 nowadays: important changes occurred in the methodology of
classification of the research journals and in the performance measurement
systems within the universities.
Our research has as information source the identified journals existing in the four
periods of time, as it follows:
Table 1. Journals analysed
Period
analyzed
Journal
Specific features
Existing journals
Historical period: 1908-1948
1908-1948
The Journal of Commerce and RGCC The idea of founding the journal was launched
Accountancy
during the first National Congress of Schools of
Commerce Alumni that took place on October
29th 1906. It materialized through the
publication of the first issue of the journal in
January 1908. When Romania entered the war in
August 1916 the publication was discontinued
for a period of four years (July 1916
December 1920). Subsequently, the journal
continued to be published until March 1947. The
area of interest is very broad, including
management accounting.
1937-1955
Accounting Bulletin
BC
The Accounting Bulletin, as an official
publication of the Body of Accountants Ilfov
Sector, was only an instrument of
communication between the professional
organization and its members. Starting in June
1939, papers are published as well, addressing a
variety of issues.
1956-1969
Accounting and Bookkeeping
EC
The renaming of the Accounting Bulletin as
Accounting and Bookkeeping brought a certain
change in the contents of the journal. Therefore,
a diversification and a specialization of the
structure of the journal can be observed, and
also a certain detachment from the generalized
Soviet model, in the sense that some discussions
on important matters occur. An important
number of management accounting articles is
published.
~1155~
Period
analyzed
1970-1989
Journal
The Accounting Journal
Specific features
Existing journals
RC
The trend of de-sovietisation in the 70 was
supported by important changes in the
accounting field, such as the renaming of the
only accounting journal in Romania. Accounting
and Bookkeeping became The Accounting
Journal.

1990-2001
The Journal of Finance, Credit, and RFCC
Accounting
2002-2004
The Journal of Public Finance and RFPC
Accounting
1993-1995
1996-1997
Accounting expertise
The General Journal of
Accounting and Expertise
Accounting and Expertise
Accounting, Expertise and
Business Auditing
EXC
RGCE
1998-2004
Business Management and

Accounting
GCF
2002- 2004
Accounting and Management

Information Systems/Contabilitate
i informatic de gestiune
AMIS
1998-1999
2000-2004
CE
CEAA
Journals according to the CNCSIS quotations

2005Accounting and Management
nowadays
Information Systems/Contabilitate i
informatic de gestiune
http://www.cig.ase.ro/revista_cig/
2005Scientific Annals of the Alexandru
nowadays
Ioan Cuza University in Ia i.
Section Economic Sciences/
Analele tiinifice ale Universitii
Alexandru Ioan Cuza din Iai
Seciunea tiine Economice
http://anale.feaa.uaic.ro/anale/en/
2005Virgil Madgearu Review of
nowadays
Economic Studies and Research/
Revista de Studii i Cercetri
Economice Virgil Madgearu/
http://www.econ.ubbcluj.ro/rvm/en/
2008-prezent Studia Universitatis Babe Bolyai.
Oeconomica
http://studiaoeconomica.ubbcluj.ro/
AMIS
Changes in the political and economic doctrine

(the transition to a free-market economy)
generated important changes in the publishing
field. Therefore, The Accounting Journal
changes its name and content to The Journal of
Finance, Credit, and Accounting and later to
The Journal of Public Finance and Accounting.
One of the topics studied is the management
accounting.
A competing journal is founded in 1993,
Accounting Expertise, edited by the Body of
Expert and Licensed Accountants of Romania
(CECCAR).
The thread interrupted in 1947 (when the
General Journal of Commerce and Accountancy
RGCC, founded in 1908, ceased to appear) is
therefore resumed. Subsequently, the journal
changed names several times, but management
accounting articles were published all along the
period.
It is a new competing journal with a very broad
area of interests, including management
accounting.
As well as the previous journals, AMIS
publishes articles on management accounting
topics. Even more than other journals in the
field, AMIS emphasizes the scientific character
of the published papers.
These journals have as a common denominator a
good
CNCSIS
classification
based
on
performance criteria, which attracts some of the
most relevant scientific papers in the field.
FEAA
VM
SUBB
a) Publishing the research results in management accounting in 1908 1949

According to the research conducted by Calu (2005), management accounting
(costing) issues began to attract the interest of accounting specialists; many articles
were published in the RGCC, in 1908-1948. Accordingly, specialized articles were
~1156~
published on a particular segment, such as the division of general administrative

expenses or an overview of the calculation of costs in different economic sectors:
industry, trade. The problem of distribution methods of the expenses was also
presented in the pages of journals; in this regard, the appearance of procedures
(methods) in the Romanian literature is noticed: the division method, the additional
method, equivalent figures method, coupling method etc.
Issues related to budgeting cost were also if interest; in this respect we recall a chapter
in Evians book Accounting Industry (The budget is a projection into the future of
the enterprises activity) and an article published by Donoaica in BC (1948).
The period under review is characterized by the concerns displayed by the academics
for choosing, defining and clarifying specific terms for cost calculation. Accordingly,
there were discussed and defined the following terms: price cost, the recovery price:
price cost, meaning the purchase (procurement) price, the recovery price a
minimum sale price, general administration overheads all the expenses connected
with rent, salaries, light and heating, various taxes etc., procurement costs for sale
all the general expenses made with the purchasing of goods and not included in
paragraph a) [the cost price], selling expenses all the expenses incurred in the sale
such as advertisement, displays, placement agencies etc. These concepts were
debated in CECCAR and were published in RGCC (1936).
At the same time, different aspects of industry experience in other countries are
presented as examples, such as standardization and cost calculation in Germany
(RGCC, 1937). Another idea found in the pages of the publications of that time is the
computation of the industrial recovery cost using extra accounting techniques.
Therefore, ... technical or extra accounting recovery costs are established using
sheets prepared for each item produced and columns containing the quantity and the
cost of the raw materials employed, wages and manufacturing overheads reported
percent (RGCC, 1940).
b) Publishing the research results in management accounting in 1949 1989
Post calculation was the part of the management accounting on which no substantial
changes were generated by the new economic doctrine. Given the possibility of a
wider exercise of the professional judgment, the cost calculation is one of the topics
covered in the pages of the journals EC and BC.
According to Calu (2005) the first research subjects that made reappearance in BC
(after the June 11th 1948 moment) were those addressing the issue of costing. The
main topics were: costing in coal mines; cost calculation in the manufacturing
industry; post calculation in publishing houses; post calculation in cotton mills. Given
that the accounting standard-setting process was developed at the industry level, there
can be noticed that most authors attempted to point out various features in the field of
management accounting as well.
Changing the name of the journal from Buletinul contabililor (BC) to Eviden a
contabil (EC) in 1956 only brought formal changes. Costing is as in the previous
period, one of the main subjects addressed in the pages of this journal. According to
Calu (2005), the subjects addressed in EC can be divided into two categories: (1) the
~1157~
presentation of classical costing methods, using different companies as examples and

providing suggestions for improvement and (2) suggestions regarding the use of new
methods (direct-costing), from the industrialized countries. In the first category of
methods, full-costing, process costing and job order costing were discussed, as
methods used assess costs in various industries. The second category, of modern
methods, began to be presented in the literature in the late 60s, initially in the form of
a book review, and subsequently in some articles addressing the issues of: recording
and calculation of production costs using THM method (machine-hour rate), the cost
calculation concepts under standard costing method, GP (George Perrin) cost
calculation method, direct-costing method.
Together with the object of accounting, the cost calculation was the subject of
articles published in RC in the period 1970-1972. It was defined as it follows: the
object of the cost calculation is, on one hand, the production and selling expenses of
the enterprise, and on the other hand, the production of material goods, works and
services conducted in a given organizational framework and expressed quantitatively
by certain units of measurement (RC, 1971).
In the late socialist period, in an article published in RC (1988), Ristea discussed the
need to organize the management accounting as an autonomous function. This
article expressed the view that accounting cannot be limited to costing and the
computation of the results only through the carriers of value, requiring a separate
accounting information structure ... called management accounting, the central
problem of which is to calculate the production costs and results and using the
specific instruments ... costing, internal budgets and internal financial control.
c) Publishing the research results in management accounting in 1990 2004
Following the Revolution of 1989, which resulted in the fall of communism and the
transition to a free market economy, the publishing environment has undergone a
significant transformation. Therefore, a transition occurred, from the existence of a
monopoly on specific accounting journals to a plurality of options. An analysis was
performed of articles published during this period in the field of management
accounting according to topic.
The duality in the post-revolutionary Romanian accounting system involves distinct
approaches regarding the problems of management accounting and costing. In the
early 90s, the benchmark treatment was represented by full costing, matched by the
accounting technique of using the Class 9 accounts form the Chart of accounts to
record costing activities. These accounts were called Management Accounts and
provided under the regulations issued by the Ministry of Finance.
Switching from a monistic accounting to a dualistic accounting system resulted in the
appearance of original articles presenting the appropriate technical solutions for the
new realities, such as introducing a practical choice for the organization of
management accounting (EXC, 1993). The issues raised were not only technical, but
they also raised questions: is there a boundary between financial and management
accounting? (EXC, 1996). Subsequently, management accounting began to be more
and more the subject of articles that relate to a modern approach. In this respect we
mention the following: activity-based costing (RFCC, 1999; CEAA, 2003; RFPC,
~1158~
2003; GCF, 2003; AMIS), target costing (AMIS), the relevance of accounting
information in making decisions on cost management within a company (GCF, 1999;
AMIS, 2004), approaches concerning the limits of the management accounting system
(GCF, 2000), the conceptual boundaries of the management accounting in the
development worldwide (RFCC, 2001), considerations of influence of the cost
calculation on the profit or loss (RFCC, 2001), comparative management accounting
(CEAA, 2002), management accounting using marginal costs (AMIS, 2004), cultural
aspects (AMIS, 2003) etc.
Linked to the management accounting issue is the management control, defined as
the process by which managers ensure that resources are obtained and used with
efficiency, effectiveness and relevance for the objectives of the organization (Ionacu
et al., 2001). Some particular aspects of management control began to be addressed in
specialized journals. In this respect, we note the overall approach of this domain:
restructuring the company and management control (RFCC, 1999), management
control for activities generating fixed overheads (GCF, 2003), internal transfer pricing
practices (CEAA, 2001, 2002), inventory management models, the concept of
management control (AMIS, 2004), budgets (AMIS, 2004), concept of performance
(AMIS, 2002, 2004), project management (AMIS, 2003), quality control and quality
costs (AMIS, 2004).
d) Publishing the research results in management accounting in 2005 2011
In 2005 the Ministry of Education established new criteria for holding teaching
positions in higher education and for achieving academic titles. Consequently, some
mutations occurred regarding the publication of scientific papers. According to the
new regulations, the most relevant criteria for holding teaching positions in higher
education and for achieving academic titles are: the number of ISI articles (A journals
in CNCSIS classification), the number of international databases indexed articles (B+
journals in CNCSIS classification), holding the position of director or member of a
research team working on a research project financed through a national competition.
Thus, the most relevant papers were published in journals classified by CNCSIS as A
(ISI) and B + (indexed in international databases).
In the same year, CNCSIS established new criteria for the evaluation of journals (A,
B, C, and D). In 2007, the B+ subcategory was introduced to stimulate the visibility of
Romanian journals on the Web. In 2008 the B+ subcategory became the category of
Romanian journals indexed in international databases, and complying with all the
conditions of the B category journals (http://www.cncsis.ro/articole/1901/Arhiva2005-2010.html).
To classify the articles published in the four journals we did as it follows: we
identified the articles with other topics than accounting, articles with financial
accounting topics, management accounting articles and other types of accounting. To
classify the management accounting articles we adapted a classification published by
Management Accounting Review (MAR) to analyze the articles published in the last
two decades (Management Accounting Research, 21 (2010) 278284). However, the
classification of these articles is the result of our work and is inevitably subjective.
Thus, the articles were classified according to two criteria: topic studied and research
~1159~
settings. After analyzing the abstracts of the articles published, the criteria were
detailed as it follows:
Table 2. Criteria used
Criteria
Topic studied
Research settings
Traditional costing techniques

Advanced costing techniques
Pricing; including transfer pricing
Management accounting practices
Management accounting change
Management and organisational control
Performance measurement
Strategic management
Risk management
Inter-organisational management control
Others
Generic
Manufacturing
Specific industries
Services
Specific countries
Other
The results obtained are the following:

Table 3. Classification of articles
Items
Total number of articles, of which:
Number of articles in other domains
Number of articles in accounting, of
which:
Number of articles in financial accounting
Number of articles in management
accounting
Number of articles in other types of
accounting
Total
u
%
731
100
391 53.49
340 46.51
AMIS
u
%
531
100
251 47.27
280 52.73
FEAA
u
%
49
100
11 22.45
38 77.55
u
61
53
8
VM
%
100
86.89
13.11
138
70
40.59
20.59
115
55
41.07
19.64
18
8
132
38.82
110
39.29
12
SUBB
u
%
90
100
76 84.44
14 15.56
47.37
21.05
1
3
12.5
37.5
4
4
28.57
28.57
31.58
50
42.86
We notice that the average percentage of papers in management accounting is 20.59%

in these journals (from 19.64% in AMIS to 37.5% in VM).
Table 4. First criteria: topics studied
Items
Traditional costing techniques

Advanced costing techniques
Pricing; including transfer
pricing
Management accounting
practices
Management accounting
change
Management and
organisational control
Performance measurement
Strategic management
MAR 20002009 (%)
u
7
12
4
%
12.73
21.82
7.27
u
2
2
%
25
25
15
2
Total
Romania
u
%
9
12.86
16
22.86
4
5.71
33.33
25
8.57
7.27
12.5
33.33
15
7.14
9.09
17
7.14
5.45
50
14
3
2
5
2.86
7.14
2
3
3.64
5.45
25
~1160~
AMIS
FEAA
VM
33.33
SUBB
Risk management
Inter-organisational
management control
Others
Total
3
6
17
100 (205 papers)
2
1
2.86
1.43
1.82
15
70
21.43
100
14
55
25.45
100
25
1
8
12.5
100
100
100
We notice that in Romania there are still a number of papers published regarding the
traditional costing systems. In the same time, the percentage of the papers dealing
with costing techniques (both traditional and advanced) is very big as compared with
MAR. Management accounting change, Management and organisational control,
Performance measurement, Inter-organisational management control are poorly
represented in the Romanian literature (for the first two the percentage is almost a half
of the one in MAR, while for the second two the percentage is almost five times
smaller than the one in MAR). In the same time, the percentage for strategic
management is two times bigger in Romania than in international literature (MAR).
Table 5. The second criteria: research settings
Items
Generic
Manufacturing
Specific industries
Services
Specific countries
Other
Total
MAR 20002009 (%)

14
9
18
14
25
20
100 (196 papers)
Total
u
33
1
9
4
2
21
70
%
47.14
1.43
12.86
5.71
2.86
30
100
AMIS
u
%
26 47.27
7
4
1
17
55
12.73
7.27
1.82
30.90
100
FEAA
u
%
5 62.5
3
8
37.5
100
u
1
1
1
3
VM
%
33.33
33.33
33.33
100
SUBB
u
%
1 25
2
50
25
100
We notice that most of the articles in Romania offer generic recipes, while the
number of articles dealing with a certain matter is small. We notice that at MAR the
services became an important research setting (trend which is not yet adopted by the
Romanian researchers). A cause may be that the most used research method at MAR
in the last 10 years was the case study (40%), while in Romania we could not
encounter this method. There is also an important difference in the Specific countries
setting, as in Romania, dealing with Generic setting we do not take into account the
characteristics of the country (especially our own country).
THE FUTURE PERSPECTIVE
The management accounting is a deregulated domain. The absence of legal
constraints has resulted in a diversity of methods of organization of the management
accounting, many of these organization methods presenting gaps from the
informational potential point of view. An analysis of the politics regarding the
selection of these methods, in the economical and cultural context of our country, is
able to highlight new valences of the accounting research in the management
accounting domain. By analyzing the international and national literature (Albu, 2007;
Baker, 2007, Scapens, 2006; Levant, 2006; Calu, 2005; Boyns, 1997; Nikitin, 1996)
we notice the obvious discrepancy between theory and practice, among the studies
undertaken in diverse geographical areas but also among the addressed research
methods.
~1161~
The research in the change in the management accounting in Romania may be based
on the evolution theory, whose potential was not fully described or used in the
accounting research (Johansson and Siverbo, 2009; Coad and Cullen, 2006). The
analysis of change in management accounting should follow two axes: the trend at the
conceptual level and the methodological one.
Form the conceptual point of view, theories in a social sciences field such as
management accounting research should provide explanations that are useful for those
we study managers, organizations and society (Malmi and Granlund, 2009). The
ultimate reason for developing a theory is to be able to use this understanding, or
theory, in creating better management accounting practices, both in terms of content
and use (Chenhall, 2003; Ittner and Larcker, 2001). An important criterion for a
theorys success is the value of the theory to users (Demski et al., 1991). As well,
there is a need for management accounting theories addressing what systems or
techniques to use, how and in which circumstances (Kaplan, 1998). Not in the last
time, we need theories explaining how to change management accounting practices
(Malmi and Granlund, 2009). Studies should address the performance implications of
various practices. Another avenue is to develop existing practice theories to more
complete theories by specifying constructs, relationships and underlying mechanisms
more clearly and addressing their limitations (Malmi and Granlund, 2009). One of the
most used theories in the management accounting change is the framework suggested
by Burns and Scapens (2000).
In terms of methodology there has been a change from the use of mathematical
models to prescribe optimal practices, through statistical generalisation to explain the
diversity of observed practices, using a combination of economic reasoning and
contingency theory to do the explaining, to an approach which focuses on
understanding the specific practices of individual organizations. According to Scapens
(2006), the evolution of the twin theory methodology in the management accounting
is presented, in time, as it follows:
Table 6. The evolution of the management accounting research
Year
1970s
1980s
1990s
2000s
Methodology
Modelling
Positivism
Interpretivism
Pluralism/Pragmatism
Theory
Economic
Contingency
Structuration
Institutional
Practical dimensions
What managers should do?
What do managers do?
Making sense of practice
Helping practitioners
Research tool used

Mathematical models
Empirical surveys
Interviews
Case studies
(Source: Scapens, 2006)
As a conclusion, the new trend in the research in management accounting at

international level is the institutional theory (most of the papers 19% published by
MAR in 2000 2009 used this theory). Institutional theory seeks to explain the
development of institutions and organizations and the way that organizations compete
for political and social power and institutional legitimacy. DiMaggio and Powell
(1983) label the process through which institutions and organizations tend to adopt
similar structures and practices, as institutional isomorphism. Institutional
isomorphism is a process that causes a particular organizational unit within a
population to resemble other units in the population facing similar sets of
environmental conditions and it can be coercive, normative and mimetic.
~1162~
From the research methodology point of view the newest existing trend at
international level is the pluralism/pragmatism, which supposes using a mixing of
methods, both qualitative and quantitative. The latest method is the triangulation.
Triangulation represents an original abstract of different research methods (e.g. case
studies and survey methods). Within the survey methods the questionnaires and the
interviews may be used. The triangulation between the case studies and the empirical
investigation methods (Modell, 2005) offers the means for assessing the degree of
convergence and, in the same time, offers the means for the presentation of
differences between the results obtained (Brewer and Hunter, 1989; Jick, 1979;
Sieber, 1973). The empirical surveys can improve the level of understanding the
impact of a certain phenomenon and/or the form and intensity of the conceptual
relationships noticed in the case studies. On the other hand, the case studies increase
the understanding level offered by the results of the empirical investigations, offering
a holistic vision and, in the same time, help explaining the obvious problems or the
problems that can appear in the future.
CONCLUSIONS
We started form the idea of comparing the research published in four Romanian
academic journals on management accounting topics. The small number of articles
published made us believe that this was not relevant. So, we compared the total
number of articles published in these journals with the articles published in MAR.
A limit of our research is that due to the lack of tradition in publishing management
accounting papers in academic journals, we could not make a comparison in time of
the results obtained. Another limit is that we only selected 4 journals, while there are
lots of other economic journals in Romania classified B+ by CNCSIS which publish
articles on this topic. Another limit is that in some journals the number of articles
published on management accounting topics is very small. Another limit is that we
could not use the entire classification presented in MAR, namely the theory used, as
many articles had only a literature review part. We also didnt present the regions of
origin of these papers, as in more than 90% of the cases (100% for the journals except
AMIS) this is Romania.
The differences in percentages show us that there is a need for a change in the
management accounting research in Romania. We notice that in Romania the
researchers are more concerned with the costing techniques than with the management
control. In the same time, the target of management accounting is to help managers in
their decision making process. This cannot be achieved since our research focuses on
generic settings and not on specific industries or services. We must pay more attention
to the accounting and management practices in the successful organizations (Malmi
and Granlund, 2009). For our country the researchers are also the professors. Since
their concerns are related to the costing techniques mostly, this is what they transmit
to their students, and their students will implement in their companies. This is why we
believe that that a change in the management accounting research topics will also lead
to a change in the management accounting practice. The target is to find the way in
which the challenges of the economical, social and legal environment are transformed
in opportunities through the changes from the management accounting.
~1163~
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THE BUCHAREST

June 8-9, 2011

AUDIT COMMITTEES AS INCREASING VECTORS OF FINANCIAL

THE FINANCIAL AUDITORS RISK BEHAVIOUR THE INFLUENCE

THE INVESTIGATION OF ROMANIAN AUDITORS' PERCEPTIONS

PS2 Public accounting

PUBLIC SECTOR PERFORMANCE FROM THE PERSPECTIVE

IMPROVEMENT IN ACCOUNTING SYSTEM AND PERFORMANCE

THE ERA OF INTERNAL AUDIT IN THE PUBLIC FINANCE SECTOR

BOUNDRIES REGARDING THE IMPLEMENTATION

PS3 Financial analysis I

FINANCIAL RATIOS AND MARKET VALUATION

A HYBRID DEVICE OF SELF ORGANIZING MAPS (SOM)

THE RELEVANCE OF COMPANY EVALUATION METHODS

FINANCIAL RISK ANALYSIS AT THE STOCK EXCHANGE LISTED

ENTERPRISE 2.0 IS THE MARKET READY?

NON-TECHNICAL CHALLENGES IN ADOPTING ENTERPRISE 2.0

CRITICAL SUCCESS FACTORS FOR THE ORACLE DATABASE

PS7 Financial instruments

USE OF FINANCIAL SECURITIES IN THE CZECH REPUBLIC: SOME

THE FINANCIAL INNOVATION AND THE DYNAMIC CAPITAL

A SELECTION FUZZY MODEL INVOLVING ASSETS AND PROJECTS

THE ROLE OF FINANCIAL DESCRIPTORS IN THE OPTIMAL

PS8 Intellectual Capital

INTELLECTUAL CAPITAL DISCLOSURE: EUROPEAN EVIDENCE

INTELLECTUAL CAPITAL: THE ANNUAL REPORTING PRACTICES

DETERMINANTS OF INTELLECTUAL CAPITAL DISCLOSURE IN

VALUE AND PERFORMANCE IN A REGULATED ENVIRONMENT:

QUO VADIS IN MEASURING BUSINESS PERFORMANCE? A

EFFECTIVE AND EFFICIENT TOOLS IN HUMAN RESSOURCES

FLEXIBILIZING THE TERMINATION OF THE EMPLOYMENT

PS11 Management information systems II

A CASE STUDY FOR START-UP COMPANIES IMPLEMENTING EBUSINESS TECHNOLOGIES

ANALYZING E-COMMERCE PROTOCOLS

MODELING ON A SEMANTIC-BASED REPRESENTATION OF

SEMANTIC ANNOTATION AND ASSOCIATION OF WEB

DECISIONS DRIVE SUCCESS

PS12 Corporate governance and ethics

CORPORATE VALUES, THE COMPANIES FRAMEWORK

HOW CAN CORPORATE GOVERNANCE MITIGATE FRAUD?

ETHICS AND RESPONSIBILITY IN IT

CORPORATE GOVERNANCE PRINCIPLES: AN EVOLUTIONARY

PS13 Issues in financial accounting

IMPACT OF FUNDED STATUS OF PENSIONS ON BORROWING

THE IMPACT OF UNREALISED FOREIGN EXCHANGE

VALUE RELEVANCE OF CONSOLIDATED VERSUS PARENT

THE ADVANTAGES VS. THE DISADVANTAGES OF OUTSOURCING

PS14 Management information systems III

IT COMPLEXITY AND COSTS

THE EFFICIENCY OF SMALL AND MEDIUM ENTERPRISES BY

13 YEARS AFTER: AN XBRL LITERATURE REVIEW AND

THE INFLUENCE OF FIRM-SPECIFIC CHARACTERISTICS ON THE

OBLIGATION OR OPPORTUNITY FOR DRAWING THE CASH-FLOW

ROMANIAN PROFESSIONAL ACCOUNTANTS PERCEPTION

ACCOUNTING PRINCIPLES AND BOOK-TAX (DIS)CONNECTION

FUNDAMENTAL DETERMINANTS OF CAPITAL STRUCTURE

IMPACT OF LONG-TERM INVESTMENT DECISIONS ON

INCLUDING BEHAVIOURAL ELEMENTS IN ASSET ALLOCATION

ACCOUNTING STUDENTS ACADEMIC PERFORMANCE: A BATTLE

PERCEPTION OF THE ROMANIAN ACCOUNTANTS REGARDING

MANAGEMENT VIEW RELATED TO HIGHER EDUCATION

SOCIAL NETWORKING IMPACT ON EDUCATIONAL PROCESSES

THE BEGINNINGS OF TRANSYLVANIAN CLUJ ACCOUNTING