A Study On Quality of Earnings in Petrochemical Industry

Volume 4, Number 3, July September 2015
ISSN (Print):2279-0896, (Online):2279-090X

PEZZOTTAITE JOURNALS
SJIF
(2012): 2.844, SJIF (2013): 5.049, SJIF (2014): 5.81
A STUDY ON QUALITY OF EARNINGS IN PETROCHEMICAL INDUSTRY

B. Sudheer Kumar24 Dr. V. Mallikaruna25 Dr. N. Kumara Swamy 26
ABSTRACT
When any investor goes for investment, he sacrifices his present benefits for the sake of future profits. Any investment made is
to earn profits by accepting some sort of risk. In the wake of present Scenario of highly publicized financial frauds and
failures and accounting manipulations, the emphasis on earnings quality has renewed. Thats why investors and creditors
from all over the world are turning toward the assessment of the earnings quality of the individual company in which they are
trying to invest their investment. Through present study on quality earnings, it was found that various earnings quality proxys
which represent the quality of earnings position in the organization. The quality earnings from a company to company vary
according to the parameters they depend on. In the study, the quality earnings often are high in personal care industry and
leather industry. The results of present investigation show that intellectual capital has positive impact on earnings quality,
because relationship between VAIC values and DA is linear and inversely proportional and its lead to conclude that
intellectual capital has a positive role in best financial practices and reporting.
KEYWORDS
Calculation of Intellectual Capital, Human Capital Coefficient, Structural Capital Coefficient etc.
INTRODUCTION
There are many way through which the organizations are manipulating the financial statements, they use certain approaches that
help a firm to hide the true conditions. The investors need to assess the extent to which a firm's reported earnings are free from
mistake or manipulation, so they should have an idea about the possible approaches and ways the firms use to lower its earning
quality and increase their speculative profits. They are:
Recording revenue too soon or of questionable quality,

Recording fictitious revenue,
Boosting income with one-time gains,
Shifting current expense to a different period,
Failing to record or improperly reducing liabilities,
Shifting current revenue to a later period, and
Shifting future expenses to the current period as a special charge.
NEED OF STUDY
In order to understand a company financial report genuinely, you need to understand the accounting concepts that are used to
justify the accounting rules. Basically, these accounting concepts provide rule makers with guidance that will result in financial
reports the best help investors, creditors and other financial report users asses. Investors overlook factors outside the financial
reporting system that quantify their profits or losses most of the time without even their acknowledgement, by the study of earning
quality of the firm we can throne a light on all the other factors that can affect earnings quality and organizations true earnings, by
which the investors, creditors, share holders and others depend on the firms financial well being get benefited.
OBJECTIVES OF STUDY
To estimate earning quality of selected industries,

To develop between intellectual capital and earning quality,
To establish relationship between earning quality and stock returns,
To develop relationship between values added intellectual co-efficient and its components,
To develop between discretionary accruals with other components.
24
Assistant Professor & H.O.D., Department of MBA, Vaagdevi Institute of Technology & Science, Andhra Pradesh, India,
bskmba06@gmail.com
25
Professor & H.O.D., Department of MBA, Sri Sai Institute of IT and Management, Andhra Pradesh, India, v.mallik@yahoo.com
26
Professor, Department f Research & Development, Madanapalli Institute of Technology & Science, Andhra Pradesh, India,
kumaraswamy41@gmail.com
International Journal of Applied Financial Management Perspectives Pezzottaite Journals.
1902 |P a g e

SJIF
(2012): 2.844, SJIF (2013): 5.049, SJIF (2014): 5.81
LITERATURE REVIEW
There are many literatures published on the different approaches used for assessment of quality of earnings. Earnings quality is
used in numerous empirical studies to show trends over time; to evaluate changes in financial accounting standards and in other
institutions, such as enforcement and corporate governance; to compare financial reporting systems in different countries; and to
study the effect of earnings quality on the cost of capital.
Frank Ecker, PerM. Olsson, Katherine Schipper (2012), Using path analysis, developed the direct and indirect links
between three measures of earnings quality and the cost of equity are investigated. The investigation is motivated by
analytical models that specify both a direct link and an indirect link that is mediated by information asymmetry, but do
not suggest which link would be more important empirically. The information asymmetry as both the adverse selection
component of the bid-ask spread and the probability of informed TRADING (PIN) are measured. For a large sample of
Value Line firms during 19932005, the statistically reliable evidence of both a direct path from earnings quality to the
cost of equity id found, and an indirect path that is mediated by information asymmetry, with the WEIGHT of the
evidence favoring the direct path as the more important.
Gary M. Entwistle, Associate Professor, Fred Phillips, Associate Professor (2003) designed instructional materials
to elicit debate about the primary accounting qualities of relevance and reliability, and consider how these qualities are
linked to the debate over earnings qualities. The case material comprises two narrative essays, which elicit divergent
views about relevance and reliability, and several discussion questions. You will use these essays and discussion
questions as the foundation for a discussion and building a deeper understanding of earnings quality, through extensive
inquiry of fundamental financial accounting concepts.
Yen H. Tong, Bin Miao (2011), examined whether dividend-paying status is associated with the quality of earnings.
To find dividend paying status is associated with (1) lower absolute values of discretionary accruals; (2) lower standard
deviation and absolute magnitude of the errors associated with the mapping of accruals into cash flows; and (3) more
value relevant earnings. Also, find evidence that the positive association between dividend paying status and earnings
quality is stronger (weaker) when the size of dividend payouts is larger (smaller). Overall, results suggest dividendpaying status is indicative of firms earnings quality.
METHODOLOGY & COLLECTION OF THE DATA

In this study, secondary data was used to achieve the designated Objectives. The secondary data is from various websites,
magazines, journals and financial newspapers.
The collected parameters are Revenue, debt, assets, book value and cash flow from operations, fixed assets, expenses and
employee cost. The analysis was made based on secondary data, published papers and expert opinion.
DATA ANALYSIS PROCEDURE
For the study, certain approaches are used to assess the quality of earnings, intellectual capital and stock returns.
Calculation of Quality Earnings
Quality of earnings is calculated through the following formula:
DAit =
DA i,t is discretio nary accrual that is a proxy of earnings quality
o = CONSTANT
1,2,3= CO-EFFICIENT
VAIC = VALUE ADDED INTELLECTUAL COEFFICIENT
VAIC = HCE+SCE+ CEE
LEVit = LEVERAGE
LEVIT = DEBT/TOTAL ASSETS
SIZEit = TOTAL ASSETS
Later the value is calculated by using the multiple regression equation, which is as follows:
1903 |P a g e

SJIF
(2012): 2.844, SJIF (2013): 5.049, SJIF (2014): 5.81
Here the equation is in the form of y = a + x1b + x2c + x3d, through applying the regression analysis to the above equation we can
get DA value. The regression analysis can be applied by the software that is analysis tool pak, after applying regression to the
above equation the resulted x1 intercept, x2 intercept, x3 intercept should be substituted in the DA formula to get the value
of DA.
Caluculation of Intellectual Capital (VAIC)
Value Added Intellectual Coefficient (VAIC) Calculation
1.
Value Added (VA)

VA = OUT IN, OUT = Revenues
IN = Expenses
2.
Human Capital Coefficient (HCE)

HCE = VA/HC, HC = Employee cost
3.
Structural Capital Coefficient (SCE)

SCE = SC/VA, SC = VA-HC
SC = Structural cost
4.
Capital Employed Efficiency (CEE)

CEE = VA/CA, CA = Book-value of net assets
5.
Value Added Intellectual Coefficient (VAIC)

VAIC = HCE+SCE+ CEE
Caluculation of Stock Returns (R)

STOCK RETURNS (R) = (P1-P0)/P0*100
Here, P1 = Closin price
P0 = Opening price
Caluculation of Leverage Ratio and Size
LEVIT = Debt/Total Assets, SIZEIT = Total assets
DATA ANALYSIS AND INTERPRETATION
General
The secondary data was analyzed using the statistical technique and the obtained results were presented in the form of graphs and
tables. The obtained results were discussed with the help of existing literature and the expert opinion.
Assessment of Earnings quality for Hindustan petroleum corporation ltd
Table-1: Values of DA of Hindustan Petroleum Corporation Ltd
YEAR
2005
2006
2007
2008
2009
DA
481933
575651.8
747637.9
730129
-6428174
YEAR
2010
2011
2012
2013
2014
DA
-272114
-317803
-446851
-442366
-427728
1904 |P a g e

SJIF
(2012): 2.844, SJIF (2013): 5.049, SJIF (2014): 5.81
Regression Statistics
Multiple R
0.380035
R Square
0.144426
Adjusted R Square
-0.10002
Standard Error
1356.922
ANOVA
Regression
Residual
Total
df
2
7
9
Intercept
X Variable 1
X Variable 2
Coefficients
1636.812
-4693.4
0.023967
SS
2175689
12888660
15064350
Standard
Error
1900.672
6201.521
0.077653
MS
1087845
1841237
F
0.590823
Significance
F
0.579296
t Stat
0.861175
-0.75681
0.308643
P-value
0.417661
0.473859
0.766576
Lower
95%
-2857.56
-19357.7
-0.15965
Upper
95%
6131.187
9970.87
0.207586
Lower
95%
-2857.56
-19357.7
-0.15965
Upper
95%
6131.187
9970.87
0.207586
Sources: Authors Compilation

Interpretation: It can be seen that the Hindustan petroleum corporation ltd company exhibit highest earning quality 747637.9. In
2006, this indicates high DA values and high earning quality and the firm shows low earning quality in 2009, which is -6428174.
Note: I can mention one sample calculation of earning quality of selected industries and remaining as usual same as above
example.
Relation b/w VAIC and DA for Hindustan petroleum corporation ltd
The values of VAIC and DA of HPCL is presented in table 4.2.1and shown in figure 4.2.1
Table-2: Relationship between VAIC and DA for HPCL
YEAR
2005
2006
2007
2008
2009
VAIC
294.868
352.7062
457.9693
447.4272
-3925.79
DA
YEAR
VAIC
481933
2010
-164.869
575651.8
2011
-192.8
747637.9
2012
-271.655
730129
2013
-268.922
-6428174
2014
-260.055
DA
-272114
-317803
-446851
-442366
-427728
Figure-1: Relationship between VAIC and DA of HPCL
Relationship b/w VAIC and DA

y = 1637x - 1938.9
R = 1
DA
DA
Linear (DA)
VAIC

Interpretation: The relationship between Vaule added intellectual capital is directly proportional. The high VAIC contribute high
DA(high earning quality) because intellectual people may maintain high accuracy in accountings and may not encourage to show
abnormal earning to boost the profit and earning per share. The relations is not signficant because correlation coeffiecient is very
low.
example.
1905 |P a g e

SJIF
(2012): 2.844, SJIF (2013): 5.049, SJIF (2014): 5.81
Relation between Stock returns and DA for HINDUSTAN PETROLEUM CORPORATION LTD
The values of stock returns and DA of HPCL is presented in table 4.3.1 and shown in figure 4.3.1
Table-3: Relation between Stock Returns and DA for HPCL
Years
2005
2006
2007
2008
2009
Stock Returns
DA
Years
Stock Returns
-6.583476764
-735.717
2010
-43.57660782
-22.39631336
-1452.94
2011
-27.5223113
55.12592593
-1397.69
2012
-26.64609053
-28.39047619
-1923.15
2013
-2.863528426
67.85145889
-2351.74
2014
84.7925608
DA
-2820.38
-2383.89
-2878.93
-2887.73
-2548.38
Figure-2: Relationship b/w STOCK RETURNS and DA of HPCL
DA
Relationship b/w Stock return and DA
y = 0.9959x - 2143
R = 0.0039
DA
STOCK RETURNS
Interpretation: It is observed that the Stock returns and DA relationship is inversely proportional because high accruals
suggesting low-quality earnings are associated with poor stock returns in that relative year. When the Stock returns are high,DA
will be less which indicates earnings quality is high.
example.
Relation b/w VAIC and its Components for HINDUSTAN PETROLEUM CORPORATION LTD
The Values of VAIC and it Component of HPCL is presented in table below:
Table-4(a)
YEAR
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
HCE
79.4259
95.49144
127.6957
118.0579
-855.773
-28.9109
-30.0769
-53.6209
-37.3343
-46.7899
VAIC
294.868
352.7062
457.9693
447.4272
-3925.79
-164.869
-192.8
-271.655
-268.922
-260.055
Table-4 (b)
YEAR
SCE
VAIC
2005
0.98741
294.868
2006
0.989528
352.7062
2007
0.992169
457.9693
2008
0.99153
447.4272
2009
1.001169
-3925.79
2010
1.034589
-164.869
2011
1.033248
-192.8
2012
1.018649
-271.655
2013
1.026785
-268.922
2014
1.021372
-260.055
Table 4.4.1(c)
YEAR
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
CEE
214.4547
256.2252
329.2814
328.3777
-3071.02
-136.992
-163.756
-219.052
-232.614
-214.286
VAIC
294.868
352.7062
457.9693
447.4272
-3925.79
-164.869
-192.8
-271.655
-268.922
-260.055
1906 |P a g e

SJIF
(2012): 2.844, SJIF (2013): 5.049, SJIF (2014): 5.81
Figure-3: Relationship b/w VAIC and HCE of Hindustan petroleum corporation ltd
Relationship b/w VAIC&HCE

y = 4.4918x - 69.304
R = 0.9996
VAIC
VAIC
Linear (VAIC)
HCE

Figure-4: Relationship b/w VAIC and SCE of Hindustan petroleum corporation ltd
Relationship b/w VAIC&SCE
VAIC
y = -4627.3x + 4318.9
R = 0.0047 VAIC
Linear (VAIC)
SCE
Figure-5: Relationship b/w VAIC and CEE of Hindustan petroleum corporation ltd
Relationship b/w VAIC&CEC
VAIC
y = 1.2862x + 21.084
R = 1
VAIC
Linear (VAIC)
CEE

example.
1907 |P a g e

SJIF
(2012): 2.844, SJIF (2013): 5.049, SJIF (2014): 5.81
Relation b/w DA and its Components for HINDUSTAN PETROLEUM CORPORATION LTD
The Values of VAIC and it Component of HPCL is presented in table below:
Table-5(a)
YEAR
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
DA
481933
575651.8
747637.9
730129
-6428174
-272114
-317803
-446851
-442366
-427728
Table-5(b)
VAIC
294.868
352.7062
457.9693
447.4272
-3925.79
-164.869
-192.8
-271.655
-268.922
-260.055
YEAR
DA
LEVit
2005
481933
0.205657
2006
575651.8
0.432728
2007
747637.9
0.522839
2008
730129
0.613774
2009
-6428174
0.679547
2010
-272114
0.64827
2011
-317803
0.666042
2012
-446851
0.676799
2013
-442366
0.702793
2014
-427728
0.680199
Table-5(c)
YEAR
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
DA
481933
575651.8
747637.9
730129
-6428174
-272114
-317803
-446851
-442366
-427728
SIZEit
10626.2
15399.57
20116.18
27349.99
33485.8
32860.34
37566.99
40601.77
46184.67
46942.21
Figure-6: Relationship b/w DA and VAIC of HPCL
Relationship b/w DA and VAIC

y = 0.0006x + 1.1845
R = 1
VAIC
VAIC
Linear (VAIC)
DA

Figure-7: Relationship b/w DA and LEV of HPCL
Relationship b/w DA and LEVit
LEVit
y = -3E-08x + 0.5672
R = 0.1329
LEVit
Linear (LEVit)
DA
1908 |P a g e

SJIF
(2012): 2.844, SJIF (2013): 5.049, SJIF (2014): 5.81
Figure-8: Relationship b/w DA and SIZE of HPCL
Relationship b/w DA and SIZEit
SIZEit
y = -0.0016x + 30175
R = 0.0745
SIZEit
Linear (SIZEit)
DA

Interpretation: The correlation between the DA and its components is non significant but these components have influenced in
the companies quality earnings because all the three components can be manipulated easily. It can also be seen that the
relationship between the DA and its components is linear.
example.
FINDINGS
Through present study on quality earnings, it was found that various earnings quality proxys which represent the quality
of earnings position in the organization.
The quality earnings from a company to company vary according to the parameters they depend on. In the study the
quality earnings is high for Oil & natural gas corporation
The results of present investigation show that intellectual capital has positive impact on earnings quality, because
relationship between VAIC values and DA is linear and directly proportional and its lead to conclude that intellectual
capital has a positive role in best financial practices and reporting.
Earnings with high accruals suggesting high-quality earnings are associated with high stock returns in that relative year.
The Human capital efficiency (HCE) and Capital employed efficiency (CEE) both have a positive relation with the VAIC
whereas Structural capital efficiency (SCE) has a inverse relationship with VAIC because the employed capital is not
properly used for the operating a structure that makes the intellectuals become efficient.
The components of the DA that are VAIC, LEV IT (leverage), SIZEIT (total assets) combine shows a little effect on the
majority of the companies however individual components especially VAIC has predominant influence on the quality
earnings.
CONCLUSION
The Study Quality Earnings is useful for the purpose of the investors and any person who are depending on the companys
financial statement. It provides the investors a perception on the firms financial position in real, rather than that reported by the
firm itself. The investors suffer when the investment is made only based on the reported earnings shown by the company due to
the manipulations done. So through the study the earnings quality of the 9 companies from 1 industry is considered.
The Quality earnings topic arose from the wake of many situations in the present scenario, which are representing the
manipulations in the reported earnings to promote the companies shares. It is revealed in the study done that most of the
companies try to manipulate the reported earnings at least to a certain extent by adding abnormal earnings to the companies true
earnings.
The investors who are trying to invest in any company should not only consider the reported earnings but should also analyze
quality of those earnings. In the study some of the companies like Bharath petroleum corporation ltd , Hindustan petroleum
corporation ltd, Oil india ltd, Petronet lng, gas authority india ltd, Cairn ltd,gujarath state petronet showed good quality earnings
so the small investors should try to invest their investment in these type of companies, whereas speculators can consider the
companies like Indian oil ltd, Oil&natural gas corporation, Nerolac, Mukta arts, Apollo tyres, Tech Mahindra that have somewhat
low earnings quality because they are ready to face risk.
1909 |P a g e

SJIF
(2012): 2.844, SJIF (2013): 5.049, SJIF (2014): 5.81
The companies that have good quality earnings are the companies that pay their taxes properly. So government can give subsides
on the taxation in order to encourage the company for maintaining true earnings.
REFERENCES
1.
www.moneycontrol.com
2.
www.bseindia.com
3.
http://economictimes.indiatimes.com
4.
The Relationship between Intellectual Capital and Earnings Quality Roya Darabi, S.Kamran Rad and M.Ghadiri (2012)
5.
Earnings Quality, Insider Trading, and Cost of Capital David aboody, John hughes, and Jing liu (2005)
6.
The Quality of Accruals and Earnings: The Role of Accrual Estimation Errors Patricia M.Dechow and Ilia D.Dichev
(2002)
7.
Earnings Quality Revisited Jennifer bender and frank Nielsen (2013)
8.
Earnings Quality Metrics and What They Measure Ralf Ewert and Alfred Wagenhofer (2009)
9.
Accruals Quality and Internal Control over Financial Reporting Jeffrey T. Doyle, Weili Ge, and Sarah McVay (2007)
10. Line-Item Analysis of Earnings Quality Nahum D. Melumad and Doron Nissim (2008)
11. Managerial Ability and Earnings Quality Peter R. Demerjian, Baruch Lev, Melissa F. Lewis, and Sarah E. McVay
(2013)
*****
1910 |P a g e

A Study On Quality of Earnings in Petrochemical Industry

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Volume 4, Number 3, July September 2015

ISSN (Print):2279-0896, (Online):2279-090X

(2012): 2.844, SJIF (2013): 5.049, SJIF (2014): 5.81