Asian Economic and Financial Review

ISSN(e): 2222-6737
ISSN(p): 2305-2147
DOI: 10.18488/journal.aefr.2020.1012.1466.1479
Vol. 10, No. 12, 1466-1479.
© 2020 AESS Publications. All Rights Reserved.
URL: www.aessweb.com

THE IMPACT OF FAIR VALUE ACCOUNTING ON EARNINGS

PREDICTABILITY: EVIDENCE FROM JORDAN

Osama Samih Al_Zaytoonah University of Jordan, Department of Accounting, Jordan.

1,2,3

Shaban1+
Atala M. Alqtish 2
Adel M.
(+ Corresponding author)
Qatawneh3

ABSTRACT
Article History The main aim of this research paper is to examine the impact of fair value
Received: 18 June 2020 measurements on earnings predictability. This study focuses on analyzing the
Revised: 9 November 2020
Accepted: 7 December 2020 relationship between fair value measurements and predictability as a measure of
Published: 21 December 2020 earnings quality. The primary data needed to achieve the study objectives were
collected through the annual reports of Jordanian commercial banks. Data from ten
Keywords commercial banks representing the study sample were collected and analyzed using a
Earnings quality
Earnings predictability time series method covering a period of eight years, from 2011 to 2018. The resolution
Commercial banks data were analyzed using the statistical program SSPS. The study concluded that the
Fair value accounting
Financial statements unrealized gains or losses of fair value forecasted through comprehensive income have a
Historical cost. high predictive power of earnings quality. The results also prove that the unrealized
gains or losses of fair value forecasted through net income have a high predictive power
JEL Classification: of earnings quality in the Jordanian commercial banks. The regression and correlation
M49, E27, G21, M41, D24, M41. coefficient analyses also refer to a strong magnitude between the two variables, the
dependent variable (fair value accounting) and the independent variable (earnings
predictability).

Contribution/Originality: This study contributes to the existing literature on fair value accounting to improve
the predictability and quality of earnings and also improves the accuracy of financial statements in order to help
users make better decisions.

1. INTRODUCTION
Since economic conditions are constantly developing and changing, so is the purchasing power of the monetary
unit according to surrounding developments and circumstances. All these factors prompted discussions on finding a
new approach to accounting measurement, which is referred to as fair value accounting.
The fair value recognition and measurement approach is the most appropriate for decision-making. Financial
statements reporting are based on initially reliable information, which is the historical cost approach. However, this
approach becomes less reliable over time and does not have the ability to make reliable decisions once a certain
period after the occurrence of the event has passed. This is because the financial reports depend on historical
records of assets and liabilities, lack up-to-date information on current values, and the historical cost includes a set
of assessments, assumptions and different postulates with which it is not possible to make highly accurate
comparisons (McDonough & Shakespeare, 2015).

1466
© 2020 AESS Publications. All Rights Reserved.
 Asian Economic and Financial Review, 2020, 10(12): 1466-1479

The fair value approach is also one of the approaches that has recently emerged to cover the shortcomings
resulting from the application of the historical cost approach. This approach provides users of financial statements
with appropriate information to make the right decisions, as this information becomes more relevant with the
application of fair value (Sodan, 2015).
The research gap is embodied in the fact that there is still no definite answer regarding specific accounting
procedures that can lead to higher earnings quality as research cannot adequately evaluate the portion resulting
from the fundamental earnings process. Also, there is no specific accounting process that can promote higher
quality earnings.
The importance of earnings quality stems from the importance of general earnings, and these earnings are the
generators of decision-making for all users. Users of financial statements and investors view earnings as a future
vision. It helps them to predict the continuity of corporate earnings in future periods, while financial analysts
consider financial statements as the primary source on which they rely for analyzing information and making
rational decisions (Schipper & Vincent, 2003). Earnings quality can be used as an indicator of dividends, as these
dividends are important matters that are taken into account when making investment decisions (Chen, Lo, Tsang &
Zhang, 2013). Earnings are also considered indirect indicators for evaluating the quality of accounting standards, as
there is a direct relationship between earnings quality and the quality of accounting information (Barth., Beaver &
Landsman, 2001). There are various measures of earnings quality, but the most well-known measures are
persistence, predictability, accruals quality, earnings smoothing and value relevance.
Predictability refers to the idea that earnings are of higher quality and are more beneficial for predicting future
earnings. It is noted that the predictive power of profits is affected by the time series of earnings and the fluctuation
of business operations, the economic environment and the accounting system used by companies. Sodan (2015)
noted that the basic assumption of value relevance of fair value research is that fair value information can predict
future cash flows. Therefore, instead of measuring the correlation between fair value estimates and market prices or
returns, the usefulness of fair value information can also be examined directly by analyzing its predictive power
with respect to future cash flows and future earnings. In other words, fair value estimates represent the present
value of expected future cash flows, so if fair values are reliable measures of asset values, changes in the fair values
(i.e., unrealized fair value gains and losses) should be reflected in changes of future performance (Barth, 1994).
Conversely, if fair value estimates are not reliable, then the correlation with future performance measures will not
be significant.
Following Sodan (2015), we adopted his concept of measurement, as he noted that exposure to fair value
accounting is measured using comprehensive or net income approaches. That is, changes in fair values can be
reported as gains and losses through net income or other comprehensive income. Therefore, we analyzed the effect
of fair value gains (losses) through other comprehensive income and net income on predictability as an earnings
quality measure.
The main aim of this research paper is to examine the impact of, and the relationship between, fair value
measurements on earnings predictability. In order to achieve the objectives of this research, the annual reports of
Jordanian commercial banks were collected and analyzed using a time series method covering the period from 2011
to 2018.

2. LITERATURE REVIEW
The historical cost approach represents the actual and the reality of an event when it occurred at the moment of
exchange, i.e., this value was formulated in the past and may not represent the real value at the present time and
may cause deviation from the present value. This drew criticism of the principle of historical cost, which forced us
to search for a new accounting alternative to keep pace with the economic conditions that are characterized by

1467
© 2020 AESS Publications. All Rights Reserved.
 Asian Economic and Financial Review, 2020, 10(12): 1466-1479

ongoing fluctuations, which cause changes in purchasing power, create instability and may lead to inflation or
depression (Muller, Riedl & Sellhorn, 2008).
It is indisputable that the concept of fair value has transferred the traditional accounting theory to new
horizons and has brought about a comprehensive change in the structure of financial statements and their
implications. This was a result of developments in accounting theory during recent years that have matured and
were implemented in international accounting standards related to fair value and it was put into practice at the
beginning of the third millennium, since 2001 (Sodan, 2015). When a company uses the fair value method, it may
generate a larger income due to the difference between fair value and book value, which is recognized as part of gain
and loss from the application of fair value. Meanwhile, by using the cost model, the amount of net income or loss is
only affected by depreciation expense (Wahyuni, Soepriyanto, Avianti & Naulibasa, 2019).
One of the most important accounting tasks is choosing the correct evaluation method for assessing assets and
liabilities. This has been confirmed by many scientists, such as McDonough & Shakespeare, 2015, who are
convinced that the financial position and results of economic activities represented in balance sheets and income
statements depend not only on the current reality, but also on the methods for estimating and calculating the
reported indicators.
The concept of fair value appeared in the nineteenth century and the beginning of the twentieth century, but
recent times have witnessed a lot of research and controversy among researchers calling for its discontinuation due
to misuse and manipulation of accounting numbers when preparing financial reports. Abuse of fair value reached a
peak during the twenties of the last century in many industrialized countries where prosperity and inflation have
encouraged the development of optimistic repercussions of values, and many of them have returned to a significant
decline due to the global recession (Thomason, 2017).
Between 2006 and 2007, new accounting statements were issued that expanded the scope of fair value
accounting, which led to a discussion that extended beyond the accounting profession to the rest of the business
community. Although fair value accounting is not a new concept or a new accounting practice, new data
requirements coupled with the recent credit crunch that started in 2007 have caused many companies and users of
financial data to question whether current fair value accounting practices should continue.
Therefore, it is important to make a decision to resolve this difference because many companies that use fair
value accounting have to record their assets and liabilities in difficult circumstances, such as the market crash,
which makes the financial statements of these companies appear much worse than they really are. Since the purpose
of financial statements is to clarify the financial condition of the company and its activities during the financial year
and allow users of financial data to forecast future cash flows of the company, when the market collapses and the
values of assets and liabilities appear below their actual value, this leads to distortion of the financial position of the
company and it appears unable to achieve its intended goals (McDonough & Shakespeare, 2015).
When searching for the concept of fair value, it was noted that it has several definitions. It was defined as a
value that is reached at a specific time according to certain assumptions and by using an appropriate accounting
method consistent with the purpose of determining that value, and at the end it is accepted by the parties concerned
(Muller et al., 2008).
The International Financial Reporting Standards (IFRS) has defined fair value as the book amount that can be
exchanged for an asset or liability settlement or equity instrument. The International Accounting Standards Board
(IASB) has defined fair value as the value by which an asset can be exchanged or a liability settled between the
parties who each have a willingness to exchange, are aware of the facts, and execute the deal with free will. IAS 40
defines fair value as the amount for which an asset can be exchanged between knowledgeable willing parties in a
transaction (IFRS, 2015).
Fair value accounting is also called mark-to-market accounting. This is an accurate description because the
assets and liabilities are evaluated on the basis of the financial statements based on the market prices and

1468
© 2020 AESS Publications. All Rights Reserved.
 Asian Economic and Financial Review, 2020, 10(12): 1466-1479

information available for the asset or liability. The fair value is used to reflect market participants’ assumptions
regarding future flows associated with an asset (future economic benefits) and future external flows associated with
liabilities (future sacrifices of economic benefits (FASB, 2018).
Moving towards the step of applying the fair value scale could improve appreciation of fair values. Fair value
estimates become more appropriate, reliable and closer to the accurate disclosure of financial statements, and
accordingly, the American Financial Accounting Standards Advisory Board related to relevance and reliability
encouraged the use of fair value measures in financial statements. It believes that fair value is more appropriate for
both investors and lenders compared to historical cost information, and institutions that implement and publish
their financial statements measured at fair value show realistic and non-overstated results (Muller et al., 2008).
The importance of accounting measurement and disclosure is one of the most important factors that affect
financial statements and make them more appropriate for investment decisions. In order to evaluate financial
investments in a way that reflects the market value more accurately, the fair value approach is recommended over
the historical cost approach. Adoption of fair value increases the quality of accounting information and helps both
management and investors to assess the efficiency of maintaining a company's assets (Sodan, 2015).
Also, the introduction of fair value leads to achieving a set of advantages that can be summed up in the
following (Sing & Meng, 2005):
 The fair value is consistent with the fair expression of the financial statements represented by the financial
position, cash flows and changes in the equity of the company.
 The fair value method is characterized by the fact that assets and liabilities are valued on the basis of
economic income where market prices are taken into account.
 The application of the fair value is consistent with the concept of preserving capital, especially when it
moves away from the historical cost approach.
Nellessen and Zuelch (2011) believe that one of the important advantages that fair value may provide is
adequate data for investors and shareholders to be able to make effective predictions.
There are many factors that a financial reporting entity must consider when determining the fair value of an
asset or a liability. It is important to first identify the asset or obligation being measured because the characteristics
of the asset or liability will affect the measurement process. Among the specific features that affect the fair value are
the condition or location of the asset, or restrictions imposed on the sale or use of the asset at the date of
measurement, if any. As there is a difference in whether the measured asset or liability is independent or under
restrictions, such as an operating asset or a financial instrument, the fair value of a group of assets or liabilities may
be different from the fair value of the individual items because the group value may be greater than the sum of the
fair values of individual items (Bowers, 2011).
Bowers (2011) indicated that the application of fair value has a set of components, such as the transaction price,
or the price of the business transaction, where the price used to determine the value of an asset or a liability is the
focus of fair value measurements. The price is determined as the amount received to sell an asset or the price paid to
transfer a liability in a hypothetical transaction. This hypothetical transaction must also be considered as structured
if the transaction has already taken place, and in order to be considered a structured transaction it must be
presented on the market for a period of time to allow the usual marketing activities to take place. Another
component is the transaction market. This is the market in which theoretical transactions take place and is one of
the important assumptions that the reporting entity must make regarding where the transaction is supposed to
occur in the main market for that asset or liability, or the most advantageous market. The market is considered to
be the one in which the notifying entity sells or transfers the obligation to the largest volume or level of activity of
that asset or liability (FASB, 2018). The market in which the reporting entity usually disposes of the asset or
liability is considered to be the most knowledgeable and most beneficial market for the item to be reported in the

1469
© 2020 AESS Publications. All Rights Reserved.
 Asian Economic and Financial Review, 2020, 10(12): 1466-1479

financial statements. Usually the main market includes buyers who are looking to buy this item and have a
thorough knowledge of it.
The third component is the market participants. In addition to the price and the transaction market, the
financial reporting entity must make assumptions regarding market participants and those involved in the
transaction. Market participants are defined as buyers and sellers in the market and are considered as one of the
main tools for determining prices. Also, market participants are the people or entities present in the market
independently from the entity preparing the financial reports and who have reasonable knowledge (i.e., they have a
reasonable understanding of the underlying or the obligations and the treatment based on all available information),
and who are able to fulfill the original obligation and are fully prepared to complete the deal.
The fair value measurement is also affected by whether the item being measured is an asset or a liability. If the
element is an asset, it should be assumed that the financial reporting entity will make the best use of the asset by
market participants (FASB, 2018). This assumption is intended to mean that market participants will use the asset
in a way that increases the value of the asset or group of assets. In order to determine a higher and better value for
use, the entity preparing the financial reports must consider how market participants use the asset, not as the
company itself considers using the asset. Financial assets, such as securities, are examples that provide the
maximum value on an independent basis.
The fifth component is the continued commitment (assessment of obligations). There are factors that affect the
measurement of fair value of the obligations. Here, the entity preparing the financial reports must assume that the
obligation continues to exist after the hypothetical transfer. As the liability remains, the risk of non-performance of
the obligation continues, and this is known as the risk of non-performance. Usually, the default risk includes the
credit risk of the reporting entity. Other risks of non-performance must also be reflected in the fair value of the
obligation because it will affect the price that will be paid to transfer the obligation. In addition, the overall credit
position of the entity preparing the financial reports must be considered when measuring the fair value of an
obligation.
The Financial Accounting Standard Board (FASB) and the International Accounting Standards Board (IASB)
have been discussing whether fair value measurement should be extended to a more complete set of financial
instruments, or whether it should be valued using the current mixed attribute model (Fontes, Panaretou & Peasnell,
2018). Recently, there have been standards issued by the International Accounting Standards with regard to fair
value. Financial Reporting Standard No. 9 for financial instruments states that the standard aims to establish
principles for preparing financial reports for financial assets and liabilities so that they display their information
appropriately and are of value to users of financial statements. This standard came to replace IAS 39 as it divided
financial assets into two groups:
 Measuring financial assets at amortized cost by extinguishing the premium or discount and recognizing
profits or losses from the asset measured at amortized cost in the income statement.
 Measuring financial assets at fair value, but financial assets intended for hedging and investing in equity
instruments are excluded.
International Accounting Standard No. 13 is also one of the standards that measures fair value. This standard
adopts the fair value approach in measuring assets and liabilities instead of the historical cost approach. This
standard defines fair value as the amount received in exchange for selling an asset or money paid to transfer a
commitment between the seller and the buyer at the same time. The standard is based on methods for measuring
fair value (Penman, 2007).
 Market method: where the asset or liability in question is measured with appropriate prices and
information.
 Cost method: the amount that is paid to replace the original measurement, which is called the current
replacement cost.

1470
© 2020 AESS Publications. All Rights Reserved.
 Asian Economic and Financial Review, 2020, 10(12): 1466-1479

 Income method: this converts future cash flows into a single amount of money, which reflects the current
market expectations for future flows.
Finally, there is widespread debate around fair value accounting since it was first used in the framework of
generally accepted accounting principles (GAAP) in the United States, but it has become a hot topic in recent years.
With the release of SFAS 157 and SFAS 159, fair value accounting has become more prominent in financial
statements and has thus attracted more attention than before. In addition, in late 2007, the major markets collapsed
due to the credit crunch that arose in the mortgage markets, and when the markets collapsed in late 2007 and 2008
the value of the asset-backed securities, especially those associated with high-risk mortgages, decreased. As soon as
that happened, financial institutions had to reduce many of their assets, which caused the market value of those
institutions to decrease and this led to current discussions about fair value (Fornelli, 2009). The discussions on fair
value accounting focused on whether or not the practice should be maintained and included businesspeople from all
over the world, not just accountants. Since financial institutions, such as banks, credit unions and insurance
companies, were the hardest hit by the credit crunch and had to devalue many of their assets, they were at the
forefront of those who opposed fair value accounting. In addition, many of the companies that were initially opposed
to fair value accounting applied fair value measurements to all assets and liabilities because they required a large
number of estimates, which can lead to large fluctuations in the income statements. There was also widespread
support for fair value accounting from many financial analysts (Jensen, 2007).
In addition, the SEC has indicated that most investors and other users of financial statements support fair value
accounting because it gives an additional insight into the risks of a company and the potential liquidity issues that it
may face if it needs to sell securities. There are many people who are either for or against fair value accounting for
various reasons. Those who oppose fair value accounting have many arguments that point to weaknesses that have
arisen during the credit crisis, especially weaknesses related to third level entries in the fair value hierarchy defined
in Statement No. SFAS 157, when the credit crunch began in late 2007 (Ball & Shivakumar, 2005). The crisis
intensified during 2008 and 2009 and caused the collapse of many markets, which led to major problems for many
companies, and this collapse caused a decrease in the liquidity ratio in global markets. As a result of the credit
crunch and the lack of liquidity in the markets, this led many financial institutions to reduce more than $350 billion
of assets. The operations of reducing these assets have led to the emergence of losses in many of these institutions
in their financial statements and have also led the institutions to stop using fair value accounting (Moyer, 2008).
Pro-cyclicality is one of the weaknesses in fair value accounting. It is defined as an amplifier of the fluctuations
of regular periodic business, whether during booms or recessions, which creates prerequisites for increased
instability and weak financial systems. It is well known that fair value accounting leads to recognition of the gains
or losses that follow economic cycles, which can lead to cycles being overrated and can exacerbate periodic
movements in the values of assets and liabilities (Lefebvre, Simonova & Mihaela, 2009). In boom times, the fair
values of the assets increase allowing companies to record the values of those assets above their actual values and
maximize profits by recognizing the gains from those assets. These increases in profits and asset values allow
financial institutions to increase their leverage, which is the amount of borrowed money used by the company,
because the amount that the company can borrow often relates to the value of a company's assets. The problem with
increasing leverage is that the company may be unable to repay its debts. In addition to the increase in leverage,
increases in profits and asset values held by the company limit the incentives provided by the company to create
reserves that can be used in times of financial crisis (Gaio & Raposo, 2011).
On the other hand, during periods of recession, fair value accounting leads companies to reduce the value of
assets to new, reduced market values, and it can also reduce pressure on prices in already weak markets, which leads
to further falls in market prices. This occurs because financial institutions may attempt to write off their assets by
selling securities in illicit markets even though the securities would have been held until maturity. Holding them
until the maturity date means that the company plans to preserve the securities until the date the securities are paid

1471
© 2020 AESS Publications. All Rights Reserved.
 Asian Economic and Financial Review, 2020, 10(12): 1466-1479

by the issuing company and selling these securities will result in a lower exit price than if the companies had held
the securities as planned. These forced sales become observable inputs that other companies use to value their assets
at fair value. By using information from forced sales, other companies must reduce the value of their assets more
than they otherwise would in order to reverse the low exit price that will be received in the current market. In
addition, non-performing companies may want to wait to sell securities in this market until the market price
recovers from the decrease due to forced sales (Laux & Leuz, 2009).
In addition to normal market fluctuations, there are situations that may cause unrealized gains and losses to be
reversed if a company maintains assets or liabilities. This occurs when market prices are bubble prices, that is, they
are unrealistic. Bubble prices are prices that have been amplified by market optimism and excess liquidity, or
decreased by market pessimism and lack of liquidity, and do not reflect the underlying values of assets or liabilities
(Ryan, 2008).
The dependent variable, earnings quality, has been the subject of many empirical studies analyzing trends and
accounting trends on this topic over time and across countries. Most of this research evaluated the effects of
changes in accounting standards, auditing and corporate governance and studied their relationship to the cost of
capital. Experimental literature has also been developed for several measures of earnings quality, including earnings
continuity, predictive power, preliminary earnings, quality of receivables, appropriate value and discretion and
tightness. Despite the widespread use of these standards, the theoretical literature provides a limited view of
whether these measures have the same or different structures. Theoretical literature also provides limited guidance
on whether these methods are alternatives or complementary to each other. These issues are of fundamental
importance for the interpretation of empirical studies using earnings quality. For example, some studies used a
single measure or multiple measures of earnings quality or grouped several measures at certain points without a
theoretical direction, nor did they show how to interpret the results of these studies.
There is also controversy over whether an increase in measurement methods leads to an increase or decrease in
earnings quality. For example, many studies have used discretionary receivables as an alternative to earnings
management, which has been translated as reducing earnings quality; other studies say that estimated receivables
carry important information and should be positively related to earnings quality. Empirical studies acknowledge the
difficulties in using these metrics and translating the results, and some authors use the term "earnings
characteristics" rather than earnings quality, which is the most neutral term (Ewert & Wagenhofer, 2015).
A number of researchers, including Kazemi, Hemmati and Faridvand (2011) and Demrjian (2007), in the field of
accounting dealt with earnings quality and its concept with several meanings according to different users of the
financial statements and what they aimed to achieve from their use. Regarding what the earnings contain in terms
of quality properties, financial researchers believe that the inclusion of the earnings disclosed on extraordinary
items needs more attention regarding the quality that these earnings contain, even if they are in line with the
generally accepted accounting principles. Legislators and auditors believe that earnings of high quality should be
disclosed in a manner consistent with generally accepted accounting principles, but there are those who consider
them to be used in the event that they have a greater ability to be converted into cash flows (Demrjian, 2007).
Kazemi et al. (2011) defined earnings quality as continuous and expected earnings that are closer to cash and of
a higher quality. DeFond (2010) also stressed that earnings quality is the ability of current earnings that a company
has to provide as a true picture of the company’s current financial situation as possible and its ability to continue in
the future. According to data users, creditors believe that earnings are used to make credit decisions and
shareholders consider earnings to be used as a measure of the efficiency of the management.
Demrjian (2007) noted that the concept of earnings quality is related to the extent of earnings continuity.
Where the earnings quality is related to cash flows, the higher the quality of earnings, the greater the cash flow.
Jenkins (2006) expressed that earnings quality is the extent to which earnings are free from earnings management

1472
© 2020 AESS Publications. All Rights Reserved.
 Asian Economic and Financial Review, 2020, 10(12): 1466-1479

practices based on the concept of total receivables and the percentage of voluntary entitlements and that the
earnings quality is high whenever the practices of earnings management are fewer.
Among the first set of profit quality measures based on accounting are persistence and predictability.
Persistence represents the continuity of accounting earnings. It also represents how the current accounting
earnings relate to future earnings, and permanent earnings are described as high-quality earnings. Persistence
measures the extent to which current earnings are currently, or will be, repeated. It is generally estimated using the
regression coefficient due to the decline of current earnings on arrears or on components of arrears, for example,
cash flows and accruals. It is worth noting that continuity is positively related to the high quality of earnings
because it refers to the process of generating stable, sustainable and less volatile earnings; this is usually evaluated
by investors. Yao, Percy, Stewart and Hu (2018) predicted that fair value exposure can either increase or decrease
earnings persistence. Fair values summarize the present values of expected future cash flows and therefore should
be an indicator of future performance. Fiechter and Meyer (2010), Jaspar (2012) and Chen et al. (2013) noted that if
managers are able to use fair value accounting to smooth earnings, then cross-sectional earnings will be more
persistent.
Predictability refers to the idea that earnings are of higher quality and are more beneficial for predicting future
earnings. Similar to persistence, predictability is seen as a desirable feature of earnings because it increases the
accuracy of earnings expectations. A common statistical scale to measure the predictive power of accounting
earnings using a regression coefficient (R2: R-squared) is a statistical measure that represents the ratio of variance
to a dependent variable, which is explained by an independent variable or variables in the regression model. It is
worth noting that the predictive power of profits is affected by the time series of profits and the fluctuation of
business operations, the economic environment and the accounting systems used by companies. Given the interest
of analysts and users of financial statements in the accounting system that measure profits, we must control other
elements that affect the results of this analysis, and for this reason, we assumed that measures of the time series of
earnings quality (after controlling other factors) led to better results than the others measures (Perotti &
Wagenhofer, 2011). Earnings predictability is primarily driven by the assumption that cash flow forecasting is
useful as an input into equity valuation models (Dechow, Ge & Schrand, 2010). Also, one of the stated purposes of
financial reporting by the International Accounting Standards Board and the Financial Accounting Standards
Board is to provide useful information for assessing future financial performance that can be operated through
future cash flows. Therefore, profits can be considered more beneficial if we accurately forecast future cash flows.
Earnings from financial reports are the main profitability indicator as well as the main source of financial
information in the capital markets, i.e., earnings are a good indicator of future cash flows and provide more useful
information about a company's economic performance. Therefore, since the earnings include information of great
importance about the value of a company, they are used as a primary means of informing external users of the
financial and accounting aspects of a company (Schipper & Vincent, 2003).
The issue of earnings quality is of great importance to market participants and the financial reporting process.
Investors also pay close attention to earnings in order to better assess a company's value and performance and to
make the right investment decisions (Gaio & Raposo, 2011). Financial analysts also use earnings to prepare
forecasts on the future results of securities. It is worth noting that investors in corporations and companies' boards
of directors are concerned with earnings in order to estimate the quality of management and a company's general
performance. Standards also view the quality of financial reports as an indicator and an indirect comment in the
assessment of the quality of financial reporting standards (Schipper & Vincent, 2003). Shareholders also use
earnings as a direct basis for awarding bonuses and indirectly as reference points to stimulate the granting of
executive stock options to senior managers (Peasnell, Pope & Young, 2000).

1473
© 2020 AESS Publications. All Rights Reserved.
 Asian Economic and Financial Review, 2020, 10(12): 1466-1479

Table 1. The predictive power of fair value gains through other comprehensive income.
Bank Year CFO CI Bank Year CFO CI
(Comprehensive (Comprehensive
Income) Income)
Arab Bank 2018 1,370,303,000 880,221,000 Jordan 2018 58,178,243 38,360,573
PLC 2017 1,047,030,000 535,054,000 Kuwait 2017 58,033,579 28,718,600
2016 969,871,000 397,409,000 Bank 2016 63,276,025 31,319,644
2015 752,219,000 234,031,000 2015 77,446,056 37,297,542
2014 847,741,000 390,185,000 2014 108,956,779 67,167,227
2013 764,818,000 326,255,000 2013 116,481,781 71,205,307
2012 417,436,000 153,127,000 2012 114,804,148 66,839,628
2011 443,528,000 111,639,000 2011 107,811,900 55,626,451
Jordan 2018 70,601,066 21,701,134 Jordan 2018 34,226,832 17,495,384
Bank 2017 67,583,363 62,720,116 Ahli Bank 2017 31,965,213 12,270,857
2016 68,004,742 76,511,280 PLC 2016 32,212,367 6,646,618
2015 66,037,368 59,355,385 2015 34,793,605 22,195,965
2014 69,396,739 41,635,466 2014 34,793,605 34,437,490
2013 63,950,205 48,096,843 2013 34,793,605 15,957,073
2012 64,384,923 36,733,677 2012 49,100,436 23,415,419
2011 64,096,020 31,648,717 2011 49,263,325 24,709,158
Cairo 2018 50,963,957 28,929,117 The 2018 194,694,406 83,715,119
Amman 2017 45,687,750 31,363,033 Housing 2017 180,883,084 132,826,087
Bank 2016 53,137,037 34,722,082 Bank for 2016 203,211,403 102,190,869
2015 63,043,843 32,240,991 Trade & 2015 197,196,317 86,484,538
2014 67,952,581 44,809,341 Finance 2014 200,164,974 97,018,065
2013 65,533,574 39,940,890 2013 224,860,734 72,639,387
2012 53,725,782 34,666,404 2012 207,017,392 64,067,288
2011 52,631,668 34,508,432 2011 182,049,276 90,884,655
Capital 2018 38,200,000 37,400,000 Arab 2018 25,821,095 15,257,757
Bank of 2017 55,500,000 31,400,000 Jordan 2017 27,582,424 18,539,334
Jordan 2016 35,800,000 27,100,000 Investment 2016 35,542,951 18,641,927
2015 19,900,000 11,100,000 Bank 2015 38,224,649 22,554,797
2014 57,800,000 50,100,000 2014 35,315,296 23,639,300
2013 49,600,000 48,700,000 2013 23,526,019 17,594,544
2012 57,600,000 29,700,000 2012 26,582,224 14,557,257
2011 17,800,000 2000,000 2011 33,542,751 16,739,134
Jordan 2018 11,730,407 4,475,414 Societe 2018 14,284,493 7,651,208
Commercial 2017 14,979,159 3,725,808 Generale 2017 10,861,355 8,276,791
Bank 2016 18,176,686 11,978,279 Jordan 2016 15,911,006 10,853,785
2015 36,442,238 24,114,060 2015 14,070,051 10,069,226
2014 19,052,187 13,840,892 2014 11,981,417 9,204,742
2013 14,514,726 4,149,256 2013 10,231,257 7,001,701
2012 3,263,158 3,036,278 2012 5,680,113 4,738,310
2011 -935,283 -992,003 2011 4,382,691 3,242,354

3. METHOD
The primary data needed to achieve the study objectives were collected through the annual reports of
Jordanian commercial banks. The study population was formulated from 13 commercial banks. Data from ten
commercial banks representing the study sample were collected and analyzed using a time series method from 2011
to 2018. The effect of unrealized fair value gains (losses) through other comprehensive income was separately
examined in each sub-model. Also, the relationship between unrealized fair value gains (losses) was tested through
net income from the sampled banks.
We applied the following regression model to examine the predictive power of comprehensive income and thus
the predictive power of fair value gains through other comprehensive income:

(1)

1474
© 2020 AESS Publications. All Rights Reserved.
 Asian Economic and Financial Review, 2020, 10(12): 1466-1479

where,
CFOi,t is defined as the net income before tax plus loan loss provisions for bank i in year t scaled by total assets.
CIi,t-1 is the comprehensive income for bank i in year t- 1 scaled by total assets.
When analyzing the predictive ability of net income and predictive ability of fair value gains and losses through
net income for banks, we applied following model:

(2)
where,
CFOi,t is defined as the net income before tax plus loan loss provisions for bank i in year t scaled by total assets.
NIi,t-1 is the net income for bank i in year t-1 scaled by total assets.

Table 2. The predictive power of fair value gains through net income.
Bank Year CFO NI (Net Bank Year CFO NI (Net
Income) Income)
Arab Bank PLC 2018 1,370,303,000 820,544,000 Jordan 2018 58,178,243 42,143,508
2017 1,047,030,000 532,963,000 Kuwait 2017 58,033,579 26,955,793
2016 969,871,000 532,666,000 Bank 2016 63,276,025 30,005,810
2015 752,219,000 442,123,000 2015 77,446,056 39,411,676
2014 847,741,000 577,153,000 2014 108,956,779 65,954,437
2013 764,818,000 326,255,000 2013 116,481,781 66,879,880
2012 417,436,000 263,001,000 2012 114,804,148 65,737,527
2011 443,528,000 145,085,000 2011 107,811,900 55,989,712
Jordan Bank 2018 70,601,066 41,244,423 Jordan 2018 34,226,832 21,277,280
2017 67,583,363 45,609,461 Ahli Bank 2017 31,965,213 13,318,885
2016 68,004,742 42,202,024 PLC 2016 32,212,367 6,274,933
2015 66,037,368 40,062,793 2015 34,793,605 22,823,724
2014 69,396,739 44,824,589 2014 34,793,605 34,160,812
2013 63,950,205 36,393,178 2013 34,793,605 16,003,889
2012 64,384,923 33,189,566 2012 49,100,436 23,895,696
2011 64,096,020 36,570,701 2011 49,263,325 23,241,924
Cairo Amman 2018 50,963,957 29,706,735 The 2018 194,694,406 94,526,738
Bank 2017 45,687,750 29,967,780 Housing 2017 180,883,084 125,204,267
2016 53,137,037 34,733,879 Bank for 2016 203,211,403 131,012,613
2015 63,043,843 41,168,254 Trade & 2015 197,196,317 124,728,034
2014 67,952,581 44,533,367 Finance 2014 200,164,974 123,917,229
2013 65,533,574 40,795,896 2013 224,860,734 106,926,629
2012 53,725,782 35,286,174 2012 207,017,392 104,488,612
2011 52,631,668 36,596,414 2011 182,049,276 100,002,298
Capital Bank of 2018 38,200,000 30,300,000 Arab 2018 25,821,095 16,816,327
Jordan 2017 55,500,000 27,300,000 Jordan 2017 27,582,424 17,174,949
2016 35,800,000 16,100,000 Investment 2016 35,542,951 22,638,300
2015 19,900,000 1,100,000 Bank 2015 38,224,649 23,185,030
2014 57,800,000 36,300,000 2014 35,315,296 24,363,372
2013 49,600,000 37,000,000 2013 23,526,019 16,662,117
2012 57,600,000 22,000,000 2012 26,582,224 16,274,749
2011 17,800,000 1,400,000 2011 33,542,751 20,238,302
Jordan 2018 11,730,407 5,029,366 Societe 2018 14,284,493 8,284,945
Commercial 2017 14,979,159 3,788,813 Generale 2017 10,861,355 7,810,209
Bank 2016 18,176,686 9,325,406 Jordan 2016 15,911,006 10,908,035
2015 36,442,238 15,756,877 2015 14,070,051 10,009,226
2014 19,052,187 10,002,131 2014 11,981,417 9,200,992
2013 14,514,726 3,199,256 2013 10,231,257 7,001,620
2012 3,263,158 2,062,878 2012 5,680,113 4,734,560
2011 -935,283 -1,329,749 2011 4,382,691 3,259,854

1475
© 2020 AESS Publications. All Rights Reserved.
 Asian Economic and Financial Review, 2020, 10(12): 1466-1479

Previous research by Sodan (2015), Francis, LaFond, Olsson and Schipper (2004) and Gaio (2010), earnings
predictability measurement is based on the variance of earnings shocks, where higher variance implies lower
predictability. Thus, predictive ability is measured as a standard deviation of estimated errors from Equations 1 or
2. Large values of standard deviations correspond to less predictable earnings, and vice versa.
Table 1 and Table 2 include the components of formula (1), the predictive power of comprehensive income, and
formula (2), the predictive power of net income.

3.1. Research Design

Figure 1. Research design.

Source: Sodan (2015).

Figure 1 illustrates the research design, which examines the impact of fair value accounting on earnings
predictability as a measure of earnings quality. It is formed from the dependent variable’s fair value accounting
through gains and losses from comprehensive and net incomes.

3.2. Research Hypotheses

H01: Fair value accounting through other comprehensive income is positively related to earnings predictability.
H02: Fair value accounting through net income is positively related to earnings predictability.

3.3. Empirical Results

Table 3. Empirical results.

The predictive power of fair value gains through comprehensive income
Standard error deviation 0.06
Correlation 0.963
R square 0.927
No. of observations 80
The predictive power of fair value gains through net income
Standard error deviation 0.032
Correlation 0.987
R square 0.975
No. of observations 80

1476
© 2020 AESS Publications. All Rights Reserved.
 Asian Economic and Financial Review, 2020, 10(12): 1466-1479

A descriptive analysis was conducted to find out the standard error deviation for the first formula—the
predictive power of fair value gains through comprehensive income. The results show that the standard error
deviation of the predictive power of fair value gains through comprehensive income is 0.06, or 6%, which indicates a
high reliance on comprehensive income or high predictable earnings of fair value through comprehensive income.
The results also show that the standard error deviation of the predictive power of fair value gains through net
income is 0.032, or 3.2%, which refers to high predictable earnings of fair value through net income, or a high
reliance on net income.
To test the first hypothesis, regression and correlation analyses were conducted for the variables included in
formula (1), CFO and comprehensive income. The results shows that regression between the two variables is 92.7%,
which refers to a high percentage of variance between the dependent variable (fair value accounting) and the
independent variable (earnings predictability) through comprehensive income, in other words, there is a strong
relationship between the two variables. The correlation coefficient was also conducted in order to measure the
statistical relationship or the magnitude between the two variables. The results of the correlation show that there is
a strong magnitude between the two variables reaching 96.3%. In other words, we can say that the dependent
variable can predict 96.3% of the value of the independent variable.
To test the second hypothesis, regression and correlation analyses were also conducted for the variables
included in formula (2), CFO and net income. The results show that regression between the two variables is 97.5%,
which refers to a high percentage of variance between the dependent variable (fair value accounting) and the
independent variable (earnings predictability) through net income. The results of the correlation show that there is
a strong magnitude between the two variables reaching 98.7%. In other words, we can say that the dependent
variable can predict 98.7% of the value of the independent variable.

4. CONCLUSIONS & RECOMMENDATIONS

The main results from the preliminary research conducted are in favor of our hypotheses, which generally
supports our expectations. The results show that the unrealized gains or loss of fair value forecasted through
comprehensive income has a high predictive power of earnings quality. Also, the results prove that the unrealized
gains or loss of fair value forecasted through net income has also a high predictive power of earnings quality in the
Jordanian commercial banks.
The results of the regression analysis show a high percentage of variance between the dependent variable (fair
value accounting) and independent variable (earnings predictability) through comprehensive income, and the
correlation coefficient also refers to a strong magnitude between the two variables.
Based on previous results, we recommend that further research is carried out on earnings quality measures
collectively (persistence, accruals, smoothness and earnings predictability) in order to have aggregate results
between fair value accounting and earnings quality.

Funding: This study received no specific financial support.

Competing Interests: The authors declare that they have no competing interests.
Acknowledgement: All authors contributed equally to the conception and design of the study.

REFERENCES
Ball, R., & Shivakumar, L. (2005). Earnings quality in UK private firms: Comparative loss recognition timeliness. Journal of
Accounting and Economics, 39(1), 83-128.Available at: https://doi.org/10.1016/j.jacceco.2004.04.001.
Barth, M. E. (1994). Fair value accounting: Evidence from investment securities and the market valuation of banks. Accounting
Review, 69(1), 1-25.

1477
© 2020 AESS Publications. All Rights Reserved.
 Asian Economic and Financial Review, 2020, 10(12): 1466-1479

Barth., M. E., Beaver, W. H., & Landsman, W. R. (2001). The relevance of the value relevance literature for financial accounting
standard setting: another view. Journal of Accounting and Economics, 31(1-3), 77-104.Available at:
https://doi.org/10.1016/s0165-4101(01)00019-2.
Bowers, K. A. (2011). Fair value accounting debate and the future of the profession. Honors Program Theses. 7. Retrieved from:
https://scholarworks.uni.edu/hpt/7.
Chen, C., Lo, K., Tsang, D., & Zhang, J. (2013). Earnings management, firm location, and financial reporting choice: An analysis of fair
value reporting for investment properties in an emerging market: Working Paper, The University of British Columbia.
Dechow, P., Ge, W., & Schrand, C. (2010). Understanding earnings quality: A review of the proxies, their determinants and their
consequences. Journal of Accounting and Economics, 50(2-3), 344-401.Available at:
https://doi.org/10.1016/j.jacceco.2010.09.001.
DeFond, M. L. (2010). Earnings quality research: Advances, challenges and future research. Journal of Accounting and Economics,
50(2-3), 402-409.Available at: https://doi.org/10.1016/j.jacceco.2010.10.004.
Demrjian, S. (2007). Accounting conservatism and auditing quality: An applied study on Egyptian corporations. European
Journal of Business and Management, 4(21), 108-116.
Ewert, R., & Wagenhofer, A. (2015). Economic relations among earnings quality measures. Abacus, 51(3), 311-355.Available at:
https://doi.org/10.1111/abac.12054.
FASB. (2018). Fair value measurements (topic 820). Disclosure Framework—Changes to the Disclosure Requirements for Fair
Value Measurement, Retrieved from: https://asc.fasb.org/ [Accessed Jan 20th 2020].
Fiechter, P., & Meyer, C. (2010). Big bath accounting using fair value measurement discretion during the financial crisis.
Working Paper: University of Zurich.
Fontes, J. C., Panaretou, A., & Peasnell, K. V. (2018). The impact of fair value measurement for bank assets on information
asymmetry and the moderating effect of own credit risk gains and losses. The Accounting Review, 93(6), 127-
147.Available at: https://doi.org/10.2308/accr-52070.
Fornelli, C. (2009). The great fair-value debate. Forbes. Retrieved from: http://www.forbes.com. [ Accessed Jan 19th 2020].
Francis, J., LaFond, R., Olsson, P. M., & Schipper, K. (2004). Costs of equity and earnings attributes. The Accounting Review,
79(4), 967-1010.Available at: https://doi.org/10.2308/accr.2004.79.4.967.
Gaio, C. (2010). The relative importance of firm and country characteristics for earnings quality around the world. European
Accounting Review, 19(4), 693-738.Available at: https://doi.org/10.1080/09638180903384643.
Gaio, C., & Raposo, C. (2011). Earnings quality and firm valuation: International evidence. Accounting & Finance, 51(2), 467-
499.Available at: https://doi.org/10.1111/j.1467-629x.2010.00362.x.
IFRS. (2015). International financial reporting standards’ Annual report, statement of financial position. Retrieved from:
https://asc.fasb.org/ [Accessed Jan 20th 2020].
Jaspar, R. (2012). Incentives for earnings management with fair value in the 2008 financial crisis. Working Paper, Master thesis
Department Accountancy, Faculty of Economics and Business Studies, Tilburg University.
Jenkins, W. (2006). Accounting conservatism and firm value: evidence from the global financial crisis. MIT Sloan Research
Paper No 4946-11.
Jensen, R. E. (2007). Fair value accounting in the USA. Retrieved from http://citeseerx.ist.psu.edu. [Accessed Jan 20th 2020].
Kazemi, H., Hemmati, H., & Faridvand, R. (2011). Investigating the relationship between conservatism and earnings attribute.
World Applied Science Journal, 12(9), 1385-1396.
Laux, C., & Leuz, C. (2009). The crisis of fair value accounting: Making sense of the recent debate. Booth School of Business, The
University of Chicago, Chicago, IL, Working Paper No. 33.
Lefebvre, R., Simonova, E., & Mihaela, S. (2009). Fair value accounting: The road to be most travelled. Retrieved from
http://www.cga-canada.org. [Accessed 20th Jan 2020].
McDonough, R. P., & Shakespeare, C. M. (2015). Fair value measurement capabilities, disclosure, and the perceived reliability of
fair value estimates: A discussion of Bhat and Ryan (2015). Accounting, Organizations and Society, 46(C), 96-99.

1478
© 2020 AESS Publications. All Rights Reserved.
 Asian Economic and Financial Review, 2020, 10(12): 1466-1479

Moyer, L. (2008). How fair is fair value accounting? Forbes. Retrieved from http://www.forbes.com. [Accessed Jan 28th 2020].
Muller, K. A., Riedl, E. J., & Sellhorn, T. (2008). Consequences of voluntary and mandatory fair value accounting: Evidence
surrounding IFRS adoption in the EU real estate industry. Boston, MA: Harvard Business School.
Nellessen, T., & Zuelch, H. (2011). The reliability of investment property fair values under IFRS. Journal of Property Investment &
Finance, 29(1), 59-73.Available at: https://doi.org/10.1108/14635781111100209.
Peasnell, K. V., Pope, P., & Young, S. (2000). Accrual management to meet earnings targets: UK evidence pre-and post-Cadbury.
The British Accounting Review, 32(4), 415-445.Available at: https://doi.org/10.1006/bare.2000.0134.
Penman, S. H. (2007). Financial reporting quality: Is fair value a plus or a minus? Accounting and Business Research, 37(sup1), 33-
44.Available at: https://doi.org/10.1080/00014788.2007.9730083.
Perotti, P., & Wagenhofer, A. (2011). Earnings quality measures and excess returns. Journal of Business Finance & Accounting,
41(5), 545–571.Available at: 10.1111/jbfa.12071.
Ryan, S. (2008). Fair value accounting: Understanding issues raised by the credit crunch. Retrieved from http://www.uic.edu.
[Accessed Jan 22th 2020].
Schipper, K., & Vincent, L. (2003). Earnings quality. Accounting Horizons, 17(sup1), 97-110.
Sing, T. Y., & Meng, S. C. (2005). Fair value accounting–relevance, reliability and progress in Malaysia. University College
Sedeya International. Working Paper: 1 – 16.
Sodan, S. (2015). The impact of fair value accounting on earnings quality in eastern European countries. Procedia Economics and
Finance, 32, 1769-1786.Available at: https://doi.org/10.1016/s2212-5671(15)01481-1.
Thomason, K. (2017). The disadvantages of fair value accounting. Retrieved from https://bizfluent.com. [Accessed 20th Jan
2020].
Wahyuni, E. T., Soepriyanto, G., Avianti, I., & Naulibasa, W. P. (2019). Why companies choose the cost model over fair value for
investment property? Exploratory study on Indonesian listed companies. International Journal of Business and Society,
20(1), 161-176.
Yao, D., Percy, M., Stewart, J., & Hu, F. (2018). Fair value accounting and earnings persistence: Evidence from international
banks. Journal of International Accounting Research, 17(1), 47-68.Available at: https://doi.org/10.2308/jiar-51983.

Views and opinions expressed in this article are the views and opinions of the author(s), Asian Economic and Financial Review shall not be responsible or
answerable for any loss, damage or liability etc. caused in relation to/arising out of the use of the content.

1479
© 2020 AESS Publications. All Rights Reserved.