firm size, leverage and profitability overriding impact of accounting information system

FIRM SIZE, LEVERAGE AND PROFITABILITY: OVERRIDING IMPACT OF ACCOUNTING INFORMATION SYSTEM

Dr. Rehana Kouser Lecturer, Department of Commerce

Bahauddin Zakariya University, Multan-PakistanTel: +92-333-6102638

Email: [email protected]

Adil AwanMS Scholar, Faculty of Management Sciences

SZABIST, Islamabad-PakistanTel: +92-300-6381155


Gul-e-RanaLecturer, Department of Management SciencesYanbu University College, Yanbu-Saudi Arabia

Tel:+966-553928002 Email: [email protected]

Farasat Ali ShahzadLecturer, Department of Commerce

Bahauddin Zakariya University, Multan-PakistanTel: +92-321-6346138


AbstractInformation systems are mainly used by many organizations to improve efficiency of business activities by automating existing operations. Past researches in show that by adopting information systems we can increase firm performance. Results discovered that by adopting accounting information system there is significant improvement in performance. Accounting information system (AIS) is a superior system that focuses on user-orientation. Core objective of AIS is to collect and record data and information that is concerned to events that can economically impact upon firms. It processes information and communicate this useful information to internal and external stakeholders. This study intends to find the effects of Accounting Information system (AIS) on profitability of Pakistani firms. It investigates whether there is any difference between adopters and non adopters of accounting system. The sample data have been taken from sixty six of public listed companies on Karachi Stock Exchange (KSE) by purposive sampling dated from 2005 to 2009 period. Study used the four variables. Independent variable is ROA which measures profitability. Two independent variables are Leverage and Firm Size. Leverage is quantified using debt ratio and firm size is measured by taking natural logarithm of total assets. These independent variables are taken on the basis of high availability as determinants of profitability. Study intends to check the overriding role of accounting system on this relation, so AS acts as intervening variable in the study.

Keywords: Accounting Information System, AIS, Leverage, Firm Size, Profitability, Pakistan

JEL Codes: M19, M41, M43, M49

mailto:[email protected]




1. IntroductionDevelopments in information technology has lead to new accounting systems, new economic models and businesses through internet .In addition these developments have decreased time, cost and money by facilitating increased transactions and communication for businesses. Ways of doing businesses is changed to due to emergence of technology developments. Prior manual accounting methods have been converted to modern accounting information system such as ERP system. Now changed have been made to information system processes like recording, classifying, reporting and analysis of data. Accounting is known as language of business, changes are also made in it due to information technology (IT) like way of book keeping, preparation statements for both financial and tax purposes and also towards auditing.Hall, (2008) defined information system as, It is the set of formal procedures by which data are collected, processed into information, and distributed to users. Rashid, Hossain, and Patrick (2001) said that in 1950’s; development of computer technology had made it possible for organizations to process more information and increased capacity to store information. Computers were capable of analyzing massive amount of data which increased the use of information and also producing accurate and timely reports. Ismail, Abdullah and Tayib (2003) argued that many processes of organization are affected by revolution in computer industry, specifically these processes and procedures relates to accounting. Rashid, Hossain and Patrick (2001) inferred that in 1960s many organizations started using Inventory Control Package. This system not only integrates but also automates their inventory control system. By using this system, many companies increased their productions and turnovers. This increased activities and transaction which require large amount of data to be recorded and updated at same time. Traditional manual accounting method cannot record this data and also update it as per requirements of business. It was in-efficient for businesses to use manual methods because they create many errors. Errors like entering wrong data, useless processes of entering data at two places in same organization and huge amount of paper usage due to small recording mistakes. These errors badly affect performance of most organizations. Due to these flaws in manual system, a new system emerged ‘‘Accounting Information System’’ (AIS). This system mostly removed deficiencies of Manual accounting. This system can easily gather information. More efficiently it can analyze and produce reports for stakeholders. In 1970’s, Material Requirement Planning (MRP) was introduced. They offer systematic scheduling for production processes. On the production requirements of finished goods, raw materials are purchased and operations are planned accordingly. In 1980’s, Manufacturing Requirements Planning (MRP II) were initiated. These programs were used for establishing co-ordination between manufacturing processes from raw material purchasing to distribution of product. In 1990s, Enterprise Resource Planning (ERP) software was being used by companies. They were mainly used for material planning, order entry, distribution, general ledger, accounting and shop floor control. In 2000, Extending ERP was used for scheduling, forecasting, capacity planning, e-commerce, warehousing and logistics. After 2005, ERP II is being used for project management, knowledge management, workflow management, customer relationship management, human resource management, portal capability and integrated financials. Earlier versions of ERP were mainly for internal processes but later versions are for both internal and external processes.Like other developing countries, adoption and diffusion of technology has faced the same problems in Pakistan. It depended mostly on the developed countries because technologies mostly transferred from them. In 1947, when Pakistan came into being, there was no IT infrastructure incountry. Work was mainly done by manual typewriters. At that time there was not a single electric typewriter. Only technology was used by Post telegram and telephone department (PT&T) established byGreat Britain was functioning in Pakistan. At that time telephone and telex were the only fastest communication medium.In 1957, ‘Packages Ltd’ became first company to use computer for work in Pakistan and this was considered as first step of using IT in Pakistan. In 1960, PIA installed IBM main frame computer for flight reservation and by 1967, there were about seventeen mainframes working throughout Pakistan in different organizations (Aslam, 2001).Although the ‘emergence’ of IT in Pakistan started in 1960’s but

its mass level diffusion has started in the last few years. Government has focused its attention on development of IT infrastructure in the country on all levels. The government also encouraging and promoting the manufacturing sector to use IT at all levels. Revolution in IT has open many ways of opportunities for the Pakistani companies. Packages Ltd. is considered first company to started using IT in Pakistan. Subsequently many companies followed them. At the present time, it is very common to use IT for doing business. A large amount of companies are using standardized ERP software of vendors like SAP and Oracle. Almost all sectors of economy are using these packages (List is attached in appendix of users of ERP).

2. Literature ReviewKharuddin et al. (2010) concluded that normally the major purpose of any organization either manufacturing or service business is to increase its profit through maximizing its business efficiency or increase its dominance in market. In order to achieve its objective the businesses require to rapidly responding to the environmental fluctuations, mainly to revolution in information technology.Hunton, (2002) quoted that information technology has become essential in all most all the business sectors these days. Especially in current environment no company can get any competitive advantage without adopting Information technology in its business. Even the survivals of the companies become difficult without IT. It has drastically changed the nature of business and accounting practice. Granlund and Mouritsen (2003) said “The preliminary interest between relationships of accounting and information technology was initially taken for granted; without information technology help accounting was not possible, and IT serves as platform for accounting data”.Wilkinson et al., (2000) said ‘‘Accounting Information System (AIS) is essential for the organizations; both profit and non profit-oriented had to adopt for their operations. To better understand the term AIS we need to understand all these three words. Accounting is called the “language of business”. It provides us all kind of financial informations which are necessary to take business decisions. Secondly information is the base of all types of decisions in the business and these decisions provide guide lines for all actions. Lastly, system is an integrated entity which focuses on the objectives of the entities. Bhatt (2001) said AIS shows integration within an entity. It engage firm’s physical assets like materials, Plant, Equipment, office supplies and all financial resource and human resources and use them to convert economic data in useable financial informations. And all these informations are used to manage and conduct of business operations and different market activities. AIS also become the source of providing fast and updated useful information to firm’s stakeholders. Definitely, when a company combines its human capital, IT, latest business and market techniques, it can easily achieve its targets. And this can also allow the company to manage its skill and knowledge successfully. Dehning and Richardson (2002) studies develop five different dimensions in their analyses and the first three are very much popular. The very first path which he explained is the relationship between information technology and firm’s performance and this is most dominant as well. Another is relation between IT and business process (BP) which is not measured so often. It means that IT helps companies to improve different business process measures like gross margin, its profit margin, turnover ratios, inventory turnover ratios, customer services, product quality, efficiency and effectiveness. He further explains in third path that how the overall firm performance is determined when these processed measures combines. Different available studies on this subject did not clearly mention in quantitative terms about the performance effects of information system (IS). Infect the impact of AIS can’t be easily determined with the study of short span of time. Most of the literatures mention the negative impressions in the implementation phase of ERP and AIS systems within one or two years after the system like shakedown, shakeout and brake-in phase. But similarly most of the studies show positive results when they studies after two, three or more years of its continuation like onward and upward phase (Liu et al. 2008). A

number of studies also report that no significant differences between ERP-adopters and non-adopters in terms of profitability or financial performance (Poston and Grabski 2001). In contrast, enormous studies discovered a great positive result ofter ERP adoption on order lead time (Cotteleer and Bendoly 2006) and on profitability (Hendricks et al. 2007), on return on assets, return on investment and asset turnover (Hunton et al. 2003) or on information response time and order cycle (Mabert et al. 2000)’’It’s very easy to determine the direct effect of IS on firms performance. It can be observed and perceived when it help the existing procedures & processes, daily routine work, implementation of work policies, availability of firms products and services which ultimately make the firm more efficient and effective without any modification and implementation of drastically new ways of doing the things done. It neither change existing ways of coordinating things nor introduce any new product or service. As Davenport (2000) emphasis in his study that ERP infect decreases the firms administrative as well operating cost. Its reality that the manual work takes much time to perform ERP eliminate the manual system which is most of the time show redundant and repetitive work tasks of the firm like data entry and reporting. It is very much obvious that due to this, firms are in a position to cut their variable cost and this benefit goes to the consumer in the form of lower prices which leads towards the increase in sales as well if demand is price-elastic. Different other relative factors also show very important part in regulating the energetic relation between IS adoption and firm performance. But on the other side it is also a fact that most of the internal benefits which we get in post adoption period of AIS can be ineffective as far as price-cutting, growth and promotions if same are adopted by our competitors in the market who have gained this efficiencies by adopting similar system’’Melville et al., (2004) ‘‘Existing studies have confined mostly to relation between IT investment and company performance especially in researches that focuses to measure the level of IT investment and company productivity or like financial return on IT investments’’. Melville et al., (2004) ‘‘mixed findings have been reported of empirical studies examining the relationship between IT and performance. As these contradictory results, tell us that there is no direct relationship between IT investments and firm performance consequently, the relationship between IT and firm performance seems to be more complex than previously theorized’’.3. Research DesignThis section is comprised of variables, samples of study, methodology. This chapter is to review and make an understanding regarding different methodology and its research approaches and research design. For application of my research study, I have used selected research approach and design as per the requirement to conduct the study the effects of ERP on its firm’s performance in the context of Pakistan. For investigating the outcome of ERP adoption on firm’s performance in the Pakistan that require first to know that does the ERP adoption have significant impact on its performance of firm’s & secondly does the firm’s able to sustain and improve its performance after the post-adoption.3.1. Variables of StudyStudy has four variables; two independent, one dependent variable, and one intervening variable. Independent variables are firm size and Leverage. Firm size is measured by the log natural of total

assets. Debt ratio is used as the proxy for Leverage. The dependent variable is Return on Asset (ROA), a proxy used for Profitability. AS (Accounting System) is intervening variable. It is the proxy for Accounting Information System

[Enterprise Recourse Planning System (ERP)]. This is a categorical variable marked 1 in case of AS presence and 0 in case of AS absence.

3.2. HypothesesResearch study tested following hypothesis:H1: There is a positive relationship between the AS and Firm’s Profitability.H2: Firms with AS have strong relationship between Debt and Profitability than Firms without AS.H3: Firms with AS have strong relationship between Firm size and Profitability than Firms without AS.3.3. Data Collection

In this research, secondary data contains company’s annual reports, company records for adoption status and other published reports. Secondary data obtained in this way is compiled and mostly used in literature review. I also used financial reports because we need variables data from them. Mainly State Bank of Pakistan Balance sheet analysis is used from year (1999-2009).Also in case of missing data in it; annual reports of companies are used.3.4. SamplingDue to survey based research design, we used the questionnaire to collect the primary data. At first questionnaires were mailed to the selected sample companies, personal visits were also performed to collect the data.There was much reluctance in providing the data.We used convenience sampling due to reluctant behavior of companies giving information about adoption of accounting system. Sixty six companies are included in our Analysis. We sent the questionnaires to twenty percent of the whole non financial listed companies in the KSE. Following table represent the statistics about the companies for research study.

Table-1: Sampling Process

Year Total Number of Non-Financial Companies Listed at KSE

1999 530

2000 520

2001 506

2002 481

2003 463

2004 451

2005 443

2006 436

2007 437

2008 437

2009 414

2010 502

Average 468

Questionnaires mailed to 94

Response Rate 72%

Included in Analysis 66

3.5. Econometric ModelsThis study hypothesize that the explanatory variables have a linear relationship with the firm performance. Linear relationship for one dependent and one independent variable is expressed normally as:Y it = α0+ β1 X it +ϵit………… (1)For i = 1, 2 …N, which means cross sectional units.t = 1, 2 …T, are the time periods.Complete research model can be expressed as follows:ROA it = β0 + β1 AS it+ β2 LNTA it + β3 DR it + ε it………… (2)ROA it = β0 + β2 LNTA it + β3 DR it + ε it………… (3)

WhereROA it = Return on assets of firms, AS it= dummy for accounting system, LNTA it = natural log of total asset as a proxy for firm size, DR it = debt ratio as a proxy for financial leverage, ε it the disturbance, and β0 is intercept. The indices i and t denote firm and time respectively.Third equation is showing the relationship of firm size and debt size with return on assets.4. Data Analyses and Empirical FindingsAs per econometric models described and explained in earlier sections, data is analyzed using different statistical packages which include Microsoft Excel 2007, SPSS and Gretl. Regression analysis is conductedof different types. At first step cross sectional OLS for all firm years based on equation 2 is calculated.Above panel is showing the strong relationship between the proposed variables of study. All the independent variables are significant (showing p-value of less than 0.05) in the study. Coefficients are also of good mathematical significance supporting our study that AS has the β of 3.133, which means a strong mathematical relation to the ROA.In next step we segregated the firm year data on the basis of AS presence and Absence.The variable of AS has eliminated from data. We computed OLS regression again for these segregated groups of data as per equation 3. Below panel 2, and 3 are showing the regression results for firm years with AS present, and regression results for firm years with absent AS respectively.We found that coefficient of determination R-Squared(32.7% and 10.2%), and goodness of fit for model adjusted R-Squared(32.1% and 8.5%) are higher in AS presence case.We can see that debt has no statistical significance (p-value of 0.293 which is greater than 0.05) in later case. Firm size too, has more effect (β of 1.306) in AS presence case.

Panel-1: Overall Firm Years OLS Analysis

Multiple R 0.501

R2 0.251

Adj. R2 0.245

Standard Error 12.021

βStandard

Error t-stat p-value

AS 3.133 1.418 2.210 0.028

DR -0.018 0.005 -3.814 0.000

Ln.TA 1.773 0.222 7.995 0.000

Panel-2: OLS Analysis for AS Present Firm Years

Multiple R 0.572

R2 0.327

Adj. R2 0.321


βStandard


DR -0.023 0.006 -4.097 0.000

Ln.TA 1.970 0.262 7.519 0.000

Panel-3: OLS Analysis for AS Absent Firm Years

Multiple R 0.319

R2 0.102

Adj. R2 0.085


βStandard


DR -0.008 0.008 -1.057 0.293

Ln.TA 1.306 0.406 3.221 0.002

5. ConclusionFrom empirical findings we know that performance of firm years have different performance for AS present and AS absent cases. Similarly it is shown by regression analysis that AS has significant influence on the profitability. However firms not having ERP system can enjoy more returns for their leverage and high amounts invested by assets by boosting their decision making process efficient through an appropriate ERP system. Companies should use ERP systems because they have many benefits and they are becoming necessities for business organization worldwide. Government should take a leading role to initiate ERP training academies so that trained ERP user could be produced who can use the system effectively. There are some training institutes but there are giving expensive training. Awareness should be given to both public and private sectors to use these systems.For future work we recommend:

ERP adoption can be studied in Government institutions, SME’s, financial sector. Study can also be done on finding Critical success factors of ERP adoption in Pakistan. A study can also be conducted what are the factors behind ERP failures in Pakistan. A study can also be conducted to see how companies select ERP systems like whether they use

outsourcing or in-house development and what are factors behind their selection. We can also conduct study on factors behind ERP implementation and its usage.

ReferencesAslam, S. M. (2001). Information Technology: Moving in the right direction, Pakistan & Gulf Economist, XX (31), 12-14.

Bhatt, G. D. (2001). Knowledge management in organizations: examining the interaction between technologies, techniques, and people. Journal of Knowledge Management, 5(1), 68-75.

Cotteleer, M. J., & Bendoly. E. (2006). Order lead-time improvement following enterprise information technology implementation: An empirical study. Management Information Systems, 30 (3), 643.

Dehning, B., Richardson, V. J., & Zmud, R. W. (2007). The financial performance effects of IT-based supply chain management systems in manufacturing firms, Journal of Operations Management (25), 806–824.

Granlund M. & Mouritsen J. (2003). Introduction: Problem arising the relationship between management control and information technology. European Accounting Review, 2 (1):77-83.

Hall, J. A. (2008). Accounting Information Systems (6th Ed.) South-Western College Pub.

Hunton, J. E. (2002). Blending Information and Communication Technology with Accounting Research. Accounting Horizons, 16(1):55-67.

Hunton, J. E., Lippincott, B., and Reck, J. L. (2003) “Enterprise resource planning systems: comparing firm performance of adopters and non-adopters,” International Journal of Accounting Information Systems (4), 165-184.

Ismail, N. A., Abdullah, A. N., & Tayib, M. (2003). Computer-based accounting systems: the case of manufacturing-based small and medium enterprises in the Northern Region of Peninsular Malaysia. Jurnal Teknologi , 39 (E), 19-36.

Kumar, V., R. Pollanen, and B. Maheshwari. (2008) Challenges in enhancing enterprise resource planning systems for compliance with Sarbanes-Oxley Act and analogous Canadian legislation. Management Research News 31 (10): 758.

Mabert, V. A., Soni, A. K., & Venkataramanan, M. A. (2000). Enterprise resource planning survey of US manufacturing firms. Production & Inventory Management Journal, 41(20), 52-58.

Melville, N., Kraemer, K., & Gurbaxani, V. (2004). Review: Information Technology and Organizational Performance: An Integrative Model of IT Business Value. MIS Quarterly, 28(2), 283-322.

Poston, R., and Grabski, S. (2001). The financial impacts of enterprise resource planning implementations. International Journal of Accounting Information Systems, 2, 271-294.

Rashid, M., Hossain, L., and Patrick, J. (2001). The Evolution of ERP Systems: A Historical Perspective.

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Appendix 1: List of Companies Included in AnalysesAhmad Hassan Textile Mills Ltd.

Al Azhar Textile Mills Ltd.

Allah Wasaya Textile Mills Ltd.

Atlas Honda Ltd.

Attock Cement Ltd.

Attock Petroleum Ltd.

Attock Refinery

Ayesha Spinning Mills Ltd.

Baig Spinning Mills Ltd.

Bestway Cement Ltd.

Cherat Cement Ltd.

Colgate Pakistan Ltd.

Colony Textile Mills Ltd.

DarEs Salaam Textile Mills Ltd.

Dandot Cement Ltd.

Data Textile Mills Ltd.

Deewan Cement Ltd.

DG Khan Cement Ltd.

EllcotSpining Mills Ltd.

Engro Corporation Ltd.

Faisal Spining Mills Ltd.

Fatima Enterprises Ltd.

Fauji Cement Ltd.

Fawad Textile Mills Ltd.

Fazal Cloth Mills Ltd.

Fecto Cement Ltd.

FFBL Ltd.

FFC Ltd.

Gharibwal Cement Ltd.

Gul Ahmad Textile Mills Ltd

Hino Pak Ltd.

Hussain Industries Ltd.

I.C.I Pakistan Ltd.

Ibrahim Fibres Ltd.

Indus Motors Ltd.

Ishaq Textile Mills Ltd.

Kohat Cement Company Ltd.

Lafarge Pak Cement Ltd.

LaksonTobaco Ltd.

Lucky Cement Ltd.

Mahmood Textile Mills Ltd.

Maple Leaf Cement

Maqbool Textile Mills Ltd

Masood Textile Mills Ltd

MehrDastagir Textile Mills Ltd.

Mubarak Textile Mills Ltd.

Mukhtar Mills Ltd.

Mustehkam Cement Ltd.

National Foods Ltd.

National Refinery Ltd.

Nestle Pakistan Ltd.

Nishat Mills Ltd.

Packages Ltd.

Pakistan Petroleum Ltd.

Pakistan Refinery Ltd.

Pakistan State Oil Ltd.

Pakistan Tobacco Co. Ltd.

Pioneer Cement Ltd.

Reliance Weaving Mills Ltd.

Sapphire Textile Mills Ltd.

Sargodha Spining Mills Ltd.

Shadab Textile Mills Ltd.

Shakarganj Mills Limited.

Sunrays Textile Mills Ltd.

Unilever Pakistan Ltd.

Zephyr Textile Ltd

firm size, leverage and profitability overriding impact of accounting information system

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