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Double Entry Bookkeeping and the Distributional Properties of a Firm's Financial Ratios

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  • David Ashton
  • Paul Dunmore
  • Mark Tippett

Abstract

Our purpose here is to assess whether the innate properties of the double entry bookkeeping system are such that financial ratios, calculated from the balance sheet summary measures implied by it, will be generated by distributional forms with non‐convergent moments. Our analysis begins with a brief summary of some important analytical properties of the debt and equity components of the double entry bookkeeping system. We then use these to determine the time series and distributional properties of the debt to equity ratio itself. Our analysis shows that even when the evolution of balance sheet summary measures like debt and equity can be described by ‘well behaved’ distributional processes, there is a distinct possibility that ratios derived from them will evolve in terms of distributional forms with non‐convergent moments. We argue that this has serious implications for parameter estimation as well as the integrity of the regression and/or discriminant procedures which underscore bankruptcy and financial distress prediction models based on financial ratios derived from the double entry bookkeeping system.

Suggested Citation

  • David Ashton & Paul Dunmore & Mark Tippett, 2004. "Double Entry Bookkeeping and the Distributional Properties of a Firm's Financial Ratios," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 31(5‐6), pages 583-606, June.
    • Handle: RePEc:bla:jbfnac:v:31:y:2004:i:5-6:p:583-606
    DOI: 10.1111/j.0306-686X.2004.00550.x
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    References listed on IDEAS

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    1. Stuart McLeay, 1997. "Boundary Conditions for Ratios with Positively Distributed Components," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 24(1), pages 67-84, January.
    2. Stuart McLeay & Duarte Trigueiros, 2002. "Proportionate Growth and the Theoretical Foundations of Financial Ratios," Abacus, Accounting Foundation, University of Sydney, vol. 38(3), pages 297-316, October.
    3. Fuller-Love, N. & Rhys, H. & Tippett, M., 1995. "Harmonic analysis, time series variations and the distributional properties of financial ratios," Omega, Elsevier, vol. 23(4), pages 419-427, August.
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    5. Mensah, Ym, 1984. "An Examination Of The Stationarity Of Multivariate Bankruptcy Prediction Models - A Methodological Study," Journal of Accounting Research, Wiley Blackwell, vol. 22(1), pages 380-395.
    6. Dambolena, Ismael G & Khoury, Sarkis J, 1980. "Ratio Stability and Corporate Failure," Journal of Finance, American Finance Association, vol. 35(4), pages 1017-1026, September.
    7. Zmijewski, Me, 1984. "Methodological Issues Related To The Estimation Of Financial Distress Prediction Models," Journal of Accounting Research, Wiley Blackwell, vol. 22, pages 59-82.
    8. Stuart McLeay, 1997. "Boundary Conditions for Ratios with Positively Distributed Components," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 24(1), pages 67-84, January.
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    Cited by:

    1. Lee, Bong Soo & Li, Ming-Yuan Leon, 2012. "Diversification and risk-adjusted performance: A quantile regression approach," Journal of Banking & Finance, Elsevier, vol. 36(7), pages 2157-2173.
    2. Douglas, Ella & Lont, David & Scott, Tom, 2014. "Finance company failure in New Zealand during 2006–2009: Predictable failures?," Journal of Contemporary Accounting and Economics, Elsevier, vol. 10(3), pages 277-295.
    3. Stuart McLeay & Maxwell Stevenson, 2006. "Modelling the Longitudinal Properties of Financial Ratios of European Firms," The Institute for International Integration Studies Discussion Paper Series iiisdp184, IIIS.
    4. Stuart McLeay & Maxwell Stevenson, 2009. "Modelling the longitudinal properties of financial ratios," Applied Financial Economics, Taylor & Francis Journals, vol. 19(4), pages 305-318.
    5. M. Naresh Kumar & V. Sree Hari Rao, 2015. "A New Methodology for Estimating Internal Credit Risk and Bankruptcy Prediction under Basel II Regime," Papers 1502.00882, arXiv.org.
    6. M. Naresh Kumar & V. Sree Hari Rao, 2015. "A New Methodology for Estimating Internal Credit Risk and Bankruptcy Prediction under Basel II Regime," Computational Economics, Springer;Society for Computational Economics, vol. 46(1), pages 83-102, June.

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