The Impact of the Type of Accounting Standards on Preparers’ Judgments

Abstract

This article examines preparers' consolidation judgments and how they are impacted by the precision of accounting standards (substance-overform versus rules-based). The examination is performed via two laboratory experiments in a consolidated accounting setting. In Experiment 1 it was found that when subjects used a substance-over-form accounting standard they justified their consolidation judgments on case specific information rather than on different interpretations of the phrase 'capacity to control'. In Experiment 2 it was found that when subjects used a rules-based standard, incentives were found to impact on accountants' consolidation judgments and more aggressive judgments were made through their assessments of case specific information. Comparison of the judgments made in Experiment 1 with one of the treatment groups in Experiment 2 enabled a comparison to be made of consolidation judgments of subjects under both substance-over-form and rules-based accounting standards. While both groups had the same incentive not to consolidate, marginally significantly more subjects using the rules-based standard did not consolidate than subjects using the substance-over-form standard. This finding is contrary to anecdotal claims that the imprecision of substance-over-form standards may be less effective in stopping biased financial reporting than rules-based standards.

Manager's Discretionary Power and Comparability of Financial Reports: An Analysis of the Regulatory Transition Process in Brazilian Accounting

“…In the model adjusted by stepwise, the years 2011 and 2012 had a significantly higher average comparability when compared to 2004. The results found corroborate other researches addressing the quality of accounting information (Collins, Pasewark, & Riley, 2012;Psaros & Trotman, 2004;Agoglia, Doupnik, & Tsakumis, 2011) and prove the superiority of the principle-based standard also over the comparability of financial reports. The main conclusion of this research is that increasing manager's discretionary power through flexibility of accounting standards does not decrease the comparability of financial reports.…”

“…According to the authors, their findings contradict the arguments that inaccurate standards taking into account the substance under the form makes them less effective to fight biases in financial reports when compared to rule-based standards. Corroborating the findings of Psaros and Trotman (2004), Agoglia et al (2011) observed in their experiments that financial directors subject to a more flexible regulatory system are less exposed to aggressive practices in financial reporting than financial directors in stricter systems. Overall, based on these studies, we notice the existence of a proven superiority of the standard based on principles over the standard based on rules.…”

“…Those who support principles claim they improve quality in the information environment and not necessarily increase variability in the accounting outcomes (Silva, 2013;Agoglia, Doupnik, & Tsakumis, 2011;Donelson, McInnis, & Mergenthaler, 2012;Jamal & Tan, 2010;Mergenthaler, 2009;Stolowy & Ding, 2003;Psaros & Trotman, 2004;Iatridis, 2010). Those supporting rules point out the contrary: that without the latter, there is no comparability and managers might be susceptible to greater manipulation of outcomes (Sunder, 2009;Schipper, 2003;D' Arcy, 2000).…”

“…Psaros and Trotman (2004) compared the judgments of management regarding the consolidation of accounting statements in two different regulatory environments, one tighter and another more flexible. Although both groups had the same incentive not to consolidate (and consolidation was the right response), the researchers were faced with a significantly greater number of individuals who choose not to consolidate in the regulatory system based on rules when compared to the system based on principles.…”

“…Although there are empirical studies that evaluated the effects of regulatory changes on outcomes of financial reports or on the interpretive behavior of a manager in translating economic events into accounting numbers (Agoglia et al, 2011;Collins et al, 2012;Dye, 1985;Dye & Verrecchia, 1995;Psaros & Trotman, 2004;Stolowy & Ding, 2003;Ashbaugh, 2001;Ashbaugh & Pincus, 2001;Nelson, 2003;Jamal & Tan, 2010;Donelson et al, 2012), there is little prior evidence of the impact of regulatory flexibility directly on the comparability of financial reThe corporate scandals that occurred in the beginning of the last decade (e.g. Enron and WorldCom) and the subprime crisis in the USA rekindled an old debate between accountants on how accounting should be regulated: according to rather strict and specific rules or rather flexible and generic principles -for more details see Merino and Coe (1978).…”