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Effects of Acct Standards

Effects of Acct Standards

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Published by Tuti Al-Jaber

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Published by: Tuti Al-Jaber on Jun 28, 2012
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 Journal of Accounting – Business & Management vol. 18 no. 2 (2011) 84-104
Effects of the Type of Accounting Standards and Motivationon Financial Reporting Decision
Gerui (Grace) Kang 
*
  Jerry W. Lin
 
 Abstract
 This study explores whether the precision (type) of accounting standardsinfluences management accounting reporting behaviors when an environmental variable, motivation, is incorporated. We predict that motivation affects management’sfinancial reporting decision. When management has motivations to make aggressivereporting, they are more likely to do so than if they do not have such motivation.Furthermore, we posit that the type of accounting standard interacts with motivationand affects management’s accounting decision. When management has motivation toreport aggressively, with rules-based accounting standards, management is more likely to be guided by the precise numerical thresholds to achieve aggressive reporting than with principles-based accounting standards. We conduct a 2x2 between-subjectsexperiment. Ninety-six senior accounting students participate in this study. Theresults support our predictions that when management has motivation for aggressivereporting, they will make motivation-consistent accounting choice. Furthermore,under rules-based accounting standards, management is more likely to chooseaggressive reporting than under principles-based accounting standards, whenmanagement has motivations to do so.Keywords:
 
Principles- versus Rules-based accounting, motivation, motivatedreasoning theory, lease, aggressive reporting, U.S. GAAP versus IFRS.
I.
 
INTRODUCTION
 The recent well-publicized accounting scandals such as Enron and WorldComhave led to criticisms that the current U.S. accounting standards may be partially responsible for the occurrence of these scandals. One of the major criticisms of thecurrent U.S. accounting standards is that they are more rules-based than principles-based and provide so many detailed directions (i.e., “bright lines”) that managers may follow to achieve their favorite accounting treatment. Furthermore, it is difficult forauditors to challenge management’s accounting choice when detailed rules serve as
*
University of MinnesotaDuluth, MN 55812Office: 218-726-6988 Fax: 218-726-8510Email:gkang@d.umn.edu 
Colorado State University Pueblo, CO 81001Phone: 719-549-2105 Fax: 719-549-2909Email:jerrywlin@gmail.com 
 
Grace and Jerry/Journal of Accounting – Business 
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Management vol. 18 no. 2 (2011)
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management’s justification (e.g., Maines et al., 2003). Nelson et al. (2002) find thatauditors responding to their survey usually are reluctant to argue “substance overform” when the clients clearly comply with precise accounting criteria. Therefore,many accounting researchers believe that it is time to reform the current U.S. GAAPand make it more principles-based. They suggest that principles-based accounting standards may mitigate aggressive financial reporting. Some studies find that thequality of accounting information improves under principles-based accounting standards presumably by constraining management’s aggressive reporting behavior(e.g., Barth et al., 2008; Jamal and Tan, 2010; Tsakumis et al., 2009; Webster and Thornton, 2005). However, other studies (e.g., Cuccia et al., 1995; Nelson et al., 2002)find that switching from rules-based to principles-based accounting does notnecessarily reduce aggressive reporting. The inconsistent results in the prior studies motivate this study. Furthermore,based on a review of relevant literature, Nelson (2003) concludes that, regardless of the precision of accounting standards, management may consciously or unconsciously choose financial reporting consistent with their incentives. Nelson (2003) suggests thatif accounting standard setters or regulators desire conservative (or less aggressive)reporting, they should set accounting standards that are imprecise enough to avoidprecise “safe harbors” so as to prevent or minimize incentive-consistent interpretationto take place. The current efforts by the FASB and the SEC to reform U.S. GAAP tomake it more principles-based have serious implications for all the stakeholdersconcerned about the quality of financial reports. Given the significant consequencesand costs of such accounting reform, it is important to examine whether switching from a rules-based to a principles- based accounting really mitigates aggressivereporting and thus improves the quality of accounting information. Using accounting for leases by the lessee, we examine whether rules-based accounting is more likely toresult in aggressive financial reporting than principles-based accounting. Also, weinvestigate whether there are some factors, such as motivation, that may accentuate ormitigate aggressive financial reporting under the two sets of accounting standards. Inthis study, we manipulate the type of accounting standards and apply the motivatedreasoning theory to address these research questions.Many behavioral studies suggest that people themselves are the number onefactor that influences their judgment and decision making (Bonner, 2008; Libby andLipe, 1999). Generally, motivation is thought to impact people’s judgment anddecision (Bonner, 2008). For example, Cuccia et al. (1995) find that motivationinfluences tax practitioner’s tax reporting decision. Nelson et al. (2002) find that,based on a survey of auditors, when managers of their clients have motivations toprepare aggressive reports, they would consciously (or unconsciously) attempt tomake financial reports consistent with their incentives no matter what type of accounting standard they have to follow. Maines et al. (2003) also suggest thatmotivation plays a crucial role in management’s financial reporting decision. Therefore, we suggest that that when management has motivation or pressure strong enough to make aggressive reporting, they will find some ways to meet therequirements of accounting standards and achieve their desired accounting goals. Weposit that when management have motivation to make aggressive reporting, they aremore likely to do so than if they do not have motivation to engage in aggressivereporting, regardless of the precision or nature of the accounting standards.Furthermore, Psyzcnski and Greenberg (1987) argue that if people have a cleartarget or goal, they would be motivated to achieve this goal. The clearer the goal is, the
 
86
Grace and Jerry/Journal of Accounting – Business 
&
Management vol. 18 no. 2 (2011)
 
stronger the motivation they have to achieve the goal. As long as people can constructa
seemingly 
reasonable (or objective) justification to convince themselves and others,they would believe that their choice is the best or most logical
.
 This is the core of motivated reasoning theory. Motivated reasoning theory describes how individualsprocess information to support their desired judgment and decision while maintaining the illusion of objectivity (Kunda 1990; Psyzcnski and Greenberg 1987). For example, whether management makes an aggressive reporting depends on whether they havethe motivation and whether they are able to construct a reasonable justification toconvince those involved in the financial reporting process, such as the independentauditors. Therefore, having a motivation and being able to construct a seemingly reasonable justification are the two necessary and sufficient conditions formanagement to make aggressive reporting. When management has motivation to report aggressively, applying rules-basedaccounting makes it easier for management to construct a seemingly reasonable orobjective justification than applying principles-based accounting. Therefore, thelikelihood for them to make aggressive reporting increases under rules-based thanunder principles-based accounting. For example, “bright lines” or numericalthresholds such as 75% of useful life and 90% of fair market value inherent in thecurrent U.S. lease accounting standard would direct management to achieve theirdesired accounting treatments by aggressively managing reported accounting numbersto meet such precise thresholds without being challenged by auditors. However, thecurrent international lease accounting standard with only vague thresholds (i.e., “majorpart”) would make it more difficult for management to construct a reasonablejustification. Management and auditors may interpret the vague thresholds differently.Management has to justify that their interpretation is more appropriate. Since no clear“target” is available to the management, the difficulty for them to hit the “target”increases. Also, the difficulty for management to construct a reasonable justificationincreases as well. Therefore, we predict that motivation and precision of accounting standards jointly influence management’s reporting behavior. When management hasmotivation to report aggressively, the likelihood for them to do so is higher whenapplying rules-based accounting standards than when applying principles-based ones. We choose accounting for leases by the lessees as the experimental standard. Inparticular, we choose the U.S. lease accounting standard (SFAS No. 13) as the proxy for rules-based accounting standard and the International Accounting Standards (IAS)lease accounting standard (IAS 17) as the proxy for principles-based accounting standard. These two accounting standards are commonly used in prior studies asexamples for rules-based versus principles-based accounting (e.g., Jamal and Tan,2010). In the experiment, we ask subjects to make their accounting choice undereither SFAS No.13 or IAS 17 and either with or without motivation for making anaggressive reporting decision. Evidence of prior research suggests that most lesseefirms prefer operating leases to capital leases (e.g., Bowman, 1980; Imhoff and Thomas, 1988; Reither, 1998) because of the negative effect on financial statements of capital leases vis-à-vis operating leases. Thus, choosing operating leases stands formaking an aggressive reporting decision. This study tests how bright lines (or the lack of) in the lease accounting standards may cause aggressive reporting when motivationexists or does not exist. We conduct a 2x2 between-subjects experiment. Motivation and the type of accounting standard are the two between-subjects variables. Participants are randomly assigned to one of the four groups. We find that when management has motivation

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