Selling-price estimates in revenue recognition and the usefulness of financial statements

Revenue is one of the largest and most value-relevant items in firms’ financial statements. Based on the “realizable” and the “earned” criteria of SFAC No. 5 (FASB in Concepts statement no. 5. Recognition and measurement in financial statements of business enterprises, 1984), revenues should reflect both selling price and timing of delivery. Of those two aspects, selling-price estimates are required for revenue recognition when standalone selling prices for products and services are not available. In this study, I examine the effects of selling-price estimates in revenue recognition on the contracting and informational roles of financial statements. Particularly, I examine the setting of SOP 97-2 (AICPA in Software revenue recognition. Statement of Position (SOP) 97-2, AICPA, New York, 1997) that removed software firms’ flexibility to recognize revenues using selling-price estimates. I find that SOP 97-2 implementation did not improve the contracting role of earnings. However its implementation partly shifted the informational role of financial statements from income-statement to balance-sheet components.