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Erschienen in: Review of Accounting Studies 1/2012

01.03.2012

Accounting complexity, misreporting, and the consequences of misreporting

verfasst von: Kyle Peterson

Erschienen in: Review of Accounting Studies | Ausgabe 1/2012

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Abstract

I examine whether accounting complexity in the area of revenue recognition increases the probability of restating reported revenue. I measure revenue recognition complexity using the number of words and recognition methods from the revenue recognition disclosure in the 10-K and a factor score based on the number of words and methods. Tests reveal that revenue recognition complexity increases the probability of revenue restatements, and these restatements are the result of both intentional and unintentional misreporting. Furthermore, complexity moderates the consequences of restatement—lower incidence of AAERs, less negative restatement announcement returns, and lower subsequent CEO turnover—suggesting that stakeholders of the firm consider accounting complexity when responding to misreporting.

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Fußnoten
1
Prior literature has not developed a definition of accounting complexity. The SEC’s Advisory Committee on Improvements to Financial Reporting (ACIFR) provides a definition in its final recommendation report (SEC 2008), and it is similar to the one presented in this paper. Accounting complexity is described more thoroughly in Sect. 2.
 
2
The results in this paper do not address whether accounting complexity is pareto optimal or should be reduced. Without an examination of all costs and benefits of complexity, it is not feasible to make any case for social welfare. For example, potential benefits of accounting complexity relative to simpler accounting could be reduced earnings management or better comparability, which are not examined in this study.
 
3
My findings suggest that firms that restate revenue have more complex revenue recognition; however, from Plumlee and Yohn (2009), it seems that firms do not necessarily highlight complexity as a reason for the restatement but are more likely to use vague descriptions like “internal error.” What managers say about the causes of misreporting does not likely include a description of all relevant factors that led to the restatement (e.g., undue pressure to meet targets, executive compensation, governance failures, complexity), but examining all these factors in a multivariate setting provides a better understanding of all these effects.
 
4
No formal definition of accounting complexity exists in the academic literature. Prior research has examined firm or organization complexity (Bushman et al. 2004), information complexity (Plumlee 2003), and information overload (Schick et al. 1990 for a review), concepts not wholly unrelated to accounting complexity.
 
5
The ACIFR define financial reporting complexity for preparers as the difficulty “to properly apply [US GAAP] and communicate the economic substance of a transaction” and for investors as the difficulty in understanding “the economic substance of a transaction or event and the overall financial position and results of a company” (SEC 2008).
 
6
Although this theory suggests managers take advantage of complex accounting by managing the financial statements, complexity is not a necessary condition for manipulation. Many fraudulent practices are implemented using simple accounting settings (e.g., fictitious sales, bill-and-hold transactions, and capitalizing expenses).
 
7
I consider SAB 101 and EITF restatements as mandatory restatements caused by a change in accounting standard. During the sample period, the Emerging Issues Task Force issued EITFs 99-19, 00-10, 00-14, 00-22, 00-25 to clarify revenue recognition issues such as recognizing gross v. net, shipping and handling costs, sales incentives, and other consideration from a vendor. Including the SAB and EITF firms in testing H1 provides similar results.
 
8
I do not match on industry because it likely introduces a noisy sort on revenue recognition complexity, potentially controlling for the effect being tested. However, I do control for industry in the regression analysis.
 
9
Certain practices or factors could also lead to increased complexity and risk of misreporting beyond what may be captured by disclosure length (see AICPA Practice Alert 98-3, 1998). In unreported analysis, I measure RRC SCORE where I also include the total number of counts in the disclosure (by using key-word searches) for the following revenue recognition practices: the percentage of completion method, multiple deliverables, vendor-specific objective evidence, barter or nonmonetary exchange revenue, or fair valuing aspects of the contract. Results using this measure are consistent with the results reported in the tables for RRC SCORE.
 
10
As a test of validity of my complexity measures, I examine whether my measures are associated with the variation and error in analysts’ forecasts of revenue, an indication that complexity increases uncertainty. Results (untabulated) indicate all three proxies are positively related to both the error and variation in analysts’ revenue forecasts with p values less than 10 percent after controlling for analyst following, size, and book-to-market.
 
11
It is also interesting to note that for both the revenue restaters and non-revenue restaters, the number of WORDS and METHODS increased in the post period, but the increase was greater for the revenue restaters (91.3 and 1.57 for revenue restaters; 38.0 and 0.53 for non-revenue restaters). The greater increase in post-restatement disclosures for revenue restaters could be an attempt to resolve confusion over already complex revenue recognition.
 
12
I exclude the variable AUDITOR from the matched-sample design because matched sample firms do not have a restatement.
 
13
In untabulated results, the marginal effects of the complexity variables are not statistically different from the marginal effects of SALEFCST, PRERET, BIGN, or AR ACCRUAL.
 
14
Erickson et al. (2006) correctly argue that SEC actions do not necessarily imply fraud or gross negligence. In these cases, the action ends with a settlement and an AAER, the firm admits to no wrongdoing but agrees to avoid future securities violations. However, Karpoff et al. (2008) find that 79 percent of enforcement actions in their sample from 1978 through 2006 include charges of fraud.
 
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Metadaten
Titel
Accounting complexity, misreporting, and the consequences of misreporting
verfasst von
Kyle Peterson
Publikationsdatum
01.03.2012
Verlag
Springer US
Erschienen in
Review of Accounting Studies / Ausgabe 1/2012
Print ISSN: 1380-6653
Elektronische ISSN: 1573-7136
DOI
https://doi.org/10.1007/s11142-011-9164-5

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