Purpose This study aims to examine the effect of principles-based accounting standards on earnings comparability within the USA. Design/methodology/approach To answer the authors’ research question, the study uses a large sample of US firms to examine to what extent principle-based accounting standards affect the comparability of financial statements. The study follows prior literature to measure a firm’s comparability and the degree to which it applies principles-based standards. Specifically, the study use Folsom et al.’s (2017) Pscore to measure the extent to which a firm-year applies principles-based standards. To measure comparability, the study follows the procedures in De Franco et al. (2011) by first regressing a firm’s earnings on its returns over the past 16 quarters. Findings The study finds that, companies that apply more principles-based standards are associated with higher financial statement comparability. The study also finds that higher operational uncertainty and lower verifiability of assets negatively moderate the positive relationship between principles-based standards and comparability. In contrast to prior research, these findings suggest that granting managers greater flexibility in the application of accounting standards provides a vehicle for managers to convey their private information, and may provide a richer information environment. Research limitations/implications In untabulated results, the study examines the role of auditors in moderating the relationship between principles-based standards and comparability, and do not find significant results. However, Francis et al. (2014) found that firms audited by the same audit firm have more comparable financial statements as each audit firm has its own audit style. Future research can examine the extent to which auditors increase the comparability of financial statements given high economic uncertainty and low verifiability in accounting measurement. Practical implications The study results suggest that comparability is improved by a greater reliance on principles-based standards; however, this improvement is much less likely to occur when the benefits of the transactions governed by the principles-based standards are highly uncertain or unverifiable. Social implications The paper has implications for public policy and contributes to the debate regarding the shift toward principles-based standards. In particular, the results suggest that the shift toward principles-based standards by the Financial Accounting Standards Board (FASB) has, in general, been improving the ability of investors to distinguish the similarities and differences between firms. Thus, to the extent that comparability is desired, this study encourages the FASB to continue their current efforts. However, it is important for regulators to take into consideration the underlying uncertainty and verifiability of accounting items when setting the degree of accounting flexibility given to managers. Similarly, in regard to audit standards and regulation, the results suggest potential areas for more extensive planning and testing to better improve the usefulness of the financial statements for investor decision-making. In regard to investor decision-making, the results suggest that investors should be able to have more confidence in making comparisons between firms in more tangible asset intensive industries. Originality/value This paper contributes to the accounting literature in two ways. First, it examines the effects of principles-based standards on comparability, an important aspect of useful accounting information. Second, the study responds to the call of Schipper (2003), and to the best of the authors’ knowledge, is the first to conduct a large-sample, cross-sectional analysis of the impact of principles-based standards on comparability for all US firms.
Chen et al. (Sat,) studied this question.
Synapse has enriched 5 closely related papers on similar clinical questions. Consider them for comparative context: