Abstract
We provide insight into an argument that firms minimize the costs imposed by new accounting standards through their adoption choices. Focusing on two standards with potentially large impacts on both balance sheet and income statement accounts for many firms, we present evidence that firms chose their strategies for SFAS No. 106 (OPEB) and 109 (DTAX) jointly rather than separately. We also provide insight into how firms view recurring versus non-recurring charges, and how they weigh the tradeoff between a large one-time (income decreasing) charge against the smaller, but longer lasting effects of amortization.
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Notes
Adoption strategy refers to either the timing of adoption of a new accounting standard or the transition method chosen. The use of the term “strategy” is not intended to imply that the firm is trying to achieve a particular objective through its choice. The objective of this paper is to examine whether these choices are consistent with efforts to achieve particular objectives.
OPEB refers to postretirement benefits under SFAS No. 106; the acronym (from Other Post Employment Benefits) was developed before the scope of the standard was limited to exclude benefits related to severance pay, wages to disabled employees, etc. OPEB includes health care costs and life insurance for retirees. DTAX refers to deferred income taxes as defined under SFAS No. 109.
However, the standard-setting process could result in efficient accounting procedures because changes in accounting policy occur jointly with changes in the environment (Ball 1980).
Balsam et al. (1995) argue that FASB provides discretion in adoption method and timing in an attempt to reduce its political costs by allowing firms to minimize the costs imposed on them.
Financial Accounting Standards Board (FASB). 2005. Accounting changes and error corrections. Statement of Financial Accounting Standards No. 154. FASB, Norwalk, CT.
For example, firms only needed to consider how to account for the investment tax credit after it was introduced by the IRS. Thus, the choice of accounting for the investment tax credit could have been a sequential decision if firms’ decisions on accounting for inventory and depreciation were viewed as “given,” or a simultaneous decision if all three choices were reconsidered.
The APBO is the actuarially-determined present value of the future benefits attributed to employees’ services rendered to a particular date.
In contrast to many previous income-decreasing standards (Balsam et al. 1995), the FASB did not allow firms to take the SFAS OPEB transition obligation directly to retained earnings.
In our sample, for firms with immaterial or zero effects from SFAS DTAX, nearly half chose the immediate approach for SFAS OPEB. However, when we separate the sample into regulated and non-regulated firms, we find that only 22% of regulated firms with zero or immaterial deferred tax effects chose the immediate approach while about 75% of non-regulated firms did. Still more (around 88%) of non-regulated firms with material or non-zero deferred taxes chose the immediate approach.
We define the ratio as the deferred tax effect (in dollars) divided by the OPEB effect (in dollars). When the DTAX effect on income is negative rather than positive; the DTAX effect is viewed as negative for this hypothesis; thus, a negative ratio signifies the case where the two standards both have negative impacts and thus reinforce rather than offset.
When the DTAX effect on income is negative rather than positive, the DTAX effect is input as negative and the OPEB effect (which is always negative) is input as positive. Thus, a negative ratio signifies the case where the two standards both have negative impacts and thus reinforce rather than offset.
We also collected data by auditor to consider the possibility that certain auditors were more likely to encourage client firms to make particular choices (e.g., early vs. late, immediate vs. prospective method, etc.), but we found no patterns that weren’t explained by other constructs in our analysis (such as regulated status); thus the auditor data are not presented.
The effects of SFAS OPEB and DTAX are calculated as if the immediate or current methods were chosen to facilitate comparison of the choices made based on similar constraints rather than on the actual outcomes.
We repeated the regression with the addition of Offset, but the inclusion of this variable (which exhibited a significant positive coefficient) resulted in multicollinearity among the two size effects, Sign, and Offset (offset being largely a combination of the other three).
The following regressions were also estimated using the sample of firms adopting the two standards in different years. For this sample, the only significant predictor of either adoption method or timing was firm size, with larger firms tending to adopt SFAS DTAX early.
This test is essentially equivalent to a Hausman test of specification for simultaneous equations in an OLS setting.
This variable may be argued to be endogenous rather than exogenous; we repeated our analysis without the Amend variable, and our results were qualitatively identical to those presented.
The discount rates used for pension plans and for OPEB plans were virtually identical for firms in our sample. This variable may be endogenous, but the reliance on the discount chosen for pensions lessens this concern. Also, the omission of this variable does not alter any conclusions.
We also estimated the regressions with an additional variable for “times interest earned” in Eq. 1. However, because Compustat sometimes combined interest expense with other expenses, the inclusion of this variable reduced our sample size; and it did not alter the results (the coefficient was not significant).
We also estimated the regressions using a variety of robustness checks for the ratio variable; and our results were consistent, whether the ratio was measured (and kept in the analysis at its actual value) for all firms, whether it was set to an upper and lower bound of 1 or −1 as well as other fixed cutoffs, whether the firms outside a relevant range were set to zero (as presented), or whether the ratio measure was limited to only those firms with positive ratios less than one.
The “offsetting” strategy is not feasible for firms with a negative (reinforcing) ratio; for firms where SFAS OPEB dwarfed SFAS DTAX (firms with a ratio less than 5%), and for firms where SFAS DTAX dwarfed SFAS OPEB (firms with a ratio greater than 200%). We note that this last category could be argued to represent total offsetting of any negative adoption effects from OPEB; thus we re-estimated our regression with these firms included at their raw ratios, and the results were robust.
To estimate the optimal leverage ratio in a manner similar to Hovakimian et al. (2001), we specified the following tobit model (estimated for all firms on Compustat with data): LEV = a0 + a1 PPE/Total Assets + a2 MKT/BV + a3 log (total assets) + a4 NOLC + vector of year and 2-digit industry SIC dummies + e, where NOLC is a binary variable that equals one if a firm has net operating loss carryforwards or zero otherwise. As an alternative measure of optimal leverage, as well as a proxy for the point at which debt covenants are referenced, we used the median leverage of each industry (3-digit SIC code) represented in our sample (including firms outside the sample in our calculation of the median). Results were similar.
Regulated industries are identified using two sources, a listing provided in Regulatory Reform: What Actually Happened (Weiss and Klass 1986) and Hogan and Jeter (1999), leading to the following industries being classified as regulated: two-digit SIC codes 10, 12, 13, 14, 20, 29, 40, 41, 42, 44, 45, 46, 48, 49, 60, 61, 62, 63, 64, and 67.
To identify amendments, we searched the note disclosures related to postretirement benefits for the terms “curtail,” “amend,” and “reduce.” In the event that our search process overlooked some amendments, we also read the disclosure notes on postretirement benefits and picked up some additional amendments.
When we estimate the equations separately for the non-regulated and regulated samples, we find that the coefficient on the OPEB effect is positive and significant for the non-regulated firms (p = 0.01) but insignificant for regulated firms (p = 0.13). The coefficients on the DTAX effect and on OPEB*OVER effect are insignificant for all samples.
As an alternative specification, we replace HIGH with the income before extraordinary items in the period of adoption, deflated by total assets, and the results were qualitatively unchanged.
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Acknowledgements
The authors acknowledge the support of the Dean’s Fund for Faculty Research at Vanderbilt University and the helpful comments of Sudipta Basu, Germain Boer, Jerry Bowman, Steven Cahan, Bruce Cooil, Ken Gaver, Paul Hutchison, Chris Jones, Sok-Hyon Kang, Krishna Kumar, Morley Lemon, Thomas Lys, Charles Mullin, Gans Narayanamoorthy, Robin Tarpley, two anonymous referees, and workshop participants at George Washington University, Vanderbilt University, the University of Auckland, at the 2002 annual meeting of the American Accounting Association and the 2004 meeting of the AAA Western Region Section, and at the 2004 Hawaii International Conference on Business.
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Jeter, D., Chaney, P. & Daley, M. Joint accounting choices: an examination of firms’ adoption strategies for SFAS No. 106 AND SFAS No. 109. Rev Quant Finan Acc 30, 153–185 (2008). https://doi.org/10.1007/s11156-007-0045-8
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DOI: https://doi.org/10.1007/s11156-007-0045-8