Discretion in Revenue Recognition and Financial Statement Comparability

Abstract

One objective of financial reporting regulation is to encourage the production of decision-useful information. This paper examines the association between the level of discretion allowed in accounting standards and financial statement comparability, a key characteristic of decision-useful reporting. To study the link between discretion and comparability, I investigate changes in four measures of comparability around two regulations, SOP 97-2 and EITF 09-3, which decreased and increased discretion in recognizing revenue on software related transactions, respectively. Using a difference-in-differences research design, I find evidence consistent with a negative association between discretion and comparability for affected firms, relative to control firms. This paper provides further information on how standard setters impact the financial reporting environment and highlights the trade-offs involved in the regulatory process.