Fair value accounting and earning management: The impact of unobservable inputs on earning quality. Evidence from the US

Marco Pompili,Marco Tutino

doi:10.22495/cocv16i2art1

Abstract

Accounting standard boards (IASB and FASB) are aimed at designing high-quality standards able to increase transparency and comparability of financial reporting. They have chosen fair value accounting (FVA) approach to improve the quality of financial reporting and at the same time help financial reporting users in the decision-making process. During recent years, an intense debate has arisen about the trade-off between relevance and reliability of accounting information using this approach. Many authors outline problems related to the fair value hierarchy valuation of financial instruments, in particular, the discretionary use of unobservable inputs in financial instruments valuation process in support of earnings management. Tutino and Pompili (2018) have identified a general negative correlation between the extent of FVA and earning quality. Stating this, the main objective of the paper, using the same approach of the previous one, is to identify the specific impacts of unobservable inputs on earning quality. Theory and previous literature suggest a major negative impact of unobservable inputs than observable ones on the quality of information provided within financial reporting. Results show a negative and strong relationship between FVA and earning quality for US banks that do not depend on the hierarchy of input used in the evaluation process. These results suggest new considerations on the reliability of fair value concerning the possibilities of manipulation given to the management with this approach.

Highlights

High-quality accounting standards were introduced by IASB and FASB in order to improve worldwide the quality of financial reporting
US GAAP and IFRS, define a unique set of accounting rules, respectively for the US and Europe, which exceeds differences existing between local GAAPs obtaining comparable financial information that could be read by investors and analysts
The goal of international standards setters is to define a set of high-quality standards that can improve disclosure providing comparable and transparent information to the users of financial reporting. In their view main users of financial reporting are investors, and IASB and FASB have chosen the criterion of fair value in order to help them in the decision-making process

Summary

Introduction

High-quality accounting standards were introduced by IASB and FASB in order to improve worldwide the quality of financial reporting. High-quality standards allow to amplify financial reporting transparency and comparability. US GAAP and IFRS, define a unique set of accounting rules, respectively for the US and Europe, which exceeds differences existing between local GAAPs obtaining comparable financial information that could be read by investors and analysts. High-quality accounting standards play a role in relation to the financial market. Financial information is related to market and investors, accounting standards must give an appropriate and transparent disclosure about firms‟ conditions and results of their operations. The transparency achieved with high-quality standards leads to a reduction of information asymmetry and at the same time brings major efficiency (Brown & Hillegeist, 2007; Ertimur, 2007)

Objectives

Results

Conclusion