Mental Accounting in Financial Reporting and Voluntary Disclosure

Abstract

Those involved in financial reporting and voluntary disclosure routinely make decisions about how to describe transactions and economic events. Key components of these decisions include how to label information, whether to aggregate or disaggregate it, and how frequently to provide it. For example, firms reporting under IFRS rules must determine whether to label interest paid as an operating or financing cash flow. Analysts evaluating a firm’s compound financial instruments must decide whether to consider them as reported (i.e., as one unit of account) or bifurcate them into their component parts. The purpose of this paper is twofold: First, we describe a robust theory from psychology, mental accounting, that can help explain how those involved in financial reporting and voluntary disclosure might make these kinds of decisions and evaluate them. Second, we provide illustrative examples of how this theory can aid scholars in their research on financial reporting issues, including those currently facing standard setters.