Restatement of In-Process Research and Development Write-Offs: The Impact of SEC Scrutiny

Abstract

In 1998, SEC Chairman Arthur Levitt voiced his concerns about earnings management, including understatements of earnings. SEC Chief Accountant Lynn Turner communicated his opposition to excessive write-offs of In-Process Research and Development costs (IPRD) in September 1998. We document how the SEC-using channels other than formal standard setting and enforcement actions-affected registrants' reporting of IPRD transactions. We investigate factors associated with large IPRD write-offs in the software and computer services industry, and test whether firms managed their earnings with IPRD, as alleged by the SEC. In addition, we examine factors associated with the resulting IPRD restatements, and assess their valuation impact. IPRD write-offs-as a percentage of assets acquired-shrink by more than half in the period following the SEC's guidance. We observe companies that initially expense large amounts of IPRD faced high investor expectations, and the stock price impact of write-off restatements is reliably negative. The results demonstrate the potent impact the SEC's opinions on proper accounting practice have on companies' financial reporting, even when the agency is not officially setting new standards.