The Effect of Bad News on SAB 74 Disclosure Compliance

Abstract

SEC Staff Accounting Bulletin No. 74 (SAB 74, U.S. SEC 1987) requires registrants to provide information about the predicted financial statement effect of an enacted but not yet adopted accounting standard. The objectives of SAB 74 disclosures are to inform users the registrant will be required to adopt a new standard, and to assist users in assessing the impact of adoption on the registrant’s financial statements upon adoption. Regulators and investors find SAB 74 disclosures useful for their decision-making (Davis-Friday et al. 1999, 2004; SEC 2005). However, little evidence exists concerning whether companies meet their SAB 74 disclosure responsibilities, and how useful SAB 74 disclosures are for predicting the financial statement impact of adopting new accounting standards. Our results indicate substantial variation in how companies complied with SAB 74 when adopting one recent accounting standard (FIN 48 in 2007), and raise questions about the quality of SAB 74 disclosures. For example, we find that less than 20% of companies provide dollar estimates of the standard’s adoption effect. Although a majority of companies disclose an immaterial adoption effect under SAB 74, many of these same companies disclose material effects upon adoption less than 60 days later. Controlling for other factors, firms with “bad news” arising from adoption of the new standard are less likely to provide SAB 74 estimates. We find that when provided, SAB 74 estimates are incrementally useful in predicting the financial statement effect of FIN 48 adoption. We develop a SAB 74 disclosure model that might be useful to regulators concerned with mandatory disclosure compliance (or lack thereof) and to investors relying upon SAB74 estimates.