| Under current accounting standards,almost all accounts presented in financial statements today reflect some elements of accounting estimates,such as fixed assets,accounts receivable,goodwill,inventory and intangible assets in balance sheet and key income statement items such as revenues,expenses,in process R&D or impairment of long-term assets.Due to the increasing intense competition,rapid technological revolutions and fast-changing market conditions,there is a growing demand for managers to exert their professional judgment on future uncertainty based on the latest available,reliable information.As a result,accounting estimates are playing an increasingly important role in today's financial statements.The impact of a wide introduction of accounting estimates to financial statements is however far-reaching and complicated.On the one hand,estimates and projections are potentially useful to investors because they are the primary means for managers to convey credibly forward-looking proprietary information to investors,creditors and other stakeholders as accounting estimates usually embody expected future inflows and outflows of economic benefits,thus enhancing the relevance of accounting information.On the other hand,the accounting estimates underlying financial information introduce a considerable and unknown degree of noise because the estimate-related transactions and events are often of high uncertainty,forward-looking and difficult to verify;in addition,the adverse impact of accounting estimates on the usefulness of financial information becomes more apparent if the manager opportunistically employ accounting estimates to manipulate earnings using the propriety information.For reasons discussed above,accounting estimates have long been a heated topic in accounting academic studies,as well as a focus of public attention among stakeholders including management,information users and regulators.In the wake of“Positive Accounting Theory”put forward by Watts and Zimmerman?1978,1986?,a large body of accounting literature have investigated firms'various accounting policies and estimate,especially the underlying incentives for accounting procedure choices,in the 1980s and 1990s.These studies mainly provide empirical evidence for“Positive Accounting Theory”,including compensation contract,covenant contract and political cost hypotheses.The progress in this stand of literature,however,has slowed on the entering of 21st century?Fields,Lys and Vincent,2001?and research results fail to provide compelling evidence.Verifiability is the enhacncing characteristic of accounting information.Therefore accounting estimates need to be at some degree verifiable in order to be faithfully presented and value relevant.However,there are not many archival evidence about how information verifiability would affect accounting estimate changes.In this study,I systematically investigates the earnings effect associated with two major types of accounting estimate changes?i.e.,revision of estimated percentage of uncollectibility for doubtful accounts and deprecation rate?made by Chinese listed firms during 2003-2011.I document consistent evidence in both estimates for doubtful accounts receivable and for depreciation of fixed assets.The main findings are:First,our evidence suggests that the two types of accounting estimates changes we studied are not associated with an aggressive earnings effect.On the contrary,we find that the more a firm's accounting estimate diverges from the normal industry level for the same category of assets,the more likely is the firm to converge with?rather than further deviate from?the industry level in the next period,which suggests that accounting estimate changes are constrained by the demand for verifiability of accounting information,and the industry-level accounting estimate serves as a relatively verifiable estimate.Second,we argue that relatively aggressive accounting estimates are likely to cause more serious economic consequences to a firm,while relatively conservative accounting estimates are likely to cause less serious economic consequences.This different behavior will drive asymmetric demands for verifiability between aggressive and conservative accounting estimates.We find evidence consistent with this argument.Specifically,the tendency to converge with the industry-level estimate is significantly stronger for previously aggressive estimates than for previously conservative estimates.In the additional analyses,we find that the tendency of previously aggressive estimates to converge with the industry-level estimate is more prominent in longer-?rather than shorter-?aged receivables and firms with greater intensity of fixed asset usage,because the likelihood of recovery of doubtful accounts receivable decreases with age and a manager likely faces greater pressure under the situation where the percentage allowance for a long-aged account receivable is estimated aggressively;similarly,for firms that are more efficient in using fixed assets to generate sales,the fixed assets are more fully employed.This likely intensifies the demand for verifiability of a relatively aggressive estimate of depreciation rate.This evidence suggests that firms'underlying economics play a role in driving a stronger demand for verifiability of relatively aggressive accounting estimates.Futher,I examine whether timing of accounting estimate affects the results on the incentive of verifiability and earnings management.Judging by the timing of disclosure on accounting estimates,I divided the full sample into two subsamples:accounting estimates made in the first half of year?January to June?versus in the latter half?July to December?.In terms of depreciation of fixed assets,the tendency of converging with?rather than further deviate from?the industry level,especially for previously aggressive estimates,is most prominent in accountings estimate changes in the latter half?July to December?.As to the potential incentives of earnings management,I document some evidence of earnings smoothing in the accounting changes in the latter half?July to December?.In contrast,no difference is found in all the proxies for verifiability and earnings management between the two subsamples of accounting estimates in the first half of year?January to June?versus in the latter half?July to December?,in terms of allowance for doubtful debts.The results indicate that the results found in this paper are consistent in both of the subsamples,and the estimate changes in depreciation made in the latter half?July to December?suggest some evidence of earnings smoothing.Finally,this paper examines how independent auditors,as an important information medium,respond to varied levels of verifiability and their potential effect on the tendency to converge on the industry level via accounting estimate changes.The results show that in the sample of accounts receivable estimates,the extent to which an individual firm's estimate deviates from the industry level is significantly and positively related to the auditor's input and effort,proxied by audit fees and audit engagement working hours.It shows that auditors invest more resources in respond to the concern of low verifiability.Meanwhile,the tendency to converge on the industry level via accounting estimate changes in period t is notably weakened when auditors put more efforts in the audit in period t.This means that independent audit of high quality has some value in enhancing the verifiability of estimate in the percentage of uncollectibility for doubtful accounts.Auditor's work and effort can attenuate the pressure faced by managers especially when their accounting estimate is relatively far from the industry level.The auditing-related evidence,however,is not found in the sample of fixed assets'depreciation sample.I propose that the differences across the two samples may be caused by the differences in liquidity,auditing complexity and auditing evidence between accounts receivables and fixed assets.It is important to caustion that even though I argue that the verifiability of accounting information poses pressure for the managers'accounting estimate decisions and as a result firms do show a tendency to converge to the more verifiable level proxied by industry medium,this paper is by no means to deny the traditional contracting and earnings-managemnet related interpretations for accounting estimate changes.In fact,I do find some evidence of earnings management in some tests,such as“big baths”and“earnings smoothing”incentives,which is consistent with prior literature?Yan,2006,for exmaple?.This paper contributes to the literature of accounting choice in the following ways:First,after controlling for firm characteristics and managerial incentives,this paper finds that the more a firm's accounting estimate diverges from the verifiable industry level,the more likely is the firm to converge with?rather than deviate from?the industry level in the next period.This reflects the demand for verifiability of accounting information,adding a more balanced view to prior accounting choice literature that focuses on managerial opportunism.In this way,this paper extends the accounting choice literature by providing a new different perspective.Second,we are among the first to document evidence consistent with asymmetric demand for verifiability.Specifically,we show that,as compared to conservative estimates,aggressive estimates are more likely to be constrained by exhibiting a stronger tendency of industry convergence.It suggests that the two studied types of accounting estimate changes are not associated with aggressive earnings effect,and moreover reflect the informational demand of firms for verifiability and accounting conservatism.I argue that the documented more conservative and asymmetrical demand for verifiability is determined by the economic consequence of accounting estimate and the underlying economics of the firm,which echoes Ball's?2013?call for attention to the basic economic forces that influence a firm's financial reporting.This paper also contributes to the literature by providing evidence that independent auditing can notably enhance the verifiability,at least for the estimates for accounts receivables;and thus add to the auditing literature on the audits of uncentainty of account estiamtes.As to the research design,this paper differs from the model in Zhiyuan Yan?2006?which use a dichotomous variable to proxy for whether or not a firm makes an accounting estimate change in a given year.The dichotomous design fails to capture the more detailed information concerning accounting estimate changes by assuming all changes are homogeneous when the dummy equals 1.Instead,in the paper I further discriminate whether a firm converges with or diverges from the verifiable industry level,by make an accounting estimate change,thus providing a more thorough understanding about the incentives and consequences of accounting estimate change.With accounting estimate changes being widely used in the practice among firms in China,this paper can be informative to other parties.As the accounting standards are currently in the process of development and there is still room for improvement of stockholders'protection in China,most investors'understanding towards accounting estimate changes is limited and mixed.Particularly,stockholders may largely doubt the reliability of accounting estimate changes.This paper shows that in general the changes in accounting estimates are not associated with an aggressive earnings effect.It may,to some degree,address concerns about the susceptibility of accounting estimates to managerial manipulation.To standard setter and market regulators,these results mean that accounting estimate changes are constrained by the demand for verifiability of accounting information,and the industry-level accounting estimate serves as a relatively verifiable benchmark.In other words,the practice of accounting estimate changes have proven some self-regulation by the demand for verifiability,which adds to the confidences of granting management more discretion power in professional judgments. |
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