The effect of retrospective versus modified retrospective application of accounting changes on financial statement usefulness

Jing Wang () and Michael Welker ()
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Jing Wang: Queen’s University
Michael Welker: Queen’s University

Review of Accounting Studies, 2024, vol. 29, issue 4, No 26, 3946-3976

Abstract: Abstract Accounting changes, whether voluntarily undertaken by firms or mandated by standard setters, are generally implemented using one of three application methods—retrospective, modified retrospective, or prospective. This study sheds light on whether the adoption method applied to accounting changes impacts financial statement usefulness. Because individual prior year results that are presented for comparative purposes are restated under retrospective application but not under modified retrospective application, we predict that retrospective application provides data that are more useful for forecasting future earnings. Our first set of tests take advantage of a change in application method for voluntary accounting changes—from modified retrospective application to retrospective application—that occurred with the adoption of SFAS 154. Our evidence shows that retrospective application increases the extent to which future earnings are reflected in current price, decreases analyst earnings forecast errors and dispersion, and moderates abnormal trading volume and return volatility at future earnings announcements. Next, we examine the recent mandated change in revenue recognition, which allowed firms to choose either retrospective or modified retrospective application. We model self-selection arising from application method options presented in that standard, and present corroborating evidence from that mandatory change, after controlling for self-selection. Our results provide valuable feedback regarding the effects of SFAS 154 related to voluntary accounting changes and the effects of the diversity of application methods arising from the application method options provided in the recent revenue recognition standard. More generally, our results also provide useful information about the costs and benefits of different application methods for accounting changes.

Keywords: Accounting changes; SFAS 154; Application methods; Revenue recognition (search for similar items in EconPapers)
JEL-codes: M41 M48 (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1007/s11142-023-09788-3

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