Conservatism and Staff Accounting Bulletin No. 108

This study examines whether firms with large conservative allowances for uncollectible accounts on their balance sheets make significant adjustments to increase net assets in response to Staff Accounting Bulletin No. 108 (SAB 108). To the extent adjustments are not made, we examine the qualitative reasons SAB 108 may have had a limited effect on these large conservative accounting estimates. In the year of enactment, SAB 108 required public companies to adjust material accumulations on the balance sheet that may have occurred prior to enactment of SAB 108 after considering all relevant quantitative and qualitative factors. Our archival results find that no firms made a SAB 108 adjustment and while sample firms tend to, at best, make small reductions to the allowance subsequent to SAB 108’s effective date, most sample firms continue to have potentially overestimated allowances several years later. To understand the qualitative forces underlying this finding, we interview key individuals involved in the financial reporting process and we survey experienced financial executives employed at our sample firms. The findings reveal that organizational forces favor conservatism because being over-reserved helps firms avoid income-decreasing surprises while being under-reserved appears careless. We conclude that conservatism remains a deeply engrained feature of accounting thought and practice, in contrast to recent emphasis by accounting standard setters on neutrality over conservatism.