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Conditional conservatism and disaggregated bad news indicators in accrual models

Author

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  • Dmitri Byzalov

    () (Temple University)

  • Sudipta Basu

    () (Temple University)

Abstract

Conditional conservatism is an integral but often unmodeled part of the normal accrual process. The standard economic determinants of accruals contain information about unrealized losses. We argue that accountants recognize these unrealized losses as disaggregated write-downs for small asset pools. Modeling disaggregated impairments yields new economic insights about accruals and improved accrual models. We predict that accrual conservatism manifests as a sum of asymmetries for a vector of news indicators, rather than as an asymmetry for a scalar aggregate news proxy. We argue that more detailed segment-level and quarterly indicators have an incremental effect on annual firm-level accruals. We also predict a dynamic effect of successive loss indicators because accountants look for consistent patterns in these variables. Empirical results for U.S. firms support our predictions. The asymmetries in accruals are consistent with conservatism in validation tests. We also document improved statistical power and type I error in earnings management tests.

Suggested Citation

  • Dmitri Byzalov & Sudipta Basu, 2016. "Conditional conservatism and disaggregated bad news indicators in accrual models," Review of Accounting Studies, Springer, vol. 21(3), pages 859-897, September.
  • Handle: RePEc:spr:reaccs:v:21:y:2016:i:3:d:10.1007_s11142-016-9361-3
    DOI: 10.1007/s11142-016-9361-3
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    References listed on IDEAS

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    Cited by:

    1. Sudipta Basu & Yi Liang, 2019. "Director–Liability–Reduction Laws and Conditional Conservatism," Journal of Accounting Research, Wiley Blackwell, vol. 57(4), pages 889-917, September.
    2. Hsieh, Yu-Ting & Chen, Tsung-Kang & Tseng, Yi-Jie & Lin, Ruey-Ching, 2018. "Top Management Team Characteristics and Accrual-Based Earnings Management," The International Journal of Accounting, Elsevier, vol. 53(4), pages 314-334.
    3. Basu Sudipta & Waymire Gregory B., 2019. "Historical Cost and Conservatism Are Joint Adaptations That Help Identify Opportunity Cost," Accounting, Economics, and Law: A Convivium, De Gruyter, vol. 9(1), pages 1-13, March.
    4. Chad R. Larson & Richard Sloan & Jenny Zha Giedt, 2018. "Defining, measuring, and modeling accruals: a guide for researchers," Review of Accounting Studies, Springer, vol. 23(3), pages 827-871, September.

    More about this item

    Keywords

    Asset impairment; Timely loss recognition; Lower of cost or market rule; Abnormal accruals; Materiality;

    JEL classification:

    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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