Did the FASB Codification Reduce the Complexity of Applying U.S. GAAP?

Published date01 December 2023
AuthorOliver Binz,Robert Hills,Matthew Kubic
Date01 December 2023
DOIhttp://doi.org/10.1111/1475-679X.12480
DOI: 10.1111/1475-679X.12480
Journal of Accounting Research
Vol. 61 No. 5 December 2023
Printed in U.S.A.
Did the FASB Codification Reduce
the Complexity of Applying U.S.
GAAP?
OLIVER BINZ,ROBERT HILLS,AND MATTHEW KUBIC
Received 10 November 2021; accepted 8 March 2023
ABSTRACT
We examine whether the Financial Accounting Standards Board (FASB)Cod-
ification made it easier for preparers and auditors to locate relevant ac-
counting guidance. We find that areas of U.S. GAAP with more dispersed
and voluminous guidance before the Codification experience a larger post-
Codification reduction in restatements. We find a similar decline in SEC com-
ment letter questions referencing areas of U.S. GAAP with more dispersed
and voluminous pre-Codification guidance. Our results suggest that before
INSEAD Asia Campus; Smeal College of Business, Pennsylvania State University;
McCombs School of Business, The University of Texas at Austin
Accepted by Douglas Skinner. We appreciate helpful comments and feedback from an
anonymous reviewer, an associate editor, Hami Amiraslani, Andrew Belnap, Daniel Bens,
Gavin Cassar, Roman Chychyla, Lisa De Simone, Shannon Garavaglia, Kurt Gee (discus-
sant), Apoorv Gogar (discussant), Nathan Herrmann, Lisa Koonce, Bill Mayew, Rick Mergen-
thaler, Reto Micheluzzi, Brian Monsen, Katherine Schipper, Rui Silva, Sara Toynbee, Spencer
Young, Stephen Zeff, and workshop participants at the University of Texas at Austin, IN-
SEAD, the 2021 BYU Accounting Symposium, the 2022 Hawaii Accounting Research Con-
ference (HARC), and the 2022 FARS Midyear Meeting. We appreciate helpful discussions
with FASB members, including current and former Board Members Christine Botosan, Bob
Herz, Lawrence Smith, Tom Hoey (technical expert on the original Codification project),
and Regenia Cafini (project manager for the ongoing Codification Improvements project).
All errors remain our own. An online appendix to this paper can be downloaded at https:
//www.chicagobooth.edu/jar-online-supplements.
1479
© 2023 The Chookaszian Accounting Research Center at the University of Chicago Booth School of
Business.
1480 o. binz, r. hills, and m. kubic
the Codification, preparers and auditors had difficulty in locating the appro-
priate accounting guidance and that the Codification mitigated this difficulty.
JEL codes: M40, M41, M48, N22
Keywords: complexity; FASB Codification; restatements; SEC comment
letters
1. Introduction
The U.S. Securities and Exchange Commission (SEC), the Financial Ac-
counting Standards Board (FASB), and academic research all acknowledge
the undesirable consequences of financial reporting complexity (Ciesielski
and Weirich [2006], SEC [2006], Dzinkowski [2007], FASB [2013]) and
document an increase in complexity over time (Guay, Samuels, and Taylor
[2016], Dyer, Lang, and Stice-Lawrence [2017], Chychyla, Leone, and
Minutti-Meza [2019]). The increase in financial reporting complexity is
due, in part, to firms engaging in more complex transactions, which led
standard setters to issue more accounting guidance in a piecemeal fashion
(SEC [2006, 2008], FASB [2014a]). As accounting guidance becomes
more voluminous and complex, preparers and auditors may fail to identify
relevant guidance, thereby increasing the incidence of unintentional
errors in financial reports (Hoitash and Hoitash [2018], Chychyla, Leone,
and Minutti-Meza [2019]). This paper investigates whether the FASB can
improve financial reporting quality by organizing historical accounting
guidance in a cohesive manner that reduces the incidence of unintentional
financial reporting errors.
During the early 2000s, SEC officials raised concerns that the volume
and dispersed nature of accounting pronouncements made it difficult for
firms to locate and apply the appropriate guidance (SEC [2006, 2008]).
Constituents told the FASB that the structure of U.S. GAAP was “unwieldy,
difficult to understand, and difficult to use,” leading to inadvertent errors
and increased financial reporting risk (FASB [2014a, p. 35]). In response
to this feedback, the FASB created the Codification with the goal of
mitigating the risk of unintentional misreporting (FASB [2008, 2014a]).
To achieve this goal, the Codification organized over 2,000 historical
pronouncements into condensed topical areas (e.g., leases, debt, revenue
recognition) with individual sections specifying the nature of the guidance
(e.g., recognition, measurement, disclosure; McEwen, Hoey, and Brozovsky
[2006], FASB [2014a]). The Codification removed redundant guidance
and nonessential material, implemented a plain-English standard, and
created subtopics, subsections, and a paragraph hierarchy. According to
the FASB, the Codification was designed to make it easier to research an ac-
counting issue and to mitigate the risk of noncompliance (FASB [2014a]).
We hypothesize that the Codification reduced the incidence of financial
reporting errors by making it easier for preparers and auditors to locate
did the fasb codification reduce complexity?1481
the appropriate guidance. We test this hypothesis by examining whether
the Codification reduced complexity-related financial misreporting.
There are several reasons why the Codification may fail to reduce finan-
cial misreporting. First, it is unclear whether difficult-to-find guidance is a
first-order determinant of misreporting. Prior research shows that report-
ing quality depends on incentives (Daske et al. [2013], Christensen et al.
[2015]) and that reputational concerns and negative market outcomes dis-
cipline both managers and auditors (Palmrose, Richardson, and Scholz
[2004], Srinivasan [2005], Hennes, Leone, and Miller [2014]). If difficulty
in locating relevant accounting guidance is not an important determinant
of misreporting, then the Codification may have little effect because it was
not designed to discipline either managers or auditors. Second, some firms
and auditors expressed a preference for the pre-Codification guidance,
which suggests that adoption of the Codification may have been limited
(Widelski and Schweitzer [2010]). Third, large accounting firms had ac-
counting research systems and standardized audit methodologies in place
before the Codification (Toerner [2009], Francis, Pinnuck, and Watanabe
[2014], Ege, Kim, and Wang [2020b]). If such preexisting systems were al-
ready effective at mitigating the difficulty of locating the appropriate guid-
ance, then the Codification would have little benefit.
To test whether the Codification improved financial reporting quality,
we must identify aspects of financial reporting that were—or were not—
affected by the Codification. Previous standard-setting research generally
measures effects at the firm level, relying on variation in the level of treat-
ment across firms (Li [2010], Christensen, Hail, and Leuz [2013], Khan
et al. [2018]). The Codification applies to all firms following U.S. GAAP,
making it difficult to identify treatment and control groups at the firm level.
To circumvent this issue, we measure treatment at the accounting-topic
level. For certain topics, the pre-Codification guidance was more dispersed
and voluminous. For example, in the pre-Codification period, a firm issuing
convertible debt would need to consider over 20 pieces of accounting guid-
ance. In the post-Codification period, that same firm would need to review
only Accounting Standard Codification (ASC) 470-10, Debt Overall and ASC
470-20, Debt with Conversion and Other Options. For other topics like the state-
ment of cash flows, pre-Codification accounting guidance was concentrated
in one or two pronouncements, making the identification of relevant guid-
ance straightforward. We assume that the Codification had a greater effect
on topics with more dispersed or voluminous pre-Codification guidance,
such as convertible debt, than on topics with concentrated pre-Codification
guidance.
We use a novel approach to measure the complexity of pre-Codification
accounting guidance. For 26 distinct accounting topics, we measure the
volume (dispersion) of pre-Codification accounting guidance using the
amount of guidance (the number of unique pre-Codification standards)
in the Codification cross-reference tool. We find that the dispersion and
volume of pre-Codification guidance are highly correlated, which suggests

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