Early evidence of the effect of ASU 2017‐12 on derivative disclosure compliance

• Published date: 01 July 2023
• Author: Joseph Troyer,Joseph Johnston,Madeline Trimble
• Date: 01 July 2023
• DOI: http://doi.org/10.1002/jcaf.22621

Received:  January  Accepted:  February 

DOI: ./jcaf.

RESEARCH ARTICLE

Early evidence of the effect of ASU 2017-12 on derivative

disclosure compliance

Joseph TroyerJoseph JohnstonMadeline Trimble

Accounting, Illinois State University,

Normal, Illinois, USA

Correspondence

Madeline Trimble, Accounting, Illinois

State University, State FarmHall of

Business, Campus Box , Normal, IL

, USA.

Email: mktrimb@ilstu.edu

Abstract

The growth in the use of financial derivatives for a variety of purposes has caused

increased complexity in derivative reporting standards. As such, financial state-

ment users have asked the Financial Accounting Standards Board to update

guidance to increase transparency while preparers seek clearer guidance on the

application of standards and a broadened scope of hedge accounting. The most

recent derivative accounting guidance update, ASU - (Topic ), broad-

ens instruments that qualify for hedge accounting, expands allowable hedge

accounting techniques, and reduces reporting requirements by omitting the

reporting of hedge ineffectiveness. While these changes might simplify report-

ing requirements, there is the risk that the omitted disclosure would have been

relevant to investors’ decision-making. In this paper, we examine how deriva-

tive disclosure practices changed following the implementation of ASU -.

Using a hand-collected sample of twenty S&P  firms, we calculate a deriva-

tive disclosure compliance (DDC) score and find that, on average, DDC scores

decreased following firm adoption of ASU -. This decline was realized

for firms regardless of the notional amounts of derivative instruments held.

However, the decline was not significant for early adopting firms suggesting a

motivation for completeness by select firms. Our initial findings indicate that

the update on derivative disclosures is not being uniformly applied potentially

lessening its value to users. As a result, further updates may be necessary.

KEYWORDS

derivatives, financial reporting, standard setting

1 INTRODUCTION

Over the last several decades, accounting for financial

derivative instruments has been a significant area of atten-

tion from financial statement users, preparers, and regu-

lators. As the volume, complexity, and regulation of these

instruments have grown, financial statement users and

preparers have called upon theFinancial Accounting Stan-

dards Board (FASB) to update the accounting guidance

governing these activities. The FASB issued ASU -

Derivatives and Hedging (Topic 815): Targeted Improve-

ments to Accounting for Hedging Activities intending to

simplify and expand the application of hedge accounting

while improving the presentation of the economic results

for firms (FASB, ). In this paper, we examine whether

the FASB achieved its goal of simplification by analyz-

ing compliance with the standards before and after ASU

-.

Our paper is motivated by the concerns of practitioners

over the complexity of accounting for financial derivatives.

J Corp Account Finance. ;:–. ©  Wiley Periodicals LLC.213wileyonlinelibrary.com/journal/jcaf

214 TROYER .

The primary objective of financial reporting is to provide

financial information that is useful to investors and credi-

tors in making resource allocation decisions (FASB,).

However,over time, the length of financial statements pro-

vided by firms has increased significantly potentially to

the point of hindering understandability and resulting in

inefficient capital allocation decisions. A report by KPMG

and the Financial Executives Research Foundation ()

found that the number of pages in the -K reports of 

Fortune  firms increased by an average of % between

 and . In that same study by KPMG regarding

the length of reporting, over % of respondents agree that

the “complexity of accounting standards” and the “vol-

ume of mandated disclosures” in the reports contribute to

disclosure complexity (KPMG, ).

While this increase in the volume of disclosures may

be linked with increased complexities in business, there

remains the question of whether the increase in quan-

tity equates to an increase in the quality of information.

Studies have shown that the increase in volume harmed

readability (Dyer et al., ) and overall reporting quality

(Loughran & McDonald, ). Additionally, practition-

ers have voiced concerns over the volume and complexity

of the financial information being reported. A follow-up

study by KPMG in  argues that “preparers have been

voicing their concerns over disclosure overload—for exam-

ple, presenting ‘at-a-minimum’ disclosures, regardless of

their materiality.” The survey notes that preparers “have

asked for waysto de-clutter financial statement disclosures

and provide more company-specific information, telling a

relevant story that is unique to their business” (KPMG,

). To address this concern, standards setters adopted

ASU - in part to simplify the reporting standardsand

ease compliance. Thus, our study examining compliance

after the change in standards would be valuable to stan-

dards setters and others to assess the extent to which the

FASB accomplished its goals.

Toexamine how compliance changed around ASU -

, we create a derivative disclosure compliance score

(DDC) based on compliance with the standard and calcu-

late this score from annual reports for three observation

periods: the year before firm adoption, the year of adop-

tion, and the year following adoption. Tomeasure DDC, we

construct indices based on the pre-ASU - account-

ing standards and the accounting standards prescribed in

ASU - and measure firms’ disclosure compliance

from the information reported in the notes to their -Ks.

We calculate weights for scoring based on the complete-

ness of firm disclosures. Weights are scored on a scale of

 to  where zero means that all firms perfectly disclose

the required information. The percent of weights greater

than zero, nonperfect disclosures, is also used to mea-

sure whether there is a trend of reporting improvement,

in conjunction with changes in DDC. If the FASB was

successful in simplifying derivative accounting guidance

for financial statement preparers, compliance with deriva-

tive disclosures should increase following ASU -

adoption.

Using a hand-collected sample of , large US publicly

listed firms, our paper examines changes in firm com-

pliance with disclosure requirements included in ASU

-. If the update does indeed simplify the reporting

process, we should observe greater compliance with the

standards following the update. Surprisingly, we find both

the percentage of nonperfect disclosures to total required

disclosures and the mean and median DDC scores of all

sampled firms decreased following the implementation

of the update. This indicates that firms applied the new

update less completely and transparently than under the

original standard FAS .

To observe whether compliance with the standards dif-

fered among derivative usage, we conduct a cross-sectional

analysis. First, we separated firms by the total notional

amount of derivatives employed. We would expect that

firms with higher notional amounts of derivative instru-

ments would have more external pressures from share-

holders and expertise in hedge accounting, and thus,

would have greater compliance relative to firms with

lower notional amounts. We also investigatewhether early

adopters had significantly different compliance with the

standards. We expect firms who adopted the update early

to be those who would benefit most and would improve

disclosure compliance greater than those who adopted it

only when required.

Ultimately, we find that regardless of exposure levels

and risk of underlying hedged instruments firms are less

compliant with disclosure requirements following the new

update. Furthermore, we find that only on-time adopters

had a significant decline in DDC score, indicating that

early adopters apply the new update to the same degree

of completeness and transparency that they did under the

old standard.

Our paper contributes to the existing literature in sev-

eral ways. First, little research has been done measuring

the effects of changes the FASB included in its guidance

update, and the research that has attempted to assess

changes in derivative standards is mixed. Several studies

show derivative standard updates tend to have a posi-

tive effect on users and preparers of financial statements

such as improved transparency (Ahmed et al., ), bet-

ter risk management (Zhang, ), and reduced investor

mispricing (Campbell et al., ).

Concerning the most recent standard update, a literature

review by Campbell et al. () called for more research

on the effectiveness of ASU -. To our knowledge,

only Chen et al. ()andAlietal.() have explored