The Impact of Recognition Versus Disclosure on Financial Information: A Preparer's Perspective

• Author: SHANA M. CLOR‐PROELL,LAUREEN A. MAINES
• Published date: 01 June 2014
• DOI: http://doi.org/10.1111/1475-679X.12053
• Date: 01 June 2014

DOI: 10.1111/1475-679X.12053

Journal of Accounting Research

Vol. 52 No. 3 June 2014

Printed in U.S.A.

The Impact of Recognition Versus

Disclosure on Financial

Information: A Preparer’s

Perspective

SHANA M. CLOR-PROELL

∗AND LAUREEN A. MAINES

†

Received 28 August 2013; accepted 27 February 2014

ABSTRACT

We investigate whether recognition on the face of the financial statements

versus disclosure in the footnotes influences the amount that financial man-

agers report for a contingent liability. Using an experiment with corporate

controllers and chief financial officers, we find that financial managers in

public companies expend more cognitive effort and exhibit less strategic bias

under recognition than disclosure. This difference appears to be associated

with capital market pressures experienced by public company managers as

we find that both the cognitive effort and bias exhibited by private company

∗M.J. Neeley School of Business, Texas Christian University (TCU); †Kelley School of Busi-

ness, Indiana University.

Accepted by Douglas Skinner. We thank Jason Brown, Andy Call, Tina Carpenter, Rick

Cazier, Margaret Christ, Ted Christensen, Lisa Gaynor, Steve Glover, Max Hewitt, Pat Hop-

kins, Lisa Koonce, Mark Nelson, Ray Pfeiffer, Chad Proell, Kathy Rupar, Casey Schwab, Geoff

Sprinkle, Jane Thayer, Jeff Wilks, David Wood, Arnie Wright, Teri Yohn, Mark Zimbelman,

an anonymous reviewer, and workshop participants at the following universities for helpful

comments on prior versions of the paper: Arizona State, Brigham Young, Cornell, Georgia,

Indiana, Northeastern, Texas Christian, South Florida, and Texas-Austin. We greatly appreci-

ate the help of Diane Biagioni and ToddStinson in creating the experimental instrument, and

Spencer Anderson, Devon Erickson, Adam Esplin, Ken House, Tim Keune, and Gabby Wang

for research assistance. We thank the KPMG Professorship at the Kelley School of Business,

the M.J. Neeley School of Business, and the Wisconsin School of Business for their generous

financial support. Finally, we thank the financial professionals who participated in the study.

671

Copyright C, University of Chicago on behalf of the Accounting Research Center,2014

672 S.M.CLOR-PROELL AND L.A.MAINES

managers are unaffected by placement. As a result, public company man-

agers make higher liability estimates for recognized versus disclosed liabilities.

Their liability estimates are similar to those of private company managers for

recognition but lower than private company managers’ estimates for disclo-

sure. Our results have implications for auditors and financial statement users

in evaluating recognized versus disclosed information for public and private

companies.

1. Introduction

We investigate whether placement of information on the face of the fi-

nancial statements (recognition) versus in the footnotes (disclosure) influ-

ences the amount financial managers in public and private companies re-

port for a contingent liability. Understanding whether and how placement

influences the judgments and decisions of managers who prepare financial

statements is important because preparers establish the initial reliability of

financial information.1While research finds that auditors tolerate less mis-

statement in recognized than disclosed information (Libby, Nelson, and

Hunton [2006]), it is unknown whether auditors’ actions serve to offset

or exacerbate reliability differences in preaudit information. Thus, our re-

search is important to auditors who attest to information reliability, as well

as to users, regulators, and standard setters who face consequences from

reliability differences remaining in audited financial information.

In addition to examining whether preparers’ estimates differ between

recognition and disclosure, we address two related issues associated with

these potential differences. First, we examine how differences in prepar-

ers’ estimates arise. Specifically, we propose that differences between rec-

ognized and disclosed amounts arise from two sources: (1) preparers’

choice of approaches for arriving at reasonable ranges for the estimate,

and (2) preparers’ choice of point estimates within those ranges. Drawing

on Bernard and Schipper [1994], we hypothesize that capital market pres-

sures from standard setters, investors, and auditors/regulators differentially

affect preparers’ motivation to engage in effortful information processing

when making contingent liability estimates that are either recognized or

disclosed. Similarly, we expect that capital market pressures will also affect

the extent to which preparers choose more justifiable estimates that are in

the middle of the range of possible outcomes, rather than biasing financial

1Historically, the Financial Accounting Standards Board (FASB)has used the term reliabil-

ity to describe information that is reasonably free from error and bias and faithfully represents

what it purports to represent (FASB [1980]). However,the FASB recently replaced the term re-

liability with representational faithfulness to describe information that is complete, free from

error, and neutral (FASB [2010]). Despite this change, the term reliability continues to ap-

pear in the FASB Codification (e.g., FASB ASC 820, FASB [2013b]) and in recent accounting

literature (e.g., Kadous, Koonce, and Thayer [2012]). We use the term reliability throughout

the paper to refer to characteristics related to the 1980 definition, that is, information that is

free from error, unbiased, and faithfully represents what it purports to represent.