Knowledge that Transforms

International Financial Reporting Standards (IFRS) allow managers flexibility in classifying interest paid, interest received, and dividends received within operating, investing, or financing activities within the statement of cash flows. In contrast, U.S. Generally Accepted Accounting Principles (GAAP) requires these items to be classified as operating cash flows (OCF). Studying IFRS-reporting firms in 13 European countries, we document firms’ cash-flow classification choices vary, with about 76, 60, and 57% of our sample classifying interest paid, interest received, and dividends received, respectively, in OCF. Reported OCF under IFRS tends to exceed what would be reported under U.S. GAAP. We find the main determinants of OCF-enhancing classification choices are capital market incentives and other firm characteristics, including greater likelihood of financial distress, higher leverage, and accessing equity markets more frequently. In analyzing the consequences of reporting flexibility, we find some evidence that the market’s assessment of the persistence of operating cash flows and accruals varies with the firm’s classification choices and the results of certain OCF prediction models are sensitive to classification choices.

This paper investigates whether changes in Generally Accepted Accounting Principles (GAAP) affect corporate investment decisions. Using a sample containing forty nine changes in GAAP, I find that changes in accounting rules affect investment decisions. I then examine two mechanisms through which changes in GAAP affect investment. First, I find that changes in GAAP affect investment, particularly R&D expenditures, when firms have financial covenants that are affected by changes in GAAP. Second, I find evidence suggesting that the process of complying with some changes in GAAP alters managers’ information sets and consequently changes their investment decisions, particularly their capital and R&D expenditures and, to a weaker extent, their acquistion expenditures. This paper contributes to the literature on the real effects of accounting by providing evidence that accounting rules affect investment decisions even when the rule change does not concern the measurement and reporting of investment, and by documenting specific mechanisms through which the relation manifests.

We study lease accounting in an international panel data set to examine how accounting outcomes vary with two features of accounting standards: the emphasis on using professional judgement to apply principles, and the presence or absence of bright-line tests. We study four countries—Australia, Canada, the UK, and the US—and companies in two lease-intensive industries—retail and transportation. Our primary study period spans the time when Australia and the UK switched from domestic to international accounting standards, and in one test, we also consider Canada’s transition to international standards. We find that neither an explicit requirement to apply a principle nor omitting bright-line tests materially increases the use of capital lease treatment among these firms. Overall, we conclude that this financial reporting outcome is relatively insensitive to these standard-setting tools.

Amendment of IAS 39 by the IASB in 2008 provided an option to reclassify investments from fair value to historical cost. We predict that too-important-to-fail (TITF) banks took less advantage of this option because the political protection they enjoyed insulated them from regulatory pressure. Banks that did not enjoy this protection had greater reason to make use of this option since doing so would protect their Tier 1 capital. As predicted, findings reveal that TITF banks made less use of the reclassification option to protect their Tier 1 capital and there is a significant moderating influence of TITF status on the incentive to reclassify investments for banks with lower regulatory capital. This finding is consistent with TITF banks placing less weight on protecting regulatory capital and thereby retaining flexibility to sell assets. Our findings provide evidence that accounting choices are affected by the importance of banks to their economies.