Does More Conservative Revenue Recognition Improve the Informativeness of Earnings?
Clayton L Forester, University of Minnesota Twin Cities ABSTRACT: Watts (2003a) and Watts and LaFond (2007) provide evidence that more conservative earnings serve an informational role in equity valuation. My study tests this assertion using a sample of treatment firms that changed their revenue recognition policies to meet the requirements of a more conservative reporting regime. I find that more conservative revenues are more informative with respect to future cash flows and that expense manipulations do not increase to counteract the effects on earnings of more conservative revenue recognition. My results provide evidence of an initial decline in earnings informativeness when more conservative practices are followed but that this decline in informativeness is temporary. My results provide important evidence for the Financial Accounting Standards Board who are currently considering two revenue recognition models that differ with respect to their degrees of conservatism envisioned. Fu
