Accounting

Accounting

In October 2008, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued their Preliminary Views on Financial Statement Presentation [FASB 2008, hereafter FSP]. The FSP proposes that firms classify assets and liabilities on the Statement of Financial Position by activity (operating, investing and financing), and then cohesively maintain those classifications across the Statement of Comprehensive Income and the Statement of Cash Flows. In addition, the boards propose that the Statement of Comprehensive Income and the Statement of Cash Flows separately list income and expense items that do not respond equally to similar economic events.

Cohesive classification and dis-aggregation both provide additional information to investors that could potentially help them make more informed judgments and decisions. Standard setters continue to debate, however, whether such information is useful enough to outweigh the costs of providing it and, if so, whether it is most appropriately placed on the face of financial statements or in footnotes. Most studies on financial statement presentation predict and find that investors attend more carefully to single items of information when they are placed on the face of financial statements rather than in the footnotes (see, for example, Hirst and Hopkins 1998 and Hirst, Hopkins and Wahlen 2004). More recent research emphasizes the importance of information items' proximity in determining the extent to which financial statement users are able to completely process multiple items of related information (Hodge, Hopkins and Wood 2010). We extend this line of research by examining analyst judgments when classification and disaggregation alter the proximity and cohesiveness of multiple information items.

Consistent with the FSP's explicit objective to provide information about companies' financial flexibility (FASB 2008, para 2.13), we conduct an experiment in which 60 experienced credit analysts are asked to identify differences between two manufacturing firms that are similar, except for one key factor: one firm produces all of its goods internally, while the other outsources most of its production. Our study includes two independent variables. First, we manipulate whether items are cohesively classified by activity on the face of the financial statements. Second, we manipulate whether expenses and cash flows are disaggregated on the face of the financial statements or in footnotes. We provide participating analysts with comprehensive financial information for both firms, and ask them to conduct analyses closely modeled on their typical job duties.

In their critique of Lev (1970), Bernhardt and Copeland (1970) note that Ijiri, Jaedicke and Knight (1966) and Sorter (1970) “hypothesize that merely changing the form of the financial statement can affect users' decisions.” If true, this calls into question the validity of the strictly informational, non-contextual view of financial-statement aggregation forwarded by Lev (1968, 1970). Ronen and Falk (1973) provide evidence confirming Bernhardt and Copeland's (1970) perspective. Specifically, in a series of experiments testing Lev's (1968, 1970) measure of aggregation-related information content, they find that financial statement format and labeling are important determinants of judgment performance in a financial statement analysis task performed by MBA student subjects. This research began a voluminous literature examining whether ...