Do Accounting Estimates Inform Assessments of Company Failure?

• In Event: Distress, Restatements, and Auditor Opinions

Abstract

Accounting estimates are prevalent throughout today’s financial statements, yet we know relatively little about the contexts in which they are informative. This study investigates whether accounting estimates that cast doubt on a company’s future earnings potentially inform assessments of company failure. We use the deferred tax asset valuation allowance to operationalize accounting estimates and measure company failure using subsequent bankruptcy filings and a broader measure of failure that also considers exchange delistings for financial reasons and poor credit ratings. Using a sample of U.S. public companies from 2004 through 2015, we find an association between accounting estimates and the likelihood of company failure. A going concern opinion does not fully mediate this association, suggesting that accounting estimates convey information incremental to that conveyed in a going concern opinion. Cross-sectional analyses reveal that the mediating effect of a going concern opinion is less when companies are more distressed, have weaker external information environments, and lower quality financial reporting, and when estimates are more conservative. Our research should be of interest to standard setters, as they continue to consider the role of accounting estimates in financial reporting; auditors, as they consider information relevant to going concern assessments; and, academics and investors interested in understanding the information contained in the deferred tax asset valuation allowance.

Authors

• Keith Czerney, University of Missouri-Columbia

• Herita Akamah, University of Nebraska-Lincoln

• Thomas C Omer, University of Nebraska-Lincoln