Joint Meeting of the Mid-Atlantic and Northeast Regions

The Impact of Conservatism and Supply Chain Finance on Bad Debt Expense

• In Event: Financial Reporting and EM

Abstract

Standard accrual models assume a parsimonious, linear relation between accruals and changes in sales but ignore the accounting methods and real transactions that generate accruals. Hence, legitimate transactions are often modeled as earnings management. We focus on a specific accrual, bad debt expense (BDE), and develop accounting-based models. We find that accounting-based models that incorporate conservatism have much better explanatory power. This is because, due to conservatism, receivables can be written off but are rarely written up, creating an asymmetry in BDE that linear models do not capture. We then investigate the effect of real transactions on BDE by examining supply chain finance, which reduces the risk of receivables. We predict and find that supply chain finance decreases the level and asymmetry of BDE, which would likely be misclassified as earnings management by standard models. Our study highlights the importance of modeling individual accruals using accounting methods and incorporating real transactions.

Authors

• Sudipta Basu, Temple University

• Tom Canace, Wake Forest University

• Mark Cecchini, University of South Carolina

• Yi Liang, Temple University