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Does Accounting Choice Matter? Evidence from the Accounting Treatment of Derivatives

Fri, April 28, 10:45am to 12:00pm, Hilton Miami Downtown, TBA

Abstract

This study analyzes whether the accounting treatment of financial instruments affects market pricing and firm accounting outcomes. Firms have a voluntary choice in designating their risk-management derivative instruments as accounting hedges or non-accounting hedges. Accounting hedge designation allows gains and losses on the derivatives to be deferred to the Comprehensive Income section and bypass the Income Statement. Using a unique data set on the amounts of hedges designated as accounting hedges and non-accounting hedges, I find that analysts forecasts are more accurate when firms designate their hedges as accounting hedges following FAS 133. In additional analysis, I provide evidence that the accounting treatment of derivatives is determined mainly by the complexity of the underlying risk exposure and that such accounting treatment can significantly reduce the levels of discretionary accruals. These results are robust to various controls of organizational complexity and to limiting the tests to significant users of derivatives. Overall, this paper demonstrates that accounting choices affect how market intermediaries process information and also affect firm financial reporting choices.

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