Journal of Accounting and Economics 31 (2001) 309–319

Discussion of empirical research on accounting choice

Jennifer Francis*
Fuqua School of Business, Duke Uni​v​ersity, Durham, NC 27708 USA

Abstract

This discussion considers four aspects of the survey paper on empirical accounting choice research by Fields, Lys and Vincent:
implications of the authors’ selection of an expansive definition of accounting choice and their decision to classify this research by
managerial motives; implications of the authors’ decision to include implementation decisions in their definition of accounting
choice; implications of the authors’ call for research on the consequences of accounting choice, including the costs of defective
accounting choices and the benefits of superior choices; implications of the authors’ call for a reconsideration of research designs
that explicitly consider groups of accounting choices. ​r ​2001 Elsevier Science B.V. All rights reserved.

​ 41
JEL classification: M

Keywords: ​Accounting choice; Accounting judgments and estimates; Accruals; Voluntary disclosure

1. Introduction

Fields et al. (2000) (FLV) review empirical and analytical studies of accounting choice published in the ​Journal of
Accountin​g ​and Economics​, the ​Journal of Accounting​ ​Research ​and ​The Accountin​g ​Re​v​iew ​in the 1990s. Their paper
extends reviews of pre-1990 studies of accounting choice (Lev and Ohlson, 1982; Holthausen and Leftwich, 1983;
Bernard, 1989; Dopuch, 1989;

*Tel.: +1-919-660-7817; fax: +1-919-660-7971.

E-mail address: ​jfrancis@duke.edu (J. Francis).

0165-4101/01/$ - see front matter ​r ​2001 Elsevier Science B.V. All rights reserved. PII: S 0 1 6 5 - 4 1 0 1 ( 0 1 ) 0 0 0 1 7 - 9
J. Francis / Journal of Accounting and Economics 31 (2001) 309–319 ​310

Watts and Zimmerman, 1990). My discussion reflects conference participants’ comments on the conference version of
the paper as well as my own reading of the revised paper. Conference discussion focussed on the problem of defining
accounting choice, the implications of FLV’s taxonomy for understanding both the literature on accounting choice and
the accounting choices available to managers and the authors’ conclusions and recommendations. My discussion
considers these three topics, as well as some of the implications of FLV’s recommendations for future research.
2. Defining accounting choice

The definition of accounting choice is important because it places boundaries on the set of topics or phenomena to
be studied. Just as the absence of an agreed-upon definition of the object of study can hinder research (examples
include ‘‘earnings quality’’ and ‘‘earnings management’’), the use of an ambiguous or overly expansive definition can
lead to disputes about what has been learned. FLV’s intentionally broad definition of accounting choice encompasses
‘‘any decision whose primary purpose is to influence (either in form or substance) the output of the accounting
system’’.
FLV’s definition of accounting choice is expansive along several dimensions. One is the ​nature of the decision
maker​. Interpreted literally, FLV’s definition includes decisions made by managers, auditors, audit committee members
and perhaps even standard setting groups, particularly if the focus is on implementation guidance (for example, the
activities of the Emerging Issues Task Force). Most accounting choice research does not include decision makers other
than managers among those responsible for making accounting choices, so it seems likely that researchers have adopted
the same restriction implied in FLV’s discussion, which directs attention to accounting choices made by managers.
However, within their framework, managerial decisions can be viewed as trading off incentives connected with others
(such as regulators or shareholders) who take an interest in, and make decisions affecting, the outputs of the accounting
system.
Expanding the scope of accounting choice to include decisions made by decision makers, other than managers,
suggests some possible research opportunities. For example, we could examine auditors’ decision-making processes
when confronted with ambiguous accounting guidance or contentious issues, and the role of audit committees in
monitoring management’s selection and implementation of accounting methods. Interpreted broadly, FLV’s definition
of accounting choice would suggest that we draw on, and encourage more, related work in the auditing and corporate
governance literatures.
A second dimension of expansiveness in FLV’s definition of accounting choice is the ​nature of the choice​. The
definition includes: choices among
J. Francis / Journal of Accounting and Economics 31 (2001) 309–319 ​311

equally acceptable rules (what I term ‘‘hard’’ accounting choices, such as selecting LIFO versus FIFO for inventory
valuation or choosing between straight line versus accelerated depreciation methods); judgments and estimates required
to implement generally accepted accounting rules (for example, the estimated service life of long-lived assets or the
estimated allowance for uncollectable accounts); disclosure decisions (such as the amount of detail provided in the
description of accounting policies); timing decisions (such as early or delayed adoption of a required accounting rule
when flexibility in the timing of adoption exists); lobbying activities (such as efforts to dissuade the Financial
Accounting Standards Board (FASB) from promulgating a rule which would require the expensing of employee stock
options); choices about display (e.g., the selection of one statement, two statements or a section of shareholders equity
to display elements of other comprehensive income as required by Statement of Financial Accounting Standards
(SFAS) No. 130); aggregation decisions (such as the extent to which components of income are displayed as separate
line items); classification decisions (e.g., the classification of hybrid securities as equity versus debt); decisions to
structure transactions in certain ways to achieve a desired accounting outcome (for example, many forms of off-balance
sheet financing); and real production and investment decisions (such as reducing expenditures on research and
development or advertising).
This definition of accounting choice covers a diverse set of activities that affect accounting numbers. On the cash
flow dimension, accounting choice includes everything from real decisions (that is, decisions with direct cash flow
implications) whose accounting consequences are simply one of several (possibly) second and third order outcomes, to
accounting decisions with no real effects (e.g., management’s allocation of an account- ing acquisition premium
between in-process research and development technology which is immediately expensed and developed technology
with a service life of three years). Heterogeneity of accounting choice along the cash flow dimension is particularly
important because, as pointed out by FLV, the motivation for a real decision ​may ​be unrelated to the accounting
outcome while the motivation for a purely accounting decision ​must ​be related to the outcome.
Another dimension along which accounting choice, as defined by FLV, displays significant heterogeneity is effects
on income. While some choices have both immediate and longer term income effects (e.g., the decision to extend asset
service lives), other choices (such as those involving aggregation and classification) affect only components of income,
period by period. This distinction implies that some choices are intended to affect the over time pattern of reported
income (e.g., shifts in loan loss provisions); some are intended to affect the components of income period by period
(e.g., alleged accounting manipulations in which costs that should be part of cost of goods
J. Francis / Journal of Accounting and Economics 31 (2001) 309–319 ​312

sold are classified as marketing expenses)​1 ​and some are intended to affect both components and over-time patterns
(e.g., special charges related to business combinations which, inappropriately, include future operating expenses).
Presumably, the motivation for these choices differs just as the intended outcome of the choices does.
FLV’s definition of accounting choice is silent on the matter of motivations. As evidenced by the taxonomy
introduced in Section 3 of their paper, accounting choice can be driven by managerial self-interest, by a wish to
maximize the interests of shareholders, possibly at the expense of some other contracting party, or by a wish to provide
information. What is not clear is whether motives are likely to be matched with choices, in the sense that only certain
choices can be used, or are best used, to achieve certain desired ends. (I consider this issue in more detail in Section 5
of this discussion). While FLV’s concerns about what they see as an inappropriately narrow focus on one motivation at
a time are certainly not misplaced, they are also exacerbated by their decision to set the boundaries of accounting choice
to encompass such a broad array of choices and, by implication, motivations.

3. Consequences of FLV’s definition of accounting choice

FLV’s decision to adopt an expansive view of accounting choice has several consequences for their paper. One
consequence is that the demarcation between accounting choice and related research areas (voluntary disclosure,
determinants of compensation, corporate governance) is not crisp. A second, very positive consequence is that FLV
provide broad coverage of an important body of accounting research. By taking an expansive view of their topic, they
are able to summarize and critique a material portion of the accounting research literature. Third, and perhaps most
important for future research, their view of accounting method choice encompasses choices made in implementing
accounting methods, in addition to choices among the methods themselves. My own view is that implementation issues
offer more opportunities than do hard accounting choices for understanding the motivations for and consequences of
accounting choice.
Consideration of implementation decisions as key elements of accounting choice seems consistent with the
behavior of several groups that evaluate financial reporting outcomes. For example, the Securities and Exchange
Commission (SEC), charged with oversight of the United States financial reporting system, seems to focus more on
implementation decisions than on

1​
Some have argued that managers of enterprises whose gross margins are subject to particular scrutiny
​ have incentives to move expenses out of
cost of goods sold and into items like marketing expenses so that they do not enter the calculation of gross margin (MacDonald, 2000).
J. Francis / Journal of Accounting and Economics 31 (2001) 309–319 ​313

accounting method choice. In particular, speeches by SEC commissioners and staff do not focus on accounting method
choice, but rather on implementation decisions (see, for example, Levitt, 1998). Recent SEC Staff Accounting Bulletins
(SABs) also focus entirely on complex implementation issues of materiality judgments (SAB No. 99), timing and
amounts of restructuring charges (SAB No. 100) and revenue recognition (SAB No. 101).
In their study of Accounting and Auditing Enforcement Releases (AAERs) issued by the SEC during 1982–1989,
Feroz et al. (1991) report that over 70% of the AAERs in their sample resulted from implementation decisions​F​pre-
mature revenue recognition and delayed inventory write-offs of inventory. Similarly, Palmrose and Scholz’s (2000)
analysis of restatements during 1995– 1999 finds that 44% involved purely technical implementation issues (e.g.,
restructuring charges, in-process research and development adjustments).
Another external evaluation metric of financial reporting outcomes is allegations made in class action lawsuits
alleging defective financial reporting. In their analysis of the allegations made in 103 private securities class action
lawsuits during 1988–1991, Francis et al. (1994) find that the majority of plaintiffs’ assertions about bad accounting
choices relate to judgments involving revenue recognition, inventory and other asset valuation, and loan loss
provisions; in only two cases did plaintiffs allege non-GAAP practices.​2
The results of these studies have at least two implications which bear on FLV’s discussion. First, they suggest that
it is not choice of rules or treatments within GAAP (such as LIFO versus FIFO) that shareholders, or parties
presumptively acting in the interests of shareholders, find troublesome; rather it is the judgments that managers make in
implementing GAAP that are problematic. Thus, one implication is that researchers should focus less on accounting
method choice and more on implementation decisions. I elaborate on this issue in Section 4.
The second implication of these studies pertains to FLV’s call for research on the ​consequences o​ f accounting
choice. The research on AAER’s and class action litigation bears directly on the ​costs of bad a​ ccounting
implementations, and suggests that quantifying the adverse effects of bad accounting (e.g., shareholder, bondholder and
possibly taxpayer losses; increases in the cost of capital or loss of access to the capital markets) might be an appropriate
extension of this literature. Arguably, managers and others are probably more interested in direct and objective
measures of the ​benefits of g​ ​ood ​accounting

2​
St. Pierre and Anderson’s (1984) and Lys and Watts’ (1994) finding that overstatements of ​assets and revenues are the most frequently alleged
manipulations in their samples of lawsuits against auditors is consistent with this conclusion. These studies do not, however, distinguish between
alleged manipulations due to non-GAAP practices versus those attributable to the exercise of within-GAAP discretion.
J. Francis / Journal of Accounting and Economics 31 (2001) 309–319 ​314

implementations. Identifying benefits has proven more difficult than identifying costs (see, for example, Botosan,
1997).

4. Implementation decisions versus method choice decisions

4.1. Responses to the recommendation that researchers focus on implementation decisions

A focus on implementation decisions can take either an aggregated or a disaggregated approach. The aggregated
approach is perhaps best exemplified by the significant body of work examining discretionary and non-discretionary
accruals. The disaggregated approach features a focus on individual account- ing items known to require substantial
managerial judgment and to have a significant impact on reported profitability (e.g., loan loss reserves in banks
(Wahlen (1994), among others) and revisions of claim loss reserves among property-casualty insurers, Petroni (1992)).
The aggregated approach has the advantage, in FLV’s framework, of considering multiple choices or at least the
aggregated outcomes of multiple choices. The disadvantages of this approach, discussed in detail by FLV, include
limitations of models used to detect accrual manipulation and limitations of the ability of the accruals approach to
address the portfolio of accounting choices that managers make.
The disaggregated approach has the potential advantage, in FLV’s frame- work, of yielding precise directional
predictions based on the researcher’s understanding and analysis of how decision makers trade off the incentives
associated with the accounting object of study. The approach also has the advantage of responding to FLV’s suggestion
that researchers use their accounting expertise to refine research designs on accounting choice. A good example of the
application of expertise and the disaggregated approach is Miller and Skinner’s (1998) investigation of deferred tax
assets. These authors examine managers’ deferred tax valuation allowances to distinguish whether these estimates are
more consistent with the intent of SFAS No. 109 (an implementation predicted by FLV’s information asymmetry
motivation), with loosening leverage-related constraints (an implementation predicted by FLV’s agency cost
motivation) or with income smoothing (an implementation predicted by a variant of FLV’s information asymmetry
motivation).
The disaggregated approach also has the disadvantage, in FLV’s framework, of providing a piecemeal,
one-choice-at-a-time analysis. I believe that FLV’s assessment of this approach​F​as opposed to the way researchers have
implemented this approach​F​is unduly pessimistic. That is, I think the disaggregated approach can be used to amass, one
study at a time, a set of empirical regularities that, taken together, provide a general set of results and
J. Francis / Journal of Accounting and Economics 31 (2001) 309–319 ​315

insights. However, since accounting researchers do not always make the effort to articulate, carefully and thoroughly,
the extent to which they believe their results are generalizable and to provide a context for both their study and its
results from the existing literature, readers of this literature can easily come away with the impression of a disjointed
series of fragmented and inconclusive studies.

4.2. Responses to the recommendation that researchers focus on choices among​ ​accountin​g ​rules

FLV also suggest a re-consideration of research designs that explicitly consider multiple accounting rules, along the
lines of those used by Hagerman and Zmijewski (1979) and Hagerman (1981). One recent study which takes such an
approach is Bowen et al.’s (2000) examination of inventory and depreciation method choices in 1984, 1990 and 1996.
They consider 19 explanatory variables drawn from two decades of research, and conclude that the explanatory power
of the variables, as a group, is 23–27%, with industry membership adding another 5–10%. Bowen et al.’s conclusion is
far less pessimistic than FLV’s, in that they conclude, ‘‘Our analysis of the economic determinants of accounting
method choice demonstrates that considerable progress has been made in the last 20 years.’’ Perhaps one reason for
Bowen et al.’s relatively more optimistic conclusion is their focus on the literature as a whole (they choose their
explanatory variables from those used in previous research) and not on large and small inconsistencies among
individual studies. As US GAAP features relatively few free choice accounting alternatives, it is possible that FLV’s
suggestion for more research on choices among accounting rules would be most effectively implemented in
international settings. Some International Accounting Standards (IAS), for example, explicitly offer both a benchmark
treatment and an allowed alternative. Consistent with the view that research on the choices among allowed alternatives
under IAS would be of interest to external evaluators of financial reporting outcomes, an August 15, 1999 letter from
SEC Chief Accountant Lynn Turner to the American Accounting Association invited research on firm characteristics
associated with choices among the alternatives provided by IAS, and the frequency with which these alternatives are
chosen.​3

5. Taxonomy of accounting choice literature

In the revised version of the paper, FLV separate studies of accounting choice, based on the primary motivation for
accounting choice examined by
 3​
This letter is available at the SEC’s website: www.sec.gov/news/extra/aaacall.htm
J. Francis / Journal of Accounting and Economics 31 (2001) 309–319 ​316

the research: agency costs, information asymmetries and third party contract- ing. The authors use this classification
scheme because they believe that ‘‘there are greater similarities among the problems and their solutions within each
category than there are across categories’’ (page 3). I agree that FLV’s taxonomy provides a useful organizing
mechanism for an apparently diverse literature. The authors’ rationale for their choice of taxonomy led me to expect,
however, that they would synthesize and evaluate the results of research studies within a given category to judge the
weight of the evidence. I was surprised, therefore, that the authors did not provide more aggressive interpretations about
what we learn from a set of studies addressing any single motivation, and instead expressed reservations about the lack
of explicit consideration of other motivations. In addition, while they provide separate summaries of studies that focus
on a single motivation and studies that consider multiple motivations, FLV do not discuss what are the key features that
distinguish the two types of research (e.g., nature of research question, research designs, data availability). Since an
understanding as to why some researchers have succeeded in considering multiple motivations or trade-offs while
others have not is missing, it is not clear how best to respond to FLV’s call for more ambitious treatments of
motivations.
The revised version of the paper contains a one-way classification scheme based only on motive. In the previous
conference version of the paper, FLV suggested a two-way partitioning of the accounting choice literature research
based on both motivation and the type of choice examined. FLV’s definition of accounting choice and their conclusions
about the lack of research examining portfolios of accounting choices suggest that they believe that the motive for
selecting among the types of accounting choices is an important and interesting question. For example, are certain types
of accounting choices the best or even perhaps the only way to achieve certain motives?
In the conference discussion, participants asked whether in the absence of a specific context, the authors could rank
managers’ preferences about the types of accounting choice? By ranking, participants meant ordering, ex-ante, the
forms of accounting choice from most to least effective in achieving the desired objective, taking account of the
possibility that the most direct and simple choices may not be the most successful if shareholders, regulators or third
party contractors can easily see through or unravel these decisions. That is, while switching from LIFO to FIFO might
achieve a desired financial reporting result quickly, the visibility of a change in a hard accounting choice may make
such decisions less successful at achieving an outcome that requires some degree of financial reporting opaqueness.
The over-riding conference sentiment was that, in the absence of a decision context, no such ranking was possible
and that even with a context, informed and reasonable persons might disagree with which type of accounting choice
would be most preferred. Notwithstanding such disagreements, participants
J. Francis / Journal of Accounting and Economics 31 (2001) 309–319 ​317

seemed to agree that research that used some industry context or institutional knowledge to refine the research
design​F​for example, by focussing attention on a specific type of accounting choice​F​was more likely to improve our
understanding of the economic determinants and consequences of accounting choice.​4 ​Examples of studies that use
context to isolate a particular motivation for or consequence of accounting choice include Jones’ (1991) study of
income- decreasing accrual manipulations by firms seeking import relief, the Beatty et al. (1995) and Collins et al.
(1995) papers on earnings management by banks, and Bartov’s (1993) analysis of asset sales. Examples of studies that
use institutional knowledge to refine a research design include McNichols and Wilson’s (1988) analysis of the
provision for bad debts and Francis et al.’s (1996) examination of asset write-offs conditional on the differential
flexibility in measuring and recognizing asset values provided under GAAP.

6. FLV’s conclusions
 FLV conclude that there has been, at best, modest progress in understanding the motivations for and consequences
of accounting choice, with the rate of progress slowing in the last decade. They have three major concerns. First, studies
fail to provide direct evidence of the implications of accounting choice; in particular, the authors call for more evidence
on the costs and benefits of alternatives. Second, researchers inappropriately examine one choice, or motivation for
choice, to the exclusion of others. Third, researchers have made limited progress in improving research designs and
methods.
It is hard to argue with these criticisms, particularly, since the authors support them with detailed discussions from
the literature. However, I do not interpret FLV’s criticisms of the accounting choice literature as a negative signal about
this research area. In my view, their critique should be read not as a list of shortcomings and faults but rather as a
thoroughly supported and insightful discussion of pointers to research opportunities. This is particularly true in cases,
such as the discussion of multiple motivations, where the authors describe approaches taken by researchers to address
one of their concerns.
Turning now to the authors’ specific recommendations, it is again hard to argue with the statement that accounting
choice research would benefit from better theoretical models. A second recommendation, that researchers use more and
deeper accounting expertise in designing studies, seems not only particularly relevant for the accounting choice
literature, but also requires the researcher to balance the benefits of accounting specificity (which implies studying one
decision at a time) against the benefits of broad measures (which

4​
Research on earnings management reached a similar conclusion. See, for example, Guay et al. (1996)
​ and Dechow et al. (1995).
J. Francis / Journal of Accounting and Economics 31 (2001) 309–319 ​318

implies studying the aggregate outcomes of many decisions). Perhaps the most intriguing of the recommendations is the
suggestion that researchers attempt to calculate, ex post, the benefits or costs of accounting choices. While research
based on motivations links ex ante or expected benefits to choice, it is certainly of interest to learn whether the choices
had the desired effects.

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