Selling-Price Estimates in Revenue Recognition and Earnings Informativeness

March 25, 2013 Leave a comment

Selling-Price Estimates in Revenue Recognition and Earnings Informativeness

Anup Srivastava Northwestern University – Kellogg School of Management

March 15, 2013
Review of Accounting Studies, Forthcoming 

Abstract: 
Revenue is one of the largest and most value-relevant items in firms’ financial statements. Based on the “realizable” and the “earned” criteria of SFAC No. 5 (FASB 1984), revenues should reflect both selling price and timing of delivery. Of those two aspects, selling-price estimates are required for revenue recognition when standalone selling prices for products and services are not available. In this study, I examine the effects of such selling-price estimates on the contracting and informational roles of financial statements. Particularly, I examine the setting of SOP 97-2 (AICPA 1997), which removed software firms’ flexibility to recognize revenues using selling-price estimates. I find that the extent to which firms use revenue accruals to manage earnings declined after SOP 97-2 was implemented. Yet, the overall frequency of earnings management did not decline, indicating that firms shift to alternative modes of earnings management when constrained from using revenue estimates to manage earnings. In addition, I find that the value relevant information contained in earnings declined post-SOP 97-2 implementation. Yet, this information was not entirely lost from financial statements, because the deferred-revenue accounts now contain more value-relevant information than before, and a firm’s topline performance is now better ascertained by analyzing both revenue and deferred-revenue accounts. This study shows that SOP 97-2 implementation did not improve the contracting role of earnings; however, its implementation partly shifted the informational role of financial statements from income-statement to balance-sheet components.

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Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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