Dissecting Earnings Recognition Timeliness

48 Pages Posted: 15 Apr 2011 Last revised: 21 May 2013

Ryan T. Ball

The Stephen M. Ross School of Business at the University of Michigan

Peter D. Easton

University of Notre Dame - Department of Accountancy

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Date Written: May 2013

Abstract

We dissect the portion of stock price change of the fiscal year that is recognized in reported accounting earnings of the year. We call this portion earnings recognition timeliness (ERT). The emphasis in our dissection is on empirical identification of two fundamental precepts of financial accounting: (1) the matching principle, which is manifested in the recognition of expenses in the same period as the related benefits (i.e., sales revenue) accrue; and, (2) recognition of expenses in the current period due to changes in expectations regarding earnings of future periods (we refer to these expenses as the expectations element of expenses). Although the expectations element has implicitly been at the core of much of the recent empirical literature on asymmetry in the earnings/return relation, it has not been explicitly identified. This recent literature is based on the premise that bad news about the future leads to more recognition of expenses in the current period (such as write-downs) whereas good news about the future tends to have a much lesser effect on expenses of the current period; asymmetry in the expenses/return relation is captured implicitly via the observation of asymmetry in the earnings/return relation (i.e., asymmetry in ERT). Since the ERT reflects the relation between sales revenue and returns, matched expenses and returns, as well as the relation between the expectations element of expenses and returns, a focus on the expectations element may lead to sharper inferences. Our straightforward empirical procedure permits a focus on this element.

Suggested Citation

Ball, Ryan T. and Easton, Peter D., Dissecting Earnings Recognition Timeliness (May 2013). Chicago Booth Research Paper No. 11-18. Available at SSRN: https://ssrn.com/abstract=1808988 or http://dx.doi.org/10.2139/ssrn.1808988

Ryan T. Ball (Contact Author)

The Stephen M. Ross School of Business at the University of Michigan ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

Peter D. Easton

University of Notre Dame - Department of Accountancy ( email )

Mendoza College of Business
Notre Dame, IN 46556-5646
United States
574-631-6096 (Phone)
574-631-5127 (Fax)

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