Imperfect Accounting and Reporting Bias

59 Pages Posted: 6 Apr 2015 Last revised: 12 Oct 2018

See all articles by Vivian W. Fang

Vivian W. Fang

University of Minnesota - Twin Cities - Department of Accounting

Allen Huang

Hong Kong University of Science and Technology - Department of Accounting

Wenyu Wang

Indiana University - Kelley School of Business - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: August 7, 2015

Abstract

Accounting is imperfect, leading to errors in financial reporting. This paper links accounting errors to firms’ incentives to bias reported earnings. We hypothesize that while errors discourage reporting bias by lowering earnings’ value relevance, they also incentivize bias by providing camouflage. Consistent with the counteracting effects, we document a hump-shaped relationship between an industry’s incidences of intentional and unintentional misstatements, our primary proxies for reporting bias and errors. This finding is robust to using several alternative proxies. To further validate the two effects, we show that, when errors are more prevalent, the market reacts less to firms’ earnings surprises, and fraud is more difficult to detect. Our findings highlight the imperfectness of accounting and shed light on accounting standard setting.

Keywords: Financial Fraud; Accounting Errors; Restatements; Earnings Response Coefficient; Fraud Detection; Principles-Based Accounting Standards; Rules-Based Accounting Standards

JEL Classification: G32; G34; G38; M40; M41; M48; M53

Suggested Citation

Fang, Vivian W. and Huang, Allen and Wang, Wenyu, Imperfect Accounting and Reporting Bias (August 7, 2015). Kelley School of Business Research Paper No. 15-29. Available at SSRN: https://ssrn.com/abstract=2590155 or http://dx.doi.org/10.2139/ssrn.2590155

Vivian W. Fang (Contact Author)

University of Minnesota - Twin Cities - Department of Accounting ( email )

321 19th Avenue South
Room 3-109
Minneapolis, MN 55455
United States

HOME PAGE: http://www.vivianfang.org

Allen Huang

Hong Kong University of Science and Technology - Department of Accounting ( email )

LSK Business School Building
HKUST
Clear Water Bay, Kowloon
Hong Kong
+852-23587559 (Phone)

HOME PAGE: http://www.AllenHuang.org

Wenyu Wang

Indiana University - Kelley School of Business - Department of Finance ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

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