Constructive Obligations, Past Practice, and Financial Statement Users' Beliefs about Non-Contractual Liabilities
48 Pages Posted: 5 Jun 2020 Last revised: 28 Mar 2022
Date Written: March 25, 2022
Abstract
Accounting standards require companies to recognize a liability when a pattern of past practice creates a constructive obligation, but it is not clear whether financial statement users’ beliefs match this perspective. In two experiments, we test whether financial statement users believe that a firm’s past practice gives rise to obligations. Consistent with psychology theory on norms, we find that users do not believe past practice alone is sufficient to create obligations. This finding is supported by both frequentist and Bayesian hypothesis testing, and suggests the broad view of obligations in the Conceptual Framework is not fully aligned with users’ beliefs about obligations. In a third experiment, we test a financial reporting consequence of this lack of alignment and find that recognizing a constructive obligation as a liability changes users’ cash flow forecasts. Our theory and results provide input to standard setters, who struggle with the issue of constructive obligations.
Keywords: liabilities, constructive obligations, financial statement users, accounting standards
JEL Classification: M41, M48
Suggested Citation: Suggested Citation