Inflation and the Effect of Reporting Nominal Components of Accounting Estimates on Financial Statement Users' Valuation Judgments

53 Pages Posted: 27 Oct 2020 Last revised: 12 Jul 2023

See all articles by Spencer B. Anderson

Spencer B. Anderson

Indiana University - Kelley School of Business - Department of Accounting

Leslie D. Hodder

Indiana University - Kelley School of Business - Department of Accounting

Patrick E. Hopkins

Indiana University - Kelley School of Business - Department of Accounting

Date Written: July 7, 2023

Abstract

Financial reports help investors make capital allocations by providing information about the amount, timing, and uncertainty of future cash flows. However, inflation adjustments are largely absent from published financial statements, and prior research suggests investors underweight inflation risk in their valuations. We examine the extent to which characteristics common to financial reporting influence the likelihood financial statement users underweight effects of inflation in their valuation judgments. In a stylized experiment, we find that increasing the prominence of separately labeled changes in the cash flow and discount rate components of fair values increases investors’ underweighting of the inflation-affected discount rate component. In a second experiment, we provide evidence that accounting rules requiring separation of cash flow and discount rate components of accounting estimates diminish the quality of investors’ valuation judgments with respect to inflation. Collectively, our results suggest deemphasizing disaggregation of fair value components can help investors more properly incorporate inflation into their valuation judgments.

Keywords: Fair Values, Money Illusion, Inflation, Financial Securities, Cash Flow, Discount Rate

JEL Classification: M40, M41, E03, G11, G02

Suggested Citation

Anderson, Spencer B. and Davis Hodder, Leslie D. and Hopkins, Patrick E., Inflation and the Effect of Reporting Nominal Components of Accounting Estimates on Financial Statement Users' Valuation Judgments (July 7, 2023). Available at SSRN: https://ssrn.com/abstract=3688524

Spencer B. Anderson (Contact Author)

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

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

Leslie D. Davis Hodder

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

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

Patrick E. Hopkins

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

Kelley School of Business
1309 E. 10th Street
Bloomington, IN 47405
United States
812-855 2617 (Phone)
812-855 8679 (Fax)

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