Accrual Accounting for Performance Evaluation

Abstract

This paper examines alternative accrual accounting rules from an incentive and control perspective. For a range of common production, financing and investment decisions we consider alternative asset valuation rules. The criterion for distinguishing among these rules is that the corresponding performance measure should provide managers with robust incentives to make present value maximizing decisions. Such goal congruence is shown to require intertemporal matching of revenues and expenses, though the specific form of matching needed for control purposes generally differs from GAAP. The practitioner oriented literature on economic profit plans has made various, and at times conflicting, recommendations regarding adjustments to the accounting rules used for external financial reporting. Our goal congruence approach provides a framework for comparing and evaluating these recommendations.

Keywords: Managerial performance measures, accrual accounting, incentive contracts, economic theory, economics of organizations, cost

JEL Classification: M40, M41, M46, G31, G39, C12, C21, C23