The Effects of Principles-Based Accounting Standards on Accounting Quality

Abstract

We investigate the accounting quality effects from implementing four accounting standards, which contain key elements of a principles-based accounting system. Consistent with the definitions for assets and liabilities in the conceptual framework, the FASB's approach to standard setting has recently focused on the balance sheet. We therefore examine the influence of four major balance sheet-oriented accounting standards on accounting quality. We provide evidence that forecast error, forecast dispersion, and the explanatory power of a valuation model are positively affected by the balance sheet accounting standards - especially with respect to pensions and other post-retirement benefits. Increasing accounting quality based on analyst forecast measures is documented even in the presence of expected increased earnings volatility. These results are consistent with benefits to analysts and investors from the new information provided by the accounting standards. Thus, we provide evidence based on existing standards that can be used to assess the merits of a principles-based model for future standard setting.

Keywords: Accounting standards, principles-based, accounting quality

JEL Classification: M41, M44, G12, G29