Economic and Industry Determinants of Accounting Method Choice

Abstract

This study synthesizes and extends the prior literature examining economic motives for manager's accounting method choices. First, we present a framework for organizing the economic factors that potentially influence managers' accounting decisions. We apply our framework to examine inventory and depreciation method choices because they are directly observable and have large sustained effects on earnings. Second, we present descriptive statistics on the distribution of these and combined-method choices for the years 1984, 1990, and 1996. Both firm and industry level data show a preponderance of income-increasing methods in each year as well as a trend toward more income-increasing methods over time. Third, we identify 19 independent variables (largely drawn from the past 20 years of research) to explain the inventory, depreciation, and combined-method choices of over 2,000 firms for the years 1984, 1990 and 1996. Taken together, these variables explain a high percentage of the cross-sectional variation in method choices (e.g., adjusted R2 of 23%-27% for combined-method choices). Finally, we add variables that proxy for industry determinants of accounting method choice, which increases total explanatory power to 28%-37% for combined-method choices. Both sets of variables, economic and industry, have incremental explanatory power over the other. Given earlier studies often explained less than 5%, our results suggest that, cumulatively, the accounting literature has made considerable progress in identifying economic factors associated with managers' accounting method choices.