Impact of accounting choices on firm valuation and earnings quality : The case of transition obligation under SFAS 106

Purpose – The purpose of this paper is to examine whether the choice of accounting treatment of transition obligation under SFAS 106 affects the value of firms, and also whether the quality of earnings is improved after the implementation of SFAS 106. Design/methodology/approach – Different regression models were employed on a sample of 50 immediate recognition firms and 50 matched prospective recognition firms. Chow test is also used to investigate the quality of earnings before and after the implementation of SFAS 106. Findings – In spite of the significant difference in impact on earnings from the choice of treatment of transition obligation, the accounting choice has no significant impact on the total value relevance of earnings and book value. When immediate recognition method is applied, investors ignore the one‐time charge of transition obligation, and rely more on book value in the valuation of a firm. However, when prospective recognition method is applied, both earnings and book value are value‐relevant in the adoption year and also in the subsequent year. In addition, the paper finds that the implementation of SFAS 106 improves the value relevance of earnings. Research limitations/implications – Results are limited by the accuracy of the models used to measure value relevance of earnings and book value of equity. Practical implications – Results may have implications for managers' choice of accounting treatment, and the evidence seems to support accrual basis over cash basis on earnings measurement. Originality/value – The paper uses the value relevance approach to analyze the impact of SFAS 106 on the quality of earnings and book value of equity.