Method-Shifting in Aggressive Earnings Reporting: The Case of the US Software Industry's Response to New US Regulation

Under rationality, firms should shift to alternative earnings management methods to achieve their earnings management goals whenever the alternatives provide greater benefit. New accounting regulation can alter the net benefit derivable from existing earnings management methods and thus may provide the impetus for method-shifting. This study investigates whether firms circumvent regulatory-imposed restrictions on their use of specific methods for accelerating earnings by shifting to alternative methods. Specifically, the study examines whether the US's adoption of a reporting standard that placed restrictions on the recognition of software revenue prompted US software-firm managers to method-shift to expense components for accelerated earnings reporting. A comparison of discretionary revenue and expense accruals and discretionary R&D expenses before and after the adoption of the standard confirmed a reduction of accelerated revenue recognition after the adoption and supported the hypothesized method-shift to expense components for accelerated earnings reporting. Copyright (c) 2010 Blackwell Publishing Ltd.