1 Amsterdam Business School Faculty of Economics & Business The Matching Principle and its Influence on Lobbying Behaviour – A case of the Revised Proposal to Revenue Recognition Master Thesis Master of Science (Accountancy & Control) Academic Year 2013 / 2014 Final Version Paul Walker 10605401 Supervisor: Dr. S.W. Bissessur Second Supervisor: Dr. I.R. Sander Van Triest 2 Abstract In May 2014, the FASB and IASB jointly released the long awaited revised standard on recognizing revenue. However, before this release there was an extensive period that allowed for comment and opinion on the proposals. These comments, a form of lobbying, form an integral part of the standard-setting process. This paper focusses on these comment letters, and attempts to analyse the issues and concerns that the respondents who sent in comment letters have about the proposed standard. In particular, we want to see how the shift in the approach to financial reporting and its effect on the matching of revenue and expenses will influence a firm’s decision to lobby against the standard. By using a mixed-method approach, this paper finds that there are seven key themes that are widespread throughout the comment letters with two of these themes indirectly referring to the matching concept. Empirically, we also examine differences between firms who chose to submit a letter with a matched sample that did not submit a comment letter. In particular, we find that there are differences in earnings characteristics between these two sets. While this paper does not examine the direct effects of the new standard, it does offer an indication of which firms are going to be most affected. More interesting, however, is that these results offer a clue in to which type of firms are more likely to lobby against a proposed standard, and the characteristics that these firms possess. Key Words IFRS, Standard Setting, Lobbying, Matching, Revenue Recognition, Due Process, Earnings, Volatility, Persistence, IASB, FASB, Comment Letter, IFRS 15 3 Contents Abstract ...................................................................................................................................... 2 Introduction ................................................................................................................................ 4 Background ............................................................................................................................ 4 Research Question .................................................................................................................. 5 Literature Review....................................................................................................................... 6 The Matching Principle .......................................................................................................... 6 Revenue Recognition ............................................................................................................. 8 IFRS 15 ................................................................................................................................ 10 Standard Setting ................................................................................................................... 13 Lobbying .............................................................................................................................. 14 Comment Letter Thematic Analysis ........................................................................................ 17 Issues Raised ........................................................................................................................ 18 Strength of Comment Letters ............................................................................................... 22 Reference to the Matching Principle .................................................................................... 25 Empirical Hypotheses and Methodology ................................................................................. 27 Hypothesis Development ..................................................................................................... 28 Methodology ........................................................................................................................ 31 Empirical Results ..................................................................................................................... 35 Conclusion, Limitations and Future Research ......................................................................... 41 Bibliography ............................................................................................................................ 46 Appendix I ............................................................................................................................... 49 4 Introduction Background On the 28th May 2014, the FASB and IASB, together, released the long awaited standard on recognizing revenue: Revenue from Contracts with Customers. The standard, subject to endorsement by the European Commission, will become effective for annual periods beginning on or after 1st January 2017. This has been a project of the FASB and IASB (hereafter the ‘Board’) since 2002, thereby taking nearly twelve years for it to come to completion. This revision was a response to the limitations in the previous revenue recognition standards, and the accounting scandals that were a consequence of these limitations. The evolution of the business environment also required that revisions were made to the standards. The old rules were seen as outdated with regard to the complex forms of transactions that have emerged in recent years. One of the key changes to this standard was the approach to which it addressed financial reporting. Whereas before there was a mix of the revenue-expense and asset-liability approach to reporting, this new standard full reflects the asset-liability style. Extant literature on this subject covers the costs and benefits of such an approach, however, one thing that seems unanimous is how this ‘balance sheet’ method of reporting will relinquish the importance of matching expenses with their appropriate revenues. This shift towards the asset-liability approach is widespread throughout the Board’s other projects, and matching certainly seems to no longer be a fundamental concept. Although the ‘Boards’ are predominately the ones in charge of the standard setting procedure, the opinions of all stakeholders need to be considered so that these standard setters can obtain legitimacy. As such, both the FASB and IASB have a ‘due process’ established whereby the concerns, comments, issues and opinions of stakeholders can be deliberated. Despite it being well known that the main goal of accounting standards is to assist investors getting decision useful information, it is widely acknowledged that economic consequences also arise because of these standards. The participation in the standard setting due process can be seen as a lobbying attempt to influence the standard, and have these “non-intended” economic consequences removed. By analysing these lobbying attempts, we can further understand what issues and concerns are underpinned in the proposal. We also want to explore the characteristics of the firms who deem it necessary to lobby against the standard, and whether these characteristics help to explain their decision to do so. 5 This paper takes a look at this due process, and the issues raised by preparers of financial statements in regard to the Revised Exposure Draft on Revenue Recognition. This was the second Exposure Draft that was published for this standard, and was released in January 2011 after amendments were made to it following comments made in the due process. In particular, we take a look at the matching concept, and how the issues raised in the due process reflect this concern. Using a model by Dichev & Tang (2008), we use earnings characteristics that are shaped by the level of matching to explore which firms are lobbying against the standard, and which are not. Using assumptions based on cost benefit analyses, the essence of our predictions is that firms who currently benefit the most from ‘better aligned’ matching have more to lose as standards no longer see matching as an important concept. We qualitatively assess the issues, reasoning’s, effects and solutions of the revised Exposure Draft to Revenue Recognition to identify the key themes that are reoccurring. Using this qualitative analysis, we then empirically test to see if there is a difference in earnings characteristics between firms who lobby, and firms who do not. Subsequently, we test to see if there is a difference in earnings characteristics between the firms who did lobby, based on the arguments and issues that they made in their response. Research Question The overarching theme of this paper is to understand the concerns that preparers have with the proposed standard to recognizing revenue, and how (if at all) these issues can be related to the matching concept. Previous literature suggests that matching is becoming less of a priority, and the benefits of good matching will consequently be diminished as a result of change of priority. By understanding the issues, we can then explore which firms are most concerned about the possible changes to the matching of revenues and expenses, and what is unique about these firms? What are the characteristics that make some firms concerned, but yet make other firms not concerned? In particular, we use previous