The effects of cognitive reflection and work experience on financial statement comparability under principles-based accounting standards

ABSTRACT

This study examines the influence of cognitive reflection and work experience on certified public accountants’ (CPAs’) classifications of assets and cash flows under principles-based accounting standards and, ultimately, on the comparability of the resulting financial statements. We explore the overlapping guidance provided by the International Financial Reporting Standards on audiovisual content (AVC) classifications to experimentally show that CPAs who are high (versus low) in cognitive reflection make less noisy choices when classifying assets and cash flows. CPAs high in cognitive reflection are also more likely than others to recognise cash flows from AVC assets as operational regardless of the asset classification. We also find that experience in listed, large, or audited firms reduces noise in CPAs’ classifications of cash flows, but it is unlikely to affect their classifications of assets.

KEYWORDS:

• Professional judgement
• principles-based accounting standards
• cognitive reflection
• work experience
• financial statement comparability
• vague

ACCEPTED BY:

• Linda Thorne

Acknowledgement

We thank the Brazilian Institute of CPAs (CFC) for inviting professionals to participate in this study, as well as the CPAs who answered the survey. We also thank the Editor of Accounting Forum Prof. Charles H. Cho, the Associate Editor Prof. Linda Thorne, the two anonymous reviewers, Kathryn Kadous, Alexandre Linhares, José Elias Almeida, and participants of the Graduate Research in Accounting Conference at Emory for helpful comments and suggestions on the previous versions of this manuscript. We also thank the Brazilian National Research Council (CNPq), Rio de Janeiro State Research Foundation (FAPERJ), and Fundação Getulio Vargas (FGV) for financial support for this study. This research was approved by the Ethics Committee of the Conselho Federal de Contabilidade. The views and opinions expressed in this study are our own and are not endorsed by the above institutions.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Data availability statement

The data supporting this study's findings are available from the authors upon request.

Notes

1 The economic magnitude of AVC producers, and the whole media and entertainment industry, is sizable. For instance, BBC, Rai, Globo, Vivendi, AT&T, Comcast, and Netflix generated a total of USD 332.8 billion in revenue and recorded a total of USD 902.4 billion in total assets for the 2020 fiscal year. The thousands of independent producers operating worldwide will likely make the total numbers more significant.

2 The recent update to the relevant US GAAP standards eliminates certain revenue-related constraints to capitalising inventory costs for episodic television. Also, it eliminates balance sheet classification requirements for film production costs and programming inventory. Thus, US GAAP adopters had to reclassify AVC assets as non-current assets. While our study does not focus on the impacts of ASU 2019-02, anecdotal evidence discussed below suggests a reduction in the variability of AVC asset classifications following its implementation.

3 AT&T Group consolidates Time Warner and HBO.

4 Comcast Corporation consolidates NBCUniversal, Comcast Cable, and Sky.

5 In addition, Netflix uses an accelerated basis of amortisation under which 90% of AVC costs are amortised within four years from the month of first availability. AT&T only uses the accelerated method of amortisation for AVC costs associated with advertising-supported networks in circumstances where the initial airing of the programme has more value than subsequent airings. Consequently, AT&T expects to amortise approximately 90% of unamortised film costs for released theatrical and television content within three years from December 31, 2020. Comcast does not disclose any information about the accelerated basis of amortisation of AVC.

6 US GAAP affords comparable classifications of AVC assets, but using different amortisation methods may hamper comparability among US GAAP adopters.

7 Recall that IAS 2 and IAS 38 specify different properties to define inventories and intangible assets, respectively. The puzzle arises because AVC matches properties from both accounting standards. On the one hand, because the license rights to exhibit the produced films are held for sale in the ordinary course of business or in the form of materials or supplies to be consumed in the rendering of services, AVC meets the criteria of IAS 2 for recognition as inventories (IASB, 2016b). On the other hand, because AVC assets are identifiable nonmonetary items without physical substance, they meet the criteria of IAS 38 for recognition as intangible assets (IASB, 2016a). Interestingly, even though IAS 38 excludes “intangible assets held by an entity for sale in the ordinary course of business” from its scope (see Paragraph 3a), the very same IAS 38 lists “motion picture films” as an example of intangible assets (see Paragraph 9). Such illustration seems plausible since the ordinary activities of most (if not all) AVC producers involve both the exhibition of internally generated films (intangible-like asset) and the sale of exhibition rights (inventory-like asset).

8 While inventory and intangible assets (operating activities and investing activities) are the only relevant options in the asset (cash flow) classification tasks in questions 5 (6), we include the irrelevant option property, plant, and equipment (financing activities) as an option in question 5 (6) for the sake of consistency given that we also include irrelevant options in questions 1-4.

9 Considering only participants who provided perfect responses to questions 1–4 (see Figure 1), as explained above, we find that 124 out of 331 participants have PEPF.

10 The asset and cash flow classification tasks and the items assessing work experience and cognitive reflection compose different blocks of questions separated by multiple questions in the interest of the CFC. Consistent with previous research (e.g., Frederick, 2005), the correlation between CR and PEPF is low (ρ < 0.06, p > 0.17).

11 One difference is that the Variability in CPAs’ classifications of AVC assets as PP&E is lower for Higher CR CPAs than for Lower CR CPAs. We also find that the Variability in CPAs’ classifications of AVC assets as PP&E is lower for CPAs with PEPF than those without PEPF. In addition, differences in the Variability of AVC cash flows as Financing activities between the Higher CR and Lower CR groups are not significant in these analyses. Importantly, as previously discussed, we have no predictions for classifications such as PP&E and financing activities and, therefore, differences between these results and our main results are irrelevant to our conclusions.

12 Note that the dependent variable for all models in Table 2 (Operating) is participants’ ratings on a 6-point scale varying from 0 (strongly disagree) to 5 (strongly agree) for the extent to which they agree with the classification of AVC cash flows as operating. Similarly, the independent variable, Inventories, is participants’ ratings on the same scale for the classification of AVC assets and inventories. The variables Higher CR and PEPF and the covariates are defined in previous sections of the paper.

13 See, for instance, https://www.trade.gov/media-entertainment.

Additional information

Funding

This work was supported by Conselho Nacional de Desenvolvimento Científico e Tecnológico [grant numbers 306997/2022-3, 444560/2020-3]; Coordenação de Aperfeiçoamento de Pessoal de Nível Superior [grant number Finance Code 001]; FAPERJ [grant number SEI-260003/003309/2022].