Further evidence of earnings management and opportunistic behavior with principles-based accounting standards: The case of conditional asset retirement obligations

FASB Interpretation No. 47 (FIN 47) clarifies the diverse accounting practices for conditional asset retirement obligations (CAROs) that arose under SFAS No. 143, which is classified as a principles-based standard by the SEC. Prior research suggests that the subjectivity in SFAS No. 143 provides management with the opportunity to manage earnings and avoid the recognition of CAROs. This study examines firms that recorded adjustments for CAROs upon FIN 47 adoption. We demonstrate that effective monitoring is essential to promote adherence with principles-based standards, and that gatekeepers may not be effective when standards are ambiguous. Univariate tests and logistic regressions reveal that FIN 47 adopters have audit committees with a greater number of financial experts and are audited by BIG 4 firms. Particular firm-specific factors are also found to be associated with the adoption decision. The results also indicate that newly-reported obligations related to asbestos in firm-owned property and restoration costs for leased premises were subject to prior management discretion. This study extends existing literature on SFAS No. 143 and FIN 47 and studies examining earnings management with principles-based standards. The case of FIN 47 provides further evidence that significant opportunities for earnings management and discretion exist within a principles-based accounting environment, particularly when standards lack clarity. It also confirms the critical role of monitoring by the audit committee and external auditors to promote adherence with the substance of such standards. (c) 2011 Elsevier Inc. All rights reserved.