Examining the timing of alternative accounting treatments to assess their influence on conservatism

This paper carries out a quantitative comparison of accounting differences between Italian reporting practice and United States generally agreed accounting principles (US GAAP) with the purpose of examining how alternative accounting treatments impact on the level of conservatism. The analysis investigates the accounting adjustments applied to net income and shareholders’ equity as included in the Form 20-F reconciliation reported by Italian firms to the Security Exchange Commission (SEC). The methodology first introduced by Gray (1980) is adapted to recognize a multi-period dimension of the accounting choice. In particular, by focussing on the timing of such adjustments – that is their attitude to reverse or become permanent over time – we develop hypotheses based on the interaction of three factors: clean vs dirty-surplus accounting, recurring vs non-recurring operations, long-term vs short-term assets and liabilities. The results are consistent with our general thesis that the level of conservatism is fundamentally measured by the prevailing directional effect of permanent accounting adjustments. Such adjustments arise and intensify when the accounting differences relate to long-term assets and liabilities that are recurring. Amongst them those stemming from the violation of the clean surplus relation are the most controversial for they generate an opposite permanent effect in the measurement of both net assets and earnings.