To manage or reserve accruals? Evidence from a balanced-budget requirement reform

IMPACT

Discretion in the financial reporting process can help reveal private information to external parties; it can also be used to avoid disclosing information that makes agents vulnerable to criticism—especially under strong political incentives to avoid transparency. This must be taken into account by higher levels of governments when designing and implementing balanced-budget requirements tied to financial reporting figures produced on an accrual basis, as well as by other stakeholders using accrual-based information for monitoring purposes.

ABSTRACT

In 2013, an accounting reform permitted Swedish municipalities to voluntarily adopt a system with accrual reserves that was designed to increase flexibility in meeting budget requirements and decrease regulatory incentives to engage in earnings management. However, since a system with accrual reserves imposes potentially undesirable transparency from the perspective of politicians, it is unclear whether the (regulatory) benefits of adopting accrual reserves are perceived to exceed the (political) costs. The authors found that municipalities with higher levels of earnings management were less likely to adopt a system of accrual reserves, and they attribute this to political incentives to avoid transparency.

KEYWORDS:

• Accrual accounting
• balanced-budget requirement
• earnings management
• incentives
• municipalities
• public sector
• regulatory incentives
• political incentives

Disclosure statement

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