The implications of research on accounting conservatism for accounting standard setting

This paper provides a commentary on the academic literature on accounting conservatism with a view to highlighting the insights of that literature that are potentially useful for accounting standard setters. We begin by introducing the basic concepts of conservatism focusing on the distinction between conditional and unconditional conservatism. We then briefly discuss the objectives of financial reporting and the economics of information, paying particular attention to the role of stewardship in the Conceptual Framework, and the economic concepts of adverse selection and moral hazard. The two middle sections of the paper provide overviews of, respectively, the theoretical and empirical literatures on accounting conservatism. Having summarised the theoretical and empirical literatures, we then try to synthesis the implications of the literature for standard setters, paying particular attention to understanding the costs and benefits of conservatism, implications for the Conceptual Framework, highlighting the particular demands of public debt markets for conservatism, and explaining how accounting standards might be adapted to allow some degree of flexibility in conservative accounting choice. The final section discusses the limitations of the academic literature from the practical point of view of standard setters, and highlights areas for new research that may be of more direct value for policy-making.