Do Modified Retrospective Transitions Facilitate Earnings Management? Evidence from ASU 2016-13

ABSTRACT

This paper considers two related earnings/capital management opportunities available to banks as they transitioned to ASU 2016-13. Under the FASB’s transition guidance, banks estimate credit losses under the new standard and take the initial adoption adjustment (IAA) directly into retained earnings. Shifting pre-adoption provision accruals to their IAA buckets enables banks to increase their reported income in the period before adoption while avoiding regulatory scrutiny, since their allowances are increased promptly. Consistent with this hypothesized behavior, we find that banks making timely adoptions of ASU 2016-13 on 1/1/2020 reported more negative abnormal provision accruals in 2019 than nonadopting banks. Negative abnormal provision accruals in 2019 were associated with larger IAAs in Q1 of 2020. We also formulate and test competing hypotheses about banks’ decisions to delay adoption under the CARES Act (U.S. Congress 2020). We find that adoption delays are associated with size-related adoption challenges rather than earnings management.

Data Availability: Data are available from the public sources cited in the text.

JEL Classifications: M42; G21.