Changes in accounting estimates: An update of priors or an earnings management strategy of “last resort”?

Evidence from prior research is mixed about whether accounting estimate changes are strategically motivated, on average, or whether they reflect new or updated information. To interpret this difference, we investigate, by category of material changes in accounting estimates, the association between estimate changes and subsequent restatements. We also explore the determinants of both income-increasing and income-decreasing estimate changes for different categories of estimate changes. We find that the motivations for and the determinants of estimate changes depend on the type of change and on whether the changes in estimates are income-increasing or income-decreasing. Overall, we conclude that when companies are motivated to bias earnings and they cannot do so by manipulating other within generally accepted accounting principles (GAAP) accruals, they sometimes resort to using estimate changes. Our more detailed investigation of estimate changes at the account level suggests a more nuanced view of the determinants of changes in accounting estimates. We develop a more complete model of the determinants of changes in accounting estimates than those used in this emerging literature, which should be of interest to accounting academics, regulators, audit practitioners and audit committee members.