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- Title
Warranty Reserve: Contingent Liability, Information Signal, or Earnings Management Tool?
- Authors
Cohen, Daniel; Darrough, Masako N.; Rong Huang; Tzachi Zach
- Abstract
We examine the information role of accounting disclosures on warranties, utilizing a database that became available due to the requirements of FIN 45. First, because firms use warranty policies as a business strategy to promote their products, a warranty reserve can serve two roles: an information signal regarding product quality, as well as a contingent liability. Consistent with this view, we find that the stock market recognizes that: (1) the warranty reserve contains information about firms' future performance, and (2) the reserve is a liability. Second, because warranty accruals require estimation of future claims, they can be used as a tool of earnings management. Our evidence indicates that managers use warranty accruals to manage earnings opportunistically to meet earnings targets. Finally, we find that the stock market recognizes the understatement of warranty liabilities of firms that managed earnings.
- Subjects
DISCLOSURE; FINANCIAL disclosure; WARRANTY; ACCRUAL basis accounting; CORPORATE finance; CORPORATE accounting; MANAGEMENT
- Publication
Accounting Review, 2011, Vol 86, Issue 2, p569
- ISSN
0001-4826
- Publication type
Article
- DOI
10.2308/accr.00000021