From the income statement model to the balance sheet model: an empirical analysis on the impact on SMEs’ earnings quality

This paper analyzes how the switch in progress from the income model (i.e., the revenue/expense approach) to the balance sheet model (i.e., the asset/liability approach) impacts on SMEs’ earnings quality. We develop our analysis by comparing the earnings quality of Italian GAAP firms (whose financial reporting model is closer to the income model) with that of the voluntary Italian IAS/IFRS adopters (clearly adopting a balance sheet model). In order to address major methodological concerns typically characterizing these investigations (self-selection bias or identification problem), we adopt a particular research design based on a single-country analysis and on a set of three different samples of Italian SMEs: i) incentivized firms voluntarily adopting IFRS; ii) incentivized firms adopting Italian-GAAP (firms participating to the Elite programme); iii) non-incentivized firms adopting Italian-GAAP. Our results show that, regardless reporting incentives, the income model (i.e., Italian-GAAP firms) shows systematically better results in terms of earnings quality and earnings management than the balance sheet model (IFRS firms), thus confirming recent theoretical arguments supporting this view.