Reporting financial information: An investigation into the effect of digital presentation formats on functional fixation
Erlane K. Ghani, Universiti Teknologi Mara, Malaysia
Fawzi Laswad, MasseyUniversity, Palmerston North, New Zealand**
Stuart Tooley, QueenslandUniversity of Technology, Brisbane, Australia
April 2008
**Corresponding author:
Fawzi Laswad
School of Accountancy
MasseyUniversity
Private Bag 11 222
Palmerston North
New Zealand
Email:
Abstract
This study examines whether, in the reporting of financial information, digital presentation formatsaddress the concern over functional fixation.The literatureindicates that the reporting of financial information either within the financial statements (i.e. recognition policy) orin the notes to the financial statements (i.e. disclosure policy) often creates functional fixation whereusers of financialstatements fail to adjust for differences in accounting policy. This leads users of financial statementsto judgewhat would otherwise beidentical financialsituationsas being different due to the different accounting policies and methodsadopted.
It has been suggested that the use of digital presentation formats may overcome functional fixation. Using an experimental design involving professional public accountants as one group of key decision maker who use financial information, the results show that digital presentation formats do not fully overcome the issue of functional fixation in the processing of financial information. Although the participants were able to identify and extract relevant information, irrespective of whether or not the information was presented within the financial statements or in the notes to the accounts,evidence was found that some degree of functional fixation remainswhenthe participants came to make a final decision based on available information.In general, the resultsindicate current technology may not be able to fully reduce functional fixation in the evaluation of financial information prepared in accordance with different accounting policies and methods.
Keywords: Presentation formats, Recognition versus disclosure, Functional fixation, Digital reporting
1.INTRODUCTION
Decision-makers are motivated to optimise their decision-makingperformance and the efficacy of the decision-making process is often dependent on the nature and content of the information provided(Libby and Lewis, 1977; 1982).However, it is generally acknowledged that decision-makers have limited ability when it comes to the processingoflarge quantities of data. The way in which information is presented (i.e. presentation format) has been proposed as a possible solution enabling a more efficient and effective decision-making process (Libby and Lewis, 1982; Rohrman, 1986; Maines, 1995).
Within the accounting context, the recent emergence and expansion of digital technology has had a significant impactin the wider dissemination of financial information and reports (Lymer and Tallberg, 1997; Lymer, 1999; Ashbaugh et al., 1999; Anderson, 2000; Oyelere et al., 2003; Smith, 2003; Fisher et al., 2004; Hodge and Pronk, 2006). The new reporting technology provides opportunity for accounting report preparers to extend their reporting medium beyond the traditional hard-copy print-based format to include alternative forms of digital reporting which has seen presentation formats evolve from the tabular and graphical to more sophisticated formats such as Portable Document Format (PDF), Hypertext Mark-up Language (HTML) and Extensible Business Reporting Language (XBRL). Such alternative forms of presentation are also seen to promote greater transparency in financial reporting (Beattie and Pratt, 2003; Hodge et al., 2004).
One of the key issues in financial reporting and standard-setting is whether accounting report users are able to adjust for differences in accounting methods and policies including whether an economic event is recognised within the financial statements or disclosed by way of note to the financial statements. Studies have shown that the placement of financial information (i.e. accounting policy of ‘recognition’ or ‘disclosure’) in the financial report often creates functional fixation whereby users are unable to adjust for differences in accounting methods (Sami and Schwatz, 1992; Barth, 1994; Hopkins, 1996; Hirst and Hopkins, 1998; Maines and McDaniel, 2000; Luft and Shields, 2001; Hodge et al., 2004).
Using an experimental design,this study examineswhetherdigitalpresentation formats, in contrast to the traditional print-based form of reporting,can minimise the occurrence of functional fixation and thereby assist financial report usersadjust for differences in the placement of key financial information.To this end, this study adapts the work of Hodge et al. (2002; 2004)who examined the interaction of presentation formats and functional fixation in the context of the reporting of stock compensation options either within the financial statements (i.e. recognition policy) or as a note to the accounts (i.e. disclosure policy). This study responds to a call from Hodge et al for similar research to be conducted in other accounting contexts.
The focus of the empirical component of the research reported in this paper is on the accounting for investment property under alternative accounting methods. The accounting standard on investment property (IAS 40) allows a change in value to be accounted for in one of two ways: either the investment property is revalued and the asset reported in the balance sheet at its market value and the resultant gain or loss recognised in the income statement (i.e. Fair value model), or the investment property remains reported in the balance sheet at cost and adisclosure of change in fair value provided in the notes to the financial statements (i.e. Cost model).Using three different forms of digital reporting technologies (i.e. PDF, HTML and XBRL)[1], an experiment is undertaken to determine if one or more digital presentation formats is used more effectively by the participants to extract and integrate key financial information, irrespective of its placement, in their investment decision-making process.
The remainder of this paper is structured as follows. Section 2 provides a literature review on the relevance of presentation formats and the link between presentation formats, placement of information (i.e. financial statement recognition or notes to the financial statements disclosure) and information processing. Section 3 provides the research framework and hypotheses. Section 4 outlines the research method and the results are presented in section 5. A discussion of the findings and their implications for financial reporting are provided in the last section.
2. LITERATURE REVIEW
Psychological studies portraydecision-makers, due to their human form, as “intellectual cripples, limited in their capacity to think, and biased by cognitive processes that interfere with rational decision-making. They are oversensitive to variables that are not included in normative theories and under sensitive to variables that are. They become more variable when given more information and increase their confidence in the accuracy of their judgements when they should not” (Ebbesen and Konecni, 1980, p.21).An extension of this view, would suggest thatdecision-makers are therefore prone to making unreliable, inconsistent and sub-optimal decisions (Ashton, 1981) and, notably,will often seek ways to perform a decision-making task with minimum cognitive effort (Newell and Simon, 1972).
The limitation of humans as processors of information can be exacerbated in tasks involving, for example, large quantities of data (Rohrman, 1986) and the placement of information (Kozminky, 1977; Chi et al., 1981; Bernard and Schipper, 1994; Hopkins, 1996; Hirst and Hopkins, 1998; Mainesand McDaniel, 2000; Libby et al., 2002; Hodge and Pronk, 2006). Decision-makersmay also have a tendency to assumethat certain information disclosure practices are followed consistently and therefore come tooverlook information that is placed outside of the ‘normal’ point of disclosure (Dyckman, 1964; Chi et al., 1981; Maines and McDaniel, 2000). Such an occurrence falls within the realm of ‘functional fixation’ and may appear in all stages of the decision-making process (Mainesand McDaniel, 2000).
Ijiri et al. (1966) noted that “psychologists have found that functional fixation exists in most human behaviour in which a person attaches a meaning to a title or an object and is unable to recognise the alternative meanings or uses. People intuitively associate a value with an item through past experience, and often do not recognise that the value of an item depends, in fact, upon the particular moment in time and may be significantly different from what it was in the past”. In an accounting context, for example, functional fixation occurs when users of financial information fail to adjust for differences arising from the adoption of different accounting policies and methods (Sami and Schwatz, 1992; Bernard and Schipper, 1994; Libby et al., 2002). As a consequence, firms with identical economic circumstances except for their choice of allowable accounting alternatives are sometimes judged to be different (Libby et al., 2002).
The phenomenon of functional fixation and itsaccounting implications for placement of key financial information has been extensively examined in the literature (Landsman, 1986; Harris and Ohlson, 1987; Harper et al., 1987; Landsman and Ohlson, 1990; Harper et al., 1991; Sami and Schwatz, 1992; Barth, 1994; Hopkins, 1996; Hirst and Hopkins, 1998; Maines and McDaniel, 2000; Luft and Shields, 2001; Hodge et al., 2002; Hodge et al., 2004). Using the perennial accounting issue of whether to recognise key financial information within the financial statements (recognition policy) or disclosure the same information in the notes to the financial statements (disclosure policy) this literatureindicates users of financial statements exhibit functional fixation when comparing financial statements of firms that adopt different accounting policies. That is, decision-makers/users do find cognitive convenience in looking for information in a to-be-expected location and the acquisition and integration of information located outside of the normal situation may be more the result of ‘accidental discovery’ (Hirst and Hopkins, 1998).
Recent studies have explored potential solutions to overcome functional fixation in situations of alternate placement of information. Luft and Shields (2001), for example, suggested that moreinstructional learning on the opportunities for alternative placements of information and the implications arising from such placementscould provide a remedy to alleviate the impact of functional fixation, but they found no supporting evidence. Their results show that instructional learning is not necessarily a quick remedy for functional fixation in accounting because accounting can,in turn,influence the learning process. That is, individuals may come to be fixated on the accounting and do not develop the skills to ‘see through’ or ‘unscramble’ the effects of alternative accounting methods (Luft and Shields, 2001).
Another group of studies have focused onwhether the way in which information is presented minimises the occurrence of functional fixation and therefore leads to a more effective decision-making process (decision outcome). The findings of these studies indicate that some forms ofpresentation formatsenhance the decision-making process (Stock and Watson, 1984; Dickson et al., 1986; Iselin, 1988; Vessey, 1991; Mackay and Villareal, 1987; Hard and Vanacek, 1991; Stone and Schkade, 1991; Anderson and Kaplan, 1992; Ramarapu et al., 1997; Frownfelter-Lohrke, 1998; Almer et al., 2003; Bizarro and Baldwin, 2004; Hodge et al., 2004). Other studies suggest thatdecision-makers experience a reduction in decision performance in completing taskswhen inappropriate presentation formats are used (Vessey, 1991; Vessey and Galletta, 1991; Umanath and Vessey, 1994; Speier et al., 2003), while another group of studies suggest that presentation formats do not affect decision performance (Bricker and Nehmer, 1995; Dull et al., 2003; So and Smith, 2003) and it is the degree of information processing and the type of task being performed that has the greatest impact on the effectiveness of presentation formats in the decision-making process.
More recent research has focused on the dissemination of financial information through digital reporting technology as opposed to the more traditional print-based reporting. In their study, Hodge et al. (2002; 2004) proposed that appropriate digital presentation formatsminimise functional fixation whereby financial information becomes more transparent irrespective of its placement. They reasoned that if presenting information in a particular style (i.e. digitalpresentation formats) enhances data structure, this would allow users to become more effective and efficient in information acquisition and usage (Larkin and Simon, 1987). Comparing PDF format (non-searchable) with XBRL format (searchable), Hodge et al. (2004) found that participants who used the PDF format incurred higher levels of functional fixation than XBRL participants at the initial information gathering stage of the decision-making process. This led to PDF participants proposing a sub-optimal investment strategy compared, for example, to the XBRL participants who were able to identify and extract a wider range of relevant and important information.
The empirical component of the Hodge et al. (2002; 2004) study was in the context of stock option compensation with key financial information either recognised within the financial statements or disclosed in the notes to the financial statements. MBA students were used as surrogates for professional decision-makers. Arguably, their research findings may be context and participant specific and not generalisable to other settings. This study extends Hodge et al. (2002; 2004) by examining the relationship betweendigital presentation formats and functional fixation usingthree forms of digital presentation formats – PDF, HTML and XBRL. The current study is located in the context of accounting for investment property anduses professional subjects who are actively engaged in investment making decisions.
3.RESEARCH FRAMEWORK AND HYPOTHESES
In this section we present the research framework and hypotheses underpinning the empirical component of this study. The framework is based on the premisethat the form of presentation format is an important characteristic of an input into the decision making process and therefore influences resulting judgements under conditions of uncertainty created by alternative placements of key information.
Decision-making is a cognitive process that leads to the selection of a course of action. In its basic form, the decision-making process involves three sequential stages: input, processing, and output (Libby and Lewis, 1977; Beach and Mitchell, 1978; Hogarth, 1980; Einhorn and Hogarth, 1981; Cloyd, 1995; Roberts, 2002). The input stage is concerned with the source and form of the information made available to decision makers. The information processing stage is seen to encompass the primary tasks of decision-making; that is, acquiring information, evaluating the relevance of different items of information, and weighting the importance of specific items for the decision task at hand. The output stage is concerned with the decision. The framework proposes that presentation format influences the performance of decision makers to acquire, to evaluate and weight information in forming a judgement (decision) on a firm’s financial performance.
For the purposes of this study the three digital presentation formats of PDF, HTML and XBRL form one group of independent variable.Bosak and Bray (1999) and Abdolmohammadi et al. (2002) distinguished between PDF, HTML and XBRL on their ability to process information where PDF allows no information processing, HTML allows static information processing and XBRL allows dynamic information processing.In their work, Hodge et al. (2002; 2004) distinguished between XBRL and PDF on the basis of their search capabilities. They described XBRL as a searchable technology that enabled directed searches and the simultaneous presentation of financial statements and related footnote information (including notes to the financial statements) whereas non-searchable technologies, such as PDF, do not allow directed searches and simultaneous presentation.They found that XBRL made information presented outside of the financial statements more transparent and consequently, the participants who used XBRL achieved a more optimal investment decision outcome compared to participants who used, for example, PDF.
Prior studies have suggested that functional fixation may occur at all stages of the decision-making process (Hodge et al., 2002; 2004; Maines and McDaniel, 2000). The framework therefore proposes that presentation format may influence the performance of decision makers to process information and form a judgement when alternative accounting models and methods are used. Accordingly, a second group of independent variable focuses on the alternate placement of information which for some accounting transactions and/or events could either be recognised within the financial statements (recognition policy) or in the notes to the financial statements (disclosure policy).There is a dearth of literature that examines the potential of different forms of digital presentation formats to minimise the occurrence of functional fixation, especially within the accounting context of financial statement recognition or notes to financial statements disclosure. Hodge et al. (2002; 2004) argued that decision-makers were more likely to rely on information that was recognised within the financial statements but were less likely to draw on relevant information that was disclosed in the notes to the financial statements. Hopkins (1996) observed that decision-makers would integrate items of disclosure if they accidentally found the information item and it was relevant to their decision-makingmodels.
Figure 1 provides a diagrammatical representation of the theoretical framework that underpins the research andidentifies the various stages of decision making as dependent variables and it is around these variables that the following null hypotheses are developed.
Figure 1:Research framework
Dependent variables Independent variables
Confounding variables
(a)Information Acquisition
In the context of this study, information ‘acquisition’ refers to an informed decision maker[2] reading the financial statements and accompanying notes and detecting sufficiently well for future recall the specific cues relating to the valuation model used to report investment properties. The framework indicates that different digital presentation formats can influence whether decision makers read all investment property related information.
H1:The choice ofdigital presentation format does not impact on the performance of decision-makers’ to identify the accounting valuation model used to account for investment properties, irrespective of the placement of relevant information.
(b)Information Evaluation
Information ‘evaluation’ involvesthe decision maker assessing the information acquired. That is, having identified and read the relevant information, the decision maker will also perceive visible characteristics of that information such as, for example, change in fair value of investment property. The framework indicates that different digital presentation formats can influence whether decision makers correctly evaluate the change in investment property fair value, regardless of where that change is reported.