The Economic Consequences of Discrete Recognition and Continuous Measurement


Discrete recognition is a long-standing and ubiquitous accounting practice, but it has been widely criticized for suppressing information and inducing accounting-motivated trans- actions. We study a model to examine the economic consequences of shifting away from discrete recognition to a continuous measurement approach. Without manipulation, discrete recognition is less informative than the continuous approach. However, the continuous regime induces more manipulation. The equilibrium informativeness is determined by both the ac- counting standard and endogenous manipulation. Discrete recognition is more informative than its continuous counterpart precisely when manipulation is a severe threat. We respond to the call in Kothari, Ramanna, and Skinner (2010) for using positive accounting theory to explain certain long-standing accounting practices. We also discuss the model’s implications for fair value accounting.