I’ll be regularly blogging on unit of account / disaggregation / net vs. gross etc. Recall a prior post where I mentioned how my head spins when I think of these concepts that are not clearly defined. Perhaps through this blog, we can make some headway on keeping these concepts distinct.

Today’s blog will be a brief summary of a paper that I’ve been working on with coauthors Sarah Bonner, Shana Clor-Proell, and Terry Wang. We conducted an experiment that indicates that the unit of account matters to financial statement preparers (because they anticipate that it will matter to investors). In a nutshell, how you aggregate gains and losses matters in a very predictable fashion on the income statement, but not on the balance sheet. Our results are quite consistent with a theory from the judgment and decision making area (that is, theory that is at the crossroads of psychology and economics). This theory is called mental accounting—developed 30 years ago by Dick Thaler.

Mental accounting is based on the ideas of prospect theory—namely, that losses are felt more strongly than gains. Mental accounting takes prospect theory further by dealing with multiple (not just one) outcome. So preferences for combining or separating gains and losses depend… and that’s what we show in our paper.
I realize that our paper is in no way a solution for the dilemma facing standard setters … which is how to define the unit of account. But at least it starts the ball rolling on thinking about it.