An empirical study on the reliability and informativeness of accounting numbers: after enforcing the internal accounting control system in Korea

Abstract

This paper examines the reliability and informativeness of accounting numbers after Internal Accounting Control System (IACS) Standards were enforced in Korea. We analyse whether the magnitude of Earnings Management (EM) and Earnings Response Coefficient (ERC) changed after enforcement. We focus on both abnormal real activities and accruals as proxies of EM and how these levels vary before and after enforcement. It is found that the magnitude of accrual-based EM is significantly reduced and the informativeness of accounting numbers is improved after the enforcement of the IACS Standards for adopters. It means that managers' ability to control earnings using abnormal accruals is effectively restricted by an IACS because the detection risk and costs become higher than ever. However, the management of real activities to control earnings is not influenced by the IACS because it is hard to detect. The results imply that the reliability of accounting information provided through the IACS is improved by the enforcement of the IACS Standards, which effectively restrict a manager's accrual-based EM. The informativeness of accounting numbers is also improved after the enforcement of the IACS Standards. Thus this paper provides overall evidence of the effectiveness of the IACS Standards enforced since 2006.