Abstract
This study investigates whether managers use classification shifting to classify operating expenses as non-operating. Using a methodology similar to McVay (2006), I find no evidence of classification shifting between operating and non-operating expenses. However, I find evidence that managers classify operating expenses as non-operating in the absence of income decreasing accrual management. This finding can be explained that income-decreasing accrual management both affects operating and non-operating expenses and measuring classification shifting without considering discretionary accrual management produces meaningless results.
Highlights
Classification shifting has received attention in recent years as an earnings management tool
Prior literature has investigated classification shifting of core expenses as income decreasing special items (McVay 2006; Fan et al 2010), classification shifting of core expenses as discontinued operations (Barua et al, 2010), classification shifting of operating expenses as non-operating expenses (Noh et al 2014). Their findings support the hypothesis that managers deliberately misclassify line items in the income statement to affect the perceptions of financial statement users
In the expectation model used by previous studies accruals are used to control performance
Summary
Classification shifting has received attention in recent years as an earnings management tool. Real earnings management can be achieved through timing of sales by providing temporary price discounts, timing of R&D expenditures, advertising and maintenance expenses, or timing of income recognition from disposal of long-lived assets and investments. Unlike these two forms of earnings management, classification shifting does not change the income of the period or the business practices. Athanasakou, Strong, and Walker (2011) explore the market response to achieving analyst earnings expectations associated with three types of earnings management (accrual management, real earnings management, and classification shifting) One of their findings states that UK firms use classification shifting to achieve analyst expectations.
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