Management of income statement variables to report small positive earnings numbers

Abstract

PurposeCharting the earnings numbers reported by Korean firms produces a bell curve, but for a sharp discontinuity in the area surrounding zero. The purpose of this paper is to investigate if and how a large segment of Korean managers might manage accounting numbers to produce the observed result.Design/methodology/approachThis study adopts an empirical research method using Korean listed firms as a sample. The primary focus of investigation is on major income statement variables that might produce the observed results in earnings from operations and net income.FindingsManagers of Korean firms opportunistically use almost all income statement variables to influence earnings numbers. They manage revenues and selling, general & administrative expenses to report small positive earnings from operations, but manage non-operating gains (losses) to report small positive net income.Research limitations/implicationsThis paper does not answer several questions related to loss avoidance. First, the paper did not examine which actions, such as discretionary accruals, opportunistic business decisions, or bogus transactions, were employed to affect line items on the income statement. Second, the paper did not investigate what specific incentives trigger Korean managers to report small positive earnings. Korean firms have traditionally raised capital by borrowing funds from creditors and governmental agencies. Thus, they may be concerned that reporting losses would reduce their borrowing capacity. Finally, corporate governance, such as CEO tenure and option grants may influence the extent of earnings management to avoid losses, but most corporate governance data for Korean companies must be manually collected. Accordingly, these subjects are left for future studies as well.Originality/valueThis study contributes to accounting literature by reporting how managers of Korean firms artificially coordinate major income statement variables and report small positive earnings figures, noting the differences between earnings management investigating methodology and ones used in previous studies.