Managing earnings using classification shifting: UK evidence

Abstract

This study examines whether UK companies engage in classification shifting in the post IFRS era. While IFRS were issued to improve the quality of accounting practices and provide users with more useful information, non-recurring items disclosure is less regulated than under UK GAAP. Therefore, firms have more opportunity to exercise discretion in the classification of items within the Income Statement. Whilst there is only weak evidence of misclassification of recurring items prior to the introduction of IFRS (Athanasakou et al., 2009), our results reveal that managers are more likely to exercise their discretion in the disclosure of non-recurring items following the adoption of IFRS. More specifically, it is found that managers are more likely to misclassify some recurring items as non-recurring when this allows them to report core earnings increases. In contrast, there is no evidence that companies engage in classification shifting to avoid reporting core losses. However, this may be logical behaviour in that, while credit rating agencies do not penalize firms who use classification shifting to avoid reporting core earnings decreases, they may penalize firms who use it to avoid reporting core losses.