Accrual Choices Research Articles

How Do Managers Delay the Revelation of Bad News? Evidence from a Coordinated Strategy using Accrual Choices and Management Forecasts

We provide evidence that some managers delay the revelation of bad news using a coordinated strategy involving both reported accruals and earnings forecasts. Specifically, we observe a correlated bias in contemporaneous accruals and management forecasts when both indicate higher, but not lower, future performance. Furthermore, this bias occurs in periods preceded by poor economic performance, where incentives to delay revealing the full extent of the bad news are greater. The joint use of inflated accruals and optimistic management forecasts is associated with optimism in analysts’ subsequent forecasts and with a decline in stock prices over the following year, suggesting that managers successfully delay the revelation of bad news using this strategy. Finally, evidence from financial statement misstatements (identified through subsequent restatements) is consistent with sample firm managers jointly issuing optimistic guidance and manipulating accruals using means outside of Generally Accepted Accounting Principles.

Does XBRL Adoption Constrain Earnings Management? Early Evidence from Mandated U.S. Filers

ABSTRACTWe examine whether the use of eXtensible Business Reporting Language (XBRL) for financial reporting (i.e., interactive data submissions) reduces earnings management during the period of XBRL implementation by the SEC. Using a sample of mandated XBRL filers, we compare the magnitude of absolute discretionary accruals in the XBRL adoption quarters with that in the non‐adopting quarters. We also take advantage of staggered (three‐stage phase‐in) XBRL implementations to perform difference‐in‐differences analyses. Our results show that absolute discretionary accruals decrease significantly from the pre‐ to the post‐XBRL period, suggesting that XBRL adoption constrains earnings management via discretionary accrual choices. Our analyses further reveal that the use of standardized official XBRL elements significantly reduces the levels of discretionary accruals, while the use of customized extension elements does not, suggesting that the former discourages accrual‐based earnings management, while the latter does not. Our results are robust to a variety of sensitivity checks.

Detection of real earnings management: The case of Vietnamese listed companies

There are a great number of incentives that drive managements to manipulate firms’ profit. Beside exploiting the allowed discretional accrual choices, managers could perform real earnings management by altering the normal operating scale of the companies. This paper examines the three most prevalent means of real earnings management, including (1) boost in sales through price discounts or more lenient credit terms; (2) reduction of discretional expenses and (3) overproduction. The main concentration of the study is the applications of these measures to avoid losses. By using data of 610 listed companies on Ha Noi and Ho Chi Minh Stock Exchange from 2008 to 2015 and verified regression models, the research finds evidence that managers do apply real earnings management to avoid losses. These findings are consistent with other researches’ result. Based on the empirical result, the paper raises recommendations to enhance the profit’s reliability and protect investors.

The association between abnormal audit fees and audit quality after IFRS adoption

Purpose This paper aims to examine how the relationship between abnormal audit fees and audit quality changed after adoption of the International Financial Reporting Standards (IFRS) in Korea. Design/methodology/approach Using empirical data collected over the period from 2008 to 2013, this study analyzes the association between abnormally high/low audit fee and audit quality. This study uses linear regression to test the hypothetical relation using discretionary accrual as a proxy for audit quality. Findings This study finds that there exists no significant relationship between abnormally high audit fees and audit quality measured by the magnitude of discretionary accruals in the pre-IFRS adoption period. However, the relationship between abnormally high audit fees and the magnitude of discretionary accruals turns to be positive in the post-IFRS adoption period. These finding suggests that the IFRS enables some clients to engage more discretion in the choice of discretionary accruals and auditors charge higher audit fees in return for allowing the discretion for such clients. Practical implications This study provides insight to regulators of the need to review carefully the financial statements of firms with abnormally high audit fees, and to investors to be more cautious when using financial information about these firms. Originality/value To the best of authors’ knowledge, this is the first study to assess IFRS impact on audit fee-quality relation. Also, unique Korean audit market with intensifying competition and discounting audit fee provides interesting setting to review the impact of abnormal audit fee on audit quality.

Does Dividend Policy Drive Earnings Smoothing?

SYNOPSISThis paper examines the earnings-smoothing behavior of dividend-paying firms. We show that dividend-paying firms engage in more earnings smoothing than non-payers through both real activities and accrual choices. More specifically, dividend-paying firms with positive (negative) pre-managed earnings changes engage in more downward (upward) earnings management than non-payers. Additional tests suggest that the results are driven by dividend-related incentives and not the differences in the economic characteristics of dividend-paying firms, are robust to alternative measures of earnings management, and are not due to spurious correlation. We also show that earnings smoothing, in part, explains the higher earnings persistence of dividend-paying firms. These findings are consistent with a firm's dividend policy having an incremental impact on earnings-smoothing behavior.JEL Classifications: M41; G35

On the Stewardship and Valuation Implications of Accrual Accounting Systems

In this paper we explore the role of accruals in determining “earnings quality” from both a stewardship and a valuation perspective. We show that the valuation and stewardship qualities of accrual accounting are maximized by either an “aggressive” or a “conservative” accrual strategy. Furthermore, accrual strategy choices can be delegated to management as it does not benefit by implementing a strategy that is not in the best interests of the shareholders. We also investigate the implications of accrual strategies for standard empirical measures of “earnings quality”: regression coefficients and R2s from price-earnings and market-to-book regressions. We show that such measures respond differently, and in some cases adversely, to the kind of strategies that make accounting constructs more correlated with the underlying economic activities of firms.

Religious Social Norms and Corporate Financial Reporting

Abstract: Religion has been shown to influence economic choices and outcomes in a variety of contexts. Honesty and risk aversion are two social norms forwarded to characterize the religious. Using the level of religious adherence in the county of a US firm's headquarters as a proxy for these religious social norms, we find that higher levels of religious adherence are associated with both a lower likelihood of financial restatement and less risk that financial statements are misrepresented because of overstated (understated) revenue/assets (expenses/liabilities). We also find that accruals of managers in areas of high religious adherence exhibit smaller deviations from expectations, and deviations, when they occur, tend to improve the time series mapping of accruals into cash flows. These results hold overall and separately for both Catholic and Protestant religious adherence. Further analysis reveals that the effects of religious social norms extend beyond accrual choices. We find that firms located in areas of high religious adherence are less likely to engage in tax sheltering, and are more forthcoming with bad news in their voluntary disclosures. Collectively, our results provide new evidence on the role of religion and social norms in corporate financial reporting.

Discussion of The Influence of Elections on the Accounting Choices of Governmental Entities

Kido, Petacchi and Weber [2012] investigate whether the occurrence of a state gubernatorial election is important to understanding the accrual choices of preparers of the state’s comprehensive annual financial report. Central to the authors’ argument is the idea that voters do not like budget deficits. Politicians, in response, have incentives to use accounting choices to mask deficits in the period before elections. Focusing on a specific accrual, the changes in compensated absences liability, the authors find evidence that the discretionary part of this accrual is smaller in the period before an election, which is consistent with politicians attempting to improve the picture of the state’s financial health. In addition, the authors show that accrual manipulation is positively associated with the vote share of incumbent governors in elections. In my discussion, I ask two questions: (1) how strong are governors’ political incentives to manipulate accruals in the run-up to elections? (2) Can the association between discretionary compensated absence accruals and elections be explained by forces other than politically motivated accounting manipulation? I argue that the incentives to manipulate accruals might well be weak given strong disciplinary mechanisms that induce politicians to transparency. What’s more, I document that elections might produce patterns in state employment. As the compensated absences liability is linked to the payroll, election-induced changes in state employment might be reflected in this accrual. Evidence of an association between the compensated absences accrual and elections, then, does not necessarily imply that politicians manage accounting numbers. To further illustrate this point, I show empirically that gubernatorial elections have little explanatory power for state financial reporting choices that are unaffected by state employment. JEL classification: H70, H72, M41

Discussion of the Influence of Elections on the Accounting Choices of Governmental Entities

Kido, Petacchi and Weber [2012] investigate whether the occurrence of a state gubernatorial election is important to understanding the accrual choices of preparers of the state’s comprehensive annual financial report. Central to the authors’ argument is the idea that voters do not like budget deficits. Politicians, in response, have incentives to use accounting choices to mask deficits in the period before elections. Focusing on a specific accrual, the changes in compensated absences liability, the authors find evidence that the discretionary part of this accrual is smaller in the period before an election, which is consistent with politicians attempting to improve the picture of the state’s financial health. In addition, the authors show that accrual manipulation is positively associated with the vote share of incumbent governors in elections. In my discussion, I ask two questions: (1) how strong are governors’ political incentives to manipulate accruals in the run-up to elections? (2) Can the association between discretionary compensated absence accruals and elections be explained by forces other than politically motivated accounting manipulation? I argue that the incentives to manipulate accruals might well be weak given strong disciplinary mechanisms that induce politicians to transparency. What’s more, I document that elections might produce patterns in state employment. As the compensated absences liability is linked to the payroll, election-induced changes in state employment might be reflected in this accrual. Evidence of an association between the compensated absences accrual and elections, then, does not necessarily imply that politicians manage accounting numbers. To further illustrate this point, I show empirically that gubernatorial elections have little explanatory power for state financial reporting choices that are unaffected by state employment.

Elections and Discretionary Accruals: Evidence from 2004

ABSTRACTWe examine the accrual choices of outsourcing firms with links to U.S. congressional candidates during the 2004 elections, when corporate outsourcing was a major campaign issue. We find that politically connected firms with more extensive outsourcing activities have more income‐decreasing discretionary accruals. Further, relative to adjacent periods, the evidence is concentrated in the two calendar quarters immediately preceding the 2004 election, consistent with heightened incentives for firms to manage earnings during the election season. The incentives can be attributed to donor firms' concerns about the potentially negative consequences of scrutiny over outsourcing for themselves and for their affiliated candidates.

The use of advertising activities to meet earnings benchmarks: evidence from monthly data

Using a unique database of monthly media advertising spending, we examine whether managers engage in real earnings management to meet quarterly financial reporting benchmarks. We extend prior literature by (1) separately analyzing advertising activities, allowing us to explore the possibility that managers could reduce or boost advertising to meet benchmarks; (2) analyzing actual activities as opposed to inferring them from reported expenses, which are also subject to accrual choices; (3) investigating the timing, within a quarter, of altered advertising spending; and (4) examining quarterly earnings benchmarks. We find that managers, on average, reduce advertising spending to avoid losses and earnings decreases. However, we also report that firms in the late stages of their life cycle increase advertising to meet earnings benchmarks. Finally, we find some evidence that firms increase advertising in the third month of a fiscal quarter and in the fourth quarter to beat prior year’s earnings.

Religious Social Norms and Corporate Financial Reporting

Religion has been shown to influence economic choices and outcomes in a variety of contexts. Honesty and risk aversion are two social norms forwarded to characterize the religious. Using the level of religious adherence in the county of a U.S. firm’s headquarters as a proxy for these religious social norms, we find that higher levels of religious adherence are associated with both a lower likelihood of financial restatement and less risk that financial statements are misrepresented because of overstated (understated) revenue/assets (expenses/liabilities). We also find that accruals of managers in areas of high religious adherence exhibit smaller deviations from expectations, and deviations, when they occur, tend to improve the time series mapping of accruals into cash flows. These results hold overall and separately for both Catholic and Protestant religious adherence. Further analysis reveals that the effects of religious social norms extend beyond accrual choices. We find that firms located in areas of high religious adherence are less likely to engage in tax sheltering, and are more forthcoming with bad news in their voluntary disclosures. Collectively, our results provide new evidence on the role of religion and social norms in corporate financial reporting.

The Use of Advertising Activities to Meet Earnings Benchmarks: Evidence from Monthly Data

Using a unique database of monthly advertising spending in media outlets, we examine whether managers engage in real earnings management to meet quarterly financial reporting benchmarks. We extend prior literature by: (1) separately analyzing advertising activities, allowing us to explore novel issues such as the possibility that managers could either reduce or boost advertising to meet an earnings benchmark; (2) analyzing actual activities as opposed to inferring them from reported expenses, which are also subject to accrual choices; (3) investigating the timing, within a fiscal quarter, of altered advertising spending; and (4) examining quarterly as opposed to annual earnings benchmarks. Overall, we find that managers reduce their advertising spending to avoid losses and avoid earnings decreases. However, we also provide evidence that firms in the late stages of their life cycle choose to increase advertising to meet earnings benchmarks. Finally, we find some evidence that firms increase their advertising activities in the third month of a fiscal quarter and in the fourth quarter to meet or beat prior year’s earnings.

Managerial Foresight and Choice of Accruals in Earnings Management

This study investigates whether information about future earnings (i.e. foresight) affects a manager’s accrual choices in income smoothing. Accruals can be employed to set aside current earnings for future use (flexibility effect). However, the reversal of accruals can lead to more variable future earnings (complexity effect). Data on accrual choices from an experiment in which managers were tasked to report smooth earnings are analysed. The results show that high foresight managers use more short- to medium- term accruals (bad debt and restructuring provisions, respectively) to reduce earnings than do low foresight managers. Low foresight managers use more long-term accruals (retirement benefits provision) to increase earnings than high foresight managers. Thus, high foresight managers’ preference for flexibility dominates their aversion to complexity when using accruals to create reserves. Low foresight managers show a greater aversion to complexity when using accruals to increase earnings.

Earnings Management Choices When Stock-Option Incentives Conflict*

Prior research suggests that managers use income-increasing (decreasing) accruals to increase the value of their stock option exercises (grants). I extend this research by modeling firms' accrual choices when incentives from stock options conflict and are confounded by other stock option features. I find that when incentives to maximize the values of option exercises (unvested options) and option grants (vested options) conflict, firms select accounting accruals to maximize the value of option exercises (unvested options). Surprisingly, despite the presence of vested options, firms use income-decreasing accruals in order to increase the value of option grants.

Fees Paid to Audit Firms, Accrual Choices, and Corporate Governance

We examine the relation between the fees paid to auditors for audit and non‐audit services, and the choice of accrual measures for a large sample of firms. Using our pooled sample, we find that the ratio of non‐audit fees to total fees has a positive relation with the absolute value of accruals similar to Frankel, Johnson, and Nelson [2002]. However, using latent class mixture models to identify clusters of firms with a homogenous regression structure reveals that this positive association only occurs for about 8.5% of the sample. In contrast to the fee ratio results, we find consistent evidence of a negative relation between the level of fees (both audit and non‐audit) paid to auditors and accruals (i.e., higher fees are associated with smaller accruals). The latent class analysis also indicates that this negative relation is strongest for client firms with weak governance. Overall, our results are most consistent with auditor behavior being constrained by the reputation effects associated with allowing clients to engage in unusual accrual choices.

Stock Option Compensation and Earnings Management Incentives

We examine whether the structure of executive compensation, specifically stock options relative to other forms of pay, is associated with opportunistic use of discretionary accruals in reported earnings. Prior research suggests that using options creates an incentive to temporarily depress the firm's stock price prior to the option award date, thereby lowering the exercise price of the options. We hypothesize, and find evidence, that relatively high option compensation is associated with income-decreasing discretionary accrual choices in periods leading up to option award dates. Furthermore, we find that this association is stronger when managers are able to publicly announce earnings prior to the option award date. Our results are consistent with the general implication from prior research that option compensation creates opportunistic incentives for managers to time the release of good and bad news to the market.

Auditor Conservatism, Asymmetric Monitoring, and Earnings Management*

AbstractIn this paper, we investigate whether, and how, audit effectiveness differentiation between Big 6 and non‐Big 6 auditors is influenced by a conflict or convergence of reporting incentives faced by corporate managers and external auditors. In so doing, we incorporate into our analysis the possibility that managers self‐select both external auditors and discretionary accruals, using the two stage “treatment effects” model. Our results show that only when managers have incentives to prefer income‐increasing accrual choices are Big 6 auditors more effective than non‐Big 6 auditors in deterring/monitoring opportunistic earnings management. Contrary to conventional wisdom, we find Big 6 auditors are less effective than non‐Big 6 auditors when both managers and auditors have incentives to prefer income‐decreasing accrual choices and thus no conflict of reporting incentives exists between the two parties. The above findings are robust to different proxies for opportunistic earnings management and different proxies for the direction of earnings management incentives.

Corporate Governance, Fees for Non-audit Services and Accrual Choices

We examine the relation between the relative amount of fees paid to auditors for non-audit services and the behavior of accrual measures. We extend prior research in two important directions. First, using a pooled sample of 2,295 firms for the fiscal year 2000, we find very little evidence of a relation between the provision of non-audit services and measure of accruals. However, there appears to be three distinct clusters of firms where only one cluster (consisting of only about 20 percent of the sample) exhibits a statistically positive association between non-audit fees and accrual behavior. Second, we examine the corporate governance characteristics of firms in the cluster with a positive association between non-audit fees and accrual behavior relative to the remaining firms. We find that this subset of firms have a smaller market capitalization, lower institutional holdings, higher insider holdings, smaller board of directors (and audit committee), and lower percentage of independent board (and audit committee) members. These results suggest that the provision of non-audit services is potentially problematic only for a small subset of firms that appear to be de facto controlled by management.

An Academic Curriculum Proposal

INTRODUCTION The first issue to confront in any curriculum design exercise is what benefits will accrue to students and faculty (both current and future generations thereof) who participate in the curriculum. The underlying premise in the following proposed design is that accounting is a scholarly academic discipline. As such, the goal for participants is to engage in fruitful, scholarly dialogue, not only with colleagues in Accounting, but also throughout the Business School and, more broadly (and perhaps most important), with scholars in many disciplines across the University. While the stated goal does not explicitly mention professional or vocational preparation, we do not intend to ignore professional preparation. Rather, we admit the plausible possibility that the best training for a profession consists of a significant number of other activities besides learning how the job is done in the real world. An easy analogy is that athletes in a particular sport seem well served to engage in a variety of sport-independent activities such as conditioning for strength, endurance, balance, etc. In terms of the curriculum, the emphasis, of course, is on exploiting the comparative advantage of the University in society relative to on the job training. Besides being beneficial to the individual, the existence of a University-based field of study nurtures the discipline itself, increasing the likelihood the profession will be dynamic and vigorous over time. (As a tangential comment, the curriculum is designed so that it might serve as a reasonable general education for someone who may not pu rsue accounting, or even business, as a vocation.) Armed with this objective, we attempt to identify curriculum topics with two attributes: (1) they possess scholarly rigor, and (2) they are such that the comparative advantage of accounting scholars can be exploited. Two general topics that appear to meet these criteria are double-entry mechanics and information. While double entry is specific to accounting, it has many properties in common with networks and circuitry, topics routinely encountered in engineering, chemistry, and elsewhere across the University. Information, of course, is pervasive in economics and other social sciences as well as in computer science, physics, etc. Accounting would seem to have a rich potential for investigating these academic topics and combining them in a unique and productive manner. It is a difficult challenge to maintain sight of accounting-specific topics while accounting in the rich and complex socio-economic context in which it occurs. In an attempt to meet the challenge, the focus of the curriculum is to: (1) identify characteristics that make accounting information unique and (2) understand how accounting is done, and study how that may be a consequence of how accounting is used. As examples of the first property, accounting data is aggregated--a small number of accounts summarize the information contained in a large number of transactions. It is prepared in accordance with double-entry rules. It is audited. It is late (historical). It is tracked over multiple periods. It gives the preparer of accounting reports a curious amount of discretion (through the choice of accruals). The curriculum also stresses that accounting information often works best when used in conjunction with other information. As for the second property, broadly stated, the curriculum emphasizes how accounting activities, practices, and institutions arise (and evolve) as a consequence of endogenous demands by various users of information (e.g., managers in the firm, investors in the capital markets, regulators, etc.). Just as using accounting in isolation can be problematic, studying accounting in isolation can be detrimental. In this regard, the curriculum highlights connections between accounting and other venerable disciplines. For example, cost functions are discussed in both microeconomics and accounting texts, but with little overlap. …