Discretionary Accruals Research Articles

Narrative disclosure and earnings quality: what is the nexus? Evidence from emerging countries

PurposeNarrative disclosures offer further elucidation of a company's financial performance beyond what is presented in numerical format. This can assist stakeholders in gaining a deeper comprehension of the elements that impact reported earnings, thereby improving the quality of financial information. The current research explores the impact of narrative disclosure on the earnings quality of firms listed on the Amman Stock Exchange (ASE).Design/methodology/approachAppropriating an index to measure the narrative disclosure level in the research sample firms, the research utilizes an analysis of the textual content of nonfinancial reports and statements issued by the management of the ASE-listed nonfinancial firms between 2013 and 2022. The financial statements issued in the annual financial reports are also adopted to extract data on earnings quality and the controlling variables. The analysis of the data and attainment of the findings necessitate using the panel data.FindingsIt is indicated that narrative disclosure affects earnings quality. To be precise, the greater the narrative disclosure, the lower the absolute value of the voluntary discretionary accruals and thus the higher the quality of accounting earnings.Research limitations/implicationsThe findings contribute to new research on disclosure issues, particularly narrative disclosure, which enhances reader confidence in financial and nonfinancial reports and prevents misleading and manipulated information.Originality/valueThis research helps decision-makers understand the relationship between reports, statements and earnings quality in a firm. It's unique in exploring this relationship, especially in developing countries. The study is the first of its kind in Jordan, known for its economic stability and strategic location in the Middle East, making its findings applicable to similar environments.

Financial reporting quality, industrial revolution 4.0 and social well-being among Malaysian public companies

PurposeThis study examines the relationship between financial reporting quality, Industrial Revolution 4.0 and social well-being of stakeholders among public companies in Malaysia.Design/methodology/approachThe sample of the study includes 232 firm-year observations of Malaysian publicly listed companies from 2013 to 2017. Social well-being is measured using social pillar scores from the Environmental, Social and Governance (ESG) data provided by Refinitiv. The study identified companies as an adopter of IR 4.0 based on their disclosure on the use of autonomous robots, simulation, cloud, horizontal and vertical system integration, cybersecurity, additive manufacturing, augmented reality and big data analytics in their financial reports. Financial reporting quality is measured using discretionary accruals.FindingsThis study found that financial reporting quality and IR 4.0 are related to social well-being, particularly the workforce. These results imply that companies with higher adoption of IR 4.0 are more likely to provide more information concerning job satisfaction, a healthy and safe workplace, maintaining diversity, equal and development opportunities for its workforce. Furthermore, the results show that firms with lower discretionary accruals (i.e. higher quality of financial reporting) are more likely to provide more information about social well-being. The results are robust even after addressing endogeneity issues.Research limitations/implicationsThis research contributes new insights into the role of financial reporting quality and IR 4.0 in enhancing social well-being in Malaysia. These findings offer valuable input for regulators striving to advance the United Nations' 2030 Agenda for Sustainable Development.Practical implicationsThis study carries substantial practical implications for policymakers and businesses alike. It underscores the importance of embracing IR 4.0 technologies and integrating them into strategic planning to foster social well-being. These insights can guide policymakers in shaping economic strategies and assist businesses in prioritizing financial reporting quality while engaging stakeholders to promote social well-being.Originality/valueThis is the first study to investigate the combined relationship of financial reporting quality and IR4.0 on social well-being, which provides valuable evidence in this novel domain. While previous studies have primarily explored the relationship of IR4.0 on sustainability from an environmental and human resource perspective, this study sheds light on the specific dimension of social well-being, hence promoting sustainable development goals by the United Nations in 2030.

Financial reporting quality dynamics in India: the role of IFRS convergence and corporate governance

Purpose This paper aims to investigate the impact of International Financial Reporting Standards (IFRS) convergence on value relevance and earnings management for Indian listed firms while also exploring whether the relationship is moderated by the firms’ corporate governance structures. Design/methodology/approach Corporate governance (CG) scores of 573 listed firms were calculated by using a self-constructed index for a period of 7 years (2014–2015 to 2020–2021). Static and dynamic panel models with generalized method of moments (GMM) estimators were used to test the conditional hypothesis that the impact of the Indian IFRS converged standards (Indian Accounting Standards [IndAS]) on information quality is affected by the firm’s corporate governance strength. Findings The estimates reveal that the positive effect of corporate governance scores on the value relevance of earnings reduces in the presence of IFRS, whereas the interaction of both the variables on book values remains insignificant. Secondly, the use of IndAS reduces discretionary accruals, but corporate governance does not have a significant moderating effect within the equation. Practical implications The results offer an interesting perspective into the debate on IFRS consequences and the role of internal institutional frameworks. It provides preliminary evidence suggesting that although corporate governance improves the value relevance of earnings, it may not be entirely effective in reducing the management of earnings. Originality/value To the best of the authors’ knowledge, it is the first study in India to provide empirical findings on the role played by corporate governance mechanisms in explaining the relationship between IFRS convergence and accounting information quality. The analysis accounts for modelling issues such as endogeneity and autocorrelation by using dynamic panel models and instrumental variables.

Investor response to engagement quality review hours

PurposeThis study aims to investigate whether mandated disclosure of engagement quality review hours provides new information that affects investors’ decision-making.Design/methodology/approachIn 2014, Korean authorities mandated that audit engagement quality review hours must be disclosed in their audit reports. Using this unique field setting in Korea, this study presents empirical evidence of the policy initiative’s effect on earnings reliability by examining both pre- and post-implementation periods.FindingsFollowing the initial disclosure of engagement quality review hours in 2014, the authors observe that the capital market’s valuation of quarterly earnings surprises, measured by earnings response coefficients (ERCs), was significantly lower for firms with high levels of abnormal engagement quality review hours than for other firms. This paper also finds that the observed association between engagement quality review hours and ERCs in the postregulation period hinges on the probability of earnings management, proxied by discretionary accruals and just meeting or beating analyst earnings forecast.Originality/valueThis paper suggests that the policy mandating disclosure of engagement quality review hours provides original information that the market considers relevant for appraising the reliability of reported earnings.

Notes Readability and Discretionary Accruals

Narrative disclosures should help external users to better understand managerial discretionary accruals. However, both narrative disclosures and accruals earnings are subject to managerial discretion. This study investigates the relationship expected between earnings management, as gauged by discretionary accruals (DA), and readability, as measured by the Fog Index (Li, 2008). Prior studies investigate the relationship in terms of the readability of the management discussion and analysis (MD&A) which is not directly related to the disclosure of accruals estimation and is also not an audited section of the company’s annual report. This study makes a unique contribution to the extant literature by providing empirical evidence on the association between DA and the readability of the notes to the financial statements (hereafter, Notes). Based on 1,021 observations for UK data drawn from FTSE All Share non-financial firms over the period 2005 to 2011, an ordinary least squares (OLS) regression finds a positive relation between DA and the readability of the Notes. A positive association shows that managers of firms who manage DA tend to produce more readable Notes. This result is likely due to the absence of an incentive to manage DA along with managers’ awareness of the associated risk of producing less-readable Notes, which might result in deeper analysis by auditors and, consequently, a greater chance of them detecting DA. Thus, market participants should not always rely on the greater readability of the Notes as an indicator of higher-quality financial statement numbers, as the results suggest that greater readability is associated with higher DA. La información narrativa debería ayudar a los usuarios externos a comprender mejor los ajustes por periodificación discrecionales de la dirección. Sin embargo, tanto la información narrativa como los beneficios devengados están sujetos a la discrecionalidad de la dirección. Este estudio investiga la relación esperada entre la gestión de los beneficios, medida por los devengos discrecionales (DA), y la legibilidad, medida por el índice Fog (Li, 2008). Los estudios anteriores investigan la relación en términos de legibilidad de la discusión y análisis de la dirección (MD&A), que no está directamente relacionada con la divulgación de la estimación de los devengos y tampoco es una sección auditada del informe anual de la empresa. Este estudio aporta una contribución única a la literatura existente al proporcionar evidencia empírica sobre la asociación entre los DA y la legibilidad de las notas a los estados financieros. Basándose en 1.021 observaciones de datos del Reino Unido extraídos de empresas no financieras del FTSE All Share durante el período 2005 a 2011, una regresión por mínimos cuadrados ordinarios (MCO) encuentra una relación positiva entre los DA y la legibilidad de las Notas. Una asociación positiva muestra que los directivos de las empresas que gestionan los DA tienden a producir Notas más legibles. Es probable que este resultado se deba a la ausencia de incentivos para gestionar los DA y a que los directivos son conscientes del riesgo que conlleva producir notas menos legibles, lo que podría dar lugar a un análisis más profundo por parte de los auditores y, en consecuencia, a una mayor probabilidad de que detecten los DA. Así pues, los participantes en el mercado no deberían confiar siempre en la mayor legibilidad de las notas como indicador de una mayor calidad de los estados financieros, ya que los resultados sugieren que una mayor legibilidad está asociada a un mayor DA.

Persistent internal control failures: Examining multiple consecutive years of disclosing material weaknesses

AbstractIn this study, we analyze a sample of accelerated filers that have reported material weaknesses (MWs) in their internal controls for multiple consecutive years. The recent emphasis by the Securities and Exchange Commission on improving accounting and controls within public companies has led to heightened scrutiny of firms with ongoing MW disclosures. Analyzing data from 2004 to 2021, we find that approximately one‐third of MW observations are for 2 or more consecutive years, with the longest duration being 12 years. Our research shows that these firms face progressively higher audit fees and longer audit report lags for each additional year of MW disclosure. Firm–years with long‐standing MW disclosures (5 or more consecutive years) have the highest audit fees and the longest audit report lags. Our findings also reveal a significant increase in the likelihood of misstatements during the first and second consecutive years of MW disclosures, and a consistent and notable rise in discretionary accruals over the initial 4 consecutive years of MW reporting for these firms. Overall, our results highlight the financial repercussions for firms that do not promptly address MWs in their internal controls. These consequences include higher audit fees, extended audit report lags, and declining financial reporting quality.

Detection of earnings manipulations during the corporate life cycle in Central European countries

Research background: The growing trend of financial distress risk worldwide increases the need for effective tools to detect accounting manipulation by stakeholders (debt holders, shareholders, suppliers, and customers). However, the well-known models of accrual earnings management do not reflect the financial specificity of individual life cycle stages and their cash flow patterns. Purpose of the article: The study examines the impact of the corporate life cycle on the reliability of accrual earnings management models and identifies appropriate models for detecting accounting manipulation in Central European countries. Methods: Seven accrual earnings management models were used. They were evaluated based on five criteria: explanatory power (adjusted coefficient of determination), overall significance of the regression model, significance of the regression coefficients, predicted sign of the regression coefficients, and standard errors of the estimated regression coefficients. Finally, a comprehensive scoring model was used to determine the overall quality of the models examined. The study was conducted on a sample of more than 30,000 enterprises from four Central European countries (the Czech Republic, Hungary, Poland, and Slovakia), with data covering the period 2017–2021. The Dickinson non-sequential life cycle model was used to distinguish life cycle stages according to cash flow patterns. Findings & value added: The results of the study suggest that, firstly, discretionary accruals vary across countries as well as over the firm's life cycle; earnings manipulations have an inverted U-shape with mature firms tending to reduce their accounting profit. The reliability of the models examined was poor in the case of start-ups. This reflects the need to distinguish between life cycle stages in the detection of earnings manipulation.

중국 상장기업의 재무적 특성이 이익조정에 미치는 영향

Purpose: This study analyzed the effects of the financial characteristics of Chinese companies on earnings management, focusing on China's social responsibility activities. Research design, data, and methodology: This study analyzed a company listed on the Shanghai Stock Exchange in China. The CSMAR (China Stock Market & Accounting Research Database) was used as the financial characteristic information data of Chinese companies. The discretionary accruals of the modified John's model were used as a proxy variable for earnings management. The social responsibility activity indicator was analyzed using the social responsibility activity score of RKS (Rankings CSR), a Chinese social responsibility evaluation agency. Results: According t o t he empirical a nalysis, f irst, c orporate e arnings m anagement h as a significant negative (-) effect on the social responsibility activities, and the same result was shown when additional characteristic variables of Chinese companies were added. In addition, both companies with high and low indicators of social responsibility activities had a significant negative (-) effect on profit adjustment. Conclusions: This paper showed that higher accounting transparency, which is a financial characteristic of a company, leads to higher reliability and usefulness of the accounting information provided by the company, so the importance of social responsibility activities indicators for corporate value inventory is increasingly being highlighted.

Business strategy, earnings properties, and earnings quality

This study explores the relationship between business strategy and earnings properties, which are frequently considered as proxies of earnings quality. Specifically, we examine the implications of different strategic positionings for earnings properties that are related to earnings management, conditional conservatism, earnings persistence, and earnings smoothness. Using an international sample, our empirical results indicate that business strategy is inherently linked to these earnings properties. Firms that focus on a business strategy of continuous innovation have larger discretionary accruals, more persistent earnings, and lower earnings smoothness relative to firms that focus on a business strategy of operation efficiency. We also find some evidence for differences in conditional conservatism, although the associations are weaker and sensitive to sample composition. Our main inference is that business strategy inherently affects earnings properties.

Bundle manipulation: the use of accounting and textual obfuscation

Purpose The purpose of this study is to explore whether managers and firms engage in bundle manipulation. It examines the effect of discretionary accruals and real activities manipulation on the level of complexity in annual reports. Design/methodology/approach The findings from the examination of the 1,435 annual reports of Canadian listed firms engaging in discretionary accruals and real activities manipulation indicate that these firms produce complex annual reports. Findings The authors, therefore, suggest that managers and firms use bundle manipulation, both accounting and textual, to mislead shareholders and stakeholders. The analyses also suggest that it is more difficult to detect the manipulation of real activities than discretionary accruals through textual analysis. Originality/value The authors propose an in-depth examination of how accruals and real activities manipulations affect the level of readability of firms’ reports. Furthermore, the authors suggest that firms engage in bundle manipulation, including accounting and textual manipulation. This paper aims to provide an in-depth analysis of the relationship between accounting and linguistic manipulations. The study suggests that investors could use the complexity of annual reports to detect earnings management. More specifically, it seems that firms engaging in discretionary accruals produce complex annual reports.

The Impact of Fraud on the Detection of Fraud in Financial Statements and Discretionary Accruals (Meta-Analysis Study)

The Impact of Fraud on the Detection of Fraud in Financial Statements and Discretionary Accruals (Meta-Analysis Study)

Reporting lag in the GCC region: exploring the nexus of earnings management and IFRS transition

PurposeThe purpose of this study is to delve into the complex interplay between earnings management (EM), the International Financial Reporting Standards (IFRS) implementation and the reporting lag (RL) within the specific context of the Gulf Cooperation Council (GCC) region, with a particular emphasis on the Saudi context, offering insights into their influence on financial reporting practices.Design/methodology/approachUsing a panel data set of 135 Saudi companies over an eight-year period, covering four years before and after the mandatory adoption of IFRS in 2017, this study investigates the Saudi financial reporting landscape. It uses interaction moderation analysis to explore variable effects and includes robustness analyses to validate the findings.FindingsThe findings reveal three key outcomes. First, they challenge conventional expectations by showing no significant impact of discretionary accruals (DACC) on RL, contrary to established accounting theories. This deviation is attributed to unique market characteristics within the GCC region, including family-owned businesses, government involvement and distinct regulations, with specific insights relevant to Saudi Arabia. Second, an unexpected positive association between IFRS adoption and RL in Saudi Arabia emerged. Several contextual factors contribute, including transition costs, compliance expenses, institutional dynamics and reconciling IFRS with local Shariah principles. Most importantly, IFRS adoption significantly reduced RL, especially for companies with high DACC levels. This highlights IFRS’s transformative role, emphasizes aligning EM with international standards for investor confidence and mitigating nonconformity risks in the GCC region’s business landscape.Practical implicationsThe research findings carry significant practical implications for companies operating within the GCC region, accentuating the strategic imperative of timely financial reporting to bolster credibility, align with international standards and fortify investor confidence. Moreover, regulators and policymakers are urged to consider tailoring accounting regulations to accommodate the distinctive GCC context, thereby adeptly addressing the intricacies stemming from the interplay of EM, IFRS adoption and RL dynamics in the region.Originality/valueThis study adds to the current body of literature by highlighting the significant moderating influence of IFRS transition on the nexus between DACC and RL. It underscores the crucial role of this global accounting framework in reshaping financial reporting practices.

Perbedaan Manajemen Laba Untuk Menghindari Penurunan Laba Berdasarkan Tipe Direktur Pada Perusahaan Yang Terdaftar Di Bursa Efek Indonesia

Profit is one of the indicators used to assess company management performance. Management tends to carry out earnings management when there is a decline in profits compared to the previous period. This study analyzes earnings management to avoid decreasing profits based on director type (professional-director and owner-director) in companies listed on the Indonesia Stock Exchange in 2017 - 2022. This research uses secondary data, namely financial statements and annual reports of companies listed on the Indonesian Stock Exchange. The sample in this study was 541 companies. The samples were analyzed using two earnings management measurements, namely accrual management (discretionary accruals adjusted for performance) and real activities management (abnormal operating cash flow). The sample was divided into two groups based on director type to analyze earnings management to avoid decreasing profits for each group. The results show that all directors types carry out earnings management. Companies managed by owner-directors tend to manage discretionary accruals to avoid profits decline. Meanwhile, companies led by professional-directors tend to manage earnings by performing real activities management.

Corporate social responsibility, CEO characteristics, and earnings management: Evidence from China

AbstractThis study examines the relationship between corporate social responsibility (CSR), earnings management (EM), and the characteristics of chief executive officers (CEOs) within the context of China's economic transformation. Drawing on stakeholder theory and upper echelon theory, this study investigates the influence of CSR on EM and the role of CEO characteristics. The empirical analysis is based on a sample of 1,980 Chinese firm‐year observations from the Shenzhen and Shanghai stock markets, between 2013 and 2017. The findings reveal a negative relationship between CSR performance and discretionary accruals (DA), suggesting that higher CSR is associated with lower EM. Moreover, this relationship is more pronounced among firms with highly educated CEOs (postgraduates) and mature CEOs (approaching retirement age). Notably, the negative CSR–EM relationship is strengthened in firms with mandatory CSR reports. This study expands prior research by exploring the impact of CEO characteristics on the CSR–EM relationship, incorporating CEO attributes alongside ownership structures and governance mechanisms. The findings offer insights for organizations in terms of selecting ethically committed CEOs, as well as guidance for shareholders in understanding CEO selection criteria. Furthermore, this study highlights the importance of mandatory CSR disclosure (CSRD) for policymakers evaluating CSR performance according to the disclosure type.

Creative Accounting Effect through Discretionary Accruals on Likelihood of Economic Unit Being Exposed to Financial Distress Risks

Many major international companies were subjected to financial faltering and then bankruptcy and collapse as a result of their managements misusing this flexibility in accounting principles and policies, which led to most economic units losing public confidence and increasing doubt about the efficiency and integrity of their management in the extent of adherence to accounting policies and standards. This type of practice is called creative accounting, which means taking advantage of the flexibility that exists in the use of accounting principles and policies, or the lack of consistency in their use from year to year, with the intention of influencing the numbers appearing in the financial statements and thus influencing the outcome of the activity and the financial position of the economic unit to achieve its goals and motives of maximizing profits. current and future financial situation or improve through manipulation to deceive shareholders and users of financial information. Hence the importance of the research through knowing the impact of creative accounting through optional entitlements on the possibility of economic units being exposed to financial default, as the concept of creative accounting will be exposed, the reasons for economic units resorting to it, its types and objectives, the concept of optional entitlements and the types of those entitlements, as well as the concept of financial default and its types. Its causes and stages, Then the applied aspect of the research will be presented by displaying the results of the questionnaire that were distributed to the research sample represented by a group of chartered accountants and containing a set of questions in three axes. The results of those answers were presented through the (SPSS) program and through the use of simple linear regression for the purpose of achieving the hypothesis. The research is based on (there is a statistically significant effect of creative accounting through optional entitlements on the exposure of the economic unit to financial distress), and then the most important results reached by the researcher and the most important recommendations were presented.

Corruption and audit fees: New evidence from EU27 countries

This study examines the relationship between country‐level corruption and audit pricing decisions across EU27 countries. Using a sample of 29,607 firm‐year observations for the period 2011–2021, I find that firms headquartered in more corrupt countries pay higher audit fees and have longer reporting lags. I also show that this relationship is stronger after the EU audit reform came into force in 2016. The results suggest that auditors respond to corruption risk stemming from the broader macroeconomic environment by increasing audit fees and audit effort. In additional analyses, I show how the association between audit fees and corruption varies across firm industries, and I document that female engagement partners tend to be more sensitive to corruption risk than their male counterparts. Ultimately, I find unexpected evidence indicating that financial reporting quality, proxied by discretionary accruals, is not adversely affected by corruption. This study addresses prior calls for a more granular understanding of external factors in audit research and provides the first European evidence of the association between corruption and auditor responses. The implications of this study should be particularly relevant for researchers, market participants and regulators.

A quantitative study on the effectiveness of the governance attributes on ‘industry-wise earnings quality’ in the UK

Despite of positive impacts of the earnings management on the business purposes, many businesses have been suffered due to the audit failures as a result of aggressive earnings management. Therefore, the study on true reflection of earnings management, the controlling factors and how aggressively manipulated earnings quality can be mitigated are the areas of concern these days. For the estimation of earnings management, performance matched discretionary accruals model has been implemented as this model has been identified as the best explanatory models. Thereafter, this research has accumulated the sector-wise earnings management to identify the impact of sectors on the sectorial earnings management. There are eleven different industries involved in the research while four of them have revealed that the managers from certain sectors have got involved in the aggressive earnings management. Further, this research has investigated the impact of the attributes of the corporate governance on the sector-wise earnings management. the variables of corporate governance like managerial ownership, block-holders, institutional ownership and non-executive directors’ fees have significant impact on sector-wise earnings management where other variables like board meeting, board size, number of female members on the board, board independence have not been identified as they have significant impact on controlling earnings management. Univariate and multivariate methods are used to demonstrate the results and to establish the inferences of the outcomes of the research. The use of coefficients (β -value) and p-value are much prominent in this study.

A Tale of Two Intermediaries: Investment Banker-Auditor Social Ties and IPO Quality

SUMMARY Firms undertaking an initial public offering (IPO) appoint investment bankers and auditors to certify information disclosed to investors. We find that social connections significantly increase the likelihood that the bankers and auditors become involved in the same IPO deal. Although some theory and evidence suggests that information transferred via social networks may enhance economic agents’ performance, other research implies that such links may admit bias into auditor judgment or impair their independence. Empirically, we find that IPO firms report higher discretionary accruals when bankers and auditors are socially connected. We also document that banker-auditor social ties are associated with lower earnings credibility and worse post-IPO performance. However, auditors benefit from social connections with bankers by attracting higher fee premiums and securing more future IPO audit businesses.

Influence of Debt Financing on Income Smoothing Practices among Listed Deposit Money Banks in Nigeria

This study examined the influence of debt financing on income smoothing among Nigerian listed deposit money banks. The study is specifically examined the influence of total debt ratio on income smoothing. Data collected from sampled twelve (12) listed Nigerian DMBs out of the fourteen (14) listed banks for period from 2009 to 2021. Data were analyzed using random effect panel regression. The results revealed that total debt to equity ratio exerts negative and significant influence on income smoothing measured by absolute discretionary accrual (t= -2.87; p<0.05) respectively. These implied that an increase in total debt ratio will reduce income smoothing. This suggests that the probability of being income smoother is lower when a firm has higher total debt. The study concluded that total debt ratio was negatively influenced the income smoothing among listed deposit money banks. The study therefore, recommends that Nigerian banks should carefully manage their debt levels so as to avoid income smoothing practices by management.

ERP implementation and earnings management: The moderating effect of an independent board of commissioners

This research examines the moderating effect of the Independent Board of Commissioners on the relationship between implementing an enterprise resource planning system (ERP) and earnings management in non-financial companies in the Indonesia Stock Exchange. The earnings management variable is proxied through discretionary accruals, which refer to the calculation of the modified Jones model. This research used panel data from 85 companies from 2017 – 2020 to obtain a sample of 340. Employed the moderated regression analysis, the research finds that ERP implementation significantly influences the decline in earnings management. At the same time, the Independent Board of Commissioners can strengthen the relationship between the implementation of ERP systems and earnings management. This study contributes to expanding literature related to company information systems by providing evidence of the influence of ERP implementation on earnings management and how the Independent Board of Commissioner contributes to the relationship.