Journal of Accounting & Finance Vol. 2, No. 2, November 2000: 104-115 Accounting Department of Economics, Faculty of Economics - Petra Christian University http://puslit.petra.ac.id/journals/accounting/ 104 EARNINGS MANAGEMENT: A literature review Tatang Ary Gumanti Lecturer Faculty of Economics Department of Management and Accounting - University of Jember ABSTRACT Earnings management or earnings management is a new phenomenon that has added to the development discourse theory accounting. The term profit management emerged as a direct consequence from the efforts of managers or the manufacturer's financial statements for to management accounting information, especially earnings (earnings), personal interests and / or the company. Profit Management alone can not be interpreted as an adverse negative effort because they do not always profit-oriented management manipulation profits. Theoretically there are many ways or methods that can be taken by managers (maker of financial statements) to affect the profit reported (reported earnings) which is possible in terms of Positive accounting theory (positive accounting theory). Positive accounting theory explained that the managers have an incentive or encouragement to be maximize welfare. Empirical evidence shows that earnings management practices encountered in many contexts. This indicates that the incident or variable-specific economic variables can be used as a means to manage earnings. The fact is providing an opportunity for the accounting research in particular, and general management researchers, to examine the possibility of earnings management in one aspect or economic context. Keywords: Management earnings, positive accounting theory, accrual, profit. Abstract Earnings management is a new phenomenon, which has contributed to the development of accounting theory. The term earnings management occurs as a direct consequence of the efforts undertaken by managers or preparers of financial statements in an attempt to affect accounting information, especially earnings, for his / her own and / or company's benefits. Earnings management can not be interpreted as a negative action since it does not solely concerned with earnings manipulation. Theoretically, there are many ways or methods available for managers or preparers of financial statements to affect reported earnings, Earnings Management: A Study Library (Tatang Ary Gumanti) Accounting Department of Economics, Faculty of Economics - Petra Christian University http://puslit.petra.ac.id/journals/accounting/ 105 which are considerably possible from the view of positive accounting theory. The positive accounting theory suggests that managers may have The incentives and intention to behave opportunistically for Obtaining his / her private gains by selecting certain accounting methods. Empirical studies have shown that earnings management is evidenced in many economic contexts. This Indicates that certain events or economic variables can be Utilized as a mechanism for managing earnings. This Evidence provides opportunity for accounting researchers, in particular, and management researchers to examine the possibility of occurrence of earnings management in various economic contexts. Keywords: Earnings management, positive accounting theory, accruals,
earnings. 1. INTRODUCTION The term earnings management or earnings management may not be too foreign for students of management and accounting, both practitioners and akademisi.1 The term began to attract the attention of researchers, especially researchers accounting, because it is often associated with the behavior of managers or the manufacturer reports finance (preparers of financial statements). At first glance, it appears that earnings management is closely linked to the level profit (earnings) or achievements of an organization's business. This is not strange because the level of profits or profits are often associated with the achievement indeed besides management is a common that the size of bonuses that will be received by the manager depending on the size of the profit diperoleh.2 Therefore it is not surprising that managers often try to emphasize achievement through profit or the profit level achieved. The term earnings management arises when researchers, particularly researchers accounting, try to link the relationship between a particular economic variable and upayaupaya managers to take advantage of these variables. When we talk 1 Earnings management or earnings management is different from leveling profit (income smoothing). Alignment profit is one aspect of earnings management. The term earnings management may more appropriate to interpret earnings management. Another term that we might encounter in mean earnings management or earnings management is the management of profits or profit management. Peng-Indonesiaan term follow Salno and Baridwan (2000:18 -19). For the purposes of discussion in this paper, the author uses the term earnings management. 2 To not obscure the interpretation, in this paper the author equates with the meaning of profit profits, (profits, earnings, gains, and income). Although in the literature these terms meaning that the concept may be different, to facilitate discussion in writing This is considered the same, because it's rather difficult to distinguish explicitly. So in writing These profits, earnings, income, and / or gains are used interchangeably (interchangeably). To in a more detailed explanation about the meaning of each term, the reader please see Anthony and Reece (1989). Journal of Accounting & Finance Vol. 2, No. 2, November 2000: 104-115 Accounting Department of Economics, Faculty of Economics - Petra Christian University http://puslit.petra.ac.id/journals/accounting/ 106 of profit management, our discussion will not be apart of a new theory on accounting, namely the positive accounting theory or positive accounting theory. Perhaps it can be said that one of the pioneers of positive accounting theory is Watts and Zimmerman (1978; 1986; 1990) .3 In their book entitled "Positive Accounting Theory", Watts and Zimmerman (1986) presented a theory accounting is trying to reveal that economic factors specific or the characteristics of a particular business unit can be associated with the behavior of managers or the maker's financial statements. More particularly, Watts and Zimmerman (1986) reveals the influence of economic variables on motivation manager to choose a method of accounting. They assert that the theory of accounting positive has a very important role in its development, because the theory This can provide guidance to the accounting policy decision makers in doing estimates or explanations of the consequences of the decision. Of the many studies, based on the theory positive accounting, one of the study and research interest is of profit management. Earnings management arise or allegedly committed by managers or the manufacturer financial statements in the financial reporting process of an organization because they expect a benefit from the action taken. Earnings management to interesting to study because it can give a manager will conduct in reporting their business activities in a given period, namely the possible emergence of a specific motivation that drives them to manage
or manage financial data reported. It should be noted here that the management profits are not to be linked to efforts to manipulate the data or information accounting, but are leaning more associated with the selection of accounting methods (accounting methods) to set the gains that can be done because was allowed by accounting regulations. Given the more interesting topics profit management for researchers accounting, in particular, and students of management, the author tried to reveal phenomenon. There's even a special comment that appears in the journal Accounting Horizon dealing fairly complete earnings management (Schipper, 1989). Another goal of this paper is to show studies associated with the phenomenon in question. Setting this paper is as follows. The second part of this paper tries to explore what factors are may cause managers manage reported financial data. This section followed by a discussion of the steps or methods that can adopted the manager to manage earnings (earnings). The fourth section is briefly discusses studies that have been done so far. The end of this paper is a summary of an outline. 3 positive accounting theory, in principle, assume that the purpose of accounting theory is to explain (to explain) and predict (to predict) accounting practices (Watts and Zimmerman, 1986:2). Earnings Management: A Study Library (Tatang Ary Gumanti) Accounting Department of Economics, Faculty of Economics - Petra Christian University http://puslit.petra.ac.id/journals/accounting/ 107 2. WHY MANAGERS manage FINANCIAL DATA Before answering the question why financial data, especially earnings, important for many parties, first expressed what is meant by profit management. Earnings management can mean many things, depending on the which side we see it. For example, from the point of ethics, earnings management is defined as "any action on the part of management which reported income and Affects which provides no true economic advantage to the organization and may in fact, in the long-term, be detrimental "(Merchant and Rockness, 1994:79). While Ayres (1994:28) defines earnings management as "an intentional structuring of reporting or production / investment decisions around the bottom line impact. It encompasses income smoothing behavior but also includes any attempt to alter reported that income would not occur unless management were Concerned with the financial reporting implications ". Another definition of earnings management is "disclosure management in the sense of purposeful intervention in the external reporting process, with intent of Obtaining some private gain "(Schipper, 1989:92). Meanwhile, Rosenzweig and Fischer (1994:31-32) defines earnings management as "the actions of managers that are intended to increase (decrease) current reported earnings of the unit for which The manager is responsible without generating a corresponding increase (decrease) in the long-term economic profitability of the unit ". Of the three definitions mentioned above, the third definition seems to have meaning deeper than the first definition and the second, or fourth. The first definition that tends to direct that management profit is the action that could endanger the existence of organizations in the future. This is probably not very appropriate, as long as earnings management is not only related with the motivation of individual managers for self-interest, but also for corporate interests and profit management is not to be linked to manipulation. Meanwhile, the second definition is too broad and was impressed not by imply that management made profits for personal gain. For the purposes of this paper is the third definition is used as the basis for discussion. In this case, earnings management is always associated with efforts to 'manage' income or profits for certain interests which are based on by economic factors particular. Although almost the same as the definition of third, the fourth definition was too broad.
The question now is why managers 'manage' or 'manage' profit?. The answer is none other than because both theory and empirical evidence indicate that earnings or profit has been used as a target in business performance assessment process of a particular department (manager) or enterprise (organization) in general. In addition, profit or benefit level also a tool to reduce agency costs (agency costs), from the theory agency (agency theory), and also the cost of the contract, from the theory of contract (contracting theory). For example, when used as a standard benefit in granting bonus, this will create the incentive for managers to manage the data finance in order to receive a bonus as he wanted. Another reason is to remember the importance of profit or gains in accounting (accounting income) for decision-making by many parties, Journal of Accounting & Finance Vol. 2, No. 2, November 2000: 104-115 Accounting Department of Economics, Faculty of Economics - Petra Christian University http://puslit.petra.ac.id/journals/accounting/ 108 such as investors, fund providers (creditors), managers, owners or shareholders, and the government. Seeing this reality, not surprising that many managers manage financial data, or profits for the interests certain. Empirical evidence also shows that the benefits of accounting is the relevant information on the company's cash flow current and future which in turn is associated with firm value (firm value) (Watts and Zimmerman, 1986). Magnan and Cormier (1997) states that there are three targets that can achieved by managers in connection with the practice of earnings management. Third target it is a political cost minimization (political cost minimization), maximization welfare manager (manager wealth maximization), and minimization of financial costs (minimization of financing costs). Clear here that the goal of profit management is quite comprehensive, covering many aspects of good corporate for personal gain or corporate managers as a whole. One of the discussion in the literature about the activities related to contract (contracting activities) shows that accounting data plays an important role in many aspects. Accounting data also play a role in interpretation of the exchange term in the contract that provides activities dorongandorongan particular for managers to organize or manage the accounting data to their own interests. On the other side of accounting profits (accounting earnings) is part of the accounting data and has been known as a signal or reference in the process of decision making and policy-makers is important for and users of financial reports and also because of widespread accounting earnings believed to be the main information provided in the financial statements of a organization (Lev, 1989; Schipper, 1989; Gujarathi and Hoskin, 1992). The result is not surprising that many managers who manage the benefits depend the underlying motivation. Agency theory (agency theory) also stressed that the accounting numbers play an important role in suppressing the conflict between the owner of the company and administrators or managers (DeAngelo, 1986). From this it is clear that why managers have the motivation to manage financial data in general and profits or earnings in particular. It did not matter what described as attempts to gain personal profit or benefit (Obtaining private gains). 3. HOW manage PROFIT Ayres (1994) in an article trying to express, albeit briefly, about practices that can be done by managers to manage earnings or by showing achievement gains. According to Ayres, there are three factors that can be associated with the emergence of these practices, namely accrual management (accruals management), application of a mandatory accounting policies
(adoption of mandatory accounting changes), and changes in accounting voluntary (voluntary accounting changes). The first factor is usually associated with all the activities that can affect cash flow and profit who personally is the authority of the managers (managers' discretion). Earnings Management: A Study Library (Tatang Ary Gumanti) Accounting Department of Economics, Faculty of Economics - Petra Christian University http://puslit.petra.ac.id/journals/accounting/ 109 Examples for this example is to accelerate or delay recognition of revenues (revenues), considered as expenses (costs) or considered as an additional investment on a cost (amortize or capitalize of an investment) (eg maintenance costs non-current assets, loss or profit on sale of assets), and accounting estimates such as eg load doubtful doubtful, and changes in accounting method changes. The second factor related to the manager's decision to implement an accounting policy which must be applied by the company, namely between apply earlier than the stipulated time or postpone it until now application of these policies. In many countries, usually for a new accounting policy is required (mandatory accounting policy), body existing accounting (accounting governing bodies) provides the opportunity for companies to be able to apply earlier than the application time. The course manager will choose to apply an accounting policy that only when the application will be able to affect both the cash flow as well as corporate profits. Not surprisingly, many researchers are interested to uncover this possibility. Examples of empirical research evidence about the obligations applying accounting policies the research conducted by Ayres (1986) and Trombley (1989). Ayres, for example, tried to examine whether certain characteristics could affect managers to apply SFAS 52 "Accounting for Foreign Currency Translation "and found evidence that companies that early adoption is smaller, less profitable, and tend have a problem with solvabilitasnya when compared with companies which adopted more recently. Ayres also found evidence that by adopting earlier, the company could raise the average profit of $ 0.38 persaham. Ayres Research proves that early adopted a certain accounting policies may affect the business performance of a company, which was an achievement as well as managers. The third factor, namely changes in accounting method on a voluntary basis, usually related to the efforts of managers to replace or change a method specific accounting of the many methods to choose from the available and recognized by the existing accounting bodies (generallly accepted accounting principles = GAAP). Examples for this is to change the method of valuation of inventory from FIFO to LIFO or vice versa, change the depreciation method of assets from line method straight (stright-line) to the method of accelerated depreciation (accelerated) or vice versa, and / or recognition of the production costs of using the cost method full (or full absorption costing) or the direct costs / variable (variable or direct costing). Although managers can not make a change in accounting method often, they can do with a form other forms of accounting changes different both individually and collectively together for some period. Empirical evidence shows that large firms tend to choose firms accounting methods that reduce the profits (usually based on the political cost hypothesis), the company that the company was facing debt difficulties tend to choose accounting methods that increase profits (usually based on debt-equity hypothesis), and managers who work in Journal of Accounting & Finance Vol. 2, No. 2, November 2000: 104-115
Accounting Department of Economics, Faculty of Economics - Petra Christian University http://puslit.petra.ac.id/journals/accounting/ 110 companies that apply the rules of a bonus will choose accounting methods that can increase profits (usually based bonus-plan hypothesis). Watts and Zimmerman (1986, 1990) discusses in detail the third hypotesis. McNichols and Wilson (1988) adds a fourth factor that could be a means for managers to influence their financial performance, namely through policy operating policies, investment, and spending (operating, investing, and financing policies). It is clear here that the many ways that can be done by managers or makers to influence the financial statements of financial performance or profits. Earnings management is also one way that can be done by managers. 4. EMPIRICAL EVIDENCE previous studies Studies that exist and which refers to the positive accounting theory has been trying to explain the relationship between specific variables company or economic factors and the selection will be given a method of accounting. Mentioned studies using the measurement approach with two methods, namely (1) choice of accounting methods (accounting method choice) and (2) methods accruals (accruals method). Those who use the method of choice approach accounting is usually tested with multivariate analysis (multivariate analysis). Contributions obtained from these studies is very diverse and include discovery or an explanation would be systematic forms of choice method of accounting, recognition of the importance of contract costs (contracting costs) for accounting, and terms will be the basis for understanding the choices accounting (accounting choices) (Watts and Zimmerman, 1990). Seeing the many studies that attempt to express the phenomenon in above (accounting choices) and as the purpose of this paper is only for talk about profit management course, the empirical evidence presented below is a research-related research the possibility of profit management. Studies have been conducted so far show that the practice of earnings management was not always evident. In other words proved earnings management in an economic activity but not in other cases. Even in certain cases, for example, research with the same case, there are conflicting findings. The following research revealed about the profit management. Healy (1985) is probably the first person who tried to reveals the possibility of the emergence of profit management, especially the linkages between management and the pattern of profit bonus (bonus schemes) in the process of data reporting finance. Healy assumes that managers will choose accounting procedures that increase reported profits in an effort to maximize bonus rewards. Healy found evidence that there is a strong relationship between accrual and certain impulses that affect the managers to manage amount of income reported, especially the manager will choose the accrual of lower income at the time bonus patterns under or above the limit Earnings Management: A Study Library (Tatang Ary Gumanti) Accounting Department of Economics, Faculty of Economics - Petra Christian University http://puslit.petra.ac.id/journals/accounting/ 111 tied, and select the accrual of raising revenue at the time limitation is not bound. In general, Healy (1985) found evidence of the emergence of earnings management. Other research (although there are many others) are trying to repeated studies Healy (1985), is Holthausen, Larcker, and Sloan (1995) and Gaver, Gaver, and Austin (1995). Both this study differ from research Healy
in the case of accrual method of measuring the total. Another difference is in terms of sample size and time period studied. When Healy (1985) found managers selecting reporting declining revenues at the time profits fell below Required, Gaver et al. (1995) found that the manager will choose accounting procedures that increase profits while profits are at required, and vice versa. Meanwhile, Holthausen et al. (1995) did not found evidence that managers manipulate profits (lower profit) at the time benefits under the minimum requirement to be receive a bonus. In kesuluruhan good Gaver and his friends and Holthausen and his friends to prove will rise in profit management samples they studied. DeAngelo (1986) found no evidence that managers manage financial data with reported lower profits than expected (expected earnings) as they lead the company planned to buy all the existing shares in the community (management buyouts of public stockholders). No such as DeAngelo (1986) who did not find evidence of engineering earnings, Perry and Williams (1994) found evidence that when the company planned to buy all outstanding shares in the community, managers reduce reported profits. This finding is of course contrary to the reported by DeAngelo (1986). For the record, Perry and Williams (1994) detection model is different from the accrual used by DeAngelo (1986). By the time they DeAngelo applying the method to test possibility of profit management, Perry and Williams stated that the difference the results of their research and research due to the characteristics DeAngelo sample, not the method used. In another study, DeAngelo (1988) found that earnings management arise when managers are facing a proxy contest in which the manager tried to demonstrate achievement benefits (improved). Similarly, DeAngelo (1986), Liberty and Zimmerman (1986) did not found evidence that earnings management arise when managers or company are facing negotiations with labor organizations. Liberty and Zimmerman assumes that managers will reduce corporate profits during the period of negotiations with the reason will be the target profit labor organization the right to demand improvements. They found no indication that managers reduce profits at the time of the negotiations. Studies other will prove overall appearance profit management. For example, earnings management is found in the context of policy of doubtful or bad debts (WcNichols and Wilson, 1988), at the time companies facing investigations exemption of import (Jones, 1991), at the time companies are in the investigation of anti-union or antitrust investigation (Resolution, 1992), at the turn of the company's top management or top executive Journal of Accounting & Finance Vol. 2, No. 2, November 2000: 104-115 Accounting Department of Economics, Faculty of Economics - Petra Christian University http://puslit.petra.ac.id/journals/accounting/ 112 changes (Pourciau, 1993), and at the companies plan to first time to sell shares to the public or an initial public offering (Friedlan, 1994). Unlike Friedlan (1994), Aharony, Lin, and Loeb (1993) in an effort to investigate the possibility of earnings management in companies who made an initial public offering, did not find strong evidence that owner of the company reported a profit increase. Aharony et al. (1993) found additional evidence that says that the practice of earnings management tend to appear at a smaller company and have a debt / equity ratio high. Studies in Indonesia showed no evidence that the period before going public, owners of companies (issuers) selecting an accounting method that increase profits (Gumanti, 1996). Research Gumanti (2000) with
using more recent data, namely for the company that went public between in 1995 and 1997 show that earnings management in the IPO market in Indonesia proved to exist, especially in the two-year period prior to go public.4 In addition to studies mentioned above, there are also studies that found evidence that managers engage in earnings management in an attempt to avoid a decrease profits and avoid losses (Burgstahler and Dichev, 1997). Earnings management practices are also evident in the situation where companies do offer limited or right issue (Rangan, 1998). With use of discretionary accruals approach, Rangan found evidence that discretionary accruals is significantly appear in the quarter where the supply done and limited in the next quarter. Evidence that is not much different from Rangan findings shown in the study Teoh, Welch, and Wong (1998). Based on the evidence above it is clear that earnings management practices are not ever appeared. In other words profit management appeared in one event certain economic, but not in other activities. This may be consistent with opinion Schipper (1989) that the events or specific events could affect the manager's decision to regulate or manage, whether it by raising or lowering, the reported profits. It seems clear that managers benefit because of the reverse motivations particular, is not just purely motivated by personal benefit but also for corporate purposes. 5. CONCLUSIONS AND RECOMMENDATIONS Based on the above discussion would be drawn some important things. First, managers manage the reported rates of return (reported income) because 4 Differences Gumanti research findings (1996; 2000) is strongly influenced by the size of the sample companies and the availability of data for research where the first test for the period two years before going public can not be done because the cash flow statement data (cash flow statement) is not mandatory for companies in Indonesia. Cash flow statement must be reported as of 1 In January 1995 after the publication of Financial Accounting Standards (SAK). Earnings Management: A Study Library (Tatang Ary Gumanti) Accounting Department of Economics, Faculty of Economics - Petra Christian University http://puslit.petra.ac.id/journals/accounting/ 113 motivated by several factors. Earnings management to be interesting because remember the importance of profit or advantage for the business performance assessment of a unit operations or the company as a whole. Second, there are four ways that can conducted by managers to manage profits is through what is known as accrual management, implementation of a mandatory accounting policies more beginning or just as required, through a change in accounting procedures allowed by the accounting bodies voluntarily (voluntary accounting changes), and through the wisdom of operating, investing and spending (operating, investing and financing activities). Finally, management practices are not always profit can be proved, although there is a possible reason for the occurrence of this it. Unique to certain matters of empirical findings showing the results different. Seeing the fact that there are findings that are even different on a specific event or events not find evidence of earnings management, is an opportunity for us, researchers who are interested in the field theory akuntansi positif, untuk melakukan penelitian-penelitian baru ataupun dengan menerapkan penelitian yang telah dilakukan di Amerika Serikat dengan sampel di negara lain. Hal ini dilakukan sebagai upaya untuk menguji validitas eksternal penelitian-penelitian yang telah ada. Selain itu, untuk para peneliti dan pemerhati akuntansi di Indonesia dan dengan mempertimbangkan kondisi yang ada, masih terbuka kesempatan bagi kita untuk dapat mengungkap fenomena-fenomena lain yang secara kharakteristik hanya mungkin terjadi di negara kita. Misalnya, dengan meniliti pengaruh pergantian pimpinan suatu badan usaha pemerintah terhadap prestasi
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