Earnings Management Motivations

8/10/2019 Earnings Management Motivations

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EARNINGS MANAGEMENT

MOTIVATIONS

TAX-POLICY IN RESPONS TO

EARNINGS MANAGEMENT


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PRESENTATION OUTLINE

Introduction

LR Discussion

Conclusion


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INTRODUCTION

Three categories of accountingchoice studies (Fields et. al., 2001):

Relation to afirms

contractualarrangement

s

Relationto asset

price

Relation toexternal parties

other than actualor potential owner

of the firm e.g.policy makers,governmentregulators


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CONTD

Firms engage in EM formany reasons

One reason is a responseto anticipated changes intax policy. E.g. changes intax rate, tax incentives

So, it falls in third categoryof accounting choice


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DISCUSSION

Key point to correlate a tax-policywith the EM:

1) What are the tax-policy

involved?

2) How the measurement to detect

EM?

3) Findings - correlations


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LITERATURE REVIEW

From six articles:NO ARTICLE TITLE AUTHOR YEAR

1 EM in response to

corporate tax rate

changes: Evidence from

the 1986 Tax Reform Act

David A.

Guenther

1994

2 Tax waiver year effect

on EM practices in

Malaysia

Jafni Hashim

& Mohd Nizal

Haniff and

Ibrahim Kamal

AbdulRahman

2012

3 EM around tax

reduction: evidence

from Chinas 2007

corporate tax reform

Tao Zeng 2014


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Contd

NO ARTICLE TITLE AUTHOR YEAR

4 The impact of tax

holidays on EM: An

empirical study of

corporate reporting

behavior in a

developing-economy

framework

Kenny Z. Lin 2006

5 Correlation between tax

holidays and EM: An

empirical study

Zinatul

Ashiqin

Bachek,

Norsiah

Ahmad &Norman Mohd

Salleh

2012

6 EM to influence tax

policy: evidence from

large Malaysian Firms

Ajay Adhikari,

Chek

Derashid &

Hao Zhang

2005


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LR DISCUSSION

(1) EM in response to corporate tax changes:Evidence from the 1986 Tax Reform Act

Author David A. Guenther (1994)

Tax-policy Changes in tax rate

Sample Financial statement data from a sample of firms

taken from 1990 COMPUSTAT Annual Industrial

Filemanufacturing, wholesale, retail and

services (other than financial services industries

Methodology Current accrual base on Jones (1991)

Findings Significantly negative current accruals in the

year to the tax rate reductions by:

a) Defer revenuedecreasing current assets

b) Accelerate expensesincreasing current

assets


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ILLUSTRATION

Before change tax

rate46%

After change tax rate

34%

Defer revenues

Inc rease expens es

Decrease current

assets to defer

revenue

Increasing current

liabilities to

accelerate

expenses


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(2) Tax waiver year effect on EM practices in

Malaysia

Author Jafni Hashim & Mohd Nizal Haniff andIbrahim Kamal Abdul Rahman (2012)

Tax policy Tax waiver year of 1999 which came

about from introduction of the Self-

Assessment System (SAS) by IRBM in

the year 2000Sample 660 companies listed on the main and

second board of Bursa Malaysia for the

period between 1998 and 2000

Methodology Modified Jones Model (adjusted)

discretionary current accruals

Finding Not significant with the hypothesis

developed - positive discretionary

current accrual (income increasing

earnings management) in the tax waiver

year of 1999


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ILLUSTRATION

During waive year

(1999) @ tax waive(0%)

After waive year (2000)

@ tax rate of (28%)

Accelerate revenues

Defer expens es

Increase accruals

through revenue

(acceleration or

expenses deferral)

Decrease(reverse)

(accruals)


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(3) EM around tax rate reduction: evidence

from Chinas 2007 corporate

Author Tao Zeng (2014)

Tax policy Tax rate reduction

Sample Financial data are collected from the

China Stock Market Financial Statement

Database (CSMAR)real estate firmsMethodology Accrual-based earnings management

and real earnings management

Finding The firms managed their earnings by

decrease income in the 4thquarter of

2007 and increase income in the 1st

quarter of 2008.

They shifting income from the 4thquarter

of 2007 when the tax rate 33% to the 1st

quarter of 2008 when the tax rate 25%


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(4) The impact of tax holidays on EM: an empirical

study of corporate reporting behavior in a

developing-economy framework

Author Kenny Z. Lin (2006)

Tax policy Tax-incentive schemetax rate increase

Sample 112 sample firms - foreign investment

enterprises (FIEs) in ChinaMethodology Discretionary current accruals

Finding The firms make income-increasing

accruals in the year before a tax-rate

increaseincome shifting behaviormanage earnings upward to take

advantage of lower tax rates that are

available in certain years


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(5) Correlation between tax holidays and EM: an

empirical study

Author Zinatul Ashiqin Bachek, Norsiah Ahmad

& Norman Mohd Salleh (2012)

Tax policy Tax-incentivepioneer status

Sample 216 companies from manufacturing

industry that have enjoyed pioneer status

and exemption expired in 2002 to 2006

Methodology Discretionary current accruals

Finding Consistent with previous studies (Lin,

2006), the company accelerate revenueto the year prior to the expiration of their

exemptions to reduce tax liabilities after

their tax exemptions expired


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(6) EM to influence tax policy: evidence from large

Malaysian firms

Author Ajay Adhikari, Chek Derashid & Hao

Zhang (2005)

Tax policy A period of possible change in tax policy

Sample Annual reports published by firms listed

on the main board of KLSE between1994 and 1997

Methodology Effective tax rate (ETR) and discretionery

accruals (low in book-tax conformity)

Proxy EMchanges in deferred tax

expenses

Finding Low ETR decrease book income prior to

a reduction in corporate tax in order to

influence tax policy


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CONCLUSIONS

Tax-policy motivated the company tomanage their earnings

Evidence from that studies may be

interest to tax policymakers in enforcingtax rules that are designed to preventabusive tax avoidance

Also have implications for externalauditors, who often face conflictingdemands to give tax minimization adviceon the one hand and to detect materialcases of client earnings management onthe other


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Earnings Management Motivations

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