A Comprehensive Analysis of the Use of Special Items to Manage Earnings
Carol Anilowski Cain
Wake Forest University
Kalin S. Kolev
Yale School of Management
Sarah E. McVay
University of Washington
February 16, 2012
AAA 2009 Financial Accounting and Reporting Section (FARS) Paper
We conduct a comprehensive analysis of the use of income-decreasing special items to manage earnings. In addition to correctly including unusual or infrequent charges in special items, managers can also misclassify future core expenses (e.g., future depreciation expense as an asset write-off), current core expenses (e.g., everyday severance fees as restructuring), or past core expenses (e.g., unrecognized bad debt expense as an asset write-off) as transitory. We model high- and low-quality special items and conclude that roughly one third of total special items would be better characterized as recurring expenses (i.e., are low-quality). We find that low-quality special items violate the concept of a transitory item, as they are associated with future operating cash flows, while high-quality special items are not, consistent with the theoretical concept of a transitory item (e.g., Ohlson 1999). Moreover, we document that low-quality special items predict accounting restatements, while high-quality special items do not.
Number of Pages in PDF File: 42
Keywords: Special items, earnings quality, earnings management, future operating cash flows, restatements
JEL Classification: M41, M43working papers series
Date posted: September 20, 2008 ; Last revised: February 21, 2012
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