Qualifying Special Items
Carol Anilowski Cain
Wake Forest University
Kalin S. Kolev
Yale School of Management
Sarah E. McVay
University of Washington
March 17, 2014
AAA 2009 Financial Accounting and Reporting Section (FARS) Paper
We examine the general composition of income-decreasing special items and assess what proportion reflect appropriately classified, economically driven transitory items versus opportunistically misclassified recurring expenses that should have been recognized in past, present or future periods. This examination is motivated by the arguments in prior research that in addition to correctly identifying economically driven unusual or infrequent charges as transitory, managers often opportunistically misclassify past, present and future recurring expenses as one-time charges. Building on the model in Reidl (2004), we propose a methodology for identifying the high- and low-quality components of special items. We conclude that roughly two-thirds of total special items are high-quality in that they are not associated with future cash flows or restatements, whereas the remaining one-third are low-quality and would be better characterized as recurring expenses. These low-quality special items violate the concept of a transitory item, as they are associated with future operating cash flows and, consistent with their initial misclassification, they are also associated with future earnings restatements. Finally, we document that low-quality special items appear to be used to meet earnings benchmarks and are more prevalent when monitoring is weaker. Thus, we provide a meaningful partitioning of special items that should be useful to investors, analysts, creditors, and regulators, as each of these parties must assess the future implications of special items.
Number of Pages in PDF File: 50
Keywords: Special items, transitory items, earnings quality, earnings management, future operating cash flows, restatements
JEL Classification: M41, M43
Date posted: September 20, 2008 ; Last revised: March 18, 2014
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