How Do Restatements Begin? Evidence of Earnings Management Preceding Restated Financial Reports

Journal of Business Finance and Accounting, Forthcoming

28 Pages Posted: 13 Sep 2007 Last revised: 22 Jun 2014

See all articles by Michael Ettredge

Michael Ettredge

University of Kansas - Accounting and Information Systems Area

Susan Scholz

University of Kansas - Accounting and Information Systems Area

Kevin R. Smith

Utah Valley University -- Woodbury School of Business

Lili Sun

University of North Texas - Department of Accounting

Multiple version iconThere are 2 versions of this paper

Date Written: February 18, 2010

Abstract

Most earnings restatements are blamed on error, or misunderstanding of GAAP, but suspicion persists that many of these restatements are instead due to intentional earnings management. We analyze balance sheet bloat, or unusually high levels of working capital account balances, for evidence of sustained, income-increasing earnings management prior to initial non-GAAP financial reports. We establish a pattern of systematically increasing balance sheet bloat for firms later issuing clearly fraudulent financial reports. Next, we compare bloat for apparently non-fraud restatements to fraud and control samples. We find non-fraud restatement companies‟ bloat is higher than control companies for two years preceding the initial misstated financial report. But, these firms accumulate less balance sheet bloat than companies with restatements clearly involving fraud. This suggests meaningful, but not pervasive, earnings management underlying even apparently non-fraudulent restatements. We extend our analysis to discretionary accruals and real activity earnings management.

Keywords: earnings management, fraud, restatements, real activity earnings management

JEL Classification: M41, M43, M44, K22

Suggested Citation

Ettredge, Michael L. and Scholz, Susan and Smith, Kevin R. and Sun, Lili, How Do Restatements Begin? Evidence of Earnings Management Preceding Restated Financial Reports (February 18, 2010). Journal of Business Finance and Accounting, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1014053 or http://dx.doi.org/10.2139/ssrn.1014053

Michael L. Ettredge

University of Kansas - Accounting and Information Systems Area ( email )

1300 Sunnyside Avenue
Lawrence, KS 66045
United States
785-864-7537 (Phone)
785-864-5328 (Fax)

Susan Scholz

University of Kansas - Accounting and Information Systems Area ( email )

1300 Sunnyside Ave
Lawrence, KS 66045
United States
785-864-7554 (Phone)
785-864-5328 (Fax)

Kevin R. Smith (Contact Author)

Utah Valley University -- Woodbury School of Business ( email )

800 West University Parkway
Orem, UT 84058
United States

Lili Sun

University of North Texas - Department of Accounting ( email )

1155 Union Circle #305219
Denton, TX 76203-5017
United States
940-565-3077 (Phone)

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