Classificatory Income Smoothing: The Impact of a Change in Regime of Reporting Financial Performance

54 Pages Posted: 17 Sep 2007

See all articles by Vasiliki E. Athanasakou

Vasiliki E. Athanasakou

Saint Mary's University, Canada - Sobey School of Business

Norman C. Strong

University of Manchester - Alliance Manchester Business School

Martin Walker

University of Manchester - Manchester Business School

Abstract

Financial Reporting Standard No 3 (FRS3) regulated the reporting of financial performance by UK firms from 1993 until the adoption of International Financial Reporting Standards in 2005. FRS3 outlawed extraordinary items, but allowed a clearer distinction between recurring and transitory income by giving firms discretion over the classifications of unusual (i.e. exceptional) items and the option to disclose alternative EPS. Through these provisions FRS3 increased the scope for classificatory choices as a means to highlight persistent profitability. We examine the impact of FRS3 on classificatory smoothing by UK firms and document a significant rise in this practice post-FRS3. We find that this increase is due mainly to deviations of net income from expected earnings inducing a significantly higher level of classificatory smoothing post-FRS3. Additional analysis shows that earnings are substantially more persistent at the pre-exceptional level post-FRS3. Overall, our results suggest greater use of classificatory choices to highlight sustainable profitability after the change in performance reporting regime.

Keywords: classificatory income smoothing, extraordinary and exceptional items, sustainable profitability, earnings persistence

JEL Classification: M41, M44, M43, M47

Suggested Citation

Athanasakou, Vasiliki E. and Strong, Norman Charles and Walker, Martin, Classificatory Income Smoothing: The Impact of a Change in Regime of Reporting Financial Performance. Journal of Accounting and Public Policy, Vol. 26, 2007. Available at SSRN: https://ssrn.com/abstract=1014453

Vasiliki E. Athanasakou (Contact Author)

Saint Mary's University, Canada - Sobey School of Business ( email )

Sobey Building 311
923 Robie Street
Halifax, Nova Scotia B3H 3C3
Canada

Norman Charles Strong

University of Manchester - Alliance Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

Martin Walker

University of Manchester - Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

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