A Test of Income Smoothing Using Pseudo Fiscal Years

50 Pages Posted: 29 Aug 2017 Last revised: 26 Jul 2021

See all articles by Dirk E. Black

Dirk E. Black

University of Nebraska at Lincoln - School of Accountancy

Spencer Pierce

Florida State University - College of Business

Wayne B. Thomas

University of Oklahoma

Date Written: June 10, 2021

Abstract

The purpose of our study is to further understand managerial incentives that affect the volatility of reported earnings. Prior research suggests that the volatility of fourth-quarter earnings may be affected by the integral approach to accounting (i.e., “settling up” of accrual estimation errors in the first three quarters of the fiscal year) or earnings management to meet certain reporting objectives (e.g., analyst forecasts). We suggest that another factor affecting fourth-quarter earnings is managers’ intentional smoothing of fiscal-year earnings. For each firm, we create pseudo-year earnings using four consecutive quarters other than the four quarters of the reported fiscal year. We then compare the earnings volatility of pseudo years to the earnings volatility of the firm’s own reported fiscal year. We find evidence consistent with fourth-quarter accruals reflecting managerial incentives to smooth fiscal-year earnings. This conclusion is validated by several cross-sectional tests, the pattern in quarterly cash flows and accruals, and several robustness tests. Overall, we contribute to the literature exploring alternative explanations for the differential volatility of fiscal year and fourth-quarter earnings.

Keywords: income smoothing, earnings management, earnings volatility, accruals

JEL Classification: M40, M41, M48

Suggested Citation

Black, Dirk E. and Pierce, Spencer and Thomas, Wayne B., A Test of Income Smoothing Using Pseudo Fiscal Years (June 10, 2021). Available at SSRN: https://ssrn.com/abstract=3026235 or http://dx.doi.org/10.2139/ssrn.3026235

Dirk E. Black (Contact Author)

University of Nebraska at Lincoln - School of Accountancy ( email )

307 College of Business Administration
Lincoln, NE 68588-0488
United States

Spencer Pierce

Florida State University - College of Business ( email )

423 Rovetta Business Building
Tallahassee, FL 32306-1110
United States

Wayne B. Thomas

University of Oklahoma ( email )

Michael F. Price College of Business,
307 W Brooks, Rm 212B
Norman, OK 73019
United States
405-325-5789 (Phone)
405-325-7348 (Fax)

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