SFAS 133 and Income Smoothing Via Discretionary Accruals: The Role of Hedge Effectiveness and Market Volatility

26 Pages Posted: 5 Jun 2018

See all articles by Abiot Mindaye Tessema

Abiot Mindaye Tessema

Zayed University - College of Business

Rogier Deumes

Maastricht University - Department of Accounting & Information Management, MARC (Maastricht Accounting, Auditing & Information Management Research Center)

Date Written: June 2018

Abstract

This study investigates whether the Statement of Financial Accounting Standard No. 133 (SFAS 133) influences firms’ income smoothing via discretionary accruals decisions. Moreover, we investigate whether the level of hedge effectiveness and market volatility affects the impact of SFAS 133 on firms’ income smoothing via discretionary accruals decisions. Consistent with our predictions, we find a significant increase in income smoothing via discretionary accruals activity after the adoption of SFAS 133. We also find that income smoothing via discretionary accruals after the adoption of SFAS 133 increases with the level of hedge ineffectiveness. By contrast, we find that perfect hedgers do not engage in more income smoothing via discretionary accruals after the adoption of SFAS 133. Finally, we find that the higher the market volatility is the larger the income smoothing is via discretionary accruals after the adoption of SFAS 133. This implies that higher market volatility makes it more difficult for firms to meet hedge accounting requirements, thereby increasing unmanaged earnings volatility and income smoothing. Prior studies suggest that regulators are expressing concern about the effect of earnings management on the quality of reported earnings and the functioning of capital markets (e.g., Barton, [Barton, J., 2001]). In this regard, our findings imply that accounting standard setters should take into account the trade‐off between transparency and income smoothing.

Keywords: derivatives and hedging, hedge effectiveness, income smoothing, market volatility, SFAS 133

Suggested Citation

Tessema, Abiot and Deumes, Rogier, SFAS 133 and Income Smoothing Via Discretionary Accruals: The Role of Hedge Effectiveness and Market Volatility (June 2018). Journal of International Financial Management & Accounting, Vol. 29, Issue 2, pp. 105-130, 2018, Available at SSRN: https://ssrn.com/abstract=3189148 or http://dx.doi.org/10.1111/jifm.12070

Abiot Tessema (Contact Author)

Zayed University - College of Business ( email )

Zayed University
P.O. Box 144534
Abu Dhabi
United Arab Emirates

Rogier Deumes

Maastricht University - Department of Accounting & Information Management, MARC (Maastricht Accounting, Auditing & Information Management Research Center) ( email )

P.O. Box 616
Maastricht, 6200 MD
Netherlands

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