Changes in Accounting Estimates: Underlying Economic Reality or Earnings Management

43 Pages Posted: 29 Jan 2019 Last revised: 15 Feb 2019

See all articles by Al (Aloke) Ghosh

Al (Aloke) Ghosh

UNC Charlotte

Subprasiri Siriviriyakul

City University of New York (CUNY) - Baruch College

Date Written: December 10, 2018

Abstract

We examine whether companies strategically change accounting estimates to manipulate earnings (“earnings management” hypothesis) or whether these modifications represent changes in the underlying fundamentals (“economic reality” hypothesis). Using audit fees to discriminate between the two hypotheses, we find no evidence that auditors charge an incremental fee for changes in accounting estimates which is consistent with the economic reality hypothesis. More directly, we find a strong association between the underlying macro-economic factors and changes in accounting estimates. Relying on conventional earnings management proxies, we find no evidence that changes in accounting estimates are used to manage earnings. Finally, our results indicate that typically “financially troubled” companies undergoing major corporate restructuring are expected to change their accounting estimates over subsequent periods because they are more vulnerable to macro-economic shocks and more likely to update prior estimates.

Keywords: change in accounting estimates, audit effort, audit fees, and earnings management

JEL Classification: M40, M41, M42

Suggested Citation

Ghosh, Al (Aloke) and Siriviriyakul, Subprasiri, Changes in Accounting Estimates: Underlying Economic Reality or Earnings Management (December 10, 2018). Baruch College Zicklin School of Business Research Paper No. 2019-02-01. Available at SSRN: https://ssrn.com/abstract=3317064 or http://dx.doi.org/10.2139/ssrn.3317064

Al (Aloke) Ghosh (Contact Author)

UNC Charlotte ( email )

9201 University City Blvd
Charlotte, NC 28223
United States

HOME PAGE: http://www.alokeghosh.com

Subprasiri Siriviriyakul

City University of New York (CUNY) - Baruch College ( email )

Box B12-225 One Bernard Baruch Way
Stan Ross Dept of Accountancy
New York, NY 10010
United States
6463123247 (Phone)

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