Accounting for Inventory Costs and Real Earnings Management Behavior
40 Pages Posted: 13 Nov 2019
Date Written: November 4, 2019
Prior research finds that managers engage in inventory overproduction to inflate current earnings, but overproduction is associated with significant economic costs. Additionally, Statement of Financial Accounting Standards No. 151 (SFAS 151) introduced new accounting penalties for underproduction. Because firms do not have to overproduce in order to avoid underproduction, and because underproduction generally follows overproduction, we posit that management’s propensity to use overproduction to meet earnings benchmarks should decrease after the adoption of SFAS No. 151, as managers attempt to avoid incurring the costs of overproduction and the underproduction that generally follows.
Consistent with expectations, our findings suggest that SFAS 151 eliminated the tendency of firms to use overproduction to meet benchmarks. Overall, our results suggest that in recent years, managers have generally avoided overproduction, presumably because of the economic costs associated with this practice. These results challenge the view that SFAS 151 inadvertently encouraged overproduction.
Keywords: Real Earnings Management, Inventory Overproduction, SFAS 151, Accounting Standards
JEL Classification: M41
Suggested Citation: Suggested Citation