Do Firms Time Changes in Accounting Estimates to Manage Earnings?

Posted: 7 Dec 2021

See all articles by Philip Keunho Chung

Philip Keunho Chung

Christopher Newport University

Marshall A. Geiger

University of Richmond

Daniel Gyung H. Paik

University of Richmond - Accounting

Collin Rabe

University of Richmond

Multiple version iconThere are 2 versions of this paper

Date Written: October 11, 2021

Abstract

Prior earnings management research often focuses on specific accounts or on estimations of discretionary accruals but provides only limited insight into the methods firms actually use to manage earnings. In order to begin exploration of some of the operational details regarding how earnings are managed, we investigate whether firms time their decisions to make changes in accounting estimates (CAEs) in consideration of their earnings benchmarks. Using CAE data across all accounts from 2006 to 2018, we find that 28.1% of income-increasing CAEs are implemented in quarters where pre-CAE earnings are below a forecasted earnings benchmark but inclusion of the CAE effectively allows the firm to meet the benchmark. We find that income-increasing CAEs are more likely implemented when a firm’s pre-CAE earnings are further below the benchmark. We also find that firms are more likely to implement income-decreasing CAEs under two scenarios: (i) when pre-CAE earnings are relatively high, as a way to either smooth earnings or to “bury bad news,” and (ii) when pre-CAE earnings are already low, as a way to take a financial “big bath” and position the firm for positive future earnings. Additionally, we present evidence that firms using CAEs to achieve an earnings benchmark face financial consequences in terms of poorer immediate stock price performance and subsequent return on assets. Our conclusions hold after performing several additional analyses, including consideration of other discretionary options, addressing endogeneity concerns, and conducting falsification tests. In sum, we contribute to the earnings management literature by presenting consistent evidence that firms appear to time CAEs to meet earnings benchmarks or achieve other reporting objectives.

Keywords: change in accounting estimate (CAE), earnings management, earnings benchmarks, discretionary financial reporting

Suggested Citation

Chung, Philip and Geiger, Marshall A. and Paik, Daniel Gyung H. and Rabe, Collin, Do Firms Time Changes in Accounting Estimates to Manage Earnings? (October 11, 2021). Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3952037

Philip Chung

Christopher Newport University ( email )

United States

Marshall A. Geiger (Contact Author)

University of Richmond ( email )

28 Westhampton Way
Richmond, VA 23173
United States
804-287-1923 (Phone)

Daniel Gyung H. Paik

University of Richmond - Accounting ( email )

United States

Collin Rabe

University of Richmond ( email )

United States

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