Managerial Foresight and Choice of Accruals in Earnings Management

Posted: 12 Jun 2007 Last revised: 5 Jul 2015

Date Written: October 16, 2010

Abstract

This study investigates whether information about future earnings (i.e. foresight) affects a manager’s accrual choices in income smoothing. Accruals can be employed to set aside current earnings for future use (flexibility effect). However, the reversal of accruals can lead to more variable future earnings (complexity effect). Data on accrual choices from an experiment in which managers were tasked to report smooth earnings are analysed. The results show that high foresight managers use more short- to medium- term accruals (bad debt and restructuring provisions, respectively) to reduce earnings than do low foresight managers. Low foresight managers use more long-term accruals (retirement benefits provision) to increase earnings than high foresight managers. Thus, high foresight managers’ preference for flexibility dominates their aversion to complexity when using accruals to create reserves. Low foresight managers show a greater aversion to complexity when using accruals to increase earnings.

Keywords: Accounting discretion, managerial foresight, accrual management, reversal of accruals, earnings management

JEL Classification: M41, M43, C92

Suggested Citation

Tan, Hwee Cheng, Managerial Foresight and Choice of Accruals in Earnings Management (October 16, 2010). University of Alberta School of Business Research Paper, Available at SSRN: https://ssrn.com/abstract=993002 or http://dx.doi.org/10.2139/ssrn.993002

Hwee Cheng Tan (Contact Author)

University of New South Wales ( email )

Kensington
High St
Sydney, NSW 2052
Australia

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