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Were regulatory changes in reporting "abnormal items" justified? : evidence of intra-period classificatory earnings management practices in Australia

Cameron , Robyn & Gallery, Natalie (2012) Were regulatory changes in reporting "abnormal items" justified? : evidence of intra-period classificatory earnings management practices in Australia. Journal of Accounting & Organizational Change, 8(2), pp. 160-185.

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Abstract

Purpose Managers generally have discretion in determining how components of earnings are presented in financial statements in distinguishing between ‘normal’ earnings and items classified as unusual, special, significant, exceptional or abnormal. Prior research has found that such intra-period classificatory choice is used as a form of earnings management. Prior to 2001, Australian accounting standards mandated that unusually large items of revenue and expense be classified as ‘abnormal items’ for financial reporting, but this classification was removed from accounting standards from 2001. This move by the regulators was partly in response to concerns that the abnormal classification was being used opportunistically to manage reported pre-abnormal earnings. This study extends the earnings management literature by examining the reporting of abnormal items for evidence of intra-period classificatory earnings management in the unique Australian setting. Design/methodology/approach This study investigates associations between reporting of abnormal items and incentives in the form of analyst following and the earnings benchmarks of analysts’ forecasts, earnings levels, and earnings changes, for a sample of Australian top-500 firms for the seven-year period from 1994 to 2000. Findings The findings suggest there are systematic differences between firms reporting abnormal items and those with no abnormal items. Results show evidence that, on average, firms shifted expense items from pre-abnormal earnings to bottom line net income through reclassification as abnormal losses.
Originality/value These findings suggest that the standard setters were justified in removing the ‘abnormal’ classification from the accounting standard. However, it cannot be assumed that all firms acted opportunistically in the classification of items as abnormal. With the removal of the standardised classification of items outside normal operations as ‘abnormal’, firms lost the opportunity to use such disclosures as a signalling device, with the consequential effect of limiting the scope of effectively communicating information about the nature of items presented in financial reports.

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ID Code: 51176
Item Type: Journal Article
Keywords: Earnings management, Abnormal items, Financial reporting, Accounting standards, Special items
DOI: 10.1108/18325911211230353
ISSN: 1832-5912
Subjects: Australian and New Zealand Standard Research Classification > COMMERCE MANAGEMENT TOURISM AND SERVICES (150000) > ACCOUNTING AUDITING AND ACCOUNTABILITY (150100) > Accounting Theory and Standards (150101)
Divisions: Current > QUT Faculties and Divisions > QUT Business School
Current > Schools > School of Accountancy
Copyright Owner: Copyright 2012 Emerald.
Deposited On: 28 Jun 2012 17:06
Last Modified: 28 Jun 2012 20:52

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