Evidence from Auditors about Managers’ and Auditors’ Earnings Management Decisions

Question 1

Most frequent accounting area for EM?

Most frequent incentive?

Answer 1

• reserves (revenue recognition, business combinations, intangibles, fixed assets, investments and leases)
• to affect the stock market (meet analysts’ estimates, to reach targets set by compensation contracts or debt covenants, to communicate economic information to stakeholders, and to smooth income or improve future income)

Question 2

Results?

Answer 2

1) when transaction structuring is involved, managers are more likely to make attempts (and auditors are less likely to adjust attempts) that are governed by precise standards
2) when transaction structuring is not involved, managers are more likely to make attempts (and auditors are less likely to adjust attempts) that are governed by imprecise standards

Question 3

Findings regarding income increasing/decreasing and materiality

Answer 3

Managers tend to make attempts that increase current-year income, but auditors are more likely to adjust these attempts. Managers are more likely to make attempts that decrease current-year income when standards are imprecise and/or with unstructured transactions. Auditors are more likely to adjust attempts they consider material and attempts made by small clients.