The effect of accounting standards on Earnings Management in

U.S. and Europe.

Student number : 11131241

Name : André Nguyen

Master Thesis date : 26 June 2017

Word count : 12,477

MSc Accountancy & Control : Specialization Accountancy

Thesis Supervisor : Dr. G. Georgakopoulos

Faculty of Economics and Business, University of Amsterdam

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Abstract

Earnings management can be distinguished as either accruals-based earnings management and

Real earnings management. In prior literature (Zang, 2012; Chunhui et al., 2014; Evans et al.,

2015), IFRS accounting standards has a negative effect on Real earnings management and U.S.

GAAP has a negative effect on accrual-based earnings management. A few researchers (Beest,

2009); (Zang, 2012); (Evans, 2015) describe that a combination of both types of earnings

management are important. This study examines the effect of applying accounting standards on

the level of earnings management. The observation is based on the countries France, Germany

and United States and the selected time horizon is from 2005 to 2015. This sample have 11,436

observations. Accrual bases earnings is measured by the modified Jones model (Jones, 1991). The

three proxies to measured Real earnings management are abnormal production, abnormal cash

flow from operation and abnormal expenditures(Roychowdhury, 2006). The hypotheses that are

examined in this study are that IFRS accounting standards have a negative effect on Real earnings

management and the U.S. GAAP have a positive effect on accrual-based earnings management.

This study concluded that there is one significant effect on the accounting standards on the level

of earnings management.

Keywords: Earnings management; Real earnings management; Accrual based earnings

management Accounting standards; IFRS; U.S. GAAP; CEO; Agency theory; Rules based

standards; Principle based standards

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Table of Contents

1. Introduction ......................................................................................................................................... 4

1.1 Motivation ..................................................................................................................................... 5

2. Literature review and Hypothesis development ............................................................................. 8

2.1 Earnings Management ................................................................................................................ 8

2.2 Two forms of earnings management ........................................................................................ 9

2.2.1 Real earnings management ................................................................................................. 9

2.2.2 Accrual based earnings management .............................................................................. 10

2.3 Agency Theory ........................................................................................................................... 12

2.4 Accounting standards ................................................................................................................ 14

2.5 Principal-based & rules-based accounting standards ........................................................... 15

2.5.1 Principles-based accounting standard ............................................................................ 15

2.5.2 Rules-based accounting standard .................................................................................... 15

2.5.3 Difference between principle based and rules-based accounting standards ............. 16

2.6 Hypothesis development .......................................................................................................... 17

3. Methodology ...................................................................................................................................... 19

3.1 Data and sample description .................................................................................................... 19

3.2.1 The modified Jones Model .............................................................................................. 20

3.3 Model to measure Real earnings management ...................................................................... 20

3.4 Dependent variables .................................................................................................................. 22

3.5 Control variables ........................................................................................................................ 23

3.6 Empirical model ......................................................................................................................... 24

4. Results ................................................................................................................................................. 26

4.1 Descriptive statistics .................................................................................................................. 26

4.2 Multicollinearity of variables .................................................................................................... 27

4.3 The results of the effects of accountings standards on earnings management ................ 31

4.4 Robustness test .......................................................................................................................... 34

5. Discussion .......................................................................................................................................... 36

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6. Limitations and conclusions ............................................................................................................ 38

7. References .......................................................................................................................................... 40

Appendix A ................................................................................................................................................. 46

Appendix B ................................................................................................................................................. 47

Appendix C ................................................................................................................................................. 48

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1. Introduction

The general purpose and objective of financial reports is to provide financial information about

the reporting firm. Information is useful to lenders and other creditors, potential and existing

investors, and suppliers in making decisions about providing resources to the entity (IFRS,

2010b, §OB2). The information in the financial reports could be used as a reflection of the

internal knowledge of the management.

The preparer of financial reports has more information regarding the entity’s

performance than users of the financial reports (Scott, 2012). When this event occurs between

the preparer and users of the financial reports this is called information asymmetry. This

information asymmetry emerges when the preparer of financial reports is able to use earnings

management to meet their objectives (Healy & Whalen, 1999). For the users of financial reports

it is difficult to monitor the actual performance of management (Scott, 2012). Due to different

motives the management apply earnings management (Watts & Zimmerman, 1986). In other

empirical studies done over the years, the motives that Watts and Zimmerman (1986) developed.

Researchers such as Eisenhardt (1989), Healy & Whalen (1999) and Scott (2012), supported the

motives.

In the previous decade, there had been an increase in the number of accounting frauds,

most notably the scandals at Lehman Brothers, Bernie Madoff and Enron. These caused

tremendous harm to the capital markets (Hellstron, 2005). Often, financial statements are

difficult to compare across borders, due differences in political, economic systems and regulation

(Hellstron, 2005). An important condition for well-functioning capital markets and economy as a

whole is high quality accounting information (Hellstron, 2005). “Value relevance” is one of the

basic attributes for the quality of financial statements (Barth et al., 2008). The value relevance

attributes to the usefulness of financial statement information for the focuses on equity valuation

and stakeholders (Bart et al., 2006; Lin et al., 2012). Francis and Schipper (1999) defined this

concept of the value relevance of accounting information as ‘the ability of accounting numbers to

summarize the information underlying the stock prices’ (Francis & Schipper, 1999; Liu & Liu 2007). (p.56)

In 2005, all European listed firms were mandated to adopt International Financial

Reporting Standards (IFRS). In the capital market, advocators of IFRS favoured the transition

from domestic GAAP accounting standards to IFRS because it conveys new information (Barth

et al., 2006). Merited by the increase of political, multinational firm’s movements and economic

interactions between countries, the demand for common standards of financial reporting was

evident (Hunton et al., 2004). This new regulation change would assist investors in making

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informed decisions, aid in forecasting future cash flows thus leading to a higher accounting

quality through transparency (Hunton et al., 2004).

Accruals are a way to influence reported earnings. The gaps between cash flows and

reported earnings are accruals (Dechow, 1994). This difference includes accounting postings like

provision, interest, depreciation and accounts receivable or payable (Dechow, 1994). Accruals are

used to capture the financial transactions or events that occurs before the actual payment or

receipt of cash. The full economic consequences of transactions are captured in a specific period

when applying accrual accounting (Bart et al., 2008). When preparing the periodic financial

reports, it is important to note the consequences of current events which may impede the

expectations on future cash flow (Palepu et al., 2007). The financial data might be valuable for

users since managers use their discretion to communicate their inside knowledge of the company

(Palepu et al., 2007). Another way to use accruals is to smooth income and avoid volatility in

earnings and to move towards an expected level of reported earnings (Beattie et al., 1994).

Managers may smooth earnings to avoid the volatile reported earnings and give a better reflection

on the firm’s current or future performance to investors (Dechow, 1994). Regarding a consistent

earnings growth, managers may think this gives a positive signal to investors. These are among

the incentives that managers may have to use their accounting discretion to influence the

reported financial data (Dechow, 1994).

Real earnings management is another manner to influence reported earnings. The focus

of Real earnings management is on manipulating real activities or the deviation from operational

and normal business activities (Kim et al., 2010). Real earnings management has a direct effect

on the cash flow (Dechow & Sloan, 1991). At the end of the fiscal year, the unmanaged earnings

can be manipulated. Firms attempt to meet the earnings benchmark by the sales of assets or by

declining the research and development expenditures (Kim et al., 2010). According to Dechow

and Sloan (1991), on the near end of the tenure, managers reduce the research and developments

expenditures to increase the earnings in the short term. The evidence in the study of Bamber et

al., (1991) shows that firms reduce the research and development expenditure to meet earnings

objectives from the previous years. It is not possible to apply real earnings activities when

Accrual based earnings management are completely applied (Kim et al., 2010).

1.1 Motivation

The introduction of the SOX act in 2002 has had a negative impact on earnings management

(Chang, 2008). Dechow et al. (1995) has shown that a strong corporate governance has a negative

influence on committing financial fraud. The study of Libby et al. (2009) shows that the

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interpretation in accounting standards influences the degree of earnings management.

Prior studies (Heemskerk & Van der Tas, 2006; Jeanjean & Stolowy, 2008; Tendeloo &

Vanstraelen, 2005) have mostly focused on Accrual based earnings management instead of Real

earnings management. Since the implementation of the SOX in 2002, consideration on Real

earnings management has increased (Evans et al., 2015). The studies (Heemskerk & Van der Tas,

2006; Tendeloo & Vanstraelen, 2005) have only measured Accrual based earnings management

on level of IFRS standards. Real based earnings management was therefore not clearly

measurable (Roychowdhury, 2006). Cohen et al. (2008), Cohen and Zarowin (2010) and Zang

(2012) measured Real earnings management based on the method of Roychowdhury (2006)

which is the most effective manner.

According to Habib (2004), the most valuable relevant researches assume that the

financial information in the financial statements are either biased reporting by management or

free of error. Stock prices and manipulating could possibly be detected by investors (Habib, 2002;

Habib, 2004). This is an interesting topic for more research because in the past there has been

inconsistent results regarding the differences and the declining value relevance of accounting

information (Ball & Brown, 1968; Beaver, 1968; Lev, 1989; Collins, 1997).

The incentives of management are crucial to examining the effect of earnings

management on the value relevance of financial information. Managers have the discretion to

make a decision that leads to negative or positive impacts on the value relevance of financial

information. For standard setters and regulators, it is a difficult task to determine the space of

discretion for the preparers of financial reports.

In the world, there are two predominant accounting standards IFRS and U.S. GAAP. The

main difference is that IFRS is a more principle based, while U.S. GAAP is more rule based. In

study is it interesting to examine whether there are differences between the accounting standards

in the value relevance of the reported earnings and in the level of earnings management.

In the past, due to the accounting scandals the capital markets have been seriously

harmed and firms have provided financial reports that the investors did not trust. It is important

to get insight within this topic by comparing value relevance of reported earnings and the level of

earnings management between the accounting standards IFRS and U.S. GAAP.

The research question for this study is formulated as:

‘What is the effect of Real earnings management for firms that are using IFRS accounting standards compared to firms that are using U.S. GAAP accounting standards?’

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The rest of this study is structured as follows. Chapter two will describe the theoretical

background of this study and a broad literature review will be given. Topics such as earnings

management, agency theory and accounting standards are employed and the hypothesis

development is discussed. The next chapter contains the research methodology used to test these

hypotheses. The description is given of how the sample was selected and which models are used.

In the fourth chapter, the research results of the effect of accounting standards on earnings

management are presented. Finally, the last chapter contains the conclusion and limitations and

the feasibility for future research.

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2. Literature review and Hypothesis development

In this chapter the topics earnings management, accounting standards and agency theory will be

discussed. The theoretical framework for this study will be explained in this paragraph. In the last

paragraph, the hypothesis will be formed based on the results of theoretical framework.

2.1 Earnings Management

The subject of earnings management is well-researched in the literature. For example, researchers

such as Healy and Wahlen (1999) and Schipper (1989) have written a definition regarding

earnings management. Scot (2012) took their definition and rewrote it. That makes this topic a

comprehensive and complex concept. For earnings management there are different definitions in

the literature.

Firms communicate through financial reporting to provide stakeholders information

regarding the performance of the firm. The performance reflects on earnings. Earnings

management is defined by Leuz & Nanda (2003) as managers altering the reported financial

performance to influence contractual performance or to mislead stakeholders. The two

definitions of earnings management most commonly used from the papers are from Healy and

Wahlen (1999) and Schipper (1989). Healy and Wahlen (1999) defines earnings management as:

“Earnings management occurs when managers use judgment in financial reporting and in structuring transactions

to alter financial reports to either mislead some stakeholders about the underlying economic performance of the

company or to influence contractual outcomes that depend on reported accounting numbers.” (p. 368)

According to this definition, misstating the financial reports could mislead stakeholders in

their investment judgement. It doesn’t reflect the true underlying economic performance of a

company. Maximizing the shareholder’s value by exploiting assets by debt and equity is the main

objective of a firm. The only incentive for shareholders to invest would be if there is a positive

future firm performance expectation. It is in the firm’s interest to report positive profits, sustain

recent performance and meet analyst expectations (Degeorge et al., 1999). Other researchers

defines their own interpretations of earnings management. Schipper (1989) defines earnings

management as:

“Earnings management is really disclosure management in the sense of a purposeful intervention in the external

financial reporting process, with the intent of obtaining some private gain as opposed to merely facilitating the

neutral operation of the process.” (p. 91-92)

According to Scott (2009), earnings management is used to minimize or maximize income

in order to meet a certain earnings objective. Managers could manipulate their earnings

management downward or upward (Scott, 2009). A firm in financial stress already expects future

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losses and might manage earnings downward to make the loss enormous (Scott, 2009). Scott

(2009) distinguishes two types of information asymmetries. First, the adverse selection where one

party has less information in a transaction than the other party. Second, moral hazard

distinguished between control and ownership whereby information asymmetry occurs.

Baralexis (2004) mentions earnings management as creative accounting, preparers process

the financial statement and intentionally violate the accounting rules for self-interest. Despite the

negative views on earnings management, Beneish (2001) and Ronen and Yaari (2008) mention

the positive sides. Managers use earnings management for their expectation of the future to

inform the stakeholders through the financial statements (Beneish, 2001). Earnings management

is divided into three alternative definitions by Ronen and Yaari (2008). The alternatives for

Earnings Management are “white”, “grey” and “black”. The first definition, white: “Earnings

management is taking advantage of the flexibility in the choice of accounting treatment to signal the manager’s

private information on future cash flows.”(p. 25). As second alternative definition, grey: “Earnings

management is choosing an accounting treatment that is either opportunistic (maximizing the utility of management

only) or economically efficient” (p. 25). In the last alternative definition, black: “Earnings management is

the practice of using tricks to mispresent or reduce transparency of the financial report” (p. 25). For this study,

the earnings management definition of Scot (2009) will be used. Scott (2009) defines:“Earnings

management is the choice by a manager of accounting policies, or orations affecting earnings, so as to achieve some

specific reported earnings objective” (p. 403). Where other authors give a negative or positive opinion

regarding earnings management, Scot (2009) describes in general and does not have a preference.

2.2 Two forms of earnings management

This study examines earnings management and whether managers manage more earnings in IFRS

standards or in U.S. GAAP standards. Earnings management can be distinguished in two forms,

(a) Real earnings management and (b) Accrual based earnings management.

2.2.1 Real earnings management

To meet financial targets earlier than estimated, managers use Real earnings management. Real

earnings management are discrepancies from ordinary operational processes. Managers have

intentionally misled stakeholders as to whether the financial targets have been met by earlier

normal operation activity. This is attained by postponing actual expenditures or cutting in the

research and development expenditures (Chunhui et al., 2014). Undoubtedly, these accounting

practices do not add firm value. Real earnings management must be applied in the advanced fiscal

year end (Evans et al., 2015; Roychowdhury, 2006). This often has an uncertain impact on

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earnings (Evans et al., 2015). Cohen (2008), Roychowdhury (2006) and Zang (2012) examined

Real earnings management due to increasing earnings by shrinking discretionary expenditures and

reducing the cost of goods sold by overproducing the inventory. This disrupts cash flow of

entities (Evans et al., 2015). Roychowdy (2006) measured real earnings manipulation activities

through (a) the abnormal level of cash flow from operations, (b) the abnormal levels of

discretionary expenses and (c) the abnormal level of production costs (Roychowdy, 2006). Cohen

et al. (2008) and Zang (2012), measured Real earnings management in the same manner as

Roychowdy (2006). Roychowdhury (2006) use these variables to measure the manipulation

method and their effects: (a) sales manipulation, (b) reduced discretionary expenditures and (c)

overproduction (Roychowdhury, 2006).

Roychowdhury(2006) defines sales manipulation as more lenient credit terms or offering

temporarily discount to increase sales. The reduction of discretionary expenditures are

expenditures that do not generate immediate income and revenue (Roychowdy, 2006). As last,

overproduction is to manage overproduction more than is necessary to meet the production

planning (Roychowdy, 2006).

2.2.2 Accrual based earnings management

Accruals are costs that are related to the operations of a firm without cash outflow. Managers

have the opportunity to use Accrual based earnings management to consider whether they to take

an accrual or not at the end of the fiscal year (Scot, 2009). Accrual accounting is defined as:

“attempts to record the financial effects on an entity of transactions and other events and circumstances that have

cash consequences for the entity in the periods in which those transactions, events, and circumstances occur rather

than only in the periods in which cash is received or paid by the entity” [FASB 1985, SFAC No. 6, para. 139].

Preparers of financial statements use accrual accounting to help aim investors in regards to

decisions of financial performance during the year. The reported earnings provide more

understandable information than cash flows for the investors (Dechow & Skinner, 2000). Zang

(2012) wrote that accrual-based earnings management can be achieved by predictions used in the

financial statement or by changing the accounting methods (Zang, 2012). The likelihood is that

the reported earning can be biased through revaluating the estimated provision for doubtful

account receivables or use another depreciation method for fixed assets (Zang, 2012).

Discretionary accruals were used as a proxy for Accrual based earnings management in prior

literature (Jones, 1991). Discretionary accruals show the difference between the normal level of

accruals and the actual accruals of a firm (Zang, 2012). The study of Dechow et al. (1995)

examines accrual bases earnings management and which model is the best to measure Accrual

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based earnings management. The models that were investigated are: (a) Healy Model, (b) the

DeAngelo Model (c) the Jones Model, (d) the Modified Jones Model and (e) the Industry Model

(Dechow et al., 1995). According to Dechow et al. (1995), the modified Jones model provided

the most robust tests for earnings management. To estimate discretionary accruals, in the study

of Zang (2012) and Cohen et al, (2008) the modified Jones (1991) model was used to measure

discretionary accruals .

Model to measure accrual-based earnings management

In the research of Dechow et al. (1995) it was shown that accrual-based earnings management is

measured in different methods. The Modified Jones Model (Jones, 1991), Healy Model (Healy,

1985) and DeAngelo model (DeAngelo, 1986) was used in the research of Dechow et al. (1995)

to measure accrual-based earnings management. The assumption is that in the previous year

Earnings management is not applied, therefore, the DeAngelo model (DeAngelo, 1986) and the

Healy model (Healy, 1985) will be used. To measure the proxy discretionary accruals the value

has to be absolute to measure the degree of Accrual based earnings management (Cohen, 2004);

(Braam et al., 2015).

Healy model

The Healy model (Healy, 1985) use the average of total accruals (Taτ) divided by scaled total

assets. The measurements of nondiscretionary accruals are from the estimated period between

the years (Healy, 1985). The formula of the Healy model (Healy, 1985) for the nondiscretionary

accruals in the current year is (Healy, 1985; Bartov et al., 2000):

NDAτ = 1/nΣτ (TAt/Aτ-1)

Where: NDA = estimated non-discretionary accruals Aτ -1 = Total Asset year t -1 N = number of years in the estimation period TA = total accruals scaled by lagged total assets; T = 1, 2, ... T is a year subscript for years included in the estimation period; and τ = a year subscript indicating a year in the event period”

DeAngelo Model

The DeAngelo model (DeAngelo, 1986) measures the nondiscretionary accruals (NDAτ) by using

the previous period’s total accruals scaled by lagged total assets. The discretionary ratio of

accruals is the difference between total accruals in the current year t scaled by At-1 and NDAτ.

The formula for the nondiscretionary accruals is (Bartov et al., 2000; Deangelo, 1986):

NDAτ = TAt-1/At-2

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Where : NDA = estimated non-discretionary accruals TA = total accruals scaled by lagged total assets; A = Total Asset; and T = 1, 2, ... T is a year subscript for years included in the estimation period;

If a manager wants a higher profit in the financial statements, the managers will decrease

or avoid accruals and release the provision in order to manipulate the financial profits (Graham,

2005). When the manager has incentive to artificially lower the financial results, the manager will

use more provisions (Jones et al., 1991). Accrual based earnings management can defined as a

manner of manipulation to the results on whether there is a revenue shift, or to take or not to

take a provision.

2.3 Agency Theory

Jensen and Meckling (1976) describe the Agency theory as the principal-agent relationship that

exists between the management that manages the firm and owners. The agency relationship is

defined by Jensen and Meckling (1976) as “a contract under which one or more persons (the principal(s)

engage(s) another person (the agent) to perform some service on behalf which involves delegating some decision

making authority to the agent” (p. 308). Agency problems emerges when there is a conflict of interest

between self-interest and duty. Moreover, the agent is assumed to be driven by self-interest

(Dalton et al., 2007). The agent has incentives to engage in behaviour that is more beneficial for

the agent rather than the principal (Jensen & Mecklin, 1976). The agency problems are

distinguished in two types, namely moral hazard and adverse selection. Moral hazard arises when

the agent behaves divergently as he has not been fully disclosed to the risks and does not need to

worry about the consequences. Adverse selection emerges when one party has more

informational advantage over another party (Scott, 2009). The agent representative in the name

of the principal by managing the business on a daily basis, while the principal receives periodic

updates (Jensen & Mecklin, 1976). It is difficult for the principal to control and monitor the agent

when the agent has more access to information and more knowledge in general. The information

asymmetry arise between the agent and the principal. In this situation gives the agent the

opportunity to behave opportunistically (Jensen & Mecklin, 1976; Shapiro, 2005).

To reduce divergence and opportunistic actions by the agent, the principal can use a

monitoring system or establish appropriate incentives (Shapiro, 2005). The principals align the

interest of the agent with the firms which often offer a compensation plans to the agent. For

example, through private contracting, incentives schemes or reward structures (Shapiro, 2005).

Nonetheless, this compensation plans might have an adverse effect on the agent’s behaviour.

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This might become incentive for the agent to manipulate earnings. To create firm value,

management compensation contracts were designed to reduce the conflict of interest between

agent and principal (Shapiro, 2005).

In the study of Jensen and Meckling (1976) they considered two types of monitoring

which might increase firm value. The board of director is the important monitoring and the audit

is a monitoring activity. For the firm, the monitoring system provides an ex post control system

(Jensen & Meckling, 1976). The agent operates in the best interest of the stakeholders when the

principals are able to obtain information about the agent’s actions in an adequate way. Less

resources are needed to reduce the conflict of interest through incentives (Eisenhardt, 1989). The

audit quality means that there is an assurance to detect omissions or material misstatements,

hence an audit can reduce the level of information asymmetry (Wali, 2015).

Older people become more conservative in their actions (Peterson et al., 2001). In the

study of Twenge and Campbell (2008) it is stated that older people have lower self-confidence

levels than younger people and older people are more likely to show ethical behaviour. Shefrin

(2005) stated that risk aversion increases until the age of 70. Over that age risk aversion

decreases. Career and financial security are less important to younger executives than to older

executives (Wiersema & Bantel, 1992). Younger executives seem to act less risk averse. In prior

studies (Patterson, 2001; Peterson et al., 2001) it was concluded that there is a significant

relationship between age and earnings management (Shefrin, 2005). Evidence showed that before

a CEO goes into retirement the riskier his behaviour as he is more likely to engage in earnings

management (Davidson et al., 2007).

Finkelstein and Hambrick (1990) found that tenure has a significant influence on

organizational outcomes. According to Geiger and North (2006), in the first years of the CEO

career there is a greater use of earnings management which reinforces the influence of CEO’s on

earnings management. Executive management stays for a long tenure in companies, and change

less in their business strategy (Geiger & North, 2006). If executives invest their time to staying at

strategic level, the executives would gain more specific knowledge about the firm than average

employees (Geiger & North, 2006; Finkelstein & Hambrick, 1990). This could imply that gaining

by taking risks is smaller than the loss of long-tenure executives (Finkelstein & Hambrick, 1990).

Zahra (2005) stated “The length of a CEO’s tenure is negatively associated with entrepreneurial risk taking,

especially a family firm’s emphasis on innovation and venturing in domestic and international markets” (p. 35)

Further in this study, evidence was found that the long tenure of CEO gives time due to the

institutionalizing of systems and business processes (Zahra, 2005)

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2.4 Accounting standards

The two predominant accounting standards are IFRS and U.S. GAAP. IFRS is used for publicly

listed firms in most the countries around the world except for the United States. The United

States uses the U.S. GAAP established by the Financial Accounting Standards Board (FASB).

Developing a single set of enforceable, high quality, understandable, and globally accepted

accounting standards is the main objective of the IASB (IASB, 2013). In the United States, there

is still some resistance for the adoption of IFRS, albeit the Security and Exchange Commission

(SEC) acknowledges the benefits of a global single set of accounting standards (Hunton et al.,

2004).

Joos and Leung (2013) estimated the perception about the switch to IFRS of investors in

the United States. The study of Joos and Leung (2013) scrutinized the stock market reaction to

several events relating to IFRS adoption in the United States. According to Joos and Leung

(2013) the findings suggest that investors react more positive to IFRS when IFRS is expected to

lead to convergence benefits. Despite this, firms with higher litigation costs showed that their

results were less positive regarding market reaction (Joos & Leung, 2013). Both accounting

standards are principle-based, the main difference between the two standards is that U.S. GAAP

is more rules-based set of standards, while IFRS is generally regarded as more principle-based

(Joos & Leung, 2013). The interpretation that is deep-rooted in IFRS standards may be used to

engage in earnings management. Nelson (2003) concludes that the level of flexibility within

accounting standards increased the level of earnings management. In a principle-based

environment, auditors allow more earnings management (Libby & Kiney, 2000). In the survey of

Jamal and Tan (2010) they examined the influence of accounting standards on the level of

aggressive reporting. Jamal and Tan (2010) discuss only that if the auditor’s attitude becomes

more principle-oriented, than principle based standards reduce earnings management. Rule-based

standards may be used for earnings management through transaction decisions (Nobes, 2005).

According to Nobes (2005), rules-based accounting standards eliminate opportunities to engage

earnings management through accounting decisions.

Researchers (Barth et al., 2012; Nelson, 2003) have begun to explore whether principles-

based standards lead to different accounting outcomes when compared to rules-based standards.

Barth et al. (2012) examined whether the earnings of firms that reports in U.S. GAAP standards

are comparable to firms that reports in IFRS standards. In the study of Bart et al. (2012) it is

indicated that the financial reports under IFRS standards have a lower value relevance than

financial reports under U.S. GAAP. Bart et al. (2012) also compared the other three dimensions

of audit quality compared, which are timeless, income smoothing and accrual quality. The

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findings of Bart et al. (2012) indicate that the differences are more mandatory for reporting firms

under U.S. GAAP standards, but the overall accounting quality is lower for reporting firms

under IFRS standards. In the literature it shows (Beest, 2009; Chunhui et al., 2014; Evans et al.,

2015) that there is consensus that there is less flexibility inherent with U.S. GAAP standards than

IFRS standards, because IFRS standards are more principle based. The flexibility may be used to

engage in earnings management.

2.5 Principal-based & rules-based accounting standards

In this paragraph, the terms principles-based and rules-based accounting standards will be

described and explained. Additionally, the terms principles-based and rules-based accounting

standards will be compared.

2.5.1 Principles-based accounting standard

The preparer has the opportunity, in principle based accounting, to provide users with relevant

information (Nobes, 2015) based on professional judgment. According to Nobes (2005) rules-

based accounting standards are opposed to principle based accounting standards. Whereas

principle based accounting standards are not only focused on the content of the judicial

definitions of financial information (Nobes, 2015). The users of financial statement desire

relevant information and this can be attained through principle-based accounting standards

(Nobes, 2015).

There is space for using earnings management in the domain of accounting standards.

With managers managing the earnings easily in a certain direction under principle-based

standards rather than under rules-based standards (Herz, 2003). There are a few ways to measure

whether an adjustment in standards has a demotivation or motivation shock on the level of

earning management (Healy, 1999). However, Libby et al. (2009) found that the degree of

earnings management is influenced by the manager in the discretionary space of Principle-based

Accounting standards. This should lead to more earning management (Libby et al., 2009). It was

found by Benson et al. (2006) that principle-based accounting standards have more earnings

management.

2.5.2 Rules-based accounting standard

Rules-based accounting standards has different interpretations. Rules-based standards provides

detailed rules that others must comply to and this leads to less earnings management (Schipper,

2003). Financial statements under principle approach reduces the comparability (Schipper, 2003).

16

Preparing the financial statements is interpreted differently by regulators, accountants and

managers. Under a principle based approach it is easier to manipulate earnings in the financial

statements (Nelson, 2003). According to Benston et al. (2006), earnings management will be

reduced by detailed regulation, all possibilities for Earnings management are mitigated.

Under rules based approach, the guideline provides a clear description regarding with the

preparation of financial statements. It is impossible for the managers to be subjective and

manage the earnings artificially. Nelson (2003) indicates that the rules have a restriction.

According to Nelson (2003), it is complex for auditing when the amount of rules increases. Based

on the results of the firm, forming an opinion for financial analysts and investors is challenging

for auditors (Nelson, 2003).

Ewert & Wagenhofer (2005) found that under rules based approach the comparability of

financial statements are enhanced. On the other hand, the question remains of whether it will

reflect the true financial performance of the firm (Ewert & Wagenhofer, 2005). Rule based

approach does not require specialized knowledge for economic and business underpinnings for

the financial reporting of the firm (Ewert & Wagenhofer, 2005). The accountant focusses solely

on the compliance of rules (Carmona & Trombetta, 2008). Managers should communicate the

accounting choices effectively between stakeholders and auditors. Auditors have to checked

whether rules are being complied rather than using their judgment on financial statements

(Carmona & Trombetta, 2008). According to Schipper (2003), following an audit plan and

checking the steps makes auditors blind for the business under rules based approach. The United

States accounting regulation are too complex and exhaustive to monitor earnings management in

the financial statements, as confirmed in the study of Herz (2003). According to findings of

Segovia et al. (2003), earnings management cannot be detect if the financial statement complies

with the accounting regulation. That idea is given by rules based approach (Segovia et al., 2003).

Nobes (2003) mentions that principles could replace a vast part of the regulations. This will

reduce the complexity of the financial statements (Nobes, 2003).

2.5.3 Difference between principle based and rules-based accounting standards

The system of principles-based accounting standards is with a reasonable degree of specificity

and based on the four accounting fundamentals: (a) decision usefulness, (b) a true and fair view,

(c) going concern and (d) substance over form (Schipper, 2003). There are fewer detailed

guidelines about the implementations. Principle based required more professional judgment and

there is more space on how to interpret (Beest, 2009).

17

Rules-based accounting system is based on comprehensive and detailed guidelines

regarding the implementation. The precise details describe what is allowed and how financial

statements should reported (Alexander & Jermakowicz, 2006). For auditors, rules-based

accounting standards are a precise elaboration and comprehensive on what ensures that financial

statements are more easy to compare. The information accuracy is easy to verify (Nelson, 2003;

Schipper, 2003).

2.6 Hypothesis development

There are contradictions in several studies in the relationship between accounting standards and

earnings management. The research of Nobes (2005) concludes that organizations report a

decrease of earnings management under IFRS standards. Principles based standards provides

space for professional judgment (Nobes, 2005).

According to Bratton (2003), earnings management are reduced when the financial

statements are reported under U.S. GAAP standards. The possibilities for earnings management

are taken into account and minimized (Bratton, 2003). There are several ways to measure the

adjustment in the rules. This has a demotivating or motivating impact on the size of earnings

management (Healy & Wahlen, 1999). Under IFRS standards the degree of earnings management

is affected by the discretion of the manager, this is shown in the studies of Benston et al. (2006)

and Libby et al. (2009). Libby et al. (2009) found that IFRS standards lead to more earnings

management. Earnings management appeared more in IFRS standard according to the study of

Benston et al. 2006. There is evidence in prior studies (Chunhui et al., 2014; Graham et al., 2005;

Nelson, 2003;) that non-U.S. firms reporting under IFRS arise more earnings management than

in U.S. firms under U.S. GAAP (Barth et al., 2012; Evans et al. 2015). Under U.S. GAAP publicly

listed firm adjust earnings upwards and prefer Real earnings management (Graham et al., 2005),

while publicly listed firms under IFRS adjust earnings downwards and prefer Accrual based

earnings management (Graham et al., 2005; Evans et al., 2015).

According to Nelson et al. (2003), the findings are that firms switching to a rules–based

standard the use of Accrual based earnings management shift to Real earnings management. The

earnings management remains the same (Nelson et al., 2003). In 2002, after the introduction of

SOX, earnings management had still not decreased. The concerns of rules based regulatory had

some influence on earnings management decisions (Cohen & Lys, 2008). Beest (2009) supports

this finding, the research found that the nature of earnings management has changed and IFRS

and U.S. GAAP lead to similar level of earnings management. The study of Beest (2009) showed

that there is an increasing effect on Real earnings management occurred by rules based

18

accounting standard. In the study of Roychowdhury (2006) shows that the U.S. GAAP standard

is significant to earnings management. According to Roychowdhury (2006), Real earnings

management and accrual based management are significant. Zang (2012) supports

Roychowdhury’s (2006) findings and mentions that both types of earnings management are

significant in the U.S.. It is difficult to determine how earnings management is applied by the

manager (Zang, 2012). According to Zhang (2012), managers always prefer a combination of

both types of earnings management. Evans et al. (2015) mention that U.S. firms that report in

U.S. GAAP standards prefer Real earnings management rather than Accrual based earnings

management. However, there is no study that examined how different IFRS vs U.S. GAAP are

used in different countries (Evans et al., 2015)

U.S. GAAP and IFRS accounting standards provide defined reporting boundaries and

whether standards could have been violated with relatively objective determinations (Evans et al.,

2015). According to Agoglia et al. (2011), IFRS are less precise accounting standards and allowing

more reporting discretion than U.S. GAAP does. Detection in regulatory environment and

relying on IFRS accountings standards are less effective than detection in environment relying on

U.S. GAAP accounting standards (Evans et al., 2015).

The above studies show various claims concerning accounting standards in relation to

earnings management. Several studies indicate that rules-based accounting standard has a

significant relationship to Real earnings management based and principles-based has a significant

relationship with accrual-based earnings management. In appendix A, Table A shows which

papers are used for the development of the hypothesis. This has led to the following two

hypotheses:

H1: Firms that report under IFRS standards are less likely to engage in Real earnings

management than firms that report under U.S. GAAP.

H2: Firms that report under U.S. GAAP standards are less likely to engage in Accrual

based earnings management than firms that report under IFRS.

19

3. Methodology

In this chapter, methodology and the structure of this study will be explained and described. As

followed the data and sample description is explained. In the next three paragraphs the

conceptual framework of the research will be discussed. In the following paragraph the

operationalization of the variables will be explained. The fifth paragraph, the data and the

method for gathering for data of the study will be explained. At last, the various steps of the

study will be described.

3.1 Data and sample description

This study uses a quantitative research to test the hypotheses and to answer the research

question. The population of three different countries are chosen and disturbing effects such as

culture and political climate must be excluded. The two IFRS accounting standards population

are Germany and France and one U.S. GAAP accounting standard population is the United

States.

The initial sample includes all non-public and publicly listed from France, Germany and

the United States for the fiscal years from 2005 to 2015. The period that was chosen is when the

accounting standards were developed after several accounting scandals such as Enron and Ahold.

The average time horizon is 20 years and in other similar studies such as Agoglia et al. (2011),

Jamal & Tan (2010) and Zang (2012) they take a period from, respectively, 20 years, 20 years and

26 years. This period included the financial crisis. This study included ex ante financial crisis and

post financial crisis (Agoglia et al., 2011; Jamal & Tan, 2010; Zang, 2012). In the period after the

crisis, the economy is in a recovering phase and there is an opportunity for managers to apply

more earnings management. This study included a time period of 10 years and compared it with

other studies where this only a half of the average. The focusses is only on the post SOX and

post IFRS adoption period for this study. For European companies, firms were selected based on

the use of IFRS accounting standards. There is no distinguishing between publicly listed and non-

listed firms. Data will be collected from Compustat Fundamentals database (Evans et al., 2015)

and Bureau van Dijk. As in the studies of Roychowdhury (2006) and Zang (2012) the utility

industry (SIC 4000-4900) and the financial industry (6000-6900) were excluded and countries

were chosen randomly. In these industries, different regulations are applied which might affect

the Real earnings management (Roychowdhury, 2006; Zang, 2012). The three datasets are obtain

from 2 different databases and merged into one dataset.

The total amount of obervations without the selected criteria for the United States,

France and Germany are 310,204 observations. In Europe, the sample contains 137,571 (France;

20

75,796 and Germany; 96,837) and in North America (United States) the sample contains 172,633.

After eliminating accounting standards other than U.S. GAAP and IFRS, the initial observation

of this study is 22,470 observations. In appendix B, Table B provide the sample observation. The

three countries are divided in two accounting standards groups. The IFRS group contains France

and Germany and the U.S. GAAP group contains United States. The respective observations are

12130 (France; 6134 and Germany; 5996) and 10,340. The total amount of firms that have a SIC

code between 4400-4999 and 6000-6999 contains 10518 observations and are deleted from the

total sample (Roychowdhury, 2006; Zang, 2012). In appendix B Table C divide the sample in

industry codes.

3.2.1 The modified Jones Model

The modified Jones model is the most robust model to measure discretionary accruals (Bartov et

al, 2000; Dechow et al., 1995). Bartov et al. (2000) stated “The modified Jones model is designed to

eliminate the conjectured tendency of the Jones model to model discretionary accruals with error when discretion is

exercised over revenues” (p. 9). The firm’s discretionary accruals are the differences between the

normal accruals and the actual total accruals. Discretionary accruals remain for the model and

need to be calculated from the dataset. The modified Jones model has the following formula to

calculate discretionary accruals (Dechow et al., 1995):

TAt/At-1 = α1 NDAt + α3 DAt

NDAt = α1 (1/At-1) +α2 ((ΔREVt- ΔRECt)/ At-1) + α3 (PPEt/ At-1)

TAt/At-1= (ΔCAt - ΔCL t – Δ Cash t + Δ STD t – Dep t) / (At-1)

TAit = total accruals of firm x for year t. Calculated by the difference between income

before extraordinary items and cash flow from operations Ait-1 = total assets of firm x at the beginning of year t ΔREVit = Change in revenues of firm x for year t-1 to year t ΔRECit = Change in receivables of firms x for year t-1 to year t PPEit = Property, plant and equipment of firm x for year t Eit = residual, representing discretionary accruals of firm x in year t

3.3 Model to measure Real earnings management

Three methods are illustrated and described as ‘abnormal levels of discretionary spending’,

‘abnormal levels of production expenses’ and ‘cash flow from operating’ for Real earnings

management (Roychowdhury, 2006). To measure the degree of Real earnings management,

Cohen et al. (2008), Cohen and Zarowin (2008) and Zang have shown that these methods

measured the degree of Real earnings management effectively.

21

Firms trying to avoid losses by engaging to exceed the budgeted production plans to

decline the cost of goods sold, offering lower sales prices to increase sales temporarily and

reducing or postponing the discretionary expenditures to improve earnings (Chunhui et al., 2014;

Roychowdhury, 2006). The study of Roychowdhury (2006) used the following formulas to

examine the level on abnormal production (PROD, discretionary expenditures (DIX) and

abnormal cash flows (CFO) (Chunhui et al., 2014; Cohen, 2007; Gunny, 2005).

PROD

According to Roychowdhury (2006), managers can override the production plans to increase

earnings. By producing more units, fixed costs per unit can be declined due to the fact that fixed

overhead costs are divided over a larger quantity of units. With a lower cost of goods sold than

originally planned in the production plans, the company is able to report higher gross margins

(Roychowdhury, 2006). The abnormal levels of production is estimated by the regression model

of Roychowdhury (2006):

COGS

Assets t − 1= β0 + β1 (

1

Assets t − 1) + 𝛽2 (

Sales t

Assets t − 1) + εt

∆ INVT t

Assets t−1= β0 (

1

Assets t − 1) β1 ( (

∆ Sales t

Assets t − 1) + β2 (

∆ Sales t − 1

Assets t − 1) + εt

PROD t

Assets t − 1

= β0 + β1 (1

Assets t − 1) + β2 (

Sales t

Assets t − 1) + β3 (

∆ Sales t

Assets t − 1)

+ β4 (∆ Sales t − 1

Assets t − 1) + εt

Where: PRODit = Sum of the cost of sales in year T plus the change in the stock related to the

year T-1. (COGS + ΔINV) Assets t-1 = Total assets in year T-1 Sales t = Net sales of company x in year T Δ Sales t = Change net sales of company x in year T Δ Sales t-1 = Change net sales of company x in year T-1 Eit = St. Error

DIX

Postponing or cutting in selling, general & administrative and research and development

expenses will decrease the entity’s costs and increases earnings for the short term. These expenses

are settled in cash, this will affect the next period that the cash flow increase (Roychowdhury,

2006). Dechow et al. (1998) developed a model that used to generate the normal levels of

22

discretionary expenses (Dechowet al., 1998). Roychowdhury (2006) also implemented this model

is his study. The Abnormal levels of discretionary expenditure formula of Roychowdhury (2006):

𝐷𝐼𝑆𝑋 t

𝐴𝑠𝑠𝑒𝑡𝑠 t − 1= 𝛽0 + 𝛽1 (

1

𝐴𝑠𝑠𝑒𝑡𝑠 t − 1) + 𝛽2 (

𝑆𝑎𝑙𝑒𝑠 t − 1

𝐴𝑠𝑠𝑒𝑡𝑠 t − 1) + 𝜀𝑡

Where: DIXit = Discretionary spending including the sum of R&D, advertising, sales, general

and administrative costs of company in year T Assets t-1 = Total assets of company x in year T-1 Sales t-1 = Net sales of company x in year T-1

𝜀𝑡 = St. Error CFO Sales temporarily increases on short terms when the firm is using lenient credit terms and price

discounts. Once the firm reverses the normal prices, this sales boost will disappear. This will

affect the cash flow as lower in the current period, but the additional sales will boost the current

earnings (Roychowdhury, 2006). The following are equations according to Roychowdhury (2006)

to estimate the normal cash flow from operation (Roychowdhury, 2006):

CashFO t

Assets t−1= β0 + β1 (

1

Assets t1) + β2 (

Sales t

Assets t1) + β3

∆Sales t

Assets t−1+ εt

Where: CFOt = operational cash flow from year t;

At-1 = total assets in year t–1;

Sales t = sales in year t

Δ Sales t-1 = mutations in net seals in year t relative to t-1

Et = st. error

3.4 Dependent variables

In previous studies (Kim et al., 2012, Roychowdhury, 2006; Zang, 2012) to detect Real earnings

management there are three proxies. Proxy abnormal production costs (AB_PROD) is the first

proxy in the study of Kim et al. (2012), Roychowdhury (2006) and Zang, (2012). Abnormal

operating cash flows (AB_CFO) is the second one in their study. The last proxy is abnormal

discretionary expenses (AB_DIX). This study will use the three proxies of Roychowdhury (2006)

to measure Real earnings management. The three proxies are into three separate formulas of

Roychowdhury (2006) . This study use has the three following formulas (Roychowdhury, 2006):

PRODit /Ait-11 = ß0+ ß 1(1/Ait-1) + ß2 (Sit/Ait-1) + ß3 (ΔSit/Ait-1) + ß4 (Δ Sit-

1/Ait-1) + εt

CFOit / Ait-1 = β0 + β1 (1/Ait-1) + β2 (Sit/Ait-1) + β3 (∆Sit/Ait-1) + εt

DISXit /Ait-1 = ß 0 + ß 1(1/Ait-1) + ß2 (Sit-1/Ait-1) + εt

23

The combined REM model to calculate Real earnings management for this study is;

Combined REM = PRODit – CFOit - DISXit

This study use the modified Jones model (Jones, 1991) to detect Accrual based earnings

management (ABS_DA). According to Dechow et al. (1995) the modified jones (Jones, 1991) is

the most powerful model to recognizing discretionary accruals. The formula for the modified

jones model (Jones, 1991) as follow:

TAt/At-1 = α0 + α1 (1/At-1) +α2 (ΔREVt - ΔRECt / At-1) + α3 (PPEt/ At-1) + εt

3.5 Control variables

This research uses different control variables which are explained in this paragraph. This study

consists the variable accounting standard. Accounting standard (AS) is added as a dummy

variable. When IFRS standard is used, the research variable will have dummy 1. The U.S. GAAP

standard gets a dummy variable with value 0. In the dataset, countries are a variable. Due to

dividing the countries in accounting standard groups, this will cover the variable countries to run

a regression.

Other factors that might have an influence on Accrual based earnings management and

Real earnings management. For this reason, other control variables are needed in this study. The

size of a firm is an important control variable that may have an enhancing effect on earnings

management (SIZE 𝜀𝑡) (Klein 2002). The entity size is measured in the total assets of a company

(Klein 2002). Besides, the included control variables in other studies are the cash flow from

operation (CFO) or the cash flow from ordinary operations (Roychowdhury, 2006; Zang, 2012).

Ibrabim & Loyd (2011) used the control variable cash flows including in operating activities on

earnings management which may have an increasing effect.

In studies of Roychowdhury (2006) and Zang (2012), a firm’s profitability is measured by

net income/total assets. Roychowdhury (2006) and Zang (2012) use the return on asset (ROA 𝜀𝑡)

as a control variable. The control variables to manage earnings are the firm’s leverage ratio

(LEV 𝜀𝑡) and debt to equity ratio (De 𝜀𝑡) are included for leverage-related incentives (Sweeney,

1994; Teoh et al, 1998). The LEV 𝜀𝑡 is measured by total debt divided by total equity and DE 𝜀𝑡

is measured by long term debt divide by total equity.

Auditors that execute higher quality audits are more likely to discover earnings

management (Evans et al., 2015). In a study of Cohen et al. (2008) there is less Accrual based

earnings management possible and audits of big 4 firm are of higher quality. Badersche et al.

(2010) concluded similar results with prior research (Cohen et al., 2008), firms with a higher

financial reporting quality are audited by big 4 auditors and engage less in earnings management.

24

As control variable (AUD), firms audited by non-big 4 firms gets a dummy variable 0 and firms

that are audited by big 4 firm have a dummy variable 1.

Estes and Hosseini (2001) reported that men generally have a higher level of confidence

in making business decisions. When the level of self-assurance is high due to a high level of

confidence, opportunities and certain risks are taken by an executive (Estes & Hosseini, 2001).

Therefore, it is expected that a man applies more Real earnings management than a woman. The

value of the dummy variable for a woman is 0 and the value for a man is 1. Therefore, in this

study the control variable GEND will be used to measure.

Changes in revenues (GROWTH) is the last control variable to measure the percentage

change of sales (Barth et al., 2008). In the study of Barth et al. (2008) this control variable was

also used for economic effects and companies have a greater incentive to use earnings

management (Rusmin, 2014).

3.6 Empirical model

This study has resulted in two hypotheses to answer on the research question: ‘What is the effect of

Real earnings management for companies that are using IFRS accounting standards than for companies that are

using U.S. GAAP accounting standards?’ This study expects a negative relation between Real

earnings management and IFRS accounting standards. The observations are random and

independent from each other. This study contains four different dependent variables DA, CFO,

DIX and PROD. A multiple linear regression model will be used in this study. The two

hypotheses that will be tested with the regression model are:

The first hypothesis that will be tested:

The regression model to test the first hypothesis is:

H1: Firms that report under IFRS standards are less likely to engage in Real earnings

management than firms that report under U.S. GAAP.

1R_ AB_PROD = β0 + β1AS 𝜀𝑡 + β2SIZE 𝜀𝑡 +β3CFO 𝜀𝑡 + β4ROA 𝜀𝑡 +β5LEV 𝜀𝑡

+β6DE 𝜀𝑡 + β7AUD 𝜀𝑡 + β8GEND 𝜀𝑡 + β9Growth 𝜀𝑡 + 𝜀𝑡

2R_ AB_EXP = β0 + β1AS 𝜀𝑡 + β2SIZE 𝜀𝑡 +β3CFO 𝜀𝑡 + β4ROA 𝜀𝑡 +β5LEV 𝜀𝑡

+β6DE 𝜀𝑡 + β7AUD 𝜀𝑡 + β8GEND 𝜀𝑡 + β9Growth 𝜀𝑡 + 𝜀𝑡

3R_AB_CFO = β0 + β1AS 𝜀𝑡 + β2SIZE 𝜀𝑡 +β3CFO 𝜀𝑡 + β4ROA 𝜀𝑡 +β5LEV 𝜀𝑡

+β6DE 𝜀𝑡 + β7AUD 𝜀𝑡 + β8GEND 𝜀𝑡 + β9Growth 𝜀𝑡 + 𝜀𝑡

4 AB_REM = 1R_PROD - 2R_CFO - 3R_EXP

25

The second hypothesis that will be tested:

H2: Firms that report under U.S. GAAP standards are less likely to engage in Accrual based

earnings management than firms that report under IFRS.

Regression model to test the second hypothesis:

5 R_ABS_DA = β0 + β1AS 𝜀𝑡 + β2SIZE 𝜀𝑡 +β3CFO 𝜀𝑡 + β4ROA 𝜀𝑡 +β5LEV 𝜀𝑡

+β6DE 𝜀𝑡 + β7AUD 𝜀𝑡 + β8GEND 𝜀𝑡 + β9Growthit + 𝜀𝑡

26

4. Results

The results of this study are discussed in this chapter. In the first paragraph, the descriptive

statistics of the sample are evaluated. Then, the Pearson’s correlation matrix is analysed and

explained. Lastly, the results of the main analysis are discussed about what effect IFRS and U.S.

GAAP standards have on the level of earnings management that are given in the coefficients

tables.

4.1 Descriptive statistics

The sample that is used in this study will be illustrated by the descriptive statistics. This

description contains the sample from United States and Europe. In the samples from Europe,

France and Germany, various factors such as cultural differences and political climate have to be

eliminated. Firms who operate in financial industries with (SIC codes between 6000 and 6500) or

in regulated industries (SIC codes between 4400 and 4999) are eliminated from this study

(Roychowdhury, 2006) ; (Zang, 2012).

The sample for the dependent variables AB_CFO and DA_ABS are respective 9353 and

9208. In comparison with the sample of Zang (2012) which 7592 is corresponding. Zang (2012)

use a period from 1987 – 2008 and this study contains a period of 10 years (2005 - 2015. The

dependent variable AB_PROD have sample of 7223 observations.

Outliers are removed in this dataset and are not able to influence the outcome. In the

next table gives an overview of the sample. The manner that outliers are removed is through

winsorizing at 1% or 99%. Table 1 shows the mean, standard deviation, median, minimum and

maximum for each variables with accounting standards as factor.

27

Table 1 Descriptive statistics

Table 1 shows the mean for U.S. GAAP is higher on dependent variable DA_ABS and AB_REM

than IFRS. In this study can make an assumption that in U.S. GAAP accounting standards

applies more earnings management for Accrual based earnings management and Real earnings

management. This study determines the effect of Earnings management through a conscious

choice to select firms of various sizes as in the studies of Roychowdhury (2006) and Zang (2012).

There are no particular abnormalities found in the other variables.

4.2 Multicollinearity of variables

This study has executed a multicollinearity test by using a Pearson’s correlation test to see there is

a high degree of correlation between the variables. The Pearson correlation test is in Table 2

shows whether there is a bivariate relationship is between the ratio of variables. The correlation

between the mulitcollinearity and independent variables is to determine, among other things that

Variables Acc. Standards Mean Median Std. Deviation Min. Max.

0 US GAAP 0.109 0.053 0.164 0.001 0.888

1 IFRS 0.032 0.024 0.040 0.001 0.888

0 US GAAP 0.556 0.416 0.582 0.000 3.429

1 IFRS 0.579 0.487 0.457 0.000 3.429

0 US GAAP 0.114 0.058 0.206 0.000 2.051

1 IFRS 0.436 0.356 0.315 0.000 2.051

0 US GAAP 0.044 0.073 0.246 -1.215 0.531

1 IFRS 0.056 0.072 0.139 -1.215 0.531

0 US GAAP 0.395 0.290 0.642 -1.346 3.244

1 IFRS 0.092 0.068 0.556 -1.346 3.244

0 US GAAP 6,118.796 404.916 15,841.947 2.044 84,017.000

1 IFRS 4,637.702 260.848 13,141.467 2.044 84,017.000

0 US GAAP 513.553 23.054 1,316.763 -112.836 6,961.372

1 IFRS 342.088 16.502 1,042.355 -112.836 6,961.372

0 US GAAP -0.034 0.031 0.285 -1.660 0.310

1 IFRS 0.006 0.032 0.134 -1.660 0.310

0 US GAAP 121.105 1.575 417.377 -107.149 2,234.179

1 IFRS 3.665 1.314 54.890 -107.149 2,234.179

0 US GAAP 0.300 0.006 0.915 -1.962 7.037

1 IFRS 0.464 0.235 0.909 -1.962 7.037

0 US GAAP 0.230 0.090 0.651 -0.740 3.968

1 IFRS 0.105 0.045 0.460 -0.740 3.968

0 US GAAP 0.802 1.000 0.399 0.000 1.000

1 IFRS 0.383 0.000 0.486 0.000 1.000

0 US GAAP 0.974 1.000 0.160 0.000 1.000

1 IFRS 0.759 1.000 0.428 0.000 1.000

GROWTH_W

Auditor

Gender

SIZE_W

CFO_W

ROA_W

LEV_W

DE_W

DA_ABS_W

AB_PROD_W

AB_DIX_W

AB_CFO_W

AB_REM_W

28

the independent variables is not too high. All dependent and control variables from Table 2 in

this paragraph are explained as are the relations between the variables.

The dependent variable Accruals-based earnings management (DA_ABS) is stronger

negatively correlated with the control variables. All control variables are significantly correlated

with the dependent variable. Control variables that are negatively significantly correlated are the

variables Accounting standards (p < 0.01), SIZE(p < 0.01), CFO(p < 0.01), ROA(p < 0.01),

LEV(p < 0.01), and DE(p < 0.01). Compared with the study of Zang (2012) the variable ROA

and SIZE are positively correlated. In the study of Zang (2012), the variable LOGSIZE is the

strongest positive correlation with the other control variables. This study shows that the ROA (-

.336) is the strongest negative correlation. To interpret this value of SIZE, it seems that the firm

size is not as important a factor compared to the other variables. As the findings can explain,

larger entities are not more likely to invest in project or assets than smaller entities. The

coefficient of variable accounting standards (-.331) can be interpreted as the accounting standards

between IFRS and U.S. GAAP do not have a high effect on Accrual based earnings

management. The study of Evans et al. (2015) concluded these results. Evans et al. (2015) stated

accounting standards are not a panacea for earnings management.

The correlation between the first dependent variable PROD of Real earnings

management is more positive correlated with the control variables. In the study of

Roychowdhury (2006) the variables Growth, CFO and ROA are negatively significantly

correlated. This study showed that the control variable ROA (p < 0.01) and Growth (p < 0.01)

have the opposite results and CFO (p > 0.1) is not significant. The SIZE is negative correlated

and not significant. This means that the overproduction is not dependable on the firm’s size and

the accounting standards do not override the production plans. Net income plays an important

factor in overproduction The cost of goods sold is through overproduction lower. This effect

that the gross margin gains.

The second dependent variable CFO (AB_CFO) of Real earnings management has a

negatively stronger correlation with the control variables. All the control variables Accounting

Standards (p < 0.05), SIZE (p < 0.01), CFO (p < 0.01) and ROA (p < 0.01) are positively

correlated and significant as in study Roychowdhury (2006). The control Variables are negative

significant LEV (p < 0.01), Growth (p < 0.01) and DE (p > 0.1) show the opposite results

compared to the study of Zang (2012). DE (p > 0.1) is not significant.

The last dependent variable of Real earnings management is the abnormal expenses

(AB_DIX). This variable is less significant compared to dependent variable AB_CFO and

AB_PROD. The dependent variable AB_DIX has a positively stronger correlation to the control

29

variables. The variables Accounting Standards (p < 0.01), ROA (p < 0.01) and GROWTH (p <

0.01) are positive correlated. This study shows that variable SIZE (p > 0.1), CFO (p > 0.1), LEV

(p > 0.1) and DE (p > 0.1) have no significant correlation to AB_DIX regarding to the studies of

Roychowdhury (2006) and Zang (2012). The accounting standards constrains the firms to

reducing or postponing in the operational expenditure or cutting in the research and

development expenses.

The combined REM variable is more positively correlated to the control variables. The

variable Accounting Standards (p < 0.01), SIZE (p < 0.01), ROA (p < 0.01), LEV (p < 0.01) and

GROWTH (p < 0.01) are significant. The accounting standards cannot reduce Real earnings

management. Therefore is the interpretation the coefficient (0.033) in which accounting

standards is more Real earnings management.

30

Tabel 2 Pearson’s correlation

1 2 3 4 5 6 7 8 9 10 11 12 13 14

Pearson

Correlation

1

Sig. (2-tailed)

Pearson

Correlation

.175** 1

Sig. (2-tailed) 0.000

Pearson

Correlation

.031* 0.009 1

Sig. (2-tailed) 0.022 0.500

Pearson

Correlation

-.345** -.033* -.170** 1

Sig. (2-tailed) 0.000 0.014 0.000

Pearson

Correlation

.228** .827** -.416** -.263** 1

Sig. (2-tailed) 0.000 0.000 0.000 0.000

Pearson

Correlation

-.331** 0.022 .494** .033* -.243** 1

Sig. (2-tailed) 0.000 0.106 0.000 0.016 0.000

Pearson

Correlation

.033* 0.020 -.245** .104** .108** -.411** 1

Sig. (2-tailed) 0.015 0.130 0.000 0.000 0.000 0.000

Pearson

Correlation

.080** -.052** -.169** 0.011 .042** -.288** .102** 1

Sig. (2-tailed) 0.000 0.000 0.000 0.404 0.002 0.000 0.000

Pearson

Correlation

-.113** -0.017 -.158** .069** .046** -.051** .173** 0.018 1

Sig. (2-tailed) 0.000 0.218 0.000 0.000 0.001 0.000 0.000 0.173

Pearson

Correlation

-.112** -0.018 -.148** .130** 0.021 -.072** .198** 0.022 .913** 1

Sig. (2-tailed) 0.000 0.190 0.000 0.000 0.119 0.000 0.000 0.108 0.000

Pearson

Correlation

-.336** .050** -.125** .733** -.135** .095** .064** -0.005 .079** .115** 1

Sig. (2-tailed) 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.688 0.000 0.000

Pearson

Correlation

.104** -0.008 -.087** -.076** .061** -.212** 0.024 .053** -.062** -.061** -.108** 1

Sig. (2-tailed) 0.000 0.537 0.000 0.000 0.000 0.000 0.075 0.000 0.000 0.000 0.000

Pearson

Correlation

-.084** -0.017 -.067** 0.000 0.018 .087** .048** -0.017 .113** .062** 0.017 .033* 1

Sig. (2-tailed) 0.000 0.217 0.000 0.982 0.174 0.000 0.000 0.197 0.000 0.000 0.201 0.014

Pearson

Correlation

.283** .153** .064** -.078** .099** -.112** .058** 0.015 -.054** -.043** -0.007 0.015 -0.006 1

Sig. (2-tailed) 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.257 0.000 0.002 0.607 0.253 0.638

14. GROWTH_W

**. Correlation is significant at the 0.01 level (2-tailed).

*. Correlation is significant at the 0.05 level (2-tailed).

c. Listwise N=5508

9. SIZE_W

10. CFO_W

11. ROA_W

12. LEV_W

13. DE_W

4. AB_CFO_W

5. AB_REM_W

6. Accounting

Standards

7. Auditor

8. Gender

1. DA_ABS_W

2. AB_PROD_W

3. AB_DIX_W

31

4.3 The results of the effects of accountings standards on earnings management

This paragraph describes the effects of accounting standards. The hypothesis that is tested will be

shown in the models. This study will explain the results from the models.

The effect of accounting standards on Real earnings management.

In this paragraph, the relation between earnings management and accounting standards of this

study will be explained whereby a positive relationship is expected between IFRS accounting

standards on Real earnings management. The results of the model summary for Real earnings

management are illustrated in this paragraph. This study used three proxies to measure Real

earnings management. The variables in this study are abnormal discretionary expenses

(AB_DIXEXP), abnormal production costs (AB_PROD) and abnormal cash flow from

operations (AB_CFO). This study expects that IFRS accounting standards to have a positive

effect on Real earnings management.

Table 3. Regression results 1

Prod

In Table 3, the model is significant (p < 0.01)the R squared is 3.00%. Only 3% of the variation of

the AB_PROD can be explained by the model. In comparison, the studies of Roychowdhury

(2006) and Zang (2012), found the R squared for the proxy AB_PROD to be 89% and 90.61,

respectively. Their models (Roychowdhury, 2006; Zang, 2012) can better explain the variation of

AB_PROD. In both of these studies the time period was over 20 years, which might play a role

in the findings of this study’s as R square is low in comparison to their studies. The control

variables cannot explain the variation of the dependent variable AB_PROD.

B Sig B Sig B Sig B Sig

(Constant) 0.555 0.000 0.140 0.000 0.061 0.000 0.380 0.000

SIZE_W 0.000 0.620 0.000 0.000 0.000 0.000 0.000 0.000

CFO_W 0.000 0.249 0.000 0.007 0.000 0.000 0.000 0.000

ROA_W 0.100 0.002 -0.273 0.000 0.659 0.000 -0.326 0.000

LEV_W 0.000 0.774 0.000 0.954 0.000 0.586 0.000 0.883

DE_W -0.023 0.001 -0.032 0.000 0.000 0.849 0.019 0.027

GROWTH_W 0.151 0.000 0.072 0.000 -0.026 0.000 0.086 0.000

Acc. Standards 0.071 0.000 0.338 0.000 -0.012 0.000 -0.285 0.000

Auditor 0.055 0.000 -0.006 0.452 0.015 0.000 0.018 0.305

Gender -0.046 0.022 -0.025 0.013 0.004 0.325 -0.046 0.042

R .177b

.559b

.739b

.291b

R Square 0.031 0.313 0.547 0.084

Adj. R Squared 0.030 0.311 0.546 0.083

AB_PROD AB_DIX AB_CFO AB_REM

32

The regression model shows that five control variables are significant on the dependent

variable AB_PROD (p < 0.01) and is significant in the mode as in the studies of Roychowdhury

(2006) and Zang (2012). The control variable ROA (p < 0.01), DE (p < 0.01), Growth (p <

0.01), Accounting standards (p < 0.01), Auditor (p < 0.01) and Gender (p < 0.05) are significant.

Firms that use the IFRS accounting standards find it has a positive effect on Real earnings

management. This means that firms with IFRS accounting standards apply more overproduction.

The coefficient of ROA (.100) can be interpreted that the net income has minimal effect on the

net income inside the IFRS standards.

The control variables that have a negative coefficient are DE and Gender. These variables

have a reversed effect. This mean that DE (-.023) and Gender (-.046) play a small role for firms

that apply U.S. GAAP accounting standards. Firm’s reporting under U.S. GAAP overproduce

more inventory and check their debt to equity ratio. In this sample, a female CEO overrides the

production plans more than a male CEO. The results lead to a stronger dependent variable

AB_PROD for firms under IFRS standards than under U.S. GAAP.

DIX

The R square of proxy AB_DIX is 31.30% and is close to the R square (38%) found in the study

of Roychowdhury (2006). In comparison to the R square (57.55%) of Zang (2012), both studies

have a low R square. The AB_DIX is stronger for firms under IFRS accounting standards than

under U.S. accountings standards.

This regression model of the dependent variable AB_DIX (p < 0.01) is significant as in

both studies of Roychowdhury (2006) and Zang (2012). In Table 3 seven control variables are

significant on AB_DIX. ROA (p < 0.01), DE (p < 0.01), GROWTH (p < 0.01), Accounting

standards (p < 0.01) and gender (p < 0.05).

The control variable SIZE (p < 0.01) is significant and the coefficient is 0. Firms under

the accounting standards IFRS or U.S. GAAP decrease or postpone the SGA and R&D

expenditure equally. The size of the firms has no effect. The control variable CFO (p < 0.01) has

a coefficient of 0. Postponing or shifting the SGA and R&D expenditure to another period also

has no influence on the cash flow. Firms under IFRS cut or postpone more in the SGA and

R&D expenditure than firms under U.S. GAAP.

CFO

This study resulted in the R square of 54.6% which is higher R square (45%) than in the study

Roychowdhury (2006) study. The control variables can explain the variation better. This can be

33

explained by the sample. The sample of Roychowdhury (2006) and Zang (2012) contains only

firms from the United States. This study selected a sample from United States, France and

Germany. Furthermore, the period that was chosen was post SOX and post IFRS adoption. This

might mean that the sample and time horizon have influence.

This regression model of the dependent variable AB_CFO (p <0.01) is significant as in

both studies of Roychowdhury (2006) and Zang (2012). In Table 3, 6 control variable are

significant on the dependent variable AB_CFO. Cash flow has no effect within the standards.

The variable Growth is an important factor for the cash flow. Firms under U.S. GAAP standards

see the growth in sales as a more important factor than those under IFRS. Shifting in revenues is

more constrained under U.S. GAAP (Evans et al.).

REM

This study resulted in the R square of 8.3% which lower in comparison with the study of

Roychowdhury (2006). The variation can be explained less by selected control variables.

According to Roychowdhury (2006), the three proxies PROD, DIX and CDO are significant.

Not all of the control variables have a significant effect in this study. The accounting standards

have a significant effect on the Real earnings management. Firms under U.S. GAAP apply more

Real earnings management and this is a reverse effect. Under IFRS, two dependent variables

AB_PROD and AB_DIX, are applied more than under U.S. GAAP. The dependent variable

AB_CFO is stronger for firms under U.S. GAAP standards than under IFRS.

After running the three regressions of Real earnings management, this study can conclude

that Real earnings management is more significant for firms under U.S. GAAP standards than

under IFRS accounting standards. Hypothesis 1 is accepted according this study. The result is

that there is an effect in U.S. accounting standards on level of Real earnings management (Evans

et al. 2012). The ROA is significant and has a weak moderated coefficient of -0.3263.

The effect of accounting standards on Accrual based earnings management

The R square of proxy AB_DIX is 27.2% and is close to the R square (28%) of the study of

Roychowdhury (2006). In the study of Zang (2012), the R square resulted in 41.97%.

34

Table 4. Regression results 2

This model regression showed that the dependent variable ABS_DA is significant, this was also

the result in the researches of Roychowdhury (2006) and Zang (2012). The control variable SIZE

(p <0.01), ROA (p <0.01), LEV (p <0.05), DE (p <0.01), Growth (p <0.01), Accounting

Standards (p <0.01), and Auditor (p <0.01) are significant. In the study of Zang (2012) the

control variable gave a similar result to this study. Non Big 4 allow more earnings management

(Cohen et al., 2008). The total debt of a firm cannot result in a firm using more deferred interest

expenses. U.S. GAAP standards have a significant positive effect on the level of Accrual earnings

management. The result was that the firms under U.S. GAAP apply more Accrual based earnings

management than under IFRS. Based on the results, the regression leads that H2 must rejected.

The results for H2 are the opposite. Nelson (2003) and Evans et al. (2015) confirmed in their

studies that IFRS accounting standards lead to more Accruals earnings management. The studies

of Cohen (2011) concluded that post SOX, Accrual based earnings management declined.

4.4 Robustness test

In this part of the analysis, this study conducts two robustness tests to determine whether the

results are robust or not. This study will examine that by conducting a robustness test: the results

of coefficients are plausible and robust. The first robustness test that is conducted is on the fixed

years effect to control the model. This study examine whether the difference in years led to more

DA_ABS_W

B Std. Error t Sig.

0.110 0.004 29.207 0.000

0.000 0.000 -2.594 0.009

0.000 0.000 -0.562 0.574

-0.163 0.005 -31.258 0.000

0.000 0.000 2.179 0.029

-0.005 0.001 -4.631 0.000

0.045 0.002 24.535 0.000

-0.069 0.002 -28.978 0.000

-0.013 0.002 -6.128 0.000

-0.002 0.003 -0.612 0.541

(Constant)

SIZE_W

CFO_W

ROA_W

LEV_W

DE_W

GROWTH_W

Acc. Standards

Auditor

Gender

35

or less earnings management in the reporting standards. Table 5 shows the results of the

additional test.

Table 5. Robustness test result 1

The robustness test did not increase the R square for this model. This study can conclude that

the differences in years cannot explain the variances for the reporting standards in this model.

In the second robustness test that is conducted, the firms of sizes of over 100 million are

selected to control the model. This study examines whether the firm size has a significance in

applying more earnings management in the reporting standards. Table 6 shows the results of the

additional test.

Table 6. Robustness test result 2

The value of the R square of dependent variables did not increase. Firm size cannot better

explain the variances in this model. The results remain the same. Hence, hypothesis 1 is still

accepted and hypothesis 2 is still rejected.

DA_ABS AB_PROD AB_DIX AB_CFO AB_REM

-0.0684 0.0789 0.3386 -0.0136 -0.2763

0.0000 0.0000 0.0000 0.0000 0.0000

.524b

.184b

.560b

.741b

.295b

0.275 0.034 0.313 0.549 0.087

0.273 0.031 0.311 0.548 0.084

Acc. Standards

B

Sig

R

R Square

Adj.R Squared

DA_ABS AB_PROD AB_DIX AB_CFO AB_REM

-0.0491 0.1277 0.3104 -0.0157 -0.1690

0.0000 0.0000 0.0000 0.0000 0.0000

.506b

.228b

.576b

.609b

.273b

0.256 0.052 0.332 0.370 0.075

0.255 0.050 0.331 0.369 0.073

Sig

R

R Square

Adjusted R Square

Acc.Standards

B

36

5. Discussion

When firm performance does not reach the management objectives, managers might be

interested in deliberately misleading the financial performance of the firm through earnings

management. The actual performance of the managers is difficult to monitor for shareholders

and investors. In recent years there has been some serious accounting fraud incidents such as

Toshiba, Olympus and Tesco. Since scandals such as Ahold and Enron, firms applying earnings

management have become more prevalent. This study examines the level of earnings

management and effect of accounting standards with the focus on Real earnings management.

This has led to different results than have been obtained in prior studies.

In the study of Nobes (2005) it was shown that firms that reports under IFRS standards

had higher earnings management than firms under U.S. GAAP. For earnings management,

professional judgement plays a vital role (Nobes, 2005). Another study indicated that in U.S.

GAAP there is less discretion applied to earnings management and it is reduced to a minimum

(Bratton, 2003). According to Benston et al. (2006) and Libby and Seybert (2009) the level of

earnings management in U.S. GAAP standard is lower in comparison with IFRS standard. Post

SOX Accrual based earnings management under U.S. GAAP was constrained due a higher level

of scrutiny in accounting practices (Zang, 2012).

The studies of Nelson et al. (2003) and Beest (2009) have shown that U.S. GAAP have an

increasing effect on Real earnings management. Evans et al. (2015) have also supported this

finding. In the study of Evans et al. (2015) it is suggested that the U.S. GAAP may lead to less

accrual-based earnings management and replace it with Real earnings management (Evans et al.,

2015). According to the studies of Roychowdhury (2006) and Zang (2012), both types of earnings

management are significant, as the combination of Accrual based earnings management and Real

earnings management are inseparable for managers. A manager can’t apply just one of the type of

earnings management. The research of Beest (2009) also supports this conclusion.

Firms that use U.S. GAAP standards apply more on Real earnings management than

firms using IFRS accounting standards (Evans et al., 2015). According to Evans et al. (2015),

there is no substitutions for accrual of real earning management in the accounting standards. The

result is that U.S. GAAP standards discourage Accrual based earnings management (Evans et al.,

2015).

This study has shown that there is no positive effect in accrual based and a positive effect

in Real earnings management. However, the IFRS standard has no more reinforcing effect than

the U.S. GAAP standards (Evans et al., 2015). The results of this study are not consistent with

the conclusion of Roychowdhury (2006) and Zang (2012). In addition, the results of H1 are more

37

in line with the research of Evans et al (2015). Within the accounting standards there is a

possibility to use the combination of Real earnings management and Accrual based earnings

management. According to Zang (2012), which form of earnings management is applied by the

manager is not easy to determine. The managers will prefer to use a combination of both types of

earnings management (Zang, 2012). The study of Roychowdhury (2006) concluded that applying

only Real earnings management is not possible. According to Van der Meulen (2006), earnings

management does not react differently to the two reporting standards. The technical issues

underlying IFRS or U.S. GAAP are too complex (Van der Meulen, 2006). In the research of

Beest (2009), earnings management cannot be constrained or eliminated by either accounting

standards.

38

6. Limitations and conclusions

The limitations and future research in this study.

This study used a period of 10 years, which may limit the findings. Other studies, such as

Roychowdhury (2006), Jamal & Tan (2010) and Zang (2012) have an empirical analysis with a

time period of, an average, of 20 years. The data for IFRS accounting standard for France and

Germany pre-voluntary IFRS adoption was not available. In 2005, the IFRS accounting standards

was mandatorily adopted for publicly listed firms. To obtain more available data, this study

recommends using publicly listed firms and more financial databases to complement missing

data. Furthermore, to balance the sample for future studies, need at least ten IFRS countries in

Europe and Asia. This study might have taken one of these countries as a sample to balance the

current sample of countries who use IFRS standards to see how it might be interpreted

differently. Additionally, the collected comparable data in Europe is higher than the U.S. as not

all financial data were available. The sample did not distinguish between listed and non-listed

firms. European country firms were selected if they applied IFRS accounting standards. In this

study, there is no crossover for countries as sample for a control group. This means that for

future research it might be advisable to sample with European listed firms in U.S. that report in

U.S. GAAP accounting standard and U.S. listed firms in Europe using IFRS accounting

standards. The European countries that use the IFRS accounting standards can be compared

with the firms that use the domestic accounting standards. This may lead future research to adopt

the time horizon as pre- and post-IFRS mandatory adoption. Therefore it can be used as a

control group for the next research. U.S. firms reporting in IFRS accounting standards can also

be taken in as the principle based standards sample. These control groups can used for future

studies. Furthermore, this study recommends that the accounting standards should be divided in

principle based accounting standards and rules based accounting standards. The principle based

standards sample would contain publicly listed firms that use IFRS accounting standards and

rules based standards would be firms using U.S. GAAP and local GAAP. What has also not been

done in this study is an examination of the effect of variable management compensation and a

comparison of continents such as Asia, Europe and North America. Taking the board size and

diversity into account may also have influence. What kind of effect would this have on the

accounting standards and earnings management?

Conclusion.

In this study, the dependent variables Accrual based earnings management and Real earnings

management are examined on which reporting standard applies more earnings management. The

sample includes two countries from Europe, France and Germany, and one country from North

39

America, the United States. The time horizon is post SOX and post IFRS adoption. It was

hypothesized that due to IFRS accounting standards, firms apply more Accrual based earnings

management compared with the U.S. GAAP accounting standards and that the firms reporting in

U.S. GAAP accounting standards apply more Real earnings management compared with IFRS

accounting standards. Post SOX, firms that report in U.S. GAAP accounting standards were

supposed to see a decline in Accrual based earnings management. However, the results obtained

from the regression analysis shows the opposite results. In this study the dependent variable

Accrual based earnings management was measured as the magnitude of absolute discretionary

accruals and the accounting standards have a negative correlation when Accrual based earnings

management increases. Firms under U.S. GAAP accounting standards prefer more Real earnings

management. This was obtained from the regression analysis.

The obtained results from the regression analysis shows that firms reporting in U.S.

GAAP standards apply more Real earnings management than firms that report in IFRS

standards. Real earnings management was measured in three proxies: AB_PROD, AB_DIX and

AB_CFO. From the proxies AB_PROD and AB_DIX the results showed that firms that

reported in IFRS standards overproduce more inventory (AB_PROD) and cut or postpone

expenditures (AB_DIX). The proxy AB_CFO showed that the cash flow was higher for firms

under U.S. GAAP accounting standards. The regression model to combine the proxies calculated

AB_REM which showed that firm’s reporting in U.S. GAAP accounting standards apply more

Real earnings management.

In this study, the research question considered one hypothesis as having a significant effect.

Firms under U.S. GAAP lean more towards Real earnings management than firms under IFRS

(Zang,2012). Results show that neither accounting standard applies more earnings management.

This is consistent with earlier studies, such as Evans et al. (2015) and Chunhui et al. (2014).

Accrual based management is more difficult to recognize between the two accounting standards.

The conclusion to this study is that the accountings standards have no effect on using more

earnings management. However, the accounting standards do recognize which form of earnings

management is applied. The results are that neither forms of earnings management can be

applied alone in the accounting standards. Prior studies such as Beest (2009) and Evans et al.

(2015) confirms these results.

40

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Appendix A

Table A. Key literature for hypothesis development

Author Year Description Important Proxies

Beest 2009 The use of accounting

standards to manipulate

earnings

The accounting

standards

differences in rule

and principle

based

Chunhui 2014 Germany Local GAAP

use US GAAP before

IFRS adoption

The two types of

earnings

management and

which standards

apply more

earnings

management

Abnormal

expenditure. Use

DA to detect

Earnings

management

DeAngelo 1986 DeAngelo model

Evans et al. 2015 Earnings management

between Europe and

North America

Could U.S. GAAP

or IFRS lead to

more earnings

management

Chief Financial

Officer

behaviour, age,

firm size

Healy &

Wahlen

1999 Accruals are used to

manageme earnings and

hav impact on the

economy

The definitions of

earnings

management

Jamal & Tan 2010 Manager have incentive

to take debt off from

balance sheet

How is lease

liability reported

in accounting

standards

Auditortype

Jones 1991 Development of

modified jones

model to calculate

DA, accrual based

earnings

management

Earnings

management

Roychowdhury 2006 Measure real earnings

management through

real activity

How real earnings

management is

measured by

abnormal

production, cash

flow and

expenditures.

AB PROD, AB

CFO and AB

DIX

Zang 2012 Managers use what kind

of type of earnings

management

The subsitutions

of the type of

earnigs

management

accrueal earnings

management and

real earnings

management

47

Appendix B

Table B. Sample of observation

Table C. Sample divided in SIC

Continents Frequency Percentage Valid % Cum. %

U.S. GAAP 10340 46.0 46.0 46.0

IFRS 12130 54.0 54.0 100.0

Total 22470 100.0 100.0

SIC codes Industry Observations Percentage Valid % Cum. %

0100 - 0999 Agriculture,

Forestry and

Fishing

120 1.0 1.0 1.0

1000 - 1499 Mining 534 4.7 4.7 5.7

1500 - 1799 Construction 256 2.2 2.2 8.0

2000 - 3999 Manufacturing 5895 51.5 51.5 59.5

5000 - 5199 Wholesale Trade 519 4.5 4.5 64.0

5200 - 5999 Retail Trade 441 3.9 3.9 67.9

7000 - 8999 Services 3649 31.9 31.9 99.8

9100 - 9729 Public

Administration

22 0.2 0.2 100.0

Total 11436 100.0 100.0

48

Appendix C

Table D. Definitions of variable

AS Accounting standards (0) U.S. GAAP, (1) IFRS

AT Total Assets;

AUD Auditor;

BIG4 (0) non- big four auditor; (1) if auditor code in Compustat is 04 (E&Y), 05

(Deloitte), 06 (KPMG), or 07(PWC),

CFO Cash Flow from Operations residual;

COGS Costs of Goods Sold residual;

DA Discretionary accruals residual;

DE Debt to equity; Long term debt divided by total equity

DISX Research & Development + Selling, General and Administrative

expenses residual;

GEND (0) Female CEO, (1) Male CEO.

GROWTH Total Sales;

INV Inventory

LEV Leverage; total liability divided by total equity

NDA Non-discretionary accruals residual;

PROD Costs of Goods Sold + Change in inventory;

REM Real earnings management proxy consist of Prod - CFO - CFO;

ROA Return on Assets; Net income divided by total assets

SIZE total assets;

TAt Total accruals in year t