Smoothing and Earnings Management Policies SpringerLink

Foreign banks with low profitability that operate in volatile economic environments do not create higher discretionary LLP than domestic private banks. This implies that their risk is not lower than that of locally owned banks, at least on the credit side. In the aftermath of the financial crisis, both foreign and state banks have become more prudent than domestic private banks, and their discretionary LLP are higher. Overall, we provide evidence that foreign and government ownership affect LLP policy in banks.

These strategies range from acceptable accounting practices and generally accepted accounting principles, application of logical reasoning etc. Consider a retiring couple, both 65, who plan to spend around $17,000 a month. They have combined tax-deferred assets of $5 million and taxable assets of nearly $2 million.

Is assurance on risk management systems relevant for bankers’ decisions?

The ex post facto research design was employed, and as such, data were gathered from secondary sources. Furthermore, the system generalized method of moments (Blundell–Bond) panel estimation technique was used for analyzing the data. Income smoothing was measured using the accrual based methods, while firm value was measured using share price.

Basically, companies get indulged in this practice as investors are willing to pay a certain premium for those stocks that have a predictable and steady Earnings stream in comparison to such stocks which have volatile earnings and are considered riskier. This latter topic is inserted in a broader context that is those of earnings quality management. Moreover, this chapter explains the real earnings management policies such as income smoothing, big bath earnings management, and income minimization and income maximization policies.

Proxies of income smoothing

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• Lenders will use liability design to tighten lending contracts when borrowing businesses have poor accounting quality.
• While deliberately slowing revenue recognition in good years may seem counterintuitive, in reality, entities with predictable financial results generally enjoy a lower cost of financing.
• Tax avoidance can result in a high EBITDA, which can be translated into a high valuation using multiple EBITDA calculation methods.
• The Nigerian Securities and Exchange Commission (SEC) was saddled with the sole responsibility of determining share price before the introduction of the SEC Act, 1990 (Fadiran and Olowookere, 2016).

The Tobin’s Q is a measure of financial market valuation premium (Feihn and Struck, 2011; Rountree et al., 2008). It is calculated as the ratio of the market value of equity + long term debt to the book value of assets (Feihn and Struck, 2011; Huang et al., 2008; Rountree et al., 2008). This has been documented in previous studies such as Ajekwe and Ibiamke (2017), Bao and Bao (2004), Chen et al. (2016), De Jong et al. (2013) and Yu et al. (2017).

Income smoothing and firm value in a regulated market: the moderating effect of market risk

This study is built on agency theory being a theory of organizational process, behavior and outcome. Agency theory provides insight and understanding of corporate processes and designs to address emerging problems from the principal–agent relationship. As a result of this inclination, “income smoothing” occurs inexorably by “income smoothing,” which means making reasonable accounting decisions—those backed by facts and circumstances—that demonstrate a pattern in outcomes, which is generally upward-sloping.

• Interest on municipal bonds is generally exempt from federal income tax; however, some bonds may be subject to the alternative minimum tax (AMT).
• If executives do not grasp the sources of earnings, income smoothing does not affect value relevance.
• The study found that majority of Nigerian firms smoothed their income, and this practice decreases the value of firms significantly.
• Of course, if its income smoothing practices are later made known to the investment community, they will probably drive down the price of its stock.

We next conduct cross-sectional analyses using a set of factors identified in prior literature that may attenuate or strengthen the association between audit fees and income smoothing. These factors capture firms’ information asymmetry, ownership structure, and operation size. In addition, the analysis for firm size reveals that for both overall and innate smoothness measures, larger firms benefit less from income smoothing as the reduction in audit fees is less pronounced. Third, our study adds to the existing literature on the relationship between financial reporting quality and audit fees.

Market reaction to auditor switching from big 4 to third-tier small accounting firms

This group raises awareness of “surprises” in financial statements and performance. It is more helpful to create consistent revenues for company planning objectives, such as budgeting so that management may plan for growth. Deferring sales during a successful year if the following year is likely to be difficult, or postponing expenditure in a poor year if productivity is expected to improve shortly, are examples of revenue-smoothing tactics. Accounting excel inventory strategies are used to smooth out swings in net income from one period to the next. The purpose is to eliminate profit swings from one period to the next so that a firm has consistent earnings. 2 Distributions taken by an individual from certain employer retirement plans and IRAs prior to attaining age 59 ½ are subject to a 10% early withdrawal penalty tax, unless such distribution satisfies an eligible exemption to the early withdrawal rules.

If the process is following the guidelines of Generally Accepted accounting principles (GAAP), income smoothing doesn’t turn out to be illegal. Competent and skilled accountants can help adjust financial books in a way that makes sure that the income smoothing is nothing but viable. In estimating the model specified in this study, the dynamic panel generalized method of moments GMM (Blundell–Bond) estimator was adopted because the number of firms under consideration in the study (30) exceeds this study’s period (8). As a result of the nature of dynamic panel data, the lagged dependent variables are endogenous and correlated with the error terms. However, research showed that difference GMM results are affected by weak instruments; therefore, this study employs the system GMM.

Smoothing is expected to be positively related to firm value if it is naturally smooth but negatively linked if it is intentionally carried out by management. The increase in firm value can be attributed to investors’ preference for more stable earnings. More so, this suggests that smoothen practices are seen to signal private information by managers to investors, thus, income smoothing is perceived from the information view rather than the garbling (managerial opportunistic) view. This practice is especially common in publicly-held companies, where investors are more likely to bid up the price of shares in a company that presents a reliable and predictable earnings stream over time.

Markets don’t always cooperate with your best laid plans, including those you’ve made for retirement. But there are strategies you can use to help improve retirement readiness, even at times such as now, when our forecasts indicate it’s unlikely that markets will perform as well as they have been in recent years going forward. (2009), “Corporative management and agency problem”, Faculty of Law, Belgrade, No. 1, pp. 5-25. Table 2 presents the results of the system generalised method of moments (GMM) estimated for the two models of this study, respectively. The authors declare that they have no known competing financial interests or personal relationships that could have appeared to influence the work reported in this paper.

Investors base their investment selections on a company’s profits, which indicate its potential. Investors evaluate a company’s financial status and decide whether or not to invest in its shares based on its financial results. If the first reporting period is likely to have a high income, the corporation may set aside $6,000 as an allowance for doubtful accounts. The securities/instruments discussed in this material may not be appropriate for all investors. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. Morgan Stanley Wealth Management recommends that investors independently evaluate specific investments and strategies, and encourages investors to seek the advice of a financial advisor.

As such, Pereira and Zhang (2010) posit that investors adapt their trading strategy to the volatility in the market. Demsetz and Villalonga (2001) argue that higher market risk (beta) indicates better prospects for managers to profit from inside information and for outside shareholders to engage in profitable monitoring of managers. The capital market tends to appreciate companies that report highly stable earnings because it is easier for future earnings of such companies to be forecast more accurately. Also, earnings variability is interpreted as an essential measure of the overall riskiness of the firm and has a direct effect on investors’ capitalization rates (Beidleman, 1973). Therefore, the main objective of this study is to examine the effect of income smoothing on the firms’ value.

While it may seem illogical to restrict revenue recognition in good years purposely, companies with predictable financial performance typically have cheaper borrowing costs. Companies engage in this approach because shareholders are more prepared to pay a premium for corporations with consistent and predictable earnings streams than for firms with more fluctuating earnings trends, which are considered hazardous. Morgan Stanley Smith Barney LLC offers insurance products in conjunction with its licensed insurance agency affiliates. Taxable distributions from insurance products (and certain deemed distributions) are subject to ordinary income tax. Depending on the country, companies pay a progressive corporate tax rate; meaning that the higher the income earned, the higher the taxes paid. To avoid this, companies may increase provisions set aside for losses or increase donations to charities; both of which would provide tax benefits.

Then in a year with low profits, the company will reduce the allowance for doubtful accounts and greatly reduce bad debt expense. That means the couple may have more resources to support spending, gifting and other financial goals. Furthermore, the agency problem created by the separation of ownership from management is perceived to be increased by the practice of rewarding/remunerating the agent based on the assessment of performance measures such as earnings.

Businesses use hedging methods to get out of high tax levels, such as boosting loss provisions or increasing charitable contributions, among other things. External parties cannot examine the company’s activities and cannot guarantee the company’s profit-shifting flexibility. When earnings improve, the company will boost staff spending and catch up on maintenance that had been neglected. In a year with poor earnings, the company may cut personnel, postpone maintenance projects, limit research and development, and so on. This is based on the latitude afforded by the GAAP definition rather than on “creative” accounting or misstatements that would be considered open fraud. Tax avoidance can result in a high EBITDA, which can be translated into a high valuation using multiple EBITDA calculation methods.