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Real Earnings Management and Timely loss Recognition

Author Affiliations

  • 1Department of Accounting, Faculty of Economics and Social Sciences, Bu-Ali Sina University, Hamadan, IRAN
  • 2 Department of Accounting, Behbahan Branch, Islamic Azad University, Behbahan, IRAN

Res. J. Recent Sci., Volume 2, Issue (12), Pages 28-37, December,2 (2013)

Abstract

Most of the contemporaneous research on earnings management focuses on the detection of abnormal accruals. The purpose of this study is to detect manipulation of real activities to meet zero earnings target in the firms listed in Tehran Stock Exchange (TSE) over 2002-2009 and investigate the relationship between real activities manipulation and timely loss recognition. Relying on prior studies (e.g. Roychowdhury) to develop our proxies for real earnings management, we analyze operating cash flows (OCF), production costs and discretionary expenses to detect evidence on real activities manipulation in TSE as an emerging capital market. Furthermore, to measure the timely loss recognition, we use the approach introduced by Basu. We detect abnormally low OCF, abnormally low discretionary expenses and abnormally high production costs for companies that report small positive net incomes at the annual level. The evidence is consistent with firms trying to increase reported annual earnings beyond zero by giving price discounts to boost sales temporarily and by overproduction and decrease in discretionary expenses. We also find that the timely loss recognition for firms engaging in real earnings management is lower than that of other firms. The paper motivates an interesting topic of earnings management in an emerging market where earnings management is more likely to be of concern. Also, this paper studies the relationship between real activities manipulation and timely loss recognition (TLR) as proxy for earnings quality.

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