International Journal of Economy, Management and Social Sciences, 2(11) November 2013, Pages: 952-958

TI Journals

International Journal of Economy, Management and Social Sciences

ISSN
2306-7276

www.tijournals.com

The Impact of Setting and Executing Accounting Standards on

Earnings Management
Mohammad Delkhosh *1, Mohammad Reza Shoorvarzy 2, Hassan Abdollahzade 3, Ahmad Taherinejad 4
1,2,3,4

Islamic Azad University, Bardaskan Branch, Department of Accounting, Bardaskan, Iran

AR TIC LE INF O

AB STR AC T

Keywords:

Institutionalizing the process of setting accounting standards is one of the essential requirements
for sustainable economic development. This process is complicated since it's influenced by social
and economic environment. In this study, the impact of setting and executing accounting standards
on earnings management for historical data of 1992-2010 of 107 listed companies on the Tehran
Stock Exchange has been studied and management variable has been estimated by Adjusted Jones
Model. After investigating descriptive statistics, paired-sample T-Test has been employed for
adopting appropriate hypothesis-testing method. Test results showed that the impact of accounting
standards influenced earnings management and actually increased it.

Accounting Standards
Earnings Management
Accruals
Operating Cash Flow
Net Income

2013 Int. j. econ. manag. soc. sci. All rights reserved for TI Journals.

1.

Introduction

Standards used by accountants and auditors have important roles in submitting and confirming financial reporting in creating
trustworthiness, accuracy and precision of financial information. It is one of the important factors in planning economic development.
Using accounting and auditory standards by providing reliable information required by planning organizations, accountants and auditors
offered worthwhile services to the economy of the countries. In some cases, accounting standards provide different choices, related to
functions of different methods of accountancy, for managers in a way that they can use their favorite accounting procedures for maximizing
their personal interest, social welfare, and stabilizing business opportunities in their business units. Moreover, regarding weak and semistrong forms of the efficacy of capital market, managers have access to confidential information which is not available to owners, creditors,
and potential investors. The above mentioned factors and the lack of confidence in determining real values of business entity, autonomy in
action, intervention managers personal judgment for measuring, all contribute to provide an appropriate opportunity for earnings
management by the managers.
1.1 Accounting Standards
Accounting standards are dominant rules on state of accountancy as a profession and guidelines for professionals. They determine the
method for the professionals and offer guidelines in the case of facing problems. In other words, one can say that the presence of standards
shows the professionals' efforts have high quality and coordinated work. No profession can continue its activities without the trust of the
society and no one can get credit in the society without coordinated, simple, and practical standards. For setting accounting standards, two
rules-based and principles-based approaches are offered and are used by major Standards Developing Organizations (SDOs). Accounting
standards are established according to predetermined rules in rules-based approach. In principles-based approach, offering general
framework, while simple, is preferred to graphic details and elaborative presentation of all probable situations. If correctly utilized,
principles-based standards will improve the quality of accounting information by focusing on superiority of the economic content of
transactions for their forms and employing the same accounting method for similar transactions.
1.2 Earnings Management
The first definition of earnings management was presented by Schipper (1989). He defined it as purposeful intervention in the external
financial reporting process, with the intent of obtaining some private gain. Degeorge et al. (1999) defined earnings management as a kind
of artificial earning manipulation for making some specific decisions. In their ideas, the major intention of earnings management is
managing the delinquencies of investors on a business unit.
According to Healy & Wahlen (1999) earnings management occurs when managers use personal judgment in financial reporting, therefore,
financial structure changes. These changes in financial reporting may mislead the beneficiaries on the performance of firms or may affect
the consequences resulted from contracts of business units which depend on reported accounting figures. In other words, managers use
judgment intentionally to create ambiguities in the intrinsic value of the company or to influence the allocation of resources in financial
reporting .
Jones & Sharma (2001) presented a comprehensive definition of earnings management. In their view, earnings management (manipulating
earning) occurs when managers use judgment in financial reporting and in structure of transactions mislead some beneficiaries on the
* Corresponding author.
Email address: mdelkhosh57@gmail.com

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Internat ional Jour nal of Economy, Mana ge ment and Social Sciences , 2(11) November 2013

economic performance of the company or to influence the results of the contract which depend on accounting figures, in this way it changes
financial reporting. Managers can manage earnings by different methods. Earnings management can occur regarding financial decisions,
financing, and investment.
1.3 Review of Literature
Afrouzmanesh (2009) in his research named the impact of setting Irans accounting standards on earnings response coefficient (ERC) ,
by studying two intervals of 1996-2000 and 2001-2005, found out that in pre-adoption period of accounting standards, 26 percent change of
the dependent variable is justifiable by independent variables, while in post-adoption period, it is about 11 percent. It shows that
accounting standards have effects on the ERC and it decreases by adopting accounting standards. [1]
In a research, Ali Akbari (2008-2009) studied the effect of utilizing accounting standards on the quality of financial reporting in listed
companies on the TSE. Financial statements and conservatism index were used to evaluate the quality of financial reporting. The accruals
quality index was used for measuring the quality of financial statements, and conservatism index (ratio of operational accruals before
amortization of the total assets since the beginning of the period) was employed for measuring the conservatism. Studying the information
of 67 listed companies on TSE in the post-adoption period of accounting standards (2001-2007) and pre-adoption period (1997-2001)
,using paired-sample T Test, showed that there is no meaningful difference between the quality of financial reporting in pre-adoption and
post-adoption period of accounting standards. [2]
Saghafi & Ebrahimi (2009) in their study named relation of setting accounting standards and quality of accounting information found out
that there is no meaningful relation between accounting standards and improving the quality of accounting information. [3]
Zohdi (2009) in his study, called the impact of setting Irans accounting standards on earnings stability, found that the earnings of the
company were more stable during the time when financial statements were not provided based on accounting standards. [4]
Studying two time intervals of 1996-2000 and 2001-2005 in her study, the impact of setting accounting standards on the quality of current
accruals Narges Gorji (2010) found that there is no meaningful relation between accounting standards and the quality of current accruals.
It shows that executing accounting standards has no effect on the quality of accruals. [5]
Mashayekhi et al. (2006) investigated the role of accruals in earnings management. The results of this study show that earnings
management is practiced in case studies. Actually the managers of these companies proceed to increase earnings by increasing discretionary
accruals when cash flow from operation decreases. [6]
Mashayekh & Amini (2010) studies the impact of practicing accounting standards on the quality of accounting during 1996-2008; earnings
management, timely loss recognition, and value relevance were considered as criteria for the quality of accounting. The results indicate that
the compulsion of employing standards result in an increase in timely loss recognition and a decrease in earnings management and value
relevance. Therefore, based on the findings of the study, the quality of accounting increased from the viewpoint of earnings management
and timely loss recognition but decreased from the viewpoint of value relevance. [7]
Wallace (2004) in his study, investigating the role of International Accounting Standards Board (IASB) in coordinating accounting
standards of public sector and the difference of these standards with accounting approaches of different countries, concluded that one can
hope to witness the coordination of accounting and auditory standards in public sector in most countries and even to level accounting
approaches between governmental and economic sectors. [16]
Barth et al. (2007) in his study named International Accounting Standards and the quality of accounting studied the companies of 21
countries which employed international accounting standards and compared them with their counterpart companies which did not utilize
these standards and were dependent on internal standards. For evaluating the quality of accounting, they used three variables of earnings
management, more timely recognition of losses, and the relevancy of accounting figures. The results of their study illustrate less
manipulation on earnings, more timely recognition of losses, and more value relevance of accounting information. Totally, their findings
demonstrate improve in quality of accounting, related to employing international standards. [11]
Kohlback & Warfield (2008) in their study,the impact of accounting standards on the quality of accounting worked on the effect of
accounting standards on the quality of accounting. They investigated four criteria of accounting standards in their study, i.e. earnings
stability, ERC, the quality of accruals, and evaluation models. The results of their study illustrated that there is no difference in dispersion
of earnings forecast or earnings stability before and after the obligation of observing accounting standards in the period of study. ERC and
quality of accruals decreases as well. They also studied the total time of descriptive changes (balanced R2) using three models of evaluation
including the model of cash value of per share, per share earnings model, and compound model of both variables. They estimated the
explanatory power (balanced R2) by annual estimation of these three models and compared them before and after adopting each standard.
They found no difference between the period before and after using accounting standards for book value of per share and compound model
but found a significant decrease in explanatory power of earnings model of per share after executing standards. [13]
Yang et al. (2005) examined the impact of setting accounting standards on relevancy and reliability of accounting information about the
change of least cost principle or market price in China during 1998-2000. In their study, they evaluated the relation between net assets and
capital market value, and accounting earnings and share return based on both historical cost accounting and least cost principle and market
and found that relevancy improved but reliability of accounting standards during the studied period did not increase. [15]

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Haung & Subramanyam (2007) studied the effects of using International Financial Reporting Standards (IFRS) on financial statements of
160 German companies during 1998-2002. They compared accounting figures reported by German Accounting Standards (HGB) with
accounting figures based on IFRS. The results proved that earnings conservatism under IFRS is considerably higher than HGB. However,
there is no significant difference in relevancy of book value and earnings between HGB and IFRS. [12]
Ahmed et al. (2009) studied the effects of obligatory utilization of IFRS on smoothing, conservatism, and timely accounting earnings for
the sample of 21 countries of the world (obliged to observe IFRS from the beginning of 2005) to the control sample of 17 countries (not
obliged to observe them). The studied period is 2002-2007 divided into pre-adoption of IFRS (2002-2004) and post-adoption period (20052007). The results explain that in pre-adoption period of IFRS, the companies of the first group had less smoothing of earnings, more
conservative accruals, and timely loss recognition in comparison to the control group. Secondly, in the period after the obligation of
employing, in companies which utilized IFRS in comparison to the control companies, smoothing of earnings and timely good news (or
positive economic performance) drastically increased but conservatism decreased. [9]
Paul & Healy & James (1999) showed in their study, titled earnings management and the implication of setting accounting standards, that
particular accruals have been used in earnings management which depends upon its importance and frequency. [14]
In the study named Accounting standards and earnings management, Haiyan et al. (2008) demonstrated that little progress was made in
the quality of accounting information by setting international accounting standards in China; also by doing so, more opportunities were
provided for managers to manipulate the earnings. [11]
D. Yu Michael (2005) showed in his study, titled International Earnings Management and Accounting Standards, finds evidence that
accounting standards can constrain earnings management after controlling for institutional factors identified in previous studies. [17]
Nikoomaram & Banimahd & Shokri (2012) showed in his study, titled An Empirical Analysis of Earnings Management Motives in Firms
Listed on Tehran Stock Exchange, that some Iranian firms engage in earnings management. The findings also demonstrate that firms with
higher debt ratio, larger size, and more changes of CEO and higher rate of return on assets are more likely to engage in earnings
management while there was no evidence of taxation effect on earnings management. [18]
Abdoli & Mehrabani & Shahri (2012) showed in his study, titled The Relationship between the Components of Corporate Transparency
and the Earnings Management, that there was a significant and negative relationship between the ownership structure and the earnings
management, and the significant relationship between the transparency in the corporate financial performance and the level of earnings
management was confirmed and this relationship was positive, but the significant relationship between the transparency in the board
structure and the level of earnings management was not confirmed. Evaluating the effect of return on assets ratio and type of ownership on
the level of earnings manipulation indicated that there is a significant and positive relationship between them, but the effect of financial
leverage ratio and the nonexclusive board ratio and the size of corporation on the level of earnings management were not confirmed. [19]

2.

Measuring Earnings Management

In this study, discretionary accruals (DA) were used, based on the Adjusted Joes Model, as a criterion for earnings management. Following
steps were taken subsequently for calculating discretionary accruals.
a. First, total accruals of the company are calculated in the intended year. In this study, Adjusted Jones model (introduced by
Dechow, et al. (1995)) was used as the following for calculating accruals
b.

T A it E it OCFit
E it

= operating earnings of firm (i) at year (t)

OCFit
=net operating cash flow of firm (i) at year (t)
TA it
= total accruals
c.

Using Excel and SPSS software and least squares method in the next step, we proceeded to calculate

1 , 2 and 3 parameters

as special parameters of the firm for estimating non-discretionary accruals (NDA) based on the following equation:

1
TAit
1
Ai (t 1)
A i (t 1)

TA it

REV it
PPE it
2
3
it

A i (t 1)
A i (t 1)

= total accruals

A i (t 1)

= total assets of firm (i) at year (t-1)

REV it = change in net income of firm (i) between years (t) and (t-1)

PPE it = property, plant, and equipment of firm (i) at year (t).

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Internat ional Jour nal of Economy, Mana ge ment and Social Sciences , 2(11) November 2013

The result of this step of fitting two equations of the regression line was as follows, in the pre-adoption and post-adoption
period of accounting standards, for calculation of special parameters of the firm.
Pre-adoption of standards:

y it 0.101 0.121x1it 0.137 x 2it 0.089x3it it

Post-adoption of standards:

yit 0.119 0.024x1it 0.141x2it 0.006 x3it it

d.

Then by using calculated parameters in part b, we proceeded to calculate NDA as follows:

1
REV it REC it
NDAit 1
2

Ai (t 1)

Ai (t 1)

PPE it
3

Ai (t 1)

REC it = change in net accounts and trade notes receivable

A i (t 1)

= total assets of firm (i) at year (t-1)

REV it = change in net income of firm (i) between years of (t) and (t-1)
NDAit

= non discretionary accruals

PPE it = property, plant, and equipment of firm (i) at year (t)

e.

After calculating NDA, we calculated DA as earnings management variable based on Adjusted Jones Model as following:

TAit
DAit
NDAit
A
i
(
t

1)

3.

Research Variables

3.1 Independent and Dependent variables

Independent variable: accounting standards (including all legislated standards in the period of study)
Dependent variable: earnings management
3.2 Population and Statistical Sampling
The population of this study is all listed companies on the TSE. To select the case sample, companies with above mentioned statistical
sampling were chosen which:
1. March 20th is the end of their fiscal year.
2. To be participants in stock exchange from 1995 to 2006.
3. The company did not change fiscal year during 1995 to 2006.
4. The required information of the company should be available.

4.

Research Hypothesis

Setting and executing accounting standards has increased earnings management in Iran.
Testing Hypothesis
1. To adopt appropriate hypothesis-testing method, at first, descriptive statistics of earnings management variables have been
studied before and after setting accounting standards.
a. As seen, in descriptive statistics of the earnings management variable after accounting standards, Std. Error of
skewness and Std. Error of Kurtosis has been shown in the range of 2 and -2 which show that the variable had
normal distribution and the related histogram chart confirms it. Since the number of data was appropriate and limited
to 856 cases, then using paired sample statistics is possible. (Table 1)

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Inter nat ional Journal of Economy, Manage ment and Social Scie nces , 2(11) Nove mber 2013

b. Per the table, in descriptive statistics of earnings management variable before accounting standards, Std. Error of
skewness and Std. Error of Kurtosis has been shown in the range of 2 and -2 which show that the variable had
normal distribution and the related histogram chart confirms it. Since the number of data was appropriate and limited
to 856 cases, then using paired sample statistics is possible. (Table 2)

2. Then to show that there is the effect of a kind of intervention (setting accounting standards) on earnings management in a society
(listed companies on the TSE before and after accounting standards), paired sample statistics was employed by using SPSS
software.
a. First, the relation (correlation) between two variables of earnings management in the period before and after adopting
accounting standards has been worked on, and then the statistical hypothesis were explained as follows.
H0: there is no meaningful correlation between the two variables
H1: there is a meaningful correlation between the two variables (Table 3)
Based on scheme number (1):
Since the offered correlation coefficient is equal to 0.075, and regarding sign which is 0.029 and is not greater than
0.05, then H 0 is rejected; therefore, correlation is witnessed between the two variables.
b. Then for studying the impact of setting accounting standards on earnings management, students t-test is used and the
average of earnings management before and after executing accounting standards has been compared with each other.
Studies hypotheses are as follows:

H 0 : 1 2 0

H 1 : 1 2 0

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Internat ional Jour nal of Economy, Mana ge ment and Social Sciences , 2(11) November 2013

In which 1 and 2 are considered the average of earnings management before and after executing accounting
standards subsequently. The result of this test is shown as follows
Scheme number (2): students t-test for comparing the average of earnings management before and after executing
accounting standards (Table 4).
As seen in the above table, the average of earnings management before executing accounting standards is equal to
0.103894026248 and -1.304880656421E3 after executing accounting standards. Regarding the amount of the test
statistic P value 0.000 0.05 , H0 is rejected. In other words, there is a significant difference between the
averages of earnings management before and after executing accounting standards, accordingly it can be concluded that
accounting standards were effective on earnings management and increased it.
95 % confidence interval for the difference of average of earnings management before and after executing accounting
standards is shown as:

1.184066 d 7.69304

5.

Limitations

One of the limitations of this study was that some companies were voluntarily employing guidelines of Auditing Organization between
1992 and 2010 and separating these companies from others was not easy to do; however, guidelines were changed to standards in 2001.

6.

Conclusion

Accounting standards were effective on earnings management and setting accounting standards did increase it.

Table 1

Statistics
A
N

Valid

856

Missing

Mean

-1.304880656421E3

Std. Error of Mean

2.7292490481869E2

Median

-1.948730463983E2

Mode

.0000000000

Std. Deviation

7.9850943101361E3

Variance

6.376E7

Skewness

-11.480

Std. Error of Skewness

.084

Kurtosis

135.993

Std. Error of Kurtosis

.167

Range

1.0709304897E5

Minimum

-1.0709211800E5

Maximum

.9309619550

Table 2

Paired Samples Correlations scheme number 1

N
Correlation
Sig.
Pair 1

B&A

856

.075

.029

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Inter nat ional Journal of Economy, Manage ment and Social Scie nces , 2(11) Nove mber 2013

Table 3

Statistics
B
N

Valid

856

Missing

Mean

.103894026248

Std. Error of Mean

.0051611341934

Median

.101174684227

Mode

.0000000000

Std. Deviation

.1510017684509

Variance

.023

Skewness

-.356

Std. Error of Skewness

0.084

Kurtosis

5.546

Std. Error of Kurtosis

.167

Range

1.8317572743E0

Minimum

-1.0132754959E0

Maximum

.8184817784

-7.69304

0.000

-4.781

1.5100176845091E-1
7.9850943101361E3

.103894026248
-1.304880656421E3

856
856

group

Std.
deviation

-1.84066

The volume
of the
sample

Statistics of
t-test

min

average

max

p-value

Table 4

95% confidence interval for the

difference of average

before
after

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