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Dwi Ratmono

Universitas Diponegoro

[Jurnal Audit – SNA 13]


This study examines whether management of public companies in Indonesia engage real earnings management to meet earnings benchmarks. This paper documents evidence consistent with real activities manipulation around earnings threshold for poor performance firms. Manager opportunistically utilize price discounts to temporarily increase sales, overproduction to report lower cost of goods sold, and reduction of discretionary expenditures to improve reported margins. Consistent with the conjecture of Roychowdhury (2006, p. 338) and Cohen & Zarowin (2010, p.3), auditors are more difficult to detect real earnings management than accrual-based earnings management.

The results of this study indicate that drawing inferences about earnings management by analyzing only accrual manipulation is inappropriate. This study contributes to literature by presenting evidence on the real earnings management, which has received little attention to date.

Keywords: real earnings management, accrual-based earnings management, abnormal CFO, abnormal discretionary expenses, abnormal production cost, audit quality

Earnings management is a topic that has received much attention in accounting research. However, most previous studies of earnings management techniques only focus on accrual-based earnings management (Cohen and Zarowin, 2010; Mc vay, 2006; Roychowdhury, 2006). Zang (2006) show that firms use various earnings management techniques, not just one technique alone to achieve profit targets.

In addition, the survey results Graham et al. (2005) showed that top managers tend to prefer real earnings management rather than accrual-based earnings management to achieve earnings targets. Therefore, studies that draw conclusions about accounting earnings management by simply basing the accrual setting alone may be invalid (Roychowdhury, 2006). Several recent studies stating the importance of earnings management to understand how companies make earnings management through real activities manipulation than accrual-based earnings management (Roychowdhury, 2006; Gunny, 2005; Zhang, 2006; Cohen et al., 2008; Cohen and Zarowin, 2010).

This is important because research results Cohen et al. (2008) show that managers have switched from accrual-based earnings management to real earnings management after the period of the Sarbanes-Oxley Act (SOX) to avoid detection is performed auditors and regulators.

In the Indonesian context, research results Leuz et al. (2003) pointed out that because of weak investor protection environment is the practice of earnings management in Indonesia tend to be more intensive than other countries with strong investor protection. However, Leuz et al. (2003) basing on the proxy-proxy for accrual-based earnings management. Therefore, it still remains an important research question is whether the real earnings management is also done by companies in Indonesia to achieve profit targets.

The first aim in this study is to provide empirical evidence of real earnings management practices by public companies in Indonesia. This study followed the suggestion of Cohen and Zarowin (2010, p.. 18) for future earnings management research should focus on testing the real earnings management, not only accrual-based earnings management only.

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