EARNINGS MANAGEMENT AND FRAMING: THE SPECIFIC CASE OF OBSOLETE INVENTORY

Abstract

Recent events have shown that earnings management is a significant problem in the business world and that the culture in place in many organizations may encourage managers to manipulate earnings. While prior research has shown that earnings management exists at the corporate level, it has not examined whether managers at the divisional level are motivated to manage earnings. The purpose of this study is to examine whether divisional managers will be more inclined to manage earnings in order to maximize personal wealth. The secondary research objective is to examine whether the information frame will impact discretionary management accounting decisions. Members of the Institute of Management Accountants participated in an earnings management study in which two conditions were manipulated. First, the annual compensation of subjects was contingent on whether target income was met or not met. Second, information about a potentially obsolete inventory item was framed as either positive or negative. Subjects were asked the likelihood they would write off the potentially obsolete inventory. Research findings support the earnings management hypothesis and indicate that managers are less likely to write off obsolete inventory when their compensation is impacted by the write-off. Study results also reveal that the manner in which the inventory information is framed may affect managers’ write-off decision. These results are important as they may indicate that earnings management is more pervasive throughout the organization than previously shown.

Citation

Murphy, M.M. and Healy, J.P. (2003), "EARNINGS MANAGEMENT AND FRAMING: THE SPECIFIC CASE OF OBSOLETE INVENTORY", Advances in Accounting Behavioral Research (Advances in Accounting Behavioural Research, Vol. 6), Emerald Group Publishing Limited, Leeds, pp. 95-119. https://doi.org/10.1016/S1474-7979(03)06005-8