Managing accruals for income smoothing: empirical evidence from Pakistan

Abstract

Purpose

The purpose of this paper is to investigate whether income smoothing helps to reduce volatility in reported earnings and which firms are more inclined to be engaged in income smoothing.

Design/methodology/approach

The authors used negative correlation between pre-managed earnings of a firm and its discretionary accruals (DAs) as proxy for income smoothing and the firms having more negative correlation coefficient are expected to have lower volatility in their reported earnings. The authors used Kothari et al.’s (2005) version of modified-Jones model to estimate DAs and used least squares estimations to investigate the research questions using six-year (2007-2012) sample of non-financial firms listed over Karachi Stock Exchange, Pakistan.

Findings

The authors found that firms experiencing more volatility in economic activities and smaller firms are more aggressively involved in income smoothing. Moreover, a predominant majority (72.2 per cent) of firms in the sample are involved in income smoothing through accruals manipulation. Also, the authors found that firms which are more aggressively involved in income smoothing have lesser volatility in reported earnings. Lastly, the level of DAs per se does not have any impact on income smoothing.

Research limitations/implications

The proxy used for income smoothing, though the authors consider it to be better, is not the only one used in literature and the sample is limited to Pakistan.

Originality/value

This study adds to earnings management literature by providing evidence on extensive accrual manipulation for income smoothing in Pakistan.

Citation

Safdar, R. and Yan, C. (2016), "Managing accruals for income smoothing: empirical evidence from Pakistan", Journal of Accounting in Emerging Economies, Vol. 6 No. 4, pp. 372-387. https://doi.org/10.1108/JAEE-07-2014-0038