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The purpose of this study is to investigate the prevalence of earnings management in the Australian not-for-profit (NFP) disability service providers sector, as well as to understand the motivations for and implications of such practices. This research is important for stakeholders, such as members and funders, as well as the broader Australian community, considering the significant financial resources allocated to these organizations from the public purse.

The authors employ a longitudinal dataset containing financial data from 154 Australian NFP disability service providers, collected over a two-year period (2015–2016). Through the analysis of detailed balance sheets and income statements, the authors seek to uncover evidence of earnings management practices in this sector. The study’s results provide valuable insights into the behaviour of the charitable human services sector.

The findings reveal that Australian NFP disability service providers engage in earnings management practices, primarily aimed at reducing reported profits to meet the normative financial expectations of stakeholders, such as public sector funders and philanthropists. The executives of these organizations strive to report profits close to zero, being cautious not to report a loss, which might raise concerns about their sustainability.

The authors contribute to the existing literature on earnings management in the NFP sector by focussing on Australian disability service providers, an area that has been under-researched due to a lack of suitable data. The results offer insights into the incentives and implications of earnings management practices in this sector and highlight the need for a revaluation of accounting standards, reporting requirements and audit arrangements applicable to the NFP sector.

The purpose of this paper is to examine the effect on earnings quality in private firms caused by a negative shock to fundamental performance, while simultaneously addressing methodological challenges measuring fundamental performance present in prior accrual-based earnings management literature.

Fundamental performance is unobservable and, therefore, difficult to measure. Existing research has used proxies that are subject to estimation errors and endogeneity concerns (e.g. DeFond and Park, 1997, Balsam et al., 1995). This study attempts to overcome these issues by taking advantage of the exogenous shock in oil price which occurred in 2014 and by using a difference-in-differences approach to investigate the effect on earnings management caused by a negative shift in fundamental performance.

The results suggest that a negative shock in fundamental performance, indicated by the oil price shock in 2014, reduces earnings quality. This result holds for various robustness tests such as the use of propensity score matching, and the inclusion of firm fixed effects. Additional analysis suggests that the reduction in earnings quality is driven by an increase in positive discretionary accruals, suggesting that managers of private firms experiencing poor performance manage earnings upwards to conceal true performance.

This study contributes to the literature by examining the effect of a negative shock to performance in a setting of private firms and by addressing methodological challenges in prior literature. Private firms are fundamentally different from public firms, with the consequence that results from public firms may not be generalizable to private firms (e.g. Hope et al., 2012, Burghstahler et al., 2006, Ball and Shivakumar, 2005).