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ABSTRACT
This research investigate whether IFRS adoption, firm size, and firm
leverage have effect on earnings management in Indonesia manufacturingfirms. Earnings management is identified using absolute value of
discretionary accruals, measured with Francis et al. (2005) model. Based on
a sample of 102 manufacturing firms listed in Indonesia Stock Exchange for
year 2010, results show that IFRS adoption in Indonesia does not have
effect on earnings management, while firm size and firm leverage have
effect on earnings management. Furthermore, results show that firm size has
negative effect on earnings management, means larger firms engage in less
earnings management and highly leveraged firms engage. Results also show
firm leverage has positive effect on earnings management, means highlyleveraged firms is associated with more earnings management.
Keywords: earnings management, IFRS adoption, firm size, firm leverage
INTRODUCTION
In recent years, there is a tendency for global business environment to use IFRS
(International Financial Reporting Standards), issued by IASB (International
Accounting Standard Board). IFRS is designed to respond global business and capital
market development, which urge for an internationally uniform set of high quality
accounting standards for financial reporting. Before adopting IFRS, each country has its
own set of financial accounting rule, which may different one with each others.
Financial statements users find difficulties in comparing an entity with another. Started
in 2001, IASB issued the first iteration of IFRS and since that IFRS has become
accepted and been adopted for public reporting purpose in over 100 countries.
IFRS is principles-based standards that are investor/market oriented and require
extensive disclosure in comparison with prior standard. The most important element of
IFRS was the introduction of the fair value principle to asset valuation and liability
recognition. Fair value principle enhances disclosed values of accounting quantities,
which should be close to their relative market values and therefore financial accounting
information is more likely to reflect true economic events. IASB also removed
allowable accounting alternatives, such as reduced managers' flexibility in valuing
assets at the lowest amount possible so as to minimize tax liabilities (Barth, 2008;
Dimitropoulos, 2013). Moreover, IFRS imposed changes on many technical accounting
issues aimed at promoting a true and fair presentation of financial information to
facilitate investors' rational investment decisions. Based on this, in theory, the adoption
of IFRS should significantly restrict the ability to engage in earnings management
behavior and increase the overall quality of disclosed information.
However, since IFRS is principle-based, which offers greater flexibility and tend
to rely more heavily on management judgment. This may bring opportunities for
management to choose accounting policies for their interest, especially when related to
estimation and judgment. For instance, when fair values are estimated using valuation
models, managers can influence the estimations through their choices of models and
parameters, thus opening the door to greater opportunistic earnings management
(Capkun et al., 2013).
Empirical researches have been conducted in countries with purpose to find out
the effect of IFRS adoption on earnings management. However, findings are different
across countries and suggest that it is not appropriate to generalize the effects of
adopting IFRS because single set of standards may not be suitable for all settings and
thus may not uniformly improve value relevance and reliability due to differences
among countries, including approach used, social, political factors (Soderstrom and
Sun, 2007; Ball et al., 2003). The International Accounting Standards Committee
(IASC) Foundation aware of this issue and has documented the need to have an
understanding of the impact of IFRS as they are adopted in particular regions (IASB,
2004: par. 93).
In Indonesia, Indonesia Financial Accounting Standards Board, called as Dewan
Standar Akuntansi Keuangan (DSAK), developed convergence program to adopt IFRS
in PSAK. The decision to converge was announced in 2008 with the aim of eliminating
the differences with local generally accepted accounting principles and increases the
quality of financial reporting. Different with countries in Europe and Australia, which
used big-bang approach, DSAK decided to use gradual implementation for its PSAKIFRS convergence program, and until 2010 there were seven PSAK revised and
effectively implemented, namely PSAK 13, PSAK 14, PSAK 16, PSAK 23, PSAK 30,
PSAK 50, and PSAK 55. However, there is no research in Indonesia purposing to find
the effect/impact of IFRS adoption on earnings management and thus the effect is still
unknown but only hypothesis.
In addition to accounting standard used, researchers find that there are also other
factors influencing earnings management practices. Two of them are firm size and firm
leverage. However, there is inconsistency between research findings.
Based on the fact above, researcher is motivated to find whether IFRS adoption
has effect on earnings management in Indonesia. Since there is no research in Indonesia
purposing to find the effect/impact, especially in manufacturing sector, finding of this
research provide new insight that is relevant for evaluating the IFRS adoption. In
addition, the gradual approach chosen by DSAK makes it interesting to conduct this
research, since the effect of IFRS adoption on earnings management may be different in
each year due to adoption progress. This research is also intended to investigate and
confirm whether firm size and firm leverage have effect on earnings management, since
there are inconsistencies in study findings.
This research uses absolute value of discretionary accruals as proxy to the extent
earnings management. Francis et al. (2005) method is used to measure discretionary
accruals. In addition, this research includes firm endogenous power of generating
accruals and absolute value of firm operating cash flows as control variables as
suggested by Becker (1998).
LITERATURE REVIEW
Agency Theory, Agency Problem, and Positive Accounting Theory (PAT)
Agency theory explains that management is expected to act on behalf of
shareholders interest in return of compensations or bonuses. For both parties, the
benefits is measured based on firm performance, which is profitability in general (Scott,
2012: 340; Conceptual Framework of PSAK, par. 17). However, there is information
asymmetric problem, which explains that management has more information compared
to shareholders. Management may take advantage of this information asymmetric on
behalf of its own interest, instead of shareholders, to alter the information before it
publicly announced to shareholders. PAT assumes that managers are rational and will
choose accounting policies that result in their own best interests, which may not
necessarily also be in the firms best interest, if able to do so (Scott, 2012: 306). To be
noted is that PAT does not assume that management will simply act so as to maximize
firm profit. Instead, management will maximize profits only if management perceives
this to be in its own benefits.
Previous Research
Chua et al. (2012) found that firms exhibit less earnings management following
the mandatory implementation of International Financial Reporting Standards (IFRS) in
Australia. The empirical results from a research in China generally indicate that
accounting quality improved, measured with decreased earnings management and
increased value relevance of accounting measures since 2007 (Liu et al., 2011). Studies
in European countries (Barth et al., 2008; Chen et al., 2010) find that adoption of IFRS
can be associated with less earnings management. This is consistent with Zeghal et al.
(2011) finding, who conducted study in French, and Dimitropoulos et al. (2013) finding,
who conducted study in Greece.
In contrast, several studies show different findings. Study in New Zealand find
that IFRS adoption does not have impact on earnings management (Kabir et al., 2010).
Research on the cross-listed firms in U.S. found that there is no significant relationship
between IFRS adoption and earnings management (Sun et al., 2011). Van Tendeloo and
Vanstrelen (2005) find that companies that have adopted IFRS engage significantly
more in earnings management than companies reporting under German GAAP.
Regarding to firm size, Gul et al. (2003), Siregar and Utama (2006), and
Handyani and Rachadi (2009) find there are negative and significant relationship
between firm size to earnings management. Different with their results, Halim, Meiden,
Tobing (2005) and Veronica and Bachtiar (2003) find that firm size has positive toward
earnings management practices. Furthermore, Guna and Herawati (2010) and Raymond
(2011) find that there is no significant relationship between firm size and earnings
management.
Regarding to firm leverage, Gul et al. (2003), Chen et al. (2010), and Sun et al.
(2011) find that there is a positive and significant relationship between firm leverage to
earnings management. This result agrees with debt covenant hypothesis, which
identifies that management in firm with high leverage tends to do earnings management
in order to avoid debt covenant violation. However, Lobo and Zhou (2001) and
Dimitropoulos et al., (2013) find that there are negative and significant relationship
between leverage to earnings management.
Hypothesis Development
Agency theory and positive accounting theory explain how firm managers may
use accounting policies that result in their own best interests, which may not necessarily
also be in the firms best interest. In IFRS, IASB identifies that it has removed
allowable accounting alternatives (Barth, 2008; Dimitropoulos, 2013). Moreover, IFRS
imposed changes on many technical accounting issues, such as the presentation of
financial statements, segment reporting, intangible assets, depreciation, related party
disclosures, aimed at promoting a true and fair presentation of financial information to
facilitate investors' rational investment decisions. Based on this, in theory, the adoption
of IFRS should significantly restrict the ability to engage in earnings management
behavior and increase the overall quality of disclosed information. However, lack of
implementation guidance, less rules enforcement, incapable external assurance service
providers may create rooms for managers to do earnings management and reverse the
positive effect of IFRS adoption into negative.
Zeghal et al. (2011), Dimitropoulos et al. (2013), Chen et al. (2010), Kabir et al.
(2010), Sun et al. (2011), Van Tendeloo and Vanstrelen (2005) find that IFRS adoption
influences earnings management. First hypothesis is formulated as follows:
H 1 : IFRS adoption has effect on earnings management
Conceptual Framework
IFRS Adoption
H1
(Independent Variable)
Firm Size
H2
(Independent Variable)
Firm Leverage
Earnings Management
H3
(Independent Variable)
(Dependent Variable)
RESEARCH METHODOLOGY
Population and Sample
The population in this research is manufacturing firm listed in Indonesia Stock
Exchange (IDX) in 2010. Manufacturing sector is chosen because there is no similar
research in this sector. In addition, selecting one type of industries minimizes the
difference in characteristics between firms. The technique for sample taken is conducted
with purposive sampling in order to obtain representative sample according to the set of
criteria. That set of criteria is as follows.
1.
2.
3.
4.
5.
N
o
1
2
3
3
4
Table 1
Sample Selection Procedures
Criterion
IDX-listed manufacturing firm in 2010
Firm do not publish complete audited financial statements during 2006-2011
Firm do not publish independent auditors report for accounting period of 2010
Firms change accounting period during 2006-2011
Incomplete financial data
Sample selected
Tot
al
129
(8)
(2)
(2)
(15)
102
Operational Definition
1.
Earnings management
This research uses absolute value discretionary accruals to proxy the extent of
(4)*
year t
a 0,
a 1, a 2 , a 3 , a 4 , a 5
CFO i,t-1
CFO i,t+1
REV i,t
: Constanta
: Coefficient
: Cash flow from operations of firm i in the year t-1
: Cash flow from operations of firm i in the year t+1
: Change in current assets of firm i between year t-1 and
PPE i,t
v i,t
10
2.
IFRS adoption
The IFRS adoption used in this research is a dummy variable. Audit report is
4.
Firm size
Firm size is measured by logarithm base ten of total assets of firm i in the year t:
Size i,t =
LOG[TA i,t]...........................................................................(8
)
Firm leverage
Firm leverage is measured by total liabilities deflated with total assets of firm i
in the year t:
5.
possibility that firms with larger absolute values of total accruals also have larger
discretionary accruals (Becker et al., 1998; Kabir et al., 2010).
6.
research controls for firm performance by including absolute value of operating cash
flows in model (Dimitropoulos et al., 2013; Van Tendeloo and Vanstrelen, 2005)
Analytical Model
The regression model is used to measure the effect of IFRS adoption, firm size,
firm leverage, and control variable on earnings management as follows:
ABSDACC i,t = 0 + 1 DIFRS i,t + 2 SIZE i,t + 3 LEV i,t + 4 [ABSTACC/TA] i,t +
5 [ABSCFO/TA] i,t + i,t ...................................................(10)
Where:
ABSDACC i,t
: Dependent variable Earnings Management
0
: Constanta
1 , 2 , 3 , 4 , 5
: Coefficients of regression
DIFRS i,t
: Independent and dummy variable for IFRS adoption
of firm i in the year t,
SIZE ,t
: Independent variable for size of firm i in the year t
LEV i,t
: Independent variable leverage of firm i in the year t
[ABSTACC/TA] i,t : Endogenous power of generating accruals as control
variable
10
11
[ABSCFO/TA] i,t
i,t
Std. Deviation
ABSDACC
DIFRS
102
102
0.0013
0.0000
0.038262
0.990196
0.0350009
0.0990148
SIZE
102
10.4530
14.0525 12.050305
0.6597154
LEV
102
0.0943
3.2100
0.616001
0.5377841
ABSTACC
102
0.0015
1.2031
0.082270
0.1278391
ABSCFO
102
0.0002
0.8557
0.123815
0.1328832
Table 3
Analytical Model Test Result
Coefficie
nt
Sig. t
Statistical
Significance
?
0.050
1.443
0.152
No
Size (SIZE)
-0.008
-1.709
0.091
Yes**
Leverage (LEV)
0.027
4.197
0.000
Yes*
0.105
3.453
0.001
Yes*
-1.470
0.145
No
Variable
* Statistically significance at 1%
** Statistically significance at 10%
From table 3, it is shown that IFRS adoption does not have significant effect on
earnings management, while firm size has negative effect and firm leverage has positive
effect, with significance at 10% and 1% respectively. Therefore, hypotheses 1 is
rejected, while hypothesis 2 and hypothesis 3 are supported.
Discussion
1. Effect of IFRS Adoption on Earnings Management
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There are two perspective to explain why IFRS adoption does not have
significant effect on earnings management. From standards change perspective, until the
end of 2010, seven PSAK were revised and effectively implemented under IFRS
convergence program. Several of them are essential for manufacturing firms, namely
PSAK No. 14 Inventory and PSAK No. 16 Fixed Assets. However, not all revised
standards impose significant changes in firms accounting practices and therefore
explains why IFRS adoption does not has effect on earnings management for year 2010.
The rest of this section presents discussion of the revised standards under IFRS
convergence in order to better explain the research finding.
PSAK No. 16 (2007) Fixed Assets is adopted from IAS 16 (2003) and
supersedes PSAK No. 16 (1994) Fixed Assets and Other Assets and PSAK No. 17
Accounting for Depreciation, effective on January 1st, 2008. The significant change
in this revised standard is firms are able to choose revaluation model to measure fixed
assets. Prior revision, firms were required to use only cost model. Occasional
revaluation was permitted and had to comply with taxation regulation. However, all of
firms in sample chose to use cost model rather than switch to revaluation model when
PSAK No. 16 R2007 was first implemented. In addition, only 2 out of 102 sample firms
chose to switch to revaluation model in 2010. Therefore, change in this standard does
not impose significant change in accounting policies and discretionary accruals earnings
management.
PSAK No. 14 (2008) Inventory is adopted from IAS 2 (2003) supersedes
PSAK No. 14 (1994)Inventory effective on January 1st, 2009. The significant change
in this revised standard is firms are no longer able to use Last-In-First-Out (LIFO) for
cost-flow assumption. However, all of sample firms did not use LIFO before transition
date (2008). Therefore, change in this standard does not impose significant change in
accounting policies and discretionary accruals earnings management.
PSAK No. 13 (2007) Investment Property is adopted from IAS 40 and
supersedes PSAK No. 13 (1994) Accounting for Investment effective on January 1st,
2008. Before revision, investment property is part of the PSAK no. 13 (1994), and has
to use cost model as accounting policy. Under PSAK No. 13 (2007), firms are able to
choose fair-value model aside from cost model. There are two sample-firms choosing
fair-value model while the rest use cost-model as accounting policy for investment
property.
PSAK No. 26 (2008) is adopted from IAS 23 (2007) and supersedes PSAK 26
(1997) effective on January 1st, 2010. PSAK No. 26 prescribed accounting treatment
for borrowing costs. There is no significant change about accounting policies in the
revised standard. PSAK No. 26 (2008) delivers additional paragraphs and sentences that
help users to have better understanding about the standard.
PSAK No. 30 (2007) Leasing is adopted from IAS 17 (2003) and supersedes
PSAK No. 30 (1994) Leasing effective on January 1st, 2008. The significant change
in this revised standard is the determination of whether an arrangement is, or contains a
lease. PSAK No. 30 2007 requires firms to focus on economic substance of
arrangement, rather than legal form. A lease that transfer substantially to the lessee all
the risks and rewards incidental to ownership of the leased item is classified as a
financial lease. A lease which does not transfer substantially all the risks and rewards
incidental to ownership of the leased item is classified as an operating lease. PSAK No.
30 (2007) also requires financial lease recognized as asset and liabilities in lessees
statement of financial position at fair value of leased asset or present value of minimum
lease payment, which one is lower. This is different with PSAK No. 30 (1994) which
only states about present value of total lease payment plus present value residual value.
In addition, PSAK No. 30 (2007) requires firms to have more disclosure related lease
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13
13
14
14
15
suggest the accounting and auditing standard setters in Indonesia about the effect of
IFRS adoption, firm size, and firm leverage on earnings management for year 2010,
which are useful to be taken into consideration in the policy-making process.
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