The Implications of Earning Management on the reliability of corporate financial Statements

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ACKNOWLEDGEMENT

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ABSTRACT

Manipulating reported earnings is a temptation faced by accountants and financial professionals around the world. Manipulating, or "managing, " one's accounting earnings takes a variety of forms and includes not only the avoidance of prescribed accounting rules but also the practice of selectively choosing accounting estimates or timing operating decisions to move reported earnings toward a desired goal. Prior research reveals wide disagreement regarding the perceived ethical acceptability of this practice. This study investigates whether national origin influences perceptions of earnings management. Participants from the United States and Mexico evaluated thirteen vignettes describing various earnings management practices (Merchant and Rockness 1994). Analyses of the responses indicate considerable variation between students from these two countries, indicating culture does significantly impact how individuals perceive opportunities to manage reported financial information.

CHAPTER 1: INTRODUCTION

We are constantly bombarded with news of corporate wrongdoing. Hardly a month goes by without the announcement of someone, or some company, acting unethically in the context of financial reporting in the US (Jubak, 2002; Grimsley, 2002; U.S. House of Representatives, 2002) and abroad (Main, 2002). Accordingly, the evaluation of ethical behavior in financial reporting continues to be an important issue in business practice and in the preparation and evaluation of financial information. The examination of individual ethical perceptions is especially germane to the assessment of the overall ethical climate in our growing international business community. With the continued expansion of companies into the "global marketplace," it is increasingly important to examine the ethical perceptions of individuals from various cultures in an attempt to evaluate the ethical climate that may exist, and therefore the potential tendency for misleading financial information in this burgeoning financial marketplace.

The purpose of this study is to increase our understanding of current ethical perceptions regarding the financial reporting practice of "earnings management" (i.e., income smoothing, or manipulating income toward a desired goal), and whether those perceptions may be influenced by national culture. Specifically, we use an instrument previously developed by Merchant and Rockness (1994) to study Mexican and U.S. students' perceptions of the practice of earnings management. The instrument requires that students' provide perceptions of the "appropriateness" of earnings management under various scenarios.

The first part of the paper presents the theory and hypothesis development. The methodology and results are presented in the second and third sections. Future research and policy considerations are provided in the final ...