Modeling Discretionary Accrual Reversal and the Balance Sheet as an Earnings Management Constraint

Baber, William R, Kang, Sok-Hyon, Li, Ying

The Accounting Review · 2011 · Volume 86 · Issue 4

Abstract

This study presents conceptual and empirical analyses of discretionary accrual reversal in the earnings management context. We specifically focus on the extent that income-increasing (decreasing) discretionary accruals initiated in a prior period reverse to become income-decreasing (increasing) accruals in the current period. The analysis suggests that the extent that such reversals constrain the ability to manage toward earnings objectives depends on both the magnitude of past accrual-based earnings management and thereversal speedof past discretionary accruals. To demonstrate the empirical implications of the analysis, we consider discretionary accrual reversal speed as an additional determinant of the balance sheet constraint on earnings management (Barton and Simko 2002). We show that, conditional on the magnitude of net operating asset overstatement, the probability of achieving quarterly earnings forecasts varies inversely with reversal speed.

Keywords

earnings management, discretionary accruals, discretionary accrual reversal, reversal speed, M4, M41, Data are available from public sources identified in the paper

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