Core Earnings Management: How Do Audit Firms Interact with Classification Shifting and Accruals Management?

50 Pages Posted: 1 Dec 2017 Last revised: 5 Oct 2020

See all articles by Aasmund Eilifsen

Aasmund Eilifsen

Norwegian School of Economics (NHH) - Department of Accounting, Auditing, and Law

Kjell Henry Knivsflå

Norwegian School of Economics (NHH) - Department of Accounting, Auditing and Law

Date Written: September 20, 2020

Abstract

This study examines the interaction of audit firm characteristics with two core earnings management tools: classification shifting (CS) and core accruals management (CACM). CS occurs when management intentionally misclassifies recurring operational expenses as special items to inflate perceptions of core earnings. A Norwegian sample of companies, with forthcoming equity issues and acquisitions, reveals that CS substitutes for CACM for clients of Big 4 and industry-specialized audit firms. By contrast, CS complements CACM for clients of non-Big 4 and non-specialized audit firms. The level of auditor-provided non-audit services during a forthcoming equity issue, a measure of economic bond potential, also interacts with CS and CACM, though this interaction is different for clients of Big 4 and non-Big 4 audit firms. The overall results suggest that auditor incentives may support tolerating CS, which raises a question about the effectiveness of current accounting and auditing standards.

Keywords: Earnings Management, Classification Shifting, Accrual Management, Audit Quality, Audit Firm Size, Industry-Specialization, Non-Audit Services, Equity Issues and Acquisitions

JEL Classification: M41, M42

Suggested Citation

Eilifsen, Aasmund and Knivsflå, Kjell Henry, Core Earnings Management: How Do Audit Firms Interact with Classification Shifting and Accruals Management? (September 20, 2020). Available at SSRN: https://ssrn.com/abstract=3080778 or http://dx.doi.org/10.2139/ssrn.3080778

Aasmund Eilifsen

Norwegian School of Economics (NHH) - Department of Accounting, Auditing, and Law ( email )

Helleveien 30
N-5045 Bergen
Norway
+47 55 95 93 23 (Phone)
+47 55 95 93 20 (Fax)

Kjell Henry Knivsflå (Contact Author)

Norwegian School of Economics (NHH) - Department of Accounting, Auditing and Law ( email )

Helleveien 30
Bergen, 5045
Norway

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