This paper examines a novel form of classification shifting as an earnings management tool using a sample of 12,804 UK listed firm-year observations for the 1995-2014 period. It proposes a new approach to classification shifting whereby firms have scope to misclassify revenues from non-operating activities as operating revenues. The results establish that firms engage in classification shifting of non-operating revenues to inflate operating revenues.They indicate that firms in the period following mandatory IFRS adoption are associated with an increase in this practice, consistent with IFRS offering greater scope for manipulation.Further tests reveal that classification shifting of revenues is more pervasive for firms that report operating losses or have low growth.
This is an empirical study of single‐period income smoothing which uses an incentives‐based model to explain classificatory choices. An index is constructed to measure the smoothing effect of these choices. Weighted least squares regression results indicate that classificatory choices consistent with smoothing are more likely to be observed in firms with high earnings variability, high dividend payout, substantial managerial holdings of share options and diffuse share ownership. The existence of material scope for smoothing strengthens these findings. The model as a whole is statistically significant and, although the proportion of variability in smoothing explained is modest, it compares very favourably with other accounting choice studies. The relationship between smoothing and alternative earnings management strategies, including big bath accounting, is explored.
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