The Effect of Financial Distress and Free Cash Flow on Earnings Management with Quality of Audit as a Moderator

Abstract

This study aims to provide empirical evidence of the relationship between financial distress with modified Altman z-score model and free cash flow on earnings management with audit quality as moderating. This study uses a sample of manufacturing companies listed on the Indonesia Stock Exchange in 2016-2020. The results showed that financial distress with the modified Altman z-score model had a negative effect on accrual earnings management. This implies that companies experiencing financial distress will perform accrual earnings management. The hypothesis that free cash flow has a negative effect on earnings management is supported which provides evidence that large free cash flows will tend to reduce accrual earnings management in fulfilling contractual commitments with company owners. Meanwhile, the hypothesis of audit quality moderating the relationship between financial distress and free cash flow on earnings management is supported. This shows that a quality audit will be able to reduce accrual earnings management in the company.