Another method to boost sales is through more lenient credit terms. The more lenient credit terms, the lower cash inflow regards with the future
receivable collectability Wardani and Kusuma 2011. It can be concluded that sales manipulation results higher production cost and lower current
period CFO than the normal level Roychowdhury 2006. B.
Reduction of discretionary expenses Managers will reduce the discretionary expenses RD, advertising,
and SGA expenses because they do not generate immediately revenue and income. It will result in unusually low discretionary expenses, and if it is in
the form of cash, it leads to lower cash outflows Roychowdhury 2006. In the end, it gives positive effect on abnormal cash flow from operation in the
current period Roychowdhury 2006. C.
Overproduction Overproduction means lower fixed costs per unit, hence, reduction in
total cost per unit. In the income statement, it will affect the cost of goods sold number; it becomes lower and firms report higher operating margins.
The incremental marginal costs incurred in producing more inventories, results in higher annual production costs relative to sales Roychowdhury
2006.
2.1.3 Patterns of Earnings Management
Earnings management doing creates some patterns. Those patterns are listed below.
A. Taking a bath
that sales manipulation re re
s su
lt s high
h er
r p
p roduction cost and lower current
period CFO tha a
n n
t the normal level Roychowdhury
2 2
00 6.
B. Re
Reduction of discret t
io i
na na
ry ry
e e
xp xp
en en
se e
s s
Managers rs
w w
il i
l l
reduce the discr et
io i
na n
ry ry
e e
xp xpenses RD
D ,
advertising, and SG
G A
A e expense
se s
s b
bec ause the
y do not g
en n
er er
at a
e imme me
di di
at at
ely reve enu
n e and
in in
co co
me me
. It w
w il
l re su
lt in unusuall y
low discretion ar
y ex
xpe p
nses ,
, an and
d if it
is i
in th
th e
e form rm
of cash, it lea
ds to lowe r
cash out fl
ow s Roych
ow wdhur
ry y 20
2 06. I
I n
n th
e e en
d, it gives positive effect on
abnorma l
cash flow from o
p perati
ti on
on i
i n
n the cu
u r
rr ent period
Ro ychowd
hu ry
2 00
6 .
C .
Overproduction Ov
erpr od
d uc
uc ti
ti on
on m
m ea
e ns lower fixed
ed c
c os
os ts
ts p
p er
e u
nit, h ence,
re red
duction n
in in
total cost per unit. In the inco o
m me s
s ta
tatement, it will affect the cost of g goo
oo d
ds so
so ld number; it becomes lower and firms report higher operatin
n g
g ma marg
rgin ins.
The i
in cr
cr em
emen ta
ta l
l ma ma
rg in
al l
c c
os osts
ts i inc
ncur urre
d i
in p
p ro
ro du
du i
ci ng
ng more in n
ve ve
nt nt
o ories,
re re
su su
lts i
in h h
ig ig
he her annual pro
o du
d ction
c costs relative
t t
o o
sa sa
les R
Roy oy
ch chowdhury
2006.
2.1.3 Patterns of Earnings s Managem
ement
Earnings management do doing
g creates some patterns. Those patterns are
listed below.
When firms have to report loss, it is most likely that managers will report a large amount of loss. Managers do this to enhance the probability of
future reported profits, because of the accruals reversal. Accruals reversal means that when managers report greater amount of loss in current period, the
subsequent period will force the future earnings upwards Scott 2012, page 425.
B. Income minimization
Managers will do income minimization during the period of high profitability. Managers do not want to report the high income for some
reasons; income tax is one of the reasons Scott 2012, page 425. C.
Income maximization Managers will do income maximization for bonuses purposes and to
hinder from the violation of debt covenant Scott 2012, page 425. D.
Income smoothing Income smoothing makes the less volatility less variable of income
numbers Fudenberg and Tirole 1995 in Bao and Bao 2004. However, not all smoothed income results from earnings management. Albrecht and
Richardson 1990 in Bao and Bao 2004 classify two types on income smoothing; natural and intentional smoothing. Natural smoothing is natural
result from income-generating process no manipulation. Meanwhile, intentional smoothing refers to real smoothing managers’ change of the
economic event and artificial smoothing managers’ change of the timing of accounting entries. It can be concluded that the intentional smoothing results
from earnings management. means that when manage
g rs
rs r
r ep
ort grea te
te r
r am
a ount of loss in current period, the
subsequent per r
io io
d d will force the future earnings u
u pw
pw ards Scott 2012, page
425. B.
. Income m
m in
in im
im i
ization Ma
Ma na
na gers w
w il
il l
l do
income minimiza ti
ti on
on durin
ng g th
th e
e period
o o
f high pr
pr of
ofit itab
ab ility.
y. M
an ag
ers do not w an
t to report th
e hi
high g
incom om
e e
fo f
r so some
re re
a asons
s; income tax
is one of the
re asons Sco
tt 2
012, page 42
425. C.
In come maximiz
at ion
Manage rs
will do i
nc om
e ma
xi mi
za tion for
b onuses p
ur p
poses and to to
hi i
nd er from the violat
io n of
d ebt covena
nt Sc
ott 2012, page 425
. D.
D. In
come s
mo mo
ot ot
hi hi
ng ng
Income smoothing mak akes
es t t
he he
less volatility less variable of inc ncom
ome nu
nu mbers Fudenberg and Tirole 1995 in Bao and Bao 2004. How
w ev
ever r
, ,
no no
t al
l smoo
th th
ed ed
i inc
om ome
e result
lt s
s fr
fr om
om e
ear ar
i nings
ma mana
na ge
ge me
me nt
nt. A
Albr r
ec echt
ht and
Ri Ri
ch ch
ar d
dson 19
1990 in Bao a a
nd n
Bao 2004 classi
i fy
fy t
t wo
w typ
p es
es o
on income smoothing; natural and inte
entional smo oothing. Natural smoothing is natural
result from income-generat ating proc
cess no manipulation. Meanwhile, intentional smoothing refers t
t o
o rea
al smoothing managers’ change of the economic event and artificial sm
m o
oothing managers’ change of the timing of
Income smoothing feature attracts many users to utilize it. Managers that are risk averse, tend to smooth earnings to get constant
bonuscompensation Scott 2012. Not only managers, but also investors also prefer less variability of income numbers because it is less risky McInnis
2010. In this context, the earnings management method used is accruals
earnings management. Previous research documented the mean of accruals earnings management in Indonesia and Philippines are higher compare to
Malaysia, Singapore, and Thailand Wardani and Kusuma 2011. It can be interpreted that accruals earnings management is mostly used in Indonesia
Wardani and Kusuma 2011. According to Leuz 2003, when the investor protection in certain
country is weak, it will result into high probability of private benefit control phenomenon. In turn, the frequency of earnings management happens will be
high. Looking at Indonesia country, Indonesia can be classified as weak
investor protection country
3
. Furthermore, the characteristic of concentrated ownership makes Indonesia vulnerable to private benefit control
phenomenon
4
. As a result, the chance of doing earnings management in Indonesia is quite open wide.
Leus 2003 implicitly indicates that Indonesia is classified as weak investor protection country
Benos and Weisbach 2003 in Hwang 2004 define private benefit control as “benefits that accrue to managersshareholders that have control over firms, but not to minority
shareholders”. It prevails in the firms with concentrated ownership. prefer less variability of
f i
i nc
ncome numb mber
er s
s because it is less risky McInnis
2010. In
In this context, the
e e
e ar
ar ni
n ng
ng s
s ma
m na
na gement metho
d d
used is accruals ea
a rn
rnings manag g
em emen
en t.
t Previous research
h d
doc oc
um um
en ented the mean
n of accruals earnin
n gs
gs m
m an
a agem
m en
en t
t in
Indonesia and P hi
i li
li pp
pp ines a
are re h
h ig
ig her comp
mpare to Ma
Mala lays
ys ia, Si
Si ng
ap or
e, and Thail an
d Wardani and K us
s um
u a
20 2011
11 .
. I
I t ca
n n be
in in
te terpre
re te
d that acc
rual s earnings managemen
t is mostly
us used
i i
n n In
In donesi
sia W
ar ar
da ni
and Kusuma 2011. Acco
rd in
g to Leu z
2 00
3, wh
en the inv
es to
r protecti o
on in certai ain
n co
o un
try is weak, it wi
ll res ul
t into hig h
probab il
ity of private b en
nefit con ontro
ol ph
ph en
omenon. In
t t
ur ur
n n,
t t
he he
f f
requency of ea a
rn rn
in in
gs gs
m m
an a
ag ement
ha pp
ppe ens will
l b
be e
high. Looking at Indonesia country, Indonesia can be classifie
ie d
d as as w
we eak
inve t
stor p
p ro
ro t
te ct
ct io
io n
n co country
3 3
. Fu Furt
rt he
herm rm
o ore, t
he he
c c
ha ha
ra ra
t ct
er er
is is
ti tic
f of con
n ce
cent nt
rated ow
owners h
hip p
m ma
ke s Indone
si si
a vuln n
e erable to pr
r iv
iv at
at e
b bene
ne fi
fi t
t control phenomenon
4
. As a result, ,
the chanc ce of doing earnings management in
Indonesia is quite open wide.
It is quite relevant that earnings management happen in Indonesia because the listed factors. However, if the question address to which is
dominant, opportunistic or informational earnings management, it is still quite mixed. Siregar and Utama 2008 found that earnings management in
Indonesia tends to be informationalefficient because of a high proportion of family ownership. Another finding, earnings management is present around
initial public offering IPO and the operating performance and stock returns subsequently underperformed Saiful, 2004. It implicitly indicates the
opportunistic earnings management. In this research, the opportunistic earnings management is the lead.
2.2 Value Relevance of Earnings 2.2.1
