Earnings management: evidence from SFAS No. 142 reporting

Abstract

Purpose To examine whether the provisions of SFAS No. 142 allow for the earnings management technique termed “big bath” and whether firm size plays a role in earnings management. Design/methodology/approach A random selection of companies with December 31, 2002 fiscal year‐ends yielded 120 firms that reported goodwill impairments in 2002 and 82 firms that did not. The firms are then stratified into two groups. Analysis consists of measuring the magnitude of the 2002 goodwill impairment loss, comparing financial metrics of impaired and non‐impaired firms, and calculating the proportion of firms with negative versus positive earnings. Findings The results suggest that SFAS No. 142 adoption allowed companies to engage in earnings management. Findings indicate that small firms experienced a significantly greater negative impact and were much more likely than large firms to take big bath charges. Originality/value This study provides evidence on the use of newly issued accounting standards to manage earnings.