Governmental accounting and financial reporting in transition: A study of 'earnings management' under the accrual and consolidation model

Over the past two decades, widespread changes have taken place internationally in governmental accounting and financial reporting. Most important, public-sector entities have moved towards the adoption of the accrual and consolidation model, commonly used by commercial entities. Conventionally, public-sector entities have accounted for and reported their activities using the compliance and liquidity model (Sacco 1996). This dissertation reports on the adoption of the accrual and consolidation model in the public sector as it relates to “earnings management.” Earnings management refers to the systematic use of reporting discretion to influence the manner by which an entity is portrayed in its external financial reports. The objective of the dissertation is to examine the extent and form by which public entities engage in “earnings management.” The findings of the study indicate that earnings management occurs within public-sector entities that are reporting using an accrual and consolidation model. These findings are important for several reasons. Most importantly, they inform about the success of using an accrual and consolidation model to hold public entities accountable for their operations. Earnings management compromises this success by reducing the overall quality of the reported information. That is, it reduces the extent to which the information purports what it is set out to purport (i.e., the reliability and relevance of financial information is compromised). Because earnings management reduces the quality of the reported financial information, the findings are also important for the prospects of using financial accounting information as a tool for improving public management. The study concludes that if the accrual and consolidation model is to be effectively utilized within public-sector entities, it may be necessary to further constrain reporting discretion.