Earnings Management Via Non-recurring Gains And Losses And Auditors’ Suppression

Accounting is the language of economy and financial statements are summaries of corporate economic performance. Therefore, accounting methods are required to keep up with the continuous reform and development of economic system. In general, the growth of China’s economy and increasing exchanges with the international market result in the convergence of our domestic accounting standards to international norms. Nevertheless, China’s accounting standards also retain some of its own guidelines adapting to Chinese characteristics in economic systems and national conditions. One obvious difference is between the definition, confirmation and disclosure of the non-recurring gains and losses. Chinese Securities Regulatory Commission put forward the concept of non-recurring gains and losses in 1999, which were gradually revised and improved four times afterwards. While the definitions of non-recurring gains and losses slightly varied, but the basic idea is their impact on the judgment of report users of the company’s business performance and profitability. Thus, since the Commission put forward the concept of non-recurring gains and losses, scholars have begun to focus on the motives and behavior of listed companies’manager using non-recurring items to conduct earnings management.Managers of listed companies conduct earnings management to fabricate financial statements that satisfy report users. So the positions of non-recurring gains and losses in the Income Statement will affect managers’choice of specific non-recurring gains and losses items applying to their concrete motivations of earnings management. China’s "Enterprise Accounting Standards" in 2007 had a major revision of the presentation of non-recurring profit and loss items in the Income Statement. A portion of below-the-line items were transferred above, which becomes integral parts of the business operating profit. In particular, the "investment income" account shows the normal business investment profits and non-recurring investment gains and losses in summary, wherein the non-recurring gains and losses are covered up. This uniqueness of "investment income" account enables managers to conceal the facts of using non-recurring items to do earnings management. So, whether managers of listed companies will take advantage of the different locations of non-recurring gains and losses in the income statement to manage the quantity of corporations earning and meanwhile the structure of earnings by outstanding operating profit depending on the non-recurring items are worth considering. In addition, will managers of listed companies use investment income account to cover the non-recurrent nature of critical earnings for the purpose of avoiding auditors issuing a qualified audit opinion?Using the sample of A-share listed companies from 2009 to 2013, this paper presents empirical evidence as fellows. Under anti-loss motivation, managers in listed companies increase earnings by kinds of non-recurring gains and losses and they especially use non-recurring investment income when there are more financial assets in hand. As a result, the degree of concealment of these earnings management behavior is deeper. Under the motivation of income smoothing, which highlights the principal status of "Operating profit", managers have done upward earnings management by using non-recurring gains and losses in "investment Income", and have done downward earnings management by using below the line items. Auditors’inclination of suppressing earnings management varies as positions of non-recurring gains and losses on the income statement differs. Under the circumstances of managers’anti-loss motivation and the disguised earnings management facts, auditors are more likely to lower the bar.The main contribution of this paper is:(1) From the perspective of disclosure of non-recurring profit and loss, this paper examined managers’ preferences of different non-recurring items under diverse incentives of earnings management and found the managers of listed companies manage earnings structure via non-recurring items; (2) This paper explored the game situations between auditors and managers and explained the underlying cause of auditors’ selective suppression of managers’ earnings management behavior; (3) This paper analyzed the motivation of managers of listed companies using non-recurring gains and losses to conduct earnings management, and further identified their selection of tools and instruments. Based on the research, this paper provided policy-making departments with a reasonable suggestion to further improve the confirmation, measurement and related specific disclosure of non-recurring gains and losses.