THE TIMING Of ASSET SALES And EARNINGS

MANIPULATION

Eli Bartov

Presented By:

Herlina Helmy 0806435495

INTRODUCTION1

PRIOR RESEARCH2

HYPOTHESES FORMULATION3

RESEARCH DESIGN4

Outline

RESULT & ANALYSIS5

6Contribution & Limitations

CONCLUSION6

INTRODUCTION

Motivation

APB opinion No. 3 classified that income or losses from PPE not recognize as ordinary item, but as Part of income from operation

Management use that houl in earnings manipulation, especially income smoothing and debt-equity hypothesis

Because of that so many managers do some earning manipulation at that time (fortune, 1989; Schipper 1989)

Cont’d..

Purpose of this study

Examining of a form of real

earning manipulation:

timing of income recognition

from disposal of assets

Research

Question

Does Manager manipulate

reported earning trough choice

timing of income recognition

from disposal of asset.

PRIOR RESEARCHResearch Result

Hand, 1989; Hand et all.1990

Explored real earning manipulation in the context of early debt retirement

Ronan & Saden 1981

Investors employ income from continuing operations, rather than net income, in their decision making

Dye 1988; Truman & Titman 1988

Managers manipulate earnings to affect investors perceptions

Barnea et al 1975 Income smoothing is a vehicle for management to convey its earnings expectations within generally accepted accounting principles (GAAP), which do not permit making direct forecasts

Watts 1982 Earnings manipulations are pointless because market participants are sophisticated and are able to undo such manipulations

Healy 1985 Bonus plan enhance of earnings manjement

HYPOTHESES FORMULATION

- The earnings-smoothing hypothesis suggest that earnings are manipulated to reduce fluctuations around some level considered normal for the firm

- This study use EPS as a target, advocates the use of this definitions by two reason:1. It is relatively simple2. It appears more realistic than other definitions

H1: There is a negative correlation between income from asset sales and earnings changes (exclusive of asset sale effects

Cont’d….

Debt covenants require borrowing firms to maintain specified levels of accounting numbers and debt-equity ratio

Larger a firm’s debt-equity ratio, the more likely its manager are to shift reported earning from future periods to a current period and to engage in Greater manipulation

In timing asset sales, debt-equity hypotheses suggest:

H2: There is a positive correlation between income from asset sales and debt-equity ratios

RESEARCH DESIGN

Data Description

- Compustat expanded annual File with OTC firms

- COMPUSTAT quarterly industrial- Daily stock returns is taken NYSE/

ASE and NASDAQ- Period: 1987-1989- Final sample: 653 firm-year

divided in 2 sample group:1. 397 gain firms2. 256 loses firms

The Research design for two task:1. To test empirical implication of earnings

smoothing and debt equity hypotheses2. To assess the sensitivity of the results to possible specification error

Hypotheses testing in 3 ways:1. Univariate Test2. Multiple regression3. Sensitivity analysis

Cont’d…. Main Model – Multiple Regression:

ASSIN: income from asset sales in current year/stock price at beginningδ EPS=EBT-income fom asset sales per shareDETEQ=Book value LTD current year/BE at beginningε=residual

Main Sensitivity Analysis

SALEP=sales of long-lived aasset (PPE)current year/MVE beginning yearSALEIN=sales of investment current year/MVE beginning yearBonus1:upper bound Bonus plan – EBT current year/ MVE awal th.

if EBT < lower bound set 0BONUS2: dummy variable.

1 = lower bound > EBT, 0 = otherTAX = dummy variable.

1 = Looses in asset sales dan EBTexclude sales looses asset bernilai postif0 = other

RESULT

• Firm size was selected due to importance in explaining cross-sectional differences with respect to such characteristic as firm performance and risk

• Current ratio was selected as a measure for the short-time soundness of the firm

• Although the sample clearly spans a wide range of firm size, sample firms are substantially smaller than other COMPUSTAT firms

• Current ratio of the sample firms are larger than those of the other COMPUSTAT firms,& the sample firms thus appear financial healthy

(Table1)

Cont’d….

Median: 0.09%, Mean: 1.23%With level significant 5%

Earnings smoothing hypothesisImplies that firms exhibit a Negative earnings changeBefore asset sale income should Report higher income from Asset sales than firms thatExperience a positive change

H1

Univariate Test

H2

Support H1

Result

Univariate Test For Earning-Smoothing Hypotheses

Cont’d….

Result• Hand et al shows result at fourth fiscal

year the sale of long-lived assets.

Univariate Test for Debt-Equity Hyphothesis

Median: 0.09%, Mean: 1.23%With level significant 5%

Debt-Equity Hypothesis Implies that income from assetSales by higher-leverage firms Exceeds that for lower-leverage firms

H2

Univariate Test

H2

Support H2

Result

- Full Sample α1 negative significant, α2 positive significant- Tests show that the earnings-smoothing and the debt-equity effects are jointly zero can be rejected with high level convidence

Multiple Regression Tests

-The earnings-smoothing effect is documented in both subsamples, Which suggest that both positive and negative earnings change may

be subject to smoothing-The slope etimates for the subsample of firms with negative EPS exceed the sub sample

Of firms with positive EPS

Multiple Regression Tests

Sensitivity Analysis

• SALEP & SALEIN positive, and significant• Bonus plan1 negative, not significant• Tax, negative significant, implies that tax play important role

in timing asset sales