The hypothesis of avoiding losses and decreases in earnings via extraordinary items

Abstract

This paper analyses the hypothesis of avoiding losses and decreases in earnings through extraordinary items. First, we examine whether there is a discontinuity at zero (i.e., a «kink») in the distribution of profits and increases of profits in two levels: ordinary income and income before tax. Second, we examine the effect of extraordinary items in the financial information. Particularly we test: a) if the recognition and distribution of the extraordinary items in the reported earnings is due an opportunistic practice from the management or b) otherwise, the asymmetric effects of special items for profit and loss firms contribute substantially to a discontinuity at zero in the distribution of earnings (due to the bias induced by the accounting principle of conservatism) (Beaver et al, 2007). The sample used is composed by Spanish listed firms that disclosed financial information during the period 1992–2000.Earnings distribution shows a discontinuity at zero in earnings before tax distributions and more accused than in the ordinary income. In this context, the empirical evidence achieved in Spain support the hypothesis that the firms systematically use the extraordinary items to improve the operating income and so get a more favourable figure in the earnings before taxes. This results can be used to reflection about the new structure of the income statement propose in the new accounting normative in Spain (PGC, 2007) where the category of extraordinary items is not allowed.

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