Differences in earnings management between firms using US GAAP and IAS/IFRS

Abstract

Purpose – The purpose of this paper is to examine whether the relatively rules-based US Generally Accepted Accounting Principles (GAAP) and the more principles-based International Accounting Standards/International Financial Reporting Standards (IAS/IFRS) provide different opportunities for earnings management (EM). Such an examination is critical as the world moves toward principles-based standards. Design/methodology/approach – Financial information for the fiscal years 1999-2004 from the annual reports of firms listed under the Prime Standard on the Germany Frankfurt Stock Exchange is analyzed. Data from the German Frankfurt Stock Exchange are used to resolve the difficulty in comparing accounting standards across different markets and countries with different institutional factors and corporate governance issues. The unique feature of dual listing in the German Frankfurt Stock Exchange allows firms listing shares under the Prime Standard to report in accordance with either the US GAAP or the IAS/IFRS before the IFRS adoption by the European Union in 2005. Strong legal enforcement in Germany ensures that reporting under each standard is in close compliance to the standard under comparison. Extending extant IFRS vs US GAAP EM research with discretionary accruals, this research contributes to a more comprehensive understanding by also examining EM through deferred tax expense and EM through research and development investment. Findings – The findings reveal that EM through research and development investment is significantly higher for the IAS/IFRS firms. Similar to prior findings, EM through accruals is not found to be significantly different between US GAAP and IAS/IFRS firms. Originality/value – The findings of this study advance the understanding of differences between US GAAP and IFRS with data from Germany where legal enforcement of standards is strong. In particular, this study reveals that principles-based standards with imprecise rules like IAS/IFRS may encourage structured management due to the expectation of error costs and compliance uncertainty. The results inform regulators considering IAS/IFRS adoption. In addition, this research highlights the importance of considering real EM in US GAAP vs IAS/IFRS studies.

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