Equity Financial Assets: A Tool for Earnings Management—A Case Study of a Chinese Corporation

Savannah Guo · Siqi Lu · Joshua Ronen · Jianfang Ye

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Auditing, Earnings Management, Governance Accounting Theory and Financial Reporting Risk Management in Financial Firms

Abstract

With China’s adoption of principles‐based international accounting standards and its convergence with International Accounting Standard 39 (IAS 39), Chinese companies have discretion under the original Accounting Standards for Enterprises 22 (CAS 22) as to how they account for the initial measurement, sale, and subsequent reclassification of financial assets. We use a Chinese company (‘Company A’) as a case study to illustrate how earnings are managed to exploit this discretion. We document that the company re‐classifies its available for sale equity investments as long‐term equity investments to decrease the volatility of the company’s apparent profits. We also make some predictions regarding how the company will handle its financial assets under the new standard, which is the same as IFRS 9. Our research contributes to the continuous improvement of China’s accounting standards and has implications for regulators of the capital market.

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References

1999A Review of the Earnings Management Literature and Its Implications for Standard Setting 2002Accounting Conservatism, the Quality of Earnings, and Stock Returns 2008Earnings management : emerging insights in theory, practice, and research 2009Fair value accounting and gains from asset securitizations: A convenient earnings management tool with compensation side-benefits 2012Extreme Estimation Uncertainty in Fair Value Estimates: Implications for Audit Assurance 2003FAIR VALUE ACCOUNTING AND THE MANAGEMENT OF THE FIRM 2011Challenges for Implementation of Fair Value Accounting in Emerging Markets: Evidence from China*2006Fair-value accounting: A cautionary tale from Enron

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