The Difference of Earnings Management before and after IFRS

Adoption in Indonesia

Ratnaningrum

, Rahmawati

, Djuminah

, Ari Kuncara Widagdo

STIE STEKOM

Department of Business and Economics, Sebelas Maret University, Indonesia

Jl Ir Sutami 36A Kentingan Solo,

Keywords: Earnings Management, IFRS, Indonesia

Abstract: This study aims to examine the difference in earnings management before and after IFRS adoption. Since

2012 Indonesia has adopted IFRS, which is a high-quality financial reporting standard that can be accepted

internationally. One feature of the quality of financial statements is the low level of earnings management.

The population was manufacturing firms listed on the IDX, with samples of 115 firm-year observations before

IFRS adoption and 115 firm-year observations after IFRS adoption. The result shows that there is no

difference in earnings management practices before compared to after IFRS adoption.

1 INTRODUCTION

The term International Financial Reporting Standards

(IFRS) is known as a single set of accounting

standards published by the International Accounting

Standards Board (IASB). Providing investors and

other users of financial statements with the ability to

compare financial performance. At present, IFRS

(International Financial Reporting Standard),

together with US GAAP (the United States Generally

Accepted Accounting Principles), is one of two

globally recognized financial reporting standards.

Before the accounting scandal that occurred in the

United States, specific accounting standards that led

to US GAAP were seen as the most effective form

(Eaton, 2005). The declining popularity of US GAAP

has caused many countries to turn to IFRS.

With economic globalization, many countries are

trying to harmonize their accounting standards, and

even adopt the same set of new reporting standards.

The actual benefit of implementing compulsory new

standards in various countries is a topic of debate

among academics and practitioners. Several

arguments led to the adoption of IFRS there was a

significant increase in the quality of financial

reporting, but there are also conflicting arguments

The argument supporting the adoption of

mandatory IFRS reporting brings significant benefits

in European with the assumption that IFRS increases

transparency and increases the comparability of

financial reporting (Daske et al., 2008)(Daske et al.,

2008). The improvement in accounting quality is

indicated by the decreasing level of earnings

management and the increasing relevance of the value

of earnings and the book value of equity (Barth, 2008;

Liu et al., 2011)

Another argument state that accounting standards

have a limited role in the quality of financial reporting

due to incentives in financial reporting. There is an

obligation in recording transactions regarding the

reappraisal of accuracy based on the present value of

assets, liability, and equity because IFRS adheres to a

fair value-based system. Standards with principle-

based that do not emphasize the rules and use much

judgment cause accounting judgments based on

subjective views so that it allows different earnings

management opportunities. (Leuz, Nanda and

Wysocki, 2003). Lang, Smith, and Wilson (2006)

found that despite the use of the same accounting

standards, the financial statements of cross-listed

(European/ other) and US companies cannot be

compared, and earnings management is more

widespread in non-US companies than in US-based

companies.

The convergence of IFRS by the European Union

and Australia in 2005 started a domino effect that

caused IFRS to be used by more than 120 countries in

the world at that time (Larson and Street, 2011).

Likewise, Indonesia began the IFRS convergence

Ratnaningrum, ., Rahmawati, ., Djuminah, . and Widagdo, A.

The Difference of Earnings Management before and after IFRS Adoption in Indonesia.

DOI: 10.5220/0009961004750480

In Proceedings of the International Conference of Business, Economy, Entrepreneurship and Management (ICBEEM 2019), pages 475-480

ISBN: 978-989-758-471-8

475

program in 2009. Before the IFRS convergence

program in Indonesia, the International Accounting

Standards and the United States Generally

Accounting Principles were the basis for the

preparation of Indonesia's financial accounting

standards.

On December 23, 2008, the Indonesian Institute

of Accountants (IAI) declared Indonesia's plan for

convergence of IFRS in setting financial accounting

standards. IAI revealed that compliance with IFRS

increased the comparability and transparency of

financial statements. Besides, relevance and

reliability are the essential qualities of financial

information within the conceptual framework of

IFRS. So it needs to be questioned whether the IFRS

convergence process, which is not cheap, results in an

increase in the quality of accounting in Indonesia.

Accounting quality is measured by earnings

management and value relevance, such as the study

conducted by (Barth, Landsman, and Lang,

2008)(Barth, 2008). Liu et al. (2011), which shows an

increase in accounting quality is shown by decreasing

the level of earnings management and increasing the

relevance of the value of earnings and book value of

equity. To find out whether IFRS affects accounting

quality in Indonesia, this study attempts to examine

differences in the level of earnings management in

Indonesia before and after IFRS adoption.

According to Scott (2015), earnings management

is earnings management actions to choose accounting

policies from a certain standard to maximize welfare

or company market value/. Earnings by managers in

a company due to agency problems, namely conflicts

of interest between principals/shareholders and

management. Management has more information

about the company so that it allows management to

practice accounting with a profit-oriented orientation

to achieve a certain performance.

This research is useful to increase knowledge

about the presence or absence of earnings

management changes due to the effect of IFRS.

Besides, this research is useful as a material

consideration for regulators in assessing the benefits

of IFRS adoption related to earnings management.

Earnings management due to agency problems,

namely conflicts of interest between

owners/shareholders and managers/management.

Management has more information about the

company so that it allows management to practice

accounting with a profit-oriented orientation to

achieve a specific performance.

Doukakis (2014) have found that there was no

impact of IFRS adoption to both changes real and

accrual-based earnings management in Europe as

measured by jones models and looking at the

abnormal level of production costs, cash flow from

operations and discretionary costs. (Callao and Jarne,

2010) found that there was an improvement in

earnings management in the period after IFRS

adoption. (Murtini and Lusiana (2016) found no

significant differences between earnings management

before and after IFRS adoption. The adoption of IFRS

in China has been proven to improve accounting

quality, which is characterized by an increase in the

relevance of earnings value and a decrease in earnings

management (Barth, Landsman and Lang, 2008);

Chen et al. (2010); Liu et al. (2011). Other studies

provide different results. Jeanjean and Stolowy

(2011) found that the pervasiveness of earnings

management did not decrease after the introduction of

IFRS, and even in fact, increased in France. So as the

study by (Ames. 2013) has shown that the earnings

quality is not significantly improved after IFRS

adoption.

That mixed result contradicts the need for

research to determine the effect of IFRS adoption on

earnings management in Indonesia. That mixed result

makes it necessary to research to determine the effect

of IFRS adoption on earnings management in

Indonesia. This research is useful to increase

knowledge about the changes in earnings

management due to the adoption of IFRS. Besides,

this research is useful as a material consideration for

regulators in assessing the benefits of IFRS adoption

related to earnings management.

2 LITERATURE REVIEW

2.1 Earnings Management

Earnings management can be defined as intentional

interference by management in the external financial

reporting process to obtain personal benefits

(Schipper, 1989). Earnings management occurs when

managers use considerations in financial reporting

and structuring transactions to change financial

statements to mislead some stakeholders about the

company's economic performance or to influence

contractual results that depend on accounting

numbers (Healy and Wahlen, 1999). Management

behavior that benefits oneself through earnings

management can be explained by agency theory. The

owner of the company is the principal who delegates

tasks to the agent, namely, management. The agent

will act to satisfy his interests and always have more

information than the principal has (Jensen and

Meckling, 1976).

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2.2 IFRS Adoption in Indonesia

Accounting standards in force in Indonesia have

experienced continued development to date. In 1974,

the Indonesian Institute of Accountants had compiled

accounting standards under the name Indonesian

Accounting Principles (PAI) with US GAAP as the

primary reference. However, ten years later,

Indonesian financial accounting standards shifted to

using the International Accounting Standards

Committee (IASC) standard as the primary reference.

Then in 1994, IAI decided to harmonize with the

accounting standards published by the IASC called

the International Accounting Standard (IAS).

Although since 1994 IAI has been harmonizing with

the International Accounting Standards, the IAI has

only taken a serious step towards the end of 2008. On

December 23, 2008, IAI inaugurated the IFRS 2012

convergence program. IFRS convergence program

aims to achieve the full adoption of the 2009 version

of IFRS in 2012. So that the financial statements in

2011 have applied standard adopted from IFRS.

The difference between US GAAP and IFRS that

is the rule-based approach that underlies US GAAP

and the principle-based approach that underlies IFRS

(Gill and Rosen, 2007). Principle-based accounting

standards are usually characterized by explicit

statements of purpose but do not have detailed

implementation instructions, so accountants are

required to use professional judgment in their

application (Collins, Pasewark and Riley, 2012).

There are two arguments related to the effect of

IFRS on the quality of financial reporting, including.

(Schipper, 2003) Argues that with a principle-based

approach, managers get more flexibility in choosing

accounting methods that reflect better economic

activity that can improve the

informativeness/relevance of accounting numbers,

which ultimately improves the quality of financial

reporting. In contrast, contradictory opinions is

stating that greater reliance on the judgment can

reduce not only the consistency and comparability of

financial information but also create manager

opportunities to manipulate accounting numbers

(Barth et al. , 2008).

The application of IFRS, which is a more stringent

standard than GAAP, is expected to reduce the level

of opportunistic earnings management so that it can

improve accounting quality (Barth et al. , 2008).

Research on the effect of IFRS adoption on earnings

management in various countries has been carried out

and found different results between countries.

Research conducted in 15 European Union member

states shows a decrease in the level of earnings

management, which is seen in a decrease in earnings

management to targets, a decrease in the absolute

value of discretionary accruals and an increase in the

quality of accruals after the adoption of IFRS (Chen

et al., 2010). Similarly, research on the adoption of

IFRS in Australia showed a decrease in the level of

earnings management after the adoption of IFRS

(Elias, 2012). However, this is not in line with IFRS

adoption in Germany, which shows no differences in

earnings management between firms that apply IFRS

and GAAP (Tendeloo and Vanstraelen, 2005) while a

study in China shows a different conclusion towards

the adoption of IFRS. (Zhou, Xiong, and Ganguli,

2009)Shows that IFRS adopting companies have

smaller earnings management when compared to

companies that use GAAP. However, Li and Park

(2012) found that there was an improvement in

earnings management by Chinese companies after the

adoption of IFRS. Research in India shows that IFRS

adopting companies are more likely to engage income

smoothing compared to non-adoption IFRS

companies (Rudra and Bhattacharjee, 2012).

Given the conflicting arguments and research

results regarding the relationship between IFRS

adoption and the quality of financial reporting, which

includes earnings management, the following

hypotheses are proposed:

H1: Earnings Management in Indonesia after

IFRS adoption is different compared to the period

before IFRS adoption.

3 METHODS

3.1 Population and Sample

The population in this study are all manufacturing

companies listed on the Indonesia Stock Exchange.

The analysis period is classified into 2 parts (2007-

2011 and 2012-2016) to reflect the situation before

and after the adoption of IFRS. The sample selection

used by stratified random sampling with

consideration of the population is homogeneous.

Manufacturing companies were chosen because they

have the same accrual characteristics. The data used

in this study from the company's financial statements

that were downloaded through the official website of

the Indonesia Stock Exchange, www.idx.co.id, as

well as a summary of share prices in the Indonesian

Capital Market Directory (ICMD). To measure

The Difference of Earnings Management before and after IFRS Adoption in Indonesia

477

3.2 Operational Definition and

Measurement of Earnings

Management

Earnings management is intentional interference by

management in the external financial reporting

process, intending to obtain personal benefits

Earnings management is measured by proxy value

discretionary accruals. Healy (1985) distinguishes

between accruals mandated by the standard drafting

bodies and accruals arising from managerial policies.

Accruals arising from the manager's policies are

called discretionary accruals or abnormal accruals. To

date, several models have been found in estimating

the number of discretionary accruals (Jones 1991,

Dechow et al., 1995; Lacker and Richardson, 2004;

Kothari et al., 2005). This study uses the modified

Jones model by Kothari et al. (2005), with current-

year ROA as the control variable in measuring the

number of discretionary accruals. The following

equation estimates discretionary accruals:

Accruals it = a + b (1/Assets t-1) + c ΔSales t + d

PPE t + e ROA t + μ t (1)

In Regression (1), total accruals (Accruals),

changes in sales (ΔSales), and gross property, plant,

and equipment (PPE) are each deflated by total assets

at the beginning of the year. (Asset). ACCRit = total

accruals for the company, i in year t, which is defined

as earnings before extraordinary items minus cash,

flows from operating activities; TAit - 1 = total assets

for the company i in year t - 1 observation. By

applying parameter estimates to the actual value for

each company-year, it produces estimates of total

accruals. The difference between total actual accruals

and estimates is a proxy for discretionary accruals.

4 RESULTS AND DISCUSSION

4.1 Descriptive Statistical Analysis

The following table shows the descriptive statistics of

earnings management variables

Table 1. Earning Management Before IFRS Adoption

Minimum

Maximum

Mean

Standard Deviation

Manajemen Laba

akrual

-1.08128

4.14929

-.0000001

.46210595

ACCRUALS /TA

-.59433

5.24268

.0487523

.51909762

1/ ASSET

.0000000652

.0000229421

.000003713197

.0000043219098

DSALES/ TA

-1.57050

1.11572

.1796539

.31719582

PPE/ TA

.00389

1.07039

.3448308

.25399922

ROA

-.22366

.53168

.0981337

.09306407

Table 2. Earnings Management After IFRS Adoption

Minimum

Maksimum

Rata-rata

Deviasi Standar

Manajemen Laba

akrual

-.47478

.55262

-.0000001

.13012004

ACCRUALS /TA

-.76251

.78903

-.0083264

.18125376

1/ ASSET

.0000000346

.0000109259

.000002289215

.0000027330836

DSALES/ TA

-.66702

.64620

.0518780

.20428540

PPE/ TA

.02819

1.08592

.3493316

.23957582

ROA

-.24683

.78810

.0857639

.13276915

The number of samples obtained was 230

companies a year, consisting of 115 samples before

IFRS adoption and 115 samples after IFRS adoption.

Tables 1 and 2 provide an overview of the accrual

earnings management sample data and the

components that make it up, namely accruals, 1 / total

assets, increased sales, property, plant, and

equipment, and the last, ROA as the control variable.

The period before (5 years) and after the adoption of

IFRS (5 years). The means of earnings management

shows negative numbers both before and after the

adoption of IFRS, meaning that accrual earnings

management is done through income decreasing, with

the same magnitude of -10

-7

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4.2 Data Normality Test

Before the model is tested, a data normality test is

performed. Kolmogorov-Smirnov test to test residual

normality. Data are normally distributed if the

significance level is> 0.05. Based on the normality

test that has been done obtained (p-value 0,000). Thus

it can be concluded that the data are not normally

distributed because the probability value is smaller

than 0.05. Because the results indicate that the data

are not perfectly rational, then this data cannot be

transformed. Furthermore, the different tests will be

performed using a different test, which includes a

non-parametric test, namely the Wilcoxon test.

4.3 Hypothesis Testing

To test the hypothesis used an independent sample t-

test with the Mann Whitney test with the basis of

decision making as follows:

H0 is accepted if probability> 0.05

H1 is rejected if probability <0.05

From the data processing, the results are obtained as

shown in table 3 below

Table 3. Hypothesis Testing Result

Wilcoxon

Asymp.

Sig

Conclusion

12417

0.414

There is no

means

difference

Based on the table above, the probability value of

0.414 is well above 0.05, so it can be concluded that

there are no average means. Thus it can be interpreted

that there is no difference in accrual earnings

management before and after the adoption of IFRS.

These results indicate that the newly adopted IFRS

standard has not been able to suppress the level of

accrual earnings management, which is likely due to

the principle-based approach of IFRS that makes

managers can still use judgment according to their

interests, including in conducting earnings

management.

5 CONCLUSION

Compliance with IFRS is expected to increase the

comparability and transparency of financial reports so

that it will improve the quality of financial statements.

One of the high-quality financial statements is seen

from the low management of opportunistic earnings.

With tighter IFRS standards than domestic standards,

it is expected that changes will occur at the level of

earnings management in Indonesia. This study aims

to examine whether there are differences in earnings

management before and after the adoption of IFRS.

The results show that there was no change in average

accrual earnings management before and after IFRS

adoption. It can be concluded that earnings

management is not changed after IFRS adoption

compared to before IFRS adoption. These results are

expected to be a consideration for standard-setting in

Indonesia to improve standards to reduce the level of

earnings management.

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