<p class="MsoBodyText2" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-style: normal; mso-bidi-font-style: italic;"><span style="font-size: x-small;"><span style="font-family: Times New Roman;">The big bath theory of earnings management suggests that firms experiencing low earnings in a given year may take discretionary write downs to reduce even further the current period&rsquo;s earnings.<span style="mso-spacerun: yes;">&nbsp; </span>The notion is that the company and its management will not be punished proportionately more for the big hit it takes to its already depressed earnings.<span style="mso-spacerun: yes;">&nbsp; </span>This &ldquo;clearing of the decks&rdquo; makes it easier to generate higher profits in later years.<span style="mso-spacerun: yes;">&nbsp; </span>SFAS No. 142, with its new requirement to test goodwill annually for impairment, provided a unique opportunity to test this big bath theory.<span style="mso-spacerun: yes;">&nbsp; </span>Examining Fortune 100 companies, this study presents compelling evidence that the big bath theory is more than just a theory but is instead a practiced method of managing earnings.</span></span></span></p>

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt; mso-pagination: none;"><span style="font-size: 10pt;"><span style="font-family: Times New Roman;">Prior research (Thomas, 1989; Das and Zhang, 2003; Jordan et al., 2008a) presents evidence that managers manipulate income to round up earnings per share (EPS) to key user reference points when unrounded EPS fall only slightly below these breakpoints.<span style="mso-spacerun: yes;">&nbsp; </span>In the U.S., studies on audit quality suggest that, relative to small audit firms, large CPA firms provide higher quality audits and, as such, more aggressively constrain their clients&rsquo; attempts to manage earnings in general (e.g., see Francis and Krishnan, 1999; Krishnan, 2003).<span style="mso-spacerun: yes;">&nbsp; </span>However, research outside the U.S. finds no consistent audit quality differential based on auditor size (e.g., see Piot and Janin, 2007; Maijoor and Vanstraelen, 2006).<span style="mso-spacerun: yes;">&nbsp; </span>The current study examines whether audit quality, as proxied by auditor size, in the U.S. constrains earnings management to effect user reference points in EPS.<span style="mso-spacerun: yes;">&nbsp; </span>Using the Big 4 versus non-Big 4 dichotomy as the measure of auditor size and audit quality, results suggest that audit quality significantly restricts management&rsquo;s attempts at rounding up EPS as clients of Big 4 firms show no major signs of this manipulative behavior while non-Big 4 auditees appear to round up the first digital position right of the decimal point in EPS across zero to increase the digit immediately left of the decimal point by one.</span></span></p>

No abstract

In the transition year (2002) during which the respective goodwill impairment standards were implemented in the U.S. and Canada, these impairment losses received favorable treatment (i.e., as below-the-line expenses in the U.S. and as adjustments to retained earnings in Canada). Research in this transition year showed that goodwill impairments were recorded opportunistically in both the U.S. and Canada. Subsequent to the transition year, however, accounting principles in all countries require that goodwill impairments be presented in a more punitive fashion, with the write downs appearing as above-the-line operating expenses in the income statement. Research in the U.S. during the post-transition period provides mixed results as some studies indicate goodwill impairments are opportunistically recorded in a manner reflective of big bath behavior while others suggest these write downs convey economic information from management to users about a firm's financial performance. No such studies have been conducted in Canada during the post-transition period. The present research fills this void in the literature by examining recent data on Canadian firms and finds evidence suggesting that goodwill impairments in this country are not being recorded opportunistically to take big baths but instead are being recognized only after multiple years of substandard earnings have occurred, thus indicating managers are recording these impairments to provide relevant information to financial statement users.

As set forth in SFAC