Real and accrual-based earnings management in Islamic Banks in Indonesia

Abstract

Islamic banks have tendency to tinker the earnings to present positive income. Therefore, it requires the examination of the relationship between Real Earnings Management (REM) and Accrual-based Earnings Management (AEM) that have contribution in promoting earnings. There are 2 theories used including prospect theory is to explain the negative relationship between REM and AEM, and agency theory is to explain whether the variables can be costs of REM or AEM. There are 63 financial reports of Islamic banks during the 2013-2018 period are determined by using purposive sampling and gathered from the banks' website. Correlation and regression test were conducted. This study found that REM is done through generating operational revenue and reducing distributed revenue sharing beyond the normal activities. REM negatively affects AEM that managers will adjust AEM based on the results of REM during the financial period. These findings confirm the prospect theory when the realized income is less than profit expectation, managers will employ accrual manipulation with the motive of prospect theory to achieve income target. Market share is found as a cost of AEM and institutional shows different result which drives REM more. The implication of this study is to provide findings how Islamic banks engage in earnings management. The relationship between REM and AEM shows the reliability of earnings that needs concern to restrict.

The Effect of CEO Compensation on Earnings Management: Is It Affected by Leverage Condition?

“…Different from previous studies, this research uses prospect theory to explain the phenomenon of earnings management [11], [12], [13], [14]. Prospect theory states that an individual tends to seek for risks when in an unfavorable situation, or loss.…”

Analyzing earnings management preferences from business strategies

“…Mughal et al (2021), Wafaretta and Restuningdiah (2020), Sohn and Shim (2018) and Achleitner et al (2014) provide evidence that accrual EM and real EM can be as substitute tools for EM. Accrual EM is the most original form of EM.…”

“…Widuri and Sutanto (2019), Chun and Cho (2017) found that companies with differentiation strategies can produce good financial performance without having to practice real EM. Previous studies revealed that generally, companies practice these two types of EM with different intensities as suggested by Wafaretta and Restuningdiah (2020), Achleitner et al (2014), Chen et al (2015), Zang (2011) and Cohen and Zarowin (2008) following the conditions faced.…”

“…Therefore, the practice of accrual EM is more appropriate to be implemented to support the cost leadership business strategy. Zang (2011) and Wafaretta and Restuningdiah (2020) prove an inverse relationship between accrual EM and real EM practice. If real EM practice increases, accrual EM practice will decrease (Zang, 2011).…”

“…If real EM practice increases, accrual EM practice will decrease (Zang, 2011). If with real EM practice the profit target has been achieved, managers avoid using the AEM (Wafaretta and Restuningdiah, 2020). Given the contingency theory, this happens to adjust to company strategy, including business strategy.…”