Evidence of earnings management using accruals as a measure of accounting discretion

A major concern in financial reporting is the extent to which managers engage in earnings management. This paper analyses a specific strategy of earnings management, income smoothing, whose purpose is to reduce income variability over time and it is mentioned in the literature as a rational behaviour that allows accomplishing several purposes in the long term. The aim of this paper is to identify income smoothing practices in a sample of companies listed on the Euronext Lisbon, gathered from SABI database, over a five-year period (2001-2005). The methodology employed, common among Anglo-Saxon studies, differs considerably from those that have been used in Portugal to analyse such practices. It consists of computing several income smoothing measures that use accruals as an earnings management instrument, some of them requiring the estimation of accruals models to obtain its discretionary component. Since this is a preliminary study, these measures were only applied to a particular activity sector - the construction sector. The results of this study provide some insight on the accounting nature of income smoothing, particularly on the use of accruals to report earnings with an artificially reduced variability.