Managerial Foresight and Choice of Accruals in Earnings Management

This study investigates whether information about future earnings (i.e. foresight) affects a manager's accrual choices in income smoothing. Accruals can be employed to set aside current earnings for future use (flexibility effect). However, the reversal of accruals can lead to more variable future earnings (complexity effect). Data on accrual choices from an experiment in which managers were tasked to report smooth earnings are analysed. The results show that high foresight managers use more short- to medium- term accruals (bad debt and restructuring provisions, respectively) to reduce earnings than do low foresight managers. Low foresight managers use more long-term accruals (retirement benefits provision) to increase earnings than high foresight managers. Thus, high foresight managers' preference for flexibility dominates their aversion to complexity when using accruals to create reserves. Low foresight managers show a greater aversion to complexity when using accruals to increase earnings