Managing Accruals for Income Smoothing : Empirical Evidence from Pakistan

Purpose – This study aims at investigating whether income smoothing helps to reduce volatility in reported earnings and which firms are more inclined to be engaged in income smoothing. Design/Methodology/Approach – We used negative correlation between pre-managed earnings of a firm and its discretionary accruals as proxy for income smoothing and the firms having more negative correlation coefficient are expected to have lower volatility in their reported earnings. We used Kothari et al.'s (2005) version of modified-Jones model to estimate discretionary accruals and used least squares estimations to investigate our research questions using six year (2007-2012) sample of non-financial firms listed over Karachi Stock Exchange, Pakistan. Findings – We found that firms experiencing more volatility in economic activities and smaller firms are more aggressively involved in income smoothing. Moreover, a predominant majority (72.2%) of firms in our sample are involved in income smoothing through accruals manipulation. Also, we found that firms which are more aggressively involved in income smoothing have lesser volatility in reported earnings. Lastly, the level of discretionary accruals per se does not have any impact on income smoothing. Originality/Value – This study adds to earnings management literature by providing evidence on extensive accrual manipulation for income smoothing in Pakistan.Limitations – The proxy used for income smoothing, though we consider it to be better, is not the only one used in literature and our sample is limited to Pakistan