Earnings Management to Round Up EPS a Penny: Testing for an Audit Quality Differential Between Big Four and Non-Big Four Accounting Firms

Document Type

Article

Publication Date

1-1-2019

School

Accountancy

Abstract

Calculating EPS frequently results in a number stretching several digits to the right of the decimal point. Yet, reporting EPS requires that it be rounded to the nearest cent (e.g., computed EPS of $.09462 would be rounded down to $.09 while $.09502 would be rounded up to $.10). The change to income required to round EPS up (rather than down) a cent can be miniscule, but the effects may be substantial for a company or its management, especially if the rounding allows the entity to meet earnings expectations. For a large sample of companies, earnings management to round EPS up, instead of down, a penny would be indicated if the third digit right of the decimal point in calculated EPS falls in the range five-nine (zero-four) significantly more (less) than fifty percent of the time. We test for this type of earnings management in post-SOX samples of entities as segregated by their audit firms (i.e., Big 4 vs. non-Big 4). The results reveal clear signs of this opportunistic reporting for the clients of non-Big 4 firms but no indication of it for the Big 4 auditees, thus providing anecdotal evidence of an audit quality differential between these two groups of auditors.

Publication Title

Journal of Forensic and Investigative Accounting

Volume

11

Issue

2

First Page

248

Last Page

260

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