Earnings Management to Round Up EPS a Penny: Testing for an Audit Quality Differential Between Big Four and Non-Big Four Accounting Firms
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.
Journal of Forensic and Investigative Accounting
Jordan, C. E.,
(2019). Earnings Management to Round Up EPS a Penny: Testing for an Audit Quality Differential Between Big Four and Non-Big Four Accounting Firms. Journal of Forensic and Investigative Accounting, 11(2), 248-260.
Available at: https://aquila.usm.edu/fac_pubs/16851