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A critical evaluation of the Jones models and the industry approach for the estimation of discretionary accruals

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  • Soon Suk Yoon
  • Hyo Jin Kim
  • Gregg S. Woodruff

Abstract

We critically examine two important methodological issues related to the estimation of discretionary accruals: the Jones models and the industry approach, both of which are considered the norms in the earnings management studies. We document that the original Jones models are the regression-through-the-origin (RTO) models. The RTO Jones models unduly overstate the significance of PPE and R2, produce inconsistent coefficients and non-zero mean discretionary accruals. If we include the intercept in the models, then they lack power. We show that the RTO Jones models are theoretically flawed while their non-RTO variations are empirically flawed. We also address the issue of using the industry approach as a sole approach for the estimation of discretionary accruals. We document that the CFO approach outperforms the industry approach. Lastly, we document that the prediction error method outperforms the estimation error method in detecting earnings management.

Suggested Citation

  • Soon Suk Yoon & Hyo Jin Kim & Gregg S. Woodruff, 2022. "A critical evaluation of the Jones models and the industry approach for the estimation of discretionary accruals," Asia-Pacific Journal of Accounting & Economics, Taylor & Francis Journals, vol. 29(2), pages 432-450, March.
    • Handle: RePEc:taf:raaexx:v:29:y:2022:i:2:p:432-450
    DOI: 10.1080/16081625.2020.1830559
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    Cited by:

    1. Grzybek, Olga, 2023. "Are accounting choices for intangible assets informative or opportunistic? Evidence from Poland," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 51(C).
    2. Joanna Lizińska & Leszek Czapiewski, 2023. "Earnings Management amid the COVID-19 Financial Crisis: The Experience of Poland," Gospodarka Narodowa. The Polish Journal of Economics, Warsaw School of Economics, issue 1, pages 93-112.
    3. Nazik Maqsood & Tanveer Ahmad Shahid & Abaid Ul Rehman, 2024. "The Impact of Dividend and Tax Avoidance on Earning Management of Companies," Bulletin of Business and Economics (BBE), Research Foundation for Humanity (RFH), vol. 13(1), pages 256-272.

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