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Misclassifying Core Expenses as Special Items: Cost of Goods Sold or Selling, General, and Administrative Expenses?

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  • Yun Fan
  • Xiaotao (Kelvin) Liu

Abstract

Prior studies of classification shifting in the income statement conclude that managers misclassify core expenses as special items to inflate reported core earnings (McVay 2006; Fan, Barua, Cready, and Thomas 2010). These studies do not distinguish between the core expense components—cost of goods sold (COGS) and selling, general, and administrative expenses (SGA). This study models COGS and SGA separately, and investigates managers’ misclassification of COGS versus SGA to meet different profitability benchmarks. We find that COGS (but not SGA) misclassification is associated with just beating the benchmark of gross margin four quarters earlier. In comparison, both COGS and SGA misclassification are associated with just beating the benchmarks of zero core earnings, prior†year core earnings, and analyst earnings forecasts in the fourth fiscal quarter. We also investigate real activities management (RAM) of COGS and SGA to meet benchmarks, and find that managers engage in RAM of COGS to achieve the gross margin benchmark, but not core earnings benchmarks. We demonstrate that unexpected SGA contains a significant misclassification effect distinct from RAM, suggesting that future RAM research should consider controlling for expense misclassification. Overall, our study extends prior literature on both classification shifting and RAM.Les études qui ont porté jusqu'ici sur le changement de classement dans l’état des résultats aboutissent à la conclusion que les gestionnaires classent indûment les charges de base dans la catégorie des éléments exceptionnels de manière à gonfler les bénéfices publiés provenant des activités principales (McVay, 2006; Fan, Barua, Cready et Thomas, 2010). Dans ces études, aucune distinction n'est faite entre les éléments qui composent les charges de base — coût des produits vendus (CPV) et frais de vente et frais généraux et administratifs (FVGA). Les auteurs modélisent le CPV et les FVGA isolément et se penchent sur le classement inapproprié du CPV et des FVGA auquel procèdent les gestionnaires pour atteindre différents indicateurs de référence au chapitre de la rentabilité. Ils constatent que le classement inapproprié du CPV (mais non des FVGA) est associé à l'objectif de dépassement minimal de l'indicateur de référence que représente la marge brute affichée quatre trimestres plus tôt. En revanche, le classement inapproprié tant des FVGA que du CPV est associé à l'objectif de dépassement minimal de l'indicateur de référence que représentent des bénéfices nuls associés aux activités principales, les bénéfices de l'exercice précédent provenant des activités principales, et les prévisions de résultats des analystes pour le quatrième trimestre de l'exercice. Les auteurs étudient également la manipulation des activités réelles en vue de modifier le CPV et les FVGA de telle sorte que les indicateurs de référence soient atteints. Ils constatent que les gestionnaires se livrent à la manipulation des activités réelles en vue de modifier le CPV de manière à atteindre l'indicateur de référence que représente la marge brute, mais non les indicateurs de référence que représentent les bénéfices provenant des activités principales. Les auteurs démontrent que les FVGA inattendus recèlent un important effet de classement inapproprié, distinct de la manipulation des activités réelles, ce qui devrait inciter les chercheurs qui s'intéresseront à la manipulation des activités réelles à songer au contrôle du classement inapproprié des charges. Dans l'ensemble, l’étude élargit les études antérieures relatives tant au changement de classement qu’à la manipulation des activités réelles.

Suggested Citation

  • Yun Fan & Xiaotao (Kelvin) Liu, 2017. "Misclassifying Core Expenses as Special Items: Cost of Goods Sold or Selling, General, and Administrative Expenses?," Contemporary Accounting Research, John Wiley & Sons, vol. 34(1), pages 400-426, March.
  • Handle: RePEc:wly:coacre:v:34:y:2017:i:1:p:400-426
    DOI: 10.1111/1911-3846.12234
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    Cited by:

    1. Malikov, Kamran & Manson, Stuart & Coakley, Jerry, 2018. "Earnings management using classification shifting of revenues," The British Accounting Review, Elsevier, vol. 50(3), pages 291-305.
    2. Tobar Arias, José E. & Mora Valencia, Andrés & Benavides Franco, Julián, 2023. "Earnings management to avoid losses: Evidence in non-listed Colombian companies," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 53(C).
    3. Surendranath Jory & Thanh Ngo & Hongxia Wang, 2021. "Non‐operating earnings and firm risk," Review of Financial Economics, John Wiley & Sons, vol. 39(1), pages 95-123, January.
    4. Estelle Y. Sun, 2021. "The Differential Role of R&D and SG&A for Earnings Management and Stock Price Manipulation," Contemporary Accounting Research, John Wiley & Sons, vol. 38(1), pages 242-275, March.
    5. Manish Bansal, 2024. "Do shifting practices vary across the firm life cycle?," Australian Journal of Management, Australian School of Business, vol. 49(2), pages 142-169, May.
    6. Al Mabsali, Yousuf Khamis & Hayward, Robert & Eliwa, Yasser, 2021. "Managerial tools used to meet or beat analyst forecasts: Evidence from the UK," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 43(C).
    7. Bansal, Manish & Kumar, Ashish & Bhattacharyya, Asit & Bashir, Hajam Abid, 2023. "Predictors of revenue shifting and expense shifting: Evidence from an emerging economy," Journal of Contemporary Accounting and Economics, Elsevier, vol. 19(1).
    8. Brooke Beyer & Binod Guragai & Eric T. Rapley, 2021. "Discontinued operations and analyst forecast accuracy," Review of Quantitative Finance and Accounting, Springer, vol. 57(2), pages 595-627, August.
    9. Junwei Lu & Xiaoxia Bu & Jing Chen, 2021. "Do inflowing sophisticated investors induce classification shifting? New evidence from market liberalisation in China," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 61(5), pages 6193-6223, December.
    10. Ahsan Habib & Dinithi Ranasinghe & Julia Yonghua Wu & Pallab Kumar Biswas & Fawad Ahmad, 2022. "Real earnings management: A review of the international literature," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 62(4), pages 4279-4344, December.
    11. Poonawala, Sakina H. & Nagar, Neerav, 2019. "Gross profit manipulation through classification shifting," Journal of Business Research, Elsevier, vol. 94(C), pages 81-88.
    12. Xiaotao (Kelvin) Liu & Biyu Wu, 2021. "Do IPO Firms Misclassify Expenses? Implications for IPO Price Formation and Post-IPO Stock Performance," Management Science, INFORMS, vol. 67(7), pages 4505-4531, July.
    13. Yun Fan & Wayne B. Thomas & Xiaoou Yu, 2019. "The Impact of Financial Covenants in Private Loan Contracts on Classification Shifting," Management Science, INFORMS, vol. 65(8), pages 3637-3653, August.

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