A DIAGNOSTIC FOR EARNINGS MANAGEMENT USING CHANGES IN ASSET TURNOVER AND PROFIT MARGIN: EVIDENCE FROM PALESTINE EXCHANGE

Abstract

Purpose - This paper aims to evaluate whether the earnings management diagnostic using changes in asset turnover and profit margin as proposed by Jansen et al., (2012) is informative in identifying earnings management Methodology - Two tests were employed: firstly, the association between the diagnostic and discretionary accruals using Kothari et al., (2005) model, was tested by using Pearson correlation and contingency tables. Secondly, by using future profitability reversals as an indicator of earnings management, the investigation of whether the diagnostic has incremental information in identifying earnings management as compared to Kothari et al., (2005) model was performed using multivariate regression analysis. Data was collected for the period from 2006 to 2017 and comprises a total of (3,108) firm-year observations from the Palestinian stock exchange. Findings- The results indicate that the diagnostic proposed by Jansen et al., (2012) is a useful indicator for earnings management, as well as this diagnostic, provides higher information content in identifying earnings management than the discretionary accruals model i.e. Kothari et al., (2005) model. Conclusion- This study contributes to the limited earnings management literature in emerging economies generally, and in the Palestinian context particularly. The results of the study benefit financial statement users to have diagnostics for earnings management that are informative.

Keywords

• Earnings management
• discretionary accruals
• future profitability reversals
• Palestine Exchange

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