On the Relation Between Real Earnings Management and Accounting Earnings Management: Income Smoothing Perspective‪.‬

INTRODUCTION The purpose of this paper is to investigate a relation between real earnings management and accounting earnings management to smooth income in Japan. We generally can divide earnings management into accounting earnings management and real earnings management. Accounting earnings management contains a choice from menu of treatments that are accepted under Generally Accepted Accounting Principles (hereafter, GAAP), such as LIFO versus FIFO for inventory valuation and depreciation. Real earnings management consists of real production and investment decisions, such as reducing research and development expenditures and affecting selling and administrative expenses. Current accounting system has some discretion that allows managers to manage earnings. Managers generally can use the discretion in reporting earnings to achieve their goal. Note that as long as managers use their discretion within the limits of GAAP, both earnings management are not illegal. Managers have some discretion in determining how aggressive or conservative their financial reporting should be. Real earnings management and accounting earnings management are useful tools to manage earnings. Burgstahler and Dichev (1997) show evidences that managers manage earnings to avoid loss and profit decline by using real earnings management and/or accounting earnings management.