Research Archive

Working paper, August 2006

Publication type: Working paper

Research Archive Topic: Accounting, Business Economics and Public Policy, Corporate Finance, Leadership

Abstract

We investigate whether firms manage quarterly earnings by adjusting expenses recorded during the year under the integral method. The integral method, which is used to determine interim cost of goods sold, selling, general, and administrative expenses, and income tax expenses, introduces management discretion into the amount and timing of costs allocated to quarterly expenses. We find that seasonal differences in each of the above expenses are significantly associated with meeting or beating analysts' earnings forecasts in a given quarter. This study is the first to show that changes in interim cost of goods sold and selling, general, and administrative expenses are associated with earnings management. In addition, this study extends prior research showing that firms can decrease effective tax rates in the fourth quarter to lower tax expense enough to meet or beat year-end analysts' forecasts. We document a positive association between seasonal differences in the provision for income taxes and meeting or beating analysts' earnings forecasts in all four quarters. These findings complement research efforts to understand the limits of multi-year earnings management to show how flexible accounts like interim expenses permit firms to manage earnings within a year.

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