Prof. Susan Wahab and Assoc. Prof. Carl Smith of the Barney School’s Accounting and Taxation Department will have their paper "Overhead Cost Allocation and Earnings Manipulation Between Quarters," co-authored with Karen Teitel, published in Management Accounting Quarterly.
Abstract: This paper investigates whether or not overhead rates are used to manage reported earnings to external users. It adds to the existing literature on earnings management by: (1) providing evidence of earnings manipulation using a specific accounting metric, overhead allocation, rather than aggregate accruals, (2) identifying conditions under which earnings manipulation is likely to occur between quarters rather than on an annual basis, and (3) presents preliminary evidence on how a metric that is manipulated for managerial reporting purposes for their personal gain can directly affect external financial reports used by capital markets participants, reducing earnings quality for stock pricing. We also examine the frequency of changes (across quarters) in gross profit margin from expectations. Patterns in managed and unmanaged forecasts errors are examined to determine whether or not gross profit margins are managed to meet/beat analysts' forecasts. Results indicate that, in all four quarters, management appears to decrease the applied overhead rate to increase gross profit margin, reducing earnings quality. On average, this allows management to turn a negative earnings surprise to a positive earnings surprise in quarters one and two, and reduce negative earnings surprises in quarters three and four. By combining perspectives of managerial and financial accounting, this paper extends this line of research to benefit both disciplines.