Schipper(1989) defined earnings management as business practice that corporate management uses its accounting discretion in order to take abnormal return through financial reporting within the boundary of corporate accounting standards. There are nume...
Schipper(1989) defined earnings management as business practice that corporate management uses its accounting discretion in order to take abnormal return through financial reporting within the boundary of corporate accounting standards. There are numerous chances of earnings management during financial reporting process; at any time, anywhere, with various methods. Schipper mentioned two different earnings management methods; Accrual-based earnings management(hereafter, DA) and Real earnings management(hereafter, REM). Most previous research also focus on these two methods. However since DA intentionally increases(decreases) current period’s income, there will be reverse effect of decrease(increase) in future reported income. Using REM may temporarily increase the earnings by increasing the revenue through extensive discount policy or decreasing the expenses like advertising or R&D, but in long term it will damage the brand value thus opportunity costs may arise. However, overstatement of operating earnings by classification shifting has three advantages over the other proxies for earnings management. First, classification shifting only manages the operating earnings upward while net income remains unchanged, thus less opportunity cost occurs compared to other proxies. Second, firms using classification shifting are relatively less restrained by auditors and regulatory agency because net income remains unaffected. Last, overstatement of operating earnings affect the stock value greater because of high durability of operating earnings, thus capital market may be deceived by giving such firms better evaluation. Overall, classification shifting has high potentials of being used by firm s management. However there is no research yet on examining the classification shifting in Japan. This paper is to examine whether management in Japan classify operating expenses as non-operating expenses for inflating operating income. Furthermore, we like to examine how classification shifting affects the accuracy of analysts operating earnings forecast. This paper provides the evidence that managers in Japan overstate the operating income by classification shifting. And this paper also shows that analysts’ forecast accuracy on operating income is decreased for the firms with frequent classification shifting in order to manipulate the operating income upward. This paper can be helpful for regulatory agencies responsible for quality of financial reporting when they supervise or audit the quality of firm’s financial reporting. As for investors, this paper contributes the need of detailed review on financial statements of firms facing specific capital market situations for investor’s decision making.