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Inference of economic truth from financial statements for detecting earnings management: inventory costing methods from an information economics perspective
Author(s) -
Herath Hemantha S.B.,
Lu Xiaoting
Publication year - 2018
Publication title -
managerial and decision economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.288
H-Index - 51
eISSN - 1099-1468
pISSN - 0143-6570
DOI - 10.1002/mde.2912
Subject(s) - activity based costing , total absorption costing , earnings , perspective (graphical) , inference , economics , earnings management , overhead (engineering) , cost accounting , variable (mathematics) , econometrics , actuarial science , business , microeconomics , operations research , computer science , accounting , mathematics , artificial intelligence , operating system , mathematical analysis
We introduce uncertainty in the classic inventory costing choice problem to investigate the underlying partitions imposed by two accounting inquiries (processes of generating information): variable costing and absorption costing. In a contemporaneous reporting environment, we show that absorption costing provides a finer partition of the state space compared to variable costing when a firm arbitrarily increases the production level (opportunistic overproduction), and the predetermined fixed overhead rate is adjusted. Grounded in an information economics perspective, the intent of the article is to propose an approach to detect real earnings management by extracting information from financial statements. The resulting managerial biases arising from earnings management are also discussed.