Accounting Rules on Loan Losses and Security Gains Contribute to Earnings Management for the Banking Industry in Sri Lanka

Main Article Content

G. K. Suren W. de Chickera
Liu Qi

Abstract

One of the most serious concerns presently facing the accounting profession is the growing complexity, extension, and significance of issues adjoining fair value measurements. Many researchers and practitioners criticized the fair value accounting and blame for it causing economic failure. This paper studies licensed commercial banks and the financial institution listed under the Colombo stock exchange to examine the association between fair value accounting and earnings management. In this research, we are examining the provisions for loan loss and discretionary security gains and losses by introducing the fair value assets and liabilities. We used the statistical methodology followed by Beatty et al. (2002) to test the banks reported fair value assets and liabilities associated with provisions for loan loss. We test several robustness tests and sensitivity analysis for our research design. We use both the current year and one-year ahead data test the provision for loan loss, discretionary security gains, and losses after controlling bank-specific features. We found evidence that; banks reported fair value assets and liabilities are positively associate with provision for loan loss. We found the evidence that the level 2 fair value assets and liabilities are a predominant determination for the association between provisions for loan loss. Our evidence is consistent with past research and persuades us that banks use fair value measurements to manage the earnings.

Keywords:
Provision for loan loss, earnings management, fair value, level 2 fair value assets and liabilities, IFRS 13, security gains and losses

Article Details

How to Cite
de Chickera, G. K., & Qi, L. (2019). Accounting Rules on Loan Losses and Security Gains Contribute to Earnings Management for the Banking Industry in Sri Lanka. South Asian Journal of Social Studies and Economics, 3(3), 1-16. https://doi.org/10.9734/sajsse/2019/v3i330104
Section
Original Research Article

References

DeFond ML. Earnings quality research: Advances, challenges and future research. J. Account. Econ. 2010;50(2–3):402–409.

Dechow PM, Skinner DJ. Earnings management: Reconciling the views of accounting academics, practitioners, and regulators. Account. Horizons. 2000;14(2): 235–250.

McNichols MF. Research design issues in earnings management studies. 2000;19:4–5.

Beaver WH, Engel EE. Discretionary behavior with respect to allowances for loan losses and the behavior of security prices. J. Account. Econ. 1996;22(1–3): 177–206.

IASB. Fair value measurement; 2014.

Nissim D. Reliability of banks’ fair value disclosure for loans. Rev. Quant. Financ. Account. 2003;20(4):355–384.

Ryan SG. Fair value accounting: Understanding the issues raised by the credit crunch. Livre blanc {à} Destin. du Counc. Institutional Investors. 2008;1–2.

Fiechter P, Meyer C. Big bath accounting using fair value measurement discretion during the financial crisis. Development; 2009.

Chen F, Lam KCK, Smieliauskas W, Ye M. Fair value measurements and auditor versus management conservatism: Evidence from the banking industry. SSRN Electron. J.; 2010.

Hitz JM. Conceptual thoughts on the decision usefulness of fair value accounting. Eur. Account. Rev.; 2007.

Badia M, Duro M, Penalva F, Ryan S. Conditionally conservative fair value measurements. J. Account. Econ. 2017;63(1):75–98.

Šodan S. The impact of fair value accounting on earnings quality in Eastern European Countries. Procedia Econ. Financ. 2015;32(15):1769–1786.

Khan U. Does fair value accounting contribute to Systemic Risk in the Banking Industry ? Columbia Bus. Sch. Res. Pap. Ser.; 2010.

Dichev ID, Graham JR, Harvey CR, Rajgopal S. Earnings quality: Evidence from the field. J. Account. Econ. 2012;56(2–3):1–33.

Ehalaiye D, Tippett M, van Zijl T. The predictive value of bank fair values. Pacific-Basin Financ. J.; 2016.

Ayres D, (Sharon) Huang X, Myring M. Fair value accounting and analyst forecast accuracy. Adv. Account. 2017;37:58–70.

da Silva RLM, Nardi PCC. Full adoption of IFRSs in Brazil: Earnings quality and the cost of equity capital. Res. Int. Bus. Financ. 2017;42:1057–1073.

Ehalaiye D, Tippett M, van Zijl T. The predictive value of bank fair values. Pacific Basin Financ. J. 2017;41:111–127.

Mary E. Barth, Wayne R. Landsman. Using fair value earnings to assess firm value. 2018;9(2013):34–40.

Houqe MN, Monem RM, Tareq M, van Zijl T. Secrecy and the impact of mandatory IFRS adoption on earnings quality in Europe. Pacific Basin Financ. J. 2016;40: 476–490.

Tutino M, Pompili M, Tutino M, Pompili M. Fair value accounting and management opportunism on earnings management in banking sector : First evidence; 2018.

Wang H, Zhang J. Fair value accounting and corporate debt structure. Adv. Account. 2017;37:46–57.

Song CJ, Thomas WB, Yi H. Value relevance of FAS No. 157 fair value hierarchy information and the impact of corporate governance mechanisms. Account. Rev. 2010;85(4):1375–1410.

Goh BW, Li D, Ng J, Ow Yong K. Market pricing of banks’ fair value assets reported under SFAS 157 since the 2008 financial crisis. J. Account. Public Policy. 2015;34(2): 129–145.

Kolev K. Do investors perceive marking-to-model as early evidence from FAS 157 disclosure; 2008.

Barth ME. Global financial reporting: Implications for U.S. academics. Account. Rev. 2008;83(5):1159–1179.

Beatty AL, Ke B, Petroni KR, Beatty AL. Earnings management to avoid earnings declines across publicly and privately held banks. Account. Rev. 2002;77(3):547–570.

Ahmed AS, Takeda C, Thomas S. Bank loan loss provisions: A reexamination of capital management, earnings management and signaling effects. J. Account. Econ. 1999;28(1):1–25.

Beatty AL, Ke B, Petroni KR. Earnings management to avoid earnings declines across publicly and privately held banks. Account. Rev. 2002;77(3):547–570.

Beatty A, Chamberlain SL, Magliolo J. Managing financial reports of commercial banks: The influence of Taxes, regulatory capital, and earnings; 1995.

Beatty A, Harris DG. The effects of taxes, agency costs and information asymmetry on earnings management: A Comparison of public and private firms. Rev. Account. Stud. 1999;4(3/4):299–326.

Wahlen JM. The nature of information bank loan in commercial loss disclosures. Account. Rev. 1994;69(3):455–478.

Healy PM, Wahlen JM. A review of the earnings management literature and its implications for standard setting. SSRN Electron. J.; 1999.

Elliott RJ, Siu TK, Fung ES. A double HMM approach to Altman Z-scores and credit ratings. Expert Syst. Appl. 2014;41(4): 1553–1560.

Baiman S, Verrecchia RE, Bainman S, Verrecchia RE. The relation among capital markets, financial disclosure, production efficiency, and insidere trading. J. Account. Res. 1996;34(1):1–22.

Bank loan loss provisions: A reexamination of capital management, earnings management and signaling effects | on Academic. [Online].
Available:https://www.onacademic.com/detail/journal_1000035487215810_6bee.html#
[Accessed: 06-Jan-2019]

Kanagaretnam K, Krishnan GV, Lobo GJ. Is the market valuation of banks’ loan loss provision conditional on auditor reputation? J. Bank. Financ. 2009;33(6):1039– 1047.

Lobo GJ, Yang DH. Bank managers’ heterogeneous decisions on discretionary loan loss provisions. Rev. Quant. Financ. Account. 2001;16(3):223– 250.