SFAS 133 and income smoothing via discretionary accruals: The role of hedge effectiveness and market volatility

Abiot Tessema
Rogier Deumes

Document Type

Article

Source of Publication

Journal of International Financial Management and Accounting

Publication Date

6-1-2018

Abstract

© 2017 John Wiley & Sons Ltd This study investigates whether the Statement of Financial Accounting Standard No. 133 (SFAS 133) influences firms’ income smoothing via discretionary accruals decisions. Moreover, we investigate whether the level of hedge effectiveness and market volatility affects the impact of SFAS 133 on firms’ income smoothing via discretionary accruals decisions. Consistent with our predictions, we find a significant increase in income smoothing via discretionary accruals activity after the adoption of SFAS 133. We also find that income smoothing via discretionary accruals after the adoption of SFAS 133 increases with the level of hedge ineffectiveness. By contrast, we find that perfect hedgers do not engage in more income smoothing via discretionary accruals after the adoption of SFAS 133. Finally, we find that the higher the market volatility is the larger the income smoothing is via discretionary accruals after the adoption of SFAS 133. This implies that higher market volatility makes it more difficult for firms to meet hedge accounting requirements, thereby increasing unmanaged earnings volatility and income smoothing. Prior studies suggest that regulators are expressing concern about the effect of earnings management on the quality of reported earnings and the functioning of capital markets (e.g., Barton,). In this regard, our findings imply that accounting standard setters should take into account the trade-off between transparency and income smoothing.

ISSN

0954-1314

Publisher

Blackwell Publishing Ltd

Volume

29

Issue

2

First Page

105

Last Page

130

Disciplines

Business

Keywords

derivatives and hedging, hedge effectiveness, income smoothing, market volatility, SFAS 133

Scopus ID

85045795343

Indexed in Scopus

yes

Open Access

no

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