Review Fixed Assets Disposal as a Method of Real Earnings Management

 

Introduction

Companies generally use unrealized gains on holding assets to increase their profits when necessary. On the other hand, the company may sell loss-making assets with the aim of transferring future losses to current periods and using a loss accumulation strategy, which seems to worsen the company's situation for the current fiscal year. But the main goal is to reduce the losses of future periods (Campa, Cao, & Donnelly, 2019).
Accounting standards as well as International Financial Reporting Standards for property, plant and equipment, as well as impairment of assets, stating that assets should be measured at either cost or fair value, provide an opportunity for judgment and prudence (Ball, 2016). It can be stated that the use of the above standards in measuring fair value leads to precautionary measures to increase profits and losses in each reporting period. In other words, managers must decide whether to change the profitability process in the current period or to continue the conservative process of maintaining assets at cost (Rashidi, 2020). In Iran, according to the Communication of the Tehran Securities and Exchange in 2016 and the difference between the real value and cost of assets as a result of inflation and more encouragement of managers to use fair value for fixed assets, companies are required to provide conditions for evaluation. Accordingly, examining the use of asset sales as a way to manage real profits is of particular importance. In this way, the risk of adverse selection for shareholders can be reduced and the conditions for evaluating the actual performance of the manager are provided.
 

Hypothesis

Company managers may be willing to sell assets when financing investment projects and when outsourcing is costly. In this paper, the goal is to review fixed asset disposal as a method of real earnings management. Thus research hypotheses have developed as follows:
H1: If the sale of a company's assets leads to a forecast profit, companies will sell the assets for profit.
H2: If the sale of company assets does not lead to the expected profit, companies will sell assets to increase losses.
H3: The relationship between the transfer of assets for non-operating profit and the failure to meet the profit margin is stronger for companies that have large accruals on their balance sheets.
H4: The relationship between the transfer of assets for non-operating losses and the failure to meet profit margins is stronger for companies with large accruals on their balance sheets.
 

Methods

The purpose of this study is descriptive and is based on the nature and method of correlation. As this research can be used in the decision making process of investors, the type of applied research is considered. In this research, library method has been used to collect data and information. Then, for collecting the research data, compact discs, visual and statistical archives of the Tehran Stock Exchange, the official website of Tehran Stock Exchange and other related online databases have been used.
For this purpose, data on 120 companies listed in Tehran Stock Exchange for the period of 2006 to 2019 were extracted and a logistic regression model was used to test the research hypotheses.
 

Results

The results show that the first and second hypotheses of the research are not confirmed but the third and fourth hypotheses are confirmed. The results of the first research hypotheses show that if the sale of firm’ assets will lead to predicted profit, companies are not approved for sale of assets in order to gain profits. Also, the second hypothesis, based on whether or not the sale of company assets achieves the expected profit, companies sell assets to increase losses has not been confirmed, but the relationship between the asset disposal to earn non-operational profits and failure to meet the profit criteria for the companies with extensive accrual on their balance sheet are confirmed. Finally, the fourth hypothesis, the relationship between the asset disposal to earn nonoperational loss and failure to meet the profit criteria for the companies with extensive accrual in their balance sheet are confirmed.
 

Discussion and Conclusion

In this study, the disposal of fixed assets as a way to manage real profits has been investigated. The first hypothesis of the research is that if the sale of the company's assets leads to a forecast profit, the companies will not sell the assets for profit. The results of this hypothesis are similar to the results of Herrmann et al. (2003). In this regard, it can be said that the goal of earnings management is to realize the management forecast of profits this year and next year. Sales managers schedule their fixed assets and investments in order to achieve the desired profit. Since the carrying amount of revalued assets is typically less than their market value (sales), the manager can manipulate the current period profit by selling the asset and identifying the gain from the increase in the asset in the period in question. Incremental profit management and decreasing profit management (Xu, Taylor, & Dugan, 2007). The second hypothesis of the study is that if the sale of company assets does not lead to the expected profit, companies will not sell assets to increase losses. The results of this hypothesis are similar to the results of Ebrahimi and Zakeri (2009). Managers do not want to lose their position in the capital market. Therefore, they focus their efforts on gaining profit (even if it is less than expected profit) and are reluctant to transfer unforeseen losses to the current period. The results of the third hypothesis are consistent with the research of Poitras et al. (2002). Investors and other users of financial information attach great importance to reported earnings. Accounting profit has information content and users use it based on their information needs. Accounting profit can be used to evaluate the performance of the business unit, management stewardship, cash forecasting, etc. Managers can change the level of accounting profit by choosing from accounting principles or standards in applying estimates and scheduling transactions such as the sale of assets. According to the results of the fourth hypothesis, the relationship between the disposal of assets for non-operating losses and the failure to meet the profit margin is confirmed for companies that have large accruals in their balance sheets. The results of this hypothesis are similar to the research of Sanjaya and Saragih (2012). Real profit management occurs during the current period and increases the loss for the company at the end of the period, and  to avoid losses, managers will manage the profit through optional accruals. When the company's actual profit is less than the managers’ expected profit, the managers try to bring the reported profit to the expected level by selling more assets, or vice versa, when the company's real profit is higher than the managers' expected profit, they try to bring the reported profit to the expected level by selling the assets that lead to the loss.