Income Smoothing

Journal of Economics, Business and Accountancy Ventura Accreditation No. 110/DIKTI/Kep/2009 the great unwashed 14, No. 1, April 2011, pages 59 78 THE THEORETICAL CONSTRUCTION OF INCOME SMOOTHING MEASUREMENT Alwan Sri Kustono Jember University E-Mail emailprotected com Tegal Besar Permai 2-E1,Jember,Propinsi Jawa Timur,Ind wizsia ABSTRACT The income smoothing is a mark of the accounts manipulation theme that has been a ttracting a great attention in the business relationship literature. A finishing of manipulation widely as cribed to managers is the desire to smooth.Reported income, Income smoothing reflects reducing the possible income fluctuations so as to make it as stable as possible throughout the ism. Almost of income smoothing research in Indonesia used Eckels king to clasify smo opposite non smo separate firms. Empirical evidences have provided support for the existence of an income smoothing behavior. The studies showed inconsistent about factors determining this smooth ing. The subprogram of the present investigation is twofold. First, we seek to determine if Eckel magnate is a reliable promoter to measure income smoothing behavior.Second, we adventure to identify the new instrument to measure incidence of income smoothing. Our research sample comprises manufacturing companies listed on the Indonesia Stock Exchange, everyplace period of 1999-2008. This study confirms Eckels index is non reliability instru ment. The new proposed index quantifies the incidence of income smoothing without imagine on n periods. The results imply that researchers should re-examine the conclusion of introductory studies, particularly that determinant, factors and effect of income smoothing practices. Key speech income smoothing, Eckels index, c oefficient of variation, reliability.INTRODUCTION It has been noticed that income statement is considered as one of the statements to be presented in financial reporting. For that reason, the participations earning is c onsidered vital information for it burn down be used to measure the corporate performance. In other words, information of the earning foot be used to assess the performance or accountability of focus and alike predict the ability of companies in the effort of contributing to the following earning. In general, earning reporting is frequently not free from the accounting manipulation. Yet it appears contrastive from the fraudulence.Accounting manipulation stick out be still in repellent when it is put in the accounting rules. In contrast, fraudulence practices tend to be against the rules and accounting standards. Thus, it is delicately different from income smoothing. In fact, one 59 of the practices of accounting manipulation is income smoothing. In connection with the pursuit of analyzing income smoothing in the companies, most definitions of it can be inferred. First of all, income smoothing is defined as the emphasis on the fluctuations in income levels that ar considere d commonplace for the confederacy (Barnea et al. 1976). For another thing, Beidleman, (1973) defines income smoothing as the management efforts to prune abnormal variations in the earning to the extent permitted by the principles of steady-going management and accounting. Income smoothing in such(prenominal) instances, is as a tool used by management to reduce the discrepancy of reported income stream relative to the target which is intentionally smoothed by using drippy or real variable. In addition, income smoothing is one-dimensional manipulation of accounts that attract the atten- ISSN 2087-3735 The Theoretical Construction (Alwan Sri Kustono) ion of many accounting literature in the realm of winnings management. Beside, income smoothing reflects the concern to reduce the possibility of fluctuations in income by making a steady flow Research on income smoothing in Indonesia generally examine several factors which atomic number 18 allegedly to motivate management to do in come smoothing. They identify the existence of such practices and followed by testing management motivation. The results of these studies have identified those most public companies in Indonesia have conducted income smoothing. All in all, most of the studies ar uniform in terms of inferring he end results. Testing the triggering factor of income smoothing policy by the smart set management has not consistently been recovered. Among the results of such studies are often inconsistent to one another. For example, Kustono (2010) stated that the mutual exclusiveness of their findings was caused by the measuring devices. These devices are thought to be unreliable. For example, Index Eckel does not have the ability to grip the practice of income smoothing between periods. In that internet site, it shows that some companies are classified by grading exclusively in one particular year.This is considered to have deviated from the definition of income smoothing. The classification grou nd on Eckel index for one company may also change because of changes in the period used to determine the coefficient of variation. Change of classification shows that the index is not reliable as a tool. In other words, Eckel is as an identifier of smoothing and not merely for smoothing. Kustono (2010) maintain the idea of the need for new instruments. This research is mean to correct weaknesses of the Eckel and construct an index measuring instrument which is more reliable income smoothing factor.This construction is very important because the use of measuring instrument error willing cause errors either in the phase of conclusions related to the classification of sample or the determinants and daze of such classification. THEORETICAL FRAMEWORK It is a fact that income smoothing becomes a phenomenon which has been often proved in some precedent studies. This practice has been investigated through various levels of different samples. Furthermore, income smoothing is considered to be an important factor. Research by Moses (1987) and Atik & Sensoy (2005) shows that at least 60% of he sample used in the study can be classified as smoothing the company earnings. Another proponent, such as Barnea et al. (1976) classified accounting income smoothing as inter-temporal smoothing and classification. Inter-temporal smoothing is based on the situation when cost and expenses are recognized and smoothing classification is done with the classification under ordinary cost and erratic one in which the ordinary post finally becomes flat. Eckel (1981) distinguishes between income smoothing as a natural smoothing and intended smoothing. Natural smoothing is he alignments resulting from transactions that inherently produce a smoothed earning. In other words, the companys trading ope symmetryns to generate income by collecting revenues and expenses are inherently to eliminate fluctuations in income flows. In other words, the touch of generating income itself generates a st ream of smoothed income. Alignment occurs without the intervention of any party. Income smoothing is accidentally triggered by the motivation which is based on the management actions. There are two types of income smoothing intentional, that is income smoothing of the real intention nd the other one is artificial income smoothing. Real income smoothing indicates management actions that seek to control economic hold ins that directly affect corporate earnings in the future. In addition, this real income smoothing affects cash flow. On the contrary, artificial income smoothing can show manipulation which is undertaken by management to smooth the earning. Thus, the action of this manipulation resulted in a fundamental or economic condition that can affect cash flow, but shifts 60 Journal of Economics, Business and Accountancy Ventura Accreditation No. 10/DIKTI/Kep/2009 the cost and/or income from one period to another. By taking for granted, such a trend can be traced from several res earch. round studies, in fact, have been conducted to identify the smoothing behavior, such as motivation and its impact on future transactions, a company that has been doing income smoothing. This can also be found in other studies such as (Lev & Kunitzky, 1974 Ammihud et al. , 1983, Wang & Williams, 1994 Michelson et al. , 1995 Iniguez & Poveda, 2004). These proponents also provide empirical support toward statement that management reduces he variability of cash flows and earning for the purpose of minimizing the risk of the company. Income smoothing is also intended to increase the value of the firm (Gordon, 1964 Trueman & Titman, 1988 Gibbins et al. , 1990 and Chaney & Lewis, 1995 1998). Estimator of Income smoothing Income smoothing can only be investigated through some periods by suspecting a certain earning rate of the targeted, e. g. , both highand low-digits earning reports. many researchers use a two-period poseur by assuming that the earning target is proportional to t he income report in the previous year Copeland, 1968). In other words, the size of alignment is the magnitude of changes in the earning from one year to the next. former(a) researchers also evaluated the earning target using multi-period test. The underlying assumption is that it should be an evenly increasing trend (Gordon, 1966). Some of the models used are the exponential model (Dascher and Malcolm, 1970), linear time series models (Barefield and Comiskey, 1972), time trend semi-logaritma (Beidleman, 1973) and model of the market return index (Ronen & Sadan, 1975). For example, Dopuch & Watts (1972) suggest the use ofBox-Jenkins techniques to ensure the alignment model is applicable. Models of earning target are differentiated from the real earning. Often, these models contain errors inherent profit target 61 Volume 14, No. 1, April 2011, pages 59 78 because its validity can not be detected empirically. In that case, Ronen & Sadan (1975) suggested that we do income smoothing app roach. In particular, income smoothing can be identified if the researcher is faced by the following four questions. 1. What is the object alignment apply by the management? 2. What is the dimension of management s used to perform smoothing. 3. What instrument of smoothing is used by management 4. What is the object of such smoothing behavior? In connection with the above efforts, Imhoff (1977) and Eckel (1981) developed a methodology based on testing the variability of income associated with the variability of sales. The model used to predict the existence of income smoothing or earnings variation is inter-period variant. They assume that the level of earning depends on the level of sales. The basic idea is that the change in sales can affect the earning. If the variance of income is less than the variance f sales, it can be cogitate that the smoothing has been done. Eckel (1981) model of the income smoothing is done by basing on the following premises. 1. Income is a linear fun ction of the sales = sales-cost variable-fixed cost. 2. The ratio of variable costs to sales is in unremitting currency units 3. Fixed costs are constant or increasing from period to period, but not likely to decline. 4. Gross sales can only be smoothed by real smoothing gross sales can not be artificially smoothed. Mathematically, Eckel illustrates all the above as the following when, I=S-VS-FC, and FC0, and FC t+1 =FC t, and 0