1

DO IFRS ADOPTION, FIRM SIZE, AND FIRM LEVERAGE INFLUENCE

EARNINGS MANAGEMENT? EVIDENCE FROM MANUFACTURING FIRM
LISTED IN INDONESIA STOCK EXCHANGE
Danny Limanto
Zaenal Fanani
Department of Accountancy, Faculty of Economic and Business Universitas Airlangga
Email: danny_limanto@yahoo.com and fanani_unair@yahoo.com

ABSTRACT
This research investigate whether IFRS adoption, firm size, and firm
leverage have effect on earnings management in Indonesia manufacturingfirms. Earnings management is identified using absolute value of
discretionary accruals, measured with Francis et al. (2005) model. Based on
a sample of 102 manufacturing firms listed in Indonesia Stock Exchange for
year 2010, results show that IFRS adoption in Indonesia does not have
effect on earnings management, while firm size and firm leverage have
effect on earnings management. Furthermore, results show that firm size has
negative effect on earnings management, means larger firms engage in less
earnings management and highly leveraged firms engage. Results also show
firm leverage has positive effect on earnings management, means highlyleveraged firms is associated with more earnings management.
Keywords: earnings management, IFRS adoption, firm size, firm leverage

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INTRODUCTION
In recent years, there is a tendency for global business environment to use IFRS
(International Financial Reporting Standards), issued by IASB (International
Accounting Standard Board). IFRS is designed to respond global business and capital
market development, which urge for an internationally uniform set of high quality
accounting standards for financial reporting. Before adopting IFRS, each country has its
own set of financial accounting rule, which may different one with each others.
Financial statements users find difficulties in comparing an entity with another. Started
in 2001, IASB issued the first iteration of IFRS and since that IFRS has become
accepted and been adopted for public reporting purpose in over 100 countries.
IFRS is principles-based standards that are investor/market oriented and require
extensive disclosure in comparison with prior standard. The most important element of
IFRS was the introduction of the fair value principle to asset valuation and liability
recognition. Fair value principle enhances disclosed values of accounting quantities,
which should be close to their relative market values and therefore financial accounting
information is more likely to reflect true economic events. IASB also removed
allowable accounting alternatives, such as reduced managers' flexibility in valuing
assets at the lowest amount possible so as to minimize tax liabilities (Barth, 2008;
Dimitropoulos, 2013). Moreover, IFRS imposed changes on many technical accounting
issues aimed at promoting a true and fair presentation of financial information to
facilitate investors' rational investment decisions. Based on this, in theory, the adoption
of IFRS should significantly restrict the ability to engage in earnings management
behavior and increase the overall quality of disclosed information.
However, since IFRS is principle-based, which offers greater flexibility and tend
to rely more heavily on management judgment. This may bring opportunities for
management to choose accounting policies for their interest, especially when related to
estimation and judgment. For instance, when fair values are estimated using valuation
models, managers can influence the estimations through their choices of models and
parameters, thus opening the door to greater opportunistic earnings management
(Capkun et al., 2013).
Empirical researches have been conducted in countries with purpose to find out
the effect of IFRS adoption on earnings management. However, findings are different
across countries and suggest that it is not appropriate to generalize the effects of
adopting IFRS because single set of standards may not be suitable for all settings and

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thus may not uniformly improve value relevance and reliability due to differences
among countries, including approach used, social, political factors (Soderstrom and
Sun, 2007; Ball et al., 2003). The International Accounting Standards Committee
(IASC) Foundation aware of this issue and has documented the need to have an
understanding of the impact of IFRS as they are adopted in particular regions (IASB,
2004: par. 93).
In Indonesia, Indonesia Financial Accounting Standards Board, called as Dewan
Standar Akuntansi Keuangan (DSAK), developed convergence program to adopt IFRS
in PSAK. The decision to converge was announced in 2008 with the aim of eliminating
the differences with local generally accepted accounting principles and increases the
quality of financial reporting. Different with countries in Europe and Australia, which
used big-bang approach, DSAK decided to use gradual implementation for its PSAKIFRS convergence program, and until 2010 there were seven PSAK revised and
effectively implemented, namely PSAK 13, PSAK 14, PSAK 16, PSAK 23, PSAK 30,
PSAK 50, and PSAK 55. However, there is no research in Indonesia purposing to find
the effect/impact of IFRS adoption on earnings management and thus the effect is still
unknown but only hypothesis.
In addition to accounting standard used, researchers find that there are also other
factors influencing earnings management practices. Two of them are firm size and firm
leverage. However, there is inconsistency between research findings.
Based on the fact above, researcher is motivated to find whether IFRS adoption
has effect on earnings management in Indonesia. Since there is no research in Indonesia
purposing to find the effect/impact, especially in manufacturing sector, finding of this
research provide new insight that is relevant for evaluating the IFRS adoption. In
addition, the gradual approach chosen by DSAK makes it interesting to conduct this
research, since the effect of IFRS adoption on earnings management may be different in
each year due to adoption progress. This research is also intended to investigate and
confirm whether firm size and firm leverage have effect on earnings management, since
there are inconsistencies in study findings.
This research uses absolute value of discretionary accruals as proxy to the extent
earnings management. Francis et al. (2005) method is used to measure discretionary
accruals. In addition, this research includes firm endogenous power of generating
accruals and absolute value of firm operating cash flows as control variables as
suggested by Becker (1998).

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LITERATURE REVIEW
Agency Theory, Agency Problem, and Positive Accounting Theory (PAT)
Agency theory explains that management is expected to act on behalf of
shareholders interest in return of compensations or bonuses. For both parties, the
benefits is measured based on firm performance, which is profitability in general (Scott,
2012: 340; Conceptual Framework of PSAK, par. 17). However, there is information
asymmetric problem, which explains that management has more information compared
to shareholders. Management may take advantage of this information asymmetric on
behalf of its own interest, instead of shareholders, to alter the information before it
publicly announced to shareholders. PAT assumes that managers are rational and will
choose accounting policies that result in their own best interests, which may not
necessarily also be in the firms best interest, if able to do so (Scott, 2012: 306). To be
noted is that PAT does not assume that management will simply act so as to maximize
firm profit. Instead, management will maximize profits only if management perceives
this to be in its own benefits.

Previous Research
Chua et al. (2012) found that firms exhibit less earnings management following
the mandatory implementation of International Financial Reporting Standards (IFRS) in
Australia. The empirical results from a research in China generally indicate that
accounting quality improved, measured with decreased earnings management and
increased value relevance of accounting measures since 2007 (Liu et al., 2011). Studies
in European countries (Barth et al., 2008; Chen et al., 2010) find that adoption of IFRS
can be associated with less earnings management. This is consistent with Zeghal et al.
(2011) finding, who conducted study in French, and Dimitropoulos et al. (2013) finding,
who conducted study in Greece.
In contrast, several studies show different findings. Study in New Zealand find
that IFRS adoption does not have impact on earnings management (Kabir et al., 2010).
Research on the cross-listed firms in U.S. found that there is no significant relationship
between IFRS adoption and earnings management (Sun et al., 2011). Van Tendeloo and
Vanstrelen (2005) find that companies that have adopted IFRS engage significantly
more in earnings management than companies reporting under German GAAP.

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Regarding to firm size, Gul et al. (2003), Siregar and Utama (2006), and
Handyani and Rachadi (2009) find there are negative and significant relationship
between firm size to earnings management. Different with their results, Halim, Meiden,
Tobing (2005) and Veronica and Bachtiar (2003) find that firm size has positive toward
earnings management practices. Furthermore, Guna and Herawati (2010) and Raymond
(2011) find that there is no significant relationship between firm size and earnings
management.
Regarding to firm leverage, Gul et al. (2003), Chen et al. (2010), and Sun et al.
(2011) find that there is a positive and significant relationship between firm leverage to
earnings management. This result agrees with debt covenant hypothesis, which
identifies that management in firm with high leverage tends to do earnings management
in order to avoid debt covenant violation. However, Lobo and Zhou (2001) and
Dimitropoulos et al., (2013) find that there are negative and significant relationship
between leverage to earnings management.

Hypothesis Development
Agency theory and positive accounting theory explain how firm managers may
use accounting policies that result in their own best interests, which may not necessarily
also be in the firms best interest. In IFRS, IASB identifies that it has removed
allowable accounting alternatives (Barth, 2008; Dimitropoulos, 2013). Moreover, IFRS
imposed changes on many technical accounting issues, such as the presentation of
financial statements, segment reporting, intangible assets, depreciation, related party
disclosures, aimed at promoting a true and fair presentation of financial information to
facilitate investors' rational investment decisions. Based on this, in theory, the adoption
of IFRS should significantly restrict the ability to engage in earnings management
behavior and increase the overall quality of disclosed information. However, lack of
implementation guidance, less rules enforcement, incapable external assurance service
providers may create rooms for managers to do earnings management and reverse the
positive effect of IFRS adoption into negative.
Zeghal et al. (2011), Dimitropoulos et al. (2013), Chen et al. (2010), Kabir et al.
(2010), Sun et al. (2011), Van Tendeloo and Vanstrelen (2005) find that IFRS adoption
influences earnings management. First hypothesis is formulated as follows:
H 1 : IFRS adoption has effect on earnings management

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Firm size can be correlated to quality of corporate governance and internal

control, reputation, attention from stakeholders, and pressure on special circumstances.
Large firms have good corporate governance, effective internal control procedures,
professional internal auditors, tendency to maintain reputation, and high number of
attracted stakeholder, which limit managers to do earnings management.
However, large firms may face more pressure on special circumstances, such as
to meet or beat analysts expectations and to make firm looks promising on initial
public offering or seasoned equity offerings, which motivates managers to do earnings
management.
Gul et al. (2003), Siregar and Utama (2006), Handayani and Rachadi (2009),
Halim, Meiden, and Tobing (2005) find that firm size influences earnings management.
Second hypothesis is formulated as follows:
H 2 : Firm size has effect on earnings management
High leverage has been found to be correlated with closeness to the violation of
debt covenants (Press and Weintrop, 1990). Therefore, managers in firm under high
leverage tend to do earnings management, for instance select accounting procedures that
increase reported earnings, in order to avoid violation of covenant. In addition,
managers may be motivated to do earnings management to make the firms financial
position and capability look better in the hope of improving their bargaining position, in
case the violation leads to a renegotiation of a debt agreement. Furthermore, high
leverage also may be associated with financial distress. DeAngelo, DeAngelo, and
Skinner (1994) documented that financially troubled companies tend to have large
negative accruals related to contractual renegotiations that provide incentives to reduce
earnings.
Lobo and Zhou (2001), Dimitropoulos et al. (2013), Gul et al. (2003), Chen et
al. (2010), Sun et al. (2011) find that firm leverage influences earnings management.
Third hypothesis is formulated as follows:
H 3 : Firm Leverage has effect on earnings management

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Conceptual Framework

IFRS Adoption

H1

(Independent Variable)
Firm Size

H2

(Independent Variable)
Firm Leverage

Earnings Management

H3

(Independent Variable)

(Dependent Variable)

Absolute Value of Total Accruals

(Control Variable)
Firm Cash Flows from Operating Activities
(Control Variable)

RESEARCH METHODOLOGY
Population and Sample
The population in this research is manufacturing firm listed in Indonesia Stock
Exchange (IDX) in 2010. Manufacturing sector is chosen because there is no similar
research in this sector. In addition, selecting one type of industries minimizes the
difference in characteristics between firms. The technique for sample taken is conducted
with purposive sampling in order to obtain representative sample according to the set of
criteria. That set of criteria is as follows.
1.

Manufacturing firms are listed in IDX in 2010.

2.

Firms completely publish their audited financial statements in 2006-2011, with

date as 31 December.

3.

Firms do not change their accounting period in 2006-2011.

4.

Independent auditors report is published for 2010 financial-statements.

5.

Firms do not get disclaimer opinion from independent auditor.

The following table summarizes the sample selection procedures:

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N
o
1
2
3
3
4

Table 1
Sample Selection Procedures
Criterion
IDX-listed manufacturing firm in 2010
Firm do not publish complete audited financial statements during 2006-2011
Firm do not publish independent auditors report for accounting period of 2010
Firms change accounting period during 2006-2011
Incomplete financial data
Sample selected

Tot
al
129
(8)
(2)
(2)
(15)
102

Operational Definition
1.

Earnings management
This research uses absolute value discretionary accruals to proxy the extent of

earnings management, whether income-increasing or income-decreasing earnings

management. Francis et al. (2005) model for determining discretionary accruals is used
in this research. There are several steps of calculation needed to determine discretionary
accruals using this model:
1. Determine total accrual.
TACC i,t = CA i,t - CL i,t - Cash i,t + STDEBT i,t DEPN i,t ...............(1)
Where:
TACC i,t : Total accruals of firm i in the year t
CA i,t
: Change in current assets of firm i between year t-1 and year t
CLi,t
: Change in current liabilities of firm i between year t-1 and year t
Cash i,t : Change in cash of firm i between year t-1 and year t
STDEBT i,t : Change in debt in current liabilities of firm i
DEPN i,t : Depreciation and amortization expense of firm i in the year t
2. Determine cash flows from operating activities.
CFO i,t = NIBE i,t - TACC i,t ..........................(2)
Where:
CFO i,t
: Cash flow from operations of firm i in the year t
NIBE i,t : Net income before extraordinary items of firm i in the year t
3. Determine total current accrual.
TCACC i,t = CA i,t - CL i,t - Cash i,t +
STDEBT i,t ........................................(3)
Where:
TCACC i,t : Total current accruals of firm i in the year t
4. Determine the residual from total current accrual regression.
TCACC i,t = a 0,i

a 1 CFO i,t-1 + a 2 CFO i,t + a 3 CFO i,t+1 + a 4 REVi,t + a 5 PPEi,t + v i,t

(4)*

*All variables are deflated by average total assets [

Where:
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year t

a 0,
a 1, a 2 , a 3 , a 4 , a 5
CFO i,t-1
CFO i,t+1
REV i,t

: Constanta
: Coefficient
: Cash flow from operations of firm i in the year t-1
: Cash flow from operations of firm i in the year t+1
: Change in current assets of firm i between year t-1 and

PPE i,t

: Change in current liabilities of firm i between year t-1 and

v i,t

: Residual from equation (4)

5. Determine accruals quality.

Accruals quality of firm i for year t is the standard deviation of residuals in
regression (4), calculated over years t-3 through t. Larger standard deviations of
residuals indicate poorer accruals quality. However, if a firm has consistently
large residuals, so that the standard deviation of those residuals is small, that
firm has relatively good accruals quality because there is little uncertainty about
its accruals.
AQ i,t = (v i,t ) ................(5)
Where:
AQ i,t
: Earnings quality
(v i,t )
: Standard deviation of residual from equation (4)
6. Determine discretionary accruals.
First, a regression of accruals quality must be done including innate or nondiscretionary components of accruals quality, which are size, volatility of cash
flows from operating activities, volatility of sales revenue, length of operating
cycle, and negative earnings capitalization. The residuals from regression is the
estimate of the discretionary accruals component.
AQ i,t = 0 + 1 LOGTA i,t + 2 (CFO) i,t + 3 (REV) i,t + 4 OperCycle i,t + 5 NegEarn i,t + u i,t.. .(6)

DAQ i,t = u i,t .........................................(7)

Where:
0,
: Constanta
1, 2 , 3 , 4 , 5 : Coefficient
(CFO) i,t
: Standard deviation of firm i's cash flows from operation
activity in year t deflated by total assets
(REV) i,t
: Standard deviation of firm i's revenue in year t deflated by
total assets
OperCycle i,t
: Log of firm i's operating cycle in year t
NegEarn i,t
: The number of years during years of observation, where
firm i reported NIBE < 0
u i,t
: Residual from equation (7)
DAQ
: Discretionary accrual of firm i in the year t

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2.

IFRS adoption
The IFRS adoption used in this research is a dummy variable. Audit report is

used to identify whether a companys financial statement is prepared using SAK,

including revised PSAK under IFRS convergence program. Therefore, value 1 is
assigned for companies with unqualified opinion and no explanatory about PSAK
compliance exception. Value 0 is assigned for otherwise.
3.

4.

Firm size
Firm size is measured by logarithm base ten of total assets of firm i in the year t:
Size i,t =
LOG[TA i,t]...........................................................................(8
)
Firm leverage
Firm leverage is measured by total liabilities deflated with total assets of firm i

in the year t:

5.

Lev i,t = TL i,t

.......................................................(9)
TA i,t
Firms endogenous power of generating accruals
Absolute value of total accruals from equation (3) is used to control for the

possibility that firms with larger absolute values of total accruals also have larger
discretionary accruals (Becker et al., 1998; Kabir et al., 2010).
6.

Firms operating cash flows

This research uses the absolute value of total accruals from equation (2) to

research controls for firm performance by including absolute value of operating cash
flows in model (Dimitropoulos et al., 2013; Van Tendeloo and Vanstrelen, 2005)
Analytical Model
The regression model is used to measure the effect of IFRS adoption, firm size,
firm leverage, and control variable on earnings management as follows:
ABSDACC i,t = 0 + 1 DIFRS i,t + 2 SIZE i,t + 3 LEV i,t + 4 [ABSTACC/TA] i,t +
5 [ABSCFO/TA] i,t + i,t ...................................................(10)
Where:
ABSDACC i,t
: Dependent variable Earnings Management
0
: Constanta
1 , 2 , 3 , 4 , 5
: Coefficients of regression
DIFRS i,t
: Independent and dummy variable for IFRS adoption
of firm i in the year t,
SIZE ,t
: Independent variable for size of firm i in the year t
LEV i,t
: Independent variable leverage of firm i in the year t
[ABSTACC/TA] i,t : Endogenous power of generating accruals as control
variable

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[ABSCFO/TA] i,t

: Absolute value of operating cash flows deflated by

total assets as control variable
: Standard error

i,t

RESULT AND DISCUSSION

Research Result Description
Table 2
Descriptive Statistics
N
Minimum Maximum
Mean
0.2465
1.0000

Std. Deviation

ABSDACC
DIFRS

102
102

0.0013
0.0000

0.038262
0.990196

0.0350009
0.0990148

SIZE

102

10.4530

14.0525 12.050305

0.6597154

LEV

102

0.0943

3.2100

0.616001

0.5377841

ABSTACC

102

0.0015

1.2031

0.082270

0.1278391

ABSCFO

102

0.0002

0.8557

0.123815

0.1328832

From table 2, IFRS adoption should be underscored. Based on average value of

0.99, it can be concluded that most of sample-firms (99%) have already prepared their
financial statement based on IFRS. This may limit a proper statistical relationship
formed between independent and dependent variables.

Table 3
Analytical Model Test Result
Coefficie
nt

Sig. t

Statistical
Significance
?

IFRS Adoption (DIFRS)

0.050

1.443

0.152

No

Size (SIZE)

-0.008

-1.709

0.091

Yes**

Leverage (LEV)

0.027

4.197

0.000

Yes*

Firm Endogenous Power of

Generating Accruals (ABSTACC /
TA)

0.105

3.453

0.001

Yes*

Operating Cash Flows (CFO / TA) -0.043

-1.470

0.145

No

Variable

* Statistically significance at 1%
** Statistically significance at 10%
From table 3, it is shown that IFRS adoption does not have significant effect on
earnings management, while firm size has negative effect and firm leverage has positive
effect, with significance at 10% and 1% respectively. Therefore, hypotheses 1 is
rejected, while hypothesis 2 and hypothesis 3 are supported.
Discussion
1. Effect of IFRS Adoption on Earnings Management

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There are two perspective to explain why IFRS adoption does not have
significant effect on earnings management. From standards change perspective, until the
end of 2010, seven PSAK were revised and effectively implemented under IFRS
convergence program. Several of them are essential for manufacturing firms, namely
PSAK No. 14 Inventory and PSAK No. 16 Fixed Assets. However, not all revised
standards impose significant changes in firms accounting practices and therefore
explains why IFRS adoption does not has effect on earnings management for year 2010.
The rest of this section presents discussion of the revised standards under IFRS
convergence in order to better explain the research finding.
PSAK No. 16 (2007) Fixed Assets is adopted from IAS 16 (2003) and
supersedes PSAK No. 16 (1994) Fixed Assets and Other Assets and PSAK No. 17
Accounting for Depreciation, effective on January 1st, 2008. The significant change
in this revised standard is firms are able to choose revaluation model to measure fixed
assets. Prior revision, firms were required to use only cost model. Occasional
revaluation was permitted and had to comply with taxation regulation. However, all of
firms in sample chose to use cost model rather than switch to revaluation model when
PSAK No. 16 R2007 was first implemented. In addition, only 2 out of 102 sample firms
chose to switch to revaluation model in 2010. Therefore, change in this standard does
not impose significant change in accounting policies and discretionary accruals earnings
management.
PSAK No. 14 (2008) Inventory is adopted from IAS 2 (2003) supersedes
PSAK No. 14 (1994)Inventory effective on January 1st, 2009. The significant change
in this revised standard is firms are no longer able to use Last-In-First-Out (LIFO) for
cost-flow assumption. However, all of sample firms did not use LIFO before transition
date (2008). Therefore, change in this standard does not impose significant change in
accounting policies and discretionary accruals earnings management.
PSAK No. 13 (2007) Investment Property is adopted from IAS 40 and
supersedes PSAK No. 13 (1994) Accounting for Investment effective on January 1st,
2008. Before revision, investment property is part of the PSAK no. 13 (1994), and has
to use cost model as accounting policy. Under PSAK No. 13 (2007), firms are able to
choose fair-value model aside from cost model. There are two sample-firms choosing
fair-value model while the rest use cost-model as accounting policy for investment
property.
PSAK No. 26 (2008) is adopted from IAS 23 (2007) and supersedes PSAK 26
(1997) effective on January 1st, 2010. PSAK No. 26 prescribed accounting treatment
for borrowing costs. There is no significant change about accounting policies in the
revised standard. PSAK No. 26 (2008) delivers additional paragraphs and sentences that
help users to have better understanding about the standard.
PSAK No. 30 (2007) Leasing is adopted from IAS 17 (2003) and supersedes
PSAK No. 30 (1994) Leasing effective on January 1st, 2008. The significant change
in this revised standard is the determination of whether an arrangement is, or contains a
lease. PSAK No. 30 2007 requires firms to focus on economic substance of
arrangement, rather than legal form. A lease that transfer substantially to the lessee all
the risks and rewards incidental to ownership of the leased item is classified as a
financial lease. A lease which does not transfer substantially all the risks and rewards
incidental to ownership of the leased item is classified as an operating lease. PSAK No.
30 (2007) also requires financial lease recognized as asset and liabilities in lessees
statement of financial position at fair value of leased asset or present value of minimum
lease payment, which one is lower. This is different with PSAK No. 30 (1994) which
only states about present value of total lease payment plus present value residual value.
In addition, PSAK No. 30 (2007) requires firms to have more disclosure related lease

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transactions. Based on observation, many firms in audited financial statements disclosed

that this revision does not impose significant change in financial reporting.
PSAK No. 50 (2006) Financial Instruments: Presentation and Disclosure is
adopted from IAS 32 and supersedes the presentation and disclosure requirements of
PSAK No. 50 (1998) Accounting for Investment in Certain Securities and PSAK No.
55 (R1999) Accounting for Derivatives and Hedging Activities. PSAK No. 55 (2006)
Financial Instruments: Recognition and Measurement is adopted from IAS 39 and
supersedes the recognition measurement requirements of several other standards. Both
PSAK No. 50 (2006) and PSAK No. 55 (2006) are effectively implemented on January
1st, 2010. Both of this revised standards imposed significant changes in firms. Prior to
2010, financial instruments are classified into trading, held-to-maturity, available for
sale. Start from 2010, financial assets are classified into financial assets at fair value
through profit or loss, loans and receivables, held-to-maturity investment, and/or
available for sale financial assets. Financial liabilities are classified into financial
liabilities measured at fair value through profit or loss, loans and borrowing, or
derivatives that are designed as hedging instrument in an effective hedge. Each
classification has different accounting treatment, including recognition and
measurement. These standards impose change in sample-firms accounting policies on
different magnitude depends on the number of financial instruments in assets and
liabilities.
In general, seven revised PSAK under IFRS convergence program do not
impose significant change in firms accounting policies and therefore this explains why
IFRS adoption does not have effect on earnings management for year 2010.
From statistical perspective, the independent variable IFRS adoption has lack of
variance, as the descriptive statistics of this varible show that only one out of 102
observations has value of zero. Lack of variance in the varible causes statistical
relationship between IFRS adoption and earnings management is not properly formed or
in other words result in insignificant relationship.
2.

Effect of Firm Size on Earnings Management

The negative relationship between firm size and earnings management can be
explained based on several arguments. As firms go bigger in size, they have more
capability to maintain an efficient internal control system and good corporate
governance, from procedures, monitoring, to competent internal auditor staffs (Ball and
Foster, 1982). Efficient internal control system and good corporate governance helps
control inaccurate financial information to the public, including inaccurate information
originating from earnings management. Therefore, larger firms are more likely
associated with less earnings management.
Large firms have usually grown up with a history during which they have
established their credibility and social responsibility in business community and in
market, including the credibility and accountability of financial information reported. In
addition, large firms also tend to attract more attention and scrutiny from investors,
analysts, creditors, and other stakeholders (Durnev and Kim, 2005). Therefore, it is a
concern for managers in large firm to maintain firm and their own reputation and it
motivates them to less engage in earnings management.
This result clarifies the finding of Gul et al. (2003), Siregar and Utama (2006),
and Handayani and Rachadi (2009), stating that there is negative relationship of firm
size on earnings management.
3.

Effect of Firm Leverage on Earnings Management

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Research result agrees with debt covenant hypothesis of positive accounting

theory, which explains the positive relationship of levels of firm leverage on earnings
management. As firm chooses to use leverage, managers actions are limited to meet
covenant of debt. Debt covenants are intended to restrict managers from engaging in
investment and financing decisions that reduce the value of creditors claims. These
covenants are frequently based on accounting information. In case managers violate the
covenant, firm incur additional cost of penalties, which may be substantial if the firm is
highly leveraged. Debt covenant hypothesis states that managers will engage in earnings
management, in way of choosing income-increasing accounting policies, in order to
reduce the likelihood of violating covenant. Managers in highly leverage firm will
engage more in earnings management in order to avoid expected high cost of violation.
Furthermore, even if earnings management cannot prevent the violation of covenant,
managers are still likely to make income-increasing accounting choices in the hope of
improving their bargaining position in case the violation leads to a renegotiation of a
debt agreement.
In addition, agency problem in agency theory can be used to explain the positive
relationship. Restructuring in management structure is one of the consequences of
violating debt covenants. Managers in leveraged firm find it is more advantageous to do
earnings management, such as shifting future income to present, to create image of I
am doing good actually in order to avoid losing their jobs or position arising from
restructuring, although it can misled capital providers.
This result clarifies the finding of Gul et al. (2003) and Chen et al. (2010),
stating that there is positive relationship of firm leverage on earnings management.
CONCLUSION
This research investigates whether IFRS adoption, firm size, and firm leverage
have effect on earnings management in Indonesia manufacturing-firms. Earnings
management is identified using absolute value of discretionary accruals, measured with
Francis et al. (2005) model. Based on a sample of 102 manufacturing firms listed in
Indonesia Stock Exchange for year 2010, results show that IFRS adoption in Indonesia
does not have effect on earnings management, while firm size and firm leverage have
effect on earnings management. Furthermore, results show that firm size has negative
effect on earnings management, means larger firms engage in less earnings management
and highly leveraged firms engage. Results also show firm leverage has positive effect
on earnings management, means highly-leveraged firms are associated with more
earnings management.
This research has limitations. Lack of variance in independent variable IFRS
adoption causes the statisctical relationship between independent and dependent is not
properly formed. Second, this research relies on independent auditors on firms
financial statements. Specifically, this research relies on phrase in conformity with
accounting principles generally accepted in Indonesia. This phrase not only includes
SAK and ISAK (Intrepretation of SAK), but also generally accepted accounting
treatment in particular industry which may not necessarily in conformity with SAK.
This research can not distinguish well which sample-firms use outside of SAK
accounting policy, and use generalization from specific identification in sample-firms
notes of financial statement to indetify whether any outside SAK accounting policies
generally used in industries
The findings of this research provides new insight about the effect of IFRS
adoption to earnings management in Indonesia for year 2010, since there is no research
purposing to find the effect. In addition, this research also empirically confirm the effect
of firm size and leverage on earnings management. Furthermore, this research findings

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suggest the accounting and auditing standard setters in Indonesia about the effect of
IFRS adoption, firm size, and firm leverage on earnings management for year 2010,
which are useful to be taken into consideration in the policy-making process.
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