Evidence of Earnings Management from the Provision for Bad Debts

Our paper examines whether managers manipulate earnings. We begin by modeling how a specific accounting number, the provision for bad debts, would be reported in the absence of earnings management. This model is motivated by generally accepted accounting principles (GAAP): the provision should ensure that net accounts receivable represents management’s expectation of future collections. We refer to the difference between the reported provision and the measurement specified by GAAP as a discretionary accrual and use our model to develop a discretionary accrual proxy. To test for earnings management, we divide our sample into partitions where the behavior of this discretionary accrual is predicted by various earnings management hypothesis.