Research On The Relevance Between Internal Control Index And Earnings Management

Recently, financial scandals occurred in succession in several major companiesin America. In2002, the financial fraud of Enron Corporation made a stir throughoutthe world, after which financial scandals of WorldCom and Xerox Corporation wereexposed. China is no exception. Fraud case of Lantian Securities, financial fraud ofGuangxia (Yinchuan) Industry Company Ltd, Wong Kwong Yu Incident of GOME,and melamine incident in China’s dairy products all put us into reflection. Thesuccessive incidents related to earnings management in domestic and foreign listedcompanies reflected that inner control was a weak link in listed companies. COSOCommittee has issued a series of related documents in which five factors and theaimlessness of inner control were improved and revised to strengthen inner controlfrom1992to2013. At the same time, inner control in Chinese companies has alsobecome more and more mature.Earnings management will influence the reliability of financial reports,misleading the users of the reports make incorrect decisions, which will harm theinterests of stakeholders. One of the five aims of internal control is to ensure thereliability of financial reports. Then, in China, will reasonable internal control preventearnings management from occurring? Will earnings management be discovered intime and be remedied? The author will do researches on these problems.Data of listed companies (excluding ST and financial companies) in A sharemarket in2012were taken as a research sample in this paper. In the evaluation ofinternal control, the index was composed of quantitative and qualitative indicators byprincipal components analysis according to the five aims of inner control. Metrics ofdependant variable which was earnings management here were analyzed by profitanalysis. Jones Model was used to regress the DA of discretional accrued profits,and the absolute value of DA represented the level of earnings management of acompany. Then regression model was used to examine the relationship betweeninternal control and earnings management. Twenty second-class indexes under fivefirst-class indexes were summed to obtain the internal control index to be used in therobustness test. The result turned out that in China internal control could effectively inhibit the earnings management of accrued items. Meanwhile, four controlledvariables in corporate governance were chosen in this paper. In the regression, it wasfound out that only the scale of the board of directors inhibited the earningsmanagement to a certain extent. From this point of view, corporate governance couldjust slightly inhibit the earnings management. According to this, this essay presentstwo suggestions:(1) Companies must publish internal control audit result.(2)Encourage related scholars to study the internal control, which can take shape aninternal control index system.The reason why this paper is creative is that it is started with the aims of innercontrol, and data base and data collected manually are combined. When getting theinternal control index, the author considered almost all aspects, so the index couldobjectively reflect the inner control of a corporation.