A Study About The Impact Of The Use Of Fair Value On Earnings Management

With the deepening of the market economy and the quickening globalization, a variety of financial products and derivative financial products emerge in an endless stream. Fair value is the only measurement attribute of the derivative financial instruments. Moreover, the rapid development of economy makes the historical cost can’t meet the requirements of stakeholders. Dual measurements model that including historical cost and fair value, is a necessary choice in financial accounting, which indicates more extensive use of fair value in financial accounting measurement.Against the background of international convergence, Chinese accounting standards reintroduced the fair value measurement in2006.Nowadays, among the38specific accounting standards issued by the Ministry of Finance,18specific accounting standards refer to the fair value. In June2009, the Ministry of Finance and accounting department released letter, seeking opinions on the fair value measurement (Draft) released by the International Accounting Standards Board. In May2012, the Ministry of Finance issued the accounting standards for "Enterprises no.X-fair value measurement (draft)", seeking advice from the community. Enterprise Accounting Standards No.39-fair value measurement was enacted in January2014, which will take effect from July,2014. As Chinese capital market is imperfect and the particularity of the socialist market economy led to many problems in the use of fair value in practice. The manipulation of the profits in the use of fair value is quite common. For example, Financial Street Holdings Co.,Ltd. earned2.2billion yuan, of which the floating surplus of fair value accounts to30%.ZTE turned loss into gain by translating the fixed assets into investment real estate. Gemdale Co.LTD changed the measurement attributes of its investment real estate from the cost pattern to the fair value pattern, leading to the floating surplus up to77.38%of the net profit.High quality of internal control can effectively inhibit earnings management, while the internal control standard system in our country establishes late. The Ministry of Finance and Securities Regulatory Commission, the Audit Commission, China banking regulatory commission and China insurance regulatory commission jointly issued the basic standard for enterprise internal control in May2008, and issued "Internal Control Guidelines" including the evaluation of internal control guidelines, audit of internal control guidelines and18application of internal control guidelines. These constitute the internal control standard system in our country. It remains to be seen whether our country’s internal control system can effectively restrain the management using fair value to earnings management.Based on the background of the promulgation of the accounting standards for enterprises and the establishment of the internal control standard system in our country, this paper collects the data of the listing corporations from2009to2012, to analyze the impact of the use of fair value on earnings management. And on this basis, this paper further studies on whether the impact of the use of fair value on earnings management is distinct under different level of the internal control. Hope this research can help the regulators have further understanding about the impact of the use of fair value on earnings management and provide reference in improving the internal control standard system. Thereby, regulate the use of fair value in our country.This paper is divided into six chapters, and the content and structure of each chapter are as following:Chapter1:introduction. It explores three issues. The first one is the analysis of background and study meaning; the second is framework and main contents of the article; and the last one is the analysis of methods and the contribution. This chapter mainly introduces the background and the overall framework of this chapter, in order to lay a good foundation for the following chapters.Chapter2:literature review. Firstly, the author sorts out the connotation of the core concepts, including fair value, earnings management and internal control. Then, the author reviews the related research on fair value and earnings management, internal control and earnings management, as well as the relationship among the fair value, earnings management and internal control. The paper recapitulates these literature reviews in order to provide reference for the following analysis.Chapter3:theoretical analysis. By analyzing the impact of fair value and internal control on earning management separately, as well as the relationship between internal control standard system in our country and the use of fair value, the author analyses whether the impact of the use of fair value on earnings management is distinct under different level of the internal control. On the basis, the article puts forward the research hypothesis.Chapter4:empirical research design. This part starts with presenting the data sources and sample selection. Then there goes the analysis on the measurement of earnings management and the identification of internal control deficiencies. In the end of this part, the paper introduces the empirical model and variable design.Chapter5:empirical analysis and the research conclusion. It’s the core part of the paper and begins with the analysis on the impact of the fair value on earnings management by the method of empirical analysis. Taking the factors of internal control into account, the paper further studies on whether the impact of the use of fair value on earnings management is distinct under different level of the internal control. In the following, in order to re-examine the regression results, there is a robustness test and case analysis. Finally, put forward the conclusion of the research.Chapter6:policy proposals and future prospects. This is part starts with putting forward the policy proposals on the basis of the conclusions above, and then presents the shortcomings of this paper. Finally, it points out the prospects for further studies.Through the research, the paper draws the following conclusions:(l)The management use fair value to make the earnings management is common among listed companiesThe research demonstrates the existence of the management using fair value to make the earnings management, In detail, there are three accounts that have significant positive correlation with earnings management, including investment income, asset impairment loss and non-operating income. Besides, there is no significant correlation between the profit and loss arising from fair value changes account and earnings management. Due to the imperfect market and incomplete laws and rules, use of fair value in these three accounts provides lager range of earnings management.(2) The level of internal control changes the impact of the use of fair value on earnings managementFirstly, compared with the listed cooperation existing no internal control deficiencies, those existing internal control deficiencies have a higher level of earnings management. It indicates that internal control deficiencies could indulge the earning management behavior, while good internal control narrows manipulation range of earnings management, decreasing the level of earnings management.Secondly, after taking the factor of internal control into consideration, the research on the impact of the use of fair value on earnings management proves that the impact of the use of fair value on earnings management is distinct under different level of the internal control. Detail statement goes following:According to the list companies with no internal control deficiencies, the good internal control can norm the recognition and measurement of asset impairment loss, resulting in insignificant positive correlation between this account and earnings management. However, the internal control standard system in our country is still imperfect, and cannot narrows manipulation range of earnings management using investment income and non-operating income. Thus, these two accounts still have significant positive correlation with earnings management.According to the list companies with internal control deficiencies, the accounts including asset impairment loss and earnings management still have significant positive correlation with earnings management. Although investment income and non-operating income still have positive correlation with earnings management, but the relationship is not significant, which indicates that companies with internal control deficiencies prefer to use asset impairment loss to manipulate profit.The innovations of this research mainly contain the following two points:(1) From a new perspective, this article will fill the gap of the research on fair value and earnings managementThrough the related literatures, it can be seen that there are many literature on fair value and earnings management are many, but few discuss the impact of the fair value on earnings management from the perspective of internal control. Besides, a large number of studies show mat high-quality internal control has inhibitory effect on earnings management. However, the internal control standard system in our country is still imperfect, especially on the norms of fair value. Whether it’s capable of inhibiting the earnings management behavior by using fair value or not need further study. By dividing the listed companies into two parts depending on whether existing internal control deficiencies, this paper further studies on the impact of fair value on the earnings management, which can deepen the study on this field.(2) The article supplements the evidence of earnings management by using specific accountsAmong the empirical study on the impact of fair value on earnings management, most researches are based on one account in the application of fair value, and few depend on several specific accounts, for example, analyzing the impact of asset impairment loss on earnings management. This means that future research in this area is quite broad. This paper, by using four typical accounts to represent the use of fair value, helps to replenish the study on this aspect. Besides, it’s useful for the standard setters to get better understanding of what account relating to the fair value are being a good specification, while what account is more likely to become the means of earnings management, In another word, it’s helpful for the regulators to have a more clear understanding of what criteria works and what criteria needs further improvement and improvement. Thus, it’s helpful to promote targeted improvement accounting standards and internal control system and further standardize the use of fair value.