Introducing an ethical dimension into the earnings management decision

Managers routinely make accounting choices that affect earnings and not all of these choices are contrary to GAAP. However, accounting choices not contrary to GAAP are not necessarily ethical decisions. Unquestionably, it is unethical to make accounting choices that are intended to mislead or defraud stakeholders. This study is motivated by the significant losses suffered by investors in companies electing to engage in questionable accounting practices. It is further motivated by the report of The National Commission on Fraudulent Financial reporting (1987), in which they concluded that earnings management decisions that are not contrary to GAAP tend to lead to later decisions that attempt to defraud stakeholders.; The objective of this study is to examine the determinants involved with earnings management behaviors. It was first designed to determine whether an individual's ethical ideology affected the earnings management decision. Second, it was designed to examine whether an individual's level of professional commitment affected the earnings management decision. Third, it was intended to observe whether the presence of a personal benefit affected both ethical orientation and the level of professional commitment.; Using a sample of 145 accounting students and 230 non-accounting students from one large mid-Atlantic university and two smaller mid-Atlantic colleges as proxy for entry-level managers, the current study proposed a causal model to assist in explaining an individual's judgment with respect to ethical dilemmas in accounting/management. As in prior studies (Shaub, Finn and Munter 1993; Douglas and Wier 2000; Elias 2002), the results of this research indicate a significant relationship between an individual's ethical orientation and their ethical judgment. It was empirically supported that individuals with a higher level of professional commitment would be less likely to engage in earnings management practices while their counterparts, individuals with a lower level of professional commitment, would be more likely to engage in earnings management practices, which is consistent with the previous literature.; The addition of the benefit manipulation in this study resulted in a fluctuation in both the ethical position and the level of professional commitment of the individual. This suggests that, when the opportunity to increase personal wealth presents itself, the "temptation" to act on that ability is negatively associated with an individual's ethical orientation as well as their level of professional commitment. Finally, the results of this study support the hypothesis that the decision to engage in earnings management practices is not determined by the position an individual holds in the company.; The results of the study are important to regulators, accounting standard setters, managers, practitioners, investors, analysts, and researchers. The results should provide a better understanding of the significance of ethical orientations in earnings management behaviors, thereby providing insight into the use of codes of ethics to reduce earnings management practices.