The Relationship between Absorption Cost Accounting and Real Earnings Management within the Companies Listed on Tehran Stock Exchange

Nowadays performance of firms is one of the topics of interest for investors and managers. Proper performance of the company attracts potential investors and creditors. Evaluation of the performance, ability to measure profitability and management efficiency in the utilization of available resources in order to make profit, and financial ratios return on assets attract the attention of investors with regards to companies. Therefore, a study of effective factors on the return of assets as a criterion of company performance evaluation is important. The necessity of the use of absorption cost for inventory valuation and calculation of cost of goods sold influences the performance of firms by changing the levels of production, especially overproduction. In absorption costing method, firms allocate manufacturing overhead between ending inventory and cost of goods. So overproduction through the absorption of fixed manufacturing overhead costs to inventory that remain unsold at the end of the period leads to transferring these costs to future periods as well as the creation of a temporary increase in profitability in current period. Thus, overproduction can be used as an important tool for real earnings management to manipulate earnings and companies’ performance. On the other hand, it seems that the higher level of fixed manufacturing overhead costs would produce more incentives for overproduction and earnings managements tend to carry greater amounts of fixed overhead costs of the current period to future periods in order to avoid losses of their companies and influence their reported earnings. Thus, the fixed manufacturing overhead costs are important factor in motivating companies to overproduce, and provide a lot of evidence about the motivations and consequences of earnings management. Therefore, the main objective of this research is to review the relationship between absorption costing and real earnings management. Research Hypothesis: In this study, two hypotheses are discussed in order to study the effect of overproduction and fixed overhead costs of the current period performance on the current and future performance of the companies. 1. Overproduction and fixed manufacturing overhead costs have a significant relationship with the current period. 2. Overproduction and fixed manufacturing overhead costs have a negative and significant relationship with the performance of future periods. In this study, 90 industrial companies listed in Tehran Stock Exchange have been examined over the years 81-90. In order to determine the proper estimation models and based on the type of data (combined data) the Hausman and Chow tests as well as multiple regression analysis were used to test the hypotheses. Statistical methods used included the T- Student and Fisher's F statistic and the adjusted coefficient of determination. The results of testing hypotheses suggest that overproduction and the fixed manufacturing overhead costs impact current performance (as measured by ROA) positively and future performance (as measured by ROA) negatively. Also, the results and findings of this study suggest that overproduction is opportunistic and done with the intention to mislead stakeholders.