Income Smoothing Using Reserve Accounts By Japanese Companies

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Wikil Kwak
Ho-Young Lee



This paper examines income-smoothing by Japanese firms using several reserve accounts. Previous studies investigated the incentives for Japanese managers to smooth income using sales of assets, discretionary accounting accruals or depreciation charges under different operating environments. Discretion in reserve accounts as a means of income-smoothing, however, has not yet been investigated. Understanding Japanese managers’ earnings management via reserve accounts is particularly interesting because of the unique legal environment for reserve accounts. We find that income-smoothing via reserve accounts is associated with size, tax, capital intensity, operating deviations, leverage, earnings variability, and securities offerings. When we partition the sample to take into account the substantial structural changes in Japan in 1990, the effects of several variables appear to be different over the two periods.


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