Accounting Quality and New Accounting Standards in Mainland China-Empirical Evidence on Earnings Management of Listed Firms

On February 15, 2006, the Ministry of Finance of the People's Republic of China formally announced the issuance of Accounting Standards for Business Enterprises ("ASBEs"), a new set of IFRS-based accounting standards, representing a stage in the efforts of China to move towards a single set of high quality, globally accepted accounting standards. It has been over four years since ASBEs became mandatory for listed Chinese enterprises on Jan.1, 2007. To find out whether the accounting reform has brought about a higher level of accounting quality, we compared earnings management of listed firms in the post-reform period and the pre-reform period. We base our metrics for earnings management on the variance of the change in net income, the ratio of the variance of the change in net income to the variance of the change in cash flows, the correlation between accruals and cash flows, and the frequency of small positive net income. Generally, we find that firms exhibit less earnings smoothing and less management of earnings towards a target in the post-reform period, indicating an apparently higher quality of earnings with the application of ASBEs.