More Researchers Find that CAEs Are Often Deployed to Meet Earnings Estimates

Yet another academic study highlights the potential abuse of changes in earnings estimates (CAEs).In Do Firms Time Changes in Accounting Estimates to Manage Earnings?, Philip Keunho Chung (Christopher Newport University), Marshall A. Geiger, Daniel Gyung Paik, and Collin Rabe (the later three at the University of Richmond) find that 28.1 percent of income-increasing CAEs occur in quarters where reported earnings would be below forecast, but for the CAE. They also find that income-decreasing CAEs are more likely to occur when pre-CAE earnings are relatively high “as a way to either smooth earnings or to ‘bury bad news’” or when pre-CAE earnings are already low, “as a way to take a financial ‘big bath’ and position the firm for positive future earnings. ”These findings are consistent with other studies of CAEs. See Accounting Quality Alarm Bell: Changes in Accounting Estimates, August 2021 Update. As noted in the August 2021 Update, audit committees should make sure that they understand management’s basis and motivation for any CAEs and the rationale for their timing.