JOURNAL OF ECONOMICS, BUSINESS, & ACCOUNTANCY Accreditation No. TopDTKTI-KeO ~— Ventura Published by: Center for Research and Community Services (PPPM) In Cooperation with the Association of Commercial Banks in East Java (Perhimpunan Bank-Bank Umum Nasional Jawa Timus-Perbanas Jat) Eaitor-in-Chiet Djuwari Editorial Board Tatik Suryani Sri Hanya §, R. Wilopo Subartono Lut? ‘Yudi Sutarso Abdul Mongid Sasongko Budisusetyo Luciana Spica Almilia Pepie Diptyana Emma Yolianti Management & Publishing Team Sri Lestari Kurniawati Chitra Laksmi R Secretariat, PPM STIE Perbanas Surabaya J. Nginden Semolo 34-36 Surabaya, 60118 Phone : +62 31 5992985, $947151/S2; Fax. ~62 31 5902985, 5935937 e-mail : ven @ yahoo.com, ventura@perbanas. acid Published quanerty (Apel, August and December) Editors receive article of research, conceptual analysis, and book analysis on Economics, Business and Accountancy. The articles should be original, not refecting the editors’ opinion. The authors must be responsible for the content ofthe articles published in this journal. Editors deserve to receive, decline and edit the articles without changing the main ideas.Journal of Economics, Business and Accountancy Vestura Volume 4, No. 1, April 2011, pages 59-78 “Accreditation No. 110/DIKTH/Kep/2000 ‘THE THEORETICAL CONSTRUCTION OF INCOME SMOOTHING MEASUREMENT Alwan Sri Kustono Jember University E-Mail: alwankustono@yahoo.com ‘Tegal Besar Permai 2-E1 Jember,Propinsi Jawa Timur,Indonesia ABSTRACT The income smoothing is a dimension of the accounts manipulation theme that has been at- tracting @ great attention in the accounting literature. A goal of manipulation widely as- cribed fo managers is the desire to smooth. Reporied income, Income smoothing reflects re- ducing the possible income fluctuations so as to make it as stable as possible throughout the ism. Almost of income smoothing research in Indonesia used Eckel’s index 10 clasify ‘smoother non smoother firms. Empirical evidences have provided support for the existence of an income smoothing behavior. The studies showed inconsistent about factors determining this smoothing. The purpose of the present investigation is twofold. First, we seek to deter- ‘mine if Eckel index is a reliable instrument to measure income smoothing behavior. Second, ‘we pretend to identify the new instrument to measure incidence of income smoothing. Our research sample comprises manufacturing companies listed on the Indonesia Stock Ex- change, over period of 1999-2008. This study confirms Eckel's index is not reliability instru. ment. The new proposed index quantifies the incidence of income smoothing without depend ‘on n periods. The results imply that researchers should re-examine the conclusion of previ- ‘ows studies, particularly that determinant, factors and effect of income smoothing practices. Key words: income smoothing, Eckel's index, coefficient of variation, reliability. INTRODUCTION of the practices of accounting manipulation Ithas been noticed that income statement isis income smoothing. considered as one of the statements to be In connection with the pursuit of analyz presented in financial reporting. For that rea- ing income smoothing in the companies, son, the company’s eaming is considered some definitions of it can be inferred, First vital information for it can be used to meas- of all, income smoothing is defined as the lure the corporate performance. In other emphasis on the fluctuations in income lev- ‘words, information of the earning can be els that are considered normal for the com- uused to assess the performance or account- pany (Bamea et al., 1976). For another ability of management and also predict the thing, Beidleman, (1973) defines income ability of companies in the effort of contrib- smoothing as the management efforts to re- tuting to the following earning. duce abnormal variations in the eaming 10 In general, eaming reporting is fie- the extent permitted by the principles of quently not free from the accounting ma- good manegement and accounting. Income nipulation. Yet it appears different from the smoothing in such instances, is as a tool fraudulence. Accounting manipulation can used by management to reduce the variabil- be still in tolerant when it is put in the ac- ity of reported income stream relative to the ‘counting rules. In contrast, fraudulence prac- target which is intentionally smoothed by tices tend to be against the rules and ac- using artificial or real variable. In addition, ‘counting standards. Thus, itis delicately dif income smoothing is one-dimensional ma- ferent from income smoothing. In fact, one nipulation of accounts that attract the atten- 39ISSN 2087-3735 tion of many accounting literature in the realm of eamings management, Beside, in- come smoothing reflects the concern 10 re- duce the possibility of fluctuations in income by making a steady flow Research on income smocthing in Indo- nesia generally examine several factors which are allegedly to motivat= management to do income smoothing. They identify the existence of such practices and followed by testing management motivation. The results of these studies have identified those most public companies in Indonesia have con- ducted income smoothing. All in all, most of the studies are uniform in terms of inferring the end results, Testing the triggering factor of income smoothing policy by the company manage- ment has not consistently been recovered Among the results of such studies are often inconsistent to onc another. For example, ‘Kustonc (2010) stated that the inconsistency of their findings was caused by the measur- ing devices. These devices are thought to be unreliable. For example, Index Eckel does not have the ability to capture the practice of income smoothing between periods. In that situation, it shows that some companies are classified by grading only in one particular year. This is considered to have deviated from the definition of income smoothing ‘The classification based on Eckel index for one company may also change because Of changes in the petiod used to determine the coefficient of variation, Change of clas- sification shows that the index is not reliable as a tool, In other words, Eckel is as an iden tifier of smoothing and not merely for smoothing. Kustono (2010) asserted the idea of the need for new instruments. This re- search is intended to correct weaknesses of the Eckel and construct an index measuring instrument which is more reliable income smoothing factor. This construction is very important because the use of measuring ine strument error will cause errors either in the ‘phase of conclusions related to the classifi cation of sample or the determinants and impact of such classification. 60 ‘The Theoretical Construction... (Alwan Sri Kustono) THEORETICAL FRAMEWORK It is a fact that income smoothing becomes a phenomenon which has been often proved in some previous studies. This practice has been investigated through various levels of different samples. Furthermore, income smoothing is considered to be an important factor, Research by Moses (1987) and Atik & Sensoy (2005) shows that at least 60% of the sample used in the study can be classi- fied as smoothing the company carnings. Another proponent, such as Bamea et al. (1976) classified accounting income smooth ing as intertemporal smoothing and classifi- cation, Inter-temporal smoothing is based on the situation when cost and expenses are recognized and smoothing classification is done with the classification under ordinary cost and extroordinary one in which the of- inary post finally becomes flat. Eckel (1981) distinguishes between in- come smoothing as a natural smoothing and intended smoothing. Natural smoothing is the alignments resulting from transactions that inherently produce a smoothed earning. In other words, the company's operations 10 generate income by collecting revenues and expenses are inherently to eliminate fluciua- tions in income flows. In other words, the process of generating income itself generates 4 steam of smoothed income. Alignment ‘occurs without the intervention of any pay. Income smoothing is accidentally ttig- gered by the motivation which is based on the management actions. There are two types of income smoothing: intentional, that is income smoothing of the real intention and the other one is artificial income smoothing, Real income smoothing indicates management actions that seek to control economic conditions that directly affect cor: porate camings in the future. In addition, this real income smoothing affects cash flow. On the contrary, artificial income smoothing ean show manipulation whieh is undertaken by management to smooth the aming. Thus, the action of this manipula tion resulted in a fundamental or economic condition that can affect cash flow, but shifts