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Earnings
Analyzing earnings management management
preferences from business strategies preferences
Golrida Karyawati Purba and Cornelia Fransisca
Universitas Pelita Harapan, Tangerang, Indonesia, and
979
Prem Lal Joshi
Western Regional Centre, ICSSR, Mumbai, India Received 13 April 2021
Revised 20 May 2021
Accepted 25 June 2021

Abstract
Purpose – This study aims to examine the preference for earnings management (EM) strategies according
to business strategies, namely, cost leadership strategies and differentiation strategies,
Design/methodology/approach – This study analyzed 262 samples of manufacturing and service
companies listed on the Indonesia Stock Exchange for the period 2019. Logistic regression analysis is used to
test the company’s EM strategy preferences based on the applied business strategy.
Findings – The results prove that business strategy has a significant effect on EM strategy preferences.
Companies that implement a cost leadership strategy tend to use an accrual form of EM rather than a real
form of EM. Conversely, companies that implement a differentiation strategy tend to use a real form of EM.
Research limitations/implications – Theoretically, this study confirms that contingency theory can
explain EM practice preferences based on business strategy. Practically, this study helps auditors and
financial statement analysts in assessing the quality of financial statements, as well as the risk of financial
misstatement based on the business strategy adopted by the companies.
Originality/value – Based on prior literature, research studies on the analysis of EM strategy preferences
based on business strategy have been limited.
Keywords Earnings management, Cost leadership, Differentiation, Business level strategy
Paper type Research paper

Background
Generally, listed companies tend to practice earnings management (EM) (Zang, 2012; Dinh
et al., 2015; Li, 2019). Previous studies have found various conditions that cause companies
to undertake EM more intensively. Among them is the need for external funds (Zhang et al.,
2020; Ater and Hansen, 2020; Alhadab, 2018; Liu et al., 2010). Ater and Hansen (2020) and
Liu et al. (2010) found that listed companies increase reported earnings ahead of debt
issuance. Alhadab (2018) proved that companies conduct EM around the initial public
offering of equity. Financial distress is also a condition that causes companies to practice
EM intensively (Li et al., 2020; Muljono and Suk, 2018; Campa and Camacho-Miñano, 2015;
Zang, 2012; Graham et al., 2005), which aims to make the company appear to be able to
overcome financial distress problems. Another condition is market competition (Wu et al.,
2015; Markarian and Santalo, 2014). In an increasingly competitive market, good financial
performance reporting is expected to increase the market value of the company, therefore
EM practice is more valued. Firms that appear to be underperforming their competitors
have more incentive to engage in EM.
Journal of Financial Reporting and
Accounting
Vol. 20 No. 5, 2022
pp. 979-993
© Emerald Publishing Limited
1985-2517
JEL classification – M410 Accounting DOI 10.1108/JFRA-04-2021-0103
JFRA EM practices can be distinguished between accrual EM and real EM (Enomoto et al.,
20,5 2015; Zang, 2012; Cohen and Zarowin, 2010; Gunny, 2010; Cohen et al., 2008; Roychowdhury,
2006). The accrual EM is carried out by using accrual accounting flexibility (Zang, 2012;
Badertscher, 2011). At a certain level, the implementation of accruals in the preparation of
financial statements provides an opportunity for companies to make judgments, estimates
and choose alternative accounting methods. On the other hand, real EM is conducted in the
980 form of real activity designed to obtain a certain amount of profit. Generally, real EM
practices affect cash outflow directly (Cohen and Zarowin, 2010; Taylor and Xu, 2010;
Roychowdhury, 2006). However, real EM is more difficult for external parties to detect.
Contingency theory (Vidal et al., 2017; Lathifah, 2014; Heiens and Pleshko, 2011) posits
that the preference for EM practice is contingent upon companies’ conditions. Purba and
Umboh (2021), for example, found that family businesses in Indonesia tend to prefer accrual
EM because EM accruals do not incur costs and family companies have more freedom to do
so. However, findings made by Cherif et al. (2020) and Razzaque et al. (2016) showed that
companies chose a real approach because the probability of being detected is smaller and it
is more flexible in terms of timing of execution.
Business strategy is an important factor to consider in analyzing EM practices. Wu et al.
(2015) concluded that companies implementing cost leadership strategies conduct EM more
intensive compared to companies implementing differentiation strategies. Business strategy
characters shape the conditions and needs of the organization. All policies, including policies
for preparing financial statements, in essence, must lead to business strategies. Therefore,
EM practices must also refer to business strategies (Islami et al., 2020; Wardani et al., 2016).
Based on contingency theory, different business strategies will lead to different EM
practices. Companies that adopt a cost leadership strategy will prioritize efficiency and
minimize expenses. The consequence is the limited use of real EM practices which require
large costs. On the other hand, real EM practices are more freely carried out by companies
implementing differentiation strategies (Ali and Kamardin, 2018; Braam et al., 2015; Zang,
2012; Badertscher, 2011; Cohen and Zarowin, 2010). Researchers (Asih, 2019; Widuri and
Sutanto, 2019; Brigita and Adiwibowo, 2017; Wu et al., 2015) concluded that there is a
relationship between business strategy and EM practices.
So far, there have been limited research studies conducted on the analysis of EM strategy
preferences based on business strategy. Asih (2019) and Widuri and Sutanto (2019), proved
that the differentiation strategy affects real EM practices, but as far as the authors know
there has been no research that analyzes the tendency of companies to choose EM practices,
both accrual EM and real EM, based on the business strategy adopted by the companies.
This study aims to examine the companies’ preference for EM strategies both accrual and
real EM, based on Porter’s business strategies which are: cost leadership and differentiation
strategies. Analysis of the selection of EM practices based on business strategies is
important in particular to assess the risk of financial misstatement based on the adopted
business strategy.

Theoretical framework
Business strategy and earnings management practices
According to Porter (1985), business strategy mainly consists of a cost leadership strategy
and a differentiation strategy. The cost leadership strategy emphasizes cost efficiency to
face market competition (Abdillah et al., 2017; Wibowo et al., 2017; Tanwar, 2013). Cost
efficiency is carried out by controlling the costs of the company’s operational activities. This
strategy tends to avoid activities that incur large costs. Aulakh et al. (2000) stated that the
cost leadership strategy tends to be applied in developing countries, including Indonesia, Earnings
where labor wage rates are lower to minimize production costs. management
The differentiation strategy focuses on the uniqueness that provides added value to a
product or service. The uniqueness offered can be in the form of design, features, technology,
preferences
to customer service so that it can differentiate the product or service produced by the company
from its competitors. Companies that implement a differentiation strategy usually invest
heavily in activities or facilities that support product differentiation such as research and
development activities, employee training and brand building (Abdillah et al., 2017; Wibowo
981
et al., 2017; Tanwar, 2013). Therefore, production costs tend to be high using this
differentiation strategy. Business strategy may be considered an important factor that causes
managers to practice EM (Chung and Choi, 2017; Bentley et al., 2013). Differences in business
strategies: cost leadership and differentiation strategies, can lead to differences in the choice of
EM strategies.
EM is the act of engineering accrual earnings to present the desired company
performance to influence the positive perceptions of users of the company’s financial
statements (Kristanti, 2019; Ahmar et al., 2016). EM practices can be done by using accruals
or through the company’s real activities (Cohen and Zarowin, 2010; Gunny, 2010; Cohen
et al., 2008; Roychowdhury, 2006). Accrual EM is carried out by using the manager’s
discretionary accruals, which is, a condition where managers have the discretion to make
accrual policy choices such as the depreciation method, uncollectible accounts, inventories
and policy estimates in provisions (Khanifah et al., 2020; Bartov et al., 2002). At a certain
level, managers have the flexibility to determine the methods and number of accrual
transactions (Khanifah et al., 2020; Bartov et al., 2002). The accrual EM is usually carried out
through accrual adjustments before the issuance of financial statements. Therefore, this
type of EM has no impact on cash flow (Zang, 2012; Cohen and Zarowin, 2010). Managers
perform accrual forms of EM intending to reducing or increasing profits.
A real EM is a manager’s action to meet profit targets through decisions related to
operational activities or real activities (Ningsih, 2015). The real EM practices are carried out
to produce the desired sales figures, for example, by giving excessive discounts or offering
more flexible credit terms so that sales increase. This action can increase the amount of
profit earned. Real profit management can also be done by increasing or decreasing
discretionary costs to achieve profit targets such as research and development costs,
advertising and marketing, as well as general and administrative costs. The real EM can be
carried out throughout the year and affects the company’s cash flow directly. Previous
researchers (Ali and Kamardin, 2018; Braam et al., 2015; Zang, 2012; Badertscher, 2011;
Cohen and Zarowin, 2010) posited that real forms of EM practices require greater costs than
accrual EM.

Hypothesis development
Contingency theory advises that even the best systems may not be universally applied. A
good system for a company is not necessarily good for other companies because of various
situational factors such as the external environment, technology, company structure and
size, as well as business strategy (Vidal et al., 2017; Lathifah, 2014; Heiens and Pleshko,
2011). Therefore, for the system to be implemented effectively, companies need to identify
situational factors that increase the effectiveness of the system (Costin, 2017; Karsam, 2017;
Soleha et al., 2014; Purwati and Zulaikha, 2006).
A good system should support a business strategy to work effectively in achieving
company goals. Companies should adopt the best system that can run effectively under the
JFRA conditions and characteristics of the company. Bozkurt et al. (2014) stated that company
20,5 executives tend to adopt systems that support the implementation of business strategies.
Business strategy is a reference in determining policies regarding the systems and
methods applied in the company (Islami et al., 2020; Wardani et al., 2016), including policies
for preparing financial statements. Business strategy determines the preferences of
managers in selecting appropriate EM methods that support the implementation of business
982 strategies. Previous research has shown that business strategy affects EM practices (Asih,
2019; Widuri and Sutanto, 2019; Brigita and Adiwibowo, 2017; Wu et al., 2015). EM practices
are not fixed on one method to achieve profit targets (Zang, 2012; Badertscher, 2011). Cohen
and Zarowin (2008) revealed that companies can apply real EM and accrual EM with
different intensities. Therefore, H1 is stated as follows:

H1. Business strategy influences the choice of EM strategy.

Different business strategies lead to different preferences in choosing the EM method to be
used. Real EM practices require greater costs to execute real activities (Ali and Kamardin,
2018; Braam et al., 2015; Zang, 2012; Badertscher, 2011; Cohen and Zarowin, 2010). This type
of EM will be more freely followed by companies that implement a differentiation strategy.
Companies that implement a differentiation strategy rely more on product uniqueness to
generate profits through premium pricing (Krismiaji, 2017). The companies allow spending
even large amounts to produce uniqueness that adds value. In addition, even though it
requires a large amount of money, the real EM is considered to be safer and difficult to detect
by auditors and regulators. Thus, the real EM is more likely to be carried out by companies
that implement a differentiation strategy than companies with a cost leadership strategy.
Previous studies have proven the positive influence of differentiation strategies on real
management (Asih, 2019; Chun and Cho, 2017). When there is an increase in the
differentiation strategy, the intensity of real EM increases (Asih, 2019). However, Widuri
and Sutanto (2019) found that companies with a differentiation strategy that had achieved
competitive advantage would avoid real EM practice because it has the potential to reduce
firm value in the long term.
The cost leadership strategy avoids activities that incur large costs so that the practice of
earning management is more limited to types of EM that do not cause cash disbursements.
Therefore, the practice of accrual EM is more appropriate to be implemented to support the
cost leadership business strategy. Zang (2011) and Wafaretta and Restuningdiah (2020)
prove an inverse relationship between accrual EM and real EM practice. If real EM practice
increases, accrual EM practice will decrease (Zang, 2011). If with real EM practice the profit
target has been achieved, managers avoid using the AEM (Wafaretta and Restuningdiah,
2020). Given the contingency theory, this happens to adjust to company strategy, including
business strategy. Therefore H1 can be extended as follows:

H1a. Companies that adopt a cost leadership strategy tend to use an accrual form of EM
compared to companies with a differentiation strategy.
H1b. Companies that adopt a differentiation strategy tend to use a real EM compared to
companies with a cost leadership strategy.

Method
Research sample
This study examines EM practice preferences based on business strategies. In general,
companies will choose a business strategy that suits the products they produce. The company’s
decision to choose a business strategy either cost leadership or differentiation strategy is a Earnings
well-planned strategic decision. When companies have chosen a business strategy, it is a management
long-term option that has not changed in years. In other words, the business strategy of the preferences
current period had also been adopted in the period before. Therefore, we consider that a
one-year data analysis already provides generalizable results. This study analyzes data for
the period 2019. The samples of this study are companies from various industries such as
manufacturing, trading, investment and service companies listed on the Indonesia Stock 983
Exchange with the sampling screening as presented in Table 1. The banking sector and
other highly regulated industries were excluded from this analysis. The research data were
obtained from S&P Capital IQ.

Research variable
Research variables to be analyzed in this study are earning management preference (EM) as
the dependent variable, both business strategies, namely, cost leadership strategy and
differentiation strategy as independent variables. EM preference is measured by a dummy
variable. The preference for accrual EM practices is given a value “1,” while the preference
for real EM practices is given a value “0.”
This study measures EM using net income variability as has been done by many
previous researchers (Barth et al., 2008; Lang et al., 2006; Leuz et al., 2003; Lang et al., 2003).
Because the research sample is companies from various industries, the variability of NI is
estimated by referring to Barth et al. (2008) which mitigates the confounding effect of the
industry, with the following model:

DNI ¼ a þ b 1 SIZE þ b 2 GROWTH þ b 3 EISSUE þ b 4 LEV þ b 5 DISSUE þ b 6 TURN

þ b 7 CF þ b 8 AUD þ «
(1)

where:
DNI = change in net income scaled by total assets;
SIZE = natural logarithm of end-of-year total assets;
GROWTH = percentage change in sales;
EISSUE = percentage change in common stock;
LEV = year-end of total liabilities divided by end of year total assets;
DISSUE = percentage change in total liabilities;
TURN = sales divided by end of year total assets;
CFO = annual net cash flow from operating activities divided by end of year total
assets; and
AUD = an indicator variable that equals one if the firm’s auditor is big four and
zero otherwise.

Criteria Total

Companies listed on IDX in 2019 348

Incomplete data (49)
Non-Rupiah currency (37) Table 1.
Total observation samples 262 Sample screening
JFRA Considering that all companies practice EM (Li, 2019; Dinh et al., 2015; Zang, 2012), the
20,5 potential for total EM lies in changes in net income. Therefore, formula (1) can be used to
estimate total EM. Barth et al. (2008) and Lang et al. (2006, 2003) derived EM accrual models
based on changes in net income as follows:

ACC ¼ a þ b 1 SIZE þ b 2 GROWTH þ b 3 EISSUE þ b 4 LEV þ b 5 DISSUE

984 þ b 6 TURN þ b 7 AUD þ « (2)

where:
ACC = net income minus cash flow divided by total assets;
SIZE = natural logarithm of end-of-year total assets;
GROWTH = percentage change in sales;
EISSUE = percentage change in common stock;
LEV = year-end of total liabilities divided by end of year total assets;
DISSUE = percentage change in total liabilities;
TURN = sales divided by end of year total assets;
CFO = annual net cash flow from operating activities divided by end of year total
assets; and
AUD = an indicator variable that equals one if the firm’s auditor is big four and
zero otherwise.
As formula (2) shows the potential for accrual EM, therefore, the difference between changes
in net income and accrual EM reflects the potential for a real EM. For this, the proxies for the
real EM can be derived as follows:

REM ¼ DNI  ACC (3)

where:
REM = Real form of earnings management;
DNI = Total earnings management; and
ACC = Accrual form of earnings management.
The independent variable of this study is the cost leadership strategy as measured by asset
turnover (ATO) and the differentiation strategy measured using profit margin (PM)
referring to previous research (Brigita and Adiwibowo, 2017; Wu et al., 2015; Banker et al.,
2014; David et al., 2002), with the following formula:

Asset TurnoverðATOÞ ¼ Total Sales=the average of total asset

Operating Income þ Research and development
Profit MarginðPMÞ ¼
Sales

If the value of ATO is greater than the value of PM, it means that the company can use
resources efficiently, so that the company is considered to be implementing a cost leadership
strategy. Conversely, if the PM value is greater than the ATO value, it means that the
company generates a high-profit margin after investing in research and development (R&D)
activities, thus, the company is considered to be implementing a differentiation strategy.
Brigita and Adiwibowo (2017), Wu et al. (2015), Banker et al. (2014) and David et al. (2002)
assess that the use of financial ratios, namely, ATO and PM, is good for measuring the
company’s business strategy. These financial ratios show more accurate results in
predicting the implementation of business strategies and minimize the perception bias of Earnings
factors that refer to the characteristics of a particular strategy. management
preferences
Empirical model
This study uses logistic regression analysis to obtain an overview of the business strategy
tendencies, namely, the cost leadership strategy and differentiation strategy in choosing the
type of EM. Logistic regression model is a non-linear model and it is used because the 985
dependent variable of this study is a dummy variable, namely, the accrual EM or real EM
category. The focus of this research is not to find a causal relationship between the
independent variable and the dependent variable but to find the tendency of companies to
choose between accrual EM or real EM practices based on business strategies. The research
model for the hypothesis is as follows:

EMP ¼ a þ b 1 ATO þ b 2 PM þ «

where:
EMP = Earnings management preference, dummy variable; 1 if accrual form > real EM
and 0 if otherwise;
ATO = Asset turnover which indicates the implementation of strategy cost leadership in
the company; and
PM = Profit margin which indicates the implementation of differentiation strategies in
companies.
To find out whether the regression model is fit for predicting the relationship among
variables matters, this study tests the goodness of fit of the regression model by using three
model tests, which are: Omnibus test, Hosmer and Lemeshow test and the Nagelkerke R2
test. The testing hypothesis will be done using the Wald test.

Result
Statistic descriptive
Descriptive statistics of the research sample are presented in Table 2. The mean value of
ATO in Table 2, namely: 1.1581 is much greater than the mean value of PM, namely: 7.097.
This means that the cost leadership strategy is implemented by most of the sample
companies. Based on the filter carried out on 262 research samples as presented in Table 3,

Variable n Minimum Maximum Mean Std. deviation

EMP 262 0 1 0.18 0.388

ATO 262 0.33 11.07 1.1581 1.33311 Table 2.
PM 262 174.38 1.33 7.097 10.80721 Descriptive statistic

EMP Business strategy

n Accrual Real ATO PM
Table 3.
262 48 214 252 10 Frequency
18.32% 81.68% 96.18% 3.82% distribution
JFRA there are 252 companies whose ATO value is greater than the PM value and 10 companies
20,5 whose ATO value is smaller than the PM value. Thus, 252 or 96% of the sample
implemented a cost leadership strategy. Therefore, it can be said that the cost leadership
strategy dominates business practice in Indonesia.
Table 2 presents the mean value of earnings management preference (EMP) which is
very far from number 1, namely, 0.18. The mean value comes from 214 companies that tend
986 to practice a real EM and 48 samples do accrual EM, as presented in Table 3. Thus, the
majority of the sample, namely, 82% (214/262) practice a real EM more intensive than the
accrual EM. This finding supports the evidence collected by Purba and Umboh (2021), who
claim that Indonesian companies practice a real EM more intensively.

Logistic regression model robustness test

The logistic regression model of this study has met the requirements of the goodness of fit
model to predict EM strategy preferences based on business strategies, as presented in
Tables 4, 5 and 6.
The results of model testing using the omnibus test are presented in Table 4 showing
that the two independent variables, which are ATO and PM, simultaneously affect the EM
variable. The significance level of the Chi-square value of the omnibus test presented in
Table 4 is 0.000. This value is smaller than the a level of 0.05, which means that
the independent variables in the model simultaneously have a significant effect on the
dependent variable. Thus, the logistic regression model is fit and can be used to predict the
relationship between the independent variable and the dependent variable.
The results of model testing using the Hosmer-Lemeshow’s are presented in Table 5.
Hosmer-Lemeshow’s testing is required in logistic regression analysis to ensure that the
model used is fitted with the observation data. The results of the Hosmer-Lemeshow test in
Table 5 show a Chi-square value of: 14.581 with a significance of: 0.068. This value is greater
than the alpha value: 0.05. This means that the logistic regression model used in this study
is fitted with the observational data, therefore the model can predict the relationship
between the independent variable and the dependent variable from existing observation
data.
The ability of ATO and PM variables as a whole to explain the variance of EMP variable
in the logistic regression model was tested using the Nagelkerke R2 test as presented in
Table 6. The value of the Nagelkerke R2 results in Table 6 is 0.201, which means that 20.1%
of the variance of EMP can be explained from the business strategy variables, namely, cost
leadership and differentiation strategies.

Step Chi-square Df Sig.

Table 4. 1 Step 34.448 2 0.000
Omnibus test of Block 34.448 2 0.000
model coefficients Model 34.448 2 0.000

Table 5. Step Chi-square df Sig.

Hosmer-Lemeshow’s
goodness of fit test 1 14.581 8 0.068
The focus of this research is to explain the preferences of EM practices from business strategies, Earnings
namely, cost leadership and differentiation strategies. This research model has been able to management
reveal the earning management preference from the issue of the business strategy of 20.1%
which is quite significant. Overall, the logistic regression model tests used show that the logistic
preferences
regression model significantly predicts the relationship between Business strategies and EMP.
The logistic regression model of this study is fit in predicting the relationship of ATO
and PM variables simultaneously with the EM variable. The effect of each independent
variable individually on the dependent variable is presented in Table 7. The value of the 987
ATO coefficient in Table 7 is positive 0.716. This value is close to 1, which means that
companies that implement a cost leadership strategy tend to choose an accrual EM strategy.
With a significance value below 0.05, it can be concluded that the tendency of companies
that apply a cost leadership strategy to choose an accrual EM strategy is significant. Thus,
H1a was accepted. Table 7 also presents the probability of EM practice in both business
strategies. The odds ratio or Exp (B) for companies that adopt a cost leadership (ATO)
strategy is 2,046, indicating that the probability of these companies practicing accrual EM is
2,046 times higher than that of practicing a real EM.
On the other side, the results testing the effect of differentiation strategy (PM) on real EM
produce a negative coefficient which is: 0.040. However, the relationship between PM
variable and the real EM variable is not significant. As seen in Table 7, the significant level of
the relationship is 0.452 on the two tails test or 0.226 on the one-tail test, which is very far
above the 10% alpha level. The odds ratio or Exp (B) for companies that adopt a
differentiation strategy (PM) which is 0.961, even proves that the probability of practicing real
EM is smaller than that of practicing accrual EM. Nevertheless, the small number of
companies adopting a differentiation strategy, namely, 10 of the 262 samples of this study,
causes the test results to be less generalizable. However, several previous studies also proved a
negative relationship between differentiation strategies. Widuri and Sutanto (2019), Chun and
Cho (2017) found that companies with differentiation strategies can produce good financial
performance without having to practice real EM. Previous studies revealed that generally,
companies practice these two types of EM with different intensities as suggested by Wafaretta
and Restuningdiah (2020), Achleitner et al. (2014), Chen et al. (2015), Zang (2011) and Cohen
and Zarowin (2008) following the conditions faced.

Discussion
This study advises that companies’ business strategy has a significant effect on the
preference for EM strategies. Companies that implement a cost leadership strategy tend to

Step 2 Log likelihood Cox and Snell R2 Nagelkerke R2 Table 6.

Nagelkerke R2
1 215.091 0.123 0.201 square test

95% C.I. for EXP(B)

Description B S.E. Wald df Sig. Exp (B) Lower Upper

Step 1a ATO 0.716 0.159 20.326 1 0.000 2.046 1.499 2.793

PM 0.040 0.053 0.566 1 0.452 0.961 0.866 1.066 Table 7.
Constant 2.468 0.276 79.898 1 0.000 0.085 Wald test
JFRA practice accrual EM more intensely than the real EM. The results of this study confirm the
20,5 reasons for companies implementing EM accruals because EM accruals do not hurt the
company’s cash flow as stated by Purba and Umboh (2021), Chen et al. (2015) and Achleitner
et al. (2014), respectively.
What is surprising is that although the results of hypothesis testing prove that
companies adopting a cost leadership strategy prefer accrual EM practices compared to real
988 EM practices, the real EM practices are more dominant in the sample companies as
presented in Table 3. The fact that as many as 82.1% of companies implement a real form of
is a very large percentage. What is even more surprising is that the majority of Indonesian
companies implement strategic cost leadership? The results of hypothesis testing and
statistical facts seem contradictory because, statistically, the real EM practices are
dominant.
Mughal et al. (2021), Wafaretta and Restuningdiah (2020), Sohn and Shim (2018) and
Achleitner et al. (2014) provide evidence that accrual EM and real EM can be as substitute
tools for EM. Accrual EM is the most original form of EM. When the opportunity to make an
EM accrual is available without significant risk, the company will choose EM accrual
(Achleitner et al., 2014).
Previous studies revealed the limitations of accrual EM that caused companies to switch
to real EM. At the country’s level, researchers such as Enomoto et al. (2015) and Leuz et al.
(2003), found the importance of investor protection. Companies in countries of high investor
protection are more limited in using accrual EM. The effectiveness of internal controls also
determines EM accrual practice. Researchers such as Mughal et al. (2021) and Sohn and
Shim (2018) revealed that Sarbanes-Oxley Act regulations limit companies from accrual EM
so that the real EM is the best solution.
Firms will also turn to EM estates as companies become increasingly under public
scrutiny. Purba and Umboh (2021) reveal that when the company gets bigger, accrual EM
practices will be easier to detect so that companies will switch to real EM which is more
difficult to detect (Graham et al., 2005; Zang, 2012; Roychowdhury, 2006). According to
Banker et al. (2014) companies with differentiation strategies are more confident in doing
real EM when these companies have sufficient resources.
Thus, the company will carry out EM accruals whenever possible, but when conditions
do not allow the company, it will switch to real EM although a real EM can be expensive.
companies will choose real EM as the last choice. In the end, EM practices are contingent
upon the conditions at hand as stated by contingency theory.

Conclusion and implications

The results of this study reveal that the business strategy adopted by the company can be
used as a reference for estimating EM practices. Companies that adopt a cost leadership
strategy prefer accrual EM to real EM. Thus, business strategy is a context that needs to be
considered in analyzing the choice of EM practice as suggested by contingency theory. The
result of this study will enrich the insight of financial statement analysts in advising users
regarding the quality of financial statements. Information about the business strategy
adopted by the company can be used as a reference for assessing the quality of financial
statements for business decision-making. The results of this study are also useful for
auditors in conducting general audits. Before undertaking fieldwork, auditors must
understand the company’s business and determine audit risks. Knowledge of the business
strategy implemented by the company can increase auditor awareness in assessing the risk
of financial misstatement to design effective fieldwork.
The results showed a negative relationship between differentiation business strategies and the Earnings
accrual EM practices. However, the results of this test are not significant. Of the 262 management
companies that were the research sample, only 10 companies implemented a differentiation
strategy, although in screening the sample the researchers had considered industry diversity
preferences
to obtain a variety of business strategies. The very few samples that implement differentiation
strategies are thought to be the cause of the insignificant relationship between differentiation
business strategies and EM practice preferences. Further research is expected to expand the
research by including all companies listed on the Indonesia Stock Exchange.
989
The results of this study reveal that although companies implementing cost leadership
strategies prefer accrual EM practices, statistically, the real EM practices dominate
Indonesian companies. The very large percentage of companies that practice the real EM
indicates the potential for a moderating variable in the relationship between business
strategies and the tendency to choose EM strategies. Future research is expected to apply
contingency theory in exploring moderating variables in the relationship between business
strategy and choice of EM practices.
The results of this study are still a question of whether it can be generalized in financial
crisis conditions such as those faced by companies since 2020 due to the COVID-19
pandemic. Further research is expected to re-examine the logistic regression model of this
study in the financial crisis period.

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Further reading 993

Banker, R.D., Hu, N., Pavlou, P.A. and Luftman, J. (2011), “CIO reporting structure, strategic
positioning, and firm performance”, MIS Quarterly, Vol. 35 No. 2, pp. 1-18.

Corresponding author
Golrida Karyawati Purba can be contacted at: golrida.karyawati@uph.edu

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