(Article 2020) A Cross-Country Study On Corpor

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Journal of Knowledge Globalization , Vol. 12(1), 2020
A Cross-Country Study on Corporate Accruals and

Financial Ratios Using Confirmatory Factor Analysis
M. Shamimul Hasan and Normah Omar

Universiti Teknologi MARA, Shah Alam, Malaysia
Morrison Handley-Schachler
Edinburgh Napier University, Edinburg, UK
A.H. Chowdhury
North South University, Dhaka, Bangladesh
Abstract
Corporate accruals create a negative impression of management and financial

reporting quality. Financial statements (FS) are frequently analyzed using
analytical procedures to evaluate operating performance, assets, and liabilities.
The objectives of this study are to measure constructs of financial ratios; to
examine the linear association between corporate accruals and constructs; and to
conduct cross-country analysis. Four constructs such as liquidity, profitability,
operating ability, and solvency are measured using confirmatory factor analysis
(CFA) on the data collected from eight Asian countries. The principal procedures
are Kaiser-Meyer-Olkin (KMO), Bartlett’s test, CFA, Two steps data
normalization, and Multiple regression model. The country-wise alpha value
demonstrates mixed reactions that indicate managerial opportunistic behavior is
not limited to the scope of accounting opportunity for accruals. Findings shows
that ratio analysis alone is not sufficient to evaluate FS and users of FS should be
aware of other mechanisms such as accounting red flags, financial shenanigans,
the reputation of the audit firm, reading of fraud magazine, business news on TV,
capital market news, business news from the daily newspaper. business journal
and the like. Primary users of FS such as investors, lenders, and creditors should
pay attention to make sure the regulator performs his duty with due diligence.
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Hasan, Omar, Schachler and Chowdhury: A Cross-Country Study on Corporate

Accruals and Financial Ratios
Keywords: Fraudulent Financial Reports, Corporate Accruals, Earnings

Management, Financial Ratios, International Comparison, Confirmatory Factor
Analysis(CFA).
JEL classification: M41, N25, C12
Introduction
Fraudulent financial reporting (FFR) usually occurs due to misreporting which

puts the organization at high cost in the end. The misreporting can happen because
of overstating/ understating/omitting of items of financial statements (FS).
Thirteen management assertions are available under three categories such as
transactions and events level, account balances level, and presentation and
disclosure level. Some of the financial statements’ assertions are Completeness,
Cutoff, Valuation, allocation & accuracy, Existence and occurrence, Rights and
obligations, Understandability and classification. These assertions are used by
management while preparing FS. Auditors need to examine these assertions by
using standard auditing tools such as tracing, vouching, inquiry, confirmation,
footing, cross footing & recalculation, re-performance, inspection, analytical
review, and the like. Auditor also assesses internal control procedures to
understand the control environment in which financial statement are prepared. FS
is prepared in accordance with generally accepted accounting principles (GAAP)
which is set by financial accounting standards board (FASB), international
accounting standards board (IASB), and governmental accounting standards
board (GASB). Audit is conducted in accordance with statements on auditing
standards (SAS), public company accounting oversight board auditing standards
(PCAOB AS), generally accepted government auditing standards (GAGAS). SAS
provides generally accepted auditing standards for the audit of non-issuer,
PCAOB AS provides generally accepted auditing standards for the audits of
issuer, and GAGAS provides guidance for audits of government organizations,
programs, activities, and of entities that receive government fund. Now, three
questions come to our mind, why, how, and when misreporting occurs as there is
professional bodies working for ‘true and fair view’ reflection in FS. Indeed, FS
is prepared based on accrual accounting. Accrual accounting needs some
37
adjustments which require estimation and judgment. Management can take

opportunity in these areas to fulfill their goals. The abuse of accrual accounting
could lead to financial crime. FFR occurs for a wide variety of reasons such as
(1) obtaining credit, long-term financing, or additional investments,

(2) hiding improper transactions,
(3) maintaining or creating capital market reputation,
(4) concealing deficiencies in performance,
(5) increasing compensation based on company performance and the like.
There are some techniques that are practiced by management to fulfill their hidden
agenda such as (1) recording pre-mature revenue, (2) recording fictitious
revenues, (3) shifting current expenses to an earlier or later period, (4) failing to
record or improperly reduce liabilities, (5) shifting current revenue to a later
period to name but a few. The fraudulent activities in FS usually occur at the time
of financial difficulties such as
1) huge pressure on economic condition due to a continuous declining of earnings,

(2) a downturn in organizational performance,
(3) a continuous decline in industry performance, and
(4) a general economic recession.
Rezaee and Riley (2010) introduced 3Cs model - conditions, corporate culture,
and choice to explain the real scenario of committing financial statement frauds.
Generally, Management, Board of Directors, and Auditors are directly involved
in the process of financial statements where management is responsible for
preparation, board of directors take care of approval procedure, and the auditor
opines on it whether the FS is prepared in accordance with applicable financial
reporting framework and are often free from errors or fraud. Audited FS is the
only source of financial information to the external stakeholders who analyze it
from different perspectives to know about the operating performance, assets, and
liabilities of a company. They compare results with previous period (inter-period
comparison), with peer company (inter-company comparison), or with their
expectations (industry average) and draw either positive or negative conclusions
based on output. Misstatements occur at preparation stage and corrupt
managements do it using discretionary authority (Hasan, 2014a). They want to
38

take short-term benefit and do not consider the negative results in the long run
such as closure of the company. These unethical managerial practices are not
allowed in professional accounting standards. Auditors provide unqualified (no
material misstatement) opinion, qualified (material misstatement but not
pervasive) opinion, adverse (material and pervasive misstatements) opinion, and
disclaimer of opinion (not independent). They provide reasonable assurance (a
high level of assurance but not absolute) based on audit works and if they fail to
maintain professional integrity only in that case, they are liable. Audit works
paper are retained for 5-7 years as a property of auditors to prove that audit is
conducted in accordance with generally accepted auditing standards (GAAS). If
auditors duly follow the guidelines of (GAAS) and fail to detect any sort of
misstatements, they are not liable. Audit procedures are applied on the sample and
not the population. So, it will be unwise to believe that audited FS are free from
fraud. The experiences of accounting fraud in corporate world such as Waste
management (1998), Enron Corporation (2001), Tyco international (2002),
WorldCom (2002), Health-South (2003), Freddi Mac (2003), American
International Group (2005), Lehman Brothers (2008), Bernie Madoff (2008), and
Satyam (2009) and the like tell the users of FS to be cautious while evaluating FS.
The poor practices of corporate governance (CG) destroy the confidence of
external stakeholders and more corporate accruals is an indication of poor
practices of CG (Hasan and Omar, 2015a). The closure of the company is the
ultimate consequences of unethical practices of management and directors (Hasan
et al, 2015b).
Ratio analysis technique is frequently used by financial analysts, consultants,

bankers, stockbrokers, lenders, borrowers, researchers, investigators,
academicians, and other interested parties for a wide variety of reason. Ratios
could be applied in two forms – individual form (gross profit percentage) and
group form (profitability). Past researchers have used individual form of ratios to
examine the influence of them on FFR (Persons, 1995; Green and Choi, 1997;
Summers and Sweeny, 1998; Kaminski et al., 2004; Kotsiantis et al., 2006;
Dechow et al., 2007; Kirkos et al., 2007; Hoogs et al., 2007; Liou, 2008; Huang
et al., 2012; Delen et al., 2013; Wuerges and Borba, 2014; Hasan et al, 2017;
Hasan et al.,2018). They neither looked upon group form of ratios nor examined
their influence on FFR. Corporate accruals (CA) are accruals by management
choice. It comes from the mind of corrupt management and does not appear in the
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accounting concept. Corporate accruals are more likely to be attributable to

manipulation (Dechow et al., 2007). That is why it is an emerging issue in
financial reporting. Estimated accruals (EA) can be determined by following the
models such as Jones, 1991; Dechow et al., 1995; Kasznik, 1999; Larcker and
Richardson, 2004; Kothari et al., 2005. Financial statement accrual (FSA) is the
difference between net income (NI) and cash flow from operating activities (CFO)
or free cash flow (FCF). Finally, CA is the difference between FSA and EA. The
difference between financial statement accruals and estimated accruals is treated
as corporate accruals (Hasan et al. 2016a). Previous studies addressed the issue of
detecting FFR using individual form of financial ratios. FFR data are collected
from Securities and Exchange Commission (SEC) filings and non-FFR matching
data are collected from annual reports. A binary variable (0, 1) is used for FFR
and non-FFR as dependent variables and financial ratios are used as independent
variables in the model to detect FFR.
However, the previous researchers did not examine the relationship between
corporate accruals and financial ratios. Besides, financial ratios in group form
have not yet been used in detection model developed by the researchers.
Therefore, a study could be undertaken to address these gaps. The present
researchers want to take the opportunity to study this relationship between
corporate accruals and financial ratios.
The primary objectives of the present study are:

(1) to form group ratios (constructs),
(2) to examine the relationship between CA and constructs, and
(3) to conduct cross-country analysis.
The remainder of this paper is arranged as follows. The next section presents a
literature review, followed by sections that describe the research model, the
methods used, and the results. The final section describes the conclusions.
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Literature Review
An extensive survey of existing literatures regarding financial ratios and corporate

accruals (earnings management) is conducted to formulate the research gap in
terms of ‘constructs of financial ratios’ and ‘association between financial ratios
and corporate accruals. The literatures are segregated in to two sections such as
literatures of ‘financial ratios’ and ‘earning management’ to identify the research
gaps by narrowing down the literatures from earlier years to present year.
The existing body of literatures of financial ratios indicates that ratios are widely
used technique to detect financial distress, financial fraud, financial performance,
financial difficulties, earnings management and so on (Hasan et al. 2017a).
Generally, individual form of ratios is used as independent variable for multiple
regression analysis. Altman (1968) used primarily 22 ratios to develop a model
called Z-score to predict firm bankruptcy and after a careful investigation chose
five ratios (Working capital to total assets, retained earnings to total assets,
earnings before interests and taxes to total assets, market value equity to book
value of total liabilities, and sales to total assets) for Z-Score models. Persons
(1995) examined nine financial ratios to identify factors associated with
fraudulent financial reporting using stepwise-logistic model. Beneish (1999) used
eight ratios (days in receivables, gross margin index, asset quality, sales growth,
depreciation index, sales general and administrative expenses index, leverage
index, and total accrual to total assets) to detect the earnings manipulation. Spathis
(2002) examined published data to develop a logistic regression model for
detecting false financial statements using nine financial ratios such as debt to
equity, sales to total assets, net profit to sales, receivable to sales, net profit to total
assets, working capital to total assets, gross profit to total assets, inventories to
total assets, and total debts to total assets. Lin et al. (2003) used six ratios such as
allowance for doubtful debts as a percentage of net sales, allowance for doubtful
debts as a percentage of accounts receivable, accounts receivable as a percentage
of net sales, accounts receivable as a percentage of total assets, and ratio of gross
margin to sales as input for assessing fraudulent financial reporting using a fuzzy
neural network model.Kaminski et al. (2004) used twenty one ratios, the same
ratios used by others in 1995, to classify financial statements into fraudulent and
non-fraudulent using a different approach - discriminant analysis. Kotsiantis et al.
(2006) examined twenty four (3 from profitability, 5 from leverage, 5 from
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liquidity, 8 from efficiency, and 3 from cash flow) financial ratios to forecast
fraudulent financial statements using data mining technique. Kirkos et al. (2007)
used 27 ratios including Z-scores for detection of fraudulent financial statements
by comparing the performance of decision trees, neural networks and Bayesian
beliefs networks. Liou (2008) examined twenty-four ratios (liquidity 7, leverage
related 2, profitability 2, operations related 2, and percentage change variable 11)
to detect fraudulent financial reporting and uses thirty three ratios of which 17 on
liquidities and 15 on leverages to predict business failure. The author compared
fraudulent financial reporting detection and business failure prediction models
using logistic regression, neural networks, and classification tress. Gerantonis et
al. (2009) examined capability of Altman Z-score, developed by using five ratios,
to predict business failures in Greece and concluded that the Altman Z-score
model performs well in predicting business failures.
Pacelli and Azzollini (2011) analyzed the credit risk management using artificial
neural network approach in which fourteen ratios were used as input variables.
Mohd Dani et al. (2013) examined eleven financial ratios to discriminate
fraudulent financial statements using backward the Wald binary logistic
regression approach. Unegbu (2013) used nine financial ratios to develop a model
called Angus Z-Score to identify falsified financial statements using stepwise
logistic regression. Delen et al. (2013) used 32 ratios (liquidity (3), asset
utilization (8), profitability (8), growth ratio (3), asset structure (8), and solvency
(6)) for measuring firm performance using decision tree approach. Li (2016) used
thirty ratios to work on ‘anomaly detection and predictive analytics for financial
risk management’ for doctoral degree. Chen (2016) applied hybrid mining
approach to detect FFR where 30 ratios (23 financial variables and 7 non financial
variables) were used. Dbouk and Zaarour (2017) examined 53 financial
statements to detect earnings manipulation using a layer of machine learning in
which eight individual ratios was used. Gullett et al., (2018) used financial ratios
to measure the quality of earnings using Q Test. Lokanan et al., (2019) built
algorithm for detecting anomalies in FS using machine learning method where
financial statement ratios were used as input. Omidi et al., (2019) applied
advanced mathematics using ratios to examine the efficacy of predictive methods
in financial statement fraud. Wadhwa et al., (2020) used ratios to estimate Z score,
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M score, and machine learning algorithm in order to predict financial statement

fraud. Mohammadi et al., (2020) used ratios to detect fraudulent financial reports
using data mining algorithm technique.
The body of knowledge of earnings management covers numerous issues in

research field of accounting. Many mathematical models have been developed to
estimate non-corporate accruals or estimated accruals. The concept of earnings
management originated with Healy in 1985. Healy (1985) measured non-
discretionary accruals by taking the mean of total accruals scaled by lagged total
assets (LTA). Later, Jones (1991) presented a model which is potentially more
effective way to estimate non-discretionary accruals. Two variables (REV and
PPE) are used to control for changes in non-discretionary accruals makes the
model more accurate and more effective for analyzing earnings manipulations.
Subsequently, researchers like Dechow et al. (1995), Kasznik (1999), Larcker and
Richardson (2004), and Kothari et al. (2005) have modified this model. In
addition, measurement of total accruals by the difference between net income (NI)
and cash flow from operating activities (CFO) was reviewed. Dechow and Ge
(2006) extended this traditional approach to determining total accruals and
presented total accruals as the difference between earnings (NI) and free cash flow
(FCF). Bukit & Iskandar (2009), Bhuiyan et al., (2013), and Hasan et al., (2016c)
also used a free cash flow approach to form a strong evidence on behalf of FCF
approach. Garcia-Meca and Sanchez-Ballesta (2009) tested the effect of firms’
boards of directors and ownership structures on earnings management and found
a significant relationship between earnings management and some corporate
governance variables. Bankoet et al. (2013) examined the influence of managerial
entrenchment on earnings management around the annual general meeting and
found evidence of a statistically significant manipulation of earnings primarily
among entrenched managers specifically, managing abnormal accruals in the
quarter immediately before the annual general meeting (AGM). Bhuiyan et al.
(2013) investigated whether there was a link between discretionary accruals and
corporate governance compliance.
Zakaria et al. (2014) examined the impact of free cash flow, dividend, and
leverage on earnings management through discretionary accruals practices in
Malaysia. Hasan et al., (2016a) defined the term discretionary accruals as
corporate accruals as they are created by management choice and other accruals
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termed as non-corporate accruals. The study investigated the relationship between

corporate accruals and corporate attributes and found a statistically significant
influence of asset size on corporate accruals only. Hasan et al. (2014b) tested the
relationship between corporate governance and corporate accruals and identified
a statistically significant association between corporate accruals and public
ownership only. The study argues that it does not come from business cycle;
rather, it comes from the mindset of corrupt managers. Hasan et al. (2016b)
measured the quality of financial reporting using corporate accruals as one of the
proxies. Corporate accruals reduce the quality of accruals and ultimately the
quality of financial reporting. Hasan et al. (2017b) analyzed corporate accruals
using multiple (eight) descriptive statistics and a seven point rating scale for
aggregating the results, according to which all countries in the sample are ranked.
Ramírez-Orellana et al. (2017) measured fraud and earnings management using
M-Score by studying case of an international family business. Gao and Huang
(2018) examined the impact of the audit committee on reporting choices using
restatements as a proxy of earnings quality. They found that audit committees
with an odd number of members are linked with fewer misstatements. Kumar et
al., (2018) conducted a research on earnings manipulation measuring M-Score for
10 foreign companies and 10 Indian companies. Sakib (2019) measured M-Score
to examine the earnings manipulation practices in Bangladesh by selecting sample
from textile industry. Papík and Papíková (2020) investigated earnings
management using two models such as linear discriminant analysis (LDA) and
logistic regression model (LRM) to detect two unintentional financial
restatements.
Development of Hypotheses
The rigorous literature review detailed in the earlier section have led to observe a
vital research gap that the earlier researchers did not investigate e.g., the
relationship between corporate accruals and financial ratios. Previous studies have
covered only ‘individual form of ratio’ such as ratios like current ratio, quick ratio
etc. and used them in regression analyses to detect the FFR. The previous study
did not cover ‘group form of ratio’ and hence the examination of association
between corporate accruals and constructs has not yet been processed. Liquidity,
profitability, operating ability, and solvency are four constructs, and every
construct has a different perspective. Besides, every construct consists of a
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number of financial ratios and the above four constructs will cover many financial
ratios and therefore, it is worthwhile to consider constructs rather than simple
ratio. In addition, shadow area of financial statement could be detected using
construct and investigation could be conducted more effectively focusing on
shadow areas. The examination of the influence of above constructs on corporate
accruals could be processed to fill another research gap. To examine the linear
relationships between corporate accruals and the above four constructs following
alternative hypotheses are tested using multiple regression model.
Overall Hypothesis:
H1: There is a significant association between corporate accruals and

constructs of financial ratios.
Specific Hypotheses:

profitability.
liquidity.
operating ability.
solvency.
Research Framework
An integrated model shown in Figure 1 consists of three phases. Phase 1

represents the calculation phase, phase 2 represents the measurement phase, and
phase 3 represents the analysis phase. Phase 1 includes calculations of financial
statement accruals (FSA), estimated accruals (EA) and corporate accruals (CA).
Phase 2 includes measurements of the four constructs of liquidity, profitability,
solvency and operating ability using confirmatory factor analysis (CFA). Ten
dimensions (X1, X2 … and X10) are selected from existing literatures for each
construct. Phase 3 includes examination of the relationships between four
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constructs and corporate accruals. Four alternative hypotheses are drawn to test
the linear relationship between the constructs and corporate accruals and shown
them in the integrated model.
X
Profit
X H
X Financial Statement Accruals (FSA) =

Liq
NI - FCF
X H
X Corporate Accruals
|CA| = |FSA| - |EA|
H
X Estimated Accruals (EA) Using Modified
Oper Jones Model
X
H
X
Solv
Measurement Phase Multiple Regression Analysis Phase Calculation Phase (1)

(2) (3)
Profit- Profitability
Liquid -Liquidity
Oper --Operating Ability
Solv. – Solvency
Figure 1: The Integrated Model
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Research Workflow
A research workflow could be prepared in a diagrammatic pattern to visualize the

whole process of the current research. The aim of presenting the research
workflow in Figure 2 is to make the reader understand how to conduct the research
is. It shows the stages of actions taken to complete the research in an orderly
manner. The actions are mainly literature reviews, selection of ratios,
measurement formula, data source (Bursa Malaysia), data type (FS data), data
collection, indicators/dimensions values, factorability tests, constructs name,
constructs type (formative constructs), measurement of constructs (confirmatory
factor analysis), independent variables, data normalization using two-step
approach, collinearity diagnostics, measurement of dependent variable using
performance-matched model, multiple regression models, country-wise results,
overall results, and the result interpretation.
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Figure 2: The Research Workflow

48

Research Approach
Data
Financial statement data used as raw data were obtained from Bursa Malaysia.
The data were collected for six years period from 2008 to 2013 of 100 listed non-
financial companies for seven East Asian countries: Malaysia, Indonesia,
Thailand, Singapore, Hong Kong, China, and Japan. A country had at least 600
firm-year samples for a number of accounting variables included in the sample.
Each firm had financial statement information for at least six consecutive years.
Forty financial ratios were selected from the literatures for the four factors of
profitability, liquidity, operating ability, and solvency and primarily each factor
consisted of ten ratios. In this study, a total of 182,000 observations were used out
of which 14,3500 (i.e. calculated for 41 variables each containing 100 firms for 5
years in 7 countries) observations were treated as inputs in the examination of
relationship between corporate accruals and financial ratios and 38,500 (i.e.
estimated for 3 variables for DV with 100 firms for 5 years in 7 countries plus 4
betas for 100 firms for 5 years in 7 countries plus 4 IVs with 100 firms in 5 years
in 7 countries) observations were treated in measuring the estimated accruals (EA
and financial statement accruals (FSA).
Methods
The discussion on methods consists of three phases, including a calculation phase,

a measurement phase, and finally an analysis phase. Financial statement accruals
estimated accruals and corporate accruals were measured under phase 1. Then,
four constructs were measured using confirmatory factor analysis (CFA) under
phase 2. Finally, multiple regression analysis was conducted to test the
relationships under phase 3. The details of each phase are discussed below:
Calculation Phase (Phase 1)

The calculation phase included three evaluations of corporate accruals such as
financial statement accruals (FSA), estimated accruals (EA), and corporate
accruals (CA). The first phase was about calculation of financial statement
accruals or total accruals. The traditional definition of total accruals is ‘the
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difference between accrual earnings (NI) and cash earnings (CFO).’ This
approach was extended by Dechow and Ge (2006) by defining total accruals as
the difference between accrual earnings (NI) and free cash flow (FCF). Bukit and
Iskandar (2009) used free cash flow approach in determining total accruals. Free
cash flow reflects the impact of cash spending on fixed assets and investments.
Companies operating with high FCF provide greater opportunities for
opportunistic behavior by management. Therefore, FCF better reflects accrual for
individual firms (Bhuiyanet al. 2013). FSA is defined as ‘the difference between
accrual earnings (NI) and free cash flow (FCF)’ for this study. The mathematical
expression of this definition could be established in the following form,
FSA = NI – FCF (1)
As the result of the above equation is compared with estimated accruals that are
measured by a deflated variable called lagged total assets (LTA), it is necessary
to keep consistency between the results of two accruals.
The above equation could be divided by LTA to remove inconsistencies between
the results,
𝐹𝑆𝐴 𝑁𝐼 𝐹𝐶𝐹
= − (2)
𝐿𝑇𝐴 𝐿𝑇𝐴 𝐿𝑇𝐴
The next step is to calculate of estimated accruals by applying the performance

matched model (Modified Kothari–Jones Model, 2005). There are many
measurement models for estimating the accruals, however, this approach is
chosen to eliminate possible mechanical relationship between performance
metric and current period’s corporate accruals. The model is as follows,
𝐸𝐴 1 ∆𝑅𝐸𝑉−∆𝐴𝑅 𝑃𝑃𝐸 𝑁𝐼
= 𝛽1 + 𝛽2 + 𝛽3 + 𝛽4 + 𝜀 (3)
𝐿𝑇𝐴 𝐿𝑇𝐴 𝐿𝑇𝐴 𝐿𝑇𝐴 𝐿𝑇𝐴
Where,
EA = Estimated accruals,
∆ REV = Change in revenues from the preceding year,
∆ AR = Change in accounts receivable from the preceding year,
PPE = Gross value of property, plant & equipment current year,
NI = Net income, and
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LTA = Lagged total assets (deflated variable).
The final step of calculation phase is to determine corporate accruals, which are
the differences between two absolute values of accruals numbers i.e., FSA and
EA. That means the sign (+/-) of accruals is ignored as it could be either positive
or negative numbers in order to focus on the differences in absolute numbers
between FSA and EA is used in measuring corporate accruals. Corporate accruals
could be measured by using the difference between the results from equations 2
and 3 and it is expressed as,
|𝐶𝐴| = |𝐹𝑆𝐴| − |𝐸𝐴| (4)
Measurement Phase (Phase 2)

Four constructs of financial ratios are measured using CFA, in which primarily
ten financial ratios for each construct are selected from review of the existing
literatures of ratios. The details of constructs, selected ratios, literatures and
measurement formula for this study are presented in Table 1.
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Table 1: The Details of Variable/Constructs, Ratios, Literatures and

Measurement Formula
Variable/
Ratios Literatures Measurements
Constructs
Dependent Variable (Y)
Corporate CA is the difference between Jones (1991), Dechow et al. (1995), Kothari et al. (2005), FSA = NI - FCF
Accruals financial statement accruals Dechow and Ge (2006), Bukit & Iskandar (2009), Bhuiyan EA = Kothari Model
(CA) and estimated accruals. et al. (2013), Hasan et al. (2014) Y = CA = |FSA- EA|
Independent Variable (X)
Lin et al. (2003), Kaminski et al .(2004), Dechow et al
X11 Gross Profit Margin GP / Sales
(2007), Huang et al. (2012), Delen et al. (2013)
Green & Choi (1997), Kaminski et al .(2004), Liou (2008),
X12 Operating Profit Ratio OP / Sales
Huang et al. (2012)
Spathis et al. (2002), Kaminski et al.(2004), Kirkos et al.
X13 Net Profit Margin NI / Sales
(2007), Delen et al. (2013)
Persons (1995), Kaminski et al .(2004), Hoogs et al (2007),
Profitability (X1)
X14 Return on Assets NI / Total Assets

Pacelli & Azzollini (2011), Huang et al. (2012)
Operating Expenses to Net
X15 Kaminski et al. (2004), Liou (2008), Delen et al. (2013) OE / Sales
Sales Ratio
Retain Earnings to Total
X16 Altman (1993), Kaminski et al. (2004), Persons (2011) RE / TA
Assets
Spathis (2002), Kirkos et al. (2007), Mohd Dani et al.
X17 Gross Profit to Total Assets GP/ TA
(2013)
Altman (1993), Spathis (2002), Karminski et al. (2004),
X18 Revenue to Total Assets REV/ TA
Kirkos et al. (2007), Person (2011), Md Dani et al. (2013)
Stice (1991), Summers and Sweeney (1998), Dechow et al.
X19 Growth Rate of Sales (Salest / Salest-1) – 1
(2007), Huang et al. (2012), Delen et al. (2013)
X110 Growth Rate of Net Income Huang et al. (2012), Delen et al. (2013) (NIt / NIt-1) – 1
Kaminski et al. (2004), Kotsaintis et al. (2006), Kirkos et
X21 Current Ratio al. (2007), Liou (2008), Huang et al. (2012), Delen et al. CA / CL
(2013)
X22 Quick Ratio Liou (2008), Huang et al. (2012), Delen et al. (2013) (CA - I) / CL
X23 Cash Ratio Liou (2008), Delen et al. (2013) Cash & Cash Equiv. / CL
Liquidity (X2)
X24 Sales to Inventory Liou (2008) Sales / Inventory

X25 Cash Flow Ratio Dechow et al. (2007), Liou (2008), Huang et al. (2012) CFO / CL
Cash Flow from Operation
X26 Liou (2008) CFO / Sales
to Sales
Working Capital to Total Altman (1993), Spathis (2002), Kotsiantis et al. (2006),
X27 WC / TA
Assets Liou (2008)
X28 Working Capital to Sales Liou (2008) WC / Sales
X29 Cash to Total Assets Liou (2008) Cash & Cash Equiv. / TA
Current Assets to Total
X210 Kaminski et al. (2004) CA / TA
Assets
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Table 1 (contd.): The Details of Variable/Constructs, Ratios, Literatures

and Measurement Formula
Variable/
Ratios Literature Measurements
Constructs
Independent Variable (X)
Accounts Receivable
X31 Green and Choi (1997), Huang et al.(2012) Sales / AR
Turnover
Persons (1995), Kirkos et al. (2007), Huang et al.
X32 Total Asset Turnover Sales / TA
(2012)
Growth Rate of Accounts
X33 Dechow et al (2007), Huang et al. (2012) (ARt - ARt-1) – 1
Operating Ability (X3)
Receivable
X34 Growth Rate of Inventory Huang et al. (2012) (Inventoryt - Inventoryt-1) – 1
Growth Rate of Accounts
X35 Summers and Sweeny (1998), Huang et al. (2012) (Art/Salest) - (ARt-1/Salest-1)
Receivable to Sales
Growth Rate of Inventory to (Inventoryt / Salest) -
X36 Huang et al. (2012)
Sales (Inventoryt-1 / Sales t-1)
Stice (1991), Persons (1995), Green and Choi
Accounts Receivable to
X37 (1997), Kaminski et al. (2004), Huang et AR / TA
Total Assets
al.(2012)
X38 Inventory to Total Assets Huang et al. (2012) Inventory / TA
X39 Cost of Goods Sold to Sales Kaminski et al. (2004) COGS / Sales
Cost of Goods Sold to
X310 Kaminski et al. (2004), Liou (2008) COGS / Inventory
Inventory
Persons (1995), Kirkos et al. (2007), Huang et al.
X41 Leverage Ratio TL / TA
(2012), Delen et al. (2013)
X42 Debt Ratio Delen et al. (2013) TL / Owner's Equity
X43 Equity to Total Assets Liou (2008) Equity / Total Assets
Long-Term Funds to Fixed
X44 Huang et al. (2012) (LTD + Equity) / Fixed Assets
Solvency (X4)
Assets
Short-Term Debt to Total
X45 Delen et al. (2013) CL / TL
Liabilities
X46 Debt-Equity Ratio Liou (2008), Delen et al. (2013) LTD / Owner's Equity
Long-Term Funds to Total
X47 Kirkos et al. (2007), Persons (2011) LTD / TA
Assets
X48 Current Liabilities to Equity Liou (2008) CL / Owner's Equity
Kaminski et al. (2004), Kotsiantis et al. (2006),
X49 Fixed Assets to Total Assets FA / TA
Liou (2008)
X410 Equity to Sales Liou (2008) Equity / Sales
In addition, constructs (profitability, liquidity, operating-ability, and solvency),

indicators (10 indicators are primarily selected for each construct), and
measurement formula for each indicator are also provided in Table 2. There is no
measurement error as all indicators/ dimensions are observed variable. Total forty
indicators are selected for four formative constructs.
53
Table 2: Construct, Indicators, and Measurements

Profitability Liquidity
Indicators Measurements Indicators Measurements
X1 GP/Sales X1 CA/CL
X2 OP/Sales X2 (CA-I)/CL
X3 NI/Sales X3 Cash and Cash Equivalent / CL
X4 NI/ Total Assets X4 Sales / Inventory
X5 OE/Sales X5 CFO/CL
X6 RE/TA X6 CFO/ Sales
X7 GP/TA X7 WC/TA
X8 REV/TA X8 WC/Sales
X9 (Salest/Salest-1) -1 X9 Cash and Cash Equivalent / TA
X10 (NIt /NIt-1) -1 X10 CA/TA
Operational ability Solvency
Indicators Measurement Indicators Measurements
X1 Sales/ AR X1 TL/TA
X2 Sales / TA X2 TL / Owners' Equity
X3 (ARt / ARt-1) -1 X3 Equity /TA
X4 (Inventory t / Inventory t-1) -1 X4 (LTD+ Equity)/FA
X5 (ARt / Salest) - (ARt-1 / Salest-1) X5 CL/TL
X6 (Inventory t / Salest) - (Inventory t-1 / Salest-1) X6 LTD/Owners' Equity
X7 AR/TA X7 LTD/TA
X8 Inventory / TA X8 CL/Owners' Equity
X9 COGS/Sales X9 FA/TA
X10 COGS/Inventory X10 Equity /sales
The CFA is performed using the Statistical Package for Social Science (SPSS) to
determine the value of each construct as these constructs will be used later as
independent variables in the model. The Kaiser-Meyer-Olkin (KMO) measure of
54

sampling adequacy and the Bartlett’s test of Sphericity are used to examine the
suitability of data for factor analysis. Primarily selected indicators (individual
ratios) of each construct are finalized at the time of experiment for the suitability
of data to achieve a desired outcome based on the benchmark for KMO and
Bartlett’s test of Sphericity. Principal component analysis (PCA) method is used
to extract the factor and the CFA model is as follows,
X = Ʌξ + δ (5)
Where, X = observed variable such as x1, x2, x3 ….x10; Ʌ = Factor loading i.e.,
connection weight between factor to observed variable, ξ = Factor/ Construct;
and δ = Error terms.
Multiple Regression Analysis (Phase 3)

The normality of the data and multicollinearity are examined before developing
the model. The histogram with normal curve option is used to see the normality.
A two step approach is used to transfer the data into normality (Templeton, 2011).
Tolerance and variance inflation factor (VIF) are two techniques that are used to
diagnose the multicollinearity problem. Then, a multiple regression model is
developed to estimate the relationship between corporate accruals and measured
constructs such as profitability, liquidity, operating ability, and solvency. These
four constructs are used in the multiple regression model as independent variable.
55
The model could be presented in the equation form as follows:
Y = α + β1X1 + β2X2+ β3X3 + β4X4+ ε (6)
Where,
α = Constant (intercept)
β = Coefficients of independent variables
Y = Corporate accruals
X1 = Profitability
X2 = Liquidity
X3 = Operating ability
X4 = Solvency; and
ε = Error terms.
The alpha (α) value for each independent variable is used to test the hypotheses
i.e., H1, H2, H3, and H4 for each country separately. The ANOVA table of the
model shows the results of the main hypothesis and the coefficients table of the
model shows the results of sub category hypotheses. The percentile analysis is
done to have an overall conclusion based on the country-wise results.
Results and Discussions
The results from sample adequacy test shown in Table 3 reveal Kaiser-Meyer-
Olkin (KMO) values for each of four constructs and for all seven countries
exceeded the measurable value of 0.50 (Kaiser 1974) which indicates the sample
is adequate for factor analysis.
56

Table 3: KMO and Bartlett’s Test for Sphericity

Hong
Constructs Tests China Kong Indonesia Japan Malaysia Singapore Thailand
KMO Measure of
0.734 0.736 0.602 0.620 0.628 0.618 0.628
Sampling
Profitability
Adequacy
Bartlett's Test of
0.000 0.000 0.000 0.000 0.000 0.000 0.000
Sphericity
KMO Measure of
Sampling 0.711 0.724 0.701 0.725 0.715 0.712 0.732
Liquidity Adequacy
Bartlett's Test of
0.000 0.000 0.000 0.000 0.000 0.000 0.000
Sphericity
KMO Measure of
Sampling 0.545 0.590 0.537 0.561 0.561 0.640 0.571
Operating
Adequacy
Ability
Bartlett's Test of
0.000 0.000 0.000 0.000 0.000 0.000 0.000
Sphericity
KMO Measure of
Sampling 0.545 0.607 0.622 0.738 0.601 0.610 0.689
Solvency Adequacy
Bartlett's Test of
0.000 0.000 0.000 0.000 0.000 0.000 0.000
Sphericity
Many indicators were dropped out at the time of experiment in order to achieve
the desired value (greater than 0.50) of KMO. For example, initially ten indicators
were selected for forming profitability construct. Out of ten, four indicators from
China, five indicators from Hong Kong, three indicators from Indonesia, two
indicators from Malaysia, and four indicators from Singapore were dropped at the
time of experiment to achieve a minimum standard of KMO value. No indicators
were excluded from Japan and Thailand. A detail of dropping history of the
indicators is presented in Table 4.
57
Table 4: Dropping Indicators

Cons tructs China Hong Kong Indones ia Japan Malays ia Singapore Thailand
X14 X11 X15 X17 X15
Profitability (X1)
X15 X16 X18 X18 X16

X18 X18 X19 X18
X19 X19 X110
X110
Total 4 5 3 0 2 4 0
X24 X24
Liquidity (X2)
X28 X26
0 2 0 0 2 0 0
Operational Ability (X3)
X33 X31 X32 X32 X32 X34 X35

X35 X34 X33 X34 X34 X35 X37
X37 X36 X34 X36 X36 X36 X38
X39 X37 X35 X39 X38 X39
X310 X310 X36
5 5 5 4 4 3 4
X46 X45 X44 X46 X48 X45 X44
X48 X46 X46 X48 X46 X45
Solvency (X4)
X49 X48 X48 X49 X48 X46

X49 X48
X49
3 4 3 3 1 3 5
It was also observed, the pattern of the behavior of data in forming constructs
from country to country were different. For example, the contribution of gross
profit margin (X11) to the profitability (X1) construct for China, Hong Kong,
Indonesia, Japan, Malaysia, Singapore, and Thailand were 0.797, 0.991, 0.743,
0.872, 0.553, 0.555, and 0.964, respectively. A detailed form of contributions of
the indicators towards constructs is presented in Table 5.
58

Table 5: Factor Loadings and Number of Dropping Case

Table 5 (contd.): Factor Loadings and Number of Dropping Case
59
60

The Bartlett’s test of sphericity (Bartlett 1954) is the test for null hypothesis that
the correlation matrix has an identity matrix. The null hypothesis (H0) indicates
that there is no statistically significant interrelationship between indicators
affecting construct whereas, the alternative hypothesis indicates that there may be
a statistically significant relationship between indicators affecting construct. The
results from Bartlett’s test of Sphericity (see Table 2) for four constructs for each
of the seven east Asian countries are significant at one percent level of
significance (p value = 0.000 < 0.05). As p < α, therefore, the null hypothesis (H0)
is rejected and the alternative hypothesis (H1) is accepted i.e., there may be
statistically significant interrelationship between indicators affecting construct,
supporting the factorability of the data. Hence factor analysis is considered as an
appropriate technique for further analysis of the data.
Principal component analysis (PCA) method of factor analysis is used to extract

the factors using SPSS version 23. The Eigen value and percent of total variance
of each construct for seven Asian countries are shown in Table 6.
Table 6: Eigen Value and Percent of Variance
Constructs Eigenvalues China Hong Kong Indonesia Japan Malaysia Singapore Thailand
Eigenvalues 2.502 3.053 3.318 4.329 2.977 2.124 4.320
Profitability
Percent of variance 41.707 61.050 47.402 43.288 37.208 35.395 43.202
Eigenvalues 4.409 4.260 4.191 5.419 4.087 3.986 4.285
Liquidity
Eigenvalues 1.512 1.721 1.434 1.947 1.637 1.935 1.549
Operational ability
Eigenvalues 2.494 2.364 3.078 4.292 3.925 2.569 2.882
Solvency
61
The Eigen value indicates the variance of the factor. According to Kaiser’s
criterion or the Eigen value rule, the minimum standard of factor’s Eigen value
should be at least 1. In this study, the minimum Eigen value for profitability,
liquidity, operating ability, and solvency are 2.124, 3.986, 1.434, and 2.364,
respectively. The corresponding countries of these Eigen values are Singapore,
Singapore, Indonesia, and Hong Kong respectively. The total variances explained
by these factors are 35.395%, 39.857%, 28.679%, and 39.999%, respectively. On
the other hand, the maximum number of Eigen value for profitability, liquidity,
operating ability, and solvency are 4.329, 5.419, 1.947, and 4.292, respectively.
The corresponding country of these Eigen values is Japan. The total variances
explained by these factors are 43.288%, 54.189%, 32.458%, and 61.312%,
respectively. The Eigen value and the percent of total variance explained for all
constructs across seven East Asian countries could be seen in Table 3. Finally, the
four constructs are taken as independent variable for further analysis to examine
the relationship between corporate accruals and these constructs.
Tolerance indicates how much of the variability of the specified independent is

not explained by other independent variables. If this value is greater than 0.10
then it suggests there is no multicollinearity. In this study, the minimum value of
tolerance for all constructs across sample countries is 0.33 for liquidity variable
of Japan i.e., the tolerance value is greater than 0.10 for all cases, suggesting no
multicollinearity. The tolerance values for each variable across sample countries
could be seen in the Table 7.
62

Table 7: Collinearity Statistics

63
On the other hand, if the value of VIF (variance inflation factor) is greater than 10
then it is a great concern for multicollinearity. Hence, the expected value is less
than 10. In this study, the maximum value of VIF 3.032 is obviously less than 10
for liquidity variable of Japan, suggesting no multicollinearity. The VIF values
for all independent variables in this study are presented in the Table 8. From the
discussion, it is clear that there is no multicollinearity problem in model.
The alpha (α) value indicates the significance level of the relationship between
dependent and independent variable. Normally, the significance level at 1 percent
and 5 percent are accepted. According to this rule, there is a mixed response on
the examination of the relationship between corporate accruals and financial
ratios. Table 8 (α value) reveals both accepted and rejected hypotheses across
countries.
64

Table 8: Alpha (α) Value

65
According to this table, H2 (0.054) and H3 (0.004) for Hong Kong, H3 (0.000) and
H4 (0.052) for Indonesia, H2 (0.08) for Japan, H1 (0.042), H2 (0.091), and H4
(0.076) for Malaysia, H4 (0.051) for Singapore and H1 (0.000), H2 (0.000), and H4
(0.000) for Thailand are accepted. Alpha values for accepted hypotheses are
shown in the parenthesis: H1 is related to profitability; H2 is related to liquidity;
H3 is related to operating ability; and H4 is related to solvency. On the other hand,
H1 and H4 for Hong Kong, H1 and H2 for Indonesia, H1, H3 and H4 for Japan, H3
for Malaysia, H1, H2, and H3 for Singapore, H3 for Thailand are rejected. None of
the hypotheses for China is accepted. The alpha values for all hypotheses across
sampled countries are presented in Table 8. It is usually expected that there may
be a statistically significant relationship between corporate accruals and financial
ratios as corporate accrual is determined through a process of some ratios used in
the model for estimation of accruals. The statistics of hypothesis (Table 9) reveal
that 29 percent of sample countries is accepted the relationship with profitability,
57 percent of sample countries is accepted the relationship with liquidity, 29
percent is accepted the relationship with operating ability, and 57 percent is
accepted the relationship with solvency. Likewise, 71 percent is rejected the
relationship with profitability, 43 percent is rejected the relationship with
liquidity, 71 percent is rejected the relationship with operating ability, and 43
percent is rejected the relationship between corporate accruals and solvency.
Table 9: Hypothesis Statistics
Hypothesis Relationship variable Countries Accepted Accepted % Countries Rejected Rejected %

Hong Kong, Japan, China, Indonesia,
29%
H1 Profitability Malaysia, Thailand 2 and Singapore 5 71%
Hong Kong, Japan, Malaysia,
57%
H2 Liquidity and Thailand 4 China, Indonesia, and Singapore 3 43%
Malaysia, Japan, China, Thailand, and
29%
H3 Operating ability Hong Kong and Indonesia 2 Singapore 5 71%
Indonesia, Malaysia,
57%
H4 Solvency Singapore, and Thailand 4 Japan, China, and Hong Kong 3 43%
Total number of countries in this study 7 Total number of countries in this study 7
66

According to these statistics, majority (57 percent) of the sampled countries

accepted the relationship between corporate accruals and liquidity as well as
solvency. On the other hand, a majority (71 percent) of the sampled countries
rejected the relationship between corporate accruals and profitability as well as
operating ability. The overall results show that 43% of ratios have s statistically
significant relationship and 57% of ratios do not have a statistically significant
relationship. Majority of the ratios are unable to detect corporate accruals because
it comes from the outside of the business cycle. Therefore, external stakeholders
keep in mind that ratio analysis alone is not sufficient to detect corporate accruals
and they should also use other mechanisms. They should be aware about the
earnings manipulation (either overstate or understate) which are done by corrupt
management using discretionary power. This study also provides another
important area where management can manipulate cash earnings. Certain
accounting shenanigans can either artificially boost reported operating cash flow
or present unsustainable cash flows such as stretching account payables, financing
of payables, securitizations of receivables, capitalizing normal operating expenses
etc. Investment community usually believes that cash cannot be manipulated and
that is a misconception. Analyzing the cash flow statement is now integral to
understanding a company’s financial performance and position and it often
provides a check to the quality of earnings shown in the income statement.
Therefore, they should also examine the liquidity and solvency while measuring
corporate operating and financial performance as well as financial position.
67
Conclusions
The study concludes that liquidity and solvency have a greater impact on
corporate accruals than profitability and operating ability. But an exception to this
conclusion is that no relation between corporate accruals and financial ratios has
been found for China (estimated). The significant relationship between corporate
accruals and liquidity as well as solvency indicates corporate management can
alter cash items and also debt items to show an artificially healthy liquidity and
solvency position. On the other hand, no significant relationship between
corporate accruals and financial ratios indicates that corporate management alters
financial figure(s) according to their needs that might be beyond the scope of
accounting opportunities for accruals. Managerial opportunistic behavior cannot
be guessed easily as they are unique position to tune up corporate financial
reporting. The mixed results suggest the need to examine each and every part of
corporate financial reporting very cautiously at the time of evaluation of corporate
performance and financial position. In this case, using past results and alternative
methods may be a good solution for discovering a true picture. Other mechanisms
of analysis are the accounting red flags, financial shenanigans, reputation of audit
firm, reading of fraud magazine, TV news of business today, Capital market news,
reading financial express and other business daily newspaper, reconcile at least
five years annual reports, and so on. Regulator performance is also important to
external stakeholders. If regulator does not perform their duty with due diligence,
external investors should take care by monitoring of outside information as
nobody is responsible for their investment. External stakeholders should keep
their eyes open like a watchdog. Further research could be conducted to provide
more empirical evidence on this issue.
68

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35

Journal of Knowledge Globalization , Vol. 12(1), 2020

A Cross-Country Study on Corporate Accruals and

M. Shamimul Hasan and Normah Omar

Corporate accruals create a negative impression of management and financial

Hasan, Omar, Schachler and Chowdhury: A Cross-Country Study on Corporate

Keywords: Fraudulent Financial Reports, Corporate Accruals, Earnings

JEL classification: M41, N25, C12

Fraudulent financial reporting (FFR) usually occurs due to misreporting which

Journal of Knowledge Globalization , Vol. 12(1), 2020

adjustments which require estimation and judgment. Management can take

(1) obtaining credit, long-term financing, or additional investments,

1) huge pressure on economic condition due to a continuous declining of earnings,

Hasan, Omar, Schachler and Chowdhury: A Cross-Country Study on Corporate

Ratio analysis technique is frequently used by financial analysts, consultants,

Journal of Knowledge Globalization , Vol. 12(1), 2020

accounting concept. Corporate accruals are more likely to be attributable to

The primary objectives of the present study are:

Hasan, Omar, Schachler and Chowdhury: A Cross-Country Study on Corporate

An extensive survey of existing literatures regarding financial ratios and corporate

Journal of Knowledge Globalization , Vol. 12(1), 2020

Hasan, Omar, Schachler and Chowdhury: A Cross-Country Study on Corporate

M score, and machine learning algorithm in order to predict financial statement

The body of knowledge of earnings management covers numerous issues in

Journal of Knowledge Globalization , Vol. 12(1), 2020

termed as non-corporate accruals. The study investigated the relationship between

Hasan, Omar, Schachler and Chowdhury: A Cross-Country Study on Corporate

H1: There is a significant association between corporate accruals and

H1: There is a significant association between corporate accruals and

An integrated model shown in Figure 1 consists of three phases. Phase 1

Journal of Knowledge Globalization , Vol. 12(1), 2020

X Financial Statement Accruals (FSA) =

Measurement Phase Multiple Regression Analysis Phase Calculation Phase (1)

Hasan, Omar, Schachler and Chowdhury: A Cross-Country Study on Corporate

A research workflow could be prepared in a diagrammatic pattern to visualize the

Journal of Knowledge Globalization , Vol. 12(1), 2020

Figure 2: The Research Workflow

Hasan, Omar, Schachler and Chowdhury: A Cross-Country Study on Corporate

The discussion on methods consists of three phases, including a calculation phase,

Calculation Phase (Phase 1)

Journal of Knowledge Globalization , Vol. 12(1), 2020

FSA = NI – FCF (1)

The next step is to calculate of estimated accruals by applying the performance

Hasan, Omar, Schachler and Chowdhury: A Cross-Country Study on Corporate

LTA = Lagged total assets (deflated variable).

|𝐶𝐴| = |𝐹𝑆𝐴| − |𝐸𝐴| (4)

Measurement Phase (Phase 2)

Journal of Knowledge Globalization , Vol. 12(1), 2020

Table 1: The Details of Variable/Constructs, Ratios, Literatures and

X14 Return on Assets NI / Total Assets

X24 Sales to Inventory Liou (2008) Sales / Inventory

Hasan, Omar, Schachler and Chowdhury: A Cross-Country Study on Corporate

Table 1 (contd.): The Details of Variable/Constructs, Ratios, Literatures

In addition, constructs (profitability, liquidity, operating-ability, and solvency),

Journal of Knowledge Globalization , Vol. 12(1), 2020

Table 2: Construct, Indicators, and Measurements

Hasan, Omar, Schachler and Chowdhury: A Cross-Country Study on Corporate

Multiple Regression Analysis (Phase 3)

Journal of Knowledge Globalization , Vol. 12(1), 2020

The model could be presented in the equation form as follows:

Y = α + β1X1 + β2X2+ β3X3 + β4X4+ ε (6)

Results and Discussions

Hasan, Omar, Schachler and Chowdhury: A Cross-Country Study on Corporate