SUMMARY: This paper investigates the relation between the extent of a firm’s past and expected future losses or negative cash flows and the ex ante probability that it will manipulate revenues. When a firm has a string of losses or negative cash flows, traditional valuation models do not yield reliable estimates of firm value, and traditional price-earnings ratios are not meaningful. Evidence suggests that market participants tend to value loss firms on the basis of the level and growth in revenues, rather than cash flows and earnings, thereby motivating these firms to overstate revenue. In fact, empirical results indicate that there is a positive relation between the number of years that firms exhibit and/or anticipate losses or negative cash flows and investment in receivables after controlling for credit policy. We further show that the ex ante likelihood that firms manipulate revenue in violation of GAAP is positively associated with the history of past and expected future losses or negative cash flows, as well as with the investment in accounts receivable (adjusted for credit policy). Our results suggest another indicator of manipulation that may be used by auditors and regulators in identifying firms that are more likely to overstate revenues.
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1 November 2008
Research Article|
November 01 2008
Revenue Manipulation and Restatements by Loss Firms
Online ISSN: 1558-7991
Print ISSN: 0278-0380
American Accounting Association
2008
AUDITING: A Journal of Practice & Theory (2008) 27 (2): 1–29.
Citation
Jeffrey L. Callen, Sean W. G. Robb, Dan Segal; Revenue Manipulation and Restatements by Loss Firms. AUDITING: A Journal of Practice & Theory 1 November 2008; 27 (2): 1–29. https://doi.org/10.2308/aud.2008.27.2.1
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