Purpose Discretionary accruals are earnings quality proxies that illustrate that the greater the value of discretionary accruals, the greater the practice of earnings management and vice versa. High-quality financial reports (especially earnings quality) are expected to help investors and potential investors to make decisions. This study analyses the factors that affect earnings quality, such as pre-managed earnings, liquidity and efficiency. Furthermore, the authors identify the moderating effect of the governance mechanisms proxied by the proportion of independent commissioners in conventional commercial banks listed on the Indonesia Stock Exchange.
Design/methodology/approach This study uses 226 banking data in the pre-corona crisis period 2013 until 2019. The data were analyzed using EViews 10 for hypothesis and MS Excel for a differential test.
Findings The results show that pre-managed earnings, liquidity and efficiency affect earnings quality. The governance mechanisms can moderate liquidity and efficiency on earnings quality, while pre-managed earnings cannot be moderated. The different bank categories (BUKU) of earnings management mechanisms are shown for each BUKU (BUKU 1, 3 and 4 perform earnings management by increasing earnings, BUKU 2 lowering earnings). Another thing is information on the earnings quality between BUKU 2 with BUKU 3 and BUKU 4 because of differences in capital and bank operating coverage regulations.
Research limitations/implications Further research expects to analyze the factors affecting banking earnings quality concerning applying IFRS 9 (PSAK 71) in Indonesia. Future researchers expect to apply mixed methods to verify the financial statement data and provide comprehensive discussion and genuine insight from their study. Future research requires more samples from companies or an international scale (cross country) to obtain maximum results and be generally accepted.
Practical implications This study implies that managers should have more control over pre-managed earnings and bank liquidity as manager's incentive to do earnings smoothing. Managers should also pay attention to cost-efficiency and effective implementation of governance mechanisms to maximize earnings quality. This study also implies that policymakers can encourage commercial banks to apply more prudential principles in terms of a reserve for failed loans to minimize earnings management in banking.
Originality/value The significance of this study revealed in the discussion of the difference test between bank core capital categories (BUKU) and its relation to earnings quality.
Earnings quality is a significant concern for investors and contractual purposes on financial statement stakeholders. High-quality earnings are earnings that have a high ability to predict future earnings (Alhadab and Al-Own, 2017). Discretionary loan loss provision (DLLP), a proxy for earnings quality, is simply an adjustment in the profit and loss accounting rules by not involving direct cash outflows. The higher the DLLP value (the higher the bank’s earnings management practice), the earnings quality worsens and vice versa.
The effect of significant loan loss provisions (LLPs) amount can reduce reported net income, retained earnings and shareholders’ equity. LLP offers signals to users of financial statements about the collectibility of loans and investments disbursed by banks (Desta, 2017; Zoubi and Al-Khazali, 2007). As a result, managers usually increase (decrease) earnings when actual earnings are low (high) and do not adjust earnings when they are aligned with expectations (Kanagaretnam et al., 2004).
6.1.1 Implications and further research
The implications of this study are beneficial for several parties such as management, regulators and further researchers. With this study, managers should have more control over pre-managed earnings and bank liquidity as manager’s incentive to do earnings smoothing. Managers should also pay attention to cost efficiency and effective implementation of governance mechanisms to maximize earnings quality. Moreover, management can consider other accrual factors that influence the decision to reserve credit defaults before the corona crisis, especially those relating to credit risk assessment and credit loss provisions, to apply the principle of prudence. This result is expected to provide an overview of the regulatory impact of determining the allowance for impairment losses previously determined. In addition, policymakers are expected to be able to determine better regulations, such as determining the amount of reserve value for each indication of loan losses, risk disclosure obligations in the banking industry, and regulating the mechanisms of banking activities so that the risk of earnings management can be minimized so that it can support the country’s economy.
Finally, further research expects to analyze the factors affecting the quality of banking earnings concerning the application of PSAK 71 that adopts IFRS 9 in Indonesia starting from 2020. Future researchers expect to apply mixed methods to verify the financial statement data and provide comprehensive discussion and genuine insight from their research. Future research requires more samples from companies or an international scale (cross country) to obtain maximum results and be generally accepted. This study proposes to be used as additional reference material for further research in the same field, such as financial accounting and banking, which will be improved.