8 3 asset quality index aqi asset quality in a given

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83. Asset Quality Index (AQI):Asset quality in a given year is the ratio of non-current assets other than property plant andequipment (PPE) to total assets and measures the proportion of total assets for which futurebenefits are potentially less certain.AQI is the ratio of asset quality in year t, relative toasset quality in year t-1.AQI is an aggregate measure of the change in the asset realizationrisk analysis suggested by Siegel (1991).If AQI is greater than 1 it indicates that the firmhas potentially increased its involvement in cost deferral.9I thus expect a positive relation8It is possible that manipulation of inventories and other production costs can lead to increasing grossmargins. This would suggest that either increased or decreased gross margins can increase the likelihood ofmanipulation. While Kellogg and Kellogg (1991, p. 10-16) state: "Barring unusual circumstances, the percentageof gross profit to sales should remain the same from year to year." it is difficult to determine what "the same"means.I considered a variable relating gross margin changes to inventory changes but it did not enhance thespecification of the model.9It is possible that part ofthe increase is attributable to acquisitions involving Goodwill.However, samplemanipulators undertake few acquisitions and those are primarily stock-for-stock exchanges accounted for usingpooling of interests.Nevertheless, I also calculate this variable using the ratio of non-current assets other thanPPE and Goodwill to total assets and find similar results.
11between AQI and the probability of earnings manipulation.An increase in asset realizationrisk indicates an increased propensity to capitalize and thus defer costs.4. Sales Growth Index (SGI):SGI is the ratio of sales in year t to sales in year t-1.Growth does not implymanipulation, but growth firms are viewed by professionals as more likely to commitfinancial statement fraud because their financial position and capital needs put pressureon managers to achieve earnings targets (National Commission on Fraudulent FinancialReporting (1987),National Association of Certified Fraud Examiners (1993)).Inaddition, concerns about controls and reporting tend to lag behind operations in periodsof high growth (National Commission on Fraudulent Financial Reporting (1987),Loebeckke et al. (1989)).If growth firms face large stock prices losses at the firstindication of a slowdown, they may have greater incentives to manipulate earnings.Tothis effect, Fridson (1993, pp. 7-8) states: "Almost invariably, companies try to dispelthe impression that their growth is decelerating, since that perception can be so costlyto them." I thus expect a positive relation between SGI and the probability of earningsmanipulation.

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Term
Spring
Professor
Devianti
Tags
Balance Sheet, Depreciation, Generally Accepted Accounting Principles, Likelihood function, Likelihood ratio test

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