Detecting Earnings Management in Not-for-Profit Entities: An Experiment

Saleha B Khumawala
University of Houston

Linda M. Parsons
George Mason University

Teresa P Gordon
University of Idaho

Abstract: This study examines whether disclosures regarding joint cost allocations are sufficiently transparent to allow donors to detect management of efficiency ratios by not-for-profit organizations. Using a laboratory experiment, we find evidence that financial statement users generally agree with the classification system embodied in the AICPA’s Statement of Position 98-2, Accounting for Costs of Activities of Not-for-Profit Organizations and State and Local Government Entities That Include Fund Raising. Financial statement users were also able to use the joint cost allocation disclosures to detect and adjust for earnings management. However, they only did so when the potential recipients of the hypothetical gift reported substantially identical results on the operating statement. We found that it was possible to mislead both novice and experienced users.

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