The Effect of Regulatory Scrutiny on Accrual-Based and Real Activities Manipulations in U.S. Hospitals

• In Event: Not-for-Profit Accounting and Accounting for U.S. Hospitals

Abstract

The purpose of this paper is to examine the influence of the recent increase in regulatory scrutiny related to the renewal of the tax exemption on the accrual-based and real activities earnings manipulations exhibit by the U.S. hospital industry. I find that not in all cases taxable hospitals (for-profit hospitals) engage in more earnings management than annually tax-exempted hospitals (not-for-profit hospitals) and permanently exempted hospitals (government hospitals). The magnitude of the manipulation of patient services costs, a specific real activity earnings management strategy, is the lowest in not-for-profit hospitals. Considering that a significant portion of these activities (e.g. patient care service costs provided as charity) are monitored by federal, state and local government agencies to evaluate the renewal of the not-for-profit hospital’s tax-exempt status, these findings suggest that regulatory scrutiny is associated with the low level of manipulations in not-for-profit hospitals. I also find that in addition to for-profit firms, not-for-profit and government firms behave as if accrual-based earnings management and real activities earnings management are substitutes—greater levels of one type of earnings management are associated with reduced levels of the other. The findings of this study suggest that state additional oversight and the new IRS regulations established in 2009 may provide not-for-profit hospitals with added incentives to switch from real activities manipulations to accrual-based earnings management, and thus require additional scrutiny of their accrual accounting.

Author

• Melvin Arnaldo Lamboy Ruiz, Iowa State University