The Effect of IFRS Adoption on Earnings Management in Indonesia:
The Moderating Role of Investor Protection Empirical Study on
Manufacturing Companies
Wulliyatu Amalinazahroh and Hamidah
Department of Accounting, Economics and Business Faculty, Airlangga University,
Jalan Airlangga No. 4–6, Surabaya, Indonesia
Keywords: IFRS Adoption, Earnings Management, Investor Protection.
Abstract: This study aims to examine the effect of IFRS adoption on an earnings management level and considers the
effect of investor protection as a moderating variable on the negative relationship between IFRS adoption
and earnings management. The samples in this study were manufacturing companies on the Indonesian
Stock Exchange in 2010–2015. Samples were selected using a purposive sampling method. The data used in
this study was analyzed using Moderated Regression Analysis (MRA) with SPSS 20. The results
demonstrate that there was a negative relationship between IFRS adoption and earnings management and,
with the influence of investor protection as a moderating variable, the negative relationship between IFRS
adoption and earnings management was strengthened.
1 INTRODUCTION
An increasingly integrated world market provides
the firm with opportunities for developing its capital
and conducting transactions between countries
without being restricted by its own geographical
position. Therefore, it is required that there is a
single high-quality international accounting
standard. The use of financial statements, which are
one of the firm's main communication tools to
investors, will be increased if there is a mutual
language around the world: the global accounting
standards. The International Accounting Standards
Board (IASB) conceptual framework identifies
relevance and presentation fairly as a basis for
qualitative characteristics in financial statements, so
that they provide beneficial accounting information
for investors and other stakeholders regarding
economic decision-making.
Driven by the above fact, the issue of accounting
standards harmonization has begun to emerge. This
harmony was finally realized with the publication of
the International Financial Reporting Standards
(IFRS) in June 2003. As explained by Ball (2006),
the IFRS is an international accounting standard that
aims to equalize accounting standards of financial
reporting among public firms around the world. He
states that the main benefit of the IFRS to investors
is an improved accounting quality, and more
accurate, comprehensive, and timely financial
reporting information.
There are two types of strategies for the adoption
of IFRS: the big bang strategy and the gradual
strategy. The big bang strategy adopts IFRS
immediately, without going through stages.
Meanwhile, the gradual strategy is a more
progressive IFRS adoption that has certain stages.
The IFRS adoption in Indonesia has been gradual
since 2008 and infrastructure preparation began in
2011 to support the implementation of PSAK, which
has already adopted IFRS. Indonesia is facilitated by
IFRS conduct so transactions can be shared with
foreign firms and will gain access to international
funding as financial statements will be more easily
communicated to global investors.
The adoption of a set of accounting standards
such as IFRS improves the quality of earnings
because management is under pressure to provide
fair statements and reduce involvement in earnings
management practices (Houqe et al., 2012). This
was also expressed by Ewert and Wagenhofer
(2005), who observed that high-quality accounting
standards would reduce earnings management
practices and improve the quality of financial
reporting. Consequently, FRS adoption in Indonesia
248
Amalinazahroh, W. and Hamidah, .
The Effect of IFRS Adoption on Earnings Management in Indonesia: The Moderating Role of Investor Protection Empirical Study on Manufacturing Companies.
In Proceedings of the Journal of Contemporary Accounting and Economics Symposium 2018 on Special Session for Indonesian Study (JCAE 2018) - Contemporary Accounting Studies in
Indonesia, pages 248-253
ISBN: 978-989-758-339-1
Copyright © 2018 by SCITEPRESS – Science and Technology Publications, Lda. All rights reserved

in PSAK is also expected to reduce earnings
management practices and produce high-quality
accounting information.
Differing interests between owner and
management may result in conflict because each
party wants to maximize its own interests (Jensen &
Meckling, 1976). The presence of information gaps
and conflicting interests between the management
and stakeholders will lead to problems of
information asymmetry (Haely & Pahlepu, 2001).
The condition of information asymmetry is actually
the cause of earnings management. According to
Scott (2012) earnings management is an act chosen
by management within accounting policies to affect
earnings but is still within the limits allowed to
achieve a certain level. IFRS adoption limits
management’s flexibility in earnings management
practice and improves the quality of accounting
information (Dimitropoulos et al., 2013). However,
principle-based space or flexibility in the IFRS,
coupled with a lack of IFRS enforcement, will
provide an opportunity to achieve earnings
management (Barth et al., 2008).
Many empirical studies have proven the
decreasing earnings management level after IFRS
was adopted (Barth et al., 2008; Dimitropoulos et
al., 2013; Ewert & Wagenhofer, 2005). Wardhani
(2009), who examined the effect of the IFRS
convergence rate in 10 countries in Asia, reported
that IFRS has an effect on earnings quality, which
means a decrease in the earnings management level.
On the other hand, there are also studies that prove
that the adoption of IFRS has no effect on the
earnings management level. Janjean and Stolowy
(2008), whose research examined the impact of the
IFRSs mandatory adoption associated with earnings
management, indicated that there was no decrease in
earnings management as a result. Barth et al. (2008)
explains the likelihood that such discrepancies are
due to a gradual shift from local accounting
standards to the IFRS that may affect the effects of
its adoption, and the lack of infrastructure to enforce
the use of it. Houqe et al. (2012) examined the
effects of investor protection at country level
regarding the IFRS adoption relationships with
earnings management in 46 countries. The results of
the study demonstrated that earnings management
will decrease when IFRS adoption is accompanied
by strong investor protection in the country.
Based on the facts in previous studies, this study
aims to examine whether there is an impact of IFRS
adoption on the earnings management level at
manufacturing firms listed on the Indonesia Stock
Exchange. This study also considers the moderating
effects of investor protection on the relationship
between the adoption of IFRS and earnings
management levels. Thus, this study is expected to
add empirical evidence regarding the impact of IFRS
adoption on the earnings management level. The
results of this study are expected to provide
reference and expand the knowledges of
management of earnings and financial accounting
related to the Financial Accounting Standards and
Investor Protection in Indonesia. It is expected to
provide information for internal and external users
about financial statements such as investors
regarding the impact of IFRS adoption on earnings
management practices in Indonesia and how investor
protection moderates the impact of IFRS adoption
on earnings management.
2 LITERATURE REVIEW AND
DEVELOPMENT OF
HYPOTHESES
The positive accounting theory, developed by Watts
and Zimmerman (1960), describes the accounting
policies and practices within the firm and predicts
which policies should be selected by managers in
certain conditions in the future. The existence of
freedom for managers in determining accounting
policies tends, according to the positive accounting
theory, to encourage opportunistic behavior.
Opportunistic behavior is an action undertaken by a
firm when choosing a favorable accounting policy
and maximizing its satisfaction (Scott, 2012, p. 395).
According to Watts and Zimmerman (1990), there
are three earnings motivation hypotheses linked by
opportunistic behaviors conducted by the firm,
namely the political cost hypothesis, debt agreement
hypothesis, and bonus plan hypothesis. These
hypotheses show that the positive accounting theory
recognizes the existence of three relationships: (1)
the relationship between management and owners;
(2) the relationship between management and
creditors; and (3) the relationship between
management and the government (Anis & Imam,
2003).
Jensen and Meckling (1976) stated that agency
relations are a contract between the management
(agent) and the investor (principal). The emergence
of earnings management can be explained by the
agency theory from which managers know more
internal information about the prospects of the firm
than the owners (shareholders). The manager is
obliged to provide information about the condition
The Effect of IFRS Adoption on Earnings Management in Indonesia: The Moderating Role of Investor Protection Empirical Study on
Manufacturing Companies
249

of the firm to the owner. The information can be
provided through the disclosure of accounting
information such as financial statements. In fact,
financial statements sometimes do not convey
accounting information that reflects the true state of
affairs. This imbalanced information leads to the
emergence of a condition known as information
asymmetry, a situation in which there is an
information gap between the manager and the firm’s
owner. Information asymmetry between the agent
and principal can provide an opportunity for
managers to conduct earnings management to
mislead owners (shareholders) about the firm’s
economic performance.
The IFRS is an international accounting standard
published by the IASB and is a global standard for
preparing public financial statements (in IFRS
FAQs). The objective of the IASC and the IASB in
issuing IFRS is to develop a higher standard of
financial statements, enhancing the transparency and
comparability of financial reporting that will be
widely accepted by countries around the world.
Indonesia unifies its accounting standards to produce
financial reports that have comparability in the
international market.
Earnings management becomes one of
accounting quality measurement attributes of
information in this study because the performance
measure is often used as the basis of business
decisions in earnings generated by the firm. Scott
(2012, p. 423) defines earnings management as the
choice of accounting policies selected by managers
to achieve specific objectives in the reporting of
earnings. In the world of finance, an investor is a
domestic or non-domestic individual agency that
undertakes an investment in either the short-term or
long-term. Protection of shareholder rights is very
important because in many countries the
expropriation of minority shareholders conducted by
the controlling shareholders is very frequent. La
Porte et al. (2006) explains the basic structure of the
way investor protection is carried out through the
Securities Law. In his research, he developed the
measure of Securities Law and stated that there is a
positive relationship between the Securities Law and
the level of protection for other investors.
2.1 IFRS Adoption Impact on Earnings
Management Level
The IFRS has the characteristics of a principle-based
standard with steps to eliminate allowed accounting
alternatives and requires a possible measurement for
describing the firm's financial position (Barth et al.,
2008). Another key characteristic brought by the
IFRS is the use of fair value in measurement and
more extensive mandatory disclosure. The adoption
of a common set of accounting standards such as the
IFRS improves the quality of earnings because
management is under pressure to provide fair
statements and to reduce involvement in earnings
management practices (Houqe et al., 2012).
The earnings management evaluated in this study
is measured by the discretionary accrual value,
supported by Dimitropoulos et al. (2013) who
provide empirical evidence of the IFRS adoption
impact on the quality of accounting information in
Greece. The measured quality relates to earnings
management through discretionary accruals,
timeliness of loss recognition, and relevance of
accounting value. The results show that the quality
of accounting information from these three
measurements is better when using IFRS than when
firms use local accounting standards.
Another conflicting study by Callao and Jarne
(2010) found that the IFRS adoption of non-financial
firms, listed in eleven equity markets in EU
countries, actually improved earnings management.
Based on this explanation, the first hypothesis in this
study is:
H
1
: IFRS adoption has an impact on the earnings
management level
2.2 Investor Protection Moderates the
Impact of IFRS Adoption on the
Earnings Management Level
Palea (2013) argues that the impact of IFRS
adoption may vary, depending on the institutional
system of firms adopting it. One of the institutional
systems that can create a different financial reporting
quality in each country is investor protection system.
Increased quality of accounting earnings depends on
at least two factors: high-quality accounting
standards and the protection of the country's overall
investors (Soderstrom & Sun, 2007).
Through another cross-country study, Houqe et
al. (2012) examined the effect of investor protection
at the country level regarding the impact of IFRS
adoption on earnings management in 46 countries.
The results of the study found that earnings
management will decrease when a country adopts
the IFRS if accompanied by strong investor
protection. The effect of investor protection in
moderating the impact of the IFRS on earnings
quality is also expressed significantly by Wardhani
(2009). Therefore, the second hypothesis in this
study is:
JCAE Symposium 2018 – Journal of Contemporary Accounting and Economics Symposium 2018 on Special Session for Indonesian Study
250

H
2
: Investor protection moderates the impact of
IFRS adoption on the earnings management
level
3 RESEARCH METHODOLOGY
3.1 Research Approach and Variable
Identification
This study uses quantitative approach done in a
structured manner using quantified data that is
generally studied through statistical analysis. This
study uses explanatory research to discover the
impact of IFRS adoption to earnings management
and how investor protection moderates that
interaction. Explanatory research explains the
relationship between variables by using hypothesis
testing (Sulistyanto et al., 2006, p. 14). This study
uses IFRS adoption as an independent variable (X),
earnings management as a dependent variable (Y),
investor protection as a moderation variable (Z), and
firm size (SIZE), firm debt (LEV), and firm growth
(GWTH) as control variables.
3.2 Types and Data Sources
The type of data used in this study is quantitative.
Secondary data required in this study includes: a list
of manufacturing firms filed on the Indonesia Stock
Exchange (BEI), between 2010 and 2015, obtained
from www.sahamok.com; financial statements of
manufacturing firms that have been audited and
published by firms within the same period obtained
from the official website of the Indonesia Stock
Exchange (IDX); IFRS and Indonesian GAAP
(SFAS); similarities and differences issued by
PricewaterhouseCoopers for the period 2010–2015;
data on investor protection measurement issued by
the World Economic Forum (WEF) for the period
2010–2015.
3.3 Data Collection Procedures and
Sample Selected
The data collection procedure used in this study is
‘documentation study’ and is carried out by
collecting secondary data in the form of a financial
report which becomes the research sample. The
sample is then selected based on criteria using
purposive sampling. It also determines the value of
IFRS adoption refers to data on the IFRS adoption
published by PricewaterhouseCoopers from 2010–
2015 and determines the value of investor protection
in reference to data measured by the World
Economic Forum (WEF) period 2010–2015.
Manufacturing firms listed on the BEI in 2015
totaled 143. However, only 68 firms per year can be
sampled. The total sample of firms recorded in this
study from 2010–2015 is 406.
3.4 Research Method
This study uses descriptive statistical analysis to
explain the variables evident from the mean,
standard deviation, variance, maximum value, and
minimum value (Ghozali, 2013). This study uses the
Moderate Regression Analysis (MRA) method to
test hypotheses one and two. From the results of the
analysis, the researchers will discover the extent of
the impact of independent variables (IFRS adoption)
to the dependent variables (earnings management)
and evaluate the extent of the impact of moderator
variables (investor protection) to the IFRS adoption
of earnings management. The Moderate Regression
Analysis method uses an analytical approach that
maintains the integrity of the sample and provides a
basis for controlling the impact of moderator
variables (Ghozali, 2013). The classical assumption
test is carried out before performing linear
regression analysis, which comprises of a normality
test, heteroscedasticity test, multicollinearity test,
and an autocorrelation test. All testing is done by
SPSS 20.0 software.
4 RESULTS AND DISCUSSION
The impact of the IFRS adoption on the earnings
management level in this study is analyzed by using
a t test which is generated using the MRA model.
Based on the regression test results, it can be
concluded that IFRS adoption has a negative effect
and proved significant to earnings management. It is
evident, based on the level of significance count
0.000 shows the significance level < 0.05. This
suggests that hypothesis one, which states the IFRS
adoption has an impact on earnings management
level is supported.
In theory, the IFRS adoption will restrict
the movement of management in creating earnings
management and improving the quality of
accounting information (Dimitropoulos et al., 2013).
The adoption of a common set of accounting
standards such as IFRS improves the quality of
earnings because management is under pressure to
The Effect of IFRS Adoption on Earnings Management in Indonesia: The Moderating Role of Investor Protection Empirical Study on
Manufacturing Companies
251

provide fair statements and to reduce involvement in
earnings management practices (Houqe et al., 2012).
The results of this study prove that IFRS can
suppress earnings management practices in
accordance with research conducted by
Dimitropoulos et al. (2013), which provides
empirical evidence that IFRS adoption impacts on
the quality of accounting information in Greece,
subsequently reducing earnings. These results also
indicate that the quality of accounting information is
better when firms adopt IFRS rather than local
accounting standards.
Based on the regression test result for hypothesis
two, regression coefficients of investor protection as
moderation variables equal to 0,150 with a level of
significance 0,023 < 0,05; investor protection (INV)
has proved to have a positive and significant impact
on IFRS adoption regarding the earnings
management level. It can be clearly seen that
investor protection as a moderating variable can
alleviate the negative impact of IFRS adoption on
the earnings management level. These results
indicate that the existence of investor protection can
moderate (strengthen or weaken) the impact of IFRS
adoption on earnings management level.
Rahmaningtyas and Farahmita (2015), supported
by the study of Leuz et al. (2003), argue that the
legal system can directly affect the quality of
accounting through investor protection, in which
opportunistic actions by management can be avoided
if there is an effective legal regulation protecting the
firm's external parties. The results of this study are
in line with cross-country studies by Houqe et al.
(2012), which examine the effect of investor-level
protection on IFRS adoption relationships with
earnings management, indicating that earnings
management will be decreased when a country
adopts IFRS accompanied by stronger investor
protection. The results of this study also support the
study by Hope (2003), which developed a
comprehensive measure of accounting standards and
suggested that strong investor protection and legal
systems are fundamental determinants of high-
quality financial statements.
5 CONCLUSIONS
This study aims to examine the negative impact of
IFRS adoption on the earnings management level
with investor protection as a moderating variable.
Based on the results and analysis conducted using
manufacturing firms listed on the Indonesia Stock
Exchange during the period 2010–2015, it can be
concluded that IFRS adoption negatively affects
earnings management in manufacturing firms and
proved to have a negative and significant effect.
These results indicate that the IFRS adoption into
local GAAP standards, in this case the PSAK, may
reduce the earnings management level that may
occur. Investor protection as a moderating variable
can strengthen (moderate) the negative relationship
between IFRS adoption and earnings management.
These results indicate that investor protection
assessed by the capital market law may reduce
earnings management simultaneously with the
adoption of IFRS.
In this study there are limitations that affect the
results of the research, namely investor protection,
which only use one measurement of capital market
law and an index of investor protection according to
the World Economic Forum (WEF). The results of
this study are expected to provide reference and
expand the knowledge of earnings management and
financial accounting related to Financial Accounting
Standards and Investor Protection in Indonesia and
provide information to internal and external users’
financial statements, such as investors regarding the
impact of IFRS implementation on earnings
management practices in Indonesia and how investor
protection affects their relationship. In addition, this
study is expected to be a reference for further studies
on the application of IFRS to earnings management
practices and how investor protection affects their
relationship.
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