Academic journal article Academy of Accounting and Financial Studies Journal

Unbilled Receivables, Loss Allowances and Earnings Management

Academic journal article Academy of Accounting and Financial Studies Journal

Unbilled Receivables, Loss Allowances and Earnings Management

Article excerpt


Unbilled receivables are amounts of money that have not been charged to the ordering entity even after construction is completed. They are marked as assets in statements of financial position. Construction and shipbuilding industries, which require long periods of time to complete orders, use a percentage-of-completion method for revenue recognition. This accounting method creates unbilled receivables. In this method, the total contract price is distributed to each year based on the percentage of completion and, generally, the percentage is calculated as the ratio of costs incurred to date divided by total estimated costs. The total estimated costs tend to increase with the passage of time owing to increases in labor cost, changes in design or increases in cost caused by upsurges in the costs of raw materials. If not reflected on time, the percentage of completion tends to be higher than in reality, which causes revenue to be recognized early, and, as the period is delayed, the possibility of additional losses tends to increase. In the case of overseas construction, additional costs or losses may be incurred because of unpredicted local circumstances, for example, due to abrupt policy changes made by a foreign government.

Recently in Korea, concerns about unbilled receivables have raised the issue of accounting management. Especially, in construction and shipbuilding industries, unbilled receivables have increased significantly before large-scale operating losses actually took place, and hence, unbilled receivables have been considered a sign of possible future insolvency. Investors must trust the publicized accounting information of a company's financial statements. A Barron's article called Watch Their Language (Racanelli, 2009) pointed to unbilled receivables as one of the accounts to which special attention should be paid in order to prevent unexpected investment losses. In addition, companies that have actively utilized unbilled receivables were proven via an empirical analysis to be accused of accounting fraud later on (Loughran & McDonald, 2011).

Accounting fraud cases in Korea's construction and shipbuilding industries have revealed that the amount of unbilled receivables alone for the top 20 construction and shipbuilding companies in Korea was estimated to be over 30 trillion won. At the end of October 2015, the Financial Services Commission and the Financial Supervisory Service announced a plan to enhance the transparency of accounting practices in order-made production industries. According to the plan, contractors in construction and shipbuilding industries will be required to re-evaluate unbilled receivables on a quarterly basis and to turn unbilled receivables with a low possibility of recovery into loss allowances. A core auditor system will also be introduced to verify the validity of estimated project progress and costs. Financial authorities are planning to secure effective means of preventing accounting fraud by establishing a "standing supervision system" to inspect accounting irregularities in order-made production industries and by expanding the imposition of fines on accounting firms that commit accounting fraud. It is highly probable that the companies have adjusted their profits by avoiding the proper accumulation of loss allowances for unbilled receivables. Considering such large stakes, this study examines the relationship between unbilled receivables and earnings management and investigates whether loss allowances for unbilled receivables demonstrate different patterns.

The remainder of this paper is organized as follows. Section 2 provides a literature review and hypothesis development. Section 3 discusses research samples and methodology. Section 4 presents descriptive statistics, correlations and regression results. The final section provides a summary and conclusions.


Unbilled Receivables

The timing of revenue recognition, billings, and cash collections results in billed accounts receivable and unbilled receivables. …

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