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How do nonprofit hospitals manage earnings?
Andrew J Leone1, R Lawrence Van Horn
1University of Rochester, William E.Simon Graduate School, Box 270100, Rochester, NY 14627, USA. leone@simon.rochester.edu
Journal of Health Economics
|May 18, 2005
Summary
Nonprofit hospitals manage earnings above zero using spending cuts and accounting changes. This earnings management, driven by incentives, impacts financial reporting and requires careful interpretation by statement users.
Area of Science:
- Health Economics
- Accounting Research
- Financial Reporting
Background:
- Nonprofit organizations, particularly hospitals, may have unique incentives influencing their financial reporting.
- Previous research suggests nonprofit hospitals exhibit less income variability compared to for-profit entities.
Purpose of the Study:
- To investigate whether nonprofit hospitals manage earnings to remain just above zero.
- To identify the specific mechanisms, such as discretionary spending and accounting accruals, used for earnings management.
Main Methods:
- Utilized regression analysis and earnings distribution tests (Burgstahler and Dichev, 1997).
- Analyzed a sample of 1,204 hospitals with 8,179 hospital-year observations.
- Examined adjustments in discretionary spending and accounting accruals.
Main Results:
- Found evidence supporting the hypothesis that nonprofit hospitals manage earnings.
- Confirmed the use of discretionary spending adjustments, consistent with prior research (Hoerger, 1991).
- Identified significant use of discretionary accruals, including adjustments to third-party allowances and doubtful accounts.
Conclusions:
- Nonprofit hospitals employ both spending adjustments and accrual management to achieve earnings objectives.
- Observed earnings management may partially explain previously reported lower income variation in nonprofit hospitals.
- Findings offer guidance for users of financial statements to predict potential biases in reported earnings.