The use of discretionary provisions in earnings management: evidence from the Netherlands

This paper studies the use of provisions in earnings management. I examine an extensive set of highly discretionary provisions, consisting of, among others, warranty provisions, provisions for maintenance cost, and provisions for underinsured risks, as reported by Dutch listed firms between 1989 and 2000. The empirical evidence indicates that Dutch firms use their discretion in recognizing these provisions under two circumstances. First, firms report unexpectedly large provisions to smooth current earnings increases. Second, when earnings are low relative to the previous year's earnings, firms report unexpectedly large provisions if they expect that current earnings are relatively transitory.