Opportunistic Misclassification of Special Items

Mads Nørr Møllebjerg & Mathias Jars Nordvig

Student thesis: Master thesis


Special items are meant to provide the user with a clearer picture of a company’s future earnings, but this is not a given, and companies tend to paint a rosy picture by misusing special items to disguise the true nature of their performance. IASB is in the process of changing IAS 1 partly due to issues with companies’ cherry-picking income decreasing rather than income increasing items as special, why it is relevant to shed light on the extent of the issues. Literature concerning special items focuses on companies under US GAAP, why this thesis seeks to expand on the literature by investigating special items for Nordic companies under IFRS. This is done by providing the reader with context concerning IASB’s upcoming changes – both in terms of why they are being implemented, but also the consequences of implementing them. The thesis will investigate how Nordic companies use special items, and how IASB can modify IAS 1 to provide equity-oriented users with a better understanding of a company’s performance, thus enabling them to make informed decisions. Inspired by Cain et al. (2020) two hypotheses concerning special items will be tested on the Nordic market. H1) The frequency and intensity of special items are independent of time, and H2) Opportunistic special items cannot be identified. The results show a clear positive relationship between time and the frequency of negative special items, with an especially high concentration in the fourth quarter. For intensity, the results are not as clear, and it is timing rather than time that affects intensity, which is significantly higher in the fourth quarter. The model constructed in this thesis shows that a rough categorization of special items in terms of quality is feasible and that low-quality special items, accounting for 49% of negative special items, will return to future core earnings. Furthermore, results imply that special items should not be considered as a binary entity that is either recurring or nonrecurring. Instead, items reported as special should be considered as in a spectrum going from completely transitory to completely recurring. The thesis does not find a significant relation between lowquality special items and future abnormal returns, why clear evidence of opportunistic misclassification in the Nordics is yet to be found. Based on the results, IASB’s proposed amendments of IAS 1 regarding the presentation of the income statement and special items are discussed and evaluated while considering the (dis)advantages of rule-based versus principle-based accounting standards. The validity and comparability of the face of the income statement are expected to improve at the expense of its relevance, while the new interpretation of special items is anticipated to be as prone to misclassification as ever. To enable users to make informed decisions when estimating future cash flows of companies, a note explicitly disclosing the content, nature, and rationale behind any unusual items is recommended.

EducationsMSc in Finance and Accounting, (Graduate Programme) Final Thesis
Publication date2021
Number of pages163
SupervisorsBjørn N. Jørgensen