Earnings management has been a controversial issue in accounting. Accounting scandals that has happened around the world mostly related to the earnings management issue. Managers could abuse the trust of the stakeholders by manipulating the accounting number. This leads to agency conflicts between managers and stakeholders.
In Indonesia, there are some companies which have committed accounting scandal relating to this issue. One of the known example is from PT Kimia Farma in 2001. PT Kimia Farma inflated the net earnings of the company from Rp 99,5 billions to Rp 132 billions. This earnings management practice was found after the goverment asked to be conducted re-audit to the financial statement of the company. The practice was done by the company’s executive by manipulating the inventory’s price.
The level of leverage utilize by a company can be used in determining earnings management practices. Some prior studies found that leverage has the positive relation with earnings management (Defond and Jiambalvo, 1994; Iatridis and Kadorinis, 2009; Chamberlain et al., 2014). In the other hand, some studies negate the positive relation between leverage and earnings management in which leveraged company might face control from creditors, making it difficult to conduct earnings management practices (Rodriguez-Pérez and Van Hemman(2010), Wassimullah Toor and Abbas (2010), Alshairiri and Salama (2011), Zamri et al. (2013), Afza and Rashid (2014)).