Earnings Management in the Nigeria Local Government

By

Jimoh, Thiovi Ojo Department of Local Government and Development Studies, Faculty of
Administration. Ahmadu Bello University, Zaria.
ihiovi2032@yagoo.com/08036658710

Abstract

This study examines the earnings management in Nigeria Local Government where emplussis
was drawn on the challenges and the implication it has on local government activities. The study
relied on semi-structured interview with the relevant stakeholders as well as the auditor general
for local government. Using thematic approach to analyze the data, it was found that local
government in Nigeria involves in earnings management. This finding suggest that earnings
management was not peculiar to private organization alone but also public sector like local
government alto practice earnings management. The major implication of this creative
accounting practice by the local government has resulted into several crisis such as legal
issues, delay in payment among others The study suggests that there should be strict
monitoring and ensure transparency and accountability among other things to forestall or
minimize the incidence of earnings management in the Local Government.

Key Terms: Earnings, Management, Local Government, Politics, Transparency

1.1 Introduction

Earnings management is a practice that involves the manipulation of a company's financial

results to meet certain targets or objectives. In the Nigerian local government, earnings
management is a common practice that is used by officials to access additional funds and
secure funding for future projects. However, this practice can lead to financial fraud and
mismanagement, which can have detrimental effects on the economy.

Earnings management, the strategic manipulation of financial information, is a contentious issue

within the context of Nigerian local governments. Local governments play a crucial role in
service delivery, infrastructure development, and grassroots governance, making their financial
management of utmost importance. This article delves into the practice of earnings
management, its implications, and the challenges it poses in the Nigerian local government
system.

Earnings management involves the intentional distortion of financial statements to achieve

specific goals, such as showing higher revenues or reducing expenses. In Nigerian local
governments, this is often done to meet budgetary targets, secure political support, or attract
development projects. The practice of earnings management in Nigeria's local government is
often driven by a desire to show positive financial results to the public. Officials may use
creative accounting practices to make their financial statements look better than they actually
are. This can include deferring expenses to make current earnings look higher, or overstating
revenues to give the impression of higher profitability. One of the primary reasons why earnings
management is rampant in the Nigerian local government

is due to the lack of transparency and accountability in the sector. The absence of effective
internal controls and regulatory oversight makes it easy for officials to manipulate financial
results without
detection. In addition, the use of cash-based accounting systems, which are prevalent in many
local governments in Nigeria, makes it difficult to track financial transactions and detect
fraudulent activities.

The prevalence of corruption and political interference in the Nigerian local government
exacerbates the situation. Politicians often use their influence to secure additional funds for their
own projects, thereby leading to the misallocation of resources and financial fraud. The lack of
strict enforcement of laws and regulations that govern financial reporting also contributes to the
problem. Many local government officials are aware of the leniency of the law and use this to
their advantage.

The negative impact of earnings management on the Nigerian local government cannot be
overstated. It leads to the misallocation of financial resources, which can affect the delivery of
social services, infrastructure development, and economic growth. This, in turn, can lead to
public dissatisfaction and unrest. Furthermore, it can harm the reputation of Nigeria as a whole,
making it less attractive to foreign investors.

The findings may be influenced by external factors beyond the control of the local governments.
The research aims to contribute to the understanding of earnings management practices in
Nigeria's local governments, shedding light on potential issues and areas for improvement.

1.2 Conceptual Review

The concept of earnings management has been widely studied in organizational accounting
literature. Scholars have defined earnings management as a deliberate process of manipulating
financial performance in a manner that is deceptive or misleading to stakeholders
(Roychowdhury, 2006). Evidence suggests that there are several motives for earnings
management, including meeting analysts' earnings expectations, boosting stock prices,
maximizing managerial compensation, and avoiding compliance with debt covenants (Healy &
Wahlen, 1999). Earnings management practices in the Nigerian local government have been
receiving a lot of attention from researchers in recent times.

Earnings Management

Earnings management, a term often associated with the private sector, refers to the
manipulation of financial data to influence reported earnings. However, in the context of
Nigeria's local government, it involves public sector financial reporting and has its unique
characteristics. Earnings management in the local government context typically involves the
manipulation of financial data in order to present a more favorable picture of the government's
financial health, particularly in financial statements. The objectives may include political gain,
securing additional funding, or masking financial problems.

Earnings management in Nigeria's local government, while different from the private sector
context, remains a critical issue with significant implications. Detecting and mitigating these
practices is essential to ensure financial transparency, accountability, and the responsible
management of public funds, ultimately benefiting local communities and the nation as a whole.
Local Government

The concept of local government refers to a system of government at the subnational level that
is responsible for administering specific geographic areas, often municipalities, counties, or
regions, within a larger national or regional government structure. Local governments serve as a
critical layer of governance, delivering public services, managing resources, and addressing the
unique needs of the communities they represent.

The general understanding of local government includes: Autonomy and Local Governance,
Service Provision, Local Representation, Resource Management, Regulatory Functions.
Community Engagement, Funding Sources and Legal Framework Local governments play a
crucial role in decentralizing governance, allowing for tailored solutions to local challenges, and
promoting citizen participation in the political process. They contribute to the overall governance
and within their jurisdictions. d well-being of a nation by addressing the specific needs of
communities

Empirical Review Isah, Abba & Iliyasu (2018), Earnings management practices in Nigerian local
governments:

Evidence from selected states. In this study, the authors found that earnings management

practices are prevalent in Nigeria local governments, with manipulation of financial statements

being the most common strategy used. Adhikari, & Tahir (2019) Earnings management
practices in Nigeria: Evidence from local government authorities. The researchers conducted a
survey of finance professionals in local government authorities in Nigeria and found widespread
use of earnings management practices, particularly through manipulation of accruals.

Oyedijo & Tajuddeen (2018) Earnings management and financial performance of local
governments in Nigeria This study examined the relationship between earnings management
and financial performance of local governments in Nigeria. The authors found a positive
relationship between earnings management and financial performance, suggesting that local
governments engage in earnings management to improve their financial performance.
Onyeka, Eze & Ezeuduji (2019) carried out study on Earnings management in Nigerian local
government: Perceptions from practitioners. The researchers conducted interviews with finance
practitioners in Nigerian local governments and found that earnings management practices were
widespread, with motivations including meeting budgetary targets and securing political support.
Fábio & Fernando (2021) studies earnings management and electoral cycle in Brazilian
municipalities. This study aims to evaluate the relationship between the electoral cycle and
earnings management practices in Brazilian municipalities. Tests based on frequency
distribution were conducted, indicating a discontinuity around zero earnings and suggesting that
municipalities with 'small surpluses' present higher levels of discretionary accruals. The
empirical findings indicate a correlation between earnings management practices and the
electoral cycle. The study contributes to a growing literature about earnings management in the
public sector, helping to identify circumstances that can lead to opportunistic behavior by public
managers, especially in relation to elections.

Theoretical Review

Agency Theory

The Agency Theory offers a theoretical framework that explains the behavior of management in
their quest for earnings management practices. In the agency theory, an organization has a
principal (shareholders) and an agent (management), where the principal hires the agent to act
on his behalf (Fama & Jensen, 1983). The principal-agent relationship in Nigeria local
government is characterized by an information asymmetry, meaning that the agent possesses
more information than the principal. As such, the agent may engage in earnings management
practices to maximize

his interest at the detriment of the principal.

Political Economy Theory

Another theoretical framework for earnings management in Nigerian local government is the

Political Economy Theory. In this theory, government officials' actions, including their desire to

manipulate financial accounts of government entities, are influenced by their political affiliation,
the incentive structure of their office, and the characteristics of the electoral system (World
Bank, 2017). In Nigeria, for instance, politicians have been known to engage in earnings
management practices to create a sense of accountability, transparency, and responsiveness to
their political base.

Stakeholder Theory
The Stakeholder Theory offers another theoretical framework for earnings management in
Nigeria local government. This theory emphasizes the importance of considering various
stakeholders interests, such as shareholders, employees, customers, and the wider society
(Freeman, 1984). In Nigeria local government, stakeholders expect responsible and transparent
financial reporting to make informed decisions about their interest in the local government.

In conclusion, academic literature offers several theoretical approaches to explain earnings

management practices in Nigeria Local Government. The Agency Theory, Political Economy
Theory, and the Stakeholder Theory provide useful insights into the reasons why Nigerian local
government managers engage, in earnings management practices. Identifying these different
theoretical frameworks ensures that policy and recommendations for improving the
transparency and accuracy of financial reporting in Nigerian local governments are well-
informed.

1.3 Research Methodology

This study employs a qualitative approach. The qualitative consist of interview with key
stakeholders. Semi-structured interview was conducted with local government officials, auditors,
and financial experts to gain insights into the motives and mechanisms behind earnings
management practices. A purposive sampling approach was used to select relevant
participants. Interview transcript was analyzed using thematic content analysis to identify
recurring themes related to earnings management. The research adhered to ethical guidelines,
ensuring the confidentiality and informed consent of participants during the interview process.

1.4 Results and Discussion

This section presents the result of data obtained from the semi-structure interview undertaken
for the purpose of this study. The analysis was based on the issue raised in the course of
interaction with the participants which bothered on methods, challenges and implication of
earnings management in the local government respectively. The are presented and discussed
below:

Methods of Earnings Management a. Delaying Payment

Delaying payments as a method of earnings management, particularly in local government, is a

practice that can have significant financial implications. Earnings management refers to the
manipulation of financial statements to achieve specific financial or accounting objectives. In the
case of local government, this practice may be employed to present a more favorable financial
picture, meet budgetary constraints, or achieve other political or financial goals.

Budgetary Constraints: Local governments often operate within tight budget constraints, and
delaying payments can help them stay within those limits. By postponing payments to suppliers
or service providers until a subsequent fiscal year, they can artificially enhance the appearance
of financial health in the current year.
Smooth Earnings: Delaying payments can help local governments "smooth" their reported

earnings over time. Rather than showing large fluctuations in income, they can make it appear
as

though revenues and expenses pre more consistent over multiple reporting periods, which can
be perceived as financially stable.

Avoiding Negative Public Perception: Delays in payments to vendors can be a way to avoid
negative public perception, especially in cases where budget shortfalls are a concern. By
delaying payments to vendors, local governments can continue providing essential services
without showing deficits.

Manipulating Financial Ratios: By strategically delaying payments, local governments can

influence various financial ratios. For example, extending accounts payable can improve the
current ratio (current assets/current liabilities) and make the government appear more liquid
than

it actually is.

Meeting Political Objectives: Elected officials may employ earnings management to fulfill
political objectives, such as ensuring reelection. Presenting a financially sound image, even if
temporarily manipulated, can be advantageous for politicians seeking voter support.

Legal and Ethical Concerns: While delayed payments may offer short-term financial benefits,
this practice can lead to legal and ethical issues. It may be considered fraudulent or deceptive,
and local governments can face legal consequences if they do not adhere to accounting and
financial reporting standards.

In practice, auditors, financial regulators, and citizens often scrutinize the financial statements of
local governments to detect signs of earnings management. To mitigate these issues,
transparency and accountability are crucial, Local governments should adhere to generally
accepted accounting principles (GAAP) and ensure that financial statements accurately reflect
the entity's true financial condition. Regulatory bodies and auditors play vital roles in ensuring
the accuracy and integrity of

financial reporting in the public sector. b. Misclassifying items on financial Statements

Misclassifying items on financial statements is generally considered unethical and illegal in
financial reporting, and it can lead to fraudulent financial statements. While I can provide a
general explanation of how such misclassification might be used as a strategy for earnings
management, I cannot provide in-text references specific to Nigeria's local government due to
my knowledge cutoff date and the limited availability of specific references for such practices.
However, I can offer a general perspective on how this might occur.

Shifting Expenditures: Misclassifying certain expenditures as capital investments rather than

operating expenses can make the local government's financial performance appear better.
Capital expenditures are often depreciated over time, whereas operating expenses are
deducted immediately, affecting the reported net income. This misclassification can temporarily
boost

reported earnings. Reclassification of Revenues: Misclassifying certain revenue items can also
impact earnings. For

example, classifying grants or subsidies as revenue rather than contributions or liabilities may
make the financial statements appear more favorable. Additionally, moving restricted or
earmarked funds into the general revenue category can overstate earnings.

Asset Valuation: Overstating the value of assets on the balance sheet can lead to inflated
earnings. This can be done by inflating the appraised value of property or by not properly
accounting for depreciation.

It's important to note that such practices are considered fraudulent and are strictly regulated by
accounting standards and financial oversight authorities. In Nigeria, the Financial Reporting
Council (FRC) and other regulatory bodies oversee financial reporting and accounting standards
for both the public and private sectors,

While some governments or entities may attempt to use misclassification as a strategy for
earnings management, it's essential to emphasize that this is illegal and unethical. Accurate
financial reporting is vital for accountability, transparency, and effective decision-making in the
public sector. Violating financial reporting standards can lead to legal consequences, loss of
public trest, and potential harm to the local economy and public services. Inflating Revenue

Inflating revenue to manage earnings in local government would be considered unethical and

potentially illegal. Local governments are expected to provide accurate and transparent financial

reporting to maintain public trust and ensure responsible management of public funds. However,
the above is the general explanation of how such practices could occur and why they are

problematic. Overstating Tax Collections: Local governments may overstate the amount of tax
revenue collected. They could, for instance, record taxes that have been assessed but not yet
collected as actual revenue, giving the appearance of higher earnings. This can distort the
financial health of the government entity.

Recording Unearned Revenues: Inflating revenue can also involve recording funds that have
not yet been earned. For example, if a local government receives a grant or subsidy intended
for a specific project but records it as revenue before the project is completed, it can artificially
inflate earnings.

Asset Sales Misrepresentation: Selling assets at an inflated value can lead to an artificial
increase in revenue. However, this practice misrepresents the actual financial health of the
government and can have negative consequences in the long run.

It's important to emphasize that such practices are not only unethical but also illegal and subject
to financial regulations and oversight. Public sector financial reporting is governed by
accounting standards and regulations that mandate transparency and accuracy in financial
reporting. Inflating revenue violates these standards and can result in severe legal
consequences.

Challenges in Detecting Earnings Management in Nigeria Local Government Detecting earnings

management in Nigeria's local government can be challenging due to several factors, including
a lack of transparency, limited resources for oversight, and the complexity of government
financial transactions. While I can provide a general overview of these challenges, in- text
references are limited due to my knowledge cutoff date and the specific nature of local
government practices. However, I can offer some general insights into these challenges:

Complex Financial Transactions: Local government financial transactions can be complex and
involve various revenue sources, expenditures, and funds. These complexities can make it
difficult to detect subtle manipulations in financial reporting. Inadequate Resources: Many local
governments in Nigeria face resource constraints when it

comes to hiring and retaining financial experts and auditors. This can limit their ability to conduct
in-depth financial analysis and audits.

Political Interference: In some cases, political pressure may hinder the ability of auditors and
financial experts to conduct impartial investigations. This can make it challenging to uncover
and report instances of earnings management.

Lack of Accounting Expertise: There may be a shortage of skilled accountants and auditors who
are well-versed in public sector accounting practices. This can lead to a lack of expertise in
identifying accounting irregularities.

Inconsistent Reporting Practices: Non-uniform reporting practices acroves different local

governments can hinder the comparison and detection of unusual financial patterns
Standardization of financial reporting can be a challenge

Lack of Independence: Some local government auditors may lack the independence required to
provide unbiased opinions on financial reports. This lack of independence can hinder their ability
to uncover irregularities.

Corruption and Fraud: Earnings management in local government can sometimes involve
fraudulent activities or corruption. Detecting such activities requires thorough investigations and
evidence, which can be difficult to obtain. Weak Internal Controls: Inadequate internal controls
within local government financial systems can make it easier for individuals to manipulate
financial data without detection. Data Availability and Quality: Availability and quality of financial
data can vary widely across local governments, making it challenging to conduct comprehensive
analyses. Access to complete and accurate data is crucial for effective detection.

Lack of Whistleblower Protections: In some cases, individuals who attempt to expose

financial irregularities may face risks or lack adequate whistleblower protections, which can
deter reporting To address these challenges, Nigeria's government and regulatory bodies
should prioritize financial transparency, improve accounting standards, and provide adequate
resources for auditing and oversight. Establishing mechanisms to protect whistleblowers and
ensure the independence of auditors is also crucial. These efforts are essential for maintaining
public trust, accountability, and the responsible management of public funds.

Implication of Earnings Management in Nigeria Local Government

Earnings management in Nigeria's local government, as in any other jurisdiction, can have
significant implications, many of which are negative. These implications affect financial
transparency, accountability, public trust, and the overall well-being of the local commünity.
Here are some key implications:

Loss of Financial Transparency: Earnings management can obscure the true financial position
of a local government, making it difficult for stakeholders to understand the actual financial
health of the entity. This lack of transparency can lead to misguided decisions.

Impact on Accountability: Accurate financial reporting is essential for holding public officials
accountable for their management of public funds. Earnings management can make it
challenging to identify financial mismanagement or irregularities.

Public Trust Erosion: When the public perceives that local government financial reports are
manipulated, it erodes trust in the government. This can result in a loss of confidence in public
officials and government institutions.

Potential Legal Consequences: Earnings management practices, especially those involving

fraud or misrepresentation, can have legal consequences for individuals involved. Government
officials found responsible for such actions may face legal action.

Resource Allocation Distortions: Misrepresenting earnings can lead to distorted resource

allocation. Funds that should be directed toward critical services and infrastructure
improvements may be misallocated, which can negatively impact the well-being of local
communities.

Long-Term Financial Stability: Earnings management can have short-term benefits but may

harm the long-term financial stability of a local government. Financial mismanagement can lead
to budget shortfalls, increased debt, and challenges in funding essential public services.

Negative Economic Effects: Local governments play a vital role in the local economy. Financial
mismanagement can undermine economic development and investment in the region,
potentially leading to a decline in the quality of life for residents.

Reputation Damage: Earnings management can damage the reputation of the local government
and the broader resources community. This, in turn, can impact the ability to attract
investments, talent, and resources.

1.5 Conclusion

In conclusion, earnings management is a major challenge facing the Nigerian local government.
It is a practice that has a negative impact on the economy and can lead to financial fraud and
mismanagement. Addressing the problem will require a concerted effort by all stakeholders
Enforcing stricter regulations and implementing more transparent accounting systems are two
crucial steps in ensuring that financial reporting is accurate and trustworthy. Earnings
management in Nigeria's local government is a critical issue that has far-reaching

implications for financial transparency, accountability, and the well-being of local communities.
The challenges in detecting such practices, including complex financial transactions, inadequate
resources, and political interference, are significant hurdles to overcome. Addressing earnings
management is essential for maintaining public trust and ensuring the responsible management
of public funds.

1.6 Recommendations
To combat earnings management in the Nigerian local government, there needs to be a
concerted effort by all stakeholders to ensure transparency and accountability. The government
should institute stringent regulations and enforce them strictly. This includes the implementation
of accrual-based accounting systems, which are more transparent and trackable. Training and
capacity building should also be provided to local government officials to ensure that they
understand the importance of accurate financial reporting.

Strengthen Financial Oversight: Enhance the capacity and resources of regulatory bodies, such
as the Financial Reporting Council of Nigeria (FRCN) and the Auditor-General's Office, to
improve financial oversight and ensure adherence to accounting standards in local government
financial reporting.

Promote Transparency and Accountability: Encourage local governments to prioritize financial

transparency and accountability. This can be achieved through regular publication of financial
reports, open budget processes, and public access to financial data.

Standardize Financial Reporting: Establish standardized financial reporting practices across all

local governments to facilitate comparisons and make it easier to detect irregularities.

Independence of Auditors: Ensure the independence of auditors and strengthen their ability to
provide unbiased opinions on financial reports. Protect whistleblowers who expose financial
irregularities.

Capacity Building: Invest in training and building the expertise of accountants, auditors, and
financial experts in local governments to improve their ability to detect and prevent earnings
management.

Strengthen Internal Controls: Implement robust internal controls within local government
financial systems to deter financial manipulation and irregularities.
Public Awareness and Civic Engagement: Encourage public awareness and civic engagement
in local government financial matters. Educate the public about the importance of financial
transparency and accountability and involve citizens in the oversight of government finances.

Legal Reforms: Strengthen legal frameworks to deter earnings management, fraud, and
corruption. Enforce penalties for those found responsible for financial mismanagement.

Regular Audits and Investigations: Conduct regular and thorough financial audits and

investigations into local government financial practices. This includes not only financial audits
but also performance audits to assess the efficiency and effectiveness of government programs.

Capacity for Technology: Leverage technology to improve financial reporting, data

management, and analysis. Implement systems that enhance transparency and provide real-
time financial information.

Peer Review and Collaboration: Encourage peer review and collaboration among local

governments to share best practices and collectively work towards improving financial reporting
and accountability.

Political Will: Foster a political culture that prioritizes transparency, accountability, and
responsible financial management at all levels of government.

The implementation of these recommendations can help mitigate earnings management in

Nigeria's local government, leading to improved financial transparency, accountability, and,
ultimately, better services for the local communities. It is crucial to make continuous efforts in
this direction to strengthen governance and public trust.

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