Real and Accrual Based Earnings Management
Advanced Accounting Theory Final Paper
April 28, 2014
Real and Accrual Based Earnings Management
1.1 Introduction The most important item in the financial statements of a company is earnings. Earnings indicate the amount of value-added activities a company has engaged in over a period of time, as well as assist in the direction of resource allocation in capital markets. Just as the eyes are the window to the soul, earnings are the window to a company’s value. Increasing earnings represent an increasing company value, while the opposite can be said about decreasing earnings. Seeing how important earnings are to a company’s value, it comes to no surprise that management has a strong incentive to report earnings in their maximum capacity. This is where Earnings Management comes in play. There is extreme emphasis on managers ability to make wise decisions when it comes to making choices in their accounting methods and actions to manage their earnings efficiently.
1.2 Purpose:
The purpose of this paper is to discuss what earnings management is, the different types of earnings management, motivations for managers to use earnings management, the various strategies and techniques, and the ethical constraints. The connection between academic research and everyday practices of earnings management will be summarized. Additionally, there will be a section covering the standard setters’ actions towards constraining earnings management.
2. Overview of Earnings Management
2.1 Definition Earnings management is defined by McGraw Hill as the “reasonable and legal management decision making and reporting intended to achieve stable and predictable financial results.” Additionally, the CPA Journal states that, “Earnings management is recognized as attempts by management to influence or manipulate reported earnings by using specific accounting methods (or changing methods), recognizing one-time non-recurring items, deferring or accelerating expense or revenue
April 28, 2014
Real and Accrual Based Earnings Management
1.1 Introduction The most important item in the financial statements of a company is earnings. Earnings indicate the amount of value-added activities a company has engaged in over a period of time, as well as assist in the direction of resource allocation in capital markets. Just as the eyes are the window to the soul, earnings are the window to a company’s value. Increasing earnings represent an increasing company value, while the opposite can be said about decreasing earnings. Seeing how important earnings are to a company’s value, it comes to no surprise that management has a strong incentive to report earnings in their maximum capacity. This is where Earnings Management comes in play. There is extreme emphasis on managers ability to make wise decisions when it comes to making choices in their accounting methods and actions to manage their earnings efficiently.
1.2 Purpose:
The purpose of this paper is to discuss what earnings management is, the different types of earnings management, motivations for managers to use earnings management, the various strategies and techniques, and the ethical constraints. The connection between academic research and everyday practices of earnings management will be summarized. Additionally, there will be a section covering the standard setters’ actions towards constraining earnings management.
2. Overview of Earnings Management
2.1 Definition Earnings management is defined by McGraw Hill as the “reasonable and legal management decision making and reporting intended to achieve stable and predictable financial results.” Additionally, the CPA Journal states that, “Earnings management is recognized as attempts by management to influence or manipulate reported earnings by using specific accounting methods (or changing methods), recognizing one-time non-recurring items, deferring or accelerating expense or revenue