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Pros and cons of earnings management
Impact of earnings management on profitability
Earnings Management
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According to an article posted in “The CPA Journal” by Michael D. Akers, Don E. Giacomino, and Jodi L. Bellovary, earnings management is defined as;
“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 transactions, or using other methods designed to influence short-term earnings.”
This definition tries to explain that managers have the control to influence the earnings and report them in a way that works in their favor. They do this using the accounting methods, therefore methods allowed by GAAP and find loopholes that are benefitting to them. This same article talks about a survey that was complete by William J. Bruns, Jr., and Kenneth A. Merchant and the conclusions of their survey was then submitted to the Harvard Business Review. Asking readers to rate the acceptability of management practices of 13 earnings management situations. The results as described in the article were “Frightening”. Following observations were made;
“It seems that if a practice is not explicitly prohibited or is only a slight deviation from rules, it is an ethical practice regardless of who might be affected either by the practice or the information that flows from it. This means that anyone who uses information on short-term earnings is vulnerable to misinterpretation, manipulation, or deliberate deception.
We have no doubt that short-term earnings are being managed in many, if not all companies. Some of these earnings-management practices can be properly labeled as immoral and unethical.”
According to this survey, short-term earnings results in misrep...
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...ond, James Jiambalvo, KR Subramanyam. "The Effect of Audit Quality on Earnings Management*." Contemporary accounting research (1998): 1-24.
George Wilson. The Effect of Sarbanes-Oxley on Earnings Management Behavio. Conference Paper. Indianapolis: Proceedings of the 18th International Business Research Conference 2012 , 2012.
Michael D. Akers, Don E. Giacomino, and Jodi L. Bellovary. "Earnings Management and Its Implications." Educating the Accounting Profession (2007): 1.
Patricia M. Dechow, Richard G. Sloan and Amy P. Sweeney. "Detecting Earnings Management." Patricia M. Dechow, Richard G. Sloan and Amy P. Sweeney. The Accounting Review. American Accounting Association, 1995. 193-225.
Stephen D. Makar, Ph.D., CPA, Ph.D., CPA Pervaiz Alam and D.B.A., CFE, CPA, CMA and Michael A. Pearson. "When does Juggling the Numbers Become Fraud?" Earnings Management (2000): 1.
Management accounting in organisation is very important for decision-making and to make the business more efficient and therefore increasing its profits. Is the process of preparing accounts that can help managers to make day-to-day and short-term decisions, by providing them with accurate and timely key financial and statistical information...
Proper revenue recognition is important in because it has a direct impact on quarterly income statements, incentive calculations, investor confidence, and perception of an organizations financial health. The scandals at Enron and WorldCom illustrate how important properly recognize revenue is to the financial integrity of a company and how abuse can be extremely dangerous. (Labaton, 2006) To maintain consistency across organizations, the Securities and Exchange Commission (SEC) relies on the standards published by the Financial Accounting Standards Board (FASB) to establish the guidelines for revenue recognition. (FASB, 2011)
Madura, Jeff. What Every Investor Needs to Know About Accounting Fraud. New York: McGraw-Hill, 2004. 1-156
... tempted to falsely inflate earnings is to take away their personal gains, if the company's stocks go up. I believe that when upper level management has too much incentive based on personal financial gain, which is directly based on the performance of the company; it compromises their judgments. I think that upper level management should not be allowed to receive stock options or to even own stock in the company as the financial statements would provide a neutral, bias-free report. Management would have no reason to "cook the books." I also feel that any management who still decides to falsify documents needs to be held more accountable for their actions and receive tougher punishments. I think that these strict guidelines would help the people in the United States and people all over the world feel more confident in investing their money into the stock market.
Marshall, M.H., McManus, W.W., Viele, V.F. (2003). Accounting: What the Numbers Mean. 6th ed. New York: McGraw-Hill Companies.
Every company or organization that operates for profit is constantly seeking new opportunities to increase its value and profitability. If the company has stocks in an open market, the pressure increases to have a profitable business that offers investors opportunities to increase their investment through dividends. To achieve this, many companies engage in unethical accounting methods to manipulate the finances of the company. One of the biggest cases in history where the hunger to have a profitable business drove the executives of a well-known chain of orthopedic hospitals to engage in numerous unethical and illegal accounting behaviors is the case of HealthSouth.
It suggested that people use information cues to make decisions about future events. The issue of how and whether information cues are used in decision making is very important to accounting professions. The model was being used as an analytical framework and the basis for most judgement studies: prediction and evaluation (Slideshare.net) In 1970, Paul and Virgil found that earnings and sales information were always obtained by financial analysts to predict financial returns on particular shares. This investigation was further agreed by Mear and Firth in 1987. Furthermore, there was also studies on addressing whether decision makers will make different decisions if relevant information are provided with the within the financial statements. A loan officer can make different judgments about an entity’s ability to repay a loan depending on if the accounting professions include footnote that provides details on liability account on the statement. Another disclosure issues that Stallman (1969) found that providing information about industry segments can reduce decision maker’s reliance on past share prices when they make choices to select particular securities. Therefore, knowing what and how information will be used by readers will help the accounting professions to determine what and how to present relevant information in a financial report, and this will
Garrison, R. H., Noreen, E. W., & Brewer, P. c. (2010). Managerial Accounting. New York: McGraw Hill/Irwin.
Schilit, H. (2010). Financial Shenanigans : How to Detect Accounting Gimmicks and Fraud in Financial Reports (3 ed.) [EReader]. Retrieved from: http:search.ebrary.com/proxy1.ncu
Accounting Theory: Conceptual Issues in a Political and Economic Environment (6th edition ed.). South Western College Pub.
Managerial accounting which is a synonym for management accounting refers to the provision of accounting information to the managerial accountants of particular organizations which they will in turn utilize in making informed decisions that touch on the business. This allows them to carry out their control and management duties effectively (Gao, 2002). According to Hall (2010), managerial accounting entails a process of identifying, measuring, accumulating, analyzing, preparing, interpreting and communicating information of accounting information by managers with the aim of assuring appropriate use of available resources and accountability.
Dowd (2016) runs above and beyond with the clarification to state accounting fraud incorporates the change of accounting records in regards to sales, incomes, costs and different components for a profit motive, for example, boosting organization stock prices, getting ideal financing or maintaining a strategic distance from obligation commitments. Dowd is of the feeling that covetousness, absence of straightforwardness, poor administration data and poor accounting interior controls are a couple of explanations behind accounting fraud. (Dowd,
Marshall, D. H., McManus, W. W, & Viele, D. (2002). Accounting: What the Numbers Mean. 5th ed. San Francisco: Irwin/McGraw-Hill.
In today’s day and age, there is a lot of news that is related to corporate accounting fraud as companies intentionally manipulate their financial statements to show a better picture of their financial health. The objective of financial reporting is to provide financial information about a company to its various stakeholders such as investors and creditors so that these stakeholders can make decisions accordingly. Companies can show a better image of their financial well being by providing misleading information. This can be done by omitting material information from the books or deceitful appropriation of assets such as inventory theft, payroll fraud, check forgery or embezzlement. Fraudulent financial reporting will have an effect on the This includes but is not limited to; check forgery, inventory theft, cash or check theft, payroll fraud or service theft.
Marshall, D., McManus, W., & Viele, D. (2004). Accounting: What the numbers mean. [University of Phoenix Custom Edition e-text]. New York, NY: McGraw-Hill Companies.