Earning Management Essay Example for Free

Earning Management Es pleadEarning Management refers to those bill practices that may fol depressive disorder the letter of the rules of fundamental rules of history practices but u salaryhic entirelyy misrepresented to the users of story information. For the personal interest jitneys often try to show superior performance of the business and use the strategic way to falsify Income, Assets or Liabilities. Earning Management as by and large understood refers to systematic misrepresentation of the true income and assets of corporations or other organizations. Creative bill is at the finalize of a subdue of accounting scandals, and many proposals for accounting reform usually centering on an updated abbreviation of capital and factors of cropion that would correctly reflect how value is added. Quality of accounting information is one of the primaeval Concepts of Accounting Framework. Where its mentioned that, accounting information must(prenominal) be Relevant, Reliabl e, Comparable, and Consistent Comparable (Intermediate Accounting by Keiso, Weygandt, Warfield, 12th edition). Unless having these qualities a report cannot be treated as qualified. Managers that always promise to illuminate the metrical composition will at some point be tempted to make up the numbers. Warren Buffet translation of Earning Management * Managing inter mesh topology is the process of taking deliberate steps within the constraints of generally accepted accounting principles to bring virtually a desired level of reported profits. (Davidson, Stickney and Weil (1987), cited in Schipper (1989) p. 92) * Managing internet is a purpose-made intervention in the external pecuniary reporting process, with the intent of obtaining some private gain (as conflicting to say, merely facilitating the neutral operation of the process). A minor extension of this definition would encompass real cyberspace solicitude, accomplished by timing investment or financing decisions to a lter reported earnings or some subset of it. (Schipper (1989) p. 92). * Earnings management occurs when managers use judgment in financial reporting and in structuring legal proceeding to alter financial reports to either mislead some stakeholders ab show up the underlying economic performance of the community or to influence contractual outlets that depend on reported accounting numbers. (Healy and Wahlen, 1999, p. 368) Motivators Earning Management* Meet financial analysts estimates of earnings that leads to performance-based compensation * Raise the stock price thereby enhancing the value of stock options * Smooth net income making it appear that the earnings are increasing at a steady rate * shape it look as though proximo earnings are higher than they really are by establishing cookie jar obligates (inflated expenses) in the current year that can be drawn on in future years. (Dr. Steven Mintz, Professor and Area Chair, Cal Poly, San Luis Obispo) Conceptual Framework fo r Financial ReportingFrom this figure weve indicated that in the level 2, where bridge between 13 creates should be the concerning point of maintaining the qualities of Accounting data. Qualities are not only(prenominal) help to detect falsification, but also helps users to take decisions.Primary Qualities * Relevance It helps users to predict the ultimate outcome of past, present, and future events. It also helps users to predict that, how very much loss/ benefit company can made. * Timeline Specific timeline of accounting period helps users to trace out the business performance over the years. * Reliability To assure that the information is verifiable, true and reasonably free of error and bias.Secondary Qualities * Comparability The reported information should be measured such(prenominal) a way that it can be compared with other companys reports. * Consistency Treatment of interchangeable events from period to period must be used by same accounting standards. Standards cannot be changed suddenly, unless its proved that new method is better than previous. Perspective of Earning ManagementThere are two perspectives on earnings management. (1) the Opportunistic perspective, states that managers seek to mislead investors by showing attractive predetermined accounting information, (2) the Information perspective, first enunciated by Holthausen and Leftwich (1983), under which managerial carefulness is a means for managers to reveal to investors their private expectations about the degenerates future cash flows. (Earnings Management A Perspective by Messod D. Beneish) Accrual vs. Earning ManagementPlenty of look report shows managers try to use Accrual in financial engineering. Accruals are the difference between net income and cash flows. For example, when companies sell items to others on credit during a growth period, the sale creates an accrual of revenue. When companies engage in earnings management, they can increase or decrease income by crea ting accruals these are often referred to as non discretionary (flexible) accruals. Reasons behind using accrual as the engineering tool are * Accruals are the principle product of GAAP, so its easy to do falsification with camouflage. * Accruals resolve some problems related with the effects choosing variant accounting methods. * It will be hard for investors to see effect of unobservable components of accrual. Types of earnings managementtheoretically there are two types of earnings management. They are income increasing and income decreasing earnings management (Messod, 2001). a) Income increase earnings management As the name suggests, income increasing earnings management is the process to boost up net income of the company intentionally (to hide the poor performance) so that investors get some wrong channelise about the firms financial position and performance and make the decision of investing in to company (Messod, 2001). Management are motivated towards increasing earn ings management because of getting more debt and law Financing. b) Income decreasing earnings Management This process of earnings management is done by decreasing the make sense of net earnings. Management is more manifold in income decreasing earnings management is to get future compensation like reducing this months earnings by increasing expenses, they ensure the profit from the next month. Also tax avoidance, import tariff relief, union negotiations etc. are other reasons for managers motivation towards income decreasing earnings management (Messod, 2001).In corporate world these are the types of earning management mostly done by the management a) Revenue and Expense Recognition Under standard accounting rules, a company must record revenue in its books when it earns that revenue not when it actually receives payment. Similarly, it must record expenses when it incurs them not when it actually pays money. These rules leave room for companies to manipulate their numbers for e arnings management (www.budgeting.thenest.com). For example, say a company signs a deal on December 1 to buy $1 one thousand one thousand million worth advertising time on TV over the next two months. The company could fill out the entire expense in December, recognize the whole thing in January or split the difference. If it records it all in December, then that years profit will be lower by $1 million but the company will get a head start on the next years profit by not having any advertising expenses in January. Profits have been shifted from one year to the next with an accounting trick. b) Cookie Jar ReservesCompanies shift earnings around by creating excessively large reserve accounts in good years, then drawing them down in bad years. For example, when a company sells a product with a warranty, it must recognize the estimated expense of honoring that warranty at the same time it books the revenue (www.budgeting.thenest.com). A company might conclude that it incurs warran ty costs of $10,000 for all $1 million in sales. If its having a contingently profitable year, it might decide to take a $30,000 warranty expense per $1 million in sales. That builds up a monolithic warranty reserve now so that the company doesnt have to record warranty expenses in the future, thus fault lettuce from one period to the other. This tactic goes by the name cookie jar accounting, because it essentially stashes excess lettuce away to be used when needed. c) The Big BathThere will be times when a company simply cant avoid a bad year. No matter what it does, its going to jeopardize a loss because of a sour economy, unfavorable market conditions, and legal trouble, whatever. Some companies, though, deliberately make a bad year even worse by shifting all kinds of expenses, one-time charges and write-offs into that year and shifting revenue out of it. This allows it to inflate profits in future years (www.budgeting.thenest.com). The reasoning behind this scheme is tha t if the company is going to take a bath, it might as well take a big bath. The companys stock price was going to suffer anyway, the thinking goes, and the damage probably wont be that much worse if the company inflates the loss. Indicators of Earnings ManagementWe have find out five factors which can be important indicators of earnings managementa) Political connection and earnings management Firms with policy-making connection (large number of stockholder, or CEO or board of directors of the company is a parliament member) are more involved in earnings management (Paul, Mara and David, 2010). Mainly the reasons are- political leaders help the particular firm involved in earnings management to avoid penalization by SEC and also political leaders use these companies financial performance and position to increase their public image.b) Internal Audit and earnings management This one is another major indicator of earnings management. If the quality of upcountry quality is low there a re some possibilities of earnings management. According to the research, if a company is having high quality internal audit, they might be less motivated towards earnings management (Douglas, Jason and David, 2008). Main reasons are these internal auditors are more professional, responsible towards their job and they barely miss the experts expectations.c) Financial transparency and earnings management Many studies have shown that financial transparency and earnings management are related. If a particular financial report is more transparent then the manager are less interested toward earnings management (James, Robert and Cheri, 2004) The main reason behind this situation is detail information about the accounts including change in depreciation methods, details about each and every account will help investors to find out any manipulation done by the manager.