Question

1. Name and explain three tricks that management can play to manage earnings. Explain how using financial ratios can help spot these tricks.

2. Why is it important to analyze profitability, specifically focusing on return on investment? Invoke the breakdown of ROI in thinking about your response.

200-300 words

Answer 1

Earnings management is the use of accounting techniques to produce financial reports that present an overly positive view of a company's business activities and financial position. Many accounting rules and principles require company management to make judgments.

Earnings are the profits of a company. Investors and analysts look to earnings to determine the attractiveness of a particular stock. Companies with poor earnings prospects will typically have lower share prices than those with good prospects. Remember that a company's ability to generate profit in the future plays a very important role in determining a stock's price.

Three techniques of earning management are listed below:

1) Revenue and Expense Recognition

2) Cookie Jar" Accounting

3) Changing Accounting Methods