Question

b) What is earnings management?

c) Give two examples on how to manage earnings up within GAAP.

Answer 1

b) Earnings management is the creative use of different accounting techniques to make the financial statements look better, within GAAP.

c) Two examples on how to manage earnings up within GAAP are:

1. Ram owns many restaurants and one of his restaurants shuts down. Ram knows that this loss will decrease reported net earnings, so he transfers maximum company's expenses to the unit shut down. He does not want creditors and investors to think that the company is at loss, so he shows some loss in one accounting period and the rest loss in the other. When the annual financial statements are available to public, the net profit of the company shown will be correct.

2. There was an electric fire at one of Shyam's pizza parlour, Shyam hires a contractor to fix it up. All that happened was at the end of the accounting period, hence, Shyam took the estimate that the contractor gave and expensed it in the current period. When the actual payment was made to the contractor, it was less than the estimate and paid in the next accounting period. Shyam, then decides to extract some of the expenses of the previous accounting period to the current accounting period according to the profit he wanted to report.