Question

What are the techniques of manipulating earnings?

Answer 1

Earnings management is the use of accounting techniques to produce financial statements that present an overly positive view of a company's business activities and financial position. Many accounting rules and principles require that a company's management make judgments in following these principles. Earnings management takes advantage of how accounting rules are applied and creates financial statements that inflate or "smooth" earnings.

Management can feel pressure to manage earnings by manipulating the company's accounting practices to meet financial expectations and keep the company's stock price up.

There are two general approaches to manipulating financial statements. The first is to exaggerate current period earnings on the income statement by artificially inflating revenue and gains, or by deflating current period expenses. This approach makes the financial condition of the company look better than it actually is in order to meet established expectations.

The second approach requires the exact opposite tactic, which is to minimize current period earnings on the income statement by deflating revenue or by inflating current period expenses. When it comes to manipulation, there are a host of accounting techniques that are at a company's disposal.

1. Recording Revenue Prematurely or of Questionable Quality
   1. Recording revenue prior to completing all services
   2. Recording revenue prior to product shipment
   3. Recording revenue for products that are not required to be purchased
2. Recording Fictitious Revenue
   1. Recording revenue for sales that did not take place
   2. Recording investment income as revenue
   3. Recording proceeds received through a loan as revenue
3. Increasing Income with One-Time Gains
   1. Increasing profits by selling assets and recording the proceeds as revenue
   2. Increasing profits by classifying investment income or gains as revenue
4. Shifting Current Expenses to an Earlier or Later Period
   1. Amortizing costs too slowly
   2. Changing accounting standards to foster manipulation
   3. Capitalizing normal operating costs in order to reduce expenses by moving them from the income statement to the balance sheet
   4. Failing to write down or write off impaired assets
5. Failing to Record or Improperly Reducing Liabilities
   1. Failing to record expenses and liabilities when future services remain
   2. Changing accounting assumptions to foster manipulation