Question

Investment professionals frequently develop concerns that earnings management may be present when they observe that a firm has voluntarily changed its inventory valuation policy from LIFO to FIFO. Similar concerns arise when the capital market discovers that a firm using LIFO is liquidating its inventory prices layers. Discuss why these two financial statement disclosures might indicate the presence of earnings management. Discuss when these disclosures might not indicate the presence of earnings management.

Answer 1

EARNING MANAGEMENT : MEANS USE OF ACCOUNTING TECHNIQUE TO PRODUCE OVERLY POSITIVE VIEW OF BUSINESS ACTIVITIES .EARNING MANAGEMENT IS A TOOL TO MANIPULATE & IMPROVE THE APPEARANCE OF COMPANY FINANCIAL POSITION.

COMPANIES USE EARNING MANAGEMENT TO SMOOTH THE VARIATION IN PROFIT EACH MONTH,QUARTER ,YEAR.FLUCTUATION MAY BE NORMAL BUT IT ALARM THE INVESTED WHO WANT STABILITY & GROWTH.MANAGEMENT CAN FEEL PRESSURE TO MANAGE EARNING SO AS TO KEEP COMPANY PRICE UP.

Discuss why these two financial statement disclosures might indicate the presence of earnings management.???

The financial statement might indicate the presence of earning management when , for eg a company use the lifo method .under lifo the newest unit are consider to be sold first . since the cost of inventory increase over time so this create high cost of sales which reduce profit.If the company switch to FIFO method the retailer will consider the older, less expensive inventory to be sold first so this create lower cost of good sold which increase profit,TO ATTRACT INVESTOR .

when these disclosures might not indicate the presence of earnings management.??

1) A change in accounting must be explained to financial statement reader & state disclosure in foot note

2)financial statement are consider consistent if the comapny use accounting policies every year because it allow user to identify variation when compare to historical trend.