Question

2. An overview of earnings management and how it is related to the topic of meeting earnings projections

Answer 1

Earnings management can be defined as a legal management decision making tool in order to achieve stable and predictable financial results .
Earnings management is a manager’s choice of accounting policies that achieves some specific objective. Even under GAAP, managers still retain some flexibility in accounting policy selection that may be able to positively impact their personal satisfaction and/or the market value of their firm.
One motivation for earning management is the need to meet shaareholders earnings expectations. Companies try to meet or beat expected earnings projections in order to grow market capitalization and increase the value of stock options.

Accounting policy choice can be divided into two categories: a
ccounting policies per se and discretionary accruals.
Examples of the latter include the timing and amounts of extraordinary items such as write-offs and provisions for reorganization, credit losses, inventory values, etc., whereby managers are able to determine when and how much of revenue and expense to classify on a current income statement.
The former, accounting policies per se, are more rigid in the sense that they dictate when and how much revenue and expense to classify in acertain period. Examples of these include amortization policies and revenue recognition

While managers can manipulate reported earnings, managers can influence corporate actions such as deferring or accelerating expense or revenue transactions . This particular principle has been considered by many to be unethical due to its ability to mislead stakeholders about the underlying economic performance of a company While there have been many individuals pushing for laws to regulate earnings management, many others argue that earnings management should not be considered negatively and can be beneficial for a business.According to Yaping, the author argues that earnings management is not harmful due to five aspects: representational faithfulness is a relative concept, earnings management is not fraudulent, wealth transfers due to earnings are justifiable, and it can add value to a corporation .Additionally, earnings management may be beneficial due to its ability to enhance the information value of earnings. For organizations that are not centralized, information regarding the company can be dispersed across various members of the company

Earnings management is the strategic choice of accounting estimates and judgments in order to meet pre-determined financial statement targets.

a)Meet Internal Targets
i)Financial goals established by the company
b)Meet External Expectations
cIncome smoothing - Managing Earnings to give smooth view of the company .Managers care about this because of Stability vs Volatility. Want to be perceived Stable not Riskiness.
d)Window Dressing for an IPO or a Loan
i)Managers care as they are selling their Initial Public Offering (IPO) oThe Earnings Management Continuum
1)Strategic Matching
•a company can make extra efforts to ensure that certain key transactions are completed quickly, or delayed, in order for them to be recognized in the most advantageous quarter.
2)Changes in Methods or Estimates with Full Disclosure
•Companies frequently change accounting estimates regarding bad debts, return on pension funds, depreciation lives, and so forth
3)Change in methods or estimates with little or no disclosure
•Accounting changes made without full disclosure§Non GAAP Accounting
•Fraudulent Reporting oRecording as an asset expenditures that have no future economic benefit is an example or recording expenses as assets
4)Fictitious Transactions
•deceptive concealment of transactions (like the sales returns) or the creation of fictitious transactions

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