Question

1. What is the difference between “Earnings Management” and “Financial Reporting Fraud”? Discuss the difference based on the definition of Earnings Management by Healy and Wahlen (1999)

2. What is a “big bath” in accounting? Why CEO is inclined to create a big bath?

Answer 1

1. Earnings Management :

According to Healy and Wahlen (1999), ''Earnings Management occurs when managers use judgement in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers''. Earnings Management has a positive effect on earnings quality.

Financial Reporting Fraud :

Financial Reporting Fraud is the representation of a firm's financial statement intentionally wrong with the hidden objective to give investors an impression to misrepresent about the profitability of the firm and also to operating performance.

Difference -

The main difference between these two is earnings management is done to mislead the stakeholders and financial reporting fraud is done to give investors a misrepresent impression about the operating performance and profitability of the firm.

2. Big Bath in accounting refers to the amount of assets taken by the company which results in lower expenses in the future. Under it management of earning is done that's why it is also called earning management technique.

CEO is inclined to create a big bath to take the credit for the next year's performance in the company so that they can blame the poor performance of the company's ex CEO.