Question

Discuss the motive for earnings management with suitable examples?

Answer 1

The motive for earnings management is to present an attractive and appealing financial statement with a better view than the actual position of the company. It uses accounting principles and policies to its advantage to present an inflated view of the company's business position. Companies use earnings management to present consistent profits along with overly positive and appealing financials.

Earnings is the profit earned by the company and it is calculated by deducting the expenses incurred from the revenue generated. Earnings management is used to hide large fluctuations in the profits of the company and present the financials in a manner which lures the investors.

Examples of Earnings Management:

• Capitalization of Costs - Various costs incurred are capitalised as assets in order to decrease the expense and thereby increase profit levels and enhance the short term earnings.
• Usage of Accounting Policies - Opting of straight light method of depreciation instead of declining balance method since depreciation expense under Declining balance method is higher in the initial years. The usage of declining balance method reduces profits due to higher charge of depreciation in the initial years of the asset whereas the straight line method spreads out the depreciation cost on an equal basis throughout the useful life of the asset.

Hence the motive behind earnings management is to enhance earnings in a consistent manner so as to meet or exceed the targets analysed.