Earnings Management and Its Implications

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Earnings Management and Its Implications
Educating the Accounting Profession By Michael D. Akers, Don E. Giacomino, and Jodi L. Bellovary

August 2007 Issue

AUGUST 2007 - In the wake of continuing, highly publicized E-mail Story financial frauds and failures, the accounting profession has placed renewed emphasis on issues related to earnings Print Story management and earnings quality. The SEC and the public are demanding greater assurance about the quality of earnings. Staff Accounting Bulletin (SAB) 101, Revenue Recognition in Financial Statements, which was Enlarge Cover issued in December 1999 in response to the Committee of Sponsoring Organizations of the Treadway Commission (COSO) report, illustrates the Features importance of earnings to the SEC.

Sunbeam & the ‗Iron Cur

In the August 1990 Management Accounting, William J. Bruns, Jr., and Kenneth A. Merchant reported the results of their survey of the readership of the Harvard Funding OPEB Liabilitie Business Review (HBR). That survey described 13 earnings-management situations that the authors had directly or indirectly observed, and asked HBR readers to rate Rebuilding FASB's Con the acceptability of those practices. Characterizing the results as ―frightening,‖ they Framework observed the following: Education's


It seems that if a practice is not explicitly prohibited or is only a slight deviation Earnings Management from rules, it is an ethical practice regardless of who might be affected either by the practice or the information that flows from it. This means that anyone who uses More This Issue | Past Iss information on short-term earnings is vulnerable to misinterpretation, manipulation, or deliberate deception. We have no doubt that short-term earnings are being managed in many, if not all companies. Some of these earnings-management practices can be properly labeled as immoral and unethical. Prior to the Bruns and Merchant study, researchers and accounting professionals paid little attention to the morality of short-term earnings management. Despite the increased research in this area during the past five years, there appears to be little evidence that the accounting profession is educating accountants about earnings management. Therefore, the authors decided to conduct a study to determine the extent to which public accounting organizations have addressed the issue of earnings management through training and continuing education. Where management does not try to manipulate earnings, there is a positive effect on earnings quality. The earnings data is more reliable because management is not influencing or manipulating earnings by changing accounting methods, recognizing one-time items, or deferring expenses or accelerating revenues to bring about desired short-term earnings results. The absence of earnings management does not,

however, guarantee high earnings quality. This is true because some information or events that affect future earnings may not (and cannot) be disclosed in the financial statements. Thus, the concept of earnings management is related to the concept of earnings quality. The authors‘ definition of earnings management is as follows: Earnings management is recognized as attempts by management to influence or manipulate reported earnings by using specific accounting methods (or changing methods), recognizing one-time non-recurring items, deferring or accelerating expense or revenue transactions, or using other methods designed to influence short-term earnings. The SEC and the public are demanding greater assurance about the quality of earnings. The first step is to use a definition of earnings quality that meets the objectives of FASB. One major objective of the FASB Conceptual Framework is to assist investors and creditors in making investing and lending decisions. The Conceptual Framework refers not only to the reliability (or truthfulness) of financial statements, but also to the relevance and predictive value...
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