When Managing Earnings Becomes Illegal

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When Managing Earnings Becomes Illegal|
Jeneen Davis|

MSAF 670/Spring 2011
University of Maryland University College
Professor John Halstead

The concept of earnings management is not a new thing. Its practice is actually very common among most companies. Managing earnings is not all necessarily bad. However, there is a fine line that shouldn’t be crossed. Corporate managers are under extreme pressures when it comes to meeting forecasted results. There are various factors that contribute to these pressures: external, company culture, and personal. Corporate management may use various transactions to help “make the numbers”. But, it is when the line between practical methods and unlawful activity is crossed that managing earnings is illegal and considered fraud. In the article entitled “When is Managing to a Forecast Illegal ‘Earnings Management’?” by Steven Bochner and Douglas Clark (2008), the authors state that “it is the cover up or...lack of disclosure” (p.3) that is the start of many problems for the company. Analysis

Earnings management is not a surprising trend. It has long been used to “smooth earnings”. However, it has not been viewed as favorable by some. In a 1998 speech “The Numbers Game”, then SEC Chairman Arthur Levitt defined earnings management as a “game that runs counter to the very principles behind our market’s strengths and success…a gray area where managers are cutting corners and where earnings reports reflect the desires of management rather than the underlying financial performance of the company”. Financial statements are very important documents that are depended upon by investors, stockholders, analysts, and the company managers themselves. If the numbers are in any way “fudged”, the true financial health of the company will be misrepresented. But, if the company fails to meet its target, it can have adverse effects on its stock price. So in essence, it’s...
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