Compare and contrast Accrual Earnings Management and Real Earnings Management.
Real Earnings Management:
a. Real activities manipulation: managers try to mislead at least some of their stakeholders to believe that the financial reporting goals have been met through normal operational practices. However, this is not a value added activity, sometimes may even reduce firm value because current actions will have negative effect on future cash flow.
b. It is probable that real earnings management will have greater future costs on the company when compared with accrual earnings management.
c. Managers normally prefer manipulating earnings through real earnings management. Reasons are as following: 1. When compared with real manipulation, accrual manipulation is more likely to get auditor or regulator scrutiny on pricing and production. 2. Company generates risk when solely depends on accrual manipulation.
d. Real activities management focuses on reducing reported expenses by having the opportunistic reduction of research and development expenditures. (Real earnings management happens more in manufacturing industry.
d. Investigation: Because normally use discretionary expenses reduction to avoid losses; thus, use discretionary expenses and productions costs for every firm- year to investigate. (Sales manipulation, reduction of discretionary expenditures, and overproduction) 1. Managers’ ability to engage in real activities manipulation is positively relates to stock of inventories receivables. 2. Real earnings management’s extent is positively relate to current liabilities at the beginning of the year (and also long term debt because they don’t want to break the debt covenants) (In general, firms who use real earnings management would perform more aggressively when having debt outstanding or high MTB. Additionally, firms with more short-term creditors may have greater extent of using real earnings management. ) 3. Institutional investor is a...
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