Earnings Management

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Is earnings management good or bad? Who (or which part of corporate governance mechanisms) is responsible to constrain earnings management? To what extent can the auditor constrain earnings management? Propose some methods for the auditors to detect and constrain earnings management. Does market react to firm's earnings management behavior?

In order to discuss earnings management and what its affects are on business and whether or not it's a good thing, one must first understand what earnings management really is. Earnings management is often referred to as creative accounting or income smoothing. By definition, earnings management is "strategies used by the management of a company to deliberately manipulate the company's earnings so that the figures match a pre-determined target" (Investopedia.com). One of the main reasons that managers or companies manage their earnings is to meet a pre-specified target, which is often set by an analyst. Companies find it important to make their numbers because their earnings are the companies' profit which analysts use to determine the attractiveness of that specific company's stock. If analysts don't like the earnings produced by the company, they find the stock to be unattractive which will affect the share price and low share price doesn't make the company or management look good. There is good earnings management and bad earnings management. Earnings management is bad when it becomes abusive, because at that point, it's illegal according to the Securities and Exchange Commission (SEC). According to the SEC, abusive earnings management is "a material and intentional misrepresentation of results" (Investopedia.com). When the SEC sees that a company was involved in abusive earnings management, they usually issue fines but investors have already received the false numbers and made their decisions based on those numbers and there is nothing they can do to recover potential losses. Improper earnings management, or abusive



Bibliography: Sources: 1. "What is earnings management?" Investopedia.com. 2007. Investopedia.com. 10 April 2007. 2. "Accounting Subjectivity and Earnings Management: A Preparer Perspective" Accounting Horizons Print ISSN: 0888-7993 Volume: 14 Issue: 4 Cover Date: December 2000 Page(s): 481-488 Author: William U Parfet 3. Gavious, Ilanit. "Market Reaction to Earnings Management: the Incremental Contribution of Analysts." International Research Journal of Finance and Economics 8 (2007): 196-214. 4. Li, Haiden, Morton Pincus, and Sonja O. Rego. "Market Reaction to Events Surrounding the Sarbanes-Oxley Act of 2002." SSRN. 14 Apr. 2007 . 5. Wayman, Richard J. "Accounting Red Flags." Forbes.com. 2002. Forbes.com. 10 April 2007. < http://www.forbes.com/2002/02/27/0227wayman.html>. 6. Glover, Steven M., Messier, Jr., William F., and Prawitt, Douglas F. "The Financial Statement Auditing Environment." Auditing & Assurance Services: A Systematic Approach. Ed. Stewart Mattson. McGraw-Hill Irwin: New York, 2008. 38-41. 7. "Financial Crimes Report to the Public Fiscal Year 2006." Federal Bureau of Investigation. 10 April 2007. .

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