Earnings management

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    Earnings management, in

    financial reports to mislead stakeholders about the organization's underlying performance, or to "influence contractual outcomes that depend on reported accounting numbers."[2]

    Earnings management has a negative effect on

    Securities and Exchange Commission chairman Arthur Levitt called earnings management "widespread".[5] Despite its pervasiveness, the complexity of accounting rules can make earnings management difficult for individual investors to detect.[6]

    Occurrence and response by regulators

    Earnings management is believed to be widespread. A 1990 report on earnings management situations stated that "short-term earnings are being managed in many, if not all companies",

    Securities and Exchange Commission (SEC) chairman Arthur Levitt called earnings management a "widespread, but too little-challenged custom".[5] In a 2013 essay, Ray Ball, while opining that accounting research was not reliably documenting earnings management, wrote: "Of course earnings management goes on. [...] People have been tried and convicted."[7] A 2020 report indicated that earnings management was the most common type of accounting fraud the SEC has taken action against under its whistleblower program.[8]

    The SEC has criticized earnings management as having adverse consequences for financial reporting, and for masking "the true consequences of management's decisions".

    accounting standards to improve financial statement transparency, and has called for increased oversight over the financial reporting process.[4] The SEC has also pressed charges against the management of firms involved in fraudulent earnings management.[9][10]

    Motivations and methods

    "Increasingly, I have become concerned that the motivation to meet Wall Street earnings expectations may be overriding common sense business practices. Too many corporate managers, auditors, and analysts are participants in a game of nods and winks. In the zeal to satisfy consensus earnings estimates and project a smooth earnings path, wishful thinking may be winning the day over faithful representation."[5]

    —Arthur Levitt, in a speech to the NYU Center for Law and Business, 28 September 1998.

    Earnings management involves the manipulation of company earnings towards a pre-determined target. This target can be motivated by a preference for more stable earnings, in which case management is said to be carrying out income smoothing.[6] Opportunistic income smoothing can in turn signal lower risk and increase a firm's market value.[11] Other possible motivations for earnings management include the need to maintain the levels of certain accounting ratios due to debt covenants, and the pressure to maintain increasing earnings and to beat analyst targets.[12]

    Earnings management may involve exploiting opportunities to make accounting decisions that change the earnings figure reported on the

    inventories can increase net income in times of rising prices by delaying purchases to future periods.[13]

    Detecting earnings management

    Earnings management may be difficult for individual investors to detect due to the complexity of accounting rules,

    accruals and weak governance structures are more likely to be engaging in earnings management.[15][16] More recent research suggested that linguistics-based methods can detect financial manipulation, for example studies in 2012 found that whether a subsequent irregularity or deceptive restatement occurred is related to the linguistics used by top management in earnings conference calls.[17][18]

    Further reading

    References

    1. ^ Schipper, Katherine. 1989. “Commentary on Earnings Management.” Accounting Horizons (December): 91–102.
    2. ^ Healy, Paul M., and James Wong. Wahlen. 1999. “A Review of the Earnings Management Literature and Its Implications for Standard Setting.” Accounting Horizons 13 (4): 365–383.
    3. ^ a b Akers, Michael D.; Giacomino, Don E.; Bellovary, Jodi L. "Earnings Management and Its Implications: Educating the Accounting Profession". The CPA Journal. The New York State Society of CPAs. Retrieved 14 January 2014.
    4. ^ a b Munter, Paul (1999). "SEC Sharply Criticizes "Earnings Management" Accounting" (PDF). Archived from the original (PDF) on 5 September 2012. Retrieved 14 January 2014.
    5. ^ a b c d "Remarks by Chairman Arthur Levitt". SEC. Retrieved 14 January 2014.
    6. ^ a b c "What is earnings management?". Investopedia. Retrieved 14 January 2014.
    7. doi:10.2308/acch-10366
      .
    8. ^ "Improper revenue recognition tops SEC fraud cases".
    9. ^ "SEC Charges Former Chief Accounting Officer of Beazer Homes for Fraudulent Earnings Management Scheme". SEC. Retrieved 14 January 2014.
    10. ^ "COMMISSION CHARGES TWO FORMER BRISTOL-MYERS OFFICERS FOR FRAUDULENT EARNINGS MANAGEMENT SCHEME". SEC. Retrieved 14 January 2014.
    11. doi:10.1016/s0165-4101(96)00434-x
      .
    12. SSRN 338681. {{cite journal}}: Cite journal requires |journal= (help
      )
    13. ^ Weil, Roman L. "Quality of Earnings and Earnings Management: A Primer for Audit Committee Members" (PDF). AICPA. Retrieved 14 January 2014.
    14. doi:10.2308/acch-50064
      . Retrieved 28 July 2016.
    15. S2CID 154999202
      . Retrieved 28 July 2016.
    16. doi:10.2308/acch.2000.14.2.235
      .
    17. doi:10.1111/j.1475-679x.2012.00450.x
      .
    18. S2CID 27832619
      .

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