Motives and Techniques Used in Earnings Management - Example

Motives and Techniques Used in Earnings Management Name: Institution: Date: Word Count: 1761 Table of Contents Table of Contents 2 1.0.Introduction 3 2.0.Definition of Earnings Management 4 3.0.Real and Accrual Earnings Management 4 4.0.Methods of Earnings Management 5 5.0.“Cookie jar reserve” technique 5 6.0.“Big Bath” Technique 6 7.0.“Big Bet on the Future” technique 6 8.0.“Flushing” the investment portfolio 6 9.0.Efforts to control earning management 7 10.0.Motives behind earnings management 7 10.1.Stock market motives 8 10.2.Concealing or Signaling private information 8 10.3.Political costs 8 10.4.Personal incentives 9 10.5.Internal motives 9 11.0.Conclusion 9 1.0. Introduction Earnings refer to the profits or net income of an organization and determine the share prices since earnings and the related circumstances indicate the long run profitability and success of the business. Earnings are significant items in financial statements since they show the volume of values added activities that the firm undertook. In the capital markets, earnings act as an indicator sign of direct resource allocation. To find out the attractiveness of a given stock, the analysts and investors look to earnings. The stock treasure of an organization is determined by the current worth of its income in the times ahead. Because of the existing direct relationship between the future earnings and the company’s stock prices, there is the need for an understanding of the choices of accounting or management of revenues by the executives to make the most appropriate decisions for the organization. The primary goal of this study is to present a critical discussion the techniques, devices, policies and schemes used by firms to manage earnings. Taking this major objective into account, the specific aims of this paper including know about earnings management, outline the methods for managing the earnings figures, motives behind earnings manipulation and the control of income manipulation. The study is derived from information in secondary sources such as websites, books, and academic literature. The paper gives information about earnings management followed a discussion of some of the methods used by organizations to manage the earnings. The study determines the factors that for manipulating the control. A recommendation of efforts and mechanisms by standard setters to monitor and prevent misuse of earnings is presented. 2.0. Definition of Earnings Management Earnings Management is referred to as a technique, legal and reasonable, employing which firm makers of decision show earning numbers in financial statements using opinions of managers based on speculation, justification, and deception. The managerial usually carry out earnings management to obtain given benefits by meeting goals of the organization with the intention of manifesting accountability towards the business as well as its stakeholders. Earnings management is employed by the administration of organizations with the goal of deliberately manipulating the earnings of the company to ensure that the accounting numbers match with the targets that are determined in advance; as a result smoothing the incomes. It is possible for accountants to manipulate the company’s earnings within the accounting standards. The tool is strategic for businesses in reducing risk and maximizing organization value (Gunny, 2010). 3.0. Real and Accrual Earnings Management Kothari et al. (2012) describe Real earnings management in the guidance of the deviation from the business customs to manipulate reported incomes, even though this is capable of negatively influencing future income of the firm. The organizations manage their earnings through real manipulative actions, such as reducing and postponing investments. A team management can also change the standards of accruals in the financial reports to get the required earning levels (Zang, 2011). The phenomenon is called accrual-based income manipulation. The principal goal of the accumulation being an illustration of the firm’s actual fulfillment, through noting remunerations to their sustenance period, preferably giving out the buck inflow and outflow (Cohen and Zarowin, 2010). 4.0. Methods of Earnings Management Earnings management is a popular word applied by decision makers to manage the earnings of a firm. Nevertheless, the term does not apply to the unlawful actions of the managers in earnings management. Earnings are achievable by managers by operation decisions or accounting choices. Because the managers are flexible in decision making concerning service and accounting decisions, they can manage earnings. Many earnings management mythologies have been utilized widely with success. Four of the techniques are discussed below: 5.0. “Cookie jar reserve” technique The cookie jar methods have dealings or business with predictions of the events of the future. Based on the accepted accounting principles, the management must predict and put on the record the mandates that are to be paid in the future depending on the current occurrences of transactions based on an accrual basis. The future is however not inevitable; thus the estimation of the future is always surrounded by uncertainty. There cannot be an accurate response; there are arguably necessary options. The managers should choose a single amount based on GAAP such that there is the possibility of taking an edge of earnings management. Whenever the accrual expenditure is lower than the estimated amount, the difference is put in the “cookie jar” and is utilized later when there is a deficit in the predicted value, and the firm needs to boost its earnings. Examples of firms that have applied this accounting technique in the recent past are Microsoft, WorldCom Inc., Fannie Mae, Bristol-Myers Squibb and Dell among many others. 6.0. “Big Bath” Technique In some instances, corporates may close down or change an operating portion or write down assets, and restructure debt when they cannot primarily avoid expenses. If the senior executives capture appraised expenditure against earnings for the change implementation cost, then the share prices are affected negatively. Viewing the restructuring charges against related operational changes may result in the raising of the stock prices. By this method, it is better for the manager to report once and gets rid of the story if the news is bad, such as loss from substantial restructuring. 7.0. “Big Bet on the Future” technique The business that acquires another is said to make a “big bet on the future.” The possibilities in such case for managing income reports are that the firm can write off the progressing costs against current incomes in the year of acquisition thus the future earnings are protected from these charges. The implication here is that incurring these costs in the future will never be put in the reports boosting the future earnings. The consolidation of the parent organization with the acquired business means an immediate increase in the current earnings. The example of firms is Samsung and emerging banking CEOs. 8.0. “Flushing” the investment portfolio Flushing is achievable through slating trading of shares with either gain or loss in worth. The firm can vend the holdings with unrealized gains and report the achievements as operating earnings or sell the unrealized securities loss and report it as operating earnings. The company can also write down impaired securities as well as change holding intent affecting the move of unrealized gain or loss from the financial statement (Rahman et al. 2013). 9.0. Efforts to control earning management The standard setters have made efforts in monitoring the earnings management through the techniques of accounting by the setting of more inclement accounting standards. Research shows that the inception of international accounting standards improves pricing efficiency, reduces transaction cost, and increases market liquidity (Horton et al. 2013). There is no enough evidence thus far, for a firm conclusion that the introduction of international accounting standards can improve the accounting information quality hence lowering the earnings management. With the high rate of globalization, there has been an enormous effort by several countries in harmonizing their accounting standards and even adopting some common standards of account reports. The organizations that have adopted international accounting standards have the reduced chances of managing accounts upwards or smooth earnings to avoid reporting loss and are more likelihood of recognizing losses than does those that fail to adopt. Many nations have employed International Financial Reporting Standards (IFRS) and many others still plan to do the same, under the leadership of the International Accounting Standards Board. Bodies like the Securities and Exchange Commission of the United States promote international harmony through giving the foreign organizations access to its capital markets as they report under IFRS (Nobes and Parker, 2008) 10.0. Motives behind earnings management The intentions that motivate earnings management are diverse ranging from the desire to satisfy the expectations of the analyst to the capacity to maintain a competitive edge in the financial market. Organizations only undertake earnings management only when the cost and the risk involved is lower than the benefits. Stability of business and dividend motivates the companies to manage their earnings (Fang et al. 2015). The Following are some of the motives of earnings management: 10.1. Stock market motives The intercommunication between reactions of the stock market and accounting figures is capable of pushing the executive officers toward earnings management. It is common for the investors to depend on the predictions by stock market analysts and for the management to beat the analysts' figures they are motivated to adopt earnings management. An organization's ability to meet the expectations of the analyst’s forecast means its capacity for more returns (Hadani et al. 2011). 10.2. Concealing or Signaling private information Failing companies sometimes change their annual financial reports to hide their financial struggles even without a prior determination of the effect on the stock prices. A combination of the growth signal with another signal like the stock split may be a good platform for sharing the private information (Armstrong et al. 2012). 10.3. Political costs This occurs when the organizations alter their financial statements with the intention of influencing the opinions of the shareholders. The policies and laws of the government may make a company manage its earnings. The company must count value if the reports make it look less profitable by escaping taxes. Political cost, therefore, presents a high motivation for earnings management (Rahman et al. 2013). 10.4. Personal incentives Apart from financial gain, a new manager may manipulate finances downwards in the year of entry and upwards on the following year while a retiring manager may use upward earnings management to create a good profile and keep in the board. 10.5. Internal motives Earnings management can at times be undertaken with motives within the company. Changing the financial reports might be needful to structure the business in a manner that meets the standards of performance. When the earnings behaviors are shifting, the managers are likely to apply accruals that are not expected but increase income. 11.0. Conclusion Earnings management is a technique that is employed to satisfy personal gains of the administrators. Nevertheless, an ethical utility of it can improve the well-being of stakeholders. For optimum benefits, there should be accounting standards capable of preventing any method of escape with manipulation of earnings. It is possible, though, to change earnings management into a good practice with intentions that are not morally corrupt. Reference List Armstrong, C.S., Balakrishnan, K. and Cohen, D., 2012. Corporate governance and the information environment: Evidence from state antitakeover laws. Journal of Accounting and Economics, 53(1), pp.185-204. Cohen, D.A. and Zarowin, P., 2010. Accrual-based and real earnings management activities around seasoned equity offerings. Journal of Accounting and Economics, 50(1), pp.2-19. Fang, V.W., Huang, A.H. and Karpoff, J.M., 2015. Short selling and earnings management: A controlled experiment. The Journal of Finance. Gunny, K.A., 2010. The relation between earnings management using real activities manipulation and future performance: Evidence from meeting earnings benchmarks. Contemporary Accounting Research, 27(3), pp.855-888. Hadani, M., Goranova, M. and Khan, R., 2011. Institutional investors, shareholder activism, and earnings management. Journal of Business Research, 64(12), pp.1352-1360. Horton, J., Serafeim, G. and Serafeim, I., 2013. Does mandatory IFRS adoption improve the information environment?. Contemporary Accounting Research, 30(1), pp.388-423. Kothari, S.P., Mizik, N. and Roychowdhury, S., 2012. Managing for the moment: The role of real activity versus accruals earnings management in SEO valuation. Working paper. Nobes, C. and Parker, R.H., 2008. Comparative international accounting. Pearson Education. Rahman, M.M., Moniruzzaman, M. and Sharif, M.J., 2013. Techniques, motives and controls of earnings management. International Journal of Information Technology and Business Management, 11(1), pp.22-34. Zang, A.Y., 2011. Evidence on the trade-off between real activities manipulation and accrual-based earnings management. The Accounting Review, 87(2), pp.675-703. Read More