When Arthur Levitt was the chairman on his speech at New York University, he spoke about companies and their efforts to use earnings management, a process in which they use accounting rules and financial manipulations to meet the goals or make their earnings seem smooth. Mr. Levitt said that many corporate managers, auditors, and analyst are participants in the game of nods and winks.
Earning management has been business practice for so long, so often, and so many that businesspeople no longer see it as an ethical issue, but an accepted business practice. Fortune magazine has even offered a feature piece on the “how to’s” and the importance of doing it.
It remains an unassailable proposition, based on the financial research, that a firms’ stock price, attains a quality of stability of earnings management. However, the financial issues, in the decision of manage earnings are but one block in the decision tree. In focusing on that one block, firms are losing sight of the impact such activities of employees, employees’ conduct, and also eventually on the company and its shareholders.
Issues on financial reporting and earnings management are at the heart of the market transparency and trust. Understanding the issue of earnings management is very important as begin of study the cases.
The Tactics in Earnings Management
Earnings management consist of action by managers used to increase or decrease current reported earnings so as to create a favorable picture for either short term or long term economic profitability.
Also earnings management consists of activities by managers to meet or exceed earnings projections in order to increase the company’s stock value.
The methods for managing earnings are varied and limited only by managers’ creativity within the fluid of accounting rules. The common physical techniques that have been around since the beginning of the commerce are as follow; (1) write down the inventory, (2) write up inventory product development for profit target (3) record supplies or next year expenses ahead of schedule (4) delay the invoices (5) defer expenditures (6) sell all of excess assets
However, in his New York University speech, chairman Levitt noted five more transactional and sophisticated methods for earnings management, there are (1) large-charge restructuring (2) creative acquisition accounting (3) cookie jar reserves (4) materiality (5) revenue recognition (6) EBITDA (Earnings before Interest, Tax, Depreciation, and Amortization) and Non GAAP (General Accepted Accounting Principles) on financial reporting.
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