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Earnings management, in accounting, is the act of intentionally influencing the process of financial reporting to obtain some private gain.[1] Earnings management involves the alteration of 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 earnings quality.[3]
Earnings management is believed to be widespread, for example the authors of a 1990 report on earnings management situations stated that "short-term earnings are being managed in many, if not all companies".[3] In a 2013 essay published in Accounting Horizons, 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."[4]
Motivations
editEarnings 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.[5] Opportunistic income smoothing can in turn signal lower risk and increase a firm's market value.[6] 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.[7]
Methods
editEarnings management may involve exploiting opportunities to make accounting decisions that change the earnings figure reported on the financial statements. Accounting decisions may affect earnings because they can influence the timing of transactions and the estimates used in financial reporting. For example, a comparatively small change in the estimates for uncollectible accounts can have a significant effect on net income, and a company using last-in, first-out accounting for inventories can increase net income in times of rising prices by delaying purchases to future periods.[8]
Detection
editEarnings management is difficult for individual investors to detect due to the complexity of accounting rules,[5] although accounting researchers have proposed several methods. For example, research has shown that firms with large accruals and weak governance structures are more likely to be engaging in earnings management.[9] 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.[10][11]
References
edit- ^ Schipper, Katherine. 1989. “Commentary on Earnings Management.” Accounting Horizons (December): 91–102.
- ^ Healy, Paul M., and James M. Wahlen. 1999. “A Review of the Earnings Management Literature and Its Implications for Standard Setting.” Accounting Horizons 13 (4): 365–383.
- ^ 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.
- ^ Ball, Ray (2013). "Accounting Informs Investors and Earnings Management is Rife: Two Questionable Beliefs". Accounting Horizons. 27 (4): 847–853. doi:10.2308/acch-10366.
- ^ a b "What is earnings management?". Investopedia. Retrieved 14 January 2014.
- ^ Subramanyam, K. R. (1996). "The pricing of discretionary accruals". Journal of Accounting and Economics. 22 (1–3): 249–281. doi:10.1016/S0165-4101(96)00434-X.
- ^ Richardson, Scott A. (October 2002). "Predicting Earnings Management: The Case of Earnings Restatements". SSRN. working paper series. SSRN 338681.
{{cite journal}}: Unknown parameter|coauthors=ignored (|author=suggested) (help)CS1 maint: date and year (link) - ^ Weil, Roman L. "Quality of Earnings and Earnings Management: A Primer for Audit Committe Members" (PDF). AICPA. Retrieved 14 January 2014.
- ^ Dechow, Patricia (2000). "Earnings Management: Reconciling the Views of Accounting Academics, Practitioners, and Regulators". Accounting Horizons. 14 (2): 235–250. doi:10.2308/acch.2000.14.2.235.
{{cite journal}}: Unknown parameter|coauthors=ignored (|author=suggested) (help) - ^ Larcker, David F. (2012). "Detecting Deceptive Discussions in Conference Calls". Journal of Accounting Research. 50 (2): 495–540. doi:10.1111/j.1475-679X.2012.00450.x.
{{cite journal}}: Unknown parameter|coauthors=ignored (|author=suggested) (help) - ^ Hobson, Jessen L. (2012). "Analyzing Speech to Detect Financial Misreporting". Journal of Accounting Research. 50 (2): 349–392. doi:10.1111/j.1475-679X.2011.00433.x.
{{cite journal}}: Unknown parameter|coauthors=ignored (|author=suggested) (help)