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Business Financial Crime: Earnings Management - Essay Example

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Business Financial Crime: Earnings Management Introduction: Financial crimes occur in businesses when there is any kind of falsification taking place in the accounting measures. This is generally carried out intentionally for the purpose of convincing others with financial results that are false, but would increase the value of the company in the industry…
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Business Financial Crime: Earnings Management
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Download file to see previous pages It can be defined as a process of intentional interference of the management in the establishment of the earnings of a business, misrepresenting the data to show better results than they actually are. Several reasons lead to management of earnings, which include manager’s compensation, raising stock price, or pushing for government funding. There are different strategies available that managers can use for the purpose of earnings management and hence satisfy their selfish objectives (Wild, 2006, pp.86-87). Earnings management, in exchange listed companies, is not fraud but a case of caveat emptor for investors. With regard to the increase in financial crimes in businesses, and several instances of earnings management being reported, this report would try to focus its study on the literature of earnings management and analyze the cases reported to draw a conclusion with a view on the concerned topic. Earnings Management: An Overview Earnings management is the process of intentionally misrepresenting financial data in the accounting measurements such that the company can show greater profits and more value than it actually has obtained. The process can be “cosmetic” where managers influence accruals without affecting cash flows or it can be “real” where cash flows are acted upon to manage earnings. There are three usual strategies that managers can exploit for earnings management. These include either increasing the current income, or taking a “big bath” by decreasing the current income, or income smoothing. Increasing the current income is done to represent a company more positively. It can be done for a long episode. In cases of growth, the accrual reversals are lesser than the current accruals, thereby increasing the income. The big bath strategy involves taking many write-offs in a time when performance is poor. Because of the unusual nature of the big bath, users generally discount the financial effect. In income smoothing, the managers enhance or reduce the reported revenue to reduce its volatility (Wild, 2006, pp.86-87). The maximum opportunities for earnings management lie in areas of revenue recognition, valuation of inventory, estimations of provisions like bad debts, and charges like restructuring or repair of assets. Important methods of earnings management include “Income Shifting” and “Classificatory Earnings Management”. The process of income shifting moves the income from one period to another. Accelerating or interrupting the revenues or expenses does this. This often results in turnaround of the effect, which is why this is very useful in the process of income smoothing. Earnings can also be managed by selectively classifying incomes and expenses in particular parts of the income statement. A common form of classificatory earnings management is to report expenses along with such unusual items that are given lesser importance by analysts (Wild, 2006, p.89). It is very important to identify and adjust the earnings management in the financial statement analysis because these distort the financial reports of a business. Before any conclusion is drawn by an analyst on whether a company is managing earnings or not, an analyst should check the incentives of the company, the history and reputation of the management, and the opportunities available for earnings mana ...Download file to see next pagesRead More
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