Accounting Theory and Analysis
Case Studies
Case 5-1: Income Smoothing
One reason accounting earnings might not be a realistic measure of economic income is the incentive and ability of business managers to manipulate reported profits for their own benefit. This may be particularly true when their company has an incentive compensation plan that is linked to reported net income. The manipulation of earnings, known as earnings management, commonly involves income smoothing. Income smoothing has been defined as the dampening of fluctuations about some level ofearningsthat is considered normal for the company. Research has indicated that income smoothing occurs because business managers prefer a stable rather than a volatile earnings trend.
Required:
a. Why do business managers prefer stable earnings trends?
b. Discuss several methods business managers might use to smooth earnings.
Case 5-2: Earnings Quality
Economic income is considered to be a better predictor of future cash flows than accounting income is. A technique used by securities analysts to determine the degree of correlation between a firm’s accounting earnings and its true economic income is quality of earnings assessment.
Required: a. Discuss measures that may be used to assess the quality of a firm’s reported earnings. b. Obtain an annual report for a large corporation and perform a quality of earnings assessment.
Respond to the required questions (about 200 words per case = 400 Total), double-spaced, APA format (source citations and reference insertions) essay.In each Case Study, you must use at least three (3) references, including the textbook (included below).
Text book reference:
Schroeder, R. G., Clark, M. W., & Cathey, J. M. (2017). Financial accounting theory and analysis: Text and cases (12th ed.). Hoboken, NJ: Wiley
(This Assignment Box maybe linked to Turnitin.)
Please use attached template(See cover letter attachment, and use as template)