Examples of where accounting can produce different numbers legally (honestly?). Interesting ones - perhaps; LIFO, FIFO Average Cost (Physical / Perpetual) Depreciation Why does management do it (not...

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  • Examples of where accounting can produce different numbers legally (honestly?).
  • Interesting ones - perhaps;
    • LIFO, FIFO Average Cost (Physical / Perpetual)
    • Depreciation
  • Why does management do it (not tax)?
  • Why not produce any numbers you like?
  • Why not require only one method or estimate?
  • Why would managers manage earnings?
  • NOT TAX – we are talking about ‘managing’ reported accounting profits not taxable income.
  • Don’t you want to look good – if you can choose which photo, which assessment marks to include etc
  • Managers want to show results that make their job easier:
  • High profits – great manager – she should be paid more
  • Low profits – not ripping the public off – should get government protection – shouldn’t be taxed more.
    • Why not produce any numbers you like?
    • There are rules; revenue recognition, conservatism etc but there still is ‘wiggle’ room (weighted ave v’s FIFO).
    • Corporate law – fraud when you just make up the numbers.
    • Auditors who independently check that the numbers are ‘true and fair’ or ‘presented fairly’ within the ‘accounting reporting framework’ (e.g. HC)
    • Post settling up – you can only lie so often.
    • Why not require only one method or estimate?
    • That adds a new kind of distortion.
    • Let’s consider a pair of shoes!
    • How do we depreciate them; method, life, residual value?
    • Accelerated? Ten years? Always have some value?
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Earnings managementExamples of where accounting can produce different numbers legally (honestly?).Interesting ones - perhaps;LIFO, FIFO Average Cost (Physical / Perpetual)DepreciationWhy does management do it (not tax)?Why not produce any numbers you like?Why not require only one method or estimate?Why would managers manage earnings?NOT TAX – we are talking about ‘managing’ reported accounting profits not taxable income.Don’t you want to look good – if you can choose which photo, which assessment marks to include etcManagers want to show results that make their job easier:High profits – great manager – she should be paid moreLow profits – not ripping the public off – should get government protection – shouldn’t be taxed more.Why not produce any numbers you like?There are rules; revenue recognition, conservatism etc but there still is ‘wiggle’ room (weighted ave v’s FIFO).Corporate law – fraud when you just make up the numbers.Auditors who independently check that the numbers are ‘true and fair’ or ‘presented fairly’ within the ‘accounting reporting framework’ (e.g. HC)Post settling up – you can only lie so often.Why not require only one method or estimate?That adds a new kind of distortion.Let’s consider a pair of shoes!How do we depreciate them; method, life, residual value?Accelerated? Ten years? Always have some value?OR Straight line? Two years? Zero residualImposing structure still gives distortions!What are we attempting to achieve when producing financial statements?Useful information (SAC 2 Objective of Financial Reporting) Barth showed useful for predicting.How do we make the information useful?Make it relevant, reliable, understandable etc (IASB Framework, Qualitative Characteristics of Financial Reporting) But problems still remain.Relevant or Reliable?Relevant to whom?Investors or creditors, casual observer?Conceptual Framework and its application.

Answered Same DayDec 20, 2021

Solution

David answered on Dec 20 2021
3 Votes
Earnings Management 1
Earnings Management
Earnings Management 2
Earnings Management
Introduction:
Earning management is a technique used by management to produce positive financial
statements. Earnings management is more often called as earnings manipulation or earning
fraud. Management uses loop holes in the accounting rules to manipulate the financial statements
and business processes. In simple words earnings management can be defined as management’s
activity to balance fluctuations in earnings of the company in order to project a more stable
financial position. Earnings management is done due to many reasons such as winning the
confidence of investors and stock analyst, procuring long term debt, meeting listings agreement
equirement etc.
Stock price of all companies are highly dependent on the financial performance of the
company, therefore company’s stock price will often increase or decrease after the company
declares it annual results, so in order to increase its stock price companies manipulate the
financial results. Therefore investor should very carefully analyze the financial statement of a
selected company before investing into it.
There are various ways in which the financial results can be manipulated such as using
most favorable method of depreciation and inventory valuation instead of the one which would
epresent more true and fair view. While computing depreciation managers often assumes longer
economic life and a higher salvage value which results in lesser amount of annual depreciation,
and this in turn increase the amount of profits earned.
Uses of Earnings Management:
Earnings management is used not to save tax but to manipulate the Revenue and expenses
in such a way that it will positively affect the stock price of the company. Management need to
Earnings Management 3
manipulate the company’s revenue and expense in order to meet the...
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