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.
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