Earnings management is typically regarded as a bad thing. I will cover why it’s considered a bad thing, and what it entails. When an executive “cooks the books” it’s referring to them providing false information in order to deceive other important employees or shareholders. This act includes, but is not limited to: falsifying receipts, inventories, balance sheets, and/or cash flow statements.
This is an important concept to familiarize yourself with because, if identified and stopped in time, could save yourself or your company from not only criminal charges, but from shutting down altogether.Companies that did not stop this from happening, or went “with the flow” of things, ended up going bankrupt when it became public, as stock holders saw that the share prices were inflated because of false earnings. As a result, these companies were shunned from the business world and withered away into nothing. Don’t let this happen to your business. Earnings management is something that all businesses consider practicing at one point or another. Before diving into what Earnings Management is, I’ll first explain what the definition of Earnings is.
Earnings are the profits of a particular company. Investors and shareholders analyze earnings before deciding whether or not to invest in the company. Because of this, companies know that their earnings play a major part of determining if their company stays afloat. Companies will use different methods of accounting to cloud the differences between reality and said company’s projections. The spectrum goes from conservative to overly aggressive to fraud.The conservative accountant will use the most realistic numbers and typically provide the lowest earnings results; As such, the overly aggressive accountants yield the “best” results, albeit usually inaccurate.
There are several reasons behind managing your earnings. One commonly accepted incentive for the consistent over-reporting of corporate income, which came to light in 2002, was the granting of stock options as part of executive compensation packages. Since stock prices reflect earning reports, stock options could be most profitably exercised when income is exaggerated, and the stock can be sold at an inflated profit.Other motivational reasons for such behavior include market expectations, personal realization of a bonus, and maintenance of position within a market sector. Management wishing to show earnings at a certain level or following a certain pattern seek loopholes in financial reporting standards that allow them to adjust the numbers as far as is feasible to achieve their desired result or to satisfy projections by financial analysts.
These adjustments amount to fraudulent financial reporting when they fall outside the bounds of GAAP, the Generally Accepted Accounting Principles.As with almost every major decision one would come across in life, there are consequences to our actions. On July 9, 2002 George W. Bush gave a speech about recent accounting scandals that had been uncovered. In spite of its stern tone, the speech did not focus on establishing any new policies, but instead focused on actually enforcing current laws, which included holding CEOs and directors personally responsible for accounting fraud.
The Enron scandal turned in the indictment and criminal conviction of auditor Arthur Andersen on June 15, 2002.Although the conviction was overturned on May 31, 2005 by the Supreme Court of the United States, the firm ceased performing audits and is currently unwinding its business operations. The Enron scandal was defined as being one of the biggest audit failures of all time. Arthur Andersen was convicted with a guilty charge of obstruction of justice for getting rid of many emails and documents that were related to auditing Enron.
From this incident, a little less than 100,000 employees lost their jobs. Although later the ruling was overturned by the U. S.Supreme Court, the image of the auditing firm have been damaged beyond repair, and was never able to come back to its full operation capacity.
In 2005, after a scandal involving insurance and mutual funds the year before, AIG was investigated for accounting fraud. The company had already lost over 45 billion US dollars worth of market capitalization because of the scandal. Investigations also discovered over a billion US dollars worth of errors in accounting transactions. The New York Attorney General's investigation led to a $1.
6 billion fine for AIG and criminal charges for some of its executives.Earning management is something that should never have come to existence, but if the temptation is there, someone will do it. The end results are all the same. If you try to cheat, one way or another, you’re going to be caught eventually and pay the price. These companies paid with their entire institution, reputation, and credibility. So if you ever have to make the decision of bending the truth to make your company look good, or keeping true to morals and expectations, just remember it’s a slippery slope and those consequences cannot be undone.
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org/downloads/chapter3. pdf (Earnings Management and Fraud) http://www. swlearning. com/pdfs/chapter/0324223250_1. PDF (What is Earnings Management? )
