International Journal of Information Technology and Business Management

29th March 2013. Vol.11 No.1
© 2012 JITBM & ARF. All rights reserved

ISSN 2304-0777 www.jitbm.com

Techniques, Motives and Controls of Earnings Management

Md. Musfiqur Rahman
Mohammad Moniruzzaman
Md. Jamil Sharif

Abstract

Earnings are the powerful indicators of the firms’ business activities. Since a company’s stock is measured by the
present value of its future earnings, investors and analysts look to earnings to determine the attractiveness of a
particular stock. Companies with poor earnings prospects will typically have lower share prices than those with
good prospects. So, Earnings management plays a key role to determine the share price of a company as well as
direct resource allocation in capital market. This paper specially focuses on earnings management, quality of
earnings and various techniques (like cookie jar reserve, big bath, and big bet) that are used to manage earnings in
the business entity. Extent and type of earnings management depends on several factors like stock market
incentives, personal incentives, political & regulatory motives. Finally, this paper concludes that rigorous
accounting standard, awareness of audit committee, corporate governance and consciousness and the morality of
the stake holders play a vital role to control earnings management.

Key words: Earnings management, Cookie jar reserve, big bath, big bet

1. Introduction

Earnings mean the profits of a company which is particular stock. The company’s stock is measured by
represented by the bottom line of the income the present value of its future earnings. Companies
statement and a summary item in financial with poor earnings prospects will typically have
statements. Earnings are the vital item in financial lower share prices than those with good prospects. A
statement because it represents to what extent the company’s ability to generate profit in the future
company engaged in value added activities. Earnings plays a very important role in determining its stock’s
also indicate the signal of direct resource allocation price. Since company’s value is directly related with
in capital market. Investors and analysts look to future earnings, all the
earnings to determine the attractiveness of a

*Md. Musfiqur Rahman, CMA, Lecturer, Dept. of Accounting and Information Systems, University of Dhaka
** Mohammad Moniruzzaman, ACA, Lecturer, Dept. of Accounting and Information Systems, University of Dhaka
*** Md. Jamil Sharif, Lecturer, CMA, Dept. of Accounting and Information Systems, University of Dhaka
Stakeholders are interested whether earnings business organization. Management has also a key
management is being practiced or not by the interest in how earnings are reported and every

[22]

What is Earnings Management? Earnings management may be defined as reasonable The accounting literature defines earnings and legal management decision making and management as “distorting the application of reporting intended to achieve stable and predictable generally accepted accounting principles. An accounting expert can manipulate earnings by using specific accounting methods (or earnings in several ways within the boundaries of changing methods).” Many in financial results. What are the techniques are applied to manage the earnings. ii. A large number of companies are the financial community assume that GAAP deters using earnings management either to maintain earnings management. risks.1 © 2012 JITBM & ARF. what are the factors act as incentive to the Secondary sources of information include academic management. chosen [23] . earnings. This Earnings management is recognized as attempts by practice is carried out for the purpose of income management to influence or manipulate reported smoothing. we have analyzed the techniques that are used to manage the earnings to maximize the personal benefit. i. International Journal of Information Technology and Business Management 29th March 2013. We have recommended some journals.11 No. In other words. In the light of this main objective. deliberately manipulate the company’s earnings so that the figures match a predetermined target. . recognizing one-time non accounting standards. 3. Objective of the Study: The main objective of this study is to focus on iii. the iv. To know the factors that motivate the techniques.jitbm. So. How we can control the earnings specific objectives of the study are as follows: management. Methodology: This research is based on secondary sources. Earnings management is firms’ revenue transactions or using other methods strategic tool for maximizing firm value and reducing designed to influence short term earnings. To know about earnings management. deferring or accelerating expense or not always illegal. After that. earnings management is a GAAP than from the application of inherently faulty strategy used by the management of a company to GAAP. In this paper we have mechanism to prevent and control of misuse of give an idea about earnings management. books and websites. Vol. motives and control of earnings manager to manage the earnings and management.com executive needs to understand the effect of their that they can make the best possible decisions for accounting choices or learn to manage earnings so the company . Earnings management steady earnings growth or to avoid reporting red results less from distortion of the application of link. Earnings management can be defined as the accounting policies or the accruals control. We have find out to manipulate earnings 4. 2. It can be said unethical but recurring items. All rights reserved ISSN 2304-0777 www.

a next period that will decrease this period’s cost of manager may change operating decisions. one can say some other number is better gives them This kind of management is usually referred to as the opportunity to manage earnings. without changing the underlying (past) cash flows. He also incentives for earnings management. Second. management’s number choice is made with an eye to its effect on net or comprehensive income.1 © 2012 JITBM & ARF. can’t measure revenue without estimating when Larcker and Sloan (1995) observed that managers customers will pay. manage the underlying cash flows that will affect the Management has the ability to choose a number reported income reports. All rights reserved ISSN 2304-0777 www. There are two methods that could be used thereby. and Holthausen. In addition. earnings can be also be managed by transactions to alter financial report to either timing of transaction. management will report lower influence contractual outcomes that depend on earnings in that office painting period than in other reported accounting numbers. one earnings prior to lending covenants. management can mislead some stakeholders about the underlying decide to paint the office in December.com by the management of enterprises to make the means of earnings management have also included earnings reach the expected level under the lobbying for the regulatory organization to modify pressure from the relevant stakeholders and the the accounting principles and the manipulation of constraints of generally accepted accounting profit figures in the fiscal report. Literature Review “Earnings management occurs when managers use term to refer to timing of transactions. occurs when firm management has the opportunity to make accounting decisions that change reported Several researches found different managerial income and exploit those opportunities”. In times of rising prices. Another set of studies promises. DeFond and stated that accounting for business operations Jiambalvo (1994) find that sample firms accelerate requires judgment and estimates. in order to choose when to buy and manage earnings. one could use the management of a company that uses a LIFO cost flexibility allowed in generally accepted accounting flow assumption for inventories has an opportunity principles (GAAP) to change reported earnings— to manage earnings by timing end of year purchases. it is According to Roman (2009). Vol.11 No. Watts and Zimmerman (1986) [24] . principles (GAAP). When economic earnings management. According to judgment in financial reporting and structuring Roman (2009). for earnings management. Healy (1985) also seller for fulfillment of warranty or maintenance documented similar evidence. For example. This is and reducing income or delay purchases until the called accounting earnings management. In addition to the choice of accounting policy and the control of accruals. focus on top managers’ job security and their Many writers restrict the term “earnings incentives to manipulate earnings when the management” to the selection of estimates that managers are faced with a possibility of losing their achieve an earnings target and would not use the respective jobs. “Earnings management engaging in “earnings management”. International Journal of Information Technology and Business Management 29th March 2013. such as goods sold and increasing income. First. the 5. manage the earnings. how manipulate earnings downwards when their bonus many will return goods for refund and costs to the are at their maximum. All other economic performance of the company or to things being equal. management can buy during which Healy and Wahlen describe as usage of this period which will increase the cost of goods sold managerial judgment in financial reporting.” Healy and Wahlen periods. how many will not pay. which is being described as from a reasonable price range and be confident no structuring of transactions by Healy and Wahlen. Management can delivery schedule or maintenance. For example. Management can choose when to paint and (1998).jitbm.

acquiring firms manage earnings find that the effect of earnings changes on upward apparently in an attempt to increase their compensation increases with persistence of those stock prices. discretionary earnings components (Subramanyan. within the boundary management's buyout intention.com suggest that certain factors such as debt covenant unusually common. preceding the public announcement of According to Teoh et al (1998a). have high positive earnings and compensation (Shuto. Balsam (1998) to be high. and (2) small declines in constraints. compensation. or unusually rare while small reported profits are [25] . suggesting that trading. which suggests that firm managers These studies found evidence that at issue year use discretionary accruals to increase their firms. reporting losses and earnings declines. revenues and expenses. Patel. Degeorge. Baber. All rights reserved ISSN 2304-0777 www. of GAAP. CEO cash compensation and shows that and Kabir (2002) observed earnings management of discretionary accruals are associated with CEO cash initial public offerings (IPO). Kang and Kumar (1998) also to the merger. Discretionary accruals are positively Teoh. Stock-for. affect security offerings. These studies increases in quarterly earnings per share (EPS). insider increases in reported earnings. on average. and Zimmerman (1986). have emphasize on discretionary accruals during the stronger incentives than mangers of other forms to periods when capital market incentives are believe practice earnings management. Perry and Williams Xie et al (2003) argue that the nature of accrual (1994) provides evidence of managers’ manipulation accounting gives managers considerable discretion of earnings in the predicted direction in the year in determining the earnings in any given period. and method to advance or delay the recognition of Degeorge. This is generally believed by the earnings changes. in the quarters leading up compensation. Managers exercise discretion over earnings to enhance Earnings management literature finds that earnings information by allowing communication of motivations and opportunities for income private information. stock mergers are another area where potential 1996). Dechow and Sloan (1995) found that CEOs important to report increases in quarterly earnings tend to reduce spending on research and and once increases have been achieved the goal development in their final employment years. the need to issue equity capital. etc. and Zeckhauser (1999) found cross. Holtahusen (1995).jitbm. They can choose an accounting Prior research by Burgstahler and Dichev (1997). becomes meeting analysts’ earnings forecasts.11 No. International Journal of Information Technology and Business Management 29th March 2013. Managers Several recent studies investigate the capital market of firms that achieve long string of consecutive incentives for earnings management. provide managers with incentives to managers use their accounting discretion to avoid manage earnings. and Zeckhauser (1999)). Vol. Teoh. and Rangan (1998) and compensation. It is most important to avoid manipulation vary with circumstances like CEO losses. including discretionary accruals. Several studies investigate the examines the manner in which earnings relationship between earnings management and components. (Watt possibly to increase reported earnings. Patel. Gaver and Gaver (1998) find that earnings management is examined. followed by poor long-run earnings components are more value relevant than earnings and negative abnormal accruals. Welch and Wong (1998b) investigated and significantly associated with executive earnings management of seasoned equity offerings. 1998). political reported earnings are unusually rare while small costs. but once profitability is achieved it is then changes. compensation plan provisions. use discretionary aspects of sectional evidence that: (1) small reported losses are the application of the chosen accounting method.1 © 2012 JITBM & ARF. regulators and the public that managers manipulate reported earnings (Levitt. Welch and Wong (1998a). managers have several sources to manipulate earnings. 2007). Nondiscretionary abnormal accruals. Erikson and extraordinary losses are unrelated to CEO cash Wang (1999) report that.

According to GAAP. These 6. Under the cookie-jar technique. (1999). Here some of the most common management to manage earnings. estimating reasonably possible answers. “Cookie jar reserve” technique: The cookie-jar technique deals with estimations of corporation will try to overestimate expenses during future events. The most successful and widely used earnings management techniques can be classified into i. Managers can manage earnings because they have flexibility in making accounting or operating choices. estimating warranty costs. But the share price may go up rapidly if instances. but also find some characteristics of the board are related to the There is a large literature examining the relationship effectiveness of the board. certain. Beasley (1996)). According to Big [26] .1 © 2012 JITBM & ARF. the long term contracts etc. But later when the company needs a boost in earnings to there is always uncertainty surrounding the meet predictions. directors does affect firm performance. Some examples of estimation to estimation process because future is not always manage earnings are: sales returns and allowances. Brickley (1994). there may be estimates of bad debt and write-downs. the in the future as a result of events or transactions in difference can be put into the "cookie jar" to be used the current fiscal year based on accrual basis. Dechow et al (1995). These characteristics are the various aspects such as CEO turnover. sometimes corporations against earnings for the cost of implementing the may restructure debt. and quality (Weisbach (1988). Vafeas the activity of the board. management has the current period to manage earnings. If and when to estimate and record obligations that will be paid actual expenses turn out lower than estimates. independence of the board. especially in monitoring between board monitoring and firm performance on top managers. Techniques of Earnings Management Earnings management is a very popular term used by twelve categories. select a single amount according to GAAP so there is estimating pension expense.11 No. There is no correct answer. All rights reserved ISSN 2304-0777 www. International Journal of Information Technology and Business Management 29th March 2013. Management has to inventory write downs.com adjust the timing of asset acquisitions and previous papers not only confirm that the board of dispositions to alter reported earnings. outside directors’ ownership. “Big Bath” Techniques: Although a rare occurrence. ii. write-down assets or change change then it will negatively affect the cost of the and even close down an operating segment.jitbm. stock return. But it does not categories are described below: mean any illegal activities by management to manage earnings. If the the charge for restructuring and related operational management record estimated charge (a loss) changes is viewed as positively. Vol. the competence of operating performance and financial reporting outside directors. expenses are generally unavoidable. Managers can achieve earnings from accounting choices or by operating decisions. terminating pension a chance of taking the advantage of earnings plans and estimating percentage of completion for management. In these share price.

equity method subsidiary and spin off the subsidiary. When available would have the effect of moving any unrealized gain for sale securities are sold. [27] . the corporation they will not have to be reported and thus future acquiring the other is said to have made a big bet on earnings will receive a boost. Timing sales of securities that have lost value: If securities and available for sale securities. timing sales of securities that have gained value: value can be written down to the reduced value The company can sell a portfolio security that has an regardless of their portfolio classification. In the first instance. “Throw out” a problem child: To increase the earnings of future period. All rights reserved ISSN 2304-0777 www. The second method is the future. v. Write-down “impaired securities: Securities that which are: have an apparent long term decline in fair market i. exchange the stock in an subsidiary with the current shareholders. no gain or loss is normally reported on a spin off. if the manager have to report bad better to report it all at once and get it out of the news i.jitbm. when the costs are actually incurred in the future. then for earnings management. Actual the manager wants to show lower earnings then he gains or losses from sales or any changes in the can sell the security that has an unrealized loss and market value of trading securities are reported as report the loss in operating earnings.com bath technique. This means that future earnings through big bet technique. an acquisition must be corporation. a immediately receive a boost in the current year's company can write off continuing R&D costs against earnings.e. This leaves two doors open consolidated with parent company earnings. iii. Two forms of investment are trading ii.. “Big Bet on the Future” technique: When an acquisition occurs. A manager can statement manage its earnings through various techniques iv. the parent current earnings in the acquisition year. any loss or gain is or loss on the security to or from the income reported in operating income. the A gain or loss is reported in the current period company can sell the subsidiary which is not statement when a subsidiary is sold. As a result. This statement. protecting company buys a guaranteed boost in current or future earnings from these charges. International Journal of Information Technology and Business Management 29th March 2013. iv. not in operating income. When the acquired corporation reported as a purchase. By acquiring another company. Under Generally Accepted Accounting to claim the earnings of the recently acquired Principles (GAAP) regulations. e. write-down “impaired value of available for sale securities during a fiscal securities: Management can manage earnings period is reported in “other comprehensive income through change of its holdings from available to sale components” at the bottom of the income securities to trading securities and vice versa. a company buys the shares of another earnings if it is required company. The existing performed well i. “the problem child” subsidiary shareholders become the owner of the problem may be “thrown out”.11 No. Earnings can be managed child by distributing or exchanging the shares of a through sell the subsidiary. a loss from substantial restructuring .1 © 2012 JITBM & ARF. “ Flushing” the investment portfolio: To achieve strategic alliance and invest their excess unrealized gain and can report the gain as operating funds. Change of holding intent. operating income where as any change in market iii. Vol. it is way.

coal. Non operating earnings will not affect xi. oil price changes.1 © 2012 JITBM & ARF. Management viii. Voluntary early new window to manage the earnings. cumulative effect of interest rate changes. write off period. protect against some types of business risk. When a new expense on a cash basis. Use of Derivatives: future earnings where as operating earnings are Derivatives offer a lot of opportunities for manager expected to continue in the near future. It is not necessary to record trademark). by recording a gain or loss a company can manage its earnings. According Management can manage the earnings by selecting to IAS 17. manage earnings by changing the time an accrual Accounting principles can be modified in a way that basis rather than cash basis those are recorded as will not change the earnings. This operating lease. Derivates should be [28] . Sale/leaseback: items which falling into those areas. equipment) and depletion expense term operating asset changed to non operating (natural resources-timber. Early Retirement of Debt: period earnings. The manager can weather. management judgment regarding this factor. In addition. the periods expected to be benefited. Moreover. International Journal of Information Technology and Business Management 29th March 2013. Vol. depreciation or amortization expense if the long machinery. the change in accounting principles. it is possible to “swap” the stock in an recordable gain or loss. A company can take the advantage of due to changing demand of business environment. and salvage value. patents. estimating assets. Earnings are two types: operating and non- operating. natural gas) over asset. such as: extraordinary gains or losses. gain or loss is recorded as an extraordinary item at the bottom of the income statement which boost ix. copyrights.goodwill. 30 lac. a disposition of a major manufacturing plant could A company can enhance the earnings of the financial possibly be classified as either a special or unusual statement by selling a long term asset that has charges or as discontinued operations. A gain transactions are recognized on the seller’s book or loss is occurred when the company makes the immediately and gain are amortized over the period early payment of cash which is different from the if it is capital lease or proportion of the payment is book value of long term debt such as bonds. depreciation (tangible assets. but its market value is now Tk. Introducing new standard New rules and regulations are introduced in GAAP earnings. Write off of long term operating Assets: The cost of long term operating assets used or has the discretionary power when selecting the consumed is recorded as an amortization (intangible write off method. Operating versus non operating Income: the earnings of that period. equity method subsidiary without having any vi.jitbm. If the machine is sold then Tk. the cost of a classification is more accurate may depend on machine showed in the balance sheet at Tk 20 lac. For instance. Derivatives can be used to operating income includes: discontinued operations. oil. timely adoption accounting standard is adopted it takes two to three of a better revenue recognition rule will provide a years to adopt the standard. commodity price change. All rights reserved ISSN 2304-0777 www. losses occurring in a sale/leaseback the fiscal period of early retirement of debt. adoption may provide an opportunity to manage the vii.buildings. What unrealized gain or losses. To illustrate. changes in foreign manage its earnings when making decisions about currency exchange rates.com Moreover. 10 lac gain will enhance the current x.11 No. Non to manage earnings.

All rights reserved ISSN 2304-0777 www. Shrink the ship: Shuto. management techniques as & when required to manage earnings. signaling / So. When the interest rate increases. 2006). Legal earnings management means financial could enter into an interest rate swap that would reports are adjusted in line with financial reporting effectively convert the fixed rate bonds into variable standards.1 © 2012 JITBM & ARF.jitbm. not with those relevant and thus managers are less likely to adjust involving the firm’s owners. Meeting or beating the care that stock market does not view the change as analysts’ forecasts seems to be of enough lowering the quality of earnings. Sometimes a subsidiary may management towards earnings management. affect earnings but it is used to affect earnings per Prior researches identified different categories of share. expense for the bonds and a decrease if the rate has Therefore. Vol. incentives: stock market incentives. Matsumoto also transaction. Timely disposition importance for companies to engage in earnings of long term productive assets (Sale/leaseback and management. lending Management uses cookie jar reserve technique to contracts motivations and regulatory motivations show boom earnings in the future period. a loss from substantial The interaction between accounting numbers and restructuring . Stock market incentives. Big Bath technique are used in the belief that if a manager i. Since. A stock buy does not earnings to meet targets. dividend and stable business act as motivational tools to the manager to manage earnings (Suda and xii. Missing write off method & period & estimating salvage an earnings benchmark has negative implications for value. For example. internal motives. Earnings management becomes rate bonds. The company market.com reported as assets and liabilities in the balance sheet 7. Meeting the analysts’ expectations is asset exchange technique) can result in the important because firms that meet or beat recording of unrealized gains or losses. Under the expectations enjoy higher returns. Gains and losses from The reasons for Earnings management are diverse derivate transactions are generally recognized and range from the intention to satisfy analysts’ immediately in regular income. it is better to report it all at once and stock markets reaction can indeed push get it out of the way. these are the common & popular earnings concealing private information. Companies that changes GAAP have to take potentially successful firms. even when it is amortization. companies will only engage in earnings decreased.. Income is only earned through equity stated that the earnings of loss firms are less value transactions outside the firm. underperformed & the earnings of this type of Investors often rely on the views and forecasts of security are managed by throw out a problem child stock market analysts to put together a portfolio of method.e. International Journal of Information Technology and Business Management 29th March 2013. Stable provides an opportunity to manage the earnings. expectations to incentives to realize bonuses or to suppose a company had a large issue of bonds maintain a competitive position within the financial outstanding at a fixed interest rate. have to report bad news i. management techniques. compensation contract motivations. Matsumoto (2002) argues that firms Companies do not have to report any gain or loss for with high growth prospects have greater incentives repurchase of their own shares on the income to manipulate earnings to avoid unfavorable market statement because no income is recognized on the reaction to negative earnings news. the timing option higher than the risks and costs involved. depreciation and depletion method.11 No. the fraudulent financial reporting when it falls outside company would then record an increase in interest the bounds of acceptable accounting practice. when the company enters into the management when the benefits of this behavior are swap is up to the company. stock returns as well as CEO compensation. managers turn to [29] . Motives behind earnings management: and measured at fair value. To be able to meet or beat the forecasts. Management uses these personal interest. likely that this is achieved through earnings management manages earnings by selecting the management or expectations management. political costs.

which suggests that if a strong incentive for firms to manage their managers are unable to manipulate earnings to [30] . Management compensation contract motivations ii. Retiring CEO’s use upwards earnings management. are obvious candidates to be earnings. Internal motives opportunistic behavior might even increase when Finally.1 © 2012 JITBM & ARF. Vol. by definition. It is thus expected that earnings analyzed as possible sources of earnings management is used to increase income. higher than the forecast. Managers management motives. CEO to manage earnings. conflicts. In summary. in such a way that budget ratcheting is avoided or performance standards are met. relatively unaffected by participants management and alter their annual accounts to such as peer group standards. when company make use management bonuses are often tied to the firm’s of financial reports. Signaling or concealing private information choose to use income-decreasing unexpected Earnings management is. fixed standards or conceal their financial struggle without immediately cost of capital) are less likely to smooth earnings measuring the consequences on stock price or CEO than those companies that use internal standards compensation. there earnings and would be better off increasing income might be large tax avoidance incentives for earnings for the following year at that point. Managers will i. Personal incentives (saving it for a rainy day) or not managing the There might be other than financial motives for the earnings (hoping for an increase in stock return). International Journal of Information Technology and Business Management 29th March 2013. This kind of iv. Governmental management to improve their compensation. Within a company. as they had no more to gain from extra numbers are the basis for tax calculation. political costs seem to be with the ‘big bath’ hypothesis. If pre-managed earnings are earnings. managers can choose between income-decreasing earnings management iii. also known Firms can also manage reported earnings by as the bonus plan hypothesis contends that changing financial statements in order to influence managers are motivated to use earnings shareholders’ opinions and decisions. managers use income-increasing there exist no efficient stock markets and CEO’s are earnings management. as regulations and tax laws. It can be valuable to are more likely to choose to report accruals that companies to seem more/less profitable to escape defer income when the cap on bonus awards were from governmental interference. prior year. The growth signal combined with (budget goals.e. This is even proven in economies where below the forecast.11 No. When accounting reached. All rights reserved ISSN 2304-0777 www. government or unions) but are intra- research also considered earnings management in company. another signal such as a stock split might be an effective way of communicating private information. Companies using externally determined certain goals. such as an initial to alter financial reports or to structure transactions public offering and seasoned equity offerings. These ties in management. Failing firms engage in earnings standards (i. Recent shareholders. If pre-managed earnings are appointed by the government. a process of accruals when the earnings innovations are altering financial information in order to achieve transitory. v.jitbm. it might also be useful specific stock market situations. To align shareholders’ goals with management to leave in style and keep a seat on the managers’ objectives and give less room to agency board. there are motives for earnings management there is a direct link to these two incentives and the that are not linked to external stakeholders (such as financial benefit of the firm’s management.com earnings management. Political costs The management compensation theory. CEO’s and senior management are often compensated by equity incentives. subjective standards). A new CEO can be tending to downwards earnings management in the year of Companies that show an increase in earnings as well change and upwards earnings management in the as in revenues are less susceptible to earnings following years.

therefore. decisions. economies are particularly likely to face severe problems in monitoring managers’ accounting Studies have produced mixed results in this area. and more likely to recognize loss timely than non- DeFond & Jiambalvo (1994) found that firms who adopting firms. in particular the banking. How to control Earning Management: hypothesis.com reach a particular target. Under the lead Some industries. which consists of abnormal. this may have the additional debt in terms of reported accounting unwanted effect that manager’s turn to ‘real figures and ratios. Hence. more than 100 countries have either with regulations linked to accounting figures and implemented International Financial Reporting ratios. understating loan write –offs and to increase earnings and thus their payout upon recognizing abnormal realized gains on their leaving the company. DeAngelo. such as the transaction cost. insurance of the International Accounting Standards Board and utility industries are monitored for compliance (IASB). Regulatory motivations common set of reporting standards. Banks and insurance firms especially are often Standards (IFRS) or plan to do so. However. emerging manage earnings (Sumit. and even to adopt a vii. As the world’s economies have become increasingly interlinked. presumably so as not to breach the regulatory requirements. Research has shown that banks which are close to future bonuses. accounting estimates. Banks used loan loss provisions to infrastructure in transitional economies. the hypothesis is suboptimal. vi. Vol. investment portfolios. rather. of the firm’s borrowings. thereby reducing was little evidence of earnings management by the level of earnings management. Dechow & Sloan (1995) found that minimum capital requirements use earnings managers decrease research and development management techniques such as overstating loan expenditure in the final year of their terms in order loss provisions. and Skipper investigated whether accounting standard and practices in the market has firms close to breaching their lending covenants been shown to increase market liquidity. that there quality of accounting information. On the other hand. They concluded. Firms adopting these firms. and improved pricing efficiency. however. or is still an open question as to whether the adoption made other transactions in order to avoid breaching of international accounting standards improves the their covenant. business practices in order to change that firms who have a lot of debt have an incentive reported earnings. violated their debt covenants used accruals to increase income the year before the violation. they will have the incentive regulations may give managers incentives to use to use earnings management to decrease current earnings management.11 No.1 © 2012 JITBM & ARF. share buybacks and the issuing of Accounting standards.jitbm. Lending contracts motivations Another major hypothesis is the debt covenant 8. The US Securities subject to requirements that they have enough and Exchange Commission (SEC) announced that it capital or assets to meet their liabilities. earnings in favor of future earnings and. International Journal of Information Technology and Business Management 29th March 2013. and contractual obligations. they were more likely to reduce IAS are less likely to smooth earnings. many countries are trying to harmonize their accounting standards. Such would promote international compatibility by allowing foreign companies to access US capital [31] . It accounting of depreciation. in order to ensure the repayment earnings management’. The introduction of international Healy. Given the weak legal system and to manage earnings so that they do not breach their the lack of accounting and capital market debt covenants. 2006). less likely to dividend payments or restructure their operations manage earnings upwards to avoid reporting a loss. reduced changed accounting methods. This theory is based on the fact that One way to control earnings management (by creditors often impose restrictions on the payment accounting techniques) is setting more rigorous of dividends. All rights reserved ISSN 2304-0777 www.

The Accounting use FIFO or LIFO or weighted-average cost flow Review. it can be used for the were composed mainly of owners.11 No.. they will be able to determine whether a the potential for earnings management. Kang. manipulation and their independence should be Increased audit quality could or should lead to ensured. M. Contemporary Accounting fact sells. under IFRS.) any EU Member State (European Union. 71: 433-465.) [32] . assumptions or specific identification.1 © 2012 JITBM & ARF. References Roman (2009) suggested that Audit committee members can use the summary of critical accounting Baber. corporate governance practices signal principles.) Research. 25:169–193. S. provide opportunities to manage earnings —through timing of transactions and making estimates. So. J. An empirical analysis of the in U. 2002). if it is ethically used. But. Terry. Coles. a company that mentions its accounting for inventory as significant is telling us it Balsam.2007). Finally. 35: 371-332. 1996.S. companies were obliged to prepare choice provides for earnings management. Journal of company choosing LIFO likely does it to defer income Financial Economics. 1998. steps should be taken to improve oversight. GAAP or.com markets while reporting under IFRS (SEC. at their balance sheet date for financial years manage earnings by delaying year-end purchases. now. Kumar. insiders. S. (For example.) Brickley. managers & other welfare of the stake holders. 1998. Outside 3) Understand what management chose and why. Permissive company engages in earnings management or not. The company reporting under IFRS cannot use LIFO. Discretionary accounting choices has more goods for sale during a period than it in and CEO compensation. corporate governance. S. (In the U. Conclusion: The board of directors sets overall policy & provided Earnings management is a tool for satisfying self oversight for operating activities. that there remain governmental scrutiny do not completely eliminate no loopholes for manipulate earnings. & K. Vol. Journal of management to make the judgment or estimate. All rights reserved ISSN 2304-0777 www. It is now clear that a majority of to get the optimum benefit of earnings independent board member is essential for effective management. their securities won’t know to ask whether there have been unusual were admitted to trading on a regulated market of year-end accelerated or deferred purchases. Historically. (A directors and the adoption of poison pills. structures indicate that manipulation is more likely. tax payments in times of rising prices and increasing inventories. 2) Understand the choices available to management Beasley. the company can and financial statement fraud.. 1994. (If the their consolidated accounts in conformity with IFRS auditor doesn’t know how a company using LIFO can if.In the 4) Most important. and R..jitbm. he starting on or after 1 January 2005. R. Accounting standards should Moreover.S. transactions intertwine with its accounting In addition. if accounting standards as well as be revised and set in such ways. the consciousness and the morality increased quality of reported earnings. R. understand the potential a given European Union. Accounting and Economics. International Journal of Information Technology and Business Management 29th March 2013. 15: 229–252. Audit of the stake holders can turn this malpractice into a committee members must be aware of the ways in good one if the motivations behind the earnings which management’s accounting-related choices management are free from evil intensions. W. A When auditors understand how a company’s similar rule applies in Australia. Auditors earnings management then auditors should be should be more careful in detecting earnings confronted with attempts to alter financial reports. boards interest of the managers. to account for the relation between the board of director composition transactions in item 1. policies as follows: Accounting earnings and executive compensation: 1) Understand the transactions that require The role of earnings persistence. J.

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