APPLICATION QUESTIONS 9.13 Table 9.

1 presents examples of some common

accounting decisions and how companies
following a conservative, moderate, aggressive or fraudulent strategy might use these to manage
earnings. Prepare a similar table and complete it in relation to the following accounting
decisions: (a) revenue recognition from services (b) intangible assets (c) impairment of non-current
assets (d) revaluation of non-current assets.
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W vu, 9.16 You have recently been appointed as a researcher for a firm of share analysts. As one of your first
roles you are required to prepare a report for your manager to outline common techniques used to
manage or manipulate earnings. From your prior accounting knowledge you would have gained
an understanding of techniques you can use to examine entity performance and profitability,
including trend analysis. Document what strategies you might use as an analyst to detect
earnings management using accounting information.
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9.22 Real activities management is an increasingly common form of earnings management examined
in academic literature. The paper by Graham, Harvey and Rajgopal referenced in this chapter explores the
range of earnings management techniques commonly used by managers in the United States. 81 Find this
paper, read it and prepare a summary of the most common techniques used by the surveyed managers,
and highlight the advantages of each technique.
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V 9.2 CASE STUDY

MASTERING CORPORATE GOVERNANCE: WHEN EARNINGS MANAGEMENT BECOMES
COOKING THE BOOKS There is often a blurred line between appropriate and inappropriate
accounting techniques, but the audit committee must attempt to clearly distinguish which is
which.
 The guiding principle of the audit committee is shifting from a focus on technical accounting
pro cedures to determining whether disclosures in the financial reports present a true and fair
view of the entity's affairs. Companies often face a great deal of pressure to meet the
earnings forecasts they present to investors and analysts, or the estimates these
analysts make. Executives of companies in this situation often resort to using a range of
'earnings management techniques to help them ‘make the numbers'. These techniques will often
exploit loopholes in generally accepted accounting principles (GAAP) to manipulate the
company's income.
It is up to the audit committee members to identify whether earnings management,
accounting estimates and other judgements are legitimate or are designed to blur the true financial
position of the company. Source: Adapted from Ira Millstein, 'When earnings management
becomes cooking the books”, The Financial Times.83

QUESTIONS 1 What earnings management techniques are outlined in the above article? 2 What role
can the audit committee play in detecting and/or limiting earnings management? 3 What
relationship does the audit committee have with the external auditors in ensuring earnings
management is within acceptable limits?
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