Activities for Week 9 (Creative accounting/Earning management)

Group 1
Please provide an article summary for Momani and Obeidat (2013). You may get the article
from spectrum.

Group 2
Refer to Rankins ( page 269 and 278)
Please answer Contemporary issues – case study and application question 9.21 and 9.22.

Group 7
1. Schipper (1989) describes earning management as “ a purposeful intervention in
external financial reporting process, with the intention of obtaining some private
fain….”. Is creative accounting necessarily bad? Why do companies employ creative
accounting techniques? Please conduct the discussion by having a debate among your
group members to discuss pros and cons of earning management. The debate should
comprises also the following points;
- Identify and explain some of the creative accounting techniques.
- What are the possible implications of creative accounting?

Group 8
Refer to Rankins (page 271 and Page 280)
Please answer : the application question 9.16 and case study 9.2

Case study 1 – Group 3

The Corporate Scandal at ABC Corporation: A Case Study on Aggressive Earnings

Management and the Role of Auditors

This case study examines the corporate scandal that unfolded at ABC Corporation, a
multinational conglomerate. The scandal involved aggressive earnings management
practices carried out by a group of directors, which resulted in significant financial
misstatements and a loss of investor trust. Additionally, the role of auditors in detecting and
addressing such manipulations will be explored.

A group of directors at ABC Corporation, driven by the pressure to meet financial targets and
maintain the company's stock price, engaged in aggressive earnings management. The
directors employed various tactics, including premature revenue recognition, manipulation
of reserves, and improper expense capitalization, to inflate reported earnings and present a
more favourable financial picture than the company's true performance.

Based on financial data, it was reported that ;

1. ABC Corporation reports abnormally high income growth compared to the industry and its
peers, without corresponding improvements in operational performance or market
conditions.
2. The company exhibits sudden changes in expense ratios or margin levels, such as a sharp
decline in cost of goods sold (COGS) ratio or a significant increase in operating expenses.
3. ABC Corporation reports inflated asset values or unusually high capitalization rates,
suggesting potential overvaluation of assets or improper capitalization of expenses.
4. The company reports significant non-operating gains or extraordinary items that are not
part of its core business operations, potentially indicating attempts to artificially boost
reported earnings.

It was reported that the auditors had issued unqualified audit report and no major issues are
found during audit process.

Task 1 : Question : Please identify possible red flags for the following case study and what
are justifications (if any) behind this. Please also explain roles of directors, shareholders
and auditors.
Task two : Please conduct internet searching and provide 3 international corporate
scandals which has practiced aggressive earning management. Describe what are
aggressive earning management committed by them.

Case study 2 (Group 4)

GHI Corporation is a technology company that has been experiencing increased competition
and pressure to meet earnings targets set by analysts and investors. The company's financial
statements indicate that earnings management may be taking place.

Financial Data:
1. GHI Corporation reports a significant increase in revenue compared to the industry
average and its historical performance, despite a stagnant market.
2. The company consistently reports steady and predictable earnings growth, without much
variability or fluctuations.
3. GHI Corporation reports consistently high profit margins that are significantly higher than
industry peers, without any clear explanation or improvement in operational efficiency.
4. There are discrepancies between reported net income and operating cash flows,
indicating potential aggressive revenue recognition or manipulation of accruals.

Task 1 : Question : Please identify possible red flags for the following case study and what
are justifications (if any) behind this

Task two : Please conduct internet searching and provide 3 Malaysia’s corporate scandals
which has practiced aggressive earning management. Describe what are aggressive
earning management committed by them.

Case study 3 (Group 5)

XYZ Corporation is a manufacturing company that produces and sells electronic devices. The
company is publicly traded and has been experiencing increased competition and pressure
to meet earnings targets set by analysts and investors. In this simulated scenario, there are
indications that earnings management may be occurring. Let's explore the scenario and the
red flags:

Despite a stagnant market and increased competition, XYZ Corporation reports a substantial
increase in revenue for the current reporting period. The reported revenue growth is
significantly higher than industry averages and the company's historical performance. XYZ
Corporation reports abnormally high profit margins compared to its competitors and
historical trends. The gross profit margin, operating profit margin, and net profit margin all
show significant improvements without any notable changes in the company's cost structure
or efficiency. XYZ Corporation reports a sudden decrease in inventory levels without any
apparent change in the company's manufacturing or sales activities. This decline contradicts
the company's historical inventory turnover ratios and is not aligned with industry trends.
The company consistently delays or accelerates expenses based on their impact on current
earnings. For example, XYZ Corporation defers certain maintenance expenses or research
and development costs to future periods, artificially inflating the current reporting period's
earnings. The company frequently reports significant one-time gains or extraordinary items
that have a positive impact on net income. These gains may come from the sale of non-core
assets, favourable legal settlements, or other non-recurring events that are not part of the
company's regular business operations.

Task 1 : Question : Please identify possible red flags for the following case study and what
are justifications (if any) behind this.

Task 2 : Creative accounting and earnings management are two practices that
involve manipulating financial statements, but they differ in their objectives
and methods. Elaborate further the above statement.

Case study 4 (Group 6)

It was reported the following red flags in 3 prominent companies.

Companies 1 (Hijau corporation): Revenue Recognition Manipulation

Red Flags:
- Premature recognition of revenue before the completion of services or delivery of
products.
- Channel stuffing, where excessive amounts of inventory are shipped to customers
near the end of a reporting period to inflate sales.
- Extended payment terms or extended warranties offered to customers to artificially
boost revenue.

Company 2 (Berjaya Limited): Expense Manipulation

Red Flags:
- Improper capitalization of expenses, such as research and development costs or
maintenance costs, to defer recognition and inflate net income.
- Income smoothing through manipulating discretionary expenses, such as
advertising and marketing expenses or provisions for bad debts.
- Overstating assets or understating liabilities to reduce depreciation or interest
expenses.

Company 3 (Khairil manufacturing): Inventory and Cost of Goods Sold (COGS)

Manipulation

Red Flags:
- Overstating inventory value through inflating purchase costs or valuing obsolete or
slow-moving inventory at higher prices.
- Manipulating the timing of recognizing costs of inventory to smooth earnings.
- Shifting expenses from COGS to other expense categories to artificially boost gross
profit margins.

Company 4 (Ricola bank): Reserves and Provisions Manipulation

Red Flags:
- Creating excessive or unnecessary reserves to manipulate earnings in future
periods.
- Releasing or reversing reserves inappropriately to inflate current period earnings.
- Underestimating liabilities or understating provisions to present a stronger financial
position.

It's important to note that the presence of these indicators or red flags does not
necessarily confirm earnings management. These are potential warning signs that
warrant further investigation and analysis. Professional judgment, careful analysis of
financial data, and consideration of the broader business context are essential to
identify and understand earnings management practices accurately.

Task 1 : Questions : Please provides/predict what are earning management

activities that the companies have conducted based on the red flags reported
above.

Task 2 : Please discuss the roles of internal auditor and external auditors related
to earning management. Discuss from the auditor’s ethical perspective.