Professional Documents
Culture Documents
Earnings Management
Overview
Earnings management (EM)
Concept (11.1)
Patterns (11.2)
Why EM? (11.3; 11.4)
Is EM good or bad? (11.5; 11.6)
Conclusion (11.7)
Earnings Management
Concept (11.1)
Earnings management (EM) is the
choice by a manager of accounting
policies (accruals) or real actions, that
affect earnings so as to achieve some
specific reported earnings objectives
What? Who? How? Why?
EM at GE (Q9, p.476)
GEs Reported Net Income
2008 $17,235
2007 22,208
2006 20,700
2005 16,353
2004 16,593
2003 15,002
2002 14,118
2001 13,684
2000 $12,735
1999 10,717
1998
9,296
1997
8,203
1996
7,280
1995
6,573
1994
4,726
1993
4,315
4
In-Class Discussion
1) From what you observe, do you believe GE has been
managing earnings or not?
2) Assume the actual net income in 1996, 1997, and
1998 is $8,203, give two techniques (one through
accruals and the other through real actions) that help
managers to
a) Reduce net income from $8203 to $7280 in 1996
b) Boost net income from $8203 to $9,296 in 1998
3) Is earnings management good or bad for GE? For
investors?
5
EM at GE (Q8, p.476)
Techniques used by GE to smooth earnings
1. Change expected rate of return on pension plan
assets
Pension costs = pension services costs return on plan assets
2. Sale of divisions
Generally lead to large non-recurring gains
3. Restructuring charges
Used to offset non-recurring gains
The timing and amount of 2&3 are tactically managed
Discretionary accruals
Management has discretion to control amounts
e.g. the GE case: note GE uses both accruals and real
actions to manage earnings
Slide #6: What are EM through accruals?
Big bath
Income minimization
Income maximization
Income smoothing
etc.
11.3 Evidence of EM
for Bonus Purposes
1. To meet contractual goals
(a) Bonus incentives
Evidence: Healy (1985)
Examines firms in which manager bonuses based on net
income
Concepts of bogey and cap (Figure 11.2, p.448)
Evidence of upward earnings management when net
income between bogey and cap
13
18
11.7 Conclusions
Some earnings management can be
good if not abused
However, managers may abuse or
opportunistically use such flexibility
Its hard to differentiate good and bad
motivations underlying earnings
management
Full disclosure helps to control bad
earnings management
19