The Distribution Of Annual Net Income Scaled By The Market Value At The Beginning Of The Year

When analysts question a firm’s earnings quality, it raises concerns regarding under or over aggressive accounting practices that may be allowing the firm to manipulate the earnings. Earnings quality is defined as the strength of the current earnings in being used to predict future earnings and cash flows. Since earning quality is indicative of future performance, analysts are more likely to address issues that have substantial impact on the earnings quality. An issue arises when the nature of the earnings is questioned. While permanent earnings are part of normal operations, any irregular, one time earnings can skew the earnings, making the firm look more profitable than it is. This is due to the inability to recreate similar one-time transactions that will give rise to such numbers. Investors prefer predictable

Understandably, there are a variety of ways in which a company can manage their earnings, and if accomplished successfully, the results can be highly profitable. Not all techniques are fraudulent, as effective earnings management is considered good for business and shareholders. Income smoothing is a specific example of permissible earnings management that involves controlling fluctuations in net income to make earnings less variable over a given period of time (Goel & Thakor, 2003). Smoothing is acceptable as long as it adheres to the restrictions of U.S. GAAP, which maintains that all revenues and expenses are accounted for in a defined fashion. There are a lot of incentives in figuring how to effectively smooth income, as substantial value can be created through the successful arrangement of financial transactions. Management is able to make more intelligent decisions with regards to the future of the firm if the earnings are able to match the forecasts. One instance this is seen is when management is faced with the decision to smooth total income or

Such an intense focus has been placed on quarterly earnings as an indication of a company’s success by everyone from analysts to executives that ethics have for the most part been thrown out the window, sacrificed to the all important number, i.e. earnings per share. This is the theory in Alex Berenson’s book “The Number: How the Drive for Quarterly Earnings Corrupted Wall Street and Corporate America.” This number has become part of a game to be played, a figure to be manipulated – beat the number and Wall Street all but throws a parade, miss it and a company’s stock may be abandoned. Take into account the incentives that executives have to beat the number and one can find plenty of reasons to manage earnings.

Like several companies, Nortel stipendiary their executives with stock choices (Collins, 2011). This compensation solely inspired the tendency to be but honest regarding the company’s finances. author closely-held stock choices that solely inspired his actions to fulfill or beat the benchmark set by analysts. If Nortel’s earnings showed to be higher than the benchmark, Nortel’s stock costs would rise creating the stock closely-held by management to be even a lot of valuable. By tweaking the books to indicate the road earnings price as critical the allowable accumulation price he created the stakeholders assume that the corporate was creating extra money than it had been. “Nortel ne'er incomprehensible a benchmark over the sixteen quarters (Collins, 2011).” it had been too tempting to bump the numbers up so the stocks gave the impression to be value over they were. “Nortel’s accounting practices junction rectifier to AN investigation by AN freelance review committee, that found that insubordination with accumulation and accounting fraud were undertaken to fulfill internally obligatory earnings targets (Collins, 2011).”

Information based on accrual accounting has historically and empirically provided a better indication of a company’s ability to generate cash flows than information gathered under the cash method. If there is not inter-period allocation, then the information is not as meaningful and will result in a mismatching of economic benefits

Increase in the profits above the actual budget can be attributed to 20% increase in sales in 2009. Although Jean’s profits were above the actual budget, French Division’s earnings were much lower than what it could have been, had they budgeted for the actual volume of sales that they ended up selling. We can partly attribute this decrease in earnings to the fact

As stated in Exhibit 3, Earnings management is the managerial use of discretion to influence reported earnings. Within the accrual accounting system, managers have significant discretion with their firms’ accounting choices. Management has the ability to make choices that can opportunistically lead to higher or lower reported earnings. Richard 's and Ira Zar’s (CFO) actions would not change if these results were the result of GAAP flexibility because he violated the rules of accounting, the conceptual framework principle of neutrality in numerous ways to report the financial results that CA did under false pretenses. It would be one thing if CA garnered these results through legitimate business decisions versus using accounting tactics like changes in accounting estimates or outright fraud as in the use of the 35 day Month. The purpose of which was solely to allow CA to meet or exceed analysts’ estimates.

* With a focus on net income, managers could be incentivized to maximize ROE at the expense of other stakeholders, particularly bondholders. For instance, managers may fuel earnings growth by over-levering the company to benefit from tax shields in order to increase the value spread.  In addition, there are many other ways in which managers can manipulate earnings, for example, by slowing down depreciation charges or selling off assets to realize extraordinary gains.

Several studies have revealed a number of motivations for engaging in earnings management. Some of the reasons for this practice include managers’ remuneration packages (Healy, 1985), meeting company forecasts (Kasznik, 1999) or analyst forecasts. Yet, one other reason for earnings management is when firms plan to make an acquisition or merger that involves an exchange of shares for a target. This is done to soar the shares price of the acquirer in order to reduce the number of shares of the acquirer that will be exchanged for the target (Goodwin, 2009).

One explanation of why firms might choose to put into practice conservative accounting practices lies in efficient contracting theory, for example, conservative accounting can be used as part of a firms strategy to ease the conflicts that arise among the many claimants of a firm’s net assets. This is because conservative accounting methods place restrictions on the distribution of those net assets thereby limiting the scope for self-serving opportunistic behavior. Conservative accounting can also help in bringing into line the interests of managers and shareholders through its impact on accounting earnings measures that are regularly used in management compensation contracts (Iyengar & Zampelli, 2010).

Jim will appear to making less money than it actually did and therefore have to report fewer taxes. In other words, Jim is seeking for a tax saving. It can be explain by using the contracting perspective where manager will choose accounting techniques that will maximizes his or her utility at the expenses and also maximize bonuses. Furthermore, by creating LIFO inventory layer adjustment it will give lower reported earnings. If the company can avoid the inventory increase for the year and instead having a reduction, they can take a credit adjustment to cost of sale and increase their profit. Under literature Scott (2000), this proposal fall under opportunistic earning management where the management report earnings opportunistically to maximize own profit. Related study are Burgstahler and Dichev (1997) conclude that managers engage in earning management to avoid reporting losses or earning decline. Research show that there is negative relationship between unexpected discretionary accruals and stock returns around the earnings announcement date. This result indicates that the market views discretionary accruals as opportunistic.

Earnings Management: Earnings management occurs when managers manipulate firms’ reported earnings through the biasing of accrual judgments and structuring of transactions or other means, eroding the usefulness of earnings information and misleading investors (Barua Cready, Fan and Thomas, 2010; Wilson, 2011; Healy and Wahlen, 1999).

Basu, S., (1997): The conservatism principle and the asymmetric timeliness of earnings. Journal of Accounting and Economi

Smoothing of income is an undeniable practice used by accountants to favour the companies ' current needs, therefore it can be showing rather higher or lower earnings than the actual latter. There are several methods through which this practice is applied depending on the preferences as well as on the requirements of the people interested in the financial statements.

Both Burgstahler and Dichev (1997) and Degeorge et al. (1999) explain threshold-driven earnings management behavior by referring to the prospect theory (Kahneman and Tversky 1979), which suggests that for a given increase in wealth, the corresponding increase in value is the greatest when the increase in wealth moves from negative to positive territory relative to a reference point (viz., zero earnings, zero change in earnings or zero forecast error). While they do not specifically explain the formulation of reference points or the usage of other reference points beyond those extensively investigated three earnings thresholds, they imply the existence of other reference points (Burgstahler and Dichev 1997), ). and They also suggest that if other reference points are used either by corporate boards or investors, and if those reference points are reflected in the executives’ reward schedulesor compensation contracts, executives