Earnings Management, in Exchange Listed Companies, Is Not Fraud but a Case of Caveat Emptor for Investors

Topics: Financial statements, International Financial Reporting Standards, Enron Pages: 7 (2057 words) Published: April 4, 2012

“Earnings management, in exchange listed companies, is not fraud but a case of caveat emptor for investors”



Student registration No: 479866

Program: International Finance and Trade, Level 2
Lecturer:A. Paparizov

“Earnings management, in exchange listed companies, is not fraud but a case of caveat emptor for investors”

With the development of the stock markets and the huge grow in the volume of money traded in them, over the past 20 years a rising attention has been aimed at towards the importance of truthful and fair accounting. The real interest in how companies chase their financial reporting has developed in the wake of a multitude of large corporate scandals that has occurred worldwide. Two of the best known examples so far for significant manipulation of accounting data and the consequences thereof are the collapses of Enron and World Com.

But now, before I continue with these two cases and concentrate in the matter of the false or “not so true and fair accounting” will focus on what is the definition of earning management, and what drives the CEO’s of these corporations to pursue the earning management style of working.

The speed at which worldwide business and trade are growing has given new characteristic to the multi-functional roles managers are forced to play. Nowadays the majority of Managers of the “blue chips” companies are more than well paid, experienced speculators. Criticism all over the world has been raised suggesting that style of management executed by those CEO’s in which the performance of the company is measured not by the output of production, neither by the satisfaction of its customers, but by the boost of its financial accounting numbers, creates incentives for the managers to act in opportunistic manners at the cost of the corporation shareholders.

“Newly appointed CEOs manipulate earnings in order to boost their salaries and to give a good impression of their work.”1

This quotation from Swedish magazine shows a CEO’s point of view over the earning management.

Earning management is one definition with many names and different aspects all over the world. According to Joshua Ronen and Varda Yaari in their book the definition of earning management is “ a strategy of generating accounting earnings which is accomplished through managerial discretion over accounting choices and operation cash flows.” Or in other words “Any action on the part of management which affects reported income and which provides no true economic advantage to the organization and may in fact, in the long-term, be detrimental.”3 No matter how we call it ; income smoothing, earnings smoothing, cosmetic accounting or what is popular in Europe ;creative accounting there are many different ways in which earnings can be managed. For a variable to qualify as an instrument for earnings management, it must be at least to a partial degree at the discretion of management.

Earning management was and continue to be pursued by the financial regulations organs all over the world.

Even that there are general rules covering the accounting practices of corporations there are a major part of subjective fundamentals involved. These regulations consist of a given amount of flexibility in a sense that accounting directive often permits a choice of policy, for example in respect to asset valuation, depreciation and etc. Significant differs may occur in the financial statement of a company, depending on what type of policy or practice a company decide to use. The other problem is that the fact today is that there are a too much spheres in the accounting that are not well regulated. I specifically had a 2nd degree Accounting diploma, and because of the knowledge I have acquired I know that a specific level of freedom in the financial reporting and preparation of accounting reports can help or improve the...

Bibliography: 1. Uppdrag granskning, ”Så gjorde vi reportaget om direktörslönerna del 2”, 2006-03-31
3. Merchant, K. A. and Rockness, J. (1994) “The Ethics of Managing Earnings: an Empirical Investigation”, Journal of Accounting and Public Policy, Volume 13, p79-94.
4. Ronen, J. and Sadan, S. (1981) “Smoothing Income Numbers: Objectives, Means and
Implications” Reading, MA: Addison-Wesle
5. Healy, P. M. and Wahlen, J. M. (1999) “A Review of the Earnings Management Literature and Its Implications for Standard Setting”, Accounting Horizons, Volume 13, p365-383.
6. Unknonw. (2006). Q&A: The Enron case. Available: http://news.bbc.co.uk/2/hi/business/3398913.stm. Last accessed 09.01.2011.
7. Merchant, K. A. (1990) “The Effects of Financial Controls on Data Manipulation and
Management Myopia”, Accounting, Organizations and Society, Volume 15, Nr 4, p297–313.
9. Ewert, R., Wagenhofer, A., 2005. Economic effects of tightening accounting standards to restrict earnings management. The Accounting Review 80, 1101-1124.
10. Street, D. L., Linthicum, C. L., 2007. IFRS in the U.S.: It may come sooner than you think: A commentary. Journal of International Accounting Research 6, xi-xvii.
11. Ball, R., Kothari, S. P., Robin, A., 2000. The effect of international institutional factors on properties of accounting earnings. Journal of Accounting and Economics 29, 1-51.
[ 4 ]. Ronen & Yaari, 2005
3 Merchant & Rockness (1994)
[ 5 ]. 4 Ronen & Sadan (1981)
[ 6 ]
[ 10 ]. (Street and Linthicum, 2007).
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