Paradigmatic- Earnings Management- 21 Gaganpreet Gaul (A) , 85 Neha Sharma (B) , 149 Parneet Kaur (C)

INTRODUCTION:

"Earnings management" occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of a company or influence contractual outcomes that depend on reported accounting numbers.

Earnings management usually involves the artificial increase (or decrease) of revenues, profits, or earnings per share figures through aggressive accounting tactics. Aggressive earnings management is a form of fraud and differs from reporting error.

Thus, earnings management is a strategy used by the management of a company to deliberately manipulate the company's earnings so that the figures match a pre-determined target. This practice is carried out for the purpose of income smoothing. Thus, rather than having years of exceptionally good or bad earnings, companies will try to keep the figures relatively stable by adding and removing cash from reserve accounts .

(Gaganpreet – A, 21)

DISCUSSION:

Although the different methods used by managers to smooth earnings can be very complex and confusing, the important thing to remember is that the driving force behind managing earnings is to meet a pre-specified target. As the great investor Warren Buffett once said,

"Managers that always promise to "make the numbers" will at some point be tempted to make up the numbers".

Problems with Earnings Management:

• Companies all too often release positive earnings reports that exclude things like stock-based compensation and acquisition-related expenses.

• Sometimes companies even take unsold inventory off their balance sheets when reporting pro-forma earnings.

• Intangibles like depreciation and goodwill are okay to write down occasionally, but it is inappropriate if the company is doing it every quarter.

Benefits of Earnings Management:

• As we mentioned earlier, pro-forma figures are supposed to give investors a clearer view of company operations. For some companies, pro-forma earnings provide a much more accurate view of their financial performance and outlook because of the nature of their businesses.

• Analysis of pro-forma earnings is an important exercise to undertake before considering an investment in a company as investors can see what the actual cash profit is

• Also prepared and used by corporate managers and investment banks to assess the operating prospects for their own businesses in the future and to assist in the valuation of potential takeover targets.

(Neha sharma – B, 85)

CONCLUSION:

As earning management is related to reasonable and legal decision making and reporting intended to achieve stable and predictable financial results so earning management need not to be confused with illegal activities to manipulate financial statement and report result that do not reflect an economic reality. It is no surprise that company management has great interest in how they are reported so every executive need to understand the effect of their accounting choices so they can make the best possible decision for the company. I show the desire of the management rather than financial performance of the company. So management should create a culture that deters the fraud and should set and communicate clear corporate policies against improper conduct.

(Parneet kaur – C, 149)