Earnings management
É Examples of where accounting can produce different numbers legally (honestly?).
É Interesting ones – perhaps;
Ð LIFO, FIFO Average Cost (Physical / Perpetual)
Ð Depreciation
É Why does management do it (not tax)?
É Why not produce any numbers you like?
É Why not require only one method or estimate?
É Why would managers manage earnings?
É NOT TAX we are talking about managing reported accounting profits not taxable income.
É Dont you want to look good if you can choose which photo, which assessment marks to include etc
É Managers want to show results that make their job easier:
Ð High profits great manager she should be paid more
Ð Low profits not ripping the public off should get government protection shouldnt be taxed more.
É Why not produce any numbers you like?
É There are rules; revenue recognition, conservatism etc but there still is wiggle room (weighted ave vs FIFO).
É Corporate law fraud when you just make up the numbers.
É Auditors who independently check that the numbers are true and fair or presented fairly within the accounting reporting framework (e.g. HC)
É Post settling up you can only lie so often.
É Why not require only one method or estimate?
É That adds a new kind of distortion.
É Lets consider a pair of shoes!
É How do we depreciate them; method, life, residual value?
É Accelerated? Ten years? Always have some value?
É OR Straight line? Two years? Zero residual
É Imposing structure still gives distortions!
É What are we attempting to achieve when producing financial statements?
Ð Useful information (SAC 2 Objective of Financial Reporting) Barth showed useful for predicting.
É How do we make the information useful?
Ð Make it relevant, reliable, understandable etc (IASB Framework, Qualitative Characteristics of Financial Reporting)
É But problems still remain.
Ð Relevant or Reliable?
Ð Relevant to whom?
· Investors or creditors, casual observer?
É Conceptual Framework and its application.