10. Financial Accounting Issues (fraud and earnings management related)

Question 1

What is earnings management?

Answer 1

The use of accounting techniques to produce financial statements that present a positive view of a company’s business activities and financial position.

Question 2

What are applications of operational (legitimate) earnings management?

Answer 2

• Sales drive to give earnings a boost.
• Reducing output in period when target has been already achieved.
• Delaying delivery of goods to the next accounting period.
• Opportunistic sale of non-core assets to book gains in periods when earnings would otherwise miss their target.
• Using accounting estimates at the ‘high’ or ‘low’ end of what is reasonable.

Question 3

What are applications of improper earnings management through fraudulent or artificial means?

Answer 3

• Hiding real operating performance through creation of artificial accounting entries.
• Stretching accounting estimates (e.g., expected useful economic life and residual value) beyond a reasonable point.
• Fraudulently getting inflated appraised values for investment properties and other assets.
• Booking revenues prematurely.
• Failing to recognise impairment in the financial statements when they arise.
• Making unsupportable reductions in charges.
• Overly aggressive or overly conservative accounting.