Earnings Management Flashcards
What are the 3 types of performance measures?
Financial
Alternative (APM)
Non-Financial
What is an Alternative performance measure
A financial measure of historical or future financial performance, financial position or cash flows other than a financial measure defined or specified in an applicable financial reporting framework
According to IAS33 how do you calculate earnings per share
Earnings (profit after tax)
_
Weighted number of equity shares
/key performance indicator
How to calculate gearing
Interest bearing debt (LT)
_
Equity (SC & reserves)
/measures of financial risk
/high gearing is a possible red flag
What is EBITDA and its advantages and disadvantages
EBITDA = earnings before interest, tax depreciation & amortisation
Advantages
-Represents the earnings management has most control over
-Indication of management performance
-Good metric to evaluate profitability (but not cash flow)
Disadvantages
-Can be subject to manipulation if directors have discretion over what is included in the calculation
-Misconception that EBITDA = cash earnings
-Stakeholders should be aware of its weaknesses & use in conjunction with other performance measures
Whats is earnings management
the use of accounting techniques to make a company’s financial reports looks better than worse
to present an overly positive/ negative view of activities and financial portion
to smooth out fluctuations
Why is earnings management used
-Increase remuneration packages
-to meet market expectation s
-to ensure the share price is not too volatile
protect employment
enhance credentials
When is financial reporting of HIGH quality?
- If the reporting is compliant with IFRS standards
- information is relevant / complete / free from errors
- statements faithfully represent reality of economic activities and financial position
When are earnings quality HIGH?
- earnings are SUSTAINABLE
- provide ADEQUATE RETURN to investors
Describe aggressive accounting
Choices that increase current period earnings and financial position
Describe conservative accounting
Choices that decrease current period earnings and financial position
Explain how government and market regulation utilise compliance mechanisms in order to maintain faithful representation
- listing particulars
- ongoing disclosure requirements
- auditing requirements
- enforcements - fines, suspension, prosecution
How to spot earnings management?
- accounting policy notes
- profits vs cash flows
- excesssivley smooth profits over time
- peer group comparison anomalies
What accounting warning signs should you look out for in financial statements?
- Revenue recognition
- depreciation methods
- capitalisation versus expensing
- Financing - new share clauses
