Earnings Management - Lecture 1 Flashcards
What is earnings management?
The use of accounting techniques to make a company’s financial reports look better (or worse)
Why is earnings management used by managers?
.Increase remuneration packages
.Meet market expectations
.To cover up fraudulent activity
.Enhance their credentials
Financial reporting quality is high if:
.Reporting is compliant with IFRS
.Information is neutral and free from errors
.Faithfully represent financial position
Earnings quality is high if:
.Earnings are sustainable
.Earnings provide adequate return to investors
What makes financial reports decision-useful?
When they are unbiased (neutral)
What are aggressive accounting choices?
Choices increase current period earnings and financial position
What are conservative accounting choices?
Choices decrease current period earnings and financial position
How may management smooth earnings using conservative and aggressive choices?
.Conservative choices when earnings are high
.Aggressive choices when earnings are low
What are some motivations for producing low quality reports?
.To increase share price
.Improve view of company by investors
.Increase reputation and remuneration
.Meet or exceed benchmark EPS
What are some opportunities for low-quality reporting?
.Weak internal controls
.Inadequate board oversight
.Range within IFRS
.Minimal consequences for inappropriate choices
How does rationalisation affect reporting quality?
Managers create reasons to justify their behaviour
What are some compliance mechanisms involving the government and market regulation?
.Disclosure requirements
.Auditing requirements
.Review of business, management commentaries
.Enforcement - Fines, prosecution
What are some compliance mechanisms relating to auditing?
.Auditors provide opinion on reports
.Check for internal controls
.Selected and paid for by company
How are private contracts used as a compliance mechanism?
.May have loan covenants
.Financial triggers for ROI
.Specific methods for calculating accounting measures
What are Non-IFRS presentations?
.Accounting measures designed to influence analysts’ earnings expectations and valuations
.Non-IFRS measures often remove negative items
What measures do Non-IFRS presentations require to be used properly?
.Must be defined
.Require an explanation for their use
.Must be reconciled with closest IFRS measure
What are some choices relating to revenue recognition?
.Discounts to increase orders in current period
.Delay shipments to defer revenue to later period
.Increase shipments to distributors
.Bill-and-hold transactions: Recognise revenue for goods that have not been shipped
What choice does management have for depreciation?
Straight-line versus accelerated
What are the depreciation estimates?
Economic life and scrap value
What is capitalisation?
Defers expenses to future periods
What are related-party transactions?
Can move earnings into or out of the firm
What choices do management have for managing operating cash flow?
.Capitalising purchases
.Stretching payables
.Capitalising cash interest costs
What are some high level financial statement checks?
.Excessively smooth trends over time
.Unexplained increase in margins
.Profits vs cash flow
.Non-IFRS presentation
What are accounting warning signs?
.They indicate more investigation is required
.Determine if statements are being manipulated
.Multiple warning signs without explanation indicate high levels of earnings management
What are some accounting warning signs related to revenue recognition?
.Revenue growth out of line with peers
.Lack of clarity on revenue recognition method
.Change in revenue recognition method
What are some warning signs related to depreciation?
.Unusual depreciation methods relative to peer group
.Useful lives appear excessively long or short
.Salvage values are excessively high or low
Is earnings management fraud?
No
