em Flashcards
What are discretionary accruals?
Adjustments to accounting estimates that managers can influence, not directly tied to real cash flows.
What is income-increasing earnings management?
When managers use discretionary accruals to inflate net income, often to meet targets or gain bonuses.
When is income-increasing EM typically used?
To maximize cash bonuses (between bogey and cap); avoid stock price drops and protect equity-based compensation; avoid debt covenant violations.
What is a “Big Bath”?
A form of income-decreasing EM where losses are maximized in a bad year to boost future performance perception.
What is income smoothing?
Adjusting earnings to reduce variability across periods and present stable performance.
What are real activities manipulations (RAM)?
Changes to actual operations (not just accounting estimates) to meet earnings targets.
Give 3 examples of RAM tactics.
- Offering big discounts to boost sales
- Cutting R&D, maintenance, or advertising
- Overproducing to spread fixed costs
Why might firms use income-decreasing accruals?
To gain political favor (e.g., subsidies, grants); reduce taxes; influence regulatory outcomes.
How can accountants reduce bad earnings management?
By ensuring transparent disclosure of: revenue recognition policies, special items, and major discretionary accruals.
What does the Burgstahler & Dichev (1997) study show?
Earnings distributions deviate from normal due to human intervention, implying earnings management.
