Question

Earnings management can be defined as the "purposeful intervention by management in the earnings process, usually to satisfy selfish objectives" (Schipper, 1989). Earnings management techniques can be separated into those that are "cosmetic" (without cash flow consequences) and those that are "real" (with cash flow consequences). The management of a company wishes to increase earnings this period.

List three "cosmetic" and three "real" techniques that can be used to achieve this objective and explain why they will achieve the objective.

Answer 1

Earning managemaent can defined as "Use of judgement and estimation in accrual accounting allowing manger to draw insider information and their experience to enhance accounting number"

Earning management can be of two type cosmetic in which no cash flow is involve and real in cash flow is involve

Cosmetic technique would be

1) Increasing salvage value of fixed asset to decrease the value of depreciation and thus increase in net profit.

2) Changing depreciation policy with retrospective effect, thus restating previous depreciation as a result increase in profit.

3) Manipulating amount provision, lower the provision higher the profit as provision are write off against profit and loss a/c

Real technique would be

1) Income shifting from a accounting period to another accounting period thus portraying favourable number of the period with low performance

2) Taking big expenses such as R&D , asset impairment on intermittent basis. This allow campanies acceleration in expenses recognization and making subsequent earning look better.

3) Charging large amount of cost such as factory overhead to discontinued business, decreasing the expenses of another set of business