Earnings management is one of the most popular measures of financial business crimes, occurring in companies on a habitual basis. It can be defined as a process of intentional interference of the management in the establishment of the earnings of a business, misrepresenting the data to show better results than they actually are. Several reasons lead to management of earnings which include manager’s compensation, raising stock price, or pushing for government funding. There are different strategies available that managers can use for the purpose of earnings management and hence satisfy their selfish objectives (Wild, 2006, pp.86-87). With regard to the increase in financial crimes in businesses, and several instances of earnings management being reported, this study focuses on the literature of earnings management and analyzes the cases reported to draw a conclusion with a view on the concerned topic. Earnings management, in exchange listed companies, is not fraud but a case of caveat emptor for investors.
Earnings Management: An Overview
Earnings management is the process of intentionally misrepresenting financial data in the accounting measurements such that the company can show greater profits and more value than it actually has obtained. The process can be “cosmetic” where managers influence accruals without affecting cash flows or it can be “real” where cash flows are acted upon to manage earnings (Wild, 2006, pp.86-87). There are three usual strategies that managers can exploit for earnings management. ...
Increasing the current income is done to represent a company more positively (Wild, 2006, pp.86-87). It can be done for a long period of time. In cases of growth, the accrual reversals are lesser than the current accruals, thereby increasing the income. The big bath strategy involves taking many write-offs in a time when performance is poor. Because of the unusual nature of the big bath, users generally discount the financial effect. In income smoothing, the managers enhance or reduce the reported revenue to reduce its volatility (Wild, 2006, pp.86-87). The process of income smoothing has been found to be an efficient process that is capable of revealing private information of the financial teams working in an organization. At the same time, stakeholders and financial analysts, who determine the financial status of a company depending on such information, can be misrepresented through the wrong information provided by this method. The purpose of such misrepresentation has been associated with the companies’ tendencies to achieve higher returns of profits. It can be understood that if a company presents itself to be in a financially good and stable position within an industry, greater number of shareholders would invest in the company and the returns of the company would also be high. Studies also reveal that companies that have been able to present their earnings to be smooth have obtained higher number of investors in comparison to those companies that have lesser smooth earnings. However, the problem arises with the method when in the long run the investors would look for the actual status of the company. Misrepresenting or presenting smooth earnings might impress the investors for a particular moment of time, thus benefitting the