Earnings management Ã? Examples of where accounting can produce different numbers legally…

Earnings management
É Examples of where accounting can
produce different numbers legally (honestly?).
É Interesting ones – perhaps;
à LIFO, FIFO Average Cost (Physical /
Perpetual)
à Depreciation
É Why does management do it (not tax)?
É Why not produce any numbers you
like?
É Why not require only one method or
estimate?
É Why would managers manage earnings?
É NOT TAX – we are talking about
‘managing’ reported accounting profits not taxable income.
É Don’t you want to look good – if you
can choose which photo, which assessment marks to include etc
É Managers want to show results that
make their job easier:
à High profits – great manager – she
should be paid more
à Low profits – not ripping the public
off – should get government protection – shouldn’t be taxed more.
É Why not produce any numbers you
like?
É There are rules; revenue
recognition, conservatism etc but there still is ‘wiggle’ room (weighted ave
v’s FIFO).
É Corporate law – fraud when you just
make up the numbers.
É Auditors who independently check
that the numbers are ‘true and fair’ or ‘presented fairly’ within the
‘accounting reporting framework’ (e.g.
HC)
É Post settling up – you can only lie
so often.
É Why not require only one method or
estimate?
É That adds a new kind of distortion.
É Let’s consider a pair of shoes!
É How do we depreciate them; method,
life, residual value?
É Accelerated? Ten years?
Always have some value?
É OR
Straight line? Two years? Zero residual
É Imposing structure still gives
distortions!
É What are we attempting to achieve
when producing financial statements?
à Useful information (SAC 2 Objective
of Financial Reporting) Barth showed useful for predicting.
É How do we make the information
useful?
à Make it relevant, reliable,
understandable etc (IASB Framework, Qualitative Characteristics of Financial
Reporting)
É But problems still remain.
à Relevant or Reliable?
à Relevant to whom?
·
Investors
or creditors, casual observer?
É Conceptual Framework and its
application.

 

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