Advantages Of Earnings Management

“The practice of earnings management according to research is present in almost all countries. But countries who have very weak legal institutions experience this practice at its highest level” (Capkun , et al., 2008). Currently, many public firms and some private firms adopt the practice of earnings management. This writing talks about the advantages including its usefulness and disadvantages that earnings management has on firms. This essay will view how and why managers choose reporting methods to mask the firm’s performance mostly when they are unable to beat the benchmark. Earnings management is a technique used by companies to control the earnings to be able to reach preset targets while reducing their losses. Earnings management is

Moreover, this can affect the firm’s earnings both currently or in the future. There are several techniques used to detect discretionary earnings in a firm. These techniques can be found under two main methods of detecting earnings management, namely; the accruals earnings management and the real activity earnings management. The accruals type of earnings management occurs when the managers use whatever conclusions drawn to make decisions that can cause a difference in the earnings of the firm. The real activity type of earnings management puts more risk on the managers as well as the firm. With this technique, the cash flows will be affected and moreover the decisions of managers are based on the current operations of the firm. Under these main types of earnings management, there exists sub techniques which are also used to manage earnings in a firm. Under the accruals earnings management, we have the cookie jar technique which focuses more on bad debts, warranties and other accruals, big bath technique which states how managers make excessive write-offs which changes the firm’s forecasted charges concerning future expenses, big bet on future technique, the change in GAAP technique, amortization, depreciation and depletion technique and the operating versus the non-operating income technique. For the real activity earnings management technique, it includes the stock

In addition to that, earnings management has negative effects on the quality of earnings. Earnings management increases the demands by the workers of the firm as well as stakeholders. Employees tend to demand for an increase in their wages due to the nature of economic performance given to them by management. Also with this same reason for the increase in demand of wages, stockholders also request for more dividends. On the dark side of earnings management, investors do not get the accurate information they need for decision making. In relation to Enron’s case, many unreal transactions were involved in their financial statement. This was amongst the reason Enron fell drastically. Enron scandal arose due to certain practices in operation. For example, they recorded revenue that did not exist. Moreover, they never recorded expenses in the correct period but rather recorded revenue. In addition to this, inflated profits were never recorded. With earnings management, the company’s financial position seems to be inaccurate thereby portraying wrong view to stakeholders of the firm. Due to this practice, Enron’s case caused many people to lose their jobs. From the research writing on the effects that audit quality has on earnings management (Becker, et