FAT Week 10 EM - FAT Week 10 EM 1 What is EM = Process of...

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FAT Week 10 EM 1. What is EM? = Process of manipulating f.s. numbers thru acc adjustments, real activities, or both. (Reporting earnings no. different from actual earnings no.) Generally, the term ‘EM’ has negative connotation (The view we take) However, EM x necessarily bad – use judgement to report earnings in the spirit of conservatism e.g. a co. very volatile earnings vs co. very uniform pattern of earnings (income smoothing – investors prefer) Both good & bad - W intent of obtaining some gain - Mislead stakeholders about underlying eco performance - Influence contractual outcomes that depend on acc reported no. 2. Method of EM a) Within GAAP (making use of flexibility) Accounting adjustments e.g. Acc rules require an account for provision for DD, X specify amount – can change from 15% to 10% Real activities b) Outside GAAP (fraud) Acc rule asks you to expense R&D costs, co. X record expense at all (violate GAAP requirements) Accounting adjustments – X effect on CF (If record more rev today, record less rev in future) 1. Changes in acc policy - Changing dep method/ useful life of assets - Less common - Difficult to change acc policy period to period, extensive disclosure required in f.s. (need to tell investors when restate acc no.) e.g. changes in valuing method of inv [FIFO, LIFO etc], ^ useful life will reduce dep expense & ^ net income - Cannot change method – acc has to be similar from yr to yr unless has significant reason 2. Adj. to accruals - If we want to manipulate net income , adjust accruals (rev & expense ) - (i) Aggressive rev recognition (record rev upfront)
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e.g. prematurely recognised $$ in revenues; Enron used mark-to- market accounting to recognise rev from LT gas contracts upfront - (ii) Deferring
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  • Fall '15
  • Income Statement, Generally Accepted Accounting Principles, earnings vs co.

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Christopher Reinemann
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