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BUSI W3013 Handout 13 | Page 1 Copyright 2004 by Doron Nissim F INANCIAL A CCOUNTING BUSI W3013 | F ALL 2009 H ANDOUT 13 P ROFESSOR A NDREW S CHMIDT Handout 13 contains: Class Notes: Earnings Management Article: The Numbers Game (Business Week 2001) Article: Auditors and Earnings Management (The CPA Journal 2001) EARNINGS MANAGEMENT Note : This material is generally excluded from the final, but it may help in understanding some issues that were discussed during the semester and are included in the final. 1.0. INTRODUCTION 1.1. Earnings Management Definitions Financial fraud, an extreme case of earnings management, is defined as “the intentional, deliberate, misstatement or omission of material facts, or accounting data, which is misleading and, when considered with all the information made available, would cause the reader to change or alter his or her judgment or decision.” (National Association of Certified Fraud Examiners, 1993) But earnings management is more general than financial fraud. In particular, earnings management activities may occur within GAAP choices. SEC Chairman Levitt (1998) noted that: “Flexibility in accounting allows it to keep pace with business innovations. Abuses such as earnings management occur when people exploit this pliancy. Trickery is employed to obscure actual financial volatility. This in turn, masks the true consequences of management’s decisions.” That is, accounting choices which are made within-GAAP can still be construed as earnings management, if they are used to “obscure” or “mask” true economic performance. Similarly, accounting researchers have defined earnings management as: “[Earnings management is] a purposeful intervention in the external financial reporting process, with the intent of obtaining some private gain (as opposed to, say, merely facilitating the neutral operation of the process).” (Schipper, Accounting Horizons, 1989)
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BUSI W3013 Handout 13 | Page 2 Copyright 2004 by Doron Nissim “Earnings management occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company, or to influence contractual outcomes that depend on reported accounting numbers.” (Healy and Wahlen, Accounting Horizons, 1999) People often refer to earnings management as synonymous with earnings overstatement. However, earnings management also includes situations where firms make accounting choices that result in understated earnings. Moreover, firms may manage line items from the financial statements or footnote information in ways that do not affect bottom line earnings. Earnings are the total of cash flow from operations and accruals (“non-cash earnings”). Thus,
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This note was uploaded on 02/27/2011 for the course BUSINESS 101 taught by Professor S during the Spring '10 term at Columbia College.

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