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Ch03 Class Notes

In simple terms this means using manipulations to

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Unformatted text preview: earnings in years when they are weak and to lower them in years when they are strong. weak It’s very well known on Wall Street that investors prefer It’s steadily increasing earnings that consistently meet or exceed financial analyst expectations. This stems from the general economic principle that investors are risk averse. In financial terms, risk aversion is associated with earnings In volatility. Cookie Jar and Big Bath Accounting Accounting Cookie Jar Accounting One type of earnings management and earnings manipulation. The practice treats the balance sheet as a cookie jar: In good years, the company stores cookies (reserves) in the cookie cookie jar (the balance sheet) so that it can take them out and eat them (place them on the income statement) when management is hungry (needs extra income to look good). (needs Big-Bath Accounting When a company makes a large oneWhen Big-Bath time write off, it is said to take a big bath to improve future earnings. time Many companies take a big bath (often in the form of restructuring or inventory write-downs) when earnings performance is already poor. inventory Earnings Management Red Flags Earnings Aggressive revenue recognition policies Hockey stick pattern near end of quarter Frequent “non-recurring” charges Changes to reserves, depreciation, etc. Related party transactions Complex financial products Unsupported top-side journal entries Underfunded defined benefit pension plans Unreasonable management compensation 32 A Thin Line There certainly is a thin line between legal There earnings management and abusive earnings management. Where does a company cross the line between criminal behavior and merely conduct that is beneficial to the organization? Chapter 3 Forensic and Investigative Accounting 33...
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