Topic 06 - EM and Fraud.pdf - MACC7012 - Financial...

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MACC7012 - Financial Accounting TheoryMaster of Accounting (2020 Intake)Topic 6. Manipulation of Financial Reporting InformationGuochang Zhang © 2021The University of Hong Kong
Financial Accounting TheoryProfessor Guochang Zhang, HKUTopic 6. Manipulation of Financial Reporting6.1 Why managers manipulate information6.2 Different approaches to earnings management-Accrual-based manipulation-Real transactions management6.3 Insights from academic research6.4 Accounting manipulation: the Chinese experience6.5 Case study (group assignment)2
Financial Accounting TheoryProfessor Guochang Zhang, HKU6.1 Why managers manipulate financial reporting outcomesFinancial reporting gives external stakeholders (eg., investors and creditors)a periodic update of the firm’s operation and financial condition.-Thisreduces the information asymmetrybetween company insiders andoutside stakeholders.But reported firm performance affects insiders’ (managers and controllingshareholders) personal interests, so they do not always disclose informationobjectively and truthfully.Under what circumstances do managers have strong incentives tomanipulate (distort)financial reporting information, and how they do so?3
Financial Accounting TheoryProfessor Guochang Zhang, HKUMotives for manipulating financial reportingManagers may manipulate financial reports in various situations:ØTo meet performance benchmarks(e.g., analyst forecasts or prior year’s EPS;or to avoid reporting a loss)ØEquity based compensation (options and shares)ØInsider tradingØExternal financing(e.g., IPOs and SEOs)ØDebt contracts (covenants)ØM&A activitiesØTo meet regulatory requirementsUsers of financial reporting information (investors, creditors, etc.) shouldbe aware of managers’ intention, and pay attention the specificcircumstances.4
Financial Accounting TheoryProfessor Guochang Zhang, HKUTools to manipulate financial reportingManagers may use different tools to manipulate financial reportinginformation. The two main tools are:ØAccrual-based manipulation. Accounting measurement involves subjective anddiscretionary elements, for example:-estimation of bad debt expenses-asset and goodwill impairment-depreciable life of a long term asset.This makes it possible for managers to engage in accounting manipulation (oftenreferred toearnings management, EM)ØReal transaction (ie., business activity) management.Managers have discretionto structure business transactions, which affects thetimingandamountofeconomic activities and transactions.Implication:(i) reported financial data do not always reflect the true state ofoperations; (ii) managers may not carry out business activities that best serve theinterest of other stakeholders (but this is hard to detect by outsiders).

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Term
Fall
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Tags
Income Statement, Generally Accepted Accounting Principles, Accounting scandals, Professor Guochang Zhang

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