senior management the higher is the risk of fraud the greater the political

Senior management the higher is the risk of fraud the

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senior management, the higher is the risk of fraud; the greater the political clout of senior management relative to external directors, the higher the risk of fraud and the greater the commitment to stock options and benefits that encourage a long-term view, oversight, and balance between the influence of management and the board of directors, the lower is the risk of fraud.
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Assessing the appropriateness of an earnings-management technique depends on its objectives. In some cases, earnings management does not involve techniques outside the scope of GAAP. Corporate managers often choose accounting policies that maximize earnings and the firm's market value. In general, these techniques involve revenue and expense recognition issues and include estimating bad debt allowances, doing inventory write-downs, estimating the percentage of completion of long-term construction projects, and choosing a depreciation method. These types of earnings-management techniques are considered legitimate; it is illegitimate earnings management and the misrepresentation of earnings that concern the SEC and the investment community. In 1998, Arthur Levitt, the former chair of the SEC, outlined five earnings-management techniques that he said threaten the integrity of financial reporting: 35 1. Taking a bath . The one-time overstatement of restructuring charges to reduce assets, which reduces future expenses. The expectation is that the one-time loss is discounted in the marketplace by analysts and investors, who will focus on future earnings. 2. Creative acquisition accounting . Avoiding future expenses by one-time charges for in-process research and development. 3. “Cookie jar” reserves . Overstating sales returns or warranty costs in good times and using these overstatements in bad times to reduce similar charges. 4. Abusing the materiality concept . Deliberately recording errors or ignoring mistakes in the financial statements under the assumption that their impact is not significant. 5. Improper revenue recognition . Recording revenue before it is earned. It was noted that over half of the SEC's enforcement cases filed in 1999 and 2000 involved improper revenue-recognition issues. Fraudulent Financial Reporting Many earnings-management activities, although aggressive, involve judgments and estimates that are acceptable under GAAP. Earnings manipulations that are intended to deceive investors and creditors, however, constitute financial statement fraud. Box 5.1 , adapted from an article by Dechow and Skinner, depicts the distinction among conservative, neutral, aggressive, and fraudulent earnings-management activities. 36 BOX 5.1 Distinction among Conservative, Neutral, Aggressive, and Fraudulent Earnings- Management Activities Conservative accounting o Overly aggressive recognition of loss or reserve provisions o Overvaluation of acquired in process research and development activities Neutral earnings o Earnings that result from using a neutral perspective Aggressive accounting o Understating loss or reserve provisions
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