Sometimes accounting quality is impugned because

Info icon This preview shows pages 33–34. Sign up to view the full content.

View Full Document Right Arrow Icon
Sometimes accounting quality is impugned because managers' intervention in the reporting proces involves fraud. For example, in 2009, Ramalinga Raju, the CEO of Satyam (an Indian information- technology conglomerate), was arrested for reporting fictitious cash and profits of over $1 billion. However, more frequently, earnings management involves subtle, small increases in net income designed to achieve an outcome such as meeting analysts' forecasts or avoiding losses. While it is more often the case that "managed" earnings (and assets) are inflated, some managers underrepon their true earnings (and assets). The highest quality accounting reports are free from biases in both directions; they are accurate because they are not over- or understated. 5-33 Module 5 I Revenue Recognition and Operating Income - Reliable Numbers That Are Not Predictive Companies can experience changes in economic events that impair the predictive ability of reli- able numbers. For example, in June 2011, Marathon Oil announced that it was breaking the company into two new companies: Marathon Oil, which will engage in upstream oil and gas exploration and development activities, and Marathon Petroleum, which will run refineries and distribute products to retail and other customers. The company's 2010 financial statements, while reliable, were no longer relevant because the company's structure was so changed that users could not use its 2010 revenues and expenses to forecast 2011 net income. Expectations about future earnings were markedly altered. Assessing and Remediating Accounting Quality There is no tried and true formula for assessing accounting quality or for identifying earnings management. But, at a minimum, we can implement the following analysis and remediation techniques: BUSINESS INSIGHT Meeting or Beating Analysts' Forecasts Missing analysts' earnings forecasts can cause stock prices to tumble. Therefore, managers ai to meet or beat the Street's expectation, sometimes resorting to earnings management involvirj; accounting accruals, and other times using real actions (such as channel stuffing). These deliber- ate manager interventions reduce accounting quality. One way analysts and researchers detea: potential earnings management is to identify unusual accruals and reversals (negative accruals) a, quantify their effect on earnings. Of particular interest are unusual accruals that move EPS enou to meet or beat analysts' earnings forecasts; such accruals raise suspicion of managerial opportun- ism. Consider the case of Green Mountain Coffee; its consensus EPS forecast was $0.38 for ths second quarter of fiscal 2011. When the company reported second-quarter earnings, they beat ths consensus forecast by $0.10 per share, a 26% margin! The company's stock price shot up near1lj 20% to $75.98. But a closer inspection of Green Mountain Coffee's financial statements reveals tna; the wide margin by which the company beat earnings forecast was not due to stellar performance but to an accounting anomaly. Its statement of cash flows reveals an unusual (negative) accrua of $22,259 thousand
Image of page 33

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 34
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern