Earnings Management
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Earnings management has been an alarming issue over the past years till now and is even viewed as detrimental to businesses. In simple terms earnings management means deliberate steps from the part of the management of a company to alter earnings to attain particular objectives. Nowadays it is important to know how this issue came up. What it is, what the motives behind it are and how it is being practiced by management. It is so critical to know about it that even the former chairman of the Securities Exchange Commission (SEC), Arthur Levitt (1998), expressed his concerns about earnings management.
Earnings play an essential role in accounting. It is the accountings summary measure of a firms performance. It is calculated by taking Revenues minus Cost of sales, Operating Expenses and taxes, over a given period of time. Earnings are the reason why corporations exist, and are often the single most important piece of information to investors because they give an indication of the companys expected future dividends and its potential growth and capital appreciation.
However, to base a judgment on a company solely looking at earnings figures is not good as management often try to manipulate these figures and the term used to describe these actions is Earnings Management. Therefore when management is willing to engage in earnings management, the reliability of these earnings becomes questionable.
There is no universally accepted definition for earnings management and therefore there have been several definitions laid down in its literature (Healey & Whalen 1999; Beneish 2001)
“Abusive earnings management involves the use of various forms of gimmicky to distort a companys true financial performance in order to achieve a desired result.” SEC (1999)
Healey & Wahlen (1999) state that ” Earnings management occurs when managers use judgment in financial reporting in structuring transactions to alter financial reports, to either mislead some stakeholders about the underlying economic performance of the economy, or to influence contractual outcomes that depends on reported accounting