A generally accepted definition of earnings management is the planned timing of revenues, expenses, gains, and losses to smooth out earnings over a number of accounting periods. Generally speaking, earnings management is used to increase income in the current year at the expense of income in future years by, for example, prematurely recognizing sales before they are complete in order to boost profits. However, earnings management can also be used to decrease current earnings, so as to increase income in the future, a practice often referred to as “cookie jar” accounting. For example, WorldCom Inc., one of the greatest U.S. corporate bankruptcies, used so-called cookie jar accounting to inflate provisions for expected expenses and later reversed them to boost earnings.

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Consider the issues that lead to earnings management and, in particular, the reasons for companies adopting cookie jar accounting practices. How might auditors overcome such practices? In your discussion, refer to widely publicized corporate collapses such as WorldCom, which have used earnings management techniques.