9.16 You have recently been appointed as a researcher for a firm of share analysts. As one of your first roles you are required to prepare a report for your manager to outline common techniques used to manage or manipulate earnings. From your prior accounting knowledge you would have gained an understanding of techniques you can use to examine entity performance and profitability, including trend analysis. Document what strategies you might use as an analyst to detect earnings management using accounting information.

9.22 Real activities management is an increasingly common form of earnings management examined in academic literature. The paper by Graham, Harvey and Rajgopal referenced in this chapter explores the range of earnings management techniques commonly used by managers in the United States.81 Find this paper, read it and prepare a summary of the most common techniques used by the surveyed managers, and highlight the advantages of each technique.

9.2 CASE STUDY

MASTERING CORPORATE GOVERNANCE: WHEN EARNINGS MANAGEMENT BECOMES COOKING THE BOOKS

There is often a blurred line between appropriate and inappropriate accounting techniques, but the audit committee must attempt to clearly distinguish which is which.The guiding principle of the audit committee is shifting from a focus on technical accounting procedures to determining whether disclosures in the financial reports present a true and fair view of the entity's affairs. Companies often face a great deal of pressure to meet the earnings forecasts they present to investors and analysts, or the estimates theseanalysts make. Executives of companies in this situation often resort to using a range of 'earnings management' techniques to help them 'make the numbers'. These techniques will often exploit loopholes in generally accepted accounting principles (GAAP) to manipulate the company's income. It is up to the audit committee members to identify whether earnings management, accounting estimates and other judgements are legitimate or are designed to blur the true financial position of the company. Source: Adapted from Ira Millstein, 'When earnings management becomes cooking the books',

QUESTIONS

1 What earnings management techniques are outlined in the above article?

2 What role can the audit committee play in detecting and/or limiting earnings management?

3 What relationship does the audit committee have with the external auditors in ensuring earnings management is within acceptable limits?

9.2 CASE STUDY

MASTERING CORPORATE GOVERNANCE: WHEN EARNINGS MANAGEMENT BECOMES COOKING THE BOOKS

There is often a blurred line between appropriate and inappropriate accounting techniques, but the audit committee must attempt to clearly distinguish which is which.The guiding principle of the audit committee is shifting from a focus on technical accounting procedures to determining whether disclosures in the financial reports present a true and fair view of the entity's affairs. Companies often face a great deal of pressure to meet the earnings forecasts they present to investors and analysts, or the estimates theseanalysts make. Executives of companies in this situation often resort to using a range of 'earnings management' techniques to help them 'make the numbers'. These techniques will often exploit loopholes in generally accepted accounting principles (GAAP) to manipulate the company's income. It is up to the audit committee members to identify whether earnings management, accounting estimates and other judgements are legitimate or are designed to blur the true financial position of the company. 'When earnings management becomes cooking the books',

QUESTIONS

1 What earnings management techniques are outlined in the above article?

2 What role can the audit committee play in detecting and/or limiting earnings management?

3 What relationship does the audit committee have with the external auditors in ensuring earnings management is within acceptable limits?