NEW YORK (CNN/Money) - The Securities and Exchange Commission and Microsoft Corp. have settled a long-running inquiry into the software maker's accounting practices. To conclude the matter, Microsoft said it has agreed to comply with SEC provisions that require companies to make accurate filings and maintain records and controls sufficient to prepare financial statements in conformity with generally accepted accounting principles, or GAAP. The agency said its investigation had determined that Microsoft had misstated its income by material amounts between July 1, 1994, and June 30, 1998. The company did so by maintaining seven reserve accounts in a manner that did not comply with GAAP, the SEC said. During 1995 through 1998, the total balance of these accounts ranged from approximately $200 million to $900 million, the SEC said. Microsoft recorded reserves, accruals, allowances, and liability accounts relating to marketing expenses, sales, depreciation, inventory obsolescence, valuation of financial assets, interest income, and impairment of manufacturing facilities that did not have properly substantiated bases, the SEC said. In its filings with the SEC, Microsoft made reference to these accounts but did not fully document them, therefore overstating its income in some quarters and understating it in others, the SEC said. Under the terms of the settlement, which was leaked to the press last week, Microsoft was ordered to discontinue the practice. The company was not fined, nor was it charged with accounting fraud. "This case emphasizes that the commission will act against a public company that issues financial statements with material inaccuracies, even in the absence of fraud charges," Stephen M. Cutler, director of the SEC's enforcement division, stated. Microsoft said the agreement has no impact on its reported financial results and no restatement of any reported financial results is required. Microsoft (MSFT: down $0.87 to $50.04, Research, Estimates) shares were down 1.8 percent in Nasdaq trading early Monday afternoon

Required:

1. In this case, Microsoft was charged of overstating its income in some quarters and understating it in others. What are the possible reasons companies are likely to engage in such kind of activities? (7 marks)

2. What are the possible ways a company may engage in earnings management activities? Please provide an example for each type of earnings management activities, and discuss how to figure out such earnings management activities as a financial analyst. (3 marks)