Beneish M-Score Model Harvard Case Solution & Analysis

RELATION OF THE TOPIC WITH THE COURSE

This topic is one of the most important part of this course. This course relates to the financial management and the financial performance of the companies.Investors, managers and the analysts want to know the true information regarding the financial health of companies. Also looking at the past corporate scandals such as the Enron scandal, more importance is being placed upon earnings management and earnings quality. The course is based on the accounting standards that are proposed by US GAAP. Although there is little room for manipulation by the companies under US GAAP but still management can manipulate the financial results accounting practices and the operational decision because a lot of estimates and subjectivity is involved in the treatment of most of the items. Therefore, this topic is being emphasized repeatedly and it is one of the core areas of the course.

ANALYSIS AND FINDINGS

For the purpose of analysis and findings, the M Score model (Beneish Model) has been applied on the Jean Phillippe Fragrances Incorporation. Normally there are two methods for calculating the mean score to find out the degree of earnings quality. The first method is the five variables method and the second method is the eight variables method. The eight variable method included all the variables that are stated above, while the five variable method includes all the variables except SGAI, TATA and LVGI. Analysis has been performed for this company based on both methods.

The financial information for both the companies has been obtained for the years 1995 and 1996. The respective ratios have been calculated based on the formulas that are mentioned above. Both the approaches are used here and the mean score has been calculated under both the approaches. If the mean score is more than -2.22, which means the value is lower in negative, then it means that the firm is a manipulator of earnings. If it is lower, which means the value is higher in negative, then it means that the management of the company is managing the earnings quite well and the earnings quality of the company is excellent.

In this case if we analyze the mean score of Jean Phillippe Fragrances Incorporation, then it can be seen that the mean score of the company under the five variable approach is -2,89 and the mean score under the standard eight part approach is -2.53. We can see that both of these scores are lower than the benchmark standard score. This shows that the management of the company is following all the standards under US GAAP. It is not manipulating the earnings of the company by recognizing sales early of delaying the expenses in next periods. The calculation of both the scores are given in the table below:

M  = -6.065+ .823 DSRI + .906 GMI + .593 AQI + .717 SGI + .107 DEPI
M-score (5-variable model)

-2.89

 
    
M  = -4.84 + .920 DSRI + .528 GMI + .404 AQI + .892 SGI + .115 DEPI
         -.172 SGAI  + 4.679 Accrual to TA  - .327 Leverage
M-score (8-variable model)

-2.53

 
Note:  if M > -2.22, firm is likely to be a manipulator 

The above mean scores will have positive impacts on the future performance, growth and stability of the company. The investors will be more attracted to invest in this company. The shareholders will also be delighted as the management is performing well. Therefore, the M Score is a very useful tool to analyze the discrepancies with the US GAAP standards and to reveal the unusual transactions in the financial statements of the company.

CONCLUSION

The importance of earnings management and earnings quality has a lot of significant influence in today’s world. The quality of the earnings is one of the most significant and important factor in the investigation of the financial statements of a company. The Beneish Model discussed above is the best investigative tool which calculates the analytical ratios of the company and then it applies the indexes of those ratios to predict the manipulation of the earnings that is taking place in the company. The main contributing factor and the real strength of this model is that, this model is based upon eight unique ratios. All of these ratios are important indicators about the financial health of the company and they predict the level of manipulation in the books correctly. There is a lot of significance of this model in today’s world, where investors and analysts demand true and fair financial statement so that they can make sound decisions for themselves.................................

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