Earning Management and Earning Quality Harvard Case Solution & Analysis

Introduction

The paper attempts to describe the concept of earning management and earning quality and elaborates the importance of the topic. The paper also discusses the ways that the topic relates to the course and provides a comprehensive findings and analysis of the earning management and earning quality. Lastly, the paper provides a summary of the entire paper.

The Concept of Earning Management

Before highlighting the concept of earnings management, it is important to understand the term earnings in financial terms. Earnings are referred to as the profits earned by a company. The most important element for analysts and the investors is to look in to the earnings of a company and to determine the value of the stock and its attractiveness. The good earnings would indicate that the company has good share prices, whereas, the companies that have poor share prices would indicate the company has poor overall earnings. Therefore, analysts investigates company’s future trends and prospects by viewing the stock prices of the company. The concept of earning management is a particular strategy which is applied by the management of a company in order to make changes deliberately in the financial reporting which is presented to its shareholders and investors so that the figures relates with the targeted figure that are set by the company’s investors (Rahman, Moniruzzaman, & Sharif, 2013).

The concept of earnings management is enabled for income smoothing which is described as a process which levels out the fluctuation of net income statement. The Security and Exchange Commission describes the process of earning management as a misrepresentation of results by the company’s management. The SEC is authorized to offer fines and penalties from the company if they pursue the earning management strategy. According to Lo (2008), the concept of earning management is defined as a manipulation in the financial reporting from the management either to gain contractual outcomes or mislead the stakeholders of the company. Therefore, the auditors and the regulators are then involved in finding out the real problem and to seek the wrongdoers. Seven elements are involved while auditors help in explaining the nature of earning management when the fraudulent activity has been carried out by the management. Auditors help in answering in understanding the crime and to detect whether it has been committed, the responsible personnel in the company, tools used in making alterations to the financial reports, victims of the fraudulent activity, motives of the fraudulent activity, opportunity involved and various explanations in understanding the causes of the crimes (Iatridi & Kadorinisb, 2009).

The concept of quality earnings is similar to the concept of earning management. The high quality earnings referred to as poor accounting standards followed by the management in generating the financial reports. The process of recognizing the earnings are referred to as earning quality.  Company may claims its strength in the stock prices but its cash flow statement may reveal the strength of its accounting structure that it has utilized. This will determine the overvaluation and the undervaluation of stocks. Earning quality is the process which represents the accurate income of the company in a particular period. However, despite of the existence of earning management it has always been difficult for researchers and auditors to document the earning management practices. The process of interpreting the malpractices is difficult because the researcher has to estimate the prior performance of the company and the earnings before the process of earning management (Iatridi & Kadorinisb, 2009).

Importance

The importance for the understanding of the concept earning management is relevant to become informative about the approaches used by the management of companies to alter financial reports. The importance of this study is to understand the ways through which these malpractices are carried out by the company through different accounting systems and methods. The earning management could be classified in to two broad categories which include real earning management and accrual management (Lo, 2008). These methods and categories involve changes in the accounting policies and the financial figures. A study reveals that the managers tend to perform changes in the financial reports by using the real earning management methods which are more costly than to those of the accruals management. The most common approach used by the managers is to decrease the discretionary spending and only a small number of managers would change the accounting assumptions (Ewert & Wagenhofer, 2012)...................

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