ACTG 4P11 Chapter Notes - Chapter 11: Earnings Management, Credit Risk, Accrual
Document Summary
Choice by a manager of accounting policies, or real actions, affecting earnings so as to achieve some specific reported earnings objective. Taking a bath management may record a larger loss during a loss period so future reported earnings will be enhanced: e. g. during periods of organizational stress or restructuring. Income minimization less extreme as taking a bath: e. g. to avoid political heat as discussed in chapter 8. Income maximization from positive accounting theory, maximize reported net income for bonus purposes: another example is firms close to debt covenant violations. Income smoothing risk-averse managers prefer a less variable bonus stream: e. g. smooth reported earnings over time so as to receive a relatively constant compensation. Healy (1985) study, confined to bonuses based on net income, extends the bonus plan hypothesis, which states that managers of firms with bonus plans will maximize current earnings.
