Textbook Notes (368,795)
Canada (162,165)
Accounting (74)
ACTG 4P11 (6)
Brown (6)
Chapter 11

Chapter 11 Notes (Key takeaways from the chapter) - .docx

3 Pages
91 Views
Unlock Document

Department
Accounting
Course
ACTG 4P11
Professor
Brown
Semester
Winter

Description
Chapter 11 – Earnings Management Earnings Management - Choice by a manager of accounting policies, or real actions, affecting earnings so as to achieve some specific reported earnings objective - Healy and Wahlen (1999): occurs when “manager uses judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of a company or influence contractual outcomes that depend on reported accounting numbers” Patters of Earnings Management - Taking a bath – management may record a larger loss during a loss period so future reported earnings will be enhanced o E.g. during periods of organizational stress or restructuring - Income minimization – less extreme as taking a bath o E.g. to avoid political heat as discussed in Chapter 8 - Income maximization – from PositiveAccounting Theory, maximize reported net income for bonus purposes o Another example is firms close to debt covenant violations - Income smoothing – risk-averse managers prefer a less variable bonus stream o E.g. smooth reported earnings over time so as to receive a relatively constant compensation Evidence of Earnings Management for Bonus Purposes - 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 - If net income is between the bogey and cap, manager is motivated to adopt accounting policies to increase reported net income - Measured discretionary accruals using total accruals as a proxy (but now based on Jones (1991) model discussed in Chapter 9) o Amortization, increase in netA/R (AFDA), increase in inventory, decrease in A/Pand accrued liabilities (warranty liability) Other Contractual Motivations - Debt covenants - Implicit contracts - Political costs - Meet investors’earning expectations o Strong negative share price reaction if expectations not met o Damage to manager reputation if expectations not met - Initial public offerings o To increase proceeds of new share issues The Good Side of Earnings Management - Investor-based arguments to credibly communicate inside information to investors o Blocked communication may inhibit direct disclosure of earnings expectations o Discretionary accrual management as a way to credibly reveal management’s inside information about earnings expectations  Manager foolish to report more earnings that can be maintained  Mana
More Less

Related notes for ACTG 4P11

Log In


OR

Join OneClass

Access over 10 million pages of study
documents for 1.3 million courses.

Sign up

Join to view


OR

By registering, I agree to the Terms and Privacy Policies
Already have an account?
Just a few more details

So we can recommend you notes for your school.

Reset Password

Please enter below the email address you registered with and we will send you a link to reset your password.

Add your courses

Get notes from the top students in your class.


Submit