In Class #1.1 Professional ethics and earnings management
Why would Day Corporation’s CEO want to “manage” earnings?
The possible motivations for Day Corporato in’s CEO to “manage” earnings include:
Manage the stock price. Day’s CEO wants to meet the forecasted earnings number
of $1.34 per share because the CEO believes that the stock price will drop if actual
earnings fall short of the forecast.
Job security. The CEO may be concerned th at the Board of Directors may have a
poor view of him if he delivers “unwel come surprises.” Depending on how much
the stock falls, they may evenconsider dismissing him.
Management incentives. The bonuses of top management and the CEO may be
based on earnings. If earnings decrease, smaller or no bonuses may be paid. If top
management and the CEO have stock options, the value of these options will be
adversely affected if the stock price falls.
Which of the items in a - g above are acceptable to Day’s controller? Which are unacceptable?
Several of the “end-of-year actions” clearly are inconflict and should be viewed as unacceptable:
(a) Subscriptions cancelled in December shoud l be recorded in December itself and not
delayed until January.
(c) Subscription revenue received in Decembe r in advance for magazines that will be
sent out in January is a liability. Showing it as revenue lsely reports next year’s
revenue as this year’s revenue.
(d) Office supplies purchased in December sh ould be recorded asan expense of the
current year and not as an expense of the next year.
(e) Booking advertising revenues that relate to January in December falsely reports
next year’s revenue as this year’s revenue.
The other “end-of-year actions” o ccur in many organizations and may fall into the “grey”
to “acceptable” area. However, mu ch depends on the circumstances surrounding each one:
(b) If the software on office computers is not updated until January, there is no
transaction or expense to record in Dece mber. The responsibilityfor ensuring that
the software is updated is that of te chief information technology officer. The
controller can do little morethan observe the absenc