An article published in Accounting Horizons describes various techniques that companies

use to manage their earnings.

Required:
In your library or from some other source, locate the article “How Are Earnings
Managed? Evidence from Auditors” in Accounting Horizons, 2003 (Supplement) and
answer the following questions:
1. What are the four most common revenue-recognition abuses identified by auditors in
that article? From the examples provided in the article, briefly explain each abuse.
2. What is the revenue-recognition abuse identified in the article related to the
percentage-of-completion method?
3. Did revenue-recognition abuses tend to increase or decrease net income in the year
they occurred?
4. Did auditors tend to require their clients to make adjustments that reduced the revenue-
recognition abuses they detected?

SOLUTION

1.
Abuse Explanation
1. Cutoff manipulation The company either closes their books early (so some current-
year revenue is postponed until next year) or leaves them open
too long (so some next-year revenue is included in the current
year).
2. Deferring too much or The company has an arrangement under which revenue should
too little revenue be deferred (for example, it should be using the installment
sales method), but it doesn’t defer the revenue. Or, a company
could defer too much revenue to shift income into future
periods.
3. Bill-and-hold sale The company records sales even though it hasn’t yet delivered
the goods to the customer.
4. Right-of-return sale The company sells to distributors or other customers and can’t
estimate returns with sufficient accuracy due to the nature of
the selling relationship.

2. Manipulating estimates of percentage complete in order to manipulate gross profit

recognition.

3. These abuses tended to increase income (75% of the time), consistent with
management generally having an incentive to increase income.

4. The auditors tended to require adjustment (56% of the time), consistent with
auditors being concerned about income-increasing earnings management.