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CC1C8L8 2008
a) 0efIne "earnIng management"
Feasonable and legal management decIsIon makIng and
reportIng Intended to achIeve stable and predIctable
fInancIal results.
EarnIng management Is not to be confused wIth Illegal
actIvItIes to manIpulate fInancIal statements and report
results that do not reflect economIc realIty.
b) What wou|d be the manager's argument to support the
content|on that smooth|ng earn|ngs |s usefu| for
shareho|ders? Lxp|a|n
AssoclaLed wlLh Lhe good" slde of earnlng managemenL
ConLracLlng perspecLlve
ood ln relaLlon Lo Lhe efflclenL conLracLlng vs opporLunlsLlc forms of
poslLlve accounLlng
AblllLy Lo manage earnlngs ln Lhe face of lncompleLe and rlgld
conLracLs
A devlce Lo convey lnslde lnformaLlon Lo Lhe markeL enabllng share
prlce Lo beLLer reflecL Lhe flrm's fuLure prospecL
llnanclal prospecLlve
A devlce Lo dellver complex lnformaLlon
Suppose Lhe 8Cu wanLs Lo encourage Lhe managers Lo communlcaLe
Lhe flrm's long run perslsLenL earnlngs poLenLlal
lf Lhe manager slmply announce Lhls lnformaLlon slmply announce
Lhls lnformaLlon Lhls announcemenL would noL llkely credlble
c) D|scuss how the shareho|ders wou|d argue aga|nst the
manager's answer as |n (b) above?
AssoclaLed wlLh Lhe bad" slde of earnlng managemenL
lrom Lhe conLracLlng perspecLlves Lhls can resulL from opporLunlsLlc
manager behavlor
1he Lendency of manager Lo use earnlngs managemenL Lo maxlmlze
Lhelr bonuses
W Larnlngs managemenL ls a noneffecLlve shorLLerm behavlour lL
wlll noL lncrease Lhelr proflLs Lhey may even aggravaLe Lhe
enLerprlses operaLlng dlfflculLles damage Lo Lhe lnLeresLs of
shareholders
W Larnlngs managemenL dellberaLely dlsLorLs some of Lhe
accounLlng daLa (such as neL lncome) Lhereby reduclng Lhe
flnanclal sLaLemenLs lnformaLlon rellablllLy falrness and
comparablllLy Lhere are llkely Lo mlslead lnvesLors [udgmenLs
and declslonmaklng and undermlnes Lhe markeL funcLlon of
efflclenL allocaLlon of resources
W Larnlngs managemenL would undermlne lnvesLors Lhe lmpresslon
LhaL Lhe quallLy of corporaLe earnlngs
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