Earnings management can range from methods that suggest astute management to outright fraud. Required: 1 . Identify and discuss the activities on the earnings management continuum. 2 . Express your opinion as to where on the earnings management continuum most companies likely fall

Answer 1

1 . The activities on the earnings management continuum are as follows:
a . Strategic Matching. Many companies time transactions so that large one-time gains and losses occur in the same quarter in an attempt to smooth income. These companies are continuously aware of the benefits of meeting earnings targets and/or reporting a stable stream of income. These benefits may be realized by accelerating or delaying the completion of certain key transactions so that these transactions are recognized in the most advantageous quarter.
b. Change in Methods or Estimates with Full Disclosure. Companies frequently change accounting estimates such as the percentage receivables not expected to be collected, the useful lives of depreciable assets, and the return on pension fund assets. These changes often are simply a part of ordinary business activities, but, when applied aggressively, these changes can be used to manage the amount of reported earnings. Full disclosure of these changes allows reasonably sophisticated financial statement users to determine if a change is motivated by the need to manage earnings or by legitimate business reasons.
c. Change in Methods or Estimates with Little or No Disclosure. Changes in accounting principles or estimates are sometimes made without full disclosure. The lack of full disclosure may make it difficult, if not impossible, for the financial statement user to determine either the nature of the change effected or the motivation for the change. Changes in methods or estimates with little or no disclosure constitute deceptive accounting.
d. Non-GAAP Accounting. Although non-GAAP accounting can result from inadvertent errors, this earnings management tool also can result in fraudulent financial reporting. As an example, business entities are required to capitalize and amortize expenditures for assets that benefit more than one accounting period. Capitalizing and amortizing over a number of accounting periods an expenditure that benefits only one accounting period results in fraudulent financial reporting.
e. Fictitious Transactions or the Concealment of Actual Transactions That Affect the Financial Position or Results of Operations of a Business Entity Adversely. These approaches represent outright fraud. Recording sales as a result of channel stuffing is an example of a fictitious transaction. Failing to record the return of goods sold as a result of customer dissatisfaction is an example of concealing transactions that have an adverse effect on the finances of a business.
2 . Many reputable companies engage in the legitimate practice of the strategic timing of transactions. Techniques utilized beyond strategic timing of transactions usually are employed as a result of operating results falling short of targets. Changing methods or estimates can easily lead to even more egregious methods if operating results continue to deteriorate.