BUSINESS

Earnings Management and BAE Systems

Discussion of Part 1

Definition of Earnings Management

Before discussing earning management it is really important to know the understanding of earnings itself, because this concept is based on earning. Earnings refer to the company's profits. In order to determine the magnetism of any particular stock, earnings is what the investors and analysts look at. Companies with good earnings will prospect to have a higher share price compared with those of poor earnings will have lower share price. It is important to keep in mind that the ability of a company to make profits in future plays very significant role in the determination of stock price.

The strategy that is used to manipulate or alter profits deliberately of a company by its management is called Earnings management therefore they can match a pre-set target. It generally entails the artificial increase or decrease in profits, revenues or EPS figures by aggressive accounting tactics. It is a type of fraud and varies from reporting error. This is just to carry out for the sake of income smoothing. In spite of having exceptionally well or bad profits since years, companies may tend to keep the earnings stable by increasing or decreasing cash through reserve accounts.

Management that wishes to demonstrate earning at a pre-determined level or just to look seek for loopholes in the standards of financial reporting that permits them to alter the figures as far as it is practical in order to get their desired aim. These adjustment results in figures are done which depends how applicable to attain their desired level of satisfaction. These items may only take only if there is any fraudulent motivation behind them.

Such behaviors which include market expectations are controlled by personal expectation of a bonus, and within a market sector position of maintenance. In most of the cases compliance to normal acceptable accounting practices (GAAP) is concerned with personal integrity. Aggressive earnings management could become more expected when a firm faces downturn in business.

Example of Real Cases of Earning Management

Earning Management- Example 1 - Creating multiple trading entities

In the earning management it involved establishing up other entities and then doing business with these entities.

This practice is a common practice. Businesses segregate their operations into different sectors that perform the specialized functions and then carry trade between various entities within the same firm. What so ever, the accounting standards (GAAP) which are followed commonly and are applicable everywhere, that would ask for some kind of consolidation because that is required and complete picture should be reported.

Nevertheless, there was a prejudice to record revenue, income and profits from transactions among these entities; rather than accounting for expenses, costs and losses.

Earning Management - Example 2 Cendant

In the year 1998, Cendant misstated its financial statements through announcement at its International unit, as a result of this announcement it concluded to have a loss of $14 billion within a single day in market capitalization. Until its announcement Wall Street considered Cendant as a ...