Earnings Management: The Continuum from Legitimacy to Fraud

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QUESTION #11

Overview —Theoretical and Conceptual Knowledge1

THEORETICAL AND CONCEPTUAL KNOWLEDGE4

Levels of Earnings Management4

Concept of the Quality of Earnings in the Continuum5

Framing the Issue6

Earnings Management Motivation and Fraud7

Fraud Emergence and Development11

Auditing Outlook and Fraud Detection14

QUESTION 216

PROFESSIONAL APPLICATION19

Emotions and Accountants Ethical Evaluations and decisions20

Earnings Management Techniques22

QUESTION 333

RESEARCH METHODS AND CRITIQUE35

Findings and Discussions on Secondary Sources of Data Collection43

QUESTION 447

ETHICAL CONSIDERATIONS47

Earnings Management and Magnitude of Consequences49

Inconsistencies between Earnings Management Behavior and Consequences49

Earnings management, ethical judgment, and intention to intervene50

Recommendations51

Corporate Mechanisms to Avoid Fraudulent Earnings Management55

Board Oversight57

External Audit and Internal Audit Reporting to Audit Committee of Board58

Whistleblower procedures58

Code of Conduct and Ethics of Financial Officers58

Philosophical Stance60

QUESTION #1

Earnings Management: The Continuum from Legitimacy to Fraud

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Overview —Theoretical and Conceptual Knowledge

Earnings management entails an extensive range of illegitimate and legitimate actions undertaken by companies and business organizations' managements, affecting the entire legal entities' overall earnings. In understanding this phenomenon of earnings management, it's important to have a wide overview of the legitimate managerial activities carried out in an entity and the fraudulent reporting that is spearheaded by accountants and the entire management of an organization. The management of earnings leans on the credibility of financial information which is adversely affected by legal or illegal undertakings.

All managerial activities within an organization have various implications and potential effects on earnings management. Such activities are designed in a view to run earnings in a smooth manner in predetermined accounting or financial periods or to achieve a certain earnings level to meet the objectives of the management and the analysts' forecasts in the financial market. Earnings management activities constitute legitimate open and optional choices made of when and why to engage in financial transactions that need recognition of accounting.

Unlike the end-year tax planning decisions that are made by the management to help accelerate deductions or even suspend income which is taxable on the basis of various considerations; discretionary actions may not overrule critical considerations. Expenditure on advertising which is expensed when incurred, may see some bit of acceleration in a certain quarter of the financial year especially the fourth one, if the business is surpassing its target on earnings or rather can be suspended or deferred if it is not meeting the set objectives on earnings for that same period. Legitimate earnings management may also include scenarios where justifiable choices are made on the way to account for financial transactions. These are critical to the entity and other events and circumstances that warrant informed choices being made for purposes of business growth and development, particularly those that involve estimates in accounting and essential accounting judgments which must conform to the generally accepted accounting principles. Reducing bad debts for the entity may call for implementation of a decisive plan geared towards enhancing credit and collective activities rendered as legitimate and in line with management requirements for the best interest of the organization (Albrecht et al., ...