Finance

Earnings Management and BAE Case Study

Discussion of Section 1

Earnings Management

Earnings is main driving force of any organization, it refers to the net income or the bottom line of any organization. It is the most important item in the financial statements. Earnings gives an indication of that till what extent the organization has involved itself in value added business activities. They give signals which can help the allocation of resources in capital market. We can also state that the theoretical value of any stock depends on its future earnings. Increase in earning represents an increase in the value of the company, and on the other side decrease in the earnings of a company gives a negative indication in the value of the firm (Merchant & Rockness, 1994, p. 17).

As we have discussed the importance of earnings, so it is obvious that the management of the company is interested how these figures are reported because that has a big impact on the market. This is the reason that every executive should understand the effects of the choices that they make in accounting so they can use it in the best interest of the organization and take best decisions. In other words they must learn how to manage the company's earnings.

Earnings management can be defined as the legal and reasonable management decisions in making and reporting with intentions to attain predictable and stable financial outcomes. It can also be explained as those attempts by management so to influence or to manipulate the reported earnings via using particular accounting methods (changing techniques), by recognizing the single time non-recurring natured items, accelerating or deferring revenue or expense transactions, or by using different methods which are designed to influence the short term earnings. Earnings management should not be confused with those activities of illegal nature which are used to alter financial statements and report those results which does not reflect actual economic reality. Such activities are known popularly as window dressing or cooking the books which involves misrepresentation of financial results (Lyons, 1984, pp.79-94).

That management which desires to project earnings at an early level by searching for loopholes in the financial standard which can allow them to change the financial figures as long as it is applicable in order to achieve their desired objective.

By these practices which can control the market expectations and this is derived by personal bonuses and also to maintain the goodwill of the firm. In majority of the cases compliance to GAAP is linked with integrity. Earnings management becomes more probable when the business is going through a downturn (Middleton, 2010).

There are different terms which are used to describe the activities of earnings management.

Window Dressing

Income Smoothing

The numbers game

Accounting hocus-pocus

Juggling the books

Accounting Magic

Creative accounting

Accounting alchemy

Aggressive accounting

Financial statement manipulation

Banking income for the future

Financial statement management

Reengineering the income statement

Financial shenanigans

Borrowing future's income

Examples of Earnings Management

Case Study of HealthSouth Corporation

CEO of Health South, Mr. Richard M. Scrushy initiated the company with $1 million as a seed capital which was later on transformed into a multibillion dollar ...