Earnings Management Ch 16 Accounting Information for Decision Making Rick Hayes, Ph.D., CPA...
-
Upload
madisyn-leeper -
Category
Documents
-
view
217 -
download
0
Transcript of Earnings Management Ch 16 Accounting Information for Decision Making Rick Hayes, Ph.D., CPA...
Earnings Management Ch 16 Accounting Information for Decision Making
Rick Hayes, Ph.D., CPACalifornia State University L.A.
Earnings Management
• A conscious manipulation of accounting processes or numbers to make a company's operations or financial position look better in order to gain some benefit for themselves or to increase the stock price of the firm.
• represents active manipulation of or conscious choices in the accounting results that produce an altered perception of the performance of an entity
Incentives to Manipulate Earnings
• Budget versus actual• Bonuses• Influence Wall Street analysts• Make stock options more valuable• Comply with debt covenants
Manipulating Information
• Pro-forma earnings– SEC ruling have to show GAAP equally
• Selective release of information– Insider trading– Regulation Fair Disclosure (FD) should be released
simultaneously to all groups
• Revenue/Gain– Sales Returns and
allowances • Cost of Sales• Depreciation/amortization• Expense• Net Income/loss
• Accounts Receivable• Allowance for Bad Debt
• Inventory• Allowance for Obsolete
Inventory• Investments• Current Assets• Fixed Assets• Intangible assets• Total Assets
• Accounts Payable• Accrued Payables• Warranty Liability• Current Liabilities• Retained Earnings• Total Liabilities and Equity
• Expense
Flexibility of accounting principles
Choices:–Inventory (LIFO, FIFO, Average Cost, Specific ID)–Depreciation (straight line, accelerated, time, salvage)–Expensing vs. Capitalizing (asset or expense?)–Allowance Accounts (uncollectable, obsolete
• Asset impairments• Restructuring costs• Inventory write-downs• Environmental liabilities• Pension assumptions• In-process R&D• Percentage of completion contracts
Manipulating Revenue
• Most frequently used• Keep books open past cut-off• Bill and Hold• Channel stuffing• Not recording returns and allowances• Incorrect percentage of completion in long term
projects
Deferring Expenses
• Not recognize expenses in proper period (violating matching principle)
• Unrealistic estimates (allowance for uncollectable accounts, depreciation, warranty, obsolete inventory, etc.)
• Not writing down assets when they become impaired
• Capitalizing expenses
Off Balance Sheet Debt
• Transferring liabilities to Special Purpose Entities (SPEs)
• Transferring poor performing assets to SPEs• Incorrectly guaranteeing debt of SPEs• Improper leases
Income Smoothing
• Smooth earnings so that it always meets or exceeds analysts expectations
• Taking “big bath” in bad years• Reversing special allowances (reorganization
allowance)• Creating the affect of no volatility in net
income
Detecting Earnings Manipulation
• Change in ratios and trends• Difference from industry data• Reasonable testing
– Revenue and Accounts receivable– Inventory and cost of sales– Bad debt, warranty and other allowances as a
percentage of sales
Accounting Tricks - Examples
Waste Management Inc.
– Understated depreciation and capitalized interest improperly, failed to write down impaired assets. Total restatement $2 billion.
Waste ManagementOverstated Income
-1000
100200300400500600700800900
92 93 94 95 96 97
Original
Restated
Accounting Tricks - Examples
WorldCom
– Recorded expenses as capital expenditures, double-booked revenues, booked revenues as cost reductions. Total restatement $4.6 billion
0
2000
4000
6000
8000
10000
12000
14000
1999 2000 2001 1st Qtr 2002
Year
EB
ITD
A (i
n m
illio
ns)
Reported EBITDA
Restated EBITDA
WorldCom – Reported vs. Restated EBITDA
Accounting Tricks - Examples
Xerox
– Recorded revenue on long-term leases of copiers prematurely. Total restatement $3 billion (but part of this increased later revenues).
Xerox – Reported and Restated Revenue
14,500
15,000
15,500
16,000
16,500
17,000
17,500
18,000
18,500
19,000
19,500
20,000
1997 1998 1999 2000 2001
Original
Restated
Accounting Tricks - Examples
Adelphia
– Hid billions in debt off-balance sheet in unconsolidated subsidiaries, diverted undetermined millions to the family stockholders, inflated subscriber numbers in press reports, overstated earnings.
Adelphia Debt Load
$3.5 Billion
$12.6 Billion
Reported Actual
Accounting Tricks - Examples
Sunbeam
– Inflated revenues by channel stuffing and bill &hold. Reduced expenses by capitalizing advertising costs, reducing allowance for bad debts.
Sunbeam – Revenues and Net Income
(400,000)
(200,000)
0
200,000
400,000
600,000
800,000
1,000,000
1,200,000
1,400,000
1996 1997
Reported Revenue
Actual Revenue
Reported NI
Actual NI
Accounting Tricks - Examples
Rite-Aid
– Inflated revenues by recording vendor rebates that pertained to future purchases. Reduced expenses by capitalizing expenses, not recording certain expenses, failing to write off inventory shrinkage, understating depreciation.
Rite-Aid – Net Income Restatement
-50
0
50
100
150
200
250
1998 1999 1Q2000
Reported
Restated
Accounting Tricks - Examples
Enron
- Hiding debt and losses in unconsolidated entities
Enron – Reported and Restated Net Income
0
200
400
600
800
1000
1200
1997 1998 1999 2000 2001
Reported
Restated