Earnings Management Decoded


Management uses several earnings management strategies to influence the earnings reported in the financial statements. Organizations use management strategies to achieve set targets and goals by eliminating all unnecessary expenses. To manage an organization’s earnings, business owners, accountants, or managers use accounting methods to increase or save their earnings. In other words, earnings management is a method to manipulate a company’s financial record to better the stakeholders. The business owners increase their profits and earnings in the short run to show a better picture.

Some of the most commonly used earnings management strategies used in about every industry are as follows:

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Focused Decisions to Increase Earnings

Business owners make decisions solely focused on increasing the organization’s earnings. The most likely way to increase an organization’s profits is by controlling its expenses. Business owners find different ways to cut costs to increase their profits. For example, companies temporarily suspend research, advertising, training, and development costs to increase their profits.

Biased Accounting Judgments

Business owners make biased decisions to increase their accounting profits. They usually consider accrual accounting techniques, which provide better opportunities to increase their earnings. Accrual accounting is generally regarded as fraudulent accounting, as the company records its expenses and revenue before they are incurred or received. Companies must follow several strategies and accounting techniques to make their decisions bias-free. In actuality, business owners manage earnings when they create policies and decisions strong enough to meet their targeted profits.

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Altering Accounting Principles

International standards provide different accounting rules for transparency and duplicate transactions. These standards allow the company to choose the desired method. For example, fixed assets are recorded at book or market value. Another example can be how to record inventory. The standard provides three rules: FIFOLIFO, and perpetual inventory system.

The management decides which rules are the best, which can help the companies to increase their earnings while minimizing their expenses.

Not only limited to this, companies also overvalue their assets and make changes in revenue recognition, impacting their profits. Many organizations use cookie jar techniques, which are aggressive accounting techniques. Business owners save profits or hold large parts of the reserves in the profit year, and there are drawbacks when the company faces a lousy year and cannot recover bad debts.

Ethical Earnings Management

External factors affect the company’s profits, including adverse government policies, changes in accounting standards, a significant export hit, currency devaluation, etc. Business owners take advantage of these factors further by increasing write-offs of all their bad debts, overvaluing asset depreciation and restructuring costs, and increasing their other expenses in the same year to reduce their overall profits. This strategy, in return, will minimize taxes. The false overvaluation increases their earnings.

Every business owner wants to increase their earnings in some way. Increasing revenues cannot always be wrong. Still, business owners make false financial statements based on such activities, giving the investors and other stakeholders a bad image of the company. The unethical activities increase the company’s market share price and make it more profitable. 

A better way to increase the earnings is to recognize the profits and expenses in the same year they are received or incurred. This strategy helps the company make consistent profits and sustain itself long-term. Managing the earnings is good when no personal interest is associated with the profits. It gets worse when a personal interest threat is associated with it, which enables business owners to take false steps that influence them to use techniques to inflate their profit.

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In summary, earnings management strategies are commonly employed by management to influence financial statements and meet organizational targets. These strategies often involve biased accounting judgments, altering accounting principles, and making focused decisions to increase earnings. While increasing profits is a natural goal for businesses, unethical practices such as fraudulent accounting and aggressive techniques can tarnish a company’s reputation and mislead stakeholders. 

Businesses must prioritize transparency and adhere to ethical accounting practices to maintain credibility and ensure long-term sustainability. Ultimately, managing earnings responsibly, without personal interests clouding judgment, is essential for fostering trust and integrity within the business community.

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