I Gusti Ayu Agung Tata Intan Tamara (1607531009)

Alit Wahyuningsih (1607531041)

Summary of Earning Management - William R. Scott Earnings

Earning management is the choice by a manager of accounting policies, or

actions affecting earnings, so as to achieve some specific reported earnings objective.
Real actions to manage earnings include increasing R&D and advertising. Accrual-based
earnings management includes the allowance for bad debts, changing amortization policy.
Managers may engage in earnings management for a variety of other reasons,
there are: Other Contracting Motivations, debt contracts typically depend on
accounting variables, arising from the moral hazard problem between manager and lender
analyzed. To control this problem, long-term lending contracts typically contain
covenants to protect against actions by managers that are against the lenders' best
interests, such as excessive dividends, additional borrowing, or letting working capital or
shareholders' equity fall below specified levels, all of which dilute the security of existing
lenders. Thus, earnings management can arise as a device to reduce the probability of
covenant violation in debt contracts. To Meet Investors' Earnings Expectations and
Maintain Reputation, Strong negative share price reaction if expectations not met and
it will also damage to manager reputation if expectations not met. Evidence: e.g., Jackson
& Liu (2010), found evidence of management of bad debt allowances to avoid missing
market’s earnings expectations. Initial Public Offerings, intended to increase proceeds
of new share issues, Cohen & Zarowin (2010) find evidence of use of income-increasing
discretionary accruals in years of SEOs. They also report use of real earnings management
techniques to increase reported net income. They report declining ROA for 3 years
following SEO, driven in part by accrual reversal.
Good earnings management will consequence to give managers some ability to
manage earnings in the face of incomplete and rigid contracts (bonus, debt covenant, &
political). Thus, we would expect some earnings management to persist for efficient
contract. In “a financial reporting context, earnings management ca be a device to convey
inside information to the market, enabling share price to better reflect the firm’s future
prospects. On the other hand, bad earnings management will consulting opportunistic
manager behavior. Example, the tendency of managers to use earnings management to
maximize their bonuses, debt covenant violations. In a financial reporting context,
earnings management can be used to increase reported net income in the short run for
raising new share capital. Example: speeding up revenue recognition, lengthening the
useful life of assets, etc.
Full disclosure helps investors evaluate the financial statements, thereby
reducing their susceptibility to behavioral biases and reducing managers; ability to exploit
poor corporate governance and market inefficiencies. For example, clear reporting of
revenue recognition policies, and detailed descriptions of major discretionary accruals
such as write-downs and provisions for reorganization, will bring bad earnings
management into the open, reducing managers’ ability to manipulate and bias the
financial statements for their own advantage. Other ways to improve disclosure include
reporting the effects on core earnings of previous write-off and, in general, assisting
investors and compensation committees to diagnose low-persistence items. Managers
would then bear the full consequences of their actions and bad earnings management
would decrease

Is good earning management still fulfill the concept of faithful representation of

financial statement?