Earnings Quality

1. Earnings Quality And Earnings Management

2. First . . . Some sage, or otherwise . . . Advice!

3. Some Sage Advice . . . • This short stories that follow have nothing to do with earnings quality or earnings management. • However they may prove useful to you in the future. • So, here are three lessons from large corporations to help you survive change Source: The Internet, of course – Where Else!

4. A crow was sitting on a tree, doing nothing all day. A small rabbit saw the crow, and asked him, "Can I also sit like you and do nothing all day long?” The crow answered: "Sure, why not.” Jumped on the rabbit... and ate it. So, the rabbit sat on the ground below the crow, and rested. CORPORATE LESSON 1 All of a sudden, a fox appeared,

5. CORPORATE LESSON 1 The moral of the story . . . To be sitting and doing nothing you must be sitting very, very high up.

6. A turkey was chatting with a bull. "I would love to be able to get to the top of that tree," sighed the turkey, "but I haven't got the energy.” "Well, why don't you nibble on some of my droppings?" replied the bull. They're packed with nutrients." Soon he was spotted by a farmer The turkey pecked at a lump of dung and found that it actually gave him enough strength to reach the first branch of the tree. The next day, after eating more dung, he reached the second branch. Finally after a fortnight, there he was proudly perched at the top of the tree Who promptly shot the turkey out of the tree.

7. CORPORATE LESSON 2 The moral of the story . . . Bullshit might get you to the top. But it won’t keep you there

8. A little bird was flying south for the winter. It was so cold, the bird froze and fell to the ground in a large field. and dropped some dung on it. While it was lying there, a cow came by A passing cat heard the bird singing and came to investigate. As the frozen bird lay there in the pile of cow dung, it began to realise how warm it was. The dung was actually thawing him out! He lay there all warm and happy, and soon began to sing for joy. Following the sound, the cat discovered the bird under the pile of cow dung, and promptly dug him out and ate him!

9. The morals of this story are: CORPORATE LESSON 3 • Not everyone who drops shit on you is your enemy. • Not everyone who gets you out of shit is your friend. • And, when you’re in deep shit, keep your mouth shut.

10. Now Back to Reality?

11. BEGINNING ENDING Life of the Firm Time Period Principle Discrete (separate) accounting periods. 00 01 02 03 04 05 06 07 08 09

12. Accrual-Basis Accounting The Accounting System Revenue Recognition Matching Principle $ $ $ $ $ $ $ $

13. First . . . Let’sat the Income Statement

15. Uses of the Income Statement • Evaluate the past performance of the enterprise. • Provide a basis for predicting future performance. • Help assess the risk or uncertainty of achieving future cash flows. Intermediate Accounting Kieso, Weygandt, and Warfield

16. The Statement’s Limitations • Items that cannot be measured reliably are not reported in the income statement. • Income numbers are affected by the accounting methods employed. • Income measurement involves judgment.

17. The Quality of Earnings Quality Of The Earnings

18. A Multidimensional Concept • Decisions made by standard setters • Choices made by management about which accounting methods to use from the set of alternatives • Judgments and estimates made by management to implement the chosen alternatives. Walter R. Teets Issues in Accounting Education November 2002

19. The Quality of Earnings • “Management may be giving way to manipulation; integrity may be losing out to illusion.” Arthur Levitt The Numbers Game Remarks to NYU Center for Law and Business, September 28, 1998

20. The “Numbers Game” • Accounting Hocus-Pocus • “Big Bath” Charges • Creative Acquisition Accounting • Miscellaneous “Cookie Jar Reserves” • Materiality • Revenue Recognition

21. The Power of a Speech • The “Numbers Game” speech provided the impetus for: • SAB 99, Materiality (August 12, 1999) • SAB 100, Restructuring and Impairment Charges (November 24, 1999) • SAB 101, Revenue Recognition (December 3, 1999) James R. Duncan Twenty Pressures to Manage Earnings

22. Do we have a problem? • 12% of CFOs had managed their earnings at the request of their superiors. • 55% were asked but refused to do so. • 60% of CFOs have felt pressure to manage earnings. James R. Duncan Twenty Pressures to Manage Earnings

23. The Quality of Earnings Earnings Management

24. Earnings Management • Practices by which “earnings reports reflect the desires of management rather than the underlying financial performance of the company.” Arthur Levitt The Numbers Game Remarks to NYU Center for Law and Business, September 28, 1998

25. Earnings Management • “Earnings management can be defined as the active manipulation of accounting information to create an altered impression of the firm’s financial performance, as measured by its earnings.” Theresa Libby and Robert Mathieu Playing by the Rules CMA Management July/August 2001

26. Earnings Management • Earnings management is often defined as the planned timing of revenues, expenses, gains, and losses to smooth out bumps in earnings. • In most cases earnings management is used to increase income in the current year at the expense of income in future years.

27. Earnings Management • Earnings management has a negative effect on the quality of earnings if it distorts the information in a way that is less useful for predicting future earnings and cash flows.