Why is earnings management allowed under gaap

Xero acquires inventory mgmt. By Daniel Hood. Firms giving back: Armanino holds 13th annual Great Give. By Sean McCabe. Career moves. On the move: CohnReznick opens Miami office. By Danielle Lee. Digital networks will power the future of accounting. Systematic and rational allocation is the cause of the distraction that GAAP introduces, the second failure.

Adoption of the definition of accounting in the s—and its retention to this day—as a process of allocation demonstrates that allocation is basic to financial reporting. Allocation characterizes most of financial accounting, including, for example, depreciation; reporting on inventories, investments, income taxes, pensions, goodwill and other intangibles; and liabilities.

A company selects each formula at the beginning of the period of allocation, supposedly to represent the effects of prospective underlying economic events.

Financial report issuers cannot possibly have that foreknowledge about events that may occur after they select the formulas. And events do not occur as regularly as the use of the formulas implies.

Moreover, allocation does not even reflect the effects of underlying economic events. Allocation merely takes amounts from the financial reporting territory, such as costs, enters them in the financial reporting map and massages them there. Eldon S. Hendriksen and Michael van Breda, the authors from Southern Methodist University of a leading text on accounting theory, have said that annual depreciation, one kind of allocation, is simply a fraction of the total cost and is not necessarily related to occurrences within the year, so it has no real-world connotations.

Accountants defend allocation mainly on the basis of realization and objectivity. Yet both are smokescreens that cover up what Leonard Lorensen, a past member of the AICPA accounting standards staff, has observed: The real goal of those who support allocation is to stabilize reported income. The smooth formulas used in allocation have that result. Apply market research to generate audience insights. Measure content performance. Develop and improve products. List of Partners vendors.

Earnings management is the use of accounting techniques to produce financial statements that present an overly positive view of a company's business activities and financial position. Many accounting rules and principles require that a company's management make judgments in following these principles.

Earnings management takes advantage of how accounting rules are applied and creates financial statements that inflate or "smooth" earnings. Earnings refers to a company's net income or profit for a certain period, such as a fiscal quarter or year. Companies use earnings management to smooth out fluctuations in earnings and present more consistent profits each month, quarter, or year. Large fluctuations in income and expenses may be a normal part of a company's operations, but the changes may alarm investors who prefer to see stability and growth.

A company's stock price often rises or falls after an earnings announcement , depending on whether the earnings meet or fall short of analysts' expectations.

Management can feel pressure to manage earnings by manipulating the company's accounting practices to meet financial expectations and keep the company's stock price up. Many executives receive bonuses based on earnings performance, and others may be eligible for stock options when the stock price increases.

Many forms of earnings manipulation are eventually uncovered either by a CPA firm performing an audit or through required SEC Securities and Exchange Commission disclosures. The Securities and Exchange Commission SEC has pressed charges against managers who engaged in fraudulent earnings management. One method of manipulation when managing earnings is to change an accounting policy that generates higher earnings in the short term.

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