Companies often try to keep accounting earnings growing at a relatively steady p

Question

Companies often try to keep accounting earnings growing at a relatively steady pace, thereby avoiding large swings in earnings from period to period. They also try to meet earnings targets. To do so, they use a variety of tactics. The simplest way to control the timing of accounting revenues and costs, which all firms can do to at least some extent. For example, if earnings are looking too low this quarter, then some accounting costs can be deferred until next quarter. This practice is called "earnings management". It is common, and it raises a lot of questions.

Why do firms do it?

Why are firms even allowed to do it under GAAP?

Is it ethical?

What are the implications for cash flow and shareholder wealth?

Explanation / Answer

The firms use earning management as a part of their accounting strategies and this helps to shift earnings from one quarter to another .This helps to make the eanrings less volatile and due to this firms focus more on managing their earning than planning other business stratgies.As a part of such management they are useful during insolvency of the firm so it is adviced to always save money for bad times with banks who release them during such times.

GAAP methods helps in just providing facts which may or may not be real. Like companies may hide their exact profit position to the market investors ,sometime they might report higher earnings for a set period .For example recording depreciation is a part of GAAP rule but companies have the right to chose their time for such recordings which at times becomes unethical if not done appropriately.

Cash flow helps to incorporate future cash flow forecasts in the earnings.Thus earnings are earnings help out to be a better forecast of future cash flows than the current flows. Earnings are a;ways preferred while evaluating performance than relying on cash flow from operations of the company.

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.