MM 7: ETHICAL OBLIGATIONS AND DECISION MAKING IN ACCOUNTING

1. Motivation to manage earnings a. To meet or beat the earnings projection to market capitalisation and increase the

value of stock optionb. Auditors are under pressure to retain clients by the firms and under pressure by the

management not to stand in the way c. To smooth net income over time – to make it appear that company is profitable and

trigger stock price increased. Practice of earnings management led to erosion in the quality of earnings and

quality of financial reporting

2. Ethics of Earning Management a. Acceptability of earnings management techniques should be judged using the ethics

frameworkb. Virtue ethics – tells the reasons for actions taken by the decision maker as well as

the action itself

3. Rationalising the ethics of earnings management a. Act-utilitarian perspective – a decision about how to account for and report a

financial transaction could be made by weighting the benefits to management and the company of using a particular technique (to smooth net income) versus the cost of providing potentially misleading information to the shareholders

b. Rule-utilitarian perspective – financial statements should never be manipulated for personal gain

4. How manager and accountants perceive earnings managementa. Accounting manipulation is less acceptable ethically than operating decision

manipulation

5. Common Earnings Management Techniques a. Recording revenue too soon or of questionable qualityb. Recording bogus revenuec. Boosting income with one time gain d. Shifting Current Expenses to a later/earlier periode. Failing to record or improperly reducing liabilities f. Shifting current revenue to a later period g. Shifting future expenses to the current period as a special charge