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Why Management Manipulates Earning?
Jan 8, 2009 20:52
  • CHINASTOCK
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For a listed company, a late filing is a violation of the listed rules which would raise great negative result, the worst of which is delisting from that exchange. I have asked one auditor, “If the management would not intend to manipulate earning, say all the auditor adjustments are completely accepted, then the audit can be completed in the planned time schedule and late filing would not happen. Is it true? “. “Absolutely”, the auditor said.

However, the management would not give up the efforts to manipulate earning. As a result, the audit is doomed to be a battle between the management and the auditors, and the result (the audit report) is a compromise between them.

As a result, management has great motivation to manipulate the earnings. There are two directions to earning manipulation. One is borrowing income from future (increasing current revenue or decreasing current expenses); the other is banking income for the future (decreasing current revenue or increasing current expenses).

To better analysis the earning quality, so as to recognize the possible earning manipulation, you should follow the following advices:

• Understand the business
• Understand the accounting policy
• Understand the business areas where accounting quality is most doubtful
• Understand situations in which management are particularly tempted to manipulate

Under some Institutional Situations where Manipulation is More Likely, I list some below:

• The firm is in the process of raising capital or renegotiating borrowing. IPO; SEO
• Debt covenants are likely to be violated
• A management change
• An auditor change
• Management rewards (like bonuses) are tied to earnings
• A weak governance structure: inside management dominate the board; there is a weak audit committee or none at all
• Management buyout
• Transactions are with related parties rather than at arm's length
• Special events such as union negotiations and proxy fights
• The firm is "in play" as a takeover target
• The firm engages in exotic arrangements (structured off-balance-sheet vehicles)

Finally, I would like to say that, for an auditor, earning manipulation is the greatest challenges in their career life. They must seek the balance between GAAP and the clients’ demand. They should know clearly when they should insist, and when to compromise. It’s both art and science.

Please contact China Stock Advice for any inquiries. Reproduction in whole or in part without China Stock Advice's permission is prohibited.

www.chinastockadvice.com -----Leading provider research on stocks traded in China’s A-share market.
Jan 8, 2009 21:54
#1  
  • MARRIE
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  • Join Date: Jan 7, 2008
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Yes, that's a big one which can be downloaded from electronic auditing bible. a ceo has a one year left to go and hints somebody to recognized put 3 years contracts in one year and the auditor does make it, which is not unusual. The thing is how accounting financial dept. is structured, cfo checked by controller who is checked by senior financial analyst...Out of internal control could be a disaster that we can see from this crisis. Auditing is really complicated and logic stuff which is far beyond you mentioned. Physical theft tricks and even bigger theft that needs high IQ backup can be caught by documentations and specific auditing software. Science is always above arts in auditing if you don't want get things ruined.

Sep 2, 2010 01:31
#2  
  • BRAXTON
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  • Join Date: Aug 31, 2010
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Hi CHINASTOCK, you have shared really useful information over here. I have read your opinion and felt that it has lot of worth for those people who have poor management skills. For more info on stock tips, share tips you many visit snpnifty.com , hope this will help to newbie too.

Thanks!





Last edited by BRAXTON: Sep 2, 2010 01:33
Dec 22, 2010 01:11
#3  
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Mar 18, 2011 05:47
#4  
GUESTBUZZING...
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