Question:
Companies often are under pressure to meet or beat Wall Street earnings projections in order to increase
stock prices and also to increase the value of stock options. Some resort to earnings management practices
to artificially create desired results.
Required:
Is earnings management always intended to produce higher income? Explain.
Answer:
No. Companies generally prefer to report earnings that follow a smooth, regular, upward path. They try
to avoid declines, but they also want to avoid increases that vary wildly from year to year. It is better to
have two years of 15% earnings increases than a 30% gain one year and none the next. As a result, some
companies “bank” earnings by understating them in particularly good years and use the banked profits to
increase earnings in bad years.
Companies often are under pressure to meet or beat Wall Street earnings projections in order to increase
stock prices and also to increase the value of stock options. Some resort to earnings management practices
to artificially create desired results.
Required:
Is earnings management always intended to produce higher income? Explain.
Answer:
No. Companies generally prefer to report earnings that follow a smooth, regular, upward path. They try
to avoid declines, but they also want to avoid increases that vary wildly from year to year. It is better to
have two years of 15% earnings increases than a 30% gain one year and none the next. As a result, some
companies “bank” earnings by understating them in particularly good years and use the banked profits to
increase earnings in bad years.
