Earning Management, Accountants & Auditor
Earning management is defined as ‘’reasonable and legal management decision making and reporting intended to achieve stable and predictable financial results’’. It is the use of accounting techniques to produce financial reports that may paint an overly positive picture of a company’s business activities and financial position. For example, a variety of approaches to valuing inventory are available to management including FIFO, weighted average, units of production (and in some jurisdictions LIFO). The use of Generally Accepted Accounting Principle (GAAP) and International Financial Reporting Framework (IFRS) by the accountants for the true and fair presentation of financial statements, which is acceptable by the auditor and market forces along with shareholders of the company.
As per IAS 8 Accounting Policies, Change in Accounting Estimates and Errors is applied in selecting and applying accounting policies, accounting for the change in estimates and reflecting the correction of prior period errors. For example, if we apply (IAS 8) in the selection of accounting policy in the management of Inventory (IAS 2), whether to go for FIFO (First in and First out) or Weighted average basis. The results of both two policies are different. So accountant must go for that policy which gives high value to inventory. This is legal and accepted by International Financial Reporting Framework (IFRS) and generally accepted accounting principles (GAAP). Some of the companies adopt Cash basis of accounting while some go for accrual basis of accounting. The auditor must check the reasonableness of accounting policies adopted by management.
The manipulation of accounting principles persuades auditor to give a Modified opinion whether qualified, adverse or disclaimer of opinion. Earnings management becomes fraud when companies intentionally provide materially misstated information. For example W.R. Grace and Co. officials, The company was charged with stashing earnings in reserve accounts in good years and then tapping them in later years to mask actual slowing earnings. In this case, the auditor shall express an adverse opinion because the auditor, have obtained sufficient appropriate audit evidence, concluded that misstatement, individually or in the aggregate, are both material and pervasive to Financial Statement.