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Q&A Forum

Is controlling earnings by utilizing discretionary accounting techniques, disingenuous and/or unethical?

A recent research study "Earnings Quality: Evidence from the Field" September 9 2012 concluded the following - 

"(i) high-quality earnings are sustainable and are backed by actual cash flows; they also reflect consistent reporting choices over time and avoid long-term estimates;

(ii) about 50% of earnings quality is driven by non-discretionary factors;

(iii) about 20% of firms manage earnings to misrepresent economic performance, and for such firms 10% of EPS is typically managed"

My problem with the study is that it really never identifies the discretions.  When most people read the question they will immediately say Yes it is unethical.   But --

Does that mean that I am unethical if I defer equipment purchase today until next year so my net income looks good?


When a bank releases reserves to hide a down month/quarter?

What are your thoughts and experiences?



Topic Expert
Linda Wright
Title: Consultant
Company: Wright Consulting
(Consultant, Wright Consulting) |

From a credit perspective, I look for consistent accounting practices and policies. If there are deviations which could come from management changes, I start to worry.

As to banks, they are highly regulated. The call report process should prevent releases from the allowances for doubtful accounts without detailed justification.

wayne ackerman
Title: CFO and SVP
Company: ATC
(CFO and SVP , ATC) |

Estimates fully disclosed and allowable under GAAP are commonplace. Whenever in doubt, I check with our CPA firm and beforehand.

(Controller) |

I had a boss who routinely tweaked certain monthly estimates, such as legal fees and reserve for bad debts, to manage monthly P&L versus budget and prior year. This was to maximize his and the other executives' performance against MBO goals. Naturally, those of us who had to post the related journal entries, prepare the monthly financial statements and write the analytical review did not participate in the upside, as our MBO goals were written differently.

Ken Stumder
Title: Finance Director / Controller
Company: Ken Stumder, CPA
(Finance Director / Controller, Ken Stumder, CPA) |

Linda sums it up in a nutshell when she says "consistent accounting practices" I believe the entire financial reporting process from close to issuance of audited financials is designed to manage volatility. Material misrepresentation is very different from managing earnings, so every company is probably guilty to some degree. From personal experience, many are probably guilty of over-conservatism. I tend to over-reserve and to defer earnings if there are any grey areas. I'm not currently at a public company, but is over-conservatism keeping a stock price compressed and thereby not rewarding shareholders properly?

Topic Expert
Barrett Peterson
Title: Senior Manager, Actg Stnds & Analysis
Company: TTX
(Senior Manager, Actg Stnds & Analysis, TTX) |

Consistent is important, but a review of certain specific assumptions underlying pension accounting, OPEB accounting, impairment analysis, and restructuring reserves can reveal permitted but awfully aggressive assumptions. Bankd accounting for its own debt at "fair value", also permitted, can produced some "managed" affects. Beware REPO accounting by financial institutions.

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