Alternative Earnings Management Techniques: What Audit Committees and Internal Auditors Should Know

AuthorRoger B. Daniels,Mike Braswell
Date01 January 2017
Published date01 January 2017
© 2017 Wiley Periodicals, Inc.
Published online in Wiley Online Library (
DOI 10.1002/jcaf.22239
Alternative Earnings Management
Techniques: What Audit Committees
and Internal Auditors Should Know
Mike Braswell and Roger B. Daniels
of audit committee
(AC) responsibilities
and the oversight of
the public accounting
profession have been
made over the past
decade to improve
the transparency of
public companies’
financial disclosures
(Sarbanes-Oxley Act
of 2002 [SOX 2002]).
Although SOX 2002
appears to have cur-
tailed management’s
use of discretionary
accounting choices
(generally accepted
accounting principles
[GAAP]-based earn-
ings management)
to achieve earnings
targets, pressure to
satisfy Wall Street
remains evident as
companies dispro-
portionately report
earnings that just
meet or exceed these
targets (Brown,
2001; Zang,2012).
The Securities and
Exchange Commis-
sion (SEC) often
cites the temptation
to meet or exceed
analysts’ earnings
per share (EPS) esti-
mates as motivation
for management to
manipulate reported
earnings, which
companies continue
to do.1
efforts to deter
GAAP-based earn-
ings management fol-
lowing the implemen-
tation of SOX 2002
appear to be effective,
but this trend reflects
management’s change
in style rather than
a change in attitude.
Managers have exhib-
ited a growing will-
ingness to adopt real
earnings management
The desire to meet analysts’ earnings expectations
has driven companies to abandon credible financial
reporting by stretching the boundaries of generally
accepted accounting principles (GAAP), and even mak-
ing operational and investment decisions that compro-
mise future financial performance. Although external
auditors have made strides in curtailing GAAP-based
earnings management, real earnings management
(REM) has been adopted by management who hope to
improve reported earnings. Such behavior should be of
concern to audit committees (ACs) whose responsibili-
ties extend beyond simple compliance with GAAP, to
include ensuring that financial information is credible
enough to facilitate risk assessments and to maintain
effective internal control systems to monitor the effec-
tive use of resources by management to maximize
long-term shareholder wealth.
The purpose of this article is to increase aware-
ness about the nature, extent, and consequences of
management’s use of REM to meet Wall Street expec-
tations. We also discuss company and governance
attributes that are associated with REM so that ACs
and internal auditors (IAs) are able to identify circum-
stances in which REM is employed to generate earn-
ings that satisfy Wall Street. Specific techniques to
detect REM are provided, as well as disclosure alter-
natives that the AC may use to assist financial state-
ment users in assessing current- and future-period
financial performance. © 2017 Wiley Periodicals, Inc.
Refereed (Double-Blind
Peer Reviewed)

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