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

• Author: Roger B. Daniels,Mike Braswell
• DOI: http://doi.org/10.1002/jcaf.22239
• Date: 01 January 2017
• Published date: 01 January 2017

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© 2017 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).

DOI 10.1002/jcaf.22239

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Alternative Earnings Management

Techniques: What Audit Committees

and Internal Auditors Should Know

Mike Braswell and Roger B. Daniels

INTRODUCTION

Enhancement

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

Regulators’

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)