1、Earnings Management:Practice and PitfallsPhilip LivingstonPresident and CEOFinancial Executives InternationalWhat is Earnings Management? The process of establishingstakeholder expectations and achieving the result through legitimate and/or illegitimate methodsWhy Are We Talking About It?Illegitimat

2、e methods CLOUD financial reporting transparencyContrary to unbiased reportingResult is low quality earnings even if the target is reached. U.S. capital markets placed a premium on predictabilitySEC action in 1998 Legitimate Earnings ManagementPlanning discretionary spendingMarketing and advertising

3、Research and development Employee meetings, T&ELegitimate Earnings Management Special Quarter-End SalesPrice reductionsSales force incentivesQuantity/truckload offers to customersShipments Hold or Push Daily management of revenueAdd warehouse workersSchedule factory and warehouse overtimeLegitimate

4、Earnings ManagementInstituting a hiring freeze, temporarily avoiding:Hiring expenseNon-essential salary expenseBenefit costs Top Problem AreaRevenue accounting manipulationSide deals by salespeople that are undisclosed to accounting allowances, deductions and credits.Shipments to distributors or int

5、ermediaries associated with great uncertainty of sale.Premature recording when right of return existsPayment contingencies tied to other eventsInvoices that are inconsistent with underlying transactions“Managing the Bottom LinePast Accounting PracticesMerger and Acquisition Reserve Abuses Setting up

6、 reserves to cover future operating costs of an acquired company Providing rich reserves that allow for future adjustments that favorably impact earnings Writing-off excessive “in-process R&D to avoid future amortization charges“Managing the Bottom LinePast Accounting PracticesRestructuring Reserve

7、AbusesProviding general restructuring reserves subject to subsequent adjustmentReserving for exit costs that will benefit future periods (employee moving and training)Including in the restructure charge the cost of assets already impaired“Managing the Bottom LinePast Accounting PracticesMateriality

8、AbusesExclusive reliance on “rule of thumb criteria (e.g. 5% of earnings) for determining materialityIntentional failure to record items deemed “immaterial per these criteriaImproperly Aggregating and Netting unrecorded adjustmentsJudgment Areas Subject to AbuseAdjusting Reserves and Accruals on a Q

9、uarterly BasisThose that require considerable judgment:Inventory obsolesce and valuationSales returns and allowancesAccruals for professional feesAccrued marketing costsWarranty claim reservesReserves for self-insured benefitsJudgment Areas Subject to AbuseAdjusting Reserves and Accruals on a Quarte

10、rly BasisThose that require considerable judgment:Bad debt allowanceInventory overhead absorption ratesTax ratePrepaid expensesSEC Actions: SAB #99 MaterialityRequires consideration of QUALITATIVE factors, not just quantitative “Is it probably that the judgment of a reasonable person relying upon th

11、e report would have been changed or influenced by correction of the item?Strives to eliminate INTENTIONAL failure to record immaterial itemsRequires consideration of the materiality of misstatements individually, and in aggregate SEC Actions: SAB #100 Restructuring and Impairment ChargesPrior to rec

12、ording a restructuring, companies must:Have a detailed plan, approved by top managementCommunicate to employees their benefits entitlementDisclose expected headcount reductions, timetable for plan execution, and expected cost by categoryReport in detail, progress against the planManaging Earnings Ex

13、pectations:Past PracticesInformal discussions with select analysts intended to influence earnings estimates“Tipping selected analysts in anticipation of earnings releases Exchanging tipped information in exchange for agreement to “rein in market expectationsRegulation FD “Fair DisclosureWhenever a c

14、ompany discloses material information, it must make publicWhenever non-intentional disclosure is made, the company must make it public within 24 hours.Public disclosure includesfiling the information with the SECpress releaseproviding public access to the conference call or meetingBest Practices Goi

15、ng ForwardStick to legitimate “operational solutionsMake earnings forecasts publicUpdate forecasts regularlyConsider providing an earnings estimate rangeDiscuss short-term forecast within the context of long-term plansFinancial Executives InternationalInternet CommunityFEI Express e Newsletter On-line Job PostingsM