Download - Earning Management
Earning Management ..........
CA RAJIV SINGHFCA, LIFA(USA),CISA(USA) CO-FOUNDER EXPLICO [email protected]
An idea that delivers …..
Earnings Management
Management Actions to Achieve desired Earnings Level
Accounting Choice
ABEM
Lower the quality of earnings and mislead investors
Departure from GAAP
Operating decisions or economic earning Management
OBEM
More costly with respect to future firm Value
Departure from normal operating practices
Key Facts about ABEM & OBEM
• ABEM decreases with stringent investor protection because it is
more likely to draw scrutiny by auditor & regulator
• Managers prefer OBEM over ABEM where investor protection is
stronger because auditors and regulators are not interested in
operating decisions
• ABEM & OBEM are restrained when large number of quality
analysts follow the company
• Effects to “Meet or Beat” analyst forecast by ABEM & OBEM have a
negative effect on a firm’s future ROA and stock price
Measures of ABEM
(i) ABEM 1 =
Where
S.D. (OI) = Standard deviation of operating Income
S.D. (CFO) = Standard deviation of Cash from Operations
(ii) ABEM 2 =
Where
ΔAccruals = Change in Accruals
ΔCFO = Change in operating Cash flow
r = Correlation Coefficient
S.D. (OI)
S.D. (CFO)
r(Δ Accruals ,Δ CFO)
Measures of ABEM
(iii) ABEM 3 =
Where
Accruals = (ΔCA-Δcash-ΔSTL) – ( ΔCL-ΔSTD-ΔTP) – Dep
CFO = Earnings – Accruals
Absolute Value of Accruals
Absolute Value of CFO
Measures of OBEM
(i) OBEM 1 =
Where
Δ Production = Change in Production Cost
Production Cost = COGS + Δ inventories
Δ Sales = Change in sales
(ii) OBEM 2 =
Where
Δ DE = Change in Discretionary Expenses
= Change in selling, general & administrative expenses
r(Δ DE ,Δ Sales)
r(Δ Production,Δ Sales)
Interpretation
(i) Lower ABEM1 and ABEM 2 score imply that accounting based EM is
used to reduce the variation of earnings and conceal economic shocks to
the CFO.
(ii) ABEM 3 reflects manager’s behaviour in their attempt to achieve specific
earning target.
(iii) OBEM 1 measures sales and production manipulation. A lower score
indicates sales and production manipulation has been carried out.
(iv) If ‘DE’ is used for ‘ÉM’ OBEM 2 value should be lower. A high OBEM
indicates that ‘DE’ is rarely managed. A negative correlation indicates
high element of EM