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Earning Management

Teaching Note on How the Earnings Management Teaching Module Can Be Taught Teaching Aims of the Module The Earnings Management Teaching Module is designed to help faculty teach how companies might manipulate earnings to maximize revenues, minimize expenses, and/or create reserves by setting aside some earnings in the current period that can be released into income at a later period. The result is to overstate earnings and mislead shareholders and creditors about the success of the company during one or more years.

Often times the motivation to manipulate earnings is to meet financial analysts’ earnings estimates, increase the value of stock options, or maximize bonuses that are based on earnings levels. The following briefly describes how each case meets the teaching goals of the Module. An International Company That Engaged in Fraudulent Reporting: Growth Electronics, Inc. Evaluating company accounting with respect to collectibility of accounts receivable, inventory valuation, and sale transactions. Interstate Transport, Inc: A Case Study in Earnings Management

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Analyzing accounting issues with respect to: revenue recognition; inventory valuation; depreciation of assets; contingent events; earnings per share and stock options; accounting for off-balance sheet entities; and the preparation and interpretation of the Cash Flow Statement. Multi-Element Revenue Recognition and Creating Reserves: Conservative Recognition or Cookie Jar Reserves? Establishing software revenue recognition rules and building reserves from income in one period to be released back into income in future periods.

The Evolving Role of the Audit Committee: The Case of BellSouth Corporation Critically evaluating the role and responsibilities of an audit committee for a public company with respect to financial statement reporting. A. H. Robins Company, Inc. – Trade Receivables Analyzing customers’ policy of deducting amounts from billed accounts receivable to increase earnings and the effect on establishing the collectibility of receivables by the supplier. Using the Module in Classroom Instruction

The cases and readings are designed to engage students in discussions about the validity of earnings amounts and asset valuation in the financial statements. Many students assume the numbers are accurate without questioning the accuracy of these amounts. The Collection can be used to point out to students the difficulties faced by accountants in developing the numbers and how unethical practices might be used to “cook the books. ” The pedagogy used for instruction might include classroom discussions, student group analysis and presentation including role playing, and written analysis of case situations.

Faculty should resist the temptation of providing the “right” answer but emphasize instead the reasoning process used by students to evaluate case situations. The cases are designed to have students step back from the process of recording financial transactions and examine the bigger picture of how the numbers are developed including the rules in accounting that establish the framework for reporting these amounts. The result should be that students gain an appreciation for the role that accounting can play in determining earnings amounts, stock prices, and stock options.

Guidance in Evaluating Student Responses The following five points can be used to assess student learning from the cases. Did the student: • Identify the accounting issues • Evaluate the acceptability of the accounting and financial reporting • Analyze the ethics of the accounting and financial reporting • Reason out alternative courses of action with respect to the facts of the case • Decide on a course of action and defend it in class discussions Concluding Thoughts

The cases chosen for this Module present a variety of basic issues in earnings management. The issues in these cases reflect topics that are typically discussed in introductory accounting classes as well as intermediate level courses. Therefore, faculty at both the undergraduate and graduate levels should feel comfortable in covering the cases in their accounting classes. When taken as a module rather than individually these cases provide an excellent tool for instruction by broadening students’ perspectives about the role of accounting in the economy and in society.

Faculty can point out that in similar cases such as Enron and WorldCom, members of top management were found guilty of enabling fraud to take place and were sentenced to about twenty-year prison terms. The lesson to be learned by students is the need for a high level of ethics in recording and presenting financial statement information and how the management of earnings violates accounting principles, deceives shareholders and creditors, and jeopardizes the future of companies that engage in such practices.


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