Columbus Business Daily

characteristics of earnings management from good, no consequence to bad.?

when and how earnings management constitute financial fraud

Public Comments

1. The CPA Journal article “Abusive Earnings Management and Early Warning Signs,” by Lorraine Magrath and Leonard G. Weld (August 2002), distinguished between earnings management activities that are simply good business practices and abusive earnings management intended to deceive the financial community. Good business practices include the following activities: Careful timing of capital gains and losses; Use of conferencing technology to reduce travel costs; and Postponement of repair and maintenance activities when faced with unexpected cash flow declines. On the other hand, abusive earnings management results from actions such as those cited in the SEC section 704 Report: Improper revenue recognition; Improper expense recognition; and Using reserves to inflate earnings in years with falling revenues. Magrath and Weld identified six relationships that investors and auditors should consider as early warning signs of abusive earnings management: Cash flows that are not correlated with earnings; Receivables that are not correlated with revenues; Allowances for uncollectible accounts that are not correlated with receivables; Reserves that are not correlated with balance sheet items; Acquisitions with no apparent business purpose; and Earnings that consistently and precisely meet analysts’ expectations