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Definitions, Activities, and Measurement of Earnings Management

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Introduction to Earnings Management

Abstract

A comprehensive definition of earnings management should take into consideration its characteristics, conditions, activities, and targets. Such a definition allows distinguishing earnings management from other activities like fraud, earnings quality, impression management, and expectation management. Managers may use different methods to manage earnings including accrual earnings management, real earnings management, earnings smoothing, income shifting, and other advanced techniques. They trade-off between these methods based on their costs and benefits to their firms and own welfare. Although different models have been introduced to measure the previous activities, most of them focused on accrual earnings management. These models suffer from shortcomings that can be mitigated by developing new models, paying more attention to measuring activities other than accrual earnings management, analysing more than one activity at a time, using more than one model to measure the same activity, and adopting qualitative methodology.

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Notes

  1. 1.

    The balance sheet approach calculates total accruals as the change in current assets (except cash items) minus the change in current liabilities (except the current portion of long term debt) minus depreciation. On the other hand, the cash-flow-statement-approach measures total accruals as the difference between earnings before extraordinary items and discontinued operations and the operating cash flows. Hribar and Collins (2002) document that the cash flow statement approach is more reliable.

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  1. Accounting and Finance Division, Leeds University Business School, Leeds, UK

    Malek El Diri

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El Diri, M. (2018). Definitions, Activities, and Measurement of Earnings Management. In: Introduction to Earnings Management. Springer, Cham. https://doi.org/10.1007/978-3-319-62686-4_2

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