A Review of the Earnings Management Literature

A Review of the Earnings Management Literature

By

Bahari Mohamed

Introduction

Company fail does not occur overnight and is the result of bad business practices that occurred many years before the company formally collapsed. It is possible; the management may be making poor decisions for example undertaking a disastrous takeover that can propagate the seeds for failure. In addition, companies may be earnings inadequate profits and may cover these deficiencies by adopting earnings management. Pressures such as the possible sacking of the CEO who is answerable for the inadequate profits may lead to the company adopting earnings management to camouflage these problems. The continued use of earnings management cannot be sustained and eventually lead to failure.

According to Mangos and Lewis, (1995) and Guan et al. (2005), accounting practices or accounting values are affected by cultural and social values. Different accounting values result in different choices of accounting accruals (earnings management). For example, countries with high degree of Conservatism may choose income decreasing accounting accruals more often than those with low degree of Conservatism. On the other hand, if a country is classified high in Secrecy, then accounting information system would provide a greater chance for earnings management. Guan et al. (2005) conducted a study on earnings management in five countries of the Asia-Pacific region: Australia, Japan, Hong Kong, Malaysia and Singapore. They found that cultural values have a significant effect on earnings management.

What is earnings management?

Earnings management and sometime called creative accounting are two words referring to accounting practices that may or may not follow the rules of standard accounting practices but certainly diverge from the spirit of those rules. They are characterized by excessive complication and the use of different ways of characterizing income, assets or liabilities. Sometimes terms...