Managing earnings is a vital aspect of both the perceived and real performance of businesses in contemporary society. Managers in an organization have a duty and an obligation to ensure financial statements are prepared in an ethical, legal and professional manner. Since financial statements are applied in short-term and long-term decision-making by entities inside and outside the organization, it is vital for earnings to be ethical managed. An article published almost three decades in 1990 in the Management Accounting illustrated that managers and leaders in an organization often adopted different moral standpoints in pursuit of achieving their projected numbers. The paper probes into the five generalizations from the study and proceeds to show the ethics of managing earning depends on many factors including the effects, time-period, and method utilized. The article argues it is ethical to manage earnings when the intention is to create value for the organization rather than mislead the stakeholders.
To put the generalizations from the study into context, it is crucial to understand earnings management. Earning management describes the purposeful intervention in the external financial report process to achieve a particular desired outcome. Therefore, it encompasses managers using judgment in financial reporting to meet specific numbers. One generalization from the study illustrates that the respondents perceived the management of short-term earning by accounting techniques as less acceptable than accomplishing the same ends through manipulating the operating decision (Berry, 2012). The observation implies that many are open to manipulating operating decisions to achieve the desired numbers rather than blatantly managing the earnings. This might be so for individuals who have reservations that deliberately manipulating the earnings is self-serving, misleading and analogous to fraudulent financial reporting as compared to managing operating decisions which can be argued it is done in the interest of the organization.
Another generalization from the study asserts that increasing earnings is often considered more harshly compared to reducing earning. Financial statements are usually prepared for the organization’s stakeholders to facilitate decision-making. Therefore, increasing the numbers often is a bigger lie since it gives the impression that the business is doing well which is not the case and in fact, the actual values reflect poorly on the managers. Therefore, increasing numbers to no small extent gives the impression that the managers are merely concentrating on protecting their interests rather than the company (Berry, 2012). Moreover, according to the study, materiality matters in the sense that earnings management with significant effects is frowned upon more compared to those with small results.
Indeed, the concept of a lie grows more pronounced when the management of earnings encompasses significant manipulations since it is unlikely the business will achieve the numbers in the next financial period and might as such change the short-term earning management to long-term (Berry, 2012). Indeed, the same idea is emphasized in one generalization from the study which claims managing short quarterly reports is more acceptable compared to doing so in the annual reporting. Apart from the amount and the time, the technique applied in managing matters. For instance, selling excess assets or using overtime to increase shipments is more acceptable compared manipulating numbers by offering extended credit terms. Therefore, it is evident what is considered depends on how much the managers apply their discretion.
While the deliberate manipulation of earnings is considered as misleading at one end of the spectrum, the US Generally Accepted Accounting Principles (GAAP) allows for managerial discretion in reporting and subsequently decision-making. Managers who consider and manage earnings to effectively manage the business as such not only capable but also competent in managing to earn in the long-term. However, in the event short-term management of earning is utilized to hide the actual numbers and such operating performance, it works to mislead the stakeholders and as such bad for both short and long-term performance of the business. Therefore, in cases where earnings management adds to the value of the organization, for instance when used to reduce the impression of a business aggressive or when used to motivate employees, it is considered more ethical and a good impression on managers’ ability in long-term decision-making compared to when it is done with the intention of misleading shareholders.
Berry, A. (2012). Introduction to financial statements and other financial reporting topics. Cengage Learning. cited from Management Accounting.