Introduction to financial statements

¶ … generalizations in this study with relating to managing earnings. One is that there is no consensus with respect to what precisely constitutes unethical or ethical behavior. The managers in the survey were not unanimous on any single question. Another generalization is that managing earnings via accounting methods is less acceptable than doing the same through management methods. A third generalization is that the direction of earnings movement as a result of the action matters. Actions that were deemed to have a negative effect on earning were considered to be more ethically acceptable than actions that did not have a negative effect.

A fourth generalization is that managing earnings by deferring discretionary expenditures to the next period is generally ethical. This is a broad generalization, since there is some disagreement on this subject. A fifth generalization is that increasing short-term earnings to meet a budget target is usually considered ethical, except to offer special credit terms to siphon sales from the following period.

These generalizations provide insight into why the ethics of financial accounting is so complex. Even within the confines of GAAP, there is significant leeway for managers to manage the earnings of a company. Ethics, then, are truly in the eye of the beholder. In those areas where there is broad consensus, the ethics of the situation could be implied but for the most part the generalizations are fairly general -- there is significant room for interpretation.

In the long-run, managers have less room to influence the financial accounting. Many of the techniques to influence earnings are best used in short-term scenarios. Managers can push earnings and expenditures from one quarter to the next without major disruption of the firm's operations or finances, but over the long run this is a difficult feat to achieve. It is simply not reasonable for a manager to push the sale of a surplus asset back by multiple years.

However, managers can influence earnings through their choice of accounting policies. While the choice of policies is allowable under GAAP, when different companies in the same industry use different policies, this can reduce the degree of comparability between the statements, negating one of the key benefits of having the GAAP system.

Ultimately, management does hold the power to influence how the firm conducts its financial accounting. In addition to dictating the type of accounting policies the firm has, management also creates the ethical culture of the firm. Most of the cases of accounting fraud in the past decade were heavily influenced by the ethical culture that management created. The results -- notably in firms like Tyco or Enron -- have been grossly inflated earnings. However, while one does not expect to see examples so egregious with any frequency, more subtle examples can occur.