Revenue Recognition Assignment
Assignment: Review the exhibit and answer the following questions.
Motivations to Use Earnings to Misrepresent Economic Performance
Motivation
To influence stock price
Because there is outside pressure to hit earnings benchmarks
Because there is inside pressure to hit earnings benchmarks
To influence executive compensation
Senior managers fear adverse career consequences if they report poor performance
To avoid violation of debt covenants
Because there is pressure to smooth earnings
Because they believe such misrepresentation will likely go undetected
Because senior managers are overconfident or overoptimistic
To reduce expectations of future earning:
To influence other shareholders, such as customers, suppliers, and employees
Because they feel other companies misrepresent performance
Motivation for Companies to Use Earnings to Misrepresent Economic Performance
Source: Dichev, I, Graham, J Harvey, C and Rajgopal, S The misrepresentation of earnings, Financial Analysts Journal,
A The exhibit notes that one motivation for using earnings to misrepresent economic performance is to influence stock prices. Why is that motivation important to management?
B The exhibit notes that motivations of using earnings to misrepresent economic performance are due to both inside and outside pressure to hit the earnings benchmark. List two insider pressures and two outside pressures to hit certain earnings benchmarks and explain why.
C How is executive compensation affected by earnings levels and hitting earnings benchmarks? Is that a sufficient incentive for managing earnings?
D Which is more costly to a firm, intentional accruals manipulation or real earnings management? Why is it more costly
E List two ways to detect earnings misrepresentation.
