earnings management’ refers to a set of manipulative accounting techniques that are used to

artificially improve a company’s financial picture during a specific period of time. The field of
accounting requires company executives to follow a set of principles and rules when compiling
financial statements. However, there are some areas in accounting where the company must make
judgment calls on how things are handled.

The techniques involved in earnings management are used to generate financial reports that
exaggerate a company’s performance. They accomplish this by inflating profits, minimizing expenses,
or changing the timing of when expenses are recorded. In short, earnings management is an
unethical set of accounting practices that do not provide an accurate picture of a company’s
financial position. As such, accountants should avoid these methods at all times.

The companies use earnings management techniques to make their financial picture seem more
profitable than it actually is. These techniques can also be used to flatten extreme fluctuations in
expenses or profits.

the overall intent of earnings management is to appease investors. Investors can become alarmed
when they see fluctuations in a company’s performance. By reducing these fluctuations, earnings
management can inspire investor confidence and drive stock prices up

MOTIVES

Managers with earnings-based compensation contracts tend to adopt income-increasing accounting

to increase earnings. When earnings drop below the lower bound or rise above the upper bound
designated by the bonus plan, managers may be inclined to select income-decreasing accounting
methods. This issue is discussed in two theories. Opportunist theory assumes that managers act with
short-term self-interest motivation and use loopholes such as the flexibility of accounting standards
to manage earnings .Management compensation theory, which is also known as the bonus plan
hypothesis, contends that managers are motivated to use earnings management to improve
compensation because management bonuses are often tied to firm earnings . managers are keen on
maintaining earnings growth because of their effects on stock prices and because their
compensations are often tied to firm earnings. earnings may not fully reflect the long-term
implications of recent executive decisions.

Tax avoidance is one of the motivations of earnings management. companies on one side do profit
manipulation through earnings management, on the other side prevent benefits from outflowing by
reduce tax expense. But for companies that have long-term good business performance, the primary
issue faced is further development when tax expense is not a critical restriction factor. At that time,
the influence of capital market motivation, contract motivation and political motivation exceed tax
avoidance motivation in business decision-making. Then it weakens the tax avoidance motivation in
earnings management. This yield Good operating performance weakens the tax avoidance
motivation. For some other listed companies, implementation of tax avoidance, as an “edge
behavior”, is risky. But when facing bad business performance, enterprises have strong tax-
avoidance motivation in order to survive. Hence, for listed-companies lack of government support,
the business performance holds a greater influence on tax-avoidance motivation. This yields The
relation between government and enterprises weaken the relation of earnings management and tax
avoidance.

Regulatory Motivations

Regulatory incentives are used to manage earnings when reported earnings influence the actions of
regulators or government officials. Earnings management may help managers influence the actions
of regulators or government officials, thereby minimizing political scrutiny and the effects of
regulation. For example, some industries such as insurance, banking, and utility industries, are
monitored for compliance with regulations linked to accounting figures and ratios. These industries
are often subject to requirements to ensure that they have sufficient assets or capital to meet their
financial obligations. These regulations may motivate managers to use earnings management to
meet requirements.

Cookie Jar Accounting Practices

The rules of accounting stipulate that companies record associated future expenses at the time that
the revenue is earned. A product that comes with a warranty is a prime opportunity to engage in
‘cookie jar accounting.’ If the cost of honoring the warranty is omitted when the revenue is earned,
the profits during that period end up being skewed.

There are other instances when a company can shift earnings from the current fiscal period to future
times. No matter what method of ‘cookie jar accounting’ a company uses, it’s unethical because it
presents a false picture of its performance.

. Switching Up Accounting Methods

A company can switch from one type of reporting to another – to one that paints a better financial
picture during a specific period. This can include the method the company uses to calculate the
value of its inventory and the depreciation schedule it uses for cash assets.

Over an extended period, these varying methods will typically produce identical results. However,
the accounting method a company uses can have a substantial impact on its earnings during a
specific period. There are times when a company changes its accounting methods for legitimate
reasons, but when it’s done to give an inaccurate picture of performance, it’s simply unethical
earnings management.

Big bath techinique

A big bath is an accounting term that is defined by a company's management

team knowingly manipulating its income statement to make poor results look
even worse in order to make future results appear better. It is often
implemented in a relatively bad year so that a company can enhance the next
year's earnings in an artificial manner.