Tag: earnings management

Do companies time changes in accounting estimates to meet analyst forecasts?

In this new paper by a group of academics from the University of Richmond (and elsewhere), the authors explore whether companies might be timing when they record changes in their accounting estimates (CAEs) to meet earnings benchmarks.  Because accounting estimates are “by their nature forward-looking, often subjective and difficult to quantify with precision,” they would seem to offer an excellent “opportunity for management to misrepresent the firm’s financial performance.” CAEs, the authors suggest, may be used to meet or beat earnings benchmarks or, alternatively, to smooth earnings or take a “big bath” when the current period’s earnings are particularly low.  For purposes of the study, the authors assumed that “most CAEs are fully justified and reasonable, and the ‘manipulation’ stems primarily from their timing, not the nature or appropriateness of the CAEs themselves.”  The study concludes, particularly with respect to analyst forecast earnings, that companies do indeed “appear to time CAEs to meet earnings benchmarks or achieve other reporting objectives.”  It’s worth noting that the SEC has recently brought charges in a couple of cases involving earnings or expense management (see this PubCo post and this PubCo post), so violations resulting from earnings management practices appear to be a focus for Enforcement.

SEC charges healthcare services company engaged in earnings management

Yesterday, the SEC announced settled charges against Healthcare Services Group, Inc., a provider of housekeeping and other services to healthcare facilities, its CFO and its controller, for alleged failures to properly accrue and disclose litigation loss contingencies—accounting and disclosure violations that “enabled the company to report inflated quarterly [EPS] that met research analysts’ consensus estimates for multiple quarters.”  This action is the result of SEC Enforcement’s “EPS Initiative, which uses risk-based data analytics to uncover potential accounting and disclosure violations caused by, among other things, earnings management practices.” Gurbir Grewal, the new Director of Enforcement, warned that the SEC will continue to leverage its “in-house data analytic capabilities to identify improper accounting and disclosure practices that mask volatility in financial performance, and continue to hold public companies and their executives accountable for their violations.” The company paid $6 million to settle the action. The SEC Order makes the matter of accruing for loss contingencies sound simple and straightforward, implying that the company’s behavior involved “big bath” accounting and other earnings management practices, and that may well be the case in this instance.  However, in many cases, deciding whether, when and what to disclose or accrue for a loss contingency is not so clear cut and can often be a challenging exercise.

Studies examine external factors that may affect accounting integrity

Are there external factors that might lead companies to fail to protect the integrity of their financial statements, to put it euphemistically? Some recent articles in CFO.com discuss studies that posit various theories.

Study shows financial restatements are “handbooks of trickery” for copycat peer companies

by Cydney Posner No, it’s not from The Onion.  According to a study reported in CFO.com,  unless the restating company faces regulatory action or shareholder litigation, the company’s competitors may use its financial restatement as a how-to guide.  The study found that, instead of driving peer companies to examine their […]