Earnings management consists of both legitimate and less legitimate decisions by manager to chang... more Earnings management consists of both legitimate and less legitimate decisions by manager to change real actions or accounting policies so as to make their earnings smooth or accomplish their specific objectives in accounting report. Usually, managers take advantage of different methods to manage their earnings. For example, managers apply the specific patterns according to their objectives or the temporal economic condition – that is, to avoid loss, increase annual earnings and meet analysts' earnings forecasts. According to Scott (2015), there are four main patterns of earnings management conducted by managers: taking a bath, income minimization, income maximization, and income smoothing. In this paper, the pattern of income smoothing will be extended and enhanced since it has been considered as most popular method nowadays. Taking a Bath pattern mainly being used during the period of corporate reorganization or organizational stress. In taking a bath, if a firm must report its loss, managers may feel it better to report a larger loss in current accounting report, because it will help company present the expected future cost and generally " cleaning the deck ". Henry and Schmitt (2001) mentioned that a company need to report a large non-recurring loss in current year in order to make future earnings not burdened, especially when its profits are already disappointed. This practice will also reduce the variability of firms' future earnings or make its future earnings perform better. So the meaning of taking bath is, when the company earning is already depressed (i.e., bad profit), the managers need to make their firm's earning worse by clearing out the rubbish which will be harmful to the company's reputations and their management ability/capacity. Due to accrual reversal, taking a bath can effectively make the probability of future reported profits better, moreover, the market's competition will push a company relatively the same whether it loss its earnings by a lot or by a little. The next pattern is Income Minimization which consists of rapid write-offs of capital, expensing A&P, research & development expenditures and intangible assets according to accounting policies. This pattern is very similar with taking a Bath, but compared with taking a bath, taking a path is less extreme. Managers mainly engage the pattern of Income minimization during periods of high profitability, the crisis and avoiding political costs, – that is, to avoid too many competitors entering and to safeguard company's reputation. Managers can usually take on income minimization especially when companies go through the periods of high profitability (Stolowy and Breton, 2004). If Companies have outstanding earning performance but do not want to attract public or political attention, income minimization will be a good excellent choice for their managers to avoiding their competitors. In addition, managers also want to manage their earnings continually upwards, this is another reason why their managers prefer to engage this pattern. According to Scott (2015), income maximization is conducted by managers to report net income for their bonus purpose. Besides, it can also present investors expected perspective for the firms' future and avoid the risk of debt covenant violations. Usually, managers have great incentives to make their company's earning perform better, because their compensation mainly depend on their company's expected values in the future. According to Healy and Wahlen (1999), if managers have ability to convince the firms have high value in the future, their bonus will therefore become great. Moreover, if a firm's report presents investors high earning performance, investors can place high incentive to invest this firm due to their high level expectation to this company's future earnings performance. Another incentive for companies to choose this pattern is to avoid debt covenant violation. As per Watts and Zimmerman (1990), when companies confront the threat of debt covenant violation, income minimization can protect the companies' healthy development. However, for making the over-reporting earning be credible signal of firm value, there must apply strict management of cost associated, otherwise, all firms would report the earning level as high as possible. Income smoothing is to level out net income fluctuations from one period to the next by using accounting techniques. Income smoothing techniques consist of delaying the recognition of expenses during in a difficult year due to the negative expected in the future or deferring revenue during a great year but the next year is expected to be a challenging one. Dye (1988) and Lambert (1984) noted that managers take advantage of income smoothing mainly on account of their smooth managerial
Earnings management consists of both legitimate and less legitimate decisions by manager to chang... more Earnings management consists of both legitimate and less legitimate decisions by manager to change real actions or accounting policies so as to make their earnings smooth or accomplish their specific objectives in accounting report. Usually, managers take advantage of different methods to manage their earnings. For example, managers apply the specific patterns according to their objectives or the temporal economic condition – that is, to avoid loss, increase annual earnings and meet analysts' earnings forecasts. According to Scott (2015), there are four main patterns of earnings management conducted by managers: taking a bath, income minimization, income maximization, and income smoothing. In this paper, the pattern of income smoothing will be extended and enhanced since it has been considered as most popular method nowadays. Taking a Bath pattern mainly being used during the period of corporate reorganization or organizational stress. In taking a bath, if a firm must report its loss, managers may feel it better to report a larger loss in current accounting report, because it will help company present the expected future cost and generally " cleaning the deck ". Henry and Schmitt (2001) mentioned that a company need to report a large non-recurring loss in current year in order to make future earnings not burdened, especially when its profits are already disappointed. This practice will also reduce the variability of firms' future earnings or make its future earnings perform better. So the meaning of taking bath is, when the company earning is already depressed (i.e., bad profit), the managers need to make their firm's earning worse by clearing out the rubbish which will be harmful to the company's reputations and their management ability/capacity. Due to accrual reversal, taking a bath can effectively make the probability of future reported profits better, moreover, the market's competition will push a company relatively the same whether it loss its earnings by a lot or by a little. The next pattern is Income Minimization which consists of rapid write-offs of capital, expensing A&P, research & development expenditures and intangible assets according to accounting policies. This pattern is very similar with taking a Bath, but compared with taking a bath, taking a path is less extreme. Managers mainly engage the pattern of Income minimization during periods of high profitability, the crisis and avoiding political costs, – that is, to avoid too many competitors entering and to safeguard company's reputation. Managers can usually take on income minimization especially when companies go through the periods of high profitability (Stolowy and Breton, 2004). If Companies have outstanding earning performance but do not want to attract public or political attention, income minimization will be a good excellent choice for their managers to avoiding their competitors. In addition, managers also want to manage their earnings continually upwards, this is another reason why their managers prefer to engage this pattern. According to Scott (2015), income maximization is conducted by managers to report net income for their bonus purpose. Besides, it can also present investors expected perspective for the firms' future and avoid the risk of debt covenant violations. Usually, managers have great incentives to make their company's earning perform better, because their compensation mainly depend on their company's expected values in the future. According to Healy and Wahlen (1999), if managers have ability to convince the firms have high value in the future, their bonus will therefore become great. Moreover, if a firm's report presents investors high earning performance, investors can place high incentive to invest this firm due to their high level expectation to this company's future earnings performance. Another incentive for companies to choose this pattern is to avoid debt covenant violation. As per Watts and Zimmerman (1990), when companies confront the threat of debt covenant violation, income minimization can protect the companies' healthy development. However, for making the over-reporting earning be credible signal of firm value, there must apply strict management of cost associated, otherwise, all firms would report the earning level as high as possible. Income smoothing is to level out net income fluctuations from one period to the next by using accounting techniques. Income smoothing techniques consist of delaying the recognition of expenses during in a difficult year due to the negative expected in the future or deferring revenue during a great year but the next year is expected to be a challenging one. Dye (1988) and Lambert (1984) noted that managers take advantage of income smoothing mainly on account of their smooth managerial
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