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    of 4

    DISCRETIONARY

    EXPENDITURES MODELS
    Professor Brian Bushee

    WHARTON ONLINE
    Discretionary Expenditures

    • Net Income = Cash Earnings + Non-cash Earnings


    • Managers can manipulate cash earnings by delaying or accelerating real
    expenditures, especially those that must be expensed immediately (i.e., not
    capitalized)
    – Research & Development
    – Advertising
    – Selling, General, & Administrative
    • Maintenance, training, travel, etc.
    • “Real Earnings Management” does not violate securities laws and is
    viewed by managers as more ethical
    – But, it must be done well in advance of the end of the period
    • Real Earnings Management is hard to detect
    • Did managers have a legitimate reason to delay expenditures due to performance?

    WHARTON ONLINE
    Model of Discretionary Expenditures

    • Normal expenditures are a function of last year’s expenditures, revenues,


    and growth
    • We’ll model change in expenditures (current year – prior year)
    – We’ll use prior year’s revenue growth and prior year’s revenue
    • Normal expenditures are budgeted based on prior year’s results
    • Using prior years ensures that model is not affected by current year sales manipulation
    • Everything is deflated by Prior Total Assets
    • Change in Expenditures =  + *Prior Sales Growth + *Prior Sales + 
    – Expenditures = SG&A Expense, R&D Expense, or Advertising Expense
    – Use industry-year regressions to get estimated a, b, and c parameters
    – Normal change in expense = a + b*Prior Sales Growth + c*Prior Sales
    • Discretionary Expenditures = Total Change in Expense – Normal Change in
    Expense

    WHARTON ONLINE
    WHARTON ONLINE

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