The easy money days of the 2010s are over. Bonuses and threats of job loss push managers to match expectations. Earnings management techniques are not always “cooking the books” to reach short term targets. Rather, they can involve making valid operational decisions that benefit shareholders.  

By Mark D. Harris

Earnings Management Techniques

Managers are under intense pressure to make quarterly and annual earnings conform to expectations of analysts in the greater market. In a given quarter, if the prevailing expectation is that Company A will have earnings of $10/share (EPS), management at Company A wants to report EPS of $10, or perhaps $10.03. They don’t want to report EPS of $11.50 because that might raise eyebrows, encourage a much higher expectation of EPS in the future, and suggest a volatile earnings pattern. Investors and lenders like smooth growth in EPS, sustainable and predictable, over the long haul.

Even worse than exceeding expectations by too much is falling short. If Company A falls short of earnings targets, reporting perhaps EPS of $9.80, Company A’s stock price is likely to drop, their cost of capital from lenders will increase, and others interested in Company A might liquidate holdings out of fear for the company’s future. Finally, managers’ bonuses, salaries, and even job security are often tied to meeting earnings targets. Woe to the manager who misses his mark.

To avoid such unpleasant circumstances, managers have an array of accounting techniques that they can use to smooth earnings, and to make them appear sustainable and predictable in the near and long term.

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