The Construct Surrounding Earnings Management Research Paper

The Construct Surrounding Earnings Management - Research Paper Example There are two types of intentional misstatements which are significant in the auditor’s assessment of fraud. These are (1) misstatements that arise from fraudulent financial reporting, and (2) misstatements that arise from the misappropriation of assets. Classified under the first type are those intentionally false and misleading statements or the omissions of amounts or disclosures that should be included in financial statements. Included in the second type are acts that constitute theft of an entity’s assets which are attended with misrepresentation thereof in the financial statements. Misappropriation of assets includes such acts as ‘embezzling receipts, stealing assets, or causing an entity to pay for goods or services not received’.There are situations where a fine line may be drawn between earnings management motivated by a desire to mislead or misrepresent, and a legitimate resort to management prerogative is being made. As noted by the official docu ment from the Public Oversight Board (2002), in par. 3.10:â€Å"Many of the factors cited in SAS No. 82 are subjective and difficult to assess, and risk factors may exist in circumstances where fraud does not exist. Even when risk factors are present and the auditor’s response to them is not definitively prescribed by the standard, SAS No. 82 states that ‘the auditor’s judgment may be that audit procedures otherwise planned are sufficient to respond to the risk factors.†.... As noted by the official document from the Public Oversight Board (2002), in par. 3.10: â€Å"Many of the factors cited in SAS No. 82 are subjective and difficult to assess, and risk factors may exist in circumstances where fraud does not exist. Even when risk factors are present and the auditor’s response to them is not definitively prescribed by the standard, SAS No. 82 states that ‘the auditor’s judgment may be that audit procedures otherwise planned are sufficient to respond to the risk factors.† (p. 76). Thus it is important to assess whether the actions that may be attribute to earnings management are actually motivated by the intent to defraud, mislead or misrepresent. In this matter, the auditor is admonished to exercise professional skepticism as the general standard of due professional care. This means ‘having an attitude that includes a questioning mind and a critical assessment of audit evidence’ (par. 3.8, p. 76). The standard requ ires the auditor to take a position that does not assume the management is dishonest on the one extreme, nor that the management possesses unquestioned honesty on the other, but that the auditor should be persuaded by the evidence unearthed by his or her investigation (Public Oversight Board, 2002).. The Motivation behind Earnings Management The foregoing definition notwithstanding, some authors defend some of the actions of corporate management by distinguishing between ‘good earnings management’ from ‘bad earnings management’ (Farag & Elias, 2012, p. 187). Ostensibly, good earnings management implies legitimate business decisions, which effectively stabilized the financial performance of the company, while bad earnings management involves violations of the GAAP. Good