Chapter 2, Problem 12CRCT

Earnings Management [LO2] Companies often try to keep accounting earnings growing at a relatively steady pace, thereby avoiding large swings in earnings from period to period. They also try to meet earnings targets. To do so, they use a variety of tactics. The simplest way is to control the timing of accounting revenues and costs, which all firms can do to at least some extent. For example, if earnings are looking too low this quarter, then some accounting costs can be deferred until next quarter. This practice is called earnings management. It is common, and it raises a lot of questions. Why do firms do it? Why are firms even allowed to do it under GAAP? Is it ethical? What are the implications for cash flow and shareholder wealth?