Management and Its Implications
Educating the Accounting Profession
D. Akers, Don E. Giacomino, and Jodi L. Bellovary
- In the wake of continuing, highly publicized financial frauds
and failures, the accounting profession has placed renewed emphasis
on issues related to earnings management and earnings quality. The
SEC and the public are demanding greater assurance about the quality
of earnings. Staff Accounting Bulletin (SAB) 101, Revenue Recognition
in Financial Statements, which was issued in December 1999
in response to the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) report, illustrates the importance of
earnings to the SEC.
the August 1990 Management Accounting, William J. Bruns,
Jr., and Kenneth A. Merchant reported the results of their survey
of the readership of the Harvard Business Review (HBR).
That survey described 13 earnings-management situations that the
authors had directly or indirectly observed, and asked HBR readers
to rate the acceptability of those practices. Characterizing the
results as “frightening,” they observed the following:
that if a practice is not explicitly prohibited or is only a
slight deviation from rules, it is an ethical practice regardless
of who might be affected either by the practice or the information
that flows from it. This means that anyone who uses information
on short-term earnings is vulnerable to misinterpretation, manipulation,
or deliberate deception.
no doubt that short-term earnings are being managed in many,
if not all companies. Some of these earnings-management practices
can be properly labeled as immoral and unethical.
the Bruns and Merchant study, researchers and accounting professionals
paid little attention to the morality of short-term earnings management.
Despite the increased research in this area during the past five
years, there appears to be little evidence that the accounting
profession is educating accountants about earnings management.
Therefore, the authors decided to conduct a study to determine
the extent to which public accounting organizations have addressed
the issue of earnings management through training and continuing
does not try to manipulate earnings, there is a positive effect
on earnings quality. The earnings data is more reliable because
management is not influencing or manipulating earnings by changing
accounting methods, recognizing one-time items, or deferring expenses
or accelerating revenues to bring about desired short-term earnings
results. The absence of earnings management does not, however,
guarantee high earnings quality. This is true because some information
or events that affect future earnings may not (and cannot) be
disclosed in the financial statements. Thus, the concept of earnings
management is related to the concept of earnings quality. The
authors’ definition of earnings management is as follows:
management is recognized as attempts by management to influence
or manipulate reported earnings by using specific accounting
methods (or changing methods), recognizing one-time non-recurring
items, deferring or accelerating expense or revenue transactions,
or using other methods designed to influence short-term earnings.
The SEC and
the public are demanding greater assurance about the quality of
earnings. The first step is to use a definition of earnings quality
that meets the objectives of FASB. One major objective of the
FASB Conceptual Framework is to assist investors and creditors
in making investing and lending decisions. The Conceptual Framework
refers not only to the reliability (or truthfulness) of financial
statements, but also to the relevance and predictive value of
information presented in financial statements. The authors’
definition of earnings quality takes into consideration those
two characteristics of earnings:
quality is a measure of the ability of reported earnings to
reflect the firm’s true earnings and to help predict future
Is the accounting
profession responding to the practice of short-term earnings management
through greater education? The authors identified existing educational
and training efforts by accounting firms, as well as those offered
by state and national accounting organizations. The authors also
conducted a survey of the top 100 accounting firms to determine
the extent to which these firms provide formal training on earnings
management, and discuss the implications for academia and the
On the academic
side of the profession, the American Accounting Association (the
primary academic accounting group) made the quality of earnings
its main theme at its 2002 annual meeting. In turn, academic journals
have invited and published recent research on earnings management.
Except for the study by Bruns and Merchant more than 15 years
ago, there is little evidence of studies that focus on earnings
management through 2000. Since then, however, several studies
have examined ethics and financial statement fraud. Recently,
many universities, some with assistance from the Association of
Certified Fraud Examiners, have begun to offer courses on fraud
examination. See www.larry-adams.com/university_fraud_courses.htm
for a listing of fraud examination courses and degrees offered
by various universities.
public accounting firms (including a Big Four firm) were contacted
by the authors to determine the extent of training on earnings
management for their employees. Neither firm provides training
to its employees on earnings management. One firm indicated that
earnings management would fall under the topic of professional
authors reviewed the continuing education courses offered by each
of the state CPA societies (including Washington, D.C.) and the
AICPA. Of the 52 organizations, 34 do not offer courses that focus
on earnings management. The other 18 offer only eight courses
that have some relevance to earnings management topics. Three
of those courses focus on revenue recognition, three cover ethics
in a broad form, one covers disclosures, and one forensic accounting.
Only the revenue recognition courses emphasize earnings management,
and only two of the courses are covered by more than two organizations.
1 identifies the state societies that offer courses related
to earnings management. The titles and descriptions of those courses
are as follows:
Accounting and Revenue Recognition Techniques—Recognizing
the Warning Signs” (offered by eight organizations).
This program emphasizes revenue recognition and discusses other
GAAP requirements and how they were violated or grossly misrepresented
by companies and their outside CPAs. More than 40 high-profile
cases are reviewed, including Parmalat, WorldCom, and Waste Management.
Emphasis is on how this relates to privately held companies.
Key to Financial Statements” (offered by New
Jersey). This program reviews the “bread and butter”
disclosures and helps participants keep current on new reporting
trends and requirements. Special emphasis is given to related-party
transactions, changes to loans and trade receivables, goodwill
and intangibles, guarantees and discontinued operations, impairments,
and cash flow disclosures. This program does not discuss SEC requirements.
Also covered are common disclosure deficiencies noted in practice
and in peer reviews; related-party transactions; and recent changes
in buy-sell agreements, guarantees, variable interest entities,
leases, contingencies, risks and uncertainties, accounting policies,
liabilities (debt violations impact classification), deferred
taxes, and income statement presentation; and changes in discontinued
operations, other categories of earnings, and cash flow statements.
in Today’s Environment for Louisiana CPAs” (offered
by Louisiana). This course provides case studies drawn from actual
litigation and administrative proceedings involving CPAs in public
practice and industry. It takes a proactive, risk-avoidance stance
by pointing out common pitfalls and presenting alternative courses
of action. The course explores ethical issues in the context of
proceedings that were resolved both in favor of and against accounting
and auditing professionals.
uses real-world accounting and auditing cases that deal with management
integrity and professional responsibilities in relation to key
business topics such as off–balance sheet financing, related-party
transactions, revenue recognition, materiality, loan and lease
loss reserves, restructuring charges, and independence. The course
identifies pitfalls faced by every financial professional and
attempts to effect a heightened sensitivity for the types of ethical
dilemmas one might face.
Accounting: Fraudulent Reporting and Concealed Assets” (offered
by two organizations). This course focuses on identifying common
forensic techniques to recognize fraud schemes and scams. Participants
learn to sharpen their forensic skills through the use of analytical
tools, and learn to follow cash flows and uncover accounting schemes.
This course’s objectives are to learn common forensic techniques
to recognize schemes and scams and detect fraud through the use
of analytical tools and other techniques.
2005 Hot Topics” (offered by two organizations).
This course is an update on the environment in which people commit
fraud, theft, or embezzlement, or enter into kickback and corruption
schemes. It covers the newest techniques and regulatory requirements,
including audit standards and Statements on Standards for Accounting
and Review Services (SSARS). Topics include: 1) how new state-level
rules and regulations apply to firms, small and midsize businesses,
and government entities and nonprofits, including new independence
rules for nonattest work; 2) the four ways employees cheat on
their travel and entertainment (T&E) reports; 3) current cases
against CPA firms and companies—who’s winning and
who’s losing; 4) why principled managers bend company rules;
5) seven industries under assault for fraud; 6) most-recent guidance
on audits of privately held companies; 7) recognizing when “adjusting”
the numbers becomes fraud, and learning to spot little numbers
that are material; and 8) how the AICPA and the FBI are working
together to stop fraud.
World Business Ethics: How Will You React?”
(offered by eight organizations). This course provides case studies
drawn from litigation and administrative proceedings involving
CPAs in public practice and industry. The course identifies common
pitfalls, and presents alternative courses of action. It also
explores ethical issues in the context of actual proceedings that
were resolved both in favor of and against accounting and auditing
professionals. The course uses real-world accounting and auditing
cases that deal with management integrity and professional responsibilities
in relation to topics such as off–balance sheet financing,
related-party transactions, revenue recognition, materiality,
loan and lease loss reserves, restructuring charges, and independence.
Recognition: Guidance, Implementation, and Fraud Concerns”
(offered by the AICPA). In its October 2002 “Report on Financial
Statement Restatement,” the General Accounting Office (GAO)
concluded that almost 38% of the 919 announced restatements between
1997 and June 2002 involved revenue recognition and that revenue
recognition was the primary reason for restatements each year.
Moreover, more than 50% of the immediate market losses following
restatements were attributable to revenue recognition–related
restatements and approximately 50% of the SEC’s enforcement
cases involved revenue recognition issues.
provides an overview of the relevant accounting literature and
the information needed to implement the authoritative guidance.
The course covers techniques for examining bill-and-hold sales,
consignment sales, and refund rights, and shows proper presentation
of revenue as gross or net on the statement of operations. The
course considers revenue recognition of nonmonetary and “round-trip”
transactions that have drawn the attention of the SEC. Finally,
the course covers multiple-element arrangements, when entities
bundle products, or products with services, to provide more complete
solutions to their customers, another area in which FASB’s
Emerging Issues Task Force (EITF) has provided guidance.
objectives are to: 1) identify situations where aggressive revenue-recognition
issues may exist, including recognizing revenue prematurely, recognizing
revenue that may not be earned, reporting sales to fictitious
or nonexistent customers, sales to related parties, and nonmonetary
exchanges; and 2) identify the differences between aggressive
accounting and financial fraud and the point at which aggressive
accounting practices become fraudulent.
Recognition in Today’s Business Climate”
(offered by three organizations). Revenue-recognition guidance
exists throughout the accounting literature, accounting and audit
guides, and audit risk alerts for specific industries, as well
as SAB 104. Yet there is no one comprehensive source. This course
reviews the current literature, looks at the implications of premature
recognition and unique revenue-recognition issues of specialized
industries, and examines current FASB projects and the impact
they will have on financial statements.
objectives are to: 1) understand the implications of faulty revenue-
recognition; 2) make appropriate revenue recognition decisions;
3) deal with unique revenue-recognition issues in specialized
industries; and 4) increase awareness of revenue-recognition developments
in the profession, such as activities of FASB and the IASB.
of the Top 100 Accounting Firms
the grave threat that abusive earnings-management practices pose
to the reliability and accuracy of financial statements, the accounting
profession may be reluctant to address this issue. Therefore,
to evaluate how, if at all, the profession has responded to the
dangers posed by earnings management, the authors surveyed the
top 100 accounting firms (from Accounting Today, “Top
100 Firms, 2005 Merger Marathon”). The results suggest that
most accounting firms do not address the topic of earnings management,
directly or indirectly, with training courses.
was directed toward abusive earnings-management practices and
defined earnings management as “[the] misapplication of
generally accepted accounting principles to actively manipulate
earnings towards a predetermined target for purposes of creating
an altered impression of business performance.” It sought
to collect data on whether the top accounting firms address abusive
earnings management through training or education and asked whether
firms have training courses specifically focusing on earnings
management. If not, the survey asked whether firms handled this
topic as part of other training courses.
indicate that accounting firms are doing little to address earnings
management. Of the 100 accounting firms surveyed, 17 responded.
Of these, only three reported having training courses specifically
addressing earnings management. Five firms reported that earnings
management was addressed within the context of other training
courses, but did not devote a specific course. Nine firms, more
than half of the respondents, reported not providing any training
courses that address earnings management. Less than 20% of responding
firms claimed to have training classes principally designed to
educate employees about earnings management. About 30% of responding
firms tangentially address this issue as part of other training
courses but do not devote a specific course to the subject. More
surprisingly, over 50% of responding firms do not address the
topic of earnings management in any training, directly or indirectly.
2 for a breakdown of responses.
3 provides descriptions of other courses that directly or
indirectly address earnings management. Three firms reported having
training classes designed to address earnings management. Only
one of these courses, “The Recording of Income,” is
narrowly tailored to earnings management and seems to adequately
address the subject. The course discusses how revenue and income
are recorded across various industries and how these figures can
be manipulated. It is directed toward junior staff, seniors, managers,
and partners, and utilizes small group discussions to share practical
experience on earnings management. The other two courses are primarily
directed toward asset allocation and financial planning, rather
than educating employees on earnings management and identifying
reported providing training that indirectly educates employees
with regard to earnings management. Two of these firms covered
earnings management in annual review or annual update courses.
One firm addressed the topic in ethics and financial reporting
classes by using material obtained from continuing education vendors.
The remaining two firms identified earnings management as a topic
to be aware of.
responses to this survey, it appears that very few of the top
100 accounting firms are training their employees in identifying
earnings management abuses. These results are further evidence
that accounting firms are not doing enough to address this problem,
and support former SEC Chairman Arthur Levitt’s call for
a cultural change among corporate management, Wall Street, and
for Academia and the Accounting Profession
is evidence that accounting educators are attempting to make accounting
students aware of abusive earnings- management practices, further
efforts are needed by state societies and public accounting firms
to better equip CPAs with the tools necessary to identify earnings-
management techniques. Education could help to reduce the expectations
gap between auditors and financial statement users. Robinson-Backmon
and Finney (Research on Accounting Ethics 1999, 5: 77-93)
found that most firms that fraudulently misstated earnings through
earnings management had employed Big Five public accounting firms
as their auditors. Business and professional publications could
educate their readers by publishing articles on how to detect
and deter earnings management schemes.
argue that auditors are in the best position to assess a firm’s
earnings quality because of their familiarity with GAAP, the client’s
controls, and its business practices. Consequently, researchers
have proposed that auditors prepare a “quality of earnings
report” on the income statement.
being done by the profession to educate CPAs about earnings management,
despite the SEC’s efforts to crack down on this type of
abuse. The public accounting profession needs to take a proactive
approach. Auditors can’t be expected to identify these schemes
without training on how they are perpetrated.
D. Akers, PhD, CPA, CMA, CFE, CIA, CBM, is a professor
and chair of the department of accounting, and the Charles T. Horngren
Professor of Accounting, in the college of business administration,
Marquette University, Milwaukee, Wisc. Don E. Giacomino,
PhD, CPA, is a professor and the Donald E. &
Beverly L. Flynn Chair Holder in the department of accounting,
also at Marquette University.
Jodi L. Bellovary, MSA, CPA, is a PhD candidate
at the University of Wisconsin–Madison.