The Portfolio Project requires you to write a memorandum to a decision-maker, such as the president of the United States, a member of Congress, a chairperson of the SEC, or a state Governor, on how to...

Memorandum
To: The Chairman, Securities and Exchange Commission
From:
Date: 28-Feb-13
Sir,
Sub: Policies towards preventing the lapses of Corporate Ethics and Earning
Management.
Introduction
The memorandum analyzed and outlines various policies aimed towards preventing the
lapses of corporate ethics as well as earning management by companies. It throws light on the
need of precision in financial reporting and accounting with a view of highlighting earning
management by the companies. It often involves window dressing financial statements,
especially the bottom line earnings number. Earnings management can be cosmetic, where
managers manipulate accruals without any cash flow consequences. It can also be real, where
managers take actions with cash flows consequences for the purpose of managing earnings.
The later part of the memorandum analyzes different costing techniques that should be
used by the companies and various performance indicators used by the companies and analyst for
measuring the performance of the company internally as well as externally compared to the other
competitors in the market. The performance measurement methods will be discussed using the
identification of key success variables, ratio analysis and growth indictors of the company.
Increased precision in accounting has become a need of the time, a key to survival in the
long run. Cases like Enron and Anthon Anderson have always been questioning the financial
eporting standards set up and the requirement if precision in accounting. Many companies use
complicating accounting techniques to cover up their losses or window dress their revenues and
costs.
Earning Management
Earning management is the outcome of the accounting anomalies arising out of flexibility
in the implementation of accounting policies, estimates and procedures (Bhimani, 2006).
Earnings management can be defined as the “purposeful intervention by management in the
earnings determination process, usually to satisfy selfish objectives”. There are two types of
earning management techniques followed by companies:
Revenue Manipulation
Revenue manipulation is the most common type of earnings management. The sales
transaction is the pillar for recognition of revenue in the business and it is this figure that is
manipulates to inflate earnings. This is resorted to by any of the following practices:
1. Vendor Financing: It occurs when a company loans money to a customer to purchase
goods from the company. The result is an increase in sales revenue on the income
statement and an increase in notes receivable on the balance sheet.
2. Trade Loan or Channel Stuffing: In this form of manipulation, sales are recorded even
efore they are earned by shipping inventory to customers before the customer really
needs it.
3. Overstatement of Value of Accounts Receivables: Yet another form of manipulation is
overstating the amount of accounts receivables or understating the allowance for
uncollectable accounts. To overstate accounts receivables, the business increase the
volume of credit sales by granting more generous credit terms or by selling to customers
with lower credit quality (Bhimani, 2006).
4. Not Recognizing Rebates or Discounts: Not reducing the sales for the promised rebates is
another technique to increase revenues. To move inventory at the close of a quarters or
the year, a business may generate sales by offering substantial rebate opportunities. But
in the books revenues are recognized at full value of the sale, with no deduction for the
associated rebate resulting in inflated revenues.
Companies in service business also resort to managing revenues. Software support and
maintenance contracts, engineering updates, equipments and maintenance contracts and others
may indulge in the long term agreement between the service provider and the customer. In order
to increase revenues, a service provider may record as revenues the entire or a substantial portion
of the contract in the first year. It is very difficult for the user of the financial statement to
identify this practice of managed revenues.
Expense Manipulation
In accordance with GAAP, an expense is recognized whenever an assay is used or a liability
or created. Like revenue recognition,...