The modern business environment is defined by increased technological advancement as well as market competitiveness, where emphasis on future outcomes dominates an organization’s everyday operational activities, towards enhancing ultimate firm and shareholder value creation. As such, management of finances and associated records represents one of the major tasks that must be accomplished towards firm goal accomplishment even though some of the practices such as income smoothing and earnings management present various challenges. Fundamentally, income smoothing involves utilization of varied accounting techniques in the management and overall reduction of a firm’s earnings fluctuations, from year to year, a practice that may represent fraudulent financial reporting or good business practice. On the other hand, earnings management entails presentation of financial results that reflect an excessively positive picture of a firm’s financial stability and position and/or its operations, which also may be directed towards addressing potential fluctuations of a firm’s earnings.
The two concepts are basically the same as they involve misrepresentation of financial results, for whatever reason that may motivate engagement in the practices, considering that investors make vital decisions on the basis of such information. These practices are generally legal and enabled through managerial discretion where accounting regulations may allow some form of flexibility in interpretation and hence the actual application of those rules, making it difficult to appreciate distinctions in relation to fraudulent manipulation of firm earnings. When informed and based on comprehensive market research and the actualization of positive, projected future outcomes, these practices can have positive outcomes such as minimized firm risk, enhanced debt management as well as firm value and low share-price volatility, among other benefits. However, these practices are considered unethical especially when outcomes are biased towards enriching individuals at the expense of the firm and also because they deliberately deceive investors, among other vital firm stakeholders whose decisions may garner adverse outcomes.
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"Income Smoothing and Earnings Management".
Furthermore, regulations and codes on corporate governance, which borrow heavily from universal moral and ethical principles, basically provide that accurate and timely disclosure on all firm activities, especially on financial aspects, be done in a transparent manner. The penalties that exist for individuals convicted of certifying fraudulent financial statements include imprisonment for a period of ten years or $1,000,000, or less for both penalties, while for deliberate or willful certification, involves 20 years imprisonment or $5,000,000 or even both penalties, in each case. These penalties were ushered through the regulations set out in the Sarbanes-Oxley Act of 2002 after serious accounting scandals such as the Enron, WorldCom and One-Tel scandals, brought to light the potential destruction that such scandals could have on national economy. The prosecution of various Enron employees including Jeffrey Skilling, Kenneth Lay, Rick Causey, Michael Kopper and Fastow, among others, for varied counts of financial fraud ranging at 2-45 years imprisonment, highlights the seriousness of manipulation or misrepresentation of financial information.
Conclusion
The highly negative outcomes brought about by practices similar to ‘smart bookkeeping or creative accounting’ such as income smoothing and earnings management basically imply that they must be eliminated not only for the good of the company but also for the industry and the nation in general. The solution to these practices should entail review of auditing and accounting principles and initiation of changes that reflect better regulation and stricter sanctions as well as a mandatory semi-annual government or external financial audit. Middle management as well as government representatives, as part of a new transparent corporate governance structure, should also be made privy to all relevant accounting information done in internal and external audits. This incorporation of varied and vital stakeholders as well as implementation of stricter regulations, will serve to enhance transparency and subsequent accountability in consideration to good corporate governance, serving as a firm foundation that discourages unethical behavior.
