BUS304 Accounting Theory Case Study 9.1 Earnings Management Sample Singapore

For information and reference only – not to be submitted as your own work.

Introduction

This extract supports students on BUS304 Accounting Theory (Singapore campus, 2026 trimester) who are working on the group case study assignment, which is worth 20%. Groups are allocated one case from Rankin, Ferlauto, McGowan and Stanton (2023), Contemporary Issues in Accounting, 3rd edition. This sample covers Case Study 9.1, The ethics of earnings management. It follows the individual-part pattern of an introduction, a short synopsis and one extended answer on the ethics question.

The original assessment brief is available on our question page: BUS 304 Assignment: Strategic Analysis of Accounting Standards & Corporate Ethics.

The exact wording of the textbook questions is not reproduced here. Align the model answer below to your own copy of the case before you adapt any part of it. The original brief is not yet on our solved questions hub, and we will link it when it is live. For planning advice, read our post on how to write the ethics of earnings management case study.

The introduction in your own report should do three things in about 100 words: name the case and its issue, state the argument your group will make, and outline the order of the sections. Keep it free of citations you have not read.

Synopsis of the issue

Earnings management is the use of managerial judgement in financial reporting, or in structuring transactions, to change reported earnings. The purpose may be to mislead some stakeholders about underlying performance or to influence outcomes that depend on reported numbers (Healy and Wahlen, 1999). The ethical debate arises because many of these choices sit inside the rules. Management may stay within accounting standards yet still shape the picture users receive.

A synopsis of about 200 words should therefore cover four points drawn from the case text: who the decision makers are, what reporting choice or transaction is involved, which stakeholders rely on the numbers, and what tension the case raises between legal compliance and fair presentation. Do not add facts that the case does not state. If the textbook leaves a detail open, say so and treat it as an assumption.

Model answer: is earnings management ethical?

The ethics question is best answered by separating what earnings management is, why managers do it, and how the main ethical lenses judge it. A defensible conclusion is that the answer depends on intent, method and effect on users, not on the label alone.

Two forms of earnings management

Researchers distinguish accrual-based management from real activities management. Accrual-based management changes the accounting treatment of an event, for example estimates, timing of recognition or provisions. Real activities management changes the underlying operations, for example discounting prices, overproducing inventory to lower unit cost, or cutting discretionary spending, to reach a reporting target (Roychowdhury, 2006). The distinction matters ethically. Accrual choices can be detected and reversed, while real actions may reduce firm value and cannot be undone by a footnote.

Survey evidence shows that real actions are not rare. Graham, Harvey and Rajgopal (2005) surveyed 401 financial executives and found that 78 per cent would give up economic value to obtain smooth earnings. A manager who does so is trading shareholders’ long-term interests for a reporting outcome, which is a strong ethical concern.

Why managers do it: positive accounting theory and agency theory

Positive accounting theory predicts accounting choices from three incentives: management bonus plans, debt covenants and political costs (Watts and Zimmerman, 1990). Bonus plans may reward managers for higher reported profit, covenants may punish breaches of leverage ratios, and politically visible firms may prefer lower profit to avoid scrutiny.

Agency theory explains why the problem persists. Owners cannot observe all managerial effort, and managers’ interests diverge from theirs, creating agency costs (Jensen and Meckling, 1976). Reported earnings are a monitoring signal. If managers can shape that signal, it loses value for contracting. Notably, Graham, Harvey and Rajgopal (2005) found that executives gave stronger weight to stock price pressure than to debt or political cost motives, so your group should not assume all three incentives apply equally in the case.

Ethical lenses applied

The standard-setting view: neutrality and faithful representation

The IASB Conceptual Framework (IASB, 2018) names faithful representation as a fundamental qualitative characteristic. A faithful depiction is complete, neutral and free from error. Neutrality means the information is not slanted to increase the probability that it will be received favourably or unfavourably. Earnings management aimed at a target fails this test in principle, because the choice is driven by the desired result, not by the economics.

Yet the framework also accepts judgement and estimation. This is why the ethical line is difficult to draw. Dechow, Ge and Schrand (2010) note that earnings quality depends on decision context and there is no single definition, so a measure that flags management in one setting may be innocent in another. Bansal (2024) reviews three decades of research and shows the field is still working out how to separate opportunistic from informative discretion.

Balanced conclusion for the answer

A strong answer takes a position and acknowledges the counter-argument. Position: earnings management is ethically problematic when it is intended to mislead users, relies on real actions that reduce firm value, or benefits management at the expense of other stakeholders. Counter-argument: some discretion is inherent in accrual accounting, and communicating credible information through reporting choices may benefit users. The group should state clearly where the case facts fall, and recommend safeguards such as audit committee oversight, clearer disclosure of key estimates and remuneration design that does not reward hitting a single earnings number.

How to adapt this to question 2

• Match the verb in your textbook question (discuss, evaluate, justify) and give your answer the same direction.
• Use at least two of the ethical lenses above, and apply each to a case fact.
• Keep within your allotted word count, and make sure the group’s sections do not repeat each other.
• Check every citation against the original source and use Harvard style as your course requires.

If your group needs help shaping the argument, see our financial accounting theory assignment help and case study assignment help pages.

About the expert

Bryan Chen is listed with a Ph.D. in Accounting from the SMU School of Accountancy. His profile shows 1,425+ completed orders, expertise across accounting assignments and experience as an accounting researcher.

References

• Bansal, M. (2024) ‘Earnings management: a three-decade analysis and future prospects’, Journal of Accounting Literature, 46(4), pp. 630-670. doi:10.1108/JAL-10-2022-0107.
• Dechow, P., Ge, W. and Schrand, C. (2010) ‘Understanding earnings quality: a review of the proxies, their determinants and their consequences’, Journal of Accounting and Economics, 50(2-3), pp. 344-401.
• Graham, J.R., Harvey, C.R. and Rajgopal, S. (2005) ‘The economic implications of corporate financial reporting’, Journal of Accounting and Economics, 40(1-3), pp. 3-73.
• Healy, P.M. and Wahlen, J.M. (1999) ‘A review of the earnings management literature and its implications for standard setting’, Accounting Horizons, 13(4), pp. 365-383. doi:10.2308/acch.1999.13.4.365.
• International Accounting Standards Board (2018) Conceptual Framework for Financial Reporting. London: IFRS Foundation.
• Jensen, M.C. and Meckling, W.H. (1976) ‘Theory of the firm: managerial behavior, agency costs and ownership structure’, Journal of Financial Economics, 3(4), pp. 305-360.
• Rankin, M., Ferlauto, K., McGowan, S. and Stanton, P. (2023) Contemporary issues in accounting. 3rd edn. Wiley.
• Roychowdhury, S. (2006) ‘Earnings management through real activities manipulation’, Journal of Accounting and Economics, 42(3), pp. 335-370.
• Watts, R.L. and Zimmerman, J.L. (1990) ‘Positive accounting theory: a ten year perspective’, The Accounting Review, 65(1), pp. 131-156.