Earnings management
Many consider the earnings or net income to be the single most important item in the financial statements. Earnings indicate the extent to which a company has engaged in value-added activities. In for-profit organizations, they are a signal that helps direct resource allocations in capital markets. In fact, the theoretical value of a for-profit company’s stock is the present value of its future earnings. Increased earnings represent an increase in company value, while decreased earnings signal a decrease in that value.
The definition of earnings management is the “reasonable and legal management decision making and reporting intended to achieve stable and predictable financial results.” Earnings management is not to be confused with illegal activities to manipulate financial statements and report results that do not reflect economic reality.
Given the scrutiny by policymakers questioning the justification for tax-exempt status, the literature argues that, in order to minimize exposure to investigation, nonprofit hospital administrators adjust discretionary spending and accounting accruals to manage earnings to a range just above zero, resulting in a potential bias of reported earnings. As a result, do you feel that reported financial performance embodies a measure of subjectivity that effectively shades the “real” performance of the nonprofit hospital? Justify your response.
Answer preview to earnings management
APA
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