Definition
In order to discuss the methods and ethics of earnings …show more content…
For fraud to occur, it must meet the three components of the Fraud Triangle: motivation, opportunity, and rationalization. There a thin line between earnings management and fraud. Unless the managers are intentionally misleading and misrepresenting accounting information, earnings management is not considered fraud. It is, however, seen as aggressive accounting.
There are strong motivations for managers to deliberately manipulate earnings management if it “result[s] in personal gain” (Senogles, & Glowka, 2013). However, this is not always the case. Studies have also shown that there is no connection between accounting fraud or high level of accounting irregularities and high level of equity-based compensation (Walker, 2006, p.460). Erickson, Hanlon, and Maydew’s 2006 study specifically looked at how managers may participate in fraud when “their wealth is tied to stock-based compensation and the resulting equity holding” (Erickson, Hanlon, & Maydew, 2006, p. 114). This study concluded that there is “no consistent evidence that executive equity incentives are associated with fraud” (Erickson, Hanlon, & Maydew, 2006, p. 114). Walker’s (2006) study does indicate that high level of earnings management in a company is often a precursor to fraud (p.