Some company has different method to disclose their earning in their financial statement. The company looks has no profit after the accountant manager adjusts some post (account). Reversely, some company make up the revenue post so they looks have much profit.

In business practice, some company does not want disclose their real earning for certain motivation. The company with abundant earning may decrease the earning to avoid high tax. Higher earning, higher tax. Certainly, the tax will decrease their earning. The high profit company should pay the dividend too or they investor will find another stock company which pay higher dividend. Another reason is labour union. The labour union may ask increasing salary or increasing bonus.

On the other hand, the loss company does not want the company looks loss. They try changing the financial statement so it looks good. They want to calm the investor with good financial statement. For example, Enron presented good financial statement the year it went bankrupt.

Undoubted, Enron, an large energy company, has loss some investor money who invest at Enron stock. Enron also decrease the public trust to the capital market.

All company could not change the account as their want. They ought to obey the General Acceptable Accounting Principle (GAAP). Changing some post for engineering financial statement is illegal accounting. The manager and the owner could be punished or jailed.

Alternatively, they change the earning to engineering the financial statement. They change as the GAAP allowed so this action is legal. This way is called earning management.

The company does to manage earning in three ways, i.e.:

1. Managers increases the current period income

The aim of increasing income is making the company looks good. Manager increase income in order to make the company looks good. This strategy just for temporary because the company could not increase the revenue next years, next two years, or so on.

2. Big Bath

The company write off some revenue. They do not want the profit looks great. They do big bath as the compensation to last year increasing income.

3. Income smoothing

Some company has volatile income because they should invest asset at the beginning but they do not receive any money. For example,An oil company should buy some rig and they could not get any oil in first eight years.

Undoubted, the earning management affect the financial statement. The analyst should be clever to analyze the financial statement. Earning management could threat inexperienced investor. A financial statement which earning has been managed should be convert to normal financial statement. Adjust the revenue or the expense of the financial statement.

Before concluding any company managed the earning, you should check:

1. Incentives for earning management. Does the company have motivation to take action for earning management?

2. The reputation of company management. Some company has bad reputation in earning management. You should be careful with this kind of company.

3. Consistent pattern. The company which has volatile pattern income should be suspected for earning management.