CASE STUDY: ETHICAL ISSUES: EARNINGS MANAGEMENT ASSIGNMENT
CASE STUDY: ETHICAL ISSUES: EARNINGS MANAGEMENT ASSIGNMENT
Lisa Borgese
School of Business, Liberty University
BUSI 532 Advanced Financial Statement Analysis
Dr. Debra Touhey
July 16th, 2023
CASE STUDY: ETHICAL ISSUES: EARNINGS MANAGEMENT ASSIGNMENT
Accounting principles at times can offer companies the flexibility to manipulate financial
data to meet their performance measures. When disclosure costs are more than benefits,
upper management have various approaches to even out the results. This may help the
company in the short run, but there are also consequences for those who are involved in these
activities. In the case of Mystery Technologies, Inc., we can see that the company’s cookie jar
reserve was used to meet the quarterly forecast, which was unethical and had consequences
for both external stakeholders, such as investors and shareholders, along with internal
stakeholders, such as the company and its employees.
The “cookie jar” reserve are savings from previous quarters that a company records as
earnings in subsequent quarters to make it appear that its earnings were higher than they really
were. According to Revsine, “reserves allow for estimated declines in asset value including
provisions for bad debt, sales returns, and various future expenditures related to corporate
restructuring.” (Revsine, 2020) The cookie jar reserve, according to Fogel-Yarri, “is adopted for
higher outcomes, when the first-period outcome does not suffice to meet the thresholds in
both periods, but missing the first-period threshold enables the firm to meet or beat
expectations in the second period.” (Fogel-Yaari, 2020) When a company has unrealistic
expectations, this can lead to over-reserving during profitable periods and keeping the reserving
going during the difficult times as well. Mystery Technologies, Inc.’s usage of the cookie jar
reserve proved to be that the company was misrepresenting its earnings. The company’s $10
million reserve for outdated inventory mean that the company was using the old inventory as a
cushion, and when they released it into earnings in the fourth quarter of 20X1, this served as a
way for the company to deceit onlookers to believe that the company had a net gain, when in
reality the company was at a net loss.
Financial professions are taught to be ethical in all their business-related actions
relationships. The American Institute of Certified Public Accountants (AICPA) provides and
maintains several principles for those who work in the financial field. According to Rule
CASE STUDY: ETHICAL ISSUES: EARNINGS MANAGEMENT ASSIGNMENT
0.300.020 of the AICPA Code of Conduct, “professionals should exercise sensitive professional
and moral judgments in all their activities.” (AICPA, 2021) The AICPA also states that, “members
should accept the obligation to act in a way that will serve the public interest, honor the public
trust, and demonstrate a commitment to professionalism.” (AICPA, 2021) In this case, Mystery
Technologies acted outside the public’s interest, by excessively using the cookie jar reserve.
“A member should maintain objectivity and be free of conflicts of interest.” (AICPA,
2021) Mystery Technologies had their own interests in the forefront, when they decided to
manipulate their earnings. This was clearly demonstrated by their dishonesty, improper
business practices and behavior and their manipulation of the earnings with the intent to deceit
the public into believing that they had over-performed during the fourth quarter.
The actions of Mystery Technologies, Inc., have multiple consequences for their external
stakeholders. Potential investors of Mystery Technologies believed that the company was
profitable, and this false belief in a profitable company may have resulted in them suffering a
loss on their investment. Had these investors known of the actual financials of Mystery
Technologies during the fourth quarter, they may have refrained from investing in the company.
Not only would investors be impacted by the manipulated earnings, but the shareholders would
be affected. As one knows, shareholders rely on accurate financials when assessing the
corporation’s performance. Because of the inaccurate financials, shareholders are under the
impression that Mystery Technologies, Inc., is performing well, but in reality, the company is
not.
Not only are external stakeholders affected by the actions of Mystery Technologies, but
also their internal stakeholders will suffer consequences from their actions. Employees that
have stock options with the company rely on accurate financial information to determine how
their investment is performing. Without accurate financial information, there would be no basis
for one to evaluate their investments. Also, Mystery Technologies itself will sustain
CASE STUDY: ETHICAL ISSUES: EARNINGS MANAGEMENT ASSIGNMENT
consequences for their bad decisions, as well. The Securities and Exchange Commission (SEC)
could file allegations against the company for their improper business practices, which could
result in fines and ruin the company’s reputation. As one can see, the manipulation of earnings
has an effect both externally and internally, where all parties are subject to some sort of
consequence.
Mystery Technologies, Inc. use of the cookie jar reserve demonstrated lack of integrity,
lack of disclosure and lack of ethics and professional behavior. “Better is a poor person who
walks in his integrity.” (Proverbs 19:1, ESV) Our Lord has called us to be honest, hence we are
commanded to act with integrity. Therefore, we, as Christian professionals, must practice
integrity and ethics especially in a place where not everyone shares these values.
References
AICPA. (2021). AICPA Code of Professional Conduct. Retrieved from
https://www.aicpa.org/research/standards/codeofconduct.html
English Standard Version Bible. (2016). Wheaton: Good News.
Fogel-Yaari, H. (2020). Earnings management strategies for meeting or beating expectations.
Journal of Accounting and Public Policy.
Revsine, L. (2020). Financial Reporting & Analysis. New York: McGraw-Hill Education.
