Question

Bobek Inc. has recently reported steadily increasing income. The company reported income of \(20,000 in 2014, \)25,000 in 2015, and \(30,000 in 2016. A number of market analysts have recommended that investors buy the stock because they expect the steady growth in income to continue. Bobek is approaching the end of its fiscal year in 2017, and it again appears to be a good year. However, it has not yet recorded warranty expense.

Based on prior experience, this year’s warranty expense should be around \)5,000, but some managers have approached the controller to suggest a larger, more conservative warranty expense should be recorded this year. Income before warranty expense is \(43,000. Specifically, by recording a \)7,000 warranty accrual this year, Bobek could report an increase in income for this year and still be in a position to cover its warranty costs in future years.

Instructions

(a) What is earnings management?

Short answer

Earnings management is the planning of business administration to make the fluctuations in the earnings. This planning presents the increased income for the current years.

Step-by-step solution

Meaning of Financial reporting

Financial reporting is one of the crucial processes of business activities. Under this process, a business entity discloses its financial data in the form of financial statements tointernal and external users.

Earnings management

Earnings management refers to the technique used by the company’s management to present its financial statements in a positive manner. The principal purpose of earnings management is to attractpotential investorsand reflect a favorable view of the company’s financial position.