Earnings Management Bryan Eubank began his accounting career as an auditor for a Big 4 CPA firm.

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operations

Profits? Yes. Increasing profits? Yes. So what is the cause of his distress? The trend in cash flows from operations, which is going in the opposite direction of net income. Upon closer review, Bryan noticed a couple events that, unfortunately, seem related:

a.The company’s credit policy has been loosened, credit terms relaxed, and payment periods lengthened. This has resulted in a large increase in accounts receivable.

b.Several of the company’s salary arrangements, including that of the CEO and CFO, are based on reported net income.

Required:

1.What is likely causing the increase in accounts receivable? How does an increase in accounts receivable affect net income differently than operating cash flows?

2.Explain why salary arrangements for officers, such as the CEO and CFO, might increase the risk of earnings management.

3.Why is the trend in cash flows from operations, combined with the additional events, such a concern for Bryan?

4.What course of action, if any, should Bryan take?

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