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Question - Assume that you are the CEO of a publicly-traded company. Your chief financial officer (CFO) informs you that your company will not be able to meet earnings per share targets for the current quarter. In that event, your stock price will likely decline. The CFO proposes reducing the quarterly provision for uncollectable accounts (bad debts expense) to increase your EPS to the level analysts expect. This will result in an allowance account that is less than it should be. The CFO explains that outsiders cannot easily detect a reduction in this allowance and that the allowance can be increased next quarter. The benefit is that your shareholders will not experience a decline in stock price.
a) Who will be affected by this proposed action and why?
b) What argument might the CFO use to convince the company's external auditors that this action is justified?
c) If you are the analyst of the company, how can you detect this earnings management activity?
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