As discussed in the All About You feature in this chapter (p. 25), some people are tempted to make their finances look worse to get financial aid. Companies sometimes also manage their financial numbers in order to accomplish certain goals. Earnings management is the planned timing of revenues, expenses, gains, and losses to smooth out bumps in net income. In managing earnings, companies’ actions vary from being within the range of ethical activity, to being both unethical and illegal attempts to mislead investors and creditors.
Instructions
Provide responses for each of the following questions.
(a) Discuss whether you think each of the following actions (adapted from www.finaid.org/fafsa/maximize.phtml) to increase the chances of receiving financial aid is ethical.
(i) Spend down the student’s assets and income first, before spending parents’ assets and income.
(ii) Accelerate necessary expenses to reduce available cash. For example, if you need a new car, buy it before applying for financial aid.
(iii) State that a truly financially dependent child is independent.
(iv) Have a parent take an unpaid leave of absence for long enough to get below the “threshold” level of income.
(b) What are some reasons why a company might want to overstate its earnings?
(c) What are some reasons why a company might want to understate its earnings?
(d) Under what circumstances might an otherwise ethical person decide to illegally overstate or understate earnings?