Question: Ethics and Governance : Understanding Revenue Recognition and Expense Recording

Revenue should be recognized when it is earned and expense when incurred. Given some lack of specificity in these terms, companies have some latitude when applying GAAP to determine the timing and amount of revenues and expenses. A few companies use this latitude to manage reported earnings.

Some have argued that it is not necessarily bad for companies to manage earnings in that, by doing so, management

(1) can better provide investors and creditors with reported earnings that are closer to "core" earnings (that is, management purges earnings of components deemed irrelevant or distracting so that share prices better reflect company performance); and

(2) can present the company in the best light, which benefits both shareholders and employees-a Machiavellian argument that "the end justifies the means."

a. Is it good that GAAP is written as broadly as it is? Explain. What are the pros and cons of defining accounting terms more strictly?

b. Assess (both pro and con) the Machiavellian argument above that defends managing earnings