Question 1

A press release titled “Luckin Coffee Agrees to Pay $180 Million Penalty to Settle Accounting Fraud Charges” by the U.S. Securities and Exchange Commission in the SEC website on 16 December 2020, reported that China –based company Luckin Coffee Inc. defrauded investors by materially misstating the company’s revenue, expenses, and net operating loss in an effort to falsely appear to achieve rapid growth and increased profitability and to meet the company’s earnings estimates.

Below is an excerpt from the press release (2020–319):
“The SEC’s complaint alleges that, from at least April 2019 through January 2020, Luckin intentionally fabricated more than $300 million in retail sales by using related parties to create false sales transactions through three separate purchasing schemes. According to the complaint, certain Luckin employees attempted to conceal the fraud by inflating the company’s expenses by more than $190 million, creating a fake operations database, and altering accounting and bank records to reflect the false sales.

The complaint further alleges that the company intentionally and materially overstated its reported revenue and expenses and materially understated its net loss in its publicly disclosed financial statements in 2019. For example, Luckin allegedly materially overstated its reported revenue by approximately 28% for the period ending June 30, 2019, and by 45% for the period ending Sept. 30, 2019, in its publicly disclosed financial statements. The complaint alleges that during the period of the fraud, Luckin raised more than $864 million from debt and equity investors. After Luckin’s misconduct was discovered in the course of the annual external audit of the company’s financial statements, Luckin reported the matter to and cooperated with SECstaff, initiated an internal investigation, terminated certain personnel, and added internal accounting controls.

“Public issuers who access our markets, regardless of where they are located, must not provide false or misleading information to investors,” said Stephanie Avakian, Director of the SEC’s Division of Enforcement. “While there are challenges in our ability to effectively hold foreign issuers and their officers and directors accountable to the same extent as U.S. issuers and persons, we will continue to use all our available resources to protect investors when foreign issuers violate the federal securities laws.”

Required:

(a) Discuss what is earnings management and the motivations for it in the case of Luckin Coffee Inc.
(b) Distinguish between aggressive accounting and fraudulent accounting. Provide examples of both, citing examples from the SEC press release where relevant.