Why would financial analysts be fooled by accounting numbers and provide optimistic and biased estimates of profits?

Healy and Wahlen (1999:386) consider it to occur when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers. The contents of accounts manipulations implicate the ways accounting is used to alter numbers reported in financial reports in order to modify users perception of firm performance. The numbers can be manipulated by use of pure accounting choice; by opportunistically classifying and discloses all the items or by structure and time real transaction to achieve reporting goals. Accounts manipulation is defined as the use of managements discretion to make accounting choices or to design transactions so as to affect the possibilities of wealth transfer between the company and society (political costs), funds providers (cost of capital) or managers(compensation plans). In the first two cases, the firm benefits from the wealth transfer, and in the third case the managers are acting against the firm. By extension, investors can be divided into several sub-groups (existing and potential shareholders) having different interests and by consequence different reactions to accounts manipulation. Analysts are also players in this field and can be split into two categories: buy-side and sell-side analysts. Financial analysts issue recommendations and forecasts. They normally try to forecast the reported numbers including the effects of manipulation (Brettonand Taffler, 1995). Underwriters price issues that they sell. They make profit if a manipulation raises prices, and furthermore the issues may be easier to sell, which is another source of profit. Auditors have two contradictory goals. First, they want to satisfy the client; second, they want to avoid excessive risk from third parties. The quality of auditors may also have an effect on the degree of earning management. Managers either may or may not believe in market efficiency. If they do not, they may try to manipulate the numbers. Their aims would be to reduce the cost of capital, to satisfy the external demand of existing shareholders, to increase their own remuneration, to

decrease the overall risk of the firm. The context of market inefficiency helps them, since the investors are easy to manipulate. There are thus many forces that influence the accounts and, more particularly, the profit figure. From the interest of each group arises the motivation to manage accountings figures.

http://fse.tibiscus.ro/anale/Lucrari2011/119.pdf

Can you offer a positive economic reason for their actions?

The objective of positive economic is based on the fact, they focus on analyze the economic statistic and data based on the figures. These theories might describe the money supply growth affect inflation, but not provide any instruction on policy. It task can provide system of generalization that used to make correct predictions about the consequences of changes while the performance is to judge by the precision, scope and conformity of prediction yields. It is not interrelation of human being and investigator is part of subject matter that being investigated in more intimate sense than physical sciences. Positive economic have two element which is language designed to promote systematic and organized methods of reason and body of substantive hypoth eses designated to abstract essential features of complex reality. According to law of demand in positive economic, lower price that will yield more quantity sold. Positive economic involve in test and evolution of economic theories, that usually operationally meaningful. Term of positive economic is value free economic, it marks how money supply growth influences inflation. It cannot independent, because it consists of statement which can accept with facts and prediction about the economic relationships. If minimize the unemployment that is goal on positive economic on produces statistics of unemployment and certain factors of unemployment. Positive economic threaten as individual well-being and possibly upset conclusion of welfare economics. The reason of making fooled on accounting number in financial analysts is due to they want to shows the good financial analysts to shareholder and to get loan from bank. Other than that, they seeks to manipulate income smoothing so they steady trend of growth in profit rather than show volatile profit with series dramatic rises and falls it is to achieve by make unnecessarily high provision for liabilities and asset values in good years. However to manipulate the profit to tie in forecasts so when they sell large part of profit that is deferred to future years to cover potential upgrade and customer support costs. Other reason is they may help company to maintain the share price by reduce the apparent levels of borrowing that let company appear subject to less risk and create appearance of good profit trend. For instance they change the amount in utilities that are

subject to authority of government regulator who prescribes the maximum amount; when company report high profit so they have respond by curbing prices, therefore company have an interest in choose the accounting method tend to reduce reported profits. Financial analysts be fooled shareholders can get the benefit because managers can manipulate reporting earning to smooth income since decrease the apparent volatility of earning and increase the value of shares. Accountant was more critical of abuse of accounting rules rather than manipulation of transaction. They may take a rule-based approach to ethics rather on impact on users of account and they may see abuse of accounting rules as fatling within domain and demand ethical judgment. They also depend on motivation of management such as based on explicit motives of self-interest attracted more disapproval than to promote the company. Well-developed stock market and focus on detailed accounting regulation rather than broad principles. Accountant need to be aware of scope for abuse of accounting policy choice and manipulation of transactions.