Financial Reporting 1

Financial Reporting

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Introduction

According to significant business and firms, earnings forms one of the most

incredible indicators of its activities. The primary reason is that most companies' measure its

present value from the future earnings, the investors. The analysis and prominent investors will

always observe and determine the attractiveness of the each every particular stock in a company.

Therefore, companies with poor prospects of earnings will typically realize lower share prices as

compared to those with better prospects. Consequently, earnings and management play

significant roles in determining the share prices of companies in addition to direct resource

allocation in the entire capital market (Howe, & Houston, 2015, p.77). The paper will focus more

on the management and earnings, the earning motivations in control, the methods of earning

management and the mechanisms for constraining the earnings.

Several motives are available behind the earnings management. The core reasons for the

earning management usually range from the bases to satisfy analysts and their expectations to the

incentives to develop bonuses or to maintain a more competitive position present within the

financial market. The legal earnings that are present within the scopes of management and the

financial reports are thus adjusted at the same time with the standards of the financial reporting

(Vieira, 2016, p.191). As a consequent, the companies will only engage themselves in those

earnings management if the benefits of the behavior are higher than the risks and the overall

costs that are involved. The dividends which are stable and the entire stability of the business

will act as close motivational tools to the manager to able to manage the earnings. There are

different categories of incentives; the stock market incentives, the political costs, the personal

interest and the internal motives.

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The Incentives of the Stock Market

The integration between the accounting numbers and the stock market and their reaction

will indeed push the management towards the earning management. The investors most of the

time rely on the issues to do with the stock market analysts to bring together a portfolio of the

potentialities of the successful firms. The analysts' expectation in the meeting of the businesses is

crucial to the companies and is mostly enjoyed by the companies. Missing the benchmark of

earning has negative impacts for the stock return together with the compensations of the CEO.

Therefore, to be able to go in line with the forecasts, the managers of companies need to turn to

earnings management. When earnings managed before time, they will be realized below forecast,

and the managers will use the income-increasing management of the earnings.

Personal Incentives

There might be possible financial motives for the company, and the CEO can be relying

on the management earnings. Therefore, a CEO can be used to go on the downwards earnings

within the management during the year of change, and in the following years, there would be an

upward earning (Limmack, 2015, p.266). The retiring CEO usually uses the upwards earnings

the management to leave and put a seat on the board.

The internal motives

Another motive of earnings management that is not connected to the outside stakeholders

like the government or the shareholders is the interior motives. Within the jurisdiction of a

company, it used to bring the financial reports to the structure transactions in a way that avoids

the performance standards (Prencipe, 2012, p.689). Many managers will choose to impact the

use of income-decreasing the unexpected happenings when the innovations are in a transitory.
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Some companies use externally determined standards that are not touched by the participants

including the rules such as peer group and other fixed standards of the cost of capital. This

likeliness is most likely to bring harmony to the earnings as compared to those other companies

that make use of the internal standards.

Management Compensations in addition to Contract Motivations

The theory of the management compensation which is also referred to as the bonus

plan hypothesis dictates that managers are far much motivated to bring to use the earnings

management to promote their benefit. The bonuses of the management are always connected

to the earnings of the firms. Therefore, it is expected that earnings and their management are

used to increase their incomes. Managers choose to report accruals in businesses that defer

from the income when the bonus awards were reached because they had no nothing to gain

from the extra earnings and thus would be better to be increased in the income for the

subsequent years (Hashim, Salleh, & Ariff, 2013, p.297). As a result, this will be based on

the hypothesis of the big bath' that speculates on the managers and their inability to

manipulate the earnings supposed to be reached by specific targets. Consequently, they will

have the incentive that uses the earnings management to bring down the current earnings to

favor the future earnings and thus creating future bonuses.

Methods of Earnings Management

Earnings management is a common term that is used by the management to care and

manage their earnings. However, this does not mean any of the illegal activities practiced by

the management. Managers are supposed to achieve earnings sourcing them from the

accounting choices or even by their decisions and operations. Managers can manage earnings
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due to having flexibility in the accounting making or activities of the choices. The most

occurring methods of the earning management are summarized into;

1. The Techniques of Cookie Jar Reserve

The technique here takes care of all the estimations of the future eventualities.

Concerning the GAAP, the management needs to estimate the recorded obligations that will

be used in the payment of the transactions or the events gotten from the present fiscal year

and which are based on the accrual basis. However, uncertainties will always cover the

estimation processes due to the future because it is not always given. The management,

therefore, has to choose a single number that is by the GAAP. As a consequence, there is not

always any chance given to take advantage of the earnings management. Under the technique

of the cookie-jar, the company will try to bring overestimations on the expenses during the

process of the management earnings. In situations where the actual costs turn out to be lower

than the required estimates, the difference can be placed into the cookie jar.'

2. The Techniques of the Big Bath

Sometimes corporations may be used to reconstruct debts and even write

down the assets of the company which may also lead to the closure of an operating system.

Following this, the expenses are thus unavoidable. In situations where the management

records an estimated charge of the previous papers may not confirm the board of directors to

influence the performance. They may also find some of the characteristics of the board that

relates to the effectiveness of the entire board particular on issues to do with training and

monitoring of the top managers. Therefore, all these characteristics are as a result of the

independence of the board, the ownership of the outside directors and the activity of the

board.
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3. A Technique on the Big Bet on the Future

In cases where there is an acquisition the corporation that is responsible for acquiring

the other is supposed to have acquired a significant bet with the future. According to the

Acquired Accounting Principles, any acquisition must be reported as being a purchase. As a

consequence, it leaves aside two doors open to be used by the earning management. From the

first instance, any company can have a writing of the already existing R&D costs and which

are against the present earnings in that acquisition year and thus protects the future earnings

(Yan, Hsu, & Yang, 2016, p.167).

Mechanisms that are used to Constraint Earnings

The corporate governance is referred to as the relationship that exists between the

corporation and all of its stakeholders and as a set of the mechanisms that is outside the

investors and their protection against any exploitation (Gell, 2012, p.43). Initially, the

corporate governance was seen to be minimizing the conflict of interest that is to the

management and other stakeholders where the separation existing between the ownership

and control are known. The framework of the agency portrays the internal monitoring

mechanisms that assist in confirming the directors and how they carry out their proposed

policies by maximizing the wealth of the stakeholders (Francis, Hasan, & Zhou, 2012, p.

272). Besides, having frequent board meetings is a crucial mechanism that will ensure there

is the effectiveness of the performance of the board and their duties will be included in the

overall process of overseeing and monitoring the behavior of the managers.

Earnings Management

The earnings management takes place when the managers use their judgment in the

entire financial reporting and in the process of structuring the transactions that will alter the
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financial reports. These will mislead some of the stakeholders concerning the underlying

performance of the economy of the organization or to bring influence to the contractual

outcomes that rely heavily on the reported accounting numbers. Therefore, earning

management can be defined as the actions that are operated by the managers and which serve

to bring increment to the current reported earnings of the division without a relating increase

of the prolonged profitability of the division (El Diri, 2017, p.67). Managers can manipulate

the reports of accounting by the idea of managing the accruals. However, there are

reasonable accruals that arise from the ordinary business and are unlikely to bring reflection

to the managerial behavior of opportunism. As a consequent, any other manipulation that

emanates from the accounting information will be held as being apparent to the abnormal

accruals.

The Relationship That Exists Between the Corporate Governance and That of

Earnings Management

The board of governance can affect the decisions and activities of its managers

directly, and can thus influence the processes of hiring, choosing and the process of

controlling the internal and external mechanisms. The board will, therefore, affect all these

activities through the systems of the audit committee. Better board of governance can make

use of the internal control systems to perform the actions of monitoring the opportunistic

earnings management. The independence of the board can be used to constrain earnings

management. They can do this due to the independence of directors who do not seek any

self-interest like the executive compensation (Easton, 2016, p.147). The independence of the

board is crucial in doing the oversights of the managerial activities that will eventually

maintain the investors interests. The board independence can deter managers and their abuse
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of power. Secondly, the inclusion of all the outside directors on board could lead to a decline

of the role of managers and their opportunistic behavior. In the USA for example, the audit

committee who own the financial expertise can prohibit the earnings management. Besides,

the audit expertise can be used to prevent the fraudsters and the manipulations of earnings,

which in turn the measure that influences the earnings management.

Conclusion

The earnings management is held as a tool used to the satisfaction of self-interests of

the board managers. However, the same can be applied entirely for the welfare of its

stakeholders, only if it is used ethically. Therefore, to realize the optimum benefit of the

resultant earnings management, some particular steps are supposed to be taken to boost the

corporate governance. The accounting standards are supposed to be revisited and be set in a

specific manner to ensure there are no any single loopholes for the manipulation of earnings.

Auditors have a duty of providing there are more accurate means of detecting any possibility

of manipulation and thus ensure there is independence. Finally, the morality of the people

inside the organization and the stakeholders can turn around the malpractices to a better one

only if the motivations behind the earnings management and are away from any evil

intentions.
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References

Easton, P. (2016). Financial Reporting: An Enterprise Operations Perspective. Journal of

Financial Reporting, 1(1), 143-151.

El Diri, M. (2017). Motives of Earnings Management. Introduction to Earnings

Management, 63-108.

Francis, B. B., Hasan, I., & Zhou, M. (2012). Strategic Conservative Earnings Management

of Technology Firms: Evidence from the IPO Market. Financial Markets, Institutions

& Instruments, 21(5), 261-293.

Gell, S. (2012). Using forecast errors to explain revisions. Determinants of Earnings

Forecast Error, Earnings Forecast Revision and Earnings Forecast Accuracy, 21-70.

Hashim, H. A., Salleh, Z., & Ariff, A. M. (2013). The Underlying Motives for Earnings

Management: Directors' Perspective. International Journal of Trade, Economics, and

Finance, 296-299.

Howe, J. S., & Houston, R. (2015). Earnings Management, Earnings Surprises, and

Distressed Firms. Accounting and Finance Research, 5(1), 46-109

Limmack, R. J. (2015). Corporate Financial Reporting Requirements. Financial Accounting

and Reporting, 260-298

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Prencipe, A. (2012). Earnings management in domestic versus multinational firms:

discussion of Where do firms manage earnings?. Review of Accounting Studies,

17(3), 688-699.

Vieira, E. F. (2016). Earnings Management in Public Family Firms under Economic

Adversity. Australian Accounting Review, 26(2), 190-207.

Yang, T., Hsu, J., & Yang, W. (2016). Firm's motives behind SEOs, earnings management,

and performance. International Review of Economics & Finance, 43, 160-169.