Introduction
According to the Encyclopedia of Business in Today’s World, earnings management can be defined simply as “an accounting process whereby managers manipulate reported earnings to obtain some private gain.” Most companies today take part in earnings management in order to maximize profits and stock value and reduce fluctuations. In the United States companies must comply with US Generally Accepted Accounting Principles; however, there is room for interpretation and judgment, which leads to earnings management. Although earnings management does not break the law, many view it as opportunistic and believe it can have a negative effect on earnings quality and may weaken the credibility of financial reports. However, some believe that earnings management is beneficial; “recent studies have argued that earnings management may be beneficial because it potentially enhances the information value of earnings”. This paper will provide a review of the different motives of earnings management, also referred to as creative accounting in European countries. There are four evident motives for earnings management which will be discussed; compensation, income smoothing, capital market pressures, and financial requirements.
Compensation
The Agency theory explains the relationship between shareholders and company executives and suggests that activities of firms are governed by the role of contracts to facilitate voluntary exchange. According to the agency theory conflicts exist when managers have selfish motives and do not always act in the best interest of the firm, but to increase their own wealth at the expense of other shareholders. The reason for this conflict is that shareholders want to maximize the return of their inves...
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...ests that even in absence of capital market pressures, firms still have incentives to manage earnings. They found that firms in countries with high financial and tax accounting alignment manage earnings to reduce taxes.
Conclusion
After evaluation of this literature, it is clear that many companies today take part in creative accounting in order to maximize profits and stock value and reduce fluctuations in earnings. There are many studies that support this evidence and suggest that the main motivations for earnings management are compensation, income smoothing, capital pressures, and financial requirements. Although there are those who believe that creative accounting produces a negative effect on earnings quality and weakens the credibility of financial reports, it is clear that many people still employ earnings management techniques for a variety of reasons.
DHALIWAL, D. S., GLEASON, C. A., & MILLS, L. F. (2004). Last-Chance Earnings Management: Using the Tax Expense to Meet Analysts' Forecasts. Contemporary Accounting Research, 21(2), 431-459.
The agency problems or conflicts are continuously happening between the principal and the agent. It particularly arises when an interest conflict occurs between the principal and the agent. In terms of finance, there are two core agency relationships; managers and stockholders and managers and creditors. To balance the interests and satisfactions between managers and stockholders which helps firm to improve performance, there are a variety of different measures have been generated and implemented by Telstra in order to optimize the bond and monitoring costs.
Auer (1996) for instance, conducted a study on Swiss firms which switched from Swiss GAAP to either the European Directives or to IFRS. The focus of this study (Auer, 1996) was on market volatility and the basic assumption was that the major indicator of higher information processing by market forces was higher price volatility which by extension is an evidence of greater value‐relevance of accounting data. The results from the study of Auer (1996) however revealed that the variance of abnormal returns changed significantly for firms that switched to the European Directives or IFRS. In Bahrain, Joshi & Basteki (1999) conducted a survey on 36 companies in which questionnaires were designed and administered. Their study found that majority of the respondents (86%) believed that the application of IASs gave the contents of their financial statements more relevance. Contrary to the above, Barth, et al (1998) examined whether the application of IAS is associated with higher accounting quality, but found amongst others that firms applying IAS exhibit less earnings smoothing and a higher degree of association between accounting numbers with share prices and returns. In a similar vein, some studies conducted in Australia (Goodwin & Ahmad, 2006; and Goodwin, Ahmed & Heaney, 2008) found that differences between IFRS and Australian
... tempted to falsely inflate earnings is to take away their personal gains, if the company's stocks go up. I believe that when upper level management has too much incentive based on personal financial gain, which is directly based on the performance of the company; it compromises their judgments. I think that upper level management should not be allowed to receive stock options or to even own stock in the company as the financial statements would provide a neutral, bias-free report. Management would have no reason to "cook the books." I also feel that any management who still decides to falsify documents needs to be held more accountable for their actions and receive tougher punishments. I think that these strict guidelines would help the people in the United States and people all over the world feel more confident in investing their money into the stock market.
Introductory, agency theory discusses the relationship in which one party, the principal, delegates work to another, the agent (Eisenhardt, 1989). The core idea behind agency theory is to through contracting align the interest of shareholders (principal) with that of the managers (agents) in order to maximize shareholders value. Thus, the decision-making is being separated from the party who bears the risk; therefore, problems can arise. Firstly, the principal cannot verify whether the agent has behaved appropriately (the agent and principal have partly di...
In contrast , the shareholder theory organisations or organisation's decision-makers only have the responsibility to their shareholders by increasing the organisation profits and should only make the decisions to increase as much as possib...
This separation between ownership and managerial control in this instance can be problematic as the principal and the agents have different interests and goals. In a large publicly traded corporation such as NOL/APL, shareholders (principals) lack direct control when the CEOs (agents) make decisions t...
Today there are many things that are influencing how managerial accountants do their job with the emergence of e-business. They can use their knowledge to streamline the e-business process (Hilton,2008). Now global competition has new challenges for managerial accounts, because trade agreements can affect the way the business performs abroad. Gillet said, “To be competitive, manufacturers must keep up with the rapidly changing marketplace. How does the federal taxes, the state of the economy, and financial markets affect business decisions in the short-term?
Financial and Managerial accounting are used for making sound financial decisions about an organization. They provide information of past quantitative financial activities and are useful in making future economic decisions. (Albrecht, Stice, Stice, & Skousen, 2002) The same financial data is used to derive reports for each accounting process yet they differ in some ways. Financial accounting primarily provides external reports for external users such as stock holders, creditors, regulating authority and others. (Garrison, Noreen, & Brewer, 2010) On the other hand Managerial accounting is concern with providing information that deals with the internal viability of the organization and is tailored to meet the needs of an individual organization. (Albrecht, Stice, Stice, & Skousen, 2002)
Everyone wants to be successful. Most people measure success on the basis money. The world operates its daily activities around money, whether it is from the perspective of an individual providing for their family or the perspective of a chief executive officer managing a high profile business. Everyone’s goal is to be a success. In the corporate world of big business, success is always measured based on the bottom line comparing company profitability from one year to the next in comparison to its competitors. The only tool to accurately measure the bottom line of a corporation’s financial standing is through the use of financial statements. Understanding financial statements can be overwhelming. There are four basic financial statements: a balance sheet, an income statement, a statement of retained earnings, and a statement of cash flow (The Four Basic). Each of these four statements is broken down into smaller detail representing the inflow and outflow of financial transa...
Agency Theory or Principal Agent Theory is the relationship that involved the contractual link between the shareholders (the principals) that provide capital to the company and the management (agent) who runs the company. The principals will engage the agent to carry out some services on their behalf and would normally delegate some decision-making authority to the agents. However, as the number of shareholders and the complexity of operations grew, the agent, who had the expertise and essential knowledge to operate the business and company tend to increasingly gained effective control and put them in a position where they were prone to pursue their own interests instead of shareholder’s interest.
Jensen, M.C and Meckling, W.H (1976). Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics, October, 1976, V. 3, No. 4, pp. 305-360. Available on: http://www.sfu.ca/~wainwrig/Econ400/jensen-meckling.pdf. [Accessed on 20th April 2014].
Reichelstein, S. (2000). Providing Managerial Incentives: Cash Flows versus Accrual Accounting. Journal of Accounting Research, 38(2), 243.
Although primary objective for managers is to maximise shareholders’ wealth, but many firms are started to focus on other stakeholders’ interests in recent years. Company can prevent transfer the damage of stakeholders’ wealth to shareholders when focus on stakeholders’ interests. In other words, “social responsibility” for the companies is to maintenance stakeholders’ relations in order to provide long-term interests to shareholders. By this way, conflict, turnover and litigation of stakeholders can be minimise. Obviously, company can achieve their primary objective by cooperation with stakeholders instead of conflict with stakeholders (Smart, Megginson, Gitman, 2002).
The success of a company is very dependent upon its financial accounting. In accounting there are numerous Regulatory bodies that govern the accounting world. These companies are extremely important to a company because they set the standards when it comes to the language and decision making of a company. These regulatory bodies can be structured as agencies, associations, commissions, and boards. Without companies like the Security and Exchange Commission (SEC), The Financial Accounting Standards Board (FASB), the Governmental Accounting Standards Board (GASB), Internal Accounting Standards Board (IASB), Internal Revenue Service (IRS), and other regulatory bodies a company could not make well informed decisions. In this paper the author will look at only four of them.