Earnings Management Practices-.com

Questions: Discuss about Earnings Management Erodes the Credibility of Financial Reporting and adversely affects the Stakeholders Interest of a Companys. Answers: The credibility of financial reporting is based on its ability to deliver maximum necessary and correct information of an entitys state of affairs to its stakeholders. Financial reports are the only effective means of communication between the entity and its stakeholders. These stakeholders are the intended users of the financial reports prepared by the management of the entity. They are generally classified into two categories i.e. internal stakeholders and external stakeholders. Internal stakeholders are those people whose decisions affects the internal operations of the company as they are directly involved in those internal operations, such as employees, managers etc. whereas external stakeholders are not involved in the internal activities of business but they are somehow associated with the business of that particular entity, such as shareholders, investors, government, local community, suppliers and the customers. As these stakeholders do not directly participate in the intern al business operations they rely on the information that is contained in the report to make economic decisions in relation to the business of the entity. One of the major purpose of preparation of these financial reports is to enable the stakeholders to determine and evaluate the efficiency of business of the reporting entity. Therefore, the relevance of those financial reports primarily depends on their ability to meet the intended users information needs. In preparation and presentation of financial reports, managers who generally acts as agents to the stakeholders, may prepare those reports in such a way that fulfils their objectives of personal profiteering by providing misleading information to the stakeholders. Those exercises are commonly known as earnings management practices (Popoola, 2016). The managers may take the undue advantage of their positions in the management of the company for their self-centred motives (Kazemian Zuraidah, 2015). For example, a manager, in order to boost their incentives like bonus or commission to be paid to him on achieving a certain targets may indulge in the practices of inflating the turnover amount than the actual amount, based on which he will be entitled to that bonus or commission. This exercise will ultimately lead to incorporation of misleading or falsified information in the financial reports to be delivered to the stakeholders of the company. Benefits like this, tempts the business mana gers to divert the funds and other resources of the company in activities that are detrimental to the interest of the stakeholders and their wealth maximisation objectives (Magrath Leonard,2002). Earnings management is, thus, the act of maximising the personal or groups benefits by taking the advantages of loopholes in the rules and laws of financial reporting (Hamid, Hafiza Zalailah, 2012). These practices generally detriment the stakeholders of the company as it directly or indirectly influences their decisions. As these stakeholders place heavy reliance on the financial reports while making decisions regarding engaging or remaining engaged with the company through any kind of business relationship, the credibility of those financial statements plays the role of utmost importance. One misleading information can impact the readers decisions causing them an unreasonable loss. For instance, the managers may manipulate various elements of the financial statements that depicts the pr ofitability and liquidity position of the business by making the several accounting adjustments to seek finances from the providers of finance such as investors, shareholders, banking institutions and other parties (Suffian, et al., 2015). The case of Enron, which is the classic example of corporate failure due to the extreme involvement of earnings management practices by the management of the company (Gordon, 2002). Enrons scandal had finally led to its bankruptcy as the management of the company had hid its financial losses from the stakeholders of the company. It was identified in that case that prime reason for the fall of the company was due to the failure of board of directors and the management to assume responsibility for the inherent risk involved in the business plans of the company as well as the use of special purpose entities i.e. the limited partnerships and companies to fulfil the temporary purposes and other related structured financing forms to misuse of the off balance sheet financing. The balance sheet of the company was misrepresented to indicate the fake favourable position to the shareholders and other stakeholders of the company. The dysfunctional corporate culture of the company made the manage rs obsessed with the short term earnings of the company so as to maximise their individual bonuses (Sims, Ronald Johannes, 2003). Therefore, Enrons employees were involved in making deals to achieve better performance ratings ignoring the quality of overall profits and cash flows of the company. Further, the company managed to raise large amounts of capital funds by adopting the earnings management exercises of concealing the actual performance of company through various accounting and financial adjustments. Therefore, it can be concluded that earnings management is the strategy that is used by companys management to intentionally manipulate the earnings of the company so as to match the figures with the pre-determined target. Rather to have a fluctuating earnings record, the management of the company strives to have a stable earnings record by making adjustments to several elements of the company. These practices are either undertaken to show the smooth earnings trends of the company or to avoid the disclosure of actual losses incurred or for the personal benefits of the managers or to hide any other economic reality of the company. So, people indulged in the practices of earnings management may have different ways and purposes. But, the acts of earnings management often affects adversely the authenticity of the financial information contained in the reports, the concept of corporate governance must be given due consideration to curb the fraudulent practices of earnings management (Mans or, et al., 2013). However, it is not always illegal to undertake earnings management. References Gordon, Jeffrey N. "What Enron means for the management and control of the modern business corporation: Some initial reflections."The University of Chicago Law Review(2002): 1233-1250. Hamid, Farisha, Hafiza Aishah Hashim, and Zalailah Salleh. "Motivation for earnings management among auditors in Malaysia."Procedia-Social and Behavioral Sciences65 (2012): 239-246. Kazemian, Soheil, and Zuraidah Mohd Sanusi. "Earnings management and ownership Structure."Procedia Economics and Finance31 (2015): 618-624. Magrath, Lorraine, and Leonard G. Weld. "Abusive earnings management and early warning signs."The CPA Journal72.8 (2002): 50. Mansor, N., et al. "Corporate governance and earnings management: A study on the Malaysian family and non-family owned PLCs."Procedia Economics and Finance7 (2013): 221-229. Popoola, Oluwatoyin Muse Johnson, Vince Ratnawati, and Mohamad Ali Abdul Hamid. "The interaction effect of Institutional Ownership and Firm Size on the relationship between Managerial Ownership and Earnings Management." (2016): 304-310. Sims, Ronald R., and Johannes Brinkmann. "Enron ethics (or: culture matters more than codes)."Journal of Business ethics45.3 (2003): 243-256. Suffian, Mohd Taufik Mohd, et al. "Manipulation of Earnings: The Pressure of Opportunistic Behavior and Monitoring Mechanisms in Malaysian Shariah-compliant Companies."Procedia Economics and Finance31 (2015): 213-227.