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Methods Of Earning Management & Mechanisms For Constraining Earnings (Coursework Sample)


Discuss the motives behind earnings management and explain some of the methods used by firms to massage their earnings. Your essay should also discuss the extent to which firm level corporate governance mechanisms can constrain earnings management practices of firms. Cite literature to support your essay! Keep relevance to the UK and use international reporting standards

FINANCIAL REPORTING By Name Course code+name Instructor’s Name University Name City, State Date of Submission 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, these 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. 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. 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 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. 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 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....
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