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 standardssource..
Date of Submission
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.
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. Un
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