Earnings Management and True and Fair View of Financial Accounts

Question: Discuss About Earnings Management and True and Fair View of Financial Accounts ? Answer: Introduction The question of validity, reliability, and relevance of financial reports to the business community has since been a concern to many parties. The widespread use of the reports by the management team and the business community at large has necessitated the need for reliable financial reports which depict a truthful and reliable view of the financial position and status of the businesses[1]. The reports are used as a measure of the activities and performance of the business entities as well as making informed decisions and strategies of developing the plans and investment decisions. Different approaches have been used by managers, where a number of tools have been employed to ensure that financial accounts reflect the actual financial position. Among these is the tool of earnings management, research has shown that this tool has been commonly used by managers in reporting the financial position and performance of their business entities. The underlying question is whether or not earnings management can be relied upon as a measure of truth and fairness of financial performance of businesses[2]. The study will, therefore, provide findings from research which will bring us to the agreement or disagreement of the research statement that earnings management is a necessary tool to ensure that financial accounts reflect the actual performance of the business. Financial accounts of any business entity shows its value or the extent to which the business or company has engaged in activities which add value to the business. These can be defined as the earnings of the company. In most case, the theoretical value of any companys stock research has shown that it presents the companys present value of its future value[3]. It is then used in direct resource allocation in capital markets. An increase in earnings of a company in most cases translates to an equal increase in companys value, while a decrease shows a decrease in the value of worthiness of a company. Earnings management can, therefore, be described as the practice of using accounting techniques by business managers in providing financial reports that present the expected true view of the activities the company activities as well as its financial position. The relevance of earnings management (EM) as a reflective tool of truthfulness and fairness in financial reporting is also affected by unethical pro-organizational behaviors. Research has provided that such behavior is socially unacceptable and in most cases, it is always driven by an individual desire to promote the companys interest at the expense of the interest of other external parties[4]. The behavior is common among accountant professionals who may experience pressure and end up altering financial accounting numbers with the intent of meeting specifically targeted earnings. The common belief in them is a misguided ideology that a morally questionable behavior is in a way acceptable as long as it acts to the benefit of the company. For example, the management team of a company may set some target goals for the annual earnings of the company. At the event that these goals or targets are not achieved, the accountant may experience some form of ethical pressure; the chances are th at they will adapt to themselves to believe that they should always protect the image and interest of their companies at the expense of consequences to external stakeholders. Other scholars have defined the term as a management decision-making process which is reasonable and legal and intends to achieve stable and predictable financial results[5]. Lastly, it can be defined as managers choice to treat accounting reports as either economically efficient or opportunistic in nature. In his findings, accounting techniques are said to be economically efficient if they maximize a firm's value and opportunistic in nature when it fails to realize or achieve a maximum value of the firm. Research has provided that, earnings management can only be achieved by the management decisions and actions that make it easier to achieve a company growth through increased earnings[6]. The decisions and actions are based on the accounting choices (GAAP) and the operating decisions which are also known as the economic earnings management. The system of earnings management has been criticized and found to reduce the transparency of financial report whereby, the GAAP has been fouled of permitting many accounting choices which require a lot of estimations and thereby providing room for opportunistic earnings management. Secondly, research has found that since most companies assume the use of innumerable operating and accounting choices, there is a likelihood of engagement in some form of earnings management mostly by default if not for an active choice[7]. Earnings management has also been mistaken by many as fraud activities. It is, therefore, important for the users of financial data and reports to distinguish between earnings management and fraud issues of the business. A report published by the National Association of Certified Fraud Examiners (NACFE), defined as the omission and misstatements of material facts and accounting data or information and in most case its deliberate and intentional[8]. The information then becomes unreliable and misleading to the users and interferes with their decision making processes or their judgments. Earnings management is hence viewed as legal while financial fraud if illegal and anyone caught of fraud activities is guilty of the offense. The most key element of financial fraud, according to research has been found to be the intent to deceive. It is carried out for personal gain which can be through direct means or indirect employment terms. For example, when an individual manipulates accounts wit h the intention of receiving a higher bonus during the sharing of dividends is a form of direct fraud. In circumstances where an individual manipulates or distorts financial information with the intent of maintaining a career path usually associated with managers who receive pressures from their partners may be termed as an indirect form of financial fraud.Research has found that a manager may adopt or use specific earnings management tools with the intent of manipulating earnings by the principle of relative cost-benefit advantage over the earnings management[9]. The evidence has been based on the fact that managers can only change the priority of earnings strategies but cannot eliminate any available earnings management. He concludes further to denote that in his case study of Taiwan, that earnings management and its prevalence to business ethical, legitimacy and moral issues. He also cautions the users of financial data and information that in most cases earnings management reflects the interests of the management and not the general and true performance of the business activities. In achieving their interests, managers commonly employ the use of discretionary accrual analysis, manipulation of operational activities which at times is a resultant of pressure from affiliated parties such as the shareholders, creditors, etc. as well as their attitudes and beliefs[10]. In most cases, the abnormal accruals may end up attracting scrutiny, and therefore it is not commonly used. Managers are said to commonly employ the strategy of real earnings management (EM), as it is possible to detect any miss-valuations in financial statements. Research also provides that altering the normal operations by the managers and subordinate executives with the intent of meeting a particular accounting target or goals is considered to be sub-optimal and it ultimately erodes the firms value. The financial crisis facing the economy is also a key factor in the examination of earnings management. Research has shown that during the financial crisis, the levels of earnings management a low[11]. It is observable that during the financial crisis the demand for high financial reporting and audit quality are very high. The underlying reasons for this trend or behavior are because during this crisis there is increased monitoring from the auditors as compared to when there are favorable economic conditions. It may also be as a resultant of the existing relationship between the quality of audit reports and the conditional conservative nature of the business. Research has shown that the most basic and fundamental push factors of earnings management are resultant of the excess pressure on the management CEOs of the companys to deliver set goals as compared to the pressure on other company executives who are driven by the long-term goal[12]. In this case, the executives may not sacrifice their long-term ambitions to achieve short term goals. The performance of the internal board of governance of any company or business entity, therefore, depends on the extent to which key company executives influence the CEOs[13]. The findings of the research stated that the longer the horizon of relationships between the CEOs and the subordinate executives, the greater the relative compensation (RC). The more dependable the internal governance is, the lesser the extent of real earnings management (REM). Hence the likelihood of manipulation of financial data and accounts by the CEOs will also depend on the internal governance of the company. Decision making has been greatly affected as well as earnings management increasing in cases of family-controlled companies. Research has provided that independence of the management board is a very important tool in earnings management. And the lack of board independence affects the validity of financial reports. It is evidenced by the existence of enabling environments of less functioning systems of control creates more loopholes for management to engage in illegal activities and alteration of accounting information. The board forms part of the internal control environment and its responsible for establishing other control systems within the company. The family-controlled companies exert pressure to the CEOs and managers with motives of achieving certain goals which increase the rates of earning management. But research shows that a more independent board is expected to reduce accounting manipulation and improve the reliability of financial reports. Another issue of primary concern in earnings management is the ethical climate surrounding decision making. Research has provided that the ethical climate of any organization depicts the attitudes and behaviors of management[14]. Research has therefore categorized these management ethical climates into; egoistic climates, principled climatesand benevolent climates. The egoistic climate is said to focus on the self-interest and self-interest maximizing behaviors. Therefore managers will tend to make decisions based on the principles of relative maximum advantage which increase the tendencies of earnings management. On the other hand, benevolent climate shifts its focus on fulfilling the wishes of the parties involved or what is best for the parties under consideration[15]. Therefore in most case, their management decisions will be based on the interest of the parties involved, which also increases the tendencies of earnings management. Lastly, the principled climate which has been reg arded as the best ethical climate centers its decision making principles on following the rules, laws and professional codes of conduct. This entails preparing reports based on the internal company rules and regulations[16]. Research has been done to promote the use of corporate social responsibility (CSR) in making management decisions rather than relying on the criticized system of earnings management. Companies can, therefore, support its business environment and society in general by developing environmental protection systems and policies. It can achieve by a developing a plan action which promotes relations with their clients. Research has also provided that corporate social responsibility is more appreciated in society as it generates positive externality in operations of the company by going above and beyond legal requirements. It is also proposed that corporate social responsibility does not only focus on the companys stakeholders needs but also lays more emphasis on the principles coherent with some socially accepted and constructed systems of norms, values, and beliefs. Lastly, a positive corporate social responsibility strategy has been argued to promote a climate of legitimacy and support am ong decision-makers, regulators, and stakeholders. The above case of corporate social responsibility minimizes the chances of increased earnings management. The study also aims at providing a relevant published journal to the study. In this case we examine a report released by the International Management Institute in their annual global annual review. Their research conducted on 119 firms by the use of Generalized Least Square and all the companies were listed under the Karachi Stock Exchange (KSE) for the financial years of 2004 to 2011. The research found out that all the firms engaged in real earnings management activities and were found to engage in manipulation of the real financial data to give a report of higher earnings which consequently lead to worse financial position in the future. They argue that earnings management always seems helpful in the current situation but in the long run creates great problems. It also provides that the firms earnings are manipulated by the managers with the intention of showing a firms good performance in the current period of the business operations. The last aspect in this study that affects the validity of earnings management in presenting a more viable and reliable view of financial reports is the moral judgment of the managers. The moral judgment presents a certain descriptive and prescriptive valuing of the obligatory or rightful decision-making[17]. Moral judgment, in this case, is assumed to deal with duties rather than personal preferences. If a manager is obligated by his roles to perform a certain duty, it is such guidelines which should guide him or her in making decision whenever presented with a financial situation which needs his or her consent. Research has also provided that people tend to exhibit a stronger preference for cooperative strategies. This is why accountants can easily manipulate financial accounts when they work as a corporate without the thought of moral judgment in their decision. Accounting numbers are therefore shaped both collective and individual culture across the world. Research has shown that management culture influences both individual moral judgment and behavior of corporate groups and hence the general corporate governance[18]. Conclusion The research above has present several cases concerning the reliability of the earnings management. From the arguments presented, it disagrees with the statement of our study that earnings management is a necessary business tool to ensure financial accounts reflect the actual financial positionand of the company. The concept of true and fair view (TFV) requires that all financial statement and reports prepared by any company should reflect a true and fair view of the companys performance and position. When such standards are achieved, then the financial institutions and firms can be trusted by both internal and external parties in a business environment. It also boosts investors confidence with the companies. Earnings management, in my opinion, cannot be a replica of truthfulness and fairness in financial reporting for the financial accounts of companies as it is subject to manipulations both by internal parties which include the management and the external business environments with the intent of achieving certain short-term goals especially by the CEOs of the company. 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"Individualism-Collectivism, Private Benefits of Control, and Earnings Management: A Cross-Culture Comparison." Journal Of Business Ethics 114, no. 4: 655-664. Education Full Text (H.W. Wilson), EBSCOhost (accessed May 1, 2017). [1]Commerford, Benjamin P., Dana R. Hermanson, Richard W. Houston, and Michael F. Peters. 2016. "Real Earnings Management: A Threat to Auditor Comfort?." Auditing: A Journal Of Practice Theory 35, no. 4: 39-56. [2]Kothari, S. P., Natalie Mizik, and Sugata Roychowdhury. 2016. "Managing for the Moment: The Role of Earnings Management via Real Activities versus Accruals in SEO Valuation." Accounting Review 91, no. 2: 559-586. [3]Ahmed, Helaluddin, and Md. Azim. 2015. "Earnings Management Behavior: A Study on the Cement Industry of Bangladesh." International Journal Of Management, Accounting Economics 2, no. 4: 264-276. [4] Tian, Qing, and Dane K. Peterson. 2016. "The effects of Ethical Pressure and power distance orientation on unethical pro-organizational behavior: the case of earnings management." Business Ethics: A European Review 25, no. 2: 159-171. [5]Dhole, Sandip, HariomManchiraju, and Inho Suk. 2016. "CEO Inside Debt and Earnings Management." Journal Of Accounting, Auditing Finance 31, no. 4: 515-550. [6]Alexander, David, and Eva Eberhartinger. 2009. "The True and Fair View in the European Union." European Accounting Review 18, no. 3: 571-594. [7] Zhang, Xu1, 2013. "Individualism-Collectivism, Private Benefits of Control, and Earnings Management: A Cross-Culture Comparison." Journal Of Business Ethics 114, no. 4: 655-664. [8]Martnez-Ferrero, Jennifer1, and Garca-Snchez. 2016. "Corporate Social Responsibility as a Strategic Shield Against Costs of Earnings Management Practices." Journal Of Business Ethics 133, no. 2: 305-324 [9] Shafer, William1, weshafer@ln.edu.hk. 2015. "Ethical Climate, Social Responsibility, and Earnings Management." Journal Of Business Ethics 126, no. 1: 43-60. [10]Prencipe, Annalisa, and Sasson Bar-Yosef. 2011. "Corporate Governance and Earnings Management in Family-Controlled Companies." Journal Of Accounting, Auditing Finance 26, no. 2: 199-227. [11] Riccardo, G 2015. "How has the financial crisis affected earnings management? A European study."Applied Economics 47, no. 3: 302-317 [12]Sawicki, Julia, and KeshabShrestha. 2014. "Misvaluation and Insider Trading Incentives for Accrual-based and Real Earnings Management." Journal Of Business Finance Accounting 41, no. 7/8: 926-949 [13]Qiang, Cheng, Lee Jimmy, and Terry Shevlin."Internal Governance and Real Earnings Management."Accounting Review 91, no. 4 (July 2016): 1051-1085. [14]Chen, Ching-Lung, Su-Hui Huang, and Hung-ShuFan."Complementary association between real activities and accruals-based manipulation in earnings reporting."JournalOf Economic Policy Reform 15, no. 2 (June 2012): 93-108. [15] Ibid. [16] Ibid., 5 [17] Ibid., 7 [18]Medeiros Cupertino, Csar, Antonio Lopo Martinez, and Newton CarneiroAffonso da Costa Jr. 2016."Consequences for Future Return with Earnings Management through Real Operating Activities."RevistaContabilidadeFinanas - USP 27, no. 71: 232-242.