Internal And External Stakeholders : Financial Statements

When analysts question a firm’s earnings quality, it raises concerns regarding under or over aggressive accounting practices that may be allowing the firm to manipulate the earnings. Earnings quality is defined as the strength of the current earnings in being used to predict future earnings and cash flows. Since earning quality is indicative of future performance, analysts are more likely to address issues that have substantial impact on the earnings quality. An issue arises when the nature of the earnings is questioned. While permanent earnings are part of normal operations, any irregular, one time earnings can skew the earnings, making the firm look more profitable than it is. This is due to the inability to recreate similar one-time transactions that will give rise to such numbers. Investors prefer predictable

Such an intense focus has been placed on quarterly earnings as an indication of a company’s success by everyone from analysts to executives that ethics have for the most part been thrown out the window, sacrificed to the all important number, i.e. earnings per share. This is the theory in Alex Berenson’s book “The Number: How the Drive for Quarterly Earnings Corrupted Wall Street and Corporate America.” This number has become part of a game to be played, a figure to be manipulated – beat the number and Wall Street all but throws a parade, miss it and a company’s stock may be abandoned. Take into account the incentives that executives have to beat the number and one can find plenty of reasons to manage earnings.

The most important thing to any company’s stakeholders is high-quality reporting of its financial statements. Investors, for instance, need to know the truth about a company in order to make an informed decision on whether to make private investment, buy stock or bonds. However, for stakeholders to get the truth about a company, they need to read and understand management’s discussion and analysis, the president’s letter, the notes, as well as the financial statements. Conversely, financial statements must be accompanied with disclosures to prevent them from misleading the stakeholders.

The most important role of financial reports is to effectively communicate financial information to outsiders in a timely and credible manner (FASB, 1984). Earnings are vital in financial statements because earnings represent the company’s value. Investors and creditors always look to

SYNOPSIS: An extensive body of academic research in accounting develops theory and empirical evidence on the relation between earnings information and stock returns. This literature provides important insights for understanding the relevance of financial reporting. In this article, we summarize the theory and evidence on how accounting earnings information relates to firms’ stock returns, particularly for the benefit of students, practitioners, and others who may not yet have been exposed to this literature. In addition, we

* For example, SME or even big companies in order for them to maintain their performance in financing reporting is to get more people to invest. It possible they would manipulate by deceiving their financial reporting to impress more investor to invest.

The United States has become increasingly concerned with the quality of earnings reported from companies. Although the quality of earnings should be able to be used as a predictor to the future of the company, management policies have been able to find a way that makes the company seem as if incoming income is steady, even if it is not. Ways like over and understating stating expenses can make a company seem better than they are. While the use of non-GAAP earnings can have benefits, many individuals are worried that using non-GAAP earning will lead to giving out false financial reports. No matter the accounting method used, all managers must act ethically on behalf of the law, and the company.

Prior to the legislation of Sarbanes-Oxley Act, the regulations of financial statement were much more lax than current. There were only the rules declared by the SEC, the 1933 and 1934 securities laws (Carol, J., 2005). These laws required public companies to disclose the corporate information and have an independent party who reviewed and assured the company’s financial report. The public trusted the financial reports which were audited by the auditors and used in making investment decision. However, no one gave precedence to the accuracy and transparency of the financial information. Hence, many companies’ management took advantage of the lax reporting rules by manipulating the financial statement to make financial

In today’s business environment where publicly traded companies feel pressure to meet short-term earnings expectations, management may be tempted to “manage earnings”. Assess how a financial statement user may be able to detect managed earnings when reviewing the firm’s balance sheet, income statement, and cash-flow statement. Indicate how a potential investor might interpret these “red-flags”. Provide support for your rationale.

Companies following GAAP can manage earnings by simply altering its accounting policy to select those accounting principles that benefit them the most. Entities have a host of reasons for selecting those principles that will paint the rosiest financial picture. Some would argue that the market demands it, as reflected by the stock price punishment for companies that differ by as little as one penny per share from prior estimates. External market pressures to “meet the numbers” conflicts with market pressure for transparency in financial reporting.

By contrast, the new budget system is based on a minimum performance standard (MPS philosophy) which has to be reached in order to start earning extra rewards, trying at the same time to ensure that these standards are realistically set by the division managers making them definitely achievable. Then, above this first and sure performance standard, managers have to set targets that represent ordinary performance levels with a 50% probability of achievement.

In order to take a close look into various financial statement users’ behaviour, two theories or concepts should be outlined here:

We believe the new incentive system was needed and reasonable because the accounting-based incentive system, where EPS was a measure of performance, raised valid concerns. The first being an agency problem. This existed within the old system as manager’s interests were not aligned with those of stockholders. EPS had improved steadily at a rate of 9% annually; however, the share price had increased only slightly in comparison. Therefore, the company’s stockholders had hardly benefited. The second issue was the use of subjectivity in granting bonus awards. These awards were given out even when their entity had not performed well. Managers began “politicking”, meaning they would try and convince their evaluators they performed better than the results had shown.

Nowadays, as our economy is facing possible everyday crises, managers undergo an increasing pressure in order to keep their company 's earnings stable. Shareholders and analysts expect companies to meet forecasted goals and not to deviate from these. Especially, reliable companies are to report positive results and shall not present any 'surprises '. Managers therefore often turn to their accounting departments for help, whose job it then is to improve the bottom line by changing the information shown in financial

The reason for this kind reporting is largely due to the nature of their main capital provider, the bank. The bank is not necessarily concerned with their positive future outlook, they are likely more concerned with their debt to income ratio, equity, and liabilities. This kind of accounting information gives a better estimate if the company will be able to sufficiently meet their new obligation in the form of bank financing.