The organizations that are operating in the economy have an ultimate aim of engaging in profit so that they can maintain their market share and on the same time maintain their market share. Every company has various expenses which they have to undertake in order to sustain their business and it is the role of the management to take care of the expenses from the income it receives (Kothari et al., 2015). The income left after meeting all the expenses is known as the net income or profit. This is even known as earnings. The profit or earnings are significant for the shareholders as an entity performance measurement as it is helpful in identifying the degree to which the company has engaged in operational activities in order to add value to the firm (Chan et al., 2014). It is even used to evaluate the performance of the managers and to aid in estimating the future cash flows and to evaluate the risk.
This paper has been designed in order to assess the process of earnings management and the three underlying issues that would reveal the engagement of the managers in the process of earnings management. These discussions would be undertaken next in the paper.
The process of earnings management has been explained as the numerous ways like the managers using their judgment during financial reporting and in framing the transactions to transform the financial report in order to either mislead certain stakeholders about the distinct economic performance of the organization or even to manipulate the contractual results that is dependent on the accounting numbers. On the other hand, Fang et al., (2016) has defined earnings management as a legal and reasonable decision making of the management and documenting the same in order to accomplish predictable and stable financial outcomes.
Barth et al., (2016) has discovered a positive relationship that is existent among the degrees of information irregularity and earnings management and therefore has provided evidence recommending that irregularities in the information is an essential situation for the earnings management. The higher degree of information irregularities makes it complex to gain access to the precise information that would make sure efficient supervision of the management decisions, actions and choices. Hence, the theory of agency has constructed a solid model for gaming knowledge about the earnings management as gives the management with economic enticements and to influence the financial outcome. There are various issues that manipulate the managers in engaging in earnings management (Enomoto et al., 2015). However, in this paper only three underlying issues require to be mentioned that have will be discussed.
Managerial Compensation Incentives
One of the most general remunerations for managing earnings is the manager’s compensation package. In most of the organizations the managers are eligible for cash bonuses or options for share on accomplishing prearranged reported earnings. It is due to this factor that the managers make use of any strategies to accomplish their target. Cohen et al., (2014) made use of accruals and transformations in the accounting policies and discovered that managers select income raising accruals as long as the revenues are within the minimum and maximum boundaries and they tend to move towards income falling accruals of the incomes are over the maximum level. Thus this has been one of the issues in managers supervising earnings.
It is seen that earnings are handled and managed for the assistance of the entity, in order to meet the estimations and the expectations of the shareholders and the analysts so that the management and the shareholders are satisfied with their work. The managers look to manage earnings in order to maximize the value of the organization and to communicate the private and secret information and to restrict the violating the limited debt covenants (Doukakis, 2014). The managers look to undertake these activities so that the earnings can be managed with ease.
The regulatory issues can even persuade the management to employ in earnings management. The organizations that are generally susceptible to the investigations that are anti-trust and the companies looking for government subsidy have a large amount of remunerations to manage the earnings that look to be less profitable. Degeorge et al., (2013) has investigated that whether regulatory assessment raises the earnings management likelihood for the companies that gets assistance like relief of import in the form or reductions in quota and increases in tariff. This has revealed that the companies making use of the income reducing earnings management in order to be eligible for the assistance of import relief. Thus, these have been the issues for the managers undertaking earnings management.
The completion of the paper has expressed that earnings management has been one of the significant issues that influences the managers to accomplish their remuneration packages by completing their prearranged tasks and even providing satisfaction to the shareholders with the help of maximising the valuation of the organization and in certain circumstances the companies looking to gain government subsidies and faces political consequences makes use of regulatory review in order to gain relief assistance. Thus this process is a significant procedure implemented by most of the organizations.
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