Accounting Theory Practice

a) It is highlighted in the article that earning management practices can be designed to assist managers in fulfilling their obligations to stakeholders. This is resulted from the contract that the management has with their stakeholders. Describe the relationship between the following contracts with earning management:

i. Lending

Lending can be classified as the temporary giving of money or property to another person with the expectation that it will be repaid. In a business and financial context, lending includes many different types of commercial loans. As an example of lending are bank financing for small business start-up and also for working capital, asset financing such as for equipment and machinery, mortgages, credit card financing and personal loans. Many studies shown that a lender such as bank that gives loans will suffer a loss for property-casualty insurers and deferred tax valuation allowances. Certain findings shows a lenders use loan and claiming a loss reserves to maintain their earnings where certain findings shows that a lenders using tax valuation allowance.

ii. Management compensation

Management compensation plan is about few items that include in the stated objective of firm value maximisation and formally tie compensation to a measure of firm value such as earnings. Studies have indicated that the presence of a performance-based bonus compensation contracts have influenced both accrual accounting and executive accounting. Regulators and investors remain concerned with earnings management and its effect on the reliability of accounting information. Agency literature suggests that a lack of compensation incentives such as bonus payments can decrease but not completely eliminate the earnings management behaviour. Findings shows the absence of compensation incentives will lead managers to make earnings increasing decisions when current earnings are below analysts’ forecasts, but they do not make earnings decreasing decisions when current earnings are above analysts’ forecasts. This manipulation of earning occur possibly to improve their performance and also their compensations.

iii. Regulatory

Generally, regulatory means principle or rule with or without the coercive power of law employed in controlling, directing or managing an activity, organization or system. In the point of view of law, regulatory is a rule-based on and meant to carry out a specific legislation that for the protection of environments. Few studies shows that certain important items need to be in financial reporting regulation of earnings management such as reporting with transparency, prior period of choices of financial reporting methods and the precision of accounting standards. These regulatory will affecting the manager decision to avoid dishonesty, fraud and also not fully disclose an earnings.

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