In present business scenarios often the organizations publicize the financial accounting statement and the financial reports for the purpose of the making the information available to all the people that are interested in the organizations financial condition. Also these reports are used by the investors, creditor, share holders etc for making many decisions, so the organizations try to manipulate these accounting reports and financial statements to show artificial profits to them. Because of these manipulations in the financial statements it increases its earnings that will in turn increase their share price and hides the firm’s true financial status.
When any investor goes for investment he sacrifices his present benefits for the sake of
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Abuses such as earnings management occur when people exploit this pliancy. Trickery is employed to obscure actual financial volatility. This in turn, masks the true consequences of management’s decisions. (Levitt, 1998). Accounting researchers have adopted a similar dentition of earnings management. For example: Earnings management occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company, or to impudence contractual outcomes that depend on reported accounting numbers.(Healy and Wahlen, 1999) Common to these dentitions is the following feature: earnings management induces an intentional bias in financial …show more content…
Under US GAAP, Financial reporting should provide information that is useful to present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective net cash inflows to the related enterprise. (SFAC No. 1, para. 37) It is interesting to note that this is precisely the information that one would need to calculate the value of an enterprise. Thus, in setting accounting principles, the FASB appears to be emphasizing the valuation role of accounting information over other uses. The use of accounting information in valuation generates capital market incentives to manage earnings. Managers may manipulate earnings to improve market participants’ perception of the firm’s risk and performance. For example, extant research indicates that investors use benchmarks such as previous year earnings or analysts’ forecasts in evaluating performance, thus motivating firm’s to overstate earnings to meet or beat these targets (e.g., Burgstahler and Dichev, 1997). Anecdotal and empirical evidence suggests that investors prefer smooth earnings and persistent patterns of increasing earnings over volatile ones (e.g., Dechow and Dichev, 2002; Tucker and Zarowin, 2006). This may induce