Introduction and method
Graham et al. (2005) surveyed the reported financial statements and their implications for accounting and financial management (Graham et al. 4). The study found out that several reasons and factors are affecting the level of reported accountings and voluntary disclosure. The intermediate relations to the earnings management were also revealed. The reason lies in the fact that in the financial reporting, the earnings management occurs with the application of judgment (Schipper 92).
Thus, the study by Graham at al. tried to explore how precisely the variations of financial reporting and the acts of earnings management can be explained by the factors described by different theoretical approaches. On the other hand, it is important to define the possible implications for the different specialists in the financial sphere, including both hazardous consequences and useful information. The main reason for the involvement of the companies in the earnings management activities and manipulations with the reported accounting is their belief that other players in the financial arena consider earnings the main indicator of the company’s performance.
Therefore, most of the managers believe that trying to smooth the company’s earnings has more positive than negative consequences and that their actions are justified by the potential benefits of earnings management. Firms that manipulate the reported earnings and use the earnings guidance of different kinds, usually have high debt, sales, profits, and credit rate (Graham et al. 13). Those factors are linked to each other and form the general background of the earnings management practices.
The importance of reported earnings
The main antecedent of applying earnings management is the necessity to represent the company’s performance in the right light. The cash flow is always one of the most significant aspects of the well-being of the firm. The transactions that intermediately relate to managing earnings include various means to boost or time the cash flow, such as manipulating debt, sales, and profits, in particular, concluding lease agreements and timing the recognized revenues (Easton, Eddey and Harris 17). Cash flow is especially important in younger firms because it is directly associated with their growth and revenues as the credit rates correlate with their reliability.
On the other hand, when a company attempts to time the revenues, the main issue is representing the GAAP earnings as the non-cash pro forma earnings that do not require being documented (Kolev, Marquardt and McVay 159). Therefore, theorists try to offer the other merits for measuring the company’s performance. The benchmarks that can be alternative measures include the comparison to the company’s performance in the same quarter in the previous year, the numbers from the previous quarter, the reported profits, and the consensus analytic estimation (Graham et al. 27).
Actions were taken to meet earnings benchmarks
The desire to meet earnings benchmarks is a result of the generally accepted assumption that the success and performance of the company can be drawn to a certain set of standards. Whereas when a company does not meet those standards, it is deemed unstable and unreliable. However, there are two ways of meeting the benchmarks of the reported earnings. The first one is to undertake real economic actions while the second one presupposes accounting actions only. The survey suggests that 80 percent of the managers are more likely to take real economic actions to meet the earnings benchmarks (Graham et al. 32). In conservative accounting, the example of boosting the company’s profits is cutting and reducing investments (Penman and Zhang 241).
Smooth earnings paths
The smooth earnings are preferable for most of the managers because they provide stakeholders, investors, and customers with the assurance that the company is reliable and stable. That factor can improve the terms of the company’s agreements and its marketplace presence. The larger the company is, the more likely it is to be involved in smoothing earnings. Also, the companies from the technological sector may want to cover the bumpy earnings because they deal with a large amount of research and development, which not always go smoothly.
Voluntary disclosure decisions
Voluntary disclosure can occur in various forms. It may be a regular monthly or quarterly newsletter on the company’s website, a press release of the accounting information, conference calls, etc. Privately and publicly owned companies have different standards of disclosing information to its partners and stakeholders, but none of the firms can be forced to disclose earnings to the public unless it is a mandatory procedure. Such a decision gives advantages in avoiding information asymmetry, corporate control contests, stock compensation, and the limitations of mandatory disclosure (Healy and Palepu 410). However, there are some risks in voluntary disclosure, including litigation risk, political and agency costs.
Summary and conclusions
Thus, in the modern context of accounting, the cash flow and the reported earnings are the primary merits of the company’s performance. Managers try to meet the benchmarks of their earnings and at the same time, report them as smooth as possible because those are the guarantees of their financial stability. Trying to overcome the misrepresentation of the company or the asymmetric information can also result in the voluntary earnings disclosure.
Works Cited
Easton, Peter D., Peter H. Eddey, and Trevor S. Harris. “An investigation of revaluations of tangible long-lived assets.” Journal of Accounting Research 1.2 (1993): 1-38. Print.
Graham, John R., Campbell R. Harvey, and Shiva Rajgopal. “The economic implications of corporate financial reporting.” Journal of accounting and economics 40.1 (2005): 3-73. Print.
Healy, Paul M., and Krishna G. Palepu. “Information asymmetry, corporate disclosure, and the capital markets: A review of the empirical disclosure literature.” Journal of accounting and economics 31.1 (2001): 405-440. Print.
Kolev, Kalin, Carol A. Marquardt, and Sarah E. McVay. “SEC scrutiny and the evolution of non-GAAP reporting.” The Accounting Review 83.1 (2008): 157-184. Print.
Penman, Stephen H., and Xiao-Jun Zhang. “Accounting conservatism, the quality of earnings, and stock returns.” The accounting review 77.2 (2002): 237-264. Print.
Schipper, Katherine. “Commentary on earnings management.” Accounting Horizons 3.4 (1989): 91-102. Print.