Topics: Governance, Management, Generally Accepted Accounting Principles Pages: 4 (1076 words) Published: March 11, 2014

Earnings management is in the best interest of shareholders. Discuss ACF 351 CORPORATE GOVERNANCE



Earnings management is in the best interest of shareholders. Discuss Earnings, sometimes called profit, net income are the single most important item in the financial statements. They indicate the extent to which a company has engaged in value added activities, they are signals that helps direct resource allocation in capital markets. The theoretical value of a company’s stock is the present value of its future earnings, thus increased earnings represents increased value and decrease in earnings signals a decrease in the company’s value. Given the importance of earnings, it’s no surprise that management of organizations have keen interest in the way they are reported. Every executive therefore needs to understand the effect of their accounting choices so that they can make the best possible choice for the organisation. In other words, they must learn to manage earnings.

There are two schools of thought on earnings management, Acceptable Earnings Management and Unacceptable Earnings Management. According to Acceptable Earnings Management view, earnings management concerns reasonable and legally accepted management decisions and financial reporting with the aim of achieving predictable financial results. Earnings management in this view can be in two forms, thus it can either be “artificial” or “real.” Real earnings management, also known as economic earnings management involves decisions that affect cash flows. Examples include leasing certain equipment instead of buying, changing the timing of investments and providing promotional discounts to increase sales toward the end of the period where revenue targets are not likely to be met. By contrast, artificial earnings management also known as accounting earnings management does not affect cash flows. This kind of management is...

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4. P. M. Healy, "The effect of bonus schemes on accounting decisions," Journal of Accounting and Economics, vol. 7,
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