Earnings management could be defined as activities that involve legal and reasonable management the ultimate aim of which is to achieve financial results that are not only predictable but also very much stable. We wouldn’t be wrong if we said that earnings management is the complete opposite of management which involves illegal activities and financial representations which do not reflect the true and accurate economic state of the company. These types of activities are also very commonly phrased as ‘cooking the books’. Earnings management could ultimately turn into a problem with the money making goals set by the company are beyond the reasonable expectations and the organization creates significant pressure to initiate the fulfillment of these objectives.
Bribery and Corruption
Corruption according to the Institute of Chartered Accountants of England and Wales is the illegal use of one’s official position to obtain an unfair advantage. The range of possible activities that a person may become involved in order to indulge in corruption is limitless. Bribery, on the other hand, could be defined as corruption that only involves the exchange of money in consideration for unfair and illicit advantages. Bribery has been considered an epidemic in many countries developed and developing alike due to all of the problems that arise with it. This is because corruption and bribery both lead to an increase in the risk as well as the cost associated with doing a business and leads to a reduction in the trust of investors. Even for the growth of the countries where bribery and corruption prevails is set back more than a few decades because due to being based on an investment system where the highest bidder is encouraged, the investor draws out and start investing in other countries.
Understanding and analyzing the common practices in Earnings Management
The very traditional and much referred to phrase Caveat Emptor gives the seller the right to misrepresent any or all information when entering into a transaction at an arm’s length. The principal calls for the buyer to make all necessary investigation when entering into a contract to ascertain that the terms and conditions of the transaction are fair. But many theorists argue that the principal of caveat emptor has been dead in the law of contract. There has been a new concept that is being applied to the market lately known as Least Cost Information Gathered (LCIG) and under this particular rule, the seller has to publish the full price of the sale and it is the same seller that is also burdened by the responsibility to undertake quality tests to ensure the buyer of the suitability of the product to be sold. It is the same principles which compel the seller to reveal any markups or vouch for the quality of the object of sale. In situations like these, there are many principles of sale that are in practice which calls for the seller to become involved in misrepresentation.
With Caveat Emptor, earning management is another problem which drives the market towards corruption and fraud, and the accompanying evidence is explained as follows. How can earnings management turn into a problem for the best of us? The problem starts with the following assumption; something that is legal may not necessarily make it ethical. It is important to highlight here that in order to look into the drawbacks of earning management; we studied what we could refer to as an ethical firm and in the results of our hypothesis, we discovered how managed earning could be wrong. According to a data of over a 1000 firms for the period between 2003 and 2008, we observed that ethical firms have been showing higher levels of income increasing cash flows and inventory production costs. With what objective we ask. The primary aim of earnings management is to become eligible for management bonuses and equity stakes.
Any reasonable person would be shocked at finding out the extent of Earnings management that is applied to the corporate sectors of today. According to a survey that was carried out in the year 1998 sponsored by CFO magazine, 78 percent of the CFOs in attendance were asked to manipulate the financial statements so that they are reflected in more favorable light and half of the CFO’s agreed to fulfill the request. Shockingly, 45 percent of the participants admitted to being asked to misrepresent these financial statements and 38 percent of these people went ahead and followed through with the request.
The same could also be made evident when we explore the techniques that are used to achieve earnings management. There are a number of techniques which applied for the management of earnings, but we are going to discuss only one in order to get an idea of the concept. One of these techniques is famous as the ‘cookie jar reserve’ and this technique makes use of the various estimates that are applied to the process of financial reporting. In order to record the amounts that the management has to pay in the future, there have to be put in place a few assumptions and for these expenses, there is no correct figure. The management will try to overstate the expected expenses under this technique, and when the actual expenses turn out less than expected, the difference is put in the cookie jar which the managers use later to boost future earnings to encash them as performance bonuses.
Do all of the similar techniques constitute fraud? Let’s again define fraud first. Fraud could be defined as an Intentional or deliberate act which deprives another of property, money results in concealments of material facts or deception. Since most of the techniques that are being used for earning management involve misrepresentation of crucial information, they could be termed as fraud in most of the cases.
In order to control earnings management, most of the economies are making use of various accounting standards including the IFRS and these standards have been focusing particularly on the accounting assumptions and the estimates that are being implemented by the management in financial reporting. These also closely regulate the other matters like the approach adopted for inventory valuation. In both UK and the US, GAAP is the body that regulates the accounting standards to be applied to financial reporting. The Accounting Standards Board (ASB) is the major body which is decided by the accounting standards to be applied and for the US, that body is the Financial Accounting Standards Board (FASB). The principle legislation that the companies have to follow is laid down in the UK in the companies’ act 2006 and while the US government plays no part in setting the reporting requirements for the companies and it leaves the responsibility entirely to the Accounting Standards set.
Understanding and analyzing the common practices in Bribery and Corruption
Whenever a government official is responsible for the distribution of benefit or cost, there is created in the economy an incentive of bribery. Corruption, therefore, depends upon the control that the government has on the distribution of resources to the general public. This is because the private firms and individuals express willingness for the distribution of these resources, and there is them demand that is created for the acquisition of the benefits or resources that are left at the discretion of any one individual to circulate. This is supply side and demand led corruption. The consequences of this corruption could prove to be crippling for the economy. These corruption and bribery practices led to inefficiency in government contracting and could lead to a decrease in the success of a number of privatizations. The same practices are also responsible for many of the delays and the red tapes that have been kept in place to avoid practices such as these. Also, because of bribery and corruption the resources that are to be allocated to the government are put to inefficient use since they are not distributed on a fair basis. As a result, the deserving parties also remain deprived of the much-deserved money and help, and the society resultantly suffers from grave inequality. On a bigger economic scale, these practices tend to slow growth and discourage people who are willing to invest to the betterment of the corporate sector.
Bribery and corruption are in fact, therefore, an endemic that plagues a number of public sector economies and in the way that corporate decisions are taken and justified during the present age; these problems have become unavoidable at best. From the loss that we are suffering because of these practices, most of us wish to bring a change, but that change will not come easy. It calls for the restructuring of public and also much of our private sector.
List of References
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Examiners, A. o. (n.d.). What Is Fraud? Retrieved February 02, 2016, from ACFE: http://www.acfe.com/fraud-101.aspx
Geest, G. D. (February 2015). The Death of Caveat Emptor. Chicago: University of Chicago Law School.
Investopedia. (n.d.). Earnings Management. Retrieved February 2016, 2016, from Investopedia: http://www.investopedia.com/terms/e/earnings-management.asp
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