Earnings Management Practices: Impact on Financial Reports

Running Head: Impact of Earnings Management Acts on Financial Reports
Earnings Management
Practices

Impact of Earnings Management Acts on Financial Reports 1
Earnings Management Practices
The credibility of financial reporting is based on its ability to deliver maximum
necessary and correct information of an entity’s state of affairs to its stakeholders. Financial
reports are the only effective means of communication between the entity and its
stakeholders. These stakeholders are the intended users of the financial reports prepared by
the management of the entity. They are generally classified into two categories i.e. internal
stakeholders and external stakeholders. Internal stakeholders are those people whose
decisions affects the internal operations of the company as they are directly involved in those
internal operations, such as employees, managers etc. whereas external stakeholders are not
involved in the internal activities of business but they are somehow associated with the
business of that particular entity, such as shareholders, investors, government, local
community, suppliers and the customers. As these stakeholders do not directly participate in
the internal business operations they rely on the information that is contained in the report to
make economic decisions in relation to the business of the entity. One of the major purpose
of preparation of these financial reports is to enable the stakeholders to determine and
evaluate the efficiency of business of the reporting entity. Therefore, the relevance of those
financial reports primarily depends on their ability to meet the intended user’s information
needs.
In preparation and presentation of financial reports, managers who generally acts as
agents to the stakeholders, may prepare those reports in such a way that fulfils their
objectives of personal profiteering by providing misleading information to the stakeholders.
Those exercises are commonly known as earnings management practices (Popoola, 2016). The
managers may take the undue advantage of their positions in the management of the company
for their self-centred motives (Kazemian & Zuraidah, 2015). For example, a manager, in order to