Impact of Earnings Management on Firms Profitability in Pakistan

467 Words1 Page
bulb-icon

Recommended: impact of earnings management on profitability

Abstract This study is an attempt to examine the impact of Earnings management on the profitability of the firms. Earnings management has emerged as a vital issue in recent past for the firms, investors, analysts and the capital markets for profitability manipulation. The study was conducted on the companies listed at Karachi Stock Exchange. The sample included 98 companies comprising different sectors and taking five year financial data from annual reports of those selected companies from year 2002 to year 2006. Modified Jones model was applied to calculate the discretionary accruals which were violently used to manage earnings and used as a proxy of earnings management in the literature. Cross sectional time series regression was used for empirical verification of the findings of the study. Results showed that the Earnings Management has negative impact on the profitability of the companies. This paper examines the impact of earnings management activities on the firms’ profitability. Earnings management has arisen as a very important issue for the firms, investors, analysts and the capital market at large. Investors estimate the businesses on the basis of earnings which indicate the extent of a company’s added value addition and provide crucial information in evaluations and comparisons of companies’ performance because they reflect concrete figures provided by the companies according to reasonable standards. Increased earnings indicate increased value, on the other hand, decreased earnings show value decline. Management remains vigilant about earnings disclosure, earnings growth, and minimization of uncertainty and manages the reports accordingly. Managers use accounting judgment and transactions to manipulate the expectatio... ... middle of paper ... ...f Private Firms: Insights into Smoothing, Agency Costs, and Information Asymmetry. Spohr, J. (2002). The quality of accounting and earnings: The role of accrual estimation errors. Swedish school of economics and business administration dept of accounting. Vol. 7, p. 3-19. Sudipto Bhattacharya (1979). Imperfect Information, Dividend Policy, and "The Bird in the Hand" Fallacy. The Bell Journal of Economics, 10: 259-270. Sumit Agarwal, Souphala Chomsisengphet, Chunlin Liu and S. Ghon Rhee (December 2003). Earnings Management during Distinct Periods of Capital Demand: Evidence from Japanese Banks. Ofheo Working Papers Yan Zhang (May, 2004). Do speculative short sellers detect earnings management? Yuan Ding, Hua Zhang, Junxi Zhang (6 July 2004). Ownership concentration and earnings management: a comparison between Chinese private and state-owned listed companies.

Show More
Related

  • IRS and Tax Regulations

    1635 Words  | 4 Pages

    DHALIWAL, D. S., GLEASON, C. A., & MILLS, L. F. (2004). Last-Chance Earnings Management: Using the Tax Expense to Meet Analysts' Forecasts. Contemporary Accounting Research, 21(2), 431-459.

    Read More

  • Accrual Basis Accounting

    802 Words  | 2 Pages

    Is the current economic environment forcing managers into a difficult position? The slowing of the general economy or industry-specific economic conditions decreases sales while increasing bad debts and obsolete inventory. The operating performance decline is amplified by the reversals of prior-period accruals based on recent experience. The original accounting estimates were made under very different economic conditions. As the economy or industry slows, managers may find it increasingly difficult to meet the earnings objectives set during the boom times.

    Read More

  • Examining Financial Statements - Landry's Restaurants

    1117 Words  | 3 Pages

    Financial statement users around the globe use financial statements to evaluate the performance of companies (Fundamentals of Financial Accounting, 2006). In order to locate a company’s reported assets, liabilities, expenses and revenues, statement users rely on four types of financial statements. The four financial statements include: Balance Sheet, Income Statement, Statement of Retained Earnings, and Statement of Cash Flows (Fundamentals of Financial Accounting, 2006, p. 6). Each of these reports provides different information to the financial statement user. The Balance Sheet reports at a point in time: a company’s assets (what it owns), liabilities (what it owes) and stockholder’s equity (what is left over for the owners) (Fundamentals of Financial Accounting, 2006, p.7). The Income Statement shows whether a business made a profit (net income) during a specific period of time (Fundamentals of Financial Accounting, 2006, p. 10). The Statement of Retained Earnings illustrates what portions of the company’s earnings was paid to stockholders and retained by the company for future operations (Fundamentals of Financial Accounting, 2006, p.12). Finally, the Statement of Cash Flows reports summarizes how a business’ “operating, investing, and financial activities caused its cash balance to change over a particular range of time” (Fundamentals of Financial Accounting, 2006, p.13).

    Read More

  • Value Valuation Models: The Residual Income Valuation Model

    1779 Words  | 4 Pages

    The theory shows that share price of the firm can be expressed in terms of fundamental statements of financial position and profit or loss components (Scott, 2003). Ohlson (1995), who based his theory of valuation on the Residual Income Valuation Model (RIVM), argued that under certain conditions share price can be expressed as a weighted average of book value and earnings. This model has generated notable empirical debates on the examination of the relevance of financial statements’ variables in determining the value of

    Read More

  • Pro-Forma Earnings: A Case Study

    526 Words  | 2 Pages

    Towards the end of the 20th century it became apparent that companies were beginning to increasingly use an unconventional way of predicting their future performance in earnings. This alternative measure of anticipated earnings was fundamentally based on assumptions rather than historical evidence, which is why it was viewed as being unconventional when casting a business plan. Pro-forma earnings, is scrutinized as being deceptive because the calculations used to come up with the figures weren't a true reflection of the businesses profitability. The earnings reported by companies to no comply to the strict guidelines of the GAAP and companies can manipulate their data or measure to and report earning that are hypothetical (Epstein 2009; James

    Read More

  • Cash Accounting Essay

    1206 Words  | 3 Pages

    What is more, the author wrote that in the companies with long operating cycles cash flow accounting would be a relatively poor measure of performance in contrast to accrual accounting (Dechow, 1994, p. 7). This research, combined with the statement about accrual method complexity, supports the claim of Professor Feleaga who said “cash accounting has overpassed the accrual accounting. Moreover, nowadays, small enterprises and most of the private businesses use, under different forms, the cash accounting” (as cited in Toma et al., 2015, p.

    Read More

  • Peregrine Systems Fraud

    1954 Words  | 4 Pages

    ... tempted to falsely inflate earnings is to take away their personal gains, if the company's stocks go up. I believe that when upper level management has too much incentive based on personal financial gain, which is directly based on the performance of the company; it compromises their judgments. I think that upper level management should not be allowed to receive stock options or to even own stock in the company as the financial statements would provide a neutral, bias-free report. Management would have no reason to "cook the books." I also feel that any management who still decides to falsify documents needs to be held more accountable for their actions and receive tougher punishments. I think that these strict guidelines would help the people in the United States and people all over the world feel more confident in investing their money into the stock market.

    Read More

  • The Pros And Cons Of Earnings Management

    909 Words  | 2 Pages

    External financing such as the use of loans would have a lower interest rate for companies that have a better financial standing and so companies exploiting the flaws would receive better external financing opportunities than if they didn’t exploit the flaws. In a scholarly article written by Dechow, Sloan and Sweeny they found factors that would have firms be tempted to manipulate earnings to reap the benefits. These factors are in which the company is more likely to; have a board of directors be dominated by management, have a CEO that’s also the chairman of the board, have a CEO that was the company’s founder and less likely to have an audit committee and an outside

    Read More

  • What Is Brunswik Lens?

    760 Words  | 2 Pages

    Modern finance theory has proved that there is a relationship between accounting earnings and share prices, the study has proven that the higher the expected future earnings, the higher the

    Read More

  • Ethics of Earnings Management

    779 Words  | 2 Pages

    I enjoyed the conversation on GAAP and earnings management relating to the case “Be Careful What You Wish For: From the Middle”. The conversation was brief, but got me thinking on the ethics of earnings management. GAAP accounting is to reflect in good faith the company’s actual financial status and present reality as is. It is not to present a manipulated set of numbers that paint a pretty picture. GAAP requires recording of revenue when there is persuasive evidence of an arrangement, assurance of collectability, a fixed or determinable price, and delivery. If Sarah recognizes revenue before delivery, she would violate GAAP and partake in channel stuffing. It would not be earnings management.

    Read More

  • Ethical Disillusion Paper

    544 Words  | 2 Pages

    Earnings management occurs when a manager, or managers, use his or her judgment, in financial reporting, to alter the company’s financial reports. The manager purposefully structures the transaction(s) to favorably alter the financial statements and mislead stakeholders about the company’s economic performance or, to influence contractual outcomes, which depend on the reported accounting numbers (Brown, 2015).

    Read More

  • Manipulating Earnings Paper

    1010 Words  | 3 Pages

    With over twenty years of work experience I have witnessed managers at all levels utilize various tricks to manipulate short-term quarterly earnings. It seems like most managers have different views on what is ethical and unethical when it comes to managing short-term earnings and tend to use questionable practices to meet company numbers. This has been confirmed from The Dangerous Morality of Managing Earnings case study as according to Gibson the accounting practice of offering a fourth quarter sales incentive and allowing customers 120 days to pay in an attempt to increase fourth quarter sales numbers was posed to the managers in the case study and returned results indicating that the practice was viewed as ethical, questionable, and even unethical (1990/2013). Without a unanimous response for this practice it is confirmed that each manager views this practice differently and with so many ways for financial numbers to be manipulated it would be difficult at times to get an accurate picture of a company’s current financial well being.

    Read More

  • Accounting Deals with Internal and External Users

    1251 Words  | 3 Pages

    Accounting deals with internal and external users. External users are the investors, customers, suppliers, employees, authorities, and creditors that use the information about the firm to make decisions regarding their future relationship with that firm. The information that they look at to make these decisions are the financial statements. Each of these external users may use the financial statements differently. An investor may look to see if it is worth investing in that specific company; while a supplier may look to see if they should do business with that specific company. The internal users of that firm prepare and report the financial statements that the external users use to make their decisions. The single most important thing that firms show on their financial statement is earnings. Earnings are the amount of profit that a firm or company makes during a period. The value of a company and its earnings go hand in hand. Higher earnings means increased value for the company and lower earnings mean a decreased value for the company. Also, if companies have continuous growth in earnings then that would result in higher stock prices. Investors will look at the earnings of a company to decide which particular stock that they would want to invest in. Since earnings are the most important thing that companies show on their financial statements, many companies undertake earnings management. Earnings management refers to the strategy that companies use to manipulate their earnings so that they can change their reported earnings on the financial statements (Investopedia). It is very hard for companies to continuously report consistent periodic earnings because of economic cycles and seasonal changes. Since it is hard t...

    Read More

  • Financial vs. Managerial Accounting

    1091 Words  | 3 Pages

    Financial and Managerial accounting are used for making sound financial decisions about an organization. They provide information of past quantitative financial activities and are useful in making future economic decisions. (Albrecht, Stice, Stice, & Skousen, 2002) The same financial data is used to derive reports for each accounting process yet they differ in some ways. Financial accounting primarily provides external reports for external users such as stock holders, creditors, regulating authority and others. (Garrison, Noreen, & Brewer, 2010) On the other hand Managerial accounting is concern with providing information that deals with the internal viability of the organization and is tailored to meet the needs of an individual organization. (Albrecht, Stice, Stice, & Skousen, 2002)

    Read More

  • Definition Of Retence Management

    2157 Words  | 5 Pages

    Researchers have been attempting to develop the definition of earnings management yet there has been an inconsistency in the definition literature. According to Schipper (1989), earnings management is defined as “a purposeful intervention in the external financial reporting process with the intent of obtaining some private gain”. Another definition, which is more extensive is presented by Healy and Wahlen, states that “earning 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 influence the contractual outcomes that depend on reported accounting numbers' (Healy and Wahlen, 1998). In a basic interpretation, earnings management is a strategy employed by the management of a company to scrutinizingly manipulate the company’s earnings so that the end results match a pre-determined target. It is also “reasonable and legal management decision making and reporting intended to achieve stable and predictable financial results', said McKee, he also emphasizes the need to understand the concept in the constructive way instead of being confused with financial accounting fraudulence.

    Read More

More about Impact of Earnings Management on Firms Profitability in Pakistan

Open Document