Essays --

Accounting is used as a tools to inform investors and other stakeholders about management’s performance. However, accounting standards permits management to use judgment in financial reporting methods for some accounts as they have best knowledge of its business so it can choose accounting alternatives that suit their business. With ability to choose its preferable reporting methods, estimates and disclosure, this flexibility creates opportunity for managers to distort earnings in which they adopt accounting methods that do not truly reflect firms’ financial status (Healy and Wahlen, 1999). In addition, due to the fact that management has better access to firms’ business transactions and operations than stakeholders do and auditing and monitoring system are not always effective, these lead to an information asymmetry problem which increases earnings management opportunity. For example, they can alter some information and do not disclose all the information to the stakeholders. This essay will first describe the definition of earnings management and its evolution. Then, the proxies used to detect earnings management will be illustrated. Next, the motives for earnings management and its effect on financial reporting process will be discussed. Subsequently, it will turn to the impact of debt financing on earnings management. Finally, this paper will examine the factors that may constrain the degree of earnings management. Definition of earnings management and its evolution Many researchers has given different earnings management definitions. For instance, Healy and Wahlen (1999,p.368) states that ‘Earnings management occurs when managers use judgment in financial reporting and in structuring transactions to alter financial repor... ...orts (Houqe et al., 2012) Also, the adaptation of widely-used accounting standards, for example, IFRS, may help prevent management from manipulating financial information and, therefore, improve the quality of earnings because such standards require managers to provide a true and fair view of its report and may help reduce the earnings management activities. Houqe et al. (2012) conclude that the adoption of mandatory IFRS increases the quality of earnings in the countries that provide strong protection for investors. However, there is some controversy if accounting standards would reduce earnings management. Tendeloo and Vanstraelen (2005, cited in Houqe et al., 2012) and Lin and Paananen (2009, cited in Houqe et al., 2012) find that after adopting IFRS, firms in Germany recorded more discretionary accruals and those accruals are lowly-correlated with cash flows.