Aggressive Accounting Stakeholders - Essay Example

Running Head: Aggressive Accounting Aggressive Accounting s 16 May, In this era of cut throat competition amongst all the players of any industry, both domestically and globally; companies do not let go any option that can make them win good numbers. However, in this pursuit of making good numbers in the short run, their management neglects the long term cost that they would have to pay. Playing with figures or managing earnings has been a common practice in the financial reporting for ages now, but the need of the hour is to separate the action from being a little manipulation of data in financial statements to criminal acts of deceiving stakeholders of the companies. This essay will shed light on the most important aspects of aggressive accounting, beginning with a brief explanation of what actually aggressive earnings management is, what motivates the top management to pressurize the accountants and senior financial executives to play with numbers. In the end, I will discuss the why do not financial executives take a stand against such practices and finally, the effects of earnings management on the users of financial statements or the stakeholders of the companies. Aggressive accounting is a practice which involves managing earnings or changing figures in financial statements in such a way, that the fake statements display a good health of the company. In other words, management in order to hide problem areas; plays with numbers so that the stakeholders can assume the company to be financially sound and economically stable (Alexander, 2009, p.779). There are various techniques which management adopts to “cook the books,” however; the motive behind aggressive accounting remains the same (MohanRam, 2003), to show higher revenues, better EPS and practically anything that the management thinks, if changed, can help them give the desired look to the financial statements of the company. The essay “A Global focus” (Durfee, 2004), has highlighted big accountings scandals which were a result of “creative accounting.” The question that arises now is why did the companies’ financial executives resort to aggressive accounting to fake good financial health for their companies? The following paragraphs tend to discuss the driving forces behind earnings management. The author in the essay “A Global Focus” has presented the finding of a research in which he explains the top most important factors which lead to aggressive accounting. These factors include personal greed, unrealistic shareholder expectations and budget targets, weak boards of directors, seniors pressurizing the executives and low budgetary controls. However, I believe that a deeper and clearer analysis of the pressures which lead to aggressive accounting can be carried out by dividing the factors on the basis of external and internal environment. External factors that pressure the management to make numbers are briefly explained as follows: 1. Companies are under immense pressure to get consistently good analysis by stock analysts, so that the shareholders do not lose confidence in the companies’ shares. Therefore, they are forced to fake a financial position which can help them get a satisfactory or required performance rating. 2. Management of a company has to fake a stable financial position in times of difficulties, because they do not want to get a poor credit rating by credit analysts. If they would have a low credit rating, it would mean that their ability to retire a debt is low, hence, their chances of getting loan for their business would get low too. 3. In corporate world, a weak player is exploited till it runs out of the industry. Hence the competition in the market in terms of greater revenue, EPS, price of stocks etc., also forces the management to play with numbers, because, obviously they do not want to fall a prey to the tough competition. 4. Companies undertake long term loans from banks and other institutions which require them to maintain specific level of certain accounts, for e.g. debt to equity ratio, EPS, etc. These obligations are contractual for the management to follow, and if they cannot abide by the contract, they might have to lose the debt financing. Hence, management remains under pressure to keep the levels of such accounts in the desired state, by hook or by crook. 5. The most immense pressure on the management is the company’s position in the stock market. Shareholders’ expectations to witness continuous rise in stock price requires outstanding financial performance and forecast. Thus, to meet their expectations, management resorts to cooking their books. Various internal factors include company’s culture and personal factors (Duncan, 2001) which are discussed as follows: 1. Many a times, company’s culture is such, that it focuses on short term gains and disregards the long term costs that they would have to pay. It is this approach which forces the financial executives to play with numbers so that the company can gain the desired position in the short run. 2. A lot of times, top management sets unrealistic goals for the management to achieve. This is driven by the belief that unless the goals will be set higher, the executives will not raise the performance bar. However, in doing so, it forces the management to meet their expectations by any option that comes by, may that be legal or illegal. 3. Management at times, resorts to aggressive accounting because they are afraid of expected losses in the subsequent years, so they inflate the revenue figures in order to tone down the effect of losses later on. 4. Aggressive accounting also becomes a feasible option when, management wants to hide some unlawful practices or transactions. 5. Last but not the least; personal factors like, greed or promotion or job retention, force financial executives to manage earnings so that they do not fall short of superiors’ expectations. This analysis makes it clear that under any circumstances, aggressive accounting is not ethically acceptable, so now the question that is posed is why do not financial executives stand up against their superiors who pressurize them to cook the books? The answer to this question lies in the fact that executives very well know that going against superiors is not an easy choice. Primarily, because, the boards of directors and top management will not only obstruct them from climbing the career ladder higher, but will also ensure that their performance appraisals would be deteriorated. Therefore, a lot of times, executives do not put their foot down against unethical practices because they want promotions in their respective fields (Duncan, 2001). Moreover, they have a desire to build their reputation as effective and efficient employees who have the ability to meet their expectations. A lot of times, executives do not want to lose their jobs or are under immense peer pressure, hence, do not opt for rowing the boats by themselves. Moreover, many a times, being a part of a group, inculcates group thinking and executives cannot pull the courage to go against them. And most importantly, the personal greed in terms of both; the money and recognition does not allow them to blow the whistle. But in doing so, accountants and financial executive tend to neglect a very important aspect regarding their company, and that is, the qualitative aspects of their performance. I believe, that executives when rely upon practices likes aggressive accounting, neglect the seriousness of under-performance, because they believe that they can hide the deficiency and make the world see the better side of the picture. Moreover, the entire culture of the organization becomes such that the real performers are not valued, rather people who are able to fake performance are considered as specialists. This bent of mind, not only pollutes the culture of the organization but also the overall business approach and practices. Another aspect is the reputation of the company which plays a very important role in stockholders’ analysis, because they would not want to invest money in any organization that has illegal or unethical practices going on without any check and accountability. At this point, it should be mentioned that earnings management not only is harmful for the company but it also causes inconvenience to the users of financial statements. The intent of aggressive accounting is to deceive the users. The company in other words, does not want the stakeholders to analyze the risk which is associated with investing in their company. It is the analysis of their financial statements, that encourages the investors to invest money in the short run, but in the long run, they have to pay the cost of management practices by losing their money. It is this reason which is why shareholders expect accountants and auditors to remain ethical in their fields, because, it their verdict which strengthens the investor confidence in the company’s performance. The essay “A Global Focus” (Durfee, 2004) has highlighted many scandals which led to not only prove the failure of companies’ management, but it also shed light on the fact that, it is the investor which is sole bearer of the shock. The money which is invested is gone forever. Therefore, aggressive accounting is extremely harmful for users of financial statements because, they unintentionally, make decisions based on fake information, which later on harms them terribly. In the end, I must say that aggressive accounting is a game which does give returns in the short run but in the long run, the company and all its stakeholders have to pay huge cost in terms of disrespect, loss of money and ruined position in the market. References: Alexander et.al.(2009). International Financial Reporting and Analysis. 4th ed. London: Thompson Learning, pp.779 Duncan, J.R. (2001). Twenty Pressures To Manage Earnings. The CPA Journal, 71. Retrieved from http://www.nysscpa.org/cpajournal/2001/0700/features/f073201.htm. Accessed on 16 May, 2010 Durfee, D. (2004). A Global Focus. CFO Magazine. Retrieved from http://www.Cfo.com/printable/article.cfm/3013527. Accessed on 16 May, 2010 MohamRam, S.P. (2003). How to Manage Earnings. Accounting World: Institute of chartered Financial Analysts of India. Retrieved from www.columbia.edu/~pm2128/docs/emanage.pdf. Accessed on 16 May, 2010 Read More