Financial Accounting 3

Earnings Management

Earnings management refers to the usage of accounting techniques that present a positive view of financial statements of the activities of the business and its position of finance (Lo, Raqmos & Rogo, 2017). Earning management also takes advantage of the rules of accounting and creates inflated financial statements.

Compare and Contrast: Paper of Graham, Harvey and Rajgopal

In the paper of Graham, Harvey and Rajgopal in the year 2005, the authors have discovered that earnings are key metrics that are seen by the outsiders rather than cash flows. Managers focus on the earnings that are short term and they are mainly focused on the meeting or beating the benchmarks of earnings that have been set. They do so for building the credibility of the capital market, stock price maintenance or improving the external team management reputation. Earning management according to the paper is achieved through real actions rather than being opposed to the manipulations of accounting.

Real economic actions are taken by managers to meet the short term earnings benchmark. Managers give up positive NPV projects or delay the maintenance or any expenditure that is to be done in the advertisement. To meet the targets of earnings, executives are reluctant in employing GAAP accounting discretion like accrual management even when accrual management is cheaper rather than giving up the economic value. Executives prefer smooth earnings that are less risky to the investors (Graham, Harvey &Rajgopal, 2005). Also, smoother earnings improve the predictability of the earnings in the future that helps in increasing the prices of the stock. Accordingly around three fourth of managers are ready for sacrificing the economic value in order to achieve the smooth earnings path.

There are corporate decisions that are made and are termed as rules of the game that depict the earning management that is as follows: - Stock market likes the predictability of the earnings as participants of the market do not like the possibility of a firm not being able to attain the earnings management target. Also, in earnings management, there is a belief which prevails that every firm needs to attain the target or else it will get punished. Managers of the firms try to make the earnings smooth as they believe that volatile earnings are not good for the company. So overall CFO’s of the company are ready to sacrifice long term economic value so as to attain the short term earnings for the company.

While in the other paper by Healy in the year 1985, it has been studied that executives who are rewarded by bonuses based on earnings select the procedures of accounting that helps in increasing the compensation for them while in the paper of Graham NPV the earnings impact is studied on the stock market. In this paper, the bonus scheme is selected to understand the decisions of accounting that are taken. Executives select the method that helps in enhancing their compensation or the bonus. There are performance plans that prevail in the corporations and managers are awarded bonuses if they are able to attain earnings targets. These are compared in terms of earnings per share or equity returns (Guidry, Leone & Rock, 1999). Managers check the flows of cash from the operations and accruals at the end of every year and then accordingly selects the accounting procedures so as to maximize the utility of the bonus awards. The schemes of bonus serve as an effective means of influencing the accounting decisions and procedures. Managers tend to choose the decreasing accruals of income when upper or lower binding bounds are there while increasing accruals when bounds are not attached. There are voluntary changes in the usage of accounting policies and procedures for discretionary decisions of accounting. Thus in the paper, it has been depicted that if bonus sheets are attached to earnings management then managers or the executives tend to choose those procedures that enhance the earning management and improve their compensation.

Thus, the two papers opted for the contrast approach one has opted for the stock exchange impacts while the other has chosen the bonus factor for improving the earnings management. In first paper image consideration for creating a value through earnings management is done while in the second, improving the bonus leads an impact on earnings management.

Message: Paper of Graham, Harvey and Rajgopal

In the paper of Graham, Harvey and Rajgopal, the main thing that has been considered is the image of the business in the capital market, stock market and performance. Earnings create an effect on the business and are a picture of future growth. If the earnings reduce for the company, then investors would not like to invest that, in turn, will affect the image of the company. So, the first paper focuses mainly on the earnings of the company because of the effect it creates on the stock market. Managers take various actions like differing the earnings or expenses so as to gain the earnings target.

The second paper of Healy focuses mainly on the bonus that the managers receive once they attain the target. This paper reflects the personal gain while the above paper reflected the gain of the company. The message that has been derived is that executives try to maximize their welfare and try to opt for the procedures that help in improving their compensation. Bonus affects the decision making procedure of the accounting treatment in the firm.

Sustainability Report

A sustainability report is a report that is published by the organization depicting the environmental, social and economic impacts of the company (Michelon, Patten &Romi, 2019). This helps the company in depicting a wide range of issues of sustainability and the ways they are tackling them. The most widely adopted framework of sustainability is the Global Reporting Initiative. Everyday there is a decision that is made by an organization that impacts the environment. Since people and governments are becoming more and more aware of the sustainability issues, companies have started to provide reports and do responsible business. This one step is also taken for the image development and legitimacy of the organization.

Legitimacy Theory

Legitimacy theory refers to the mechanism that supports the organization which develops and implements environmental and social disclosures so as to gain recognition in the eyes of the public that will help in their survival in a turbulent scenario (Dube & Maroun, 2017). By providing sustainability reporting, they gain the approval of investors and the general public through legitimacy theory. Sustainability reports depict the activities of business considering the environment and society for the organization. This, in turn, will help them in building their image. Also, investors would like to invest more in the company that, in turn, will also help the company in turbulent times.

Strategic Decision

Sustainability reporting is also a good strategic decision. Since the time is changing and investors are becoming more and more responsible, they try to invest in the companies that are responsible for the environment. Also, acceptance of people brings legitimacy to the organization otherwise at times when it is not supported by the people, it leads to closure. A case of TATA in Singur is an example of the same The Company was not legitimatized as people did not accept it. So, for the company, it is required that it gets legitimatized in the eyes of people and the sustainability report helps in doing so (Michelon, Patten & Romi, 2019).

In the paper by Islam and Deegan, 2010 corporate social responsibility of two multinational corporations, Nike and Hennes&Maurtiz are discussed. These are the two companies that source their products from the developing countries that have a lower cost. The paper draws a connection between legitimacy theory and the agenda of media theory. According to the paper, as per the legitimacy theory, the community expects the organization for attending the issues that are beyond the performance of finance. Company when demonstrating the responsibilities that are broader are also inclined towards the strategic desire for ensuring the success of the company. The desire for morally appropriate behavior is suppressed over strategic desires. The results of the paper depicted that social and environmental disclosure can be explained according to the media agenda theory and the theory of legitimacy.

The paper states that negative media attention is driven globally that are related to topics like working conditions and child labor in the countries that are developing (Islam & Deegan, 2010). Nike being a brand has generated a lot of negative media attention due to its child labor policy while H&M has gotten strong support due to its better disclosures of sustainability from the people. Nike's image was affected due to the reason for child labor. Also, the activities that are against the social and environmental practice are highlighted by the non-governmental organizations that are also supported by the media and are brought into the limelight globally. So, the sustainability report is a strategic decision that is taken by the companies for the proper use of media in a manner that builds the image and helps the company in walking out of the turbulent times.

Conclusion on Paper of Graham, Harvey and Rajgopal

Companies nowadays ae subject to various media scrutinization because of which they are required to depict their sustainability report of the organization. Sustainability reports are usually presented because of strategic decisions rather than embracing morally appropriate behaviors. Communities nowadays and also the investors have become more and more aware of environmental and social responsibility. They like to invest in the firms that are socially responsible and environmentally sustainable as then only they will be able to sustain themselves in the market. The sustainability report will provide them legitimacy in the eyes of communities. This will help them in turbulent times and also at the time of investments as investors would like to invest in company that is more socially responsible. If the company is adopting the techniques that are harmful to the environment or do not ensure sustainable development then it is highlighted by the media and also it is opposed by the public that hinders their functioning and creates a bad name for them in the market. Thus, the company takes a strategic decision of providing reports so as to gain legitimacy in the eyes of communities that will lead them to survive. This is a strategic decision that is made by the company so as to sustain appropriately in the market.

Private Prisons in Australia

Prisons that are run by private companies form a part of the system that is run around by many countries in the world. The trials for private prisons are undertaken by the Australian government the most in the last 20 years. Privatization in prison has started in the year 1980 (Guido, 2019).. That includes catering, medical service, security, juvenile's prison, and people on remand and adult offenders. The concept of private prison i.e. transfer of responsibility from public to private started 40 years ago in the United States and has moved to British and Australia. In Australia, about 17.8% of prisons are held by private companies.

Reasons for Privatization

The path of privatization has been undertaken due to various benefits. It includes the reduction in the cost of operation of the government and also the cost of labor has been reduced in the process of privatization. When privatization takes place in the industry of prison, it provides a way to the government for limiting the barriers that are related to the construction and financing of the prisons. It also helps in improving the service as the private sector is able to provide a better service than the public sector in the country (Cuadrado-Ballesteros & Pena-Miguel, 2019). Even though there are various benefits of privatization, there is an issue of accountability in the process. In Australia, accountability for the prisons has measures for performance, compliance and monitoring because of poor outcomes in the prison and specifically the community of Australia.

Dysfunctional Effect

According to the paper of Andrew in the year 2007, there are various issues that are to be considered for the privatization of prisons in Australia. The very first dimension is about accountability's technicality and morality. It describes that the Australian government mainly focuses on the cost-effectiveness of prisons rather than the quality of service. The accountability has been limited.

Also, fundamentally when the criminal is held accountable then there is right of execution accountability for the sentencing objective. Now, private entities have created an interest in profit in the process of incarnation. The current delegation of the public to private has taken over democracy. The fees awarded in the prison management contract vary in different states. These fees vary with respect to the differences in the payment and the level of services that have been provided (Andrew, 2007). There is no set benchmark through which the cost can be set. The fees set to be simple in the term but is controversial at the end. The prisons have no limit on how they can source the funds for clothing or other requirements of the detainers or the prisoners.

In the series of privatization, there is a performance-linked fee that is paid to the company for meeting certain standards. Due to this incentive, private companies usually show the number of incidences rather than providing appropriate services. The aim has changed to profit-making completely.

Privatization has overall connected the punishment with the profits that has eroded the concept of democracy and has become an activity for profit-making. This also creates an ethical dilemma for the country and no accountability standards to describe the fees that are to be taken by private organizations.

Contemporary Situation

In the modern era, every industry is getting privatized be it education, health, or prison. This in terms is mudding the lines of accountability. The more things are getting privatized, the lesser they are in the knowledge of the public. This is creating an issue as private firms focus more and more on profits rather than on services. Accountability of the activities or the money-making has been reduced. It cannot be determined from where the funding is generated. A private organization has no set benchmarks of the fees (Mills, 2017). They charge it according to their requirements and try to reduce the cost so as to generate more profits for the organization. This has also created an ethical issue.

For making things private, it is required that set parameters are disclosed and also the disclosure of fees by the private institution for the services should be set. This will help in privatizing with proper accountability for the sectors.

Conclusion on Privatization in The Prison Industry

Privatization in the prison industry has various dysfunctionality as described in the paper. There is an issue of accountability as the funds are not being disclosed and also there is an ethical issue for representing or charging the fees. Privatization has been included in various industries like education etc and it is required that proper guidelines are created so that there is no exploitation of the public takes place. It is required that benchmarks are set so that charges are procured accordingly. Thus, privatization might save the cost but leads to exploitation at the point. So it required that there is a proper channel of accounting disclosures that are to be done.

References for Financial Accounting

Andrew, J. (2007). Prisons, the profit motive and other challenges to accountability. Critical Perspectives on Accounting, 18(8), 877-904.

Cuadrado-Ballesteros, B., & Peña-Miguel, N. (2019). Does privatisation reduce public deficits?. Policy & Politics, 47(2), 287-308.

Dube, S., & Maroun, W. (2017). Corporate social responsibility reporting by South African mining companies: Evidence of legitimacy theory. South African Journal of Business Management, 48(1), 23-34.

Graham, J. R., Harvey, C. R., &Rajgopal, S. (2005). The economic implications of corporate financial reporting. Journal Of Accounting and Economics, 40(1-3), 3-73.

Guido, M. (2019). Private Prison Labour: Paradox Or Possibility: Evaluating Modern-Day Systems and Establishing a Model Framework through the Lens of the Forced LabourConvention. UCLJLJ, 8, 33.

Guidry, F., Leone, A. J., & Rock, S. (1999). Earnings-based bonus plans and earnings management by business-unit managers. Journal Of Accounting and Economics, 26(1-3), 113-142.

Lo, K., Ramos, F., &Rogo, R. (2017). Earnings management and annual report readability. Journal of Accounting and Economics, 63(1), 1-25.

Michelon, G., Patten, D. M., &Romi, A. M. (2019). Creating legitimacy for sustainability assurance practices: Evidence from sustainability restatements. European Accounting Review, 28(2), 395-422.

Mills, A. (2017). Privatisation of Criminal Justice. In The Palgrave Handbook of Australian and New Zealand Criminology, Crime and Justice (pp. 467-481).

Muhammad Azizul Islam & Craig Deegan (2010) Media pressures and corporate disclosure of social responsibility performance information: A study of two global clothing and sports retail companies, Accounting and Business Research, 131-148

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Accounting and Finance Assignment Help

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