Outline the Two (2) Perspectives on Earnings Management I.E. from a Financial Reporting Perspective and a Contracting Perspective (5marks)

Outline the two (2) perspectives on earnings management i.e. from a financial reporting perspective and a contracting perspective (5marks)

1. Financial reporting perspective

From the financial reporting perspective, manager may be able to affect the market value of their firm’s share by earnings management. Managers may use earnings management to meet analyst’s earnings forecasts, thereby avoiding the reputation damage and strong negative share price reaction that quickly follows a failure to meet investor expectations. For example, management may use earnings management to report stream smooth and growing earnings over time.

Besides that, earnings management also can be a vehicle for the communication of management’s inside information to investors. This is because securities market efficiency requires management to draw on its inside information. So, income smoothing leads to the interesting, and perhaps surprising, conclusion that some earnings management can be useful from a financial reporting perspective.

1. Contractual perspective

From a contractual perspective, earning managements can be used as a low-cost way of protecting firm from the consequences of unforeseen events in the presence of rigid and incomplete contracts. Managerial compensation contracts that allow some earnings management can be more efficient than ones that do not, due to the high costs of eliminating earnings management completely. For example, managers alter earnings to mask poor managerial performance and safeguard themselves from possible dismissals or managing earnings to maximize remuneration or increase personal wealth.

Identify four (4) main problems facing Vesania Networks with reference to the case above.

(5 marks)

1. Management dysfunctional

Management has no credibility. They keep saying that their problem are behinds them and will be find in the next quarter. But the truth is the problems were can not be solved and become worth in the future. They never said the real problems. They cheat to the others. They said that they can grow 3% to 5% faster than the industry. But the truth is the industry is growing 15% faster and their sales were declining. The management is not responsible because they did not blame themselves but they blame the market.