Question

State two (2) disadvantages of earnings management from the stakeholders’ point of view

Answer 1

Two Disadvantages of Earnings Managemnet from the stakeholders' point of view.

1.Excessive Earnings Management by window dressing of profits(financial statements) of an year(or quarter) do not reveal the exact credit worthiness of a company to its creditors and banks(lenders).These creditors could fall for the overly 'optimistic' earnings reports without properly understanding the accounting manipulatons behind the curtain.Usually earnings management is adopted by companies going through bankruptcy risks;Granting loans to such firms based on misleading informations can bring huge losses to the lenders.

2.Earnings Management beyond a certain degree will affect the reliability and comparability of the accounting information.We know the stakeholders use the accounting informations provided in the reports for evaluating the financial position of the company.Income smoothening technique used the management tries to portray a continuous growth pattern as well as predictable(steady) earnings to the investors.It is used to hide the volatility of the market and for forcing the investors to invest more.Such Investments made without knowing the real market volatility and unpredictabilty in earnings could lead these investors to suffer losses in future.Destroying the confidence and economic interests of investors will lead to downfall of value of the enterprise and its collapse.

Heavy penalties(fines) will be charged in case of tax evasion(avoidance) through account manipulations being caught.That also impacts the stakeholders(return).