Question

When preparing financial statements, management may present biased information to stakeholders. There are several reasons why management would do this. Please identify at least 3 reasons management may present bias information, including 1-2 sentences explaining each reason.

Answer 1

Answer :-

Brief Background

Information contained in the financial statements must be free from bias. It should reflect a balanced view of the affairs of the company without attempting to present them in a favored light.

The primary objective of the financial statements is to provide information to stakeholders to enable them to make decisions about providing resources to the entity.

Financial statement manipulation is an ongoing problem across the world. Financial statement fraud is accomplished by improper revenue recognition, manipulation of expenses, non-recognition of liabilities and improper cash flow presentation. Misstated financial statements can lead to wrong business decisions.

There are numerous reasons why management present the bias information, the 3 key reasons are described below:

1.            In many cases, the compensation of corporate executives is directly related to the financial performance of the company. As a result, they have a direct incentive to depict incorrect picture of the company's financial condition in order to meet established performance expectations and achieve their personal compensation.

2.            The financial statements of the companies are audited by the independent auditing/professional accounting firms. The firms have a direct conflict of interest because they are compensated, often quite significantly, by the very companies that they audit. As a result, the auditors could be tempted to bend the accounting rules to portray the financial condition of the company in a manner that will keep the client happy and keep its business.

3.            The Accounting Standards Board of different countries, which sets the GAAP (Generally Accepted Accounting Principles) standards, provides a significant amount of flexibility in accounting provisions and methods. The flexibility in the GAAP standards makes it feasible for corporate management to show a particular picture of the financial condition of the company.