Accounting Management help study on: Conservative Financial Reporting
It can be seen that information irregularity among investors creates deadweight losses and subsequently applies conservatism in finance reporting. Conservatism is different verifiability which is required for the identification of accounting income versus loss which creates an understatement of assets and liabilities. It is observed that conservative financial reporting practices have been adopted by the company to create a well informed and designed capital market as compared to financial reports which include non verifiable information. Conservative financial reporting practices are argued to reflect information quality of the reporting firms. In general, a good quality of financial reporting reduces the weighted average cost of capital and enhances allocation of capital efficiency. The function of financial reporting is high when information irregularity and uncertainty is high. It is very clear that managers of the company have adequate discretion under GAAP to accept more or less policies of conservative financial reporting. The purpose of the financial reporting is to provide information that is relevant and significant to investors , creditors and suppliers in order to make rational investment and financial decisions, provides information to investors, suppliers and creditors in analyzing the timing and risk of cash receipts, help investors in making of financial decisions, helps the users in making of long term actions & decisions, helps in enhancing and improving the efficiency of the business and helps the company in maintenance of financial records. There are some conditions which show relevant differences among response of earnings coefficients for companies whose finance managers follow a conservative financial reporting and those who finance managers do not follow conservative financial reporting. The substantial research has been documented for effecting the position of debt &conservative reporting in order to address the issues of agency conflicts. Many studies have examined information asymmetry/irregularity and its impact on accounting practice and the capital market. It is observed that parties who rely on information based on accounting helps parties in estimation of future aspects of the firm. The implementation of financial reports helps firms to estimate and predict financial difficulties and problems when investments are made by the user. There are various reasons which show that conservative financial reporting must be preferred by companies, firms, users and suppliers (Beaver & Ryan, 2005)
The motive behind the adoption of conservative financial reporting
It can be seen that conservatism in financial reporting helps in minimization of information irregularity and cost of the agency by minimizing the manager’s capability to implement information irregularity related with options of the growth to destroy financial statements to produce information asymmetry. It is the path which helps in minimization of deadweight losses.
Another reason of adopting conservatism in financial reporting that it helps in minimization of information asymmetry by restricting the capability of the manager to exaggerate expected cash flows and his capability to hold back information and knowledge on losses. The party attached with contracts of debt wants to be updated about the problems of agency and the consequence of different accounting methods because in general the information given enhances the total excellence of debenture & equity (Beaver & Ryan, 2005)
It can be seen that firms may enjoy benefits after adoption of conservative financial reporting like attainment of financial flexibility. The conservative financial reporting helps in reduction of the cost which may occur from the investment opportunity. In general, financial flexibility may be achieved through huge cash balances and debt capacity.
It can be seen that firms may adopt conservative financial reporting because of precautionary methods against financial problems. For e.g. In general firms may face financial constraints like firms who have huge balances are restricted to access finance from outside and ultimately follow less leverage.
It is very clear that conservatism helps in improving of contract efficiency. It is provided that conservative financial reporting offers a greater standard of authentication for recognition of profit as compared to loss recognition, it helps in minimization of the risk that suppliers shall bear losses due to their relationship with the company. The conservative accounting practices offers users & suppliers with great information against other types of information that can be checked and helps in improving the credibility of non related accounting information and minimizing the uncertainty that suppliers and users shall be trapped into non favorable investments.
It can be seen that bad earnings may cause the firm to again make the financial statements and this situation will lead for adoption of conservative financial reporting. The improvement in contracts has been done in order to rectify the problems of financial reporting. Improving the excellence of financial reporting may provide a chance to firms to gain financial credibility.
The relevance and significance of financial statements for a range of contracts among mangers and stakeholders and made a point that shareholders wants more adequate and timely reporting when shareholders are worried about managers updated information. According to the perspective of shareholders, companies with higher degree of information irregularity among internal and external investors obligate to have higher degree of conservatism in reporting. The concept of conservatism is required to implement in debt contracts, compensation contracts and taxes. In general, conservatism prevails due to irregularities in information between parties to regulation and litigation and the incapability to authenticate the enhance information of more knowledgeable parties (Chung, Firth, & Kim, 2002)
It can be seen that conservatism in financial reporting allows firms to disclose bad realizations of financial and economic transactions. Conservatism is a requirement which helps firms in recognition of losses in earnings and income in an appropriate manner. The preference for adoption of conservative financial reporting shows that the place of the market replies to the value of the firm in the occurrence of uncertainty. In general the market discounts the value of the firm in the verge of uncertainty. It is observed that when firm follows full disclosure policies then it results in higher prices in comparison to lesser prices earlier and the manager would become responsible to act strategically. The information given in the monetary and financial statements would help users in analyzing of entity’s efficiency and liquidity.
It is observed that firms who have timely and adequate disclosure would face lesser conventional financial reporting structure as compared to other firms who have inadequate and non timely disclosure. There must be a stronger relation among returns of the market and earnings on accounting when the regime of financial reporting is adequately conservative because lesser conservative firms shall prevent their reports by offering timely and adequate voluntary disclosures.
It can be seen that external director wants high quality and timely information to efficiently control and give suggestions to managers, but nowadays managers try to have better information than external directors and they have incentives with them to destroy and cheat private information. Conservative financial reporting focuses on disclosing of bad transactions. The implementation of conservatism in financial reporting helps in identification of bad news in income and earnings in a timely manner as compared to identification of good news in income and earnings (Chung, Firth, & Kim,. 2002)
Measures
The empirical methods employed by researchers to determine and measure conservative financial reporting.
There is one method such as Information Asymmetry which helps in measuring of information among informed & non informed investors of equity. The chance of confidential information trading score was incorporated by Easley. This method helps in measuring of information among well informed and non informed investors in market of equity. For e.g. In contract of debt the significant information irregularity is among finance manager and banks that given funds privately to companies and firms. PIN is role of the irregular order flow. The assumption is that information on public is completely involved in prices because the maker of the market would affect prices to the suitable level at the point of information and there may be no any trading action. Private and confidential information creates excess purchasing and selling depends upon on the kind of information. The motive behind using the PIN measure is firms which reveal long deviations from their normal point of order likely to have higher point of trading based upon confidential information that shows deviations from the ordinary point of flow.
Another method LEV is used for the contract of debt which demands conservatism. The information irregularity among informed and non informed investors of equity that creates conservatism for both who uses LEV and MB. There are so many reasons which show that monitor and control shall be reasonable (Sterling, 1970)
The history of the accounting is constant with contract of debt and being a main contracting effect on conservatism.
The existing evidence is constant with inability of accounting ion order to show the options of the growth which drives the minimization in the implementation of both accounting based contracts and debt contracts (Sterling, 1970)
Another method for measuring quality of financial reporting is index of earnings management. This method is required to absorb broad variety of practices of earnings management. This method is designed to measure companies reporting incentives that managers might implement to complicate economic performance.
It is observed that other method of measuring the quality of financial reporting is timely loss recognition of revenue which shows different verifiability may be required for identification of profits and losses.
Information quality plays a major role in facilitation of transactions which involve investment in various ways. It can be seen that disclosure of information would tackle the recipient successfully to estimate the upcoming developments and then plan accordingly. The quality of information also helps in minimization of cost related with chance behavior by enhancing the effectiveness with mechanisms of market enforcement that reveals opportunism. It is observed that inadequate information destroys the normal rules and regulation applicable in predicting the incentives of cheating and fraud and analyzing the stage of assurance which must be sought lead to non efficiencies due to supply of stage of assurance which gives augment to chance behavior. Irregularity of the information among informed and non informed investors creates a requirement for conservatism. Information irregularity produces deadweight loss and minimizes firms estimated cash flows (Watts, 2003)
It is observed that, information on accounting has been used by users and suppliers to analyze both the probability that the company shall react opportunistically once the savings has been done and the subsequent stage of assurance that must be viewed. It can be seen that companies are expected to act in a manner when their financial and monetary performance is bad, suppliers and users have a robust chance to find out whether the company had faced any financial problems. In general users, suppliers and creditors shall bear from insufficient protection when the financial performance of companies is overstated and understated. Due to these kinds of problems companies are expected to follow conservative financial reporting.
It can be seen that loans available with credit rating, loans of profitable firms and loans available to public companies are dealing at lesser bid ask spreads whereas loans raised by conventional investors and distressed loans are related with high degree of information costs. This result shows that conservative financial reporting reduces information irregularity and asymmetry concerning a borrower and enhances the effectiveness of the dealing of debt contracts and securities. It is observed that a great quality of financial reporting helps in facilitation of economic growth (Watts, 2003)
It is observed that parties involved in a debt and equity contract depends upon accounting information to find out the exact type of investment and saving and stage of assurance needed to influence the obligations of the contract because information on accounting is an significant resource in estimation of the company future scenario. The implementation of financial reporting helps in prediction of financial problems when investments are made because financial problems may affect company’s incentives to implicit the contract.
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