Financial Reporting Quality and Analysts’ Forecasts Accuracy
Financial reporting is defined as the strategy that is used by various companies to present financial opacity to assist in decision making (Eames & Yongtae, 2012). The generated data is utilized to give an overview of the future performance of the business, based on the facts detailed down by the experts. Similarly, the analyst’s forecast is described by Cheong et al. (2010) as the professional predictability of the future performance of the company. It could entail an increase of assets ownership or change of the human capital. The primary idea is that the expert’s decision should be guided by well-interpreted data, lest the final report could divert the resources of the organization to the wrong path (Acquire et al., 2011). Therefore, the major purpose of this section is to read through the available secondary resources, to identify the applicability of quality financial reporting and analysts’ forecast accuracy.
To derive the maximum understanding concerning the topic under study, the literature review will be organized into different subsections. The very first paragraph will introduce the broad perspective about the issue, to give the reader an overview of the complete theme. It will be followed by the identification of the gap section, theoretical foundation, review of the literature and a final summary compounding all thoughts discussed in the entire chapter. The purpose of organizing this work in the detailed format is to develop an understanding of thesis statement (Walker &Jones, 2003). Every subtopic discusses the unique concept, based on the opinions of the different researchers. Consequently, synthesis of the authors’ ideas will be contrasted to support the current research’s methodology, design, and the gap.
The sources were searched based on key phrases that allowed generation of secondary sources from the esteemed authors. Hutira (2016) affirms that the enormous number of peer-reviewed papers give the research more meaning and authenticity. It eliminates the biasness of the information and improves the quality of the final work. Also, the papers were grouped based on the year of publication. Again, only researches that were conducted in English were utilized, hence improving the reliability of the data collected. Themes were identified after reading the papers and regrouping related concepts. The following table illustrates the terms that were used to come up with the sources.
|Financial reporting …||633|
|Factors to consider in financial reporting….||88|
|Challenges in financial reporting….||160|
|Evolution of financial reporting…||31|
|Analyst forecast accuracy…||5|
|Standards of financial forecast…||40|
|Factors to consider in the financial forecast…||16|
|Accounting standards about financial reporting…||37|
Table 1: Search terms
Financial reporting and forecast inaccuracy are detrimental to the performance of any business (Michelon et al., 2015). The structure of the organization should be based on how well the accounting records are stored. Similarly, Morhardt (2010) contends that the accuracy of any prediction is pegged around the correct figures recorded in the books of accounts. According to Muslu et al. (2015) financial reporting has for long been the point of concern for regulatory bodies such as International Accounting Standards. He noted most of the companies are much focused on how to measure the value of assets and ignore when the assessment should be conducted. He affirms that traditional methods of evaluating costs randomly, are not enough to give a clear reflection of the actual performance of the nation’s economy or the business.
Fair value accounting has for long dominated the market realms (Walker &Jones, 2003). Companies have adopted the system while ignoring the modern methods that are more promising. Morhardt (2010) notes that lack of proper accounting records mitigates the chances of the business from curbing the future risks, which are caused by poor management. In his paper, he argues on the need to have a system that can measure the actual state of the firm, at specific periods of the year. Currently, businesses are adopting the system of releasing the financial statements in phases (Muslu et al., 2015). Most embrace quarterly and annual reports that are used by management to make pertinent decisions. Furthermore, the information is used as a mirror, to reflect the future demand both internally and externally (Acquire et al., 2011). As the time progress, organizations are absorbing more helpful financial reporting methods, which meet the required regulations.
Morhardt (2010) noted time and systematic differences in financial prediction. Based on the research, he identified that most of the researches that have been conducted (Sethi et al., 2014) fail to explain the disparities. The authors do not explain the factors which contribute to the errors in the process of assessing the future position of the business or the economy. While French & O’Hare (2014) held the assertion that errors cannot be missed along the way, his research revealed that the characteristics of the analyst have a linear relationship with the quality of prediction. The skills and the complexity of the task dictate the direction of the final results. With time, forecasting has transitioned from traditional stereotyping of the financial records to the one that embraces the inputs of the customers (Michelon et al., 2015).
Advancement of the modern technology has been integrated into various companies, as a way to fasten the productivity and reduce the operational costs (Eames & Yongtae, 2012). Businesses are leveraging from the use of big data, to determine the tastes and preferences of the customers (Sethi et al., 2015). Due to the ability to cover broad geographic locations by use of the modern technology, enormous feedback from the customers are used to make decisions on the mode of entry, channels of distribution, among others (Hutira, 2016). These lead the organization to employ an analyst, who has technical experience and understands the market from the raw figures. Due to the metamorphoses of the technology, traditional experts who relied on balance sheets to make meaningful guidelines are continually being faced away (Morhardt, 2010). They are compelled to refine their skills, to align with the modern needs in the market. However, the differences that occur at various stages of financial forecast and reporting are not yet solved (Walker &Jomes, 2003). Irrespective of compounding both theoretical and technical approaches in heightening the quality of the prediction, more standardized procedures have to be invoked to safeguard the integrity of output.
Morhardt (2010) surveyed 400 top executives to determine the factors that cause poor financial reporting and forecasting. In his work, he collected the views of the various business leaders and found out that they would rather make decisions with long-term economic impact than follow the GAAP accounting choices. They argued that adherence to the set-out procedures is expensive, and involving, which could cost the business more. Furthermore, it was noted that managers work to sustain the predictability of the earnings, which makes them not to disclose correct figures of the actual performance. The scenario is supported by Muslu et al. (2015) who contends that the performance of the business is linked to the ideas of the top management. If they fail to execute sound decisions, the organization stands a chance to lose heavily. In the same vein, ignoring the standards set out by the experts on the best practices to conduct proper financial reporting is equalized to self-destruction.
The state of financial reporting has been declining for the past twenty years (Sethi et al., 2014). The authors note that complete adherence to standards has not been achieved. The operations of the businesses are not represented correctly, which scares away the potential investors. Some of the challenges that were reported to have contributed to the scenario are such as increased innovation. This is making it hard for startups and not-well –established companies find it challenging to adopt. Also, stiff competitions posed by large corporations necessitates some businesses to conceal their information, thus present the wrong data. The paper portrays that there is a huge gap left in respecting the financial reporting and forecasting standards. Hutira (2016) and Michelon et al. (2015) agree on the issue of ignorance of set out procedures as the source errors in financial reporting. In their argument, if all businesses would adopt the policies designed by the regulatory bodies, conflicts of the stakeholders would be significantly reduced.
Previous study conducted by Ioannou & Serafeim (2015) indicates that modern technology has impacted the way reporting and financial forecasting is conducted in various companies. In their assessment, they argue that IT has varying degree of impact on the culture of the business. The internal and external environments determine how the organization leverages on the modern technology. For example, some startups and large corporations conceal the true information, as a fight back to scare the competitors. Furthermore, the characteristics of the managerial team are elemental in guiding the company, in using the correct and well-established standards (Hutira, 2016). These go beyond obeying the ethical rules, but also integrating the right analysts in conducting evaluation process. The focuses of researchers have shifted from looking at the standards compliance to effects the modern technology has on defying the accounting principles (Sethi et al., 2014). However, the challenge of correctness in reporting and forecasting persists. The previous researchers lack theoretical guidance, and a number of them have not discussed what should be done(Espahbodi et al.,2015). They indicate that more research should be conducted to come up with solutions to the differences that arise when performing financial reporting and forecast.
The static theory is based on the correctness of the figures that are recorded on the balance sheet (Ritter &Wells, 2006). Drawing up the balance sheet, the difference between the liabilities and the assets constitutes the net worth of the business. The input or deduction disrupts the stability of the equation, which is reflected as either profit or loss. According to Muslu et al.(2015), the nature of the business dictates the spread of the balance sheet recordings. Through his findings, he affirmed that lack of proper input of all transactions in the correct format, can significantly impact the performance negatively. Alongside, Morhardt (2010) supports the idea by documenting that the defined nature of the economy cannot be disrupted, and the investor expects excellent performance. To gain maximally from the investment, the business person has to continually embrace correct recording of the accounts books(Acquire et al.,2011). Shifting the numbers to entice potential partners and customers increase the future challenges.
Far and above, the dynamic theory that was put across by Schmalenbach (French & O’Hare.2014) defines the success of a business from the point of cumulative achievements, rather than the amount it amasses over a given period. The valuation of the company is conducted after a certain time, which is unique for every business. This theory advocates for comparing the previous performances, and identifying the strategies that were used to arrive at optimal performance. Schmalenbach is of the idea that this kind of approach is more long-lasting, and provides permanent solutions. He further notes that the accumulated profits are a manifestation of the system that was invoked to achieve the desired output. Currently, organizations tend to direct their energies toward achieving the huge profits but fail to track the major reasons that allowed them to sail higher in the market (Morhardt, 2010). The process is contrary to what dynamic theory proposes. Thus, a huge number of businesses end up stagnating at one point. Despite the managements having the information on the modern ways of representing the companies, they continue to shrug what they know is right (Morhardt, 2010). If management adopts this theory, it will ameliorate the pitfalls presented in the sophisticated market.
Economic theory (Ashbaugh & Pincus, 2001)) propounds that the market phenomenon occurs cyclically and repeats themselves at particular intervals. Coined to this assertion, the data collected from the customers and other stakeholders can be used to make future predictions about the business. The analysts use graphical or mathematical equations to derive meaning from an array of information. To achieve the objectives of economic assessment, various elements such as trends and variations have to be studied well. Business cycles might be challenging to predict, hence the need to supplement with other methods. This theory supports accurate market forecast, as the tool to shape the future performance of the business (Eames & Yongtae, 2012). The primary disconnect that is witnessed in the today’s business is lack of motivation to use the right procedures in conducting the financial prediction, which lowers the prospect of growth (Michelon et al., 2015).
The impacts of financial reporting and prediction are strongly associated with the culture of the business (Dhaliwal et al., 2012). A company that engages in ethical practices to sustain the loyalty of the investors and other stakeholders continually reviews its accounts, based on the stipulated regulations. Walker and Jones (2003) stress that in the wake of stiff competitions; companies manipulate the information regarding their true financial stand, which affects the performance negatively. Also, the idea is supported by French & O’Hare (2014), who contends on the need for management, to leverage on modern technology to boost the growth. The topic under study is split into sections (analysts’ forecast accuracy and financial reporting quality) to have an in-depth overview of the phenomenon.
Financial forecast experts normally referred to as analysts serve as intermediaries in the market, connecting the business owner to the market (Ashbaugh & Pincus (2001). They have skills and experiences that allow them to detect the changes in the economy, through use of data presented to them by the accounting department. Valuation is the only strategy that can be employed to clearly illustrate the prospects of the business (Ritter & Wells, 2006). It’s important to highlight that the financial reports rarely give the true information about a certain business (Ritter & Wells, 2006). According to Cheong et al. (2010) accounting standards limits the number of items that constitute an evaluation of the actual performance. He goes ahead to give an example of intangible assets, which are counted as expenses. Through their research, they noted that the regulators impose policies that mitigate inclusion of other information.
Hutira (2016) conducted a study among 100 companies listed in the stock market of Australia. He aimed to evaluate the effects of changing the regime of the Australian accounting standards, to the AIFRS system. To achieve his objectives, he employed quantitative methodology, which entailed collecting the information directly from the respondents. In other instances, the author used questionnaires and direct interviews to document the responses of the various participants. AIFRS was reported to have low quality compared to the previous system of the local accounting standards. The interviewed top executives reported that AIFRS eliminated some of the assets from the balance sheet, which affected the accuracy of the analyst. In response to the questions that were presented to them, they indicated that Australian GAAP was by far important to them, because it lowered the inconsistencies in the final data.
Espahbodi et al. (2015) raises the concern on the reliability of the IFRS, as a tool for making future prediction of the organization’s performance. The system would remove the intangible assets such as brand image, customer’s loyalty and mastheads, which are elemental in overall performance. Walker & Jones (2003) affirms that investment on such finite elements is important for the growth of any business. Thus, IFRS affects the accuracy of what the analyst present in the final report. Authors such as (Cheong et al., 2010) are of the idea that the change in accounting system has no impact on the accuracy of the analysts. Instead, the professionals should be equipped and be ready to adopt the changes in the market. In their proposition, they restate the argument of Ritter &Wells (2006), who relates the performance of the company to the skills of its employees.
In other words, changes are inevitable, and it’s the responsibility of the analyst to conform to new methods. In the same vein, factors that affect the accuracy of the financial forecast are discussed in the following paragraphs.
Earning management is useful in decision making. In the context of this research paper, earning management is defined as the actions that are employed by both the management and analyst in undermining the true value of the financial position (Walker &Jones, 2003). Literature document that the current disparities and unpredictable figures presented by various businesses emanate from the deliberate actions of the executive to misrepresent the organizations (Espahbodi et al.,2015). They do so with the intention of seeking to garner more customers and attract investors to partner with them.Hutira (2016) stresses in his research that the only way to shy off from wrong predictions is to invoke all standards that are stipulated by the regulatory agencies. The argument is supported by Ashbaugh & Pincus (2006), who details some of the factors that lead to business failure. Among them are unethical behavior from both the analysts &the management and false financial reports. Nevertheless, reporting the actual earning improves the quality of the forecast. Mukhopadhyay et al. (2011) holds a contrary opinion, based on the ethics that controls the actions of all professionals. In his research, he evaluated the impact of earnings management on the growth of large companies, using qualitative methodology. The results revealed that although the management concealed some actual figures of their finances, it had little effects. The companies that followed the reporting guideline provided by the regulatory bodies had more accurate data.
French & O’Hare (2014) defines forecast horizon as the time difference between the submission of EPS by the analyst and the final release by the company. Time is of the essence in the business realm. The economic cycles continually change, and the present figures might fail to make meaning when the management delays in reporting (Mukhopadhyay et al., 2011). Eames & Yongtae (2012) documents that time latency affects most of the companies and ends up making wrong decisions at different seasons of the year. For example, quarterly data cannot be used to make annual projections. However, when the former is read at the end of the year, investors and stakeholders take the information as final. Ideally, information must be used at the time it’s prepared. Hutira (2016) conducted a qualitative study to determine the factors that affect the forecast accuracy. The results achieved indicated that there was a linear relationship between forecast horizon and the error in the analysts’ forecast. The graph below illustrates the relationship that was achieved in his study (Hutira, 2016).
Figure 1: Relationship between analysts’ forecast and forecast horizon (Hutira, 2016)
Corporate Social Responsibility (CSR)
The predominant CSR has shifted from serving the objectives of the management (Acquire et al., 2011). In the present times, more efforts are directed to the effects the actions of an organisation have on the stakeholders (Acquire et al., 2011). The legitimacy of the company’s policies significantly influences the actual performance. Dhaliwal et al. (2011) observed a change in behaviour, where the CSR decisions are used to determine the nature of the investment to engage in. Moreover, investors are much inclined to support the companies that have embraced social consideration in their operations. Ioannou & Serafeim (2015) opines that the modern technology has changed the way of doing business. Currently, the top executives are integrating intangible assets, in establishing the best way to impact the employees and customers (Muslu et al., 2015). This disclosure enables the analyst to leverage of extra information, in giving an informed prediction.
Dhaliwal et al. (2012) conducted a study to establish the effects of CSR to the forecast accuracy. They engaged 1297 companies spread across 31 countries. There was linearity in the CSR reporting versus prediction error. The study showed a decrease in analyst prediction error, in companies where the disclosure of the corporate social responsibility reports were availed correctly. The authors note the importance of financial opacity as the tool to improve performances of the organizations. The results are supported by Ioannou & Serafeim (2015) who acknowledge the need for quality reporting on CSR, to heighten the accuracy of the analysts’ final output. To arrive at this judgment, they conducted a qualitative study of 614 companies in 42 countries. The firms that forwarded the correct CSR reports minimized the forecast error by 10% every year.
While other researchers such as Cheong et al. (2010) have focused on impacts of CSR reporting on analysts’ behavior, Dhaliwal et al. (2012) has capitalized on the direct impacts to the quality of the forecast. However, they all agree that quality presentation of the CSR is important in achieving the right financial information of the business. The disparity that is witnessed in the mentioned studies is how to control the CSR, to ensure the information that is presented to the analyst is correct. To get more insight regarding the issue, the results were tabulated by Ioannou & Serafeim(2015) relating CSR from companies sampled from different countries alongside the forecast errors.
Table 2: Relationship between forecast error and CSR reporting accuracy (Ioannou & Serafeim, 2015)
The table illustrates that the CSR performance has direct relationship with the forecast error. As the mean increases, the error decreases, and the reverse is true. Intangible assets are included when assessing the CSR strategies. Acquire et al. (2011) advocate for the inclusion of such elements, as they have been shown to reduce the analysts’ output. The literature discussed in this topic show a high correlation of accuracy of social responsibility reporting to that of financial prediction.
The operations of the businesses vary, based on what they specialize in (Abernathy,2010). According to John (French & O’Hare, 2014), the level of financial forecast differs from one industry to another, due to the variations in levels of production. Cheung et al. (2011) noted that some of the causes of such differences emanate from factors such as innate behaviors of the analysts. As it was eluded earlier, the skills and experiences of the experts have a linear relationship with the accuracy of the prediction. Less skilled experts provide inaccurate information, which misleads the entire organization. However, a well-informed analyst can detect the finite elements that are necessary for providing the correct output. Moreover, the stability of the business directs on the type of strategy the management employs to make future judgments (Michelon et al., 2015). For example, the startups have little capital, and they cannot be able to use complicated accounting guidelines. Hutira (2016) opines that such companies have no proper accounting records, thus proliferating the possibilities of recording manipulated information. The assertion is supported by Dhaliwa et al. (2012), who conducted a study among 400 companies, across 20 countries. He employed secondary sources of information and explorative design to investigate the adherence of the said businesses to the accounting standards. In his research, he found out that 20% of the sampled participants agreed that they follow the policies mandated by regulatory body. Subsequently, the group comprising of top executives stressed that the performances of their businesses dictated the kind of analyst they employed to perform the financial forecast.
Furthermore, aggregate coverage is another factor that affects the forecast accuracy. Ioannou & Serafeim (2015) contends that the number of items that are included in the books of accounts have a direct implication on the report compiled by the experts. In some of the industries, the analysts are required to refrain from adding any extant information. The management avail the data, which in most cases lacks important intangible assets information. Beest et al. (2009) noted that this trend is growing among large companies that face stiff competitions from the rivals. In his research to determine the causes of inaccuracy in forecast prediction, he noted that organization resort to faking data as a marketing mechanism. Nevertheless, the business owners should understand the nature of the businesses they operate, to assist in disclosing all the required information for proper analysis (Morhardt, 2010).
As noted by Downen (2014) and Cheung et al.(2010), the level of the financial forecast has been declining for the past ten years. In their studies, they indicated that the magnitude of the unpredictability of the market is enormous and is largely contributed by lack of goodwill by the management. Based on the sampled companies, the results revealed massive defiant to the simple accounting rules, which contributed to wrong recordings of finances. Again, the participants in the research commented that the changes in the economy were other factors that made it difficult to predict the future performance. Elbannan (2009) surveyed 50 large corporations listed in the Forbes and unearthed some interesting information. The results confirmed that the top management felt that pressuring exogenous environment affected their financial reporting systems, hence the inaccuracy of the forecast.
However, authors such as Cheung et al. (2010) believe that the forecast should not be affected by the prevailing economic environment. In their proposition, they argue on the need of any analyst, to derive meaningful information irrespective of the seasons in the market. Hutira (2016) supports the idea, by propounding that market is not perfect. Ups and downs of the markets have been there since decade, and the same is expected to happen in the future. Well experienced analysts should be able to use various tools, to make a clear judgment regarding the direction of the economy. The authors agree that financial position of a business should not deter predictions. If the financial crisis in the nation or within the business is experienced, a negative performance should be registered. He (2015) stresses that the financial prediction is not necessarily optimistic. It can be either way, which allows the organization to structure mechanism of mitigating the chances of making losses.
The performance of any business is strongly pegged to its ability to produce correct records of the operation. Honu & Gajevszky (2014) defines financial reporting as the revelation of statements that give the status of an organization to investors and other stakeholders. The information is used to seek partnership with financiers and also to comply with the Jurisdictions of the land. Public companies are compelled by the regulatory bodies to adopt the right procedures of availing theoretical financial reports to the market (Klai & Omri, 2011). The move is intended to increase the transparency of their operations and avoid unethical behavior of concealing pertinent data. Most of the nations such as the U.S are focusing on merging GAAP standards to IFRS, with the intention of heightening the quality of accounting recordings (Elbnan, 2009) in the same vein; the regulatory bodies all over the world are integrating various policies, to form a common international guideline. According to Usman (2013), different nations vary in the way they handle financial reporting. Some developing states have little consideration on ethical practices in reporting, which makes them vulnerable to the negative consequences. The evidence is presented by lack of established local companies. Most of the new entrants in the market succumb to the turmoil of the economy and ends up to closure.
Financial reporting is, therefore, paramount for any business that wants to progress in offering the services to the customers. Honu & Gajevszky (2014) noted some of the documents that should be accurately recorded. According to his research, he noted that a balance sheet is essential for both large and small organizations. It’s structured to reflect the assets and liabilities over a given period. A quick scan through this document allows an investor and the management to identify the true value of the company. Second, cash flow statement details the continuous performance. It is normally recorded on a daily basis, hence gives the actual standing of the firm. The executives can use the information to alter the internal factors such as labor, tangibles assets among others (Klai & Omri, 2011). Furthermore, income statements detail all the profits and losses made by the business. To have an understanding of the financial reporting, the following paragraphs will discuss some of the factors that influence its accuracy.
The analysts are influential professionals, who have direct impact on the kind of prediction an organization receives (Usman, 2013). They serve as intermediaries in connecting the management to the real situations in the market sphere. Due to this effect, they have a pertinent role in safeguarding the standards that are set by various regulatory bodies all over the world. Walker et al. (2013) argues that analysts understand and interpret sophisticated information more easily than a naive investor. Furthermore, they have broad access to resources; hence can process challenging data more easily. Therefore, when the financial analyst is provided with the correct accounting records, they can make correct forecast devoid of errors (Zang et al., 2013)
Downen (2014) noted that accounting standards affect the quality of reporting. In his research, he noted that the paradigm shift towards IFRS encourages disclosure of more elements of accounting. Based on this method, a fair value of the assets is presented as opposed to the traditional cost-based approach. Intangible characteristics such as loyalty of the customers, stakeholders’ views among others are considered in this new measurement method. Beest et al.(2009) argue that the new transition affects the performance of the business. For example, integrating the system requires adjustments of various internal assets, and also retraining the employees. This might affect the results if the management is not willing to adopt the changes. The shift signifies that IFRS gives a clearer picture of the actual performance of the company. However, He (2015) is of the idea that IFRS could lower the quality of accounting. He attributes it to the increased earning management, which would necessitate the top executives to hide some confidential information.
Empirical research (Cao et al.,2011)) attempted to compare the efficiency of IFRS to that of previous methods employed in accounting reporting. The results confirm that IFRS has more consideration of finite elements, which are ignored by ancient methods. The method takes more consideration of the economic value. The traditional approaches assume the normal assets and liabilities factors, without considering other external influencers.
Producing correct financial reports is determined by the nature of incentives the companies have to actualize this objective. Research conducted by Abernathy (2010) finds that US GAAP provides more faithful data compared to the IFRS. Based on the findings, they noted that IFRS is more inclined towards providing more relevant information. Moreover, Cao et al. (2009) surveyed fifty companies listed in the U.S stock market. He aimed to identify the impacts of adopting IFRS in presenting accounting records. The findings showed that the accuracy of reporting had increased significantly, after integration of the system.
Research conducted by Cheung et al. (2010) illustrate that adoption of the new accounting methods impacts the performance of an organization in different ways. One, the change could result in increased levels of errors reported in the final report. Second, he notes that the shift to a new method could reduce the inconsistencies experienced by use of traditional ones. Choi & Pae (2011) researched the impacts of IAS integration among the companies listed in the Australian stock market. He interviewed the top management and recorded their responses. Findings show that the IAS disclosed more information that is needed for projecting accurate performance of a particular business. Also, the convergences of policies and set out standards have a positive impact on the growth of the business. IFRS and IAS restrict the management to using the aspect of value, rather than employing liabilities and assets as the only measure of making future forecast. Furthermore, Downen (2014) argues that IASB has a direct influence on the performances of the analysts who are entrusted with the task of assessing the net worth of the company. Among the four hundred professionals who were interviewed by Downen (2014) they reported positive feedback concerning the role of IASB in the profession. In their responses, they cited exposure to more defined ways of doing things as an input in their career. However, the accounting standards are not the only measure of quality financial reporting.
The restatement is defined by Elbannan (2009) as the process of revising the previous financial reports. It is done with the intention of eliminating the conflicting information that might be different from the actual expectations of the company. The inaccuracies in the reports are negative show to both the customers and investors, who might have interest in partnering with the company. He (2015) identifies several factors that might necessitate financial restatements: one is financial frauds. According to his research, he established that the wake of modern technology had increased the cases of theft within the business. He cites cases of cyber insecurity from both external aggressors and employees to have a negative repercussion to the achievements of the goals and objectives. Second, noncompliance with accounting standards such as US GAAP is another factor that results in the restatement. Honu & Gajevszky (2014) in his research paper affirm that modern companies have little consideration of the guidelines set out by the regulatory bodies. They think that the management is not doing enough, to remain compliant. Due to this, organizations have resorted to the creation of their policies that do not conform to the international standards.
Financial statement from the auditor is the clear indicator of the errors in the books of the account. It’s the mirror to justify whether the required procedures were followed while assessing the worthiness of the company. Elbannan (2009) conducted a study to establish the effects of the financial restatement on the accuracy of the reporting. In his research, he sampled one hundred large companies in forty different countries. Using qualitative methodology, he found out that there was a linear relationship between the financial restatement and the quality of reporting (Khai & Omri, 2011). Furthermore, the organizations which embraced deep scrutiny from the auditors registered more accurate information. However, testimonies from respondents revealed a lot of errors from the previous reports.
Usman (2013) is of the idea that it’s the responsibility of the business owner to control the behavior of the analysts, to influence the output positively. While authors such as Walker et al. (2013) think that financial misstatements arise as a result of the auditor’s mistake, Zang et al. (2013) stresses on the importance of all the stakeholders in working together to achieve the common objective; of minimizing the errors in the final report.
The performance of any business relies on the behaviors of the customers, employees, analysts, among other stakeholders. According to Honu & Gajevszky(2014) every company should have a strategy on how to conduct their activities. Downen (2014) defines business ethics as a code of conducts set by regulatory bodies in guiding the employer and employee, on the best way to offer services without violating the jurisdictions of the land. A study conducted by Cao et al.(2011) affirms that high level of commitment to ethics results to accurate financial reporting. In his paper, he proposes that organizations that have close supervision of analysts make correct accounting figures. Ethics are related with the business culture in the sense that they complement each other. For example, multinational companies have a strong respect for their culture of quality and responding to the customers’ requests. To propagate their way of doing things, the employees follow suit. Downen (2014) argues that ethical considerations go beyond the internal policies, to following the standards set by regulatory bodies. The figure below illustrates the commitment of an organization to ethics and relationship with financial reporting (Abernathy,2010).
Figure 2: Relationship of corporate commitment with financial reporting
The entire leadership of an organization is essential in ensuring the reports that are released at various seasons conform to the accounting standards (Beest et al., 2009). In most cases, the responsibility of the management is not felt. They direct their energies in making profits while negating the very virtue of quality reporting. Despite employment of concerted efforts by regulatory bodies to restrict the companies to use the internationally recognized practices in financial reporting, manipulation takes precedence in some. Research conducted by Choi & Pae (2011) illustrates that the small companies alter the accounts records to attract investors and curb stiff competition posed by established businesses. The long-term effects are reflected in the form of underperformance and unsatisfied customers.
Corporate governance influences the quality of reporting adopted by a certain company (Elbannan, 2009). He noted that some of the external influences are such as government, investors, and customers. The assertion is supported by Klai & Omri (2011), who noted that the strategy adopted by an organization to report the financial stand is complemented by other playing factors. Based on the study, he argues that one of the most reported factors is the government influence. Some political leaders with interest in buying shares of a particular company make the management to alter the true value of the capital (Cao et al., 2011). They end up changing the data, to lure the potential partners. The practice is not healthy for the business since it can collapse due to incorrect decisions.
Abernathy (2010) defines auditing as an independent verification of financial reporting of the company. The auditor aims to cross check the accuracy and reliability of the report provided by the internal accounts team. Since assessing the performance is an integral process, care must be taken when conducting it. One of the variables that should be considered is the auditing committee (Cao et al., 2011). It comprises of a group of experts, who have excelled in the analysis of the business for a while. They supervise the entire process, by ensuring the activities of the contracted auditor conform to both the ethics and the accounting standards. According to Choi & Pae(2011), the committee members hire and scrutinize the skills of the expert. He further notes that the team works independently; therefore, the management has no control over their activities. This ensures that they can detect any form of manipulation. The team has a fundamental role in establishing a viable environment to provide the true reflection of the business. According to Abernathy (2010), the experiences and skills of the committee members influence the quality of the financial report. In his argument, he notes that organizations that employ highly skilled members register minimal errors in their reporting. Again, change of the committee (Downen,2014) impacts the output. He notes that continued reliance on one team increases the chances of self-interest engagements with management. Using different professionals at different times of the year allows the input of others people, who might factor in important elements of evaluation.
Previous researchers (Cheung et al., 2010) argue that inclusion of the financial experts on the auditing committee increases the level of accuracy of the financial reporting. They noted that professionals with knowledge of the performance of the economy are better placed in offering important solutions. Also, He (2015) affirms that the size of the firm accounts for the quality of the work performed by the auditor. A study conducted by (Zang et al.,2013)) among the large corporations listed in Forbes elucidated that the external fee paid out contributed to the accuracy of the financial reports. They portrayed a strong relationship between the amounts paid, to the loyalty of the experts. The authors found out that large corporation engages the most expensive auditing firms such as Deloitte, PWC, Earnest & Young, which provides them with more accurate and reliable information(Walker et al.,2013). However, the organizations should strengthen their internal compliance, before considering external inputs.
Reputation is defined by Abernathy (2010) as the outlook of the business to its customers, employees and other stakeholders. In the current sophisticated markets, large corporations work on their reputations as the differentiating factor in the market. This could be experienced regarding quality products, offering discounts to the customers, presenting correct financial statements, among others. According to Elbannan (2009) the reputation of the company is the basis for its operation in the market. An organization that serves a huge base of customers would prefer to disclose the correct information to avoid the chances of losing their loyalty. Choi & Pae (2011) contends that investors are attracted to the business that gives the true value of its stand. Therefore, a well-known brand sticks to the recommended standards of financial reporting to achieve a long-term reputation.
The accuracy of financial reporting and forecasting has for long been the point of concern for various regulatory bodies such as US GAAP. The international accounting standards are facing boycott from the organizations, which are resorting to use of internally designed methods of financial evaluation. Due to this effect, most of them risk closure as they base their decisions from already altered data. According to Usman (2013), there is a huge gap in the market in regards to the compliance of the standards. The literature reviewed depicted some of the elements that impact the accuracy of analysts’ forecast as: earning management, forecast horizon, corporate social responsibility, the size of the industry and financial crisis. The effects of each factor are different from the other. For example, forecast horizon is purely controlled by the management. They can decide when to report the financial positions. Contrary, financial crisis engages economic cyclicality, which are beyond the control of the organization. In such a scenario, more impacts are felt and change the method to use in evaluating the performance. Furthermore, the elements that affect financial reporting quality were identified as: adherence to accounting standards, auditing, business ethics and financial restatements. The information from the different authors confirms that businesses have continually ignored the right procedures of presenting their accounting records. One of the reasons noted by Downen (2014) is to improve the competitive advantage over the rivals in the market.
Static theory stresses the importance of reporting the liabilities and assets correctly, as the only way to make correct future predictions. The argument goes along with dynamic theory, which defines the success of a business as cumulative achievements over a long period. In other words, an organization should aim to trace the value, instead of focusing on making profits alone. This can only be achieved by use of the right financial reporting and prediction strategies. Far and above, economic theory confirms that the movement of the economy is difficult to predict, hence the need for more inclusive procedures in assessing the business. This research used secondary sources to evaluate the ideas of different authors concerning the topic.
Dhaliwa et al. (2012) conducted a study to evaluate the effects of earnings management on the accuracy of the financial forecast. They employed secondary sources collected from established business databases in the U.S. The results indicated that there was a direct relationship between earning management with the accuracy of the forecast. In the same vein Cheung et al. (2010) researched on the factors that cause errors in the financial reports, among 100 companies listed in the Australian stock market. In his work, he combined both secondary sources and direct interviews. The respondents affirmed that the skills of the analyst and adherence to the accounting standards influenced the projection of the future performance. This gives the current research a more focused inclination into using previous secondary sources. The literature reveals that characteristics of various stakeholders affect the accuracy of financial reporting and forecast. Also, organizations have failed to embrace internationally recommended auditing methods. Regulatory bodies should impose more policies to compel the management of different industries to integrate a common method of valuation.