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The Corporate Finance Institute
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Accounting
Supply and demand of accounting information
The existence of information asymmetry creates a supply and demand
for financial reporting. Financial reporting is the preparation of
information about the reporting entity and the transmission of that
information from those who have it (supply) to those who need it
(demand). Suppliers of accounting information refer to accountants and
the body that produces the financial statements. Those who demand
the information refer to internal/external users who require that
information to make investment decisions.
The Purpose of Financial Reporting
Although the specific objective and purpose of financial reporting may be
different for different accounting bodies, the general theme is highly
similar. According to IFRS, the objective of financial reporting is to
“provide financial information about the reporting entity that is useful to
existing and potential investors, lenders and other creditors in making
decisions about providing resources to the entity. Those decisions
involve buying, selling, or holding equity and debt instruments, and
providing or settling loans and other forms of credit.” IFRS also states
that these decisions depend on the user’s expectations on the risk,
amount, and timing of future net cash inflows of the reporting entity.
Those decisions involve buying, selling, or holding equity and debt
instruments, and providing or settling loans and other forms of credit.”
IFRS also states that these decisions depend on the user’s expectations
on the risk, amount, and timing of future net cash inflows of the
reporting entity.
Positive financial accounting theory
Given the non-ideal market that we live in today, it is only natural that
management will take advantage of this information asymmetry.
Although company perceptions are important, managers are
predominantly concerned with ways of maximizing their perks
and their compensation. This is commonly referred to as earnings
management, or management’s efforts to influence financial information
in one way or another. Therefore, there is a theory called positive
accounting theory that tries to understand a manager’s motivations,
accounting policy choices, and reactions to different accounting
standards. Some reasons why earnings management is done may
include the following reasons:
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