Generally Accepted Accounting Principles (GAAP) allow managerial discretion, subject to certain restrictions, in determining financial reporting policies and procedures. This discretion makes earnings susceptible to manipulation, which has prompted some to question the desirability of allowing discretion in accounting choice (Sankar and Subramanyam, Reporting discretion and private information communication through earnings, Journal of Accounting Research, 2001, p.366).

Required:

1. Explain the motivations for earnings management.

(20 marks)

2. Critically discuss the above statement with reference to arguments for and against earnings management.