2.

0 Literature Review
2.1 Conservatism and its effects on accounting measurement
Conservatism in accounting has been the topic of empirical research for many years.
Conservatism has been a long-term trend and concern in the accounting profession. It had
affected the accounting practices in the past and would continue to do so in the future.
Adaptation of accounting conservatism, according to Alkurdi et al., 2017 reasoning, is beneficial
in alleviating agency difficulties, improving contractual agreements, lowering litigation
expenses, and also helps for decision making. The link between ownership structures and
accounting conservatism is substantial, with the structure influencing the amount of accounting
conservatism and providing more dependable financial reporting. Smith et al., 2008 contends
that there is a good and substantial link between ownership and accrual conservatism, which
resolves information asymmetries and monitoring opportunistic managerial choices and actions,
resulting in more transparent financial reporting. Conservative accounting is preferred by high-
profit businesses because it reduces conflicts of interest between owners and creditors and
improves the reliability of the company's accounting information, making it more trustworthy to
consumers. Mora & Walker (2015) asserts that financial reporting's academic significance is
based on neutrality, while its efficiency is based on accounting conservatism. The lack of
accounting conservatism in the IASB project rendered the conceptual framework incompatible
with neutrality and the possibility for misapplication of the idea to control earnings. He claims
that accounting conservatism is critical for financial statement preparation and the IASB's
standard-setting process. Managers are in a position of knowledge asymmetry, and they have
incentives to manipulate earnings in their favor. As a result, conservatism plays a key role in
limiting managers' opportunistic behavior by making it costly for them to stray from reporting
the firm's genuine economic profitability.

2.2 Earnings management tools and its effectiveness

There are various ways of manipulating earnings management. Sun and Rath (2010) in there are
article have identified six of the ways that the managers use to show their reports in positive
light. It includes accounting choices, real transaction, discretional accruals, specific accrual,
earnings distribution and income smoothing. It was pinpointed by the Sun and Rath (2010) that
Managers may prefer to manipulate earnings via accruals from the standpoint of manipulators.
GAAP is the product of accruals. Managers can make adjustments to cash flows using accruals
under the accrual accounting method. Accruals may be preferred by management since they are
less obvious and do not need disclosure. Accruals are made up of a variety of estimations and
transactions, the overall impact of which on accounting results is neither reported nor easily
calculated. Any change in accounting choices or actual transactions, on the other hand, must be
disclosed, making managers' discretion easier to monitor. (Sun & Rath, 2010) Similarly the
finding suggests (Irani and Oesch 2016) that managers respond to the lack of coverage by
reducing actual profits management while increasing accrual manipulation. These impacts are
much larger among companies with less coverage and those nearing the zero-earnings threshold.
However, managers utilize real earnings management to boost short-term performance in
response to analyst pressure, impacts that are missed when using accrual-based approaches
alone.

2.3 Conservatism and Earnings Management relationship

According to Krismiaji and Astuti (2019) conservatism in accounting affects the earnings
management positively. Their research was based on proving that having conservatism in
accounting measures leads to increase in the accrual earnings management. Thus, the study by
him indicated the use of conservatism in accounting leads to increase the earning management.
However, (Abed, et al, 2012) provides proof that conservative policies aid in the management of
earnings. There is negative relationship existing between the discretionary accruals and
accounting conservatism. This article is contrary to the above one as it had revealed that there is
negative relationship between earnings management and conservatism. Similarly, there is
negative association of conservatism and real earnings management and “the effect of the
negative association between accounting conservatism and earnings management would be
amplified if the businesses' financial debt was larger”. (Li, 2019).

Moreover, over the years, empirical study has revealed that the employment of conservative
practices and earning management can impact the quality of earnings. The findings revealed that
accounting conservatism and earnings management had a substantial negative association with
earning sustainability conservatism and earnings management both has negative effect on
earnings quality. (Delkosh & Sadeghi, 2017)
2.4 Challenges of using Conservatism and Earnings Management in accounting
According to (Owais 2021) the use of conservatism in accounting, have negative impact on the
intellectual capital of the firm. The example of the pharmaceutical and medical sector of Jorden
was given as an example whereby the IC is negatively affected by the use of conservatism in
accounting. Their findings suggest that accounting conservatism in Jordanian pharmaceutical
businesses is negatively related to IC performance in their operations. The challenge here is how
the medical firms and pharmaceutical would recognize Intellectual and intangible asset and
would ensure that the use of conservatism do no adversely affect the use of IC.

Additionally, it becomes a challenge for the external auditors and the government regulators to
identify use of earnings management that increase fraudulent activates thus have to take extra
precautions when going over the financial reports. It also becomes difficult for the managers to
satisfy and meet the needs of all the users of the financial reports. Thus, this would lead to use of
excessive earnings management tools whereby there would misrepresent their financial
statements. (Obigbemi, et al., 2016)
3.0 Research Objective
1. The main objective of this research project is to investigate and compare the level of
conservatism in accounting policies adopted by FMF and Punjas.
 To find out the effects of using conservatism in accounting measurement.
2. Examine the effect of such measurements on earnings management of FMF and Punjas as
two major manufacturing companies in Fiji.
 To identify the earnings management tools used by FMF and Punjas
 To discover the effectiveness of the earnings management tools
 To identify the relationship between conservatism and earnings management
3. The challenges associated with using conservatism and earnings management in
accounting measurement in both the companies
4.0 Theoretical Underpinnings
4.1Agency theory
According to agency theory, the principals and agents' interests are not always aligned, thus the
principal chooses agents to manage resources and make important choices on their behalf. The
theory focuses on the nature of stakeholder-agent relationships, including how successful they
are and where possible conflicts of interest and ethics exist as a result of divergence and
information asymmetry. A conflict of interest can result in agency costs, such as management
actions that aren't in the best interests of shareholders. To defend their actions, managers may
manipulate reported earnings. Results management may result in an agency cost, which occurs
when investors make poor investment decisions based on stated earnings. In a circumstance
where a firm has a large free cash flow, the manager may participate in earnings management in
order to improve the company's performance. The agency theory can be used to explain this
relationship (Kazemian, & Sanusi, 2015).

Financial statements are an indication of economic reality due to agents' selective and accepted
reporting of economic events by various accounting systems, exacerbated by alternate
accounting procedures and assumptions. The proclivity for deferring accounting recognition of
some transactions shows that financial statements are out of step with reality. The agency
problem refers to the distinction between actual and imagined realities. The risk attitudes of
principals (shareholders) and agents are a key feature of this dilemma (management). In terms of
individual enterprises, shareholders are thought to be risk averse. They have the ability to
diversify their stock holdings across numerous companies. Palliam, & Shalhoub, 2003) On the
other hand, agents' security and income are firmly bound to a single company. It's not
unexpected to discover agents that are risk averse while making business judgments. The risk-
neutral shareholders who desire that agent maximize their profits are immediately drawn to the
opportunity costs that occur. In the principal-agent relationship, the risk differential between
agents and principals causes a difficulty. Supervisory and incentive alignment procedures that
change agents' risk orientation are built up within this framework. Agents are influenced by
powerful incentives when they exercise their judgment, especially when the judgment might
result in a stock market reaction that affects the organization in a variety of ways. Agents are in
charge of overseeing earnings. Not all of the strategies employed to reach this aim are equally
beneficial in the eyes of a principal. Agents can either boost productivity or influence
profitability by intentionally manipulating accounting decisions. The latter strategy does not need
any productivity adjustments. (Palliam, & Shalhoub, 2003)
5.0 Research Methods
The methods which were used to collect information pertaining to the completion of this report are as
follows:

Participants

Two people who were interviewed were, firstly, Sharol Narayan who is a Financial Account of FMF Foods
Limited. Secondly, Moshin Ali who is the Internal Audit Manager of Punjas Group Limited.

Material

The questions were created and sent to the above mentioned people that we had individually
interviewed. We were able to obtain information from the respondents via email.

Research

The report was also created using secondary data. The majority of the material was obtained from the
annual financial reports of the two companies.

Online research was also done using the online resources from USP Library. These were mostly journal
articles from ProQuest.

Online sources such as company website and business publications were also very helpful in providing
relevant information about the two companies.

Procedure

The questions were prepared and sent to the respective respondents via email due to the movement
restrictions of COVID-19. The respondents were given a week of time to submit their responses. The
final step was to compile the data provided by the interviewees and to analyze that data and prepare a
comprehensive discussion based on their responses.
6.0 Analysis and Findings
6.1 Analysis

Figure 6.1.1 Does The Company Use Conservatism

Principle?

Punjas Group Limited

FMF Foods Limited

0 20 40 60 80 100 120

No Yes

The Fig 6.1.1 above illustrates whether the companies use the principle of Conservatism in its practices.
Both, Punjas Group Limited and FMF Foods Limited have responded positively towards this as they both
incorporate Conservatism Principle in its practices and preparation of its financial reports. Conservatism
principle is based on the foundation of reliability and accuracy wherein the stakeholders require reliable
information to be presented in the financial statements. The application of conservatism principle ensures
that the appropriate estimates are factored into the accounts of the company so as to not inflate the results
and only recognize gains when they are realized while any losses are recorded when they are determined
to have an impact on the accounts. This ensures that the financials are prepared with a high degree of
verification and accuracy. Both companies have been using Conservatism Principle since the business
was established and had maintained its financial statements.
 Figure 6.1.2Did the company encounter any is-
sues when putting the conservatism principle in
place?
Yes No

50% 50%

The data shown in Figure 6.1.2 was collected and compiled after conducting interviews and reviewing the
financial statements of both the companies. FMF Foods Limited stated that the issues encountered by the
company after the implementation of the conservatism principle was calculating reliable and almost-
accurate estimates that are taken up in the books of accounts and also getting the estimates close to the
actuals is a bit of challenging situation however, over time, standards have been maintained and
accordingly passed in the books. The Punjas Group Limited however stated that the company did not
encounter any problems when implementing the conservatism principle but if the accountant wants to
overstate the profit then this principle can be ignored in order to show higher profit to shareholders.
 Figure 6.1.3 Does the use of the Conser-
vatism principle have an impact on your
company’s Earnings Management?
Yes No

50% 50%

Fig.6.1.3 above shows that the use of the conservatism principle had an impact on the FMF Foods
Limited earnings management whereas it had no impact on Punjas Group Limited’s earnings
management. FMF Foods Limited ensures that the conservatism principle does not hugely impact on the
earnings management as the company is focused on providing accurate and reliable financials to its
stakeholders. Thus, the earnings management is not significantly impacted. Punjas Group Limited stated
that the conservatism principle does not affect their company however they also provided explanations on
when it can occur. They stated that it can happen in other companies when there is pressure from
shareholder to increase earning and the accountant will tend to deliberately manipulate the profit in order
to have a good financial statement.
Fig. 6.1.4 depicts how the reports are prepared in the two companies. FMF Foods Limited has its reports
prepared externally while Punjas Group Limited has its reports prepared both internally and externally. It's
important to keep in mind that both companies keep their own books and prepare their own interim and
yearly financial statements. Both companies have internal auditors that conduct the audits internally.
However, Punjas Group Limited also has its annual reports prepared externally. External auditors are
assigned to prepare the reports of Punjas Group Limited. This can be an effective way of comparing the
financial reports prepared both internally and externally. As it would be enable the management to detect
errors or alterations in the reports should there be any different conclusions in the reports prepared by the
individual auditors. It would give a clear picture of the company’s financial status since the reports would be
prepared internally and externally, making it easier to cross-check the data and information in reports.

6.2 Discussion
This research was mainly conducted to find out the effects of using the principle of Conservatism in
accounting measurement in FMF Foods Limited and Punjas Group Limited. After reviewing results from
the interview, the Financial Accountant of FMF stated that “Conservatism principle is based on the
foundation of reliability and accuracy wherein the stakeholders require reliable information to be
presented in the financial statements. The application of conservatism principle ensures that the
appropriate estimates are factored into the accounts of the company so as to not inflate the results and
only recognize gains when they are realized while any losses are recorded when they are determined to
have an impact on the accounts. This ensures that the financials are prepared with a high degree of
verification and accuracy” (Narayan , 2021). Internal Audit Manager of Punjas Group Limited, however,
stated that “Expense provision and Accrual are taken up in accounts to show the correct financial
performance of the company. Expected Income such as insurance claim receivable is less likely taken up
in accounts when using conservative approach” (Ali, 2021). The interviewees were also asked if their
respective companies had encountered any issue while putting the conservatism principle in place, to
which the financial accountant of FMF responded “The issues encountered are calculating reliable and
almost-accurate estimates that are taken up in the books of accounts. Getting the estimates close to the
actuals is a bit of challenging situation however, over time, standards have been maintained and
accordingly passed in the books” (Narayan , 2021). In contrast, the Internal Audit Manager of Punjas
responded that “There were no issues encountered while putting the Conservatism principle in place, but
if the accountant wants to overstate the profit then this principle can be ignored in order to show higher
profit to shareholders” (Ali, 2021).

To add on, the use of Conservatism principle has an impact on the earnings management of FMF Foods
Limited as “The company ensures that conservatism does not hugely impact on the earnings management
as the company is focused on providing accurate and reliable financials to its stakeholders.” (Narayan ,
2021). The Internal Audit Manager stated that “the conservatism principle did not have an impact on their
earnings management; it can happen in other company when there is pressure from shareholder to
increase earning and the accountant will tend to deliberately manipulate the profit in order to have a good
financial statement” (Ali, 2021). The interviewees were also asked if there were any benefits or losses
incurred in the earnings management of their respective companies after adapting the conservatism
principle. Respondent of FMF said that “It all depends on the level of conservatism taken. The more
conservative approach, the weaker results at bottom line and the vice-versa, however, the focus is always
on providing accurate results” (Narayan , 2021). However, the respondent from Punjas stated that “it was
not the case for Punjas, benefits of using this principle that you will have accurate financial performance
and position for the business and correct decision can be made. Losses will be when wrong financial
decision are made, such as bank financing the company loan based on inflated high EBITA, but in fact
the company is not able to service the loan, which can result in bankruptcy” (Ali, 2021). The interview
conducted also highlighted some risk management techniques used by the respective firms. In FMF Foods
Limited, “the company has a Risk Management Policy whereby the Board is entrusted with providing
oversight and monitoring the effectiveness of the risk management policies. It ensures that appropriate
internal control mechanisms are in place. Furthermore, the senior management is handed the task of
implementing these policies and identify the key business and operational risks. Additionally, the
mitigation of these risks needs to be also considered” (Narayan , 2021). Likewise, Punjas Group Limited
incorporates “data analysis and contingency planning” as its techniques for risk management” (Ali, 2021).
Data analysis assists in taking the speculation out of managing risk-related issues by utilizing a
variety of tactics and technological advances to generalise observations, calculate possible
options, and forecast future occurrences. Contingency planning helps to mitigate the risk's impact
once it arises. Without a strategy in place, the risk's full consequences might have a significant
influence on the project. The contingency plan is the final line of protection in the event of a
disaster.
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