CPA Requirements: Using Accounting for Management

Financial accounting numbers can also be used to influence the business decisions of managers, investors, and creditors, who provide a company with its capital, can direct and monitor the actions of its managers by requiring that their contracts be written in terms of accounting numbers.

Stockholders have incentives to encourage management to act in ways that maximize the present value of future dividend payments and stock price appreciation.  Since such returns depend on a company’s earning power and long-run profitability, stockholders want management to make business decisions that maintain high levels of earning power.  A common method used to attain such a goal is to base a significant portion of management’s compensation of reported profits.  Such compensation scheme, which are set by a company’s board of directors, can lead to payments either in the form of cash or shares of stock.  Exxon Corporation, for example, has implemented a management incentive program that pays eligible employees a percentage of the company’s earnings if net income in a giving year exceeds 6 percent of invested capital (as defined in the bonus plan).  These bonuses have been paid in both cash and shares of Exxon common stock.  When studying to get your CPA requirements you will learn the importance of accuracy when gauging the numbers of a company.

Creditors are also interested in protecting their investments by influencing the business decisions of management.  They are concerned that companies may not be able to meet their loan obligations because company assets may have been 1) paid to the shareholders in the form of dividends of purchases of outstanding stock, 2) pledged to other creditors, or 3) mismanaged.  To reduce the probability of such events, a creditor may restrict certain business decisions of managers as a condition of the loan.  Such restrictions are written into the loan contract and expressed in terms of financial accounting numbers.

 

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