Issues in Management of a Public Limited Company

Lecture- IA (BECG)

Prof. C. Anand Faculty IBS, Hyderabad

Contents
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11.

Corporate Objectives/Goals Ownership Pattern Revisiting Corporate Goals Ethics in Managing Creative Accounting (CA) Ways of committing Frauds in Financial Statements Characteristics of Management Prone to Fraud Classification of CA Practices Expected Rewards for Resorting to CA methods Problems relating to CA Prevention of CA

Culture consists of shared values, beliefs, and norms of the organization, which grow over time, based upon the assumptions of what it takes to be successful.
. this can lead to corporate failure
3

1. Corporate Objectives/Goals

Objectives/Goals are end points towards which activities are aimed. Objectives are the results to be achieved and are verifiable if it is possible, at the end of the period, to determine whether or not they have been accomplished. Managers should determine the number of objectives they should realistically set for themselves by analyzing the nature of the job and how much they can do themselves and how much they can delegate. In any case, managers should know the relative importance of each of their goals.
4

Management by Objectives (MBO)

MBO is a system of managing. MBO is a process consisting of setting goals at the highest level of the organization, clarifying the specific roles of those responsible for achieving the goals, and setting and modifying objectives for subordinates. Goals can be set for line as well as staff managers or personnel. Goals can be qualitative as well as quantitative. MBO results in better managing, often forces managers to clarify the structure of their organizations, encourages people to commit themselves to their goals, and helps develop effective controls.
5

Examples of Corporate Objectives

Shareholders wealth maximization Total Computerization Profit maximization Developing better managers Productivity Improvement Globalization Sales maximization
6

Hierarchy of Objectives:
A. Top-Down Approach:
Socio-economic purpose Mission Overall objectives of Organization (Long range and Strategic) More Specific Objectives (Key Result Areas - KRAs) Division Objectives Department and Unit objectives Individual Objectives (Performance and Personal Development) B. Bottom-up Approach (Reverse of TDA)
7

Objectives of a University

Attracting highly qualified students Offering basic training in professional fields Granting Ph.D. degrees to qualified candidates Attracting highly regarded faculty Discovering and organizing new knowledge through research Operating a school thru gifts of alumni.
8

2. Ownership Pattern
A. Forms of Business organizations in India: Sole Proprietorship (Ownership and control are united in this one individual, who is identified as the entrepreneur). Partnership (Two are more persons associate in economic activity by pooling their resources or efforts together). Corporate Sector (Pvt. & Public Ltd Cos.) Pvt. Ltd. Co. means limited members (50) and can not go public. Founders retain control. Public Ltd. Co. is large, no limit for members and can go public to raise resources to finance big projects.
9

2. Ownership Pattern (Contd.)

Multinational Companies ( As wholly owned subsidiaries or joint ventures or as licensees. MNCs HQ is located in Home country and other branches/offices are located in various Host countries) Co-operatives (Producers association of workers, Consumers association of consumers to buy collectively and share the profits, Credit &Thrift Cooperatives members save and grant loans to members at low interest rates) Public Enterprises (Departmental undertakings are controlled by Govt. Departments; in Govt. Cos. Govt ownes 51% of share capital or more; and Public Corporations are statutory bodies) Joint sector Companies (Largely public resources 10 and pvt. promoters managerial skills)

2. Ownership Pattern (Contd.)

B. Ownership Pattern of Organizations: Public Sector [ (i) Departmental Undertaking like Railways
coming under the control of a Government Department, (ii) Government Company like BHEL, a Joint Stock Company where 51% or more shareholdings are owned by Central/State Governments and Public Corporations like Statutory Bodies viz. MMTC, FCI etc. which are autonomous but accountable to Parliament)

Joint Sector (26% by Public Sector and 25% by Pvt Sector and rest by general public) Private Sector (Wholly private sector or predominantly private sector)
11

3. Revisiting Corporate Goals

At the planning stage, a corporation sets its goals. The goals are consistent with the corporate objectives, which are based on business priorities, deliverables, enablers and satisfiers. Deliverables focus on achieving excellence; enablers are the infrastructure and the people working for the organization and their skills; and the satisfiers include those enhancing the customer service and providing information to the public policy making decisions. Additionally, there is an overall corporate strategic objective for Financial Management.
12

3. Revisiting Corporate Goals (Contd.)

The principal objective of a private sector firm is to make a profit. But the objectives of public sector enterprises are often conflicting in nature they have to strike a balance between making a profit and providing public services. Nowadays, even large private sector companies are much concerned about the effect of their operations on the life and welfare of the community, by revisiting their goals.
13

4. Ethics in Managing
All Persons, whether in business, government, university, or any other enterprise are concerned with ethics. Ethics is defined as the discipline dealing with what is good and bad and with moral duty and obligation. Thus personal ethics has been referred to as the rules by which an individual lives his/her personal life. Accounting ethics pertains to the code that guides the professional conduct of accountants. Business ethics is concerned with truth and justice and has a variety of aspects such as expectations of society , fair competition, advertising, public relations, social responsibilities, consumer autonomy and corporate behavior.

14

5. Creative Accounting (CA)

Creative accounting (CA) refers to accounting practices that may or may not follow the letter of the rules of standard accounting practices but certainly deviate from the spirit of those rules. They are characterized by excessive complication and the use of novel ways of characterizing income, assets or liabilities. The terms "innovative" or "aggressive" are also sometimes used.
15

5. Creative Accounting (CA) (Contd.)

CA refers to systematic misrepresentation of the true income and assets of corporations. CA is at the root of a number of accounting scandals, and many proposals for accounting reforms usually center on an updated analysis of capital and factors of production that would correctly reflect how value is added. Newspaper and television journalists have hypothesized that the stock market downturn of 2002 was precipitated by reports of accounting irregularities at the Enron, Worldcom, and other business entities in the United States.
16

5. Creative Accounting (CA) (Contd.)

CA includes (i) Improper Revenue Recognition; (ii) Misreporting Expenses; and (iii) Self-Dealings. One commonly accepted incentive for the systemic overreporting of corporate income which came to light in 2002 was the granting of stock options as part of executive compensation packages. Since stock prices reflect earning reports, stock options could be most profitably exercised when income is exaggerated, and the stock can be sold at an inflated profit. Enron scandal led to the Sarbanes-Oxley Act to curb such activities.

17

5. Creative Accounting (contd.)

Earnings management usually involves the artificial increase (or decrease) of revenues, profits, or earnings per share figures through aggressive accounting tactics. Aggressive earnings management is a form of fraud and differs from reporting error.

18

6. Ways of committing Frauds in Financial Statements

Fictitious Revenues (These are shown in books, but not earned. This is done by booking non-existent revenues by creating journal entries by debiting accounts receivable and crediting sales. Sometimes false sales are shown to existing customers. Smart accountants select transactions with a few major customers like large organizations and government agencies that they will be difficult to confirm. Sometimes major vendors are willing to confirm false confirmations to the auditors. But these accounts can be detected by verifying unusual journal entries and other supporting documents.)
19

6. Ways of committing Frauds in Financial Statements (Contd.)

Improper or Fraudulent Disclosures or Omissions (GAAP requires adequate disclosures and fraudulent disclosures or omissions materially mislead the investors. Any material facts not covered in the financial statements should be disclosed in the foot notes) Creative Accounting (This is done creatively valuing or manipulating the stock and the workin-progress. Cash can be manipulated by varying the timing of payments and receipts.)
20

6. Ways of committing Frauds in Financial Statements (Contd.)

Fraudulent Timing Differences ( Assets and income can be overstated by taking undue advantage of accounting cut-off period to either boost sales and/or reduce liabilities and expenses. Such differences can be eliminated by early revenue recognition and delayed recording of expenses.) Concealed Liabilities & Expenses (These are not shown in the financial statements. These occur when companies do not record certain liabilities or understate contingencies, warranty costs / liabilities and report only revenues when cash is received.)
21

6. Ways of committing Frauds in Financial Statements (Contd.)

Fraudulent Asset Valuation takes place in estimating falsely stating its value or methods of valuation from and so on).

(This usually inventory by changing the FIFO to LIFO

22

7. Characteristics of Management Prone to Fraud

Unduly aggressive financial targets Domination by person or group without controls Major performance-related compensation Pressure to reduce tax liabilities Aggressive accounting policies to keep stock prices high Inadequate monitoring of significant controls
23

8. Classification of CA Practices

Recognizing Pre-mature or Fictitious Revenue Aggressive Capitalization & Extended Amortization Policies Misreported Assets & Liabilities Getting Creative with the Income Statement Problems with Cash Flow Reporting
(Source: Financial Numbers Game: Detecting Creative Accounting Practices. Authors: Charles W Mulford & Eugene M Comiskey)
24

9. Expected Rewards for Resorting to CA methods

Favorable Effect on Share Prices Lower Corporate Borrowing Costs (Due to Improved Credit Rating) Incentive Compensation Plans for Corporative Officers/Key Employees Political gains

25

How to Detect CA?

Ask the following questions: 1. How the company makes money? 2. How is it accounting for money?

26

10. Problems relating to CA

CA masks the true and fair view of a Co. CA fools the market. Its prevention and detection is difficult. Practicing CA is unethical and fraudulent (illegal). CA is a growing issue in many countries CA is manipulation of accounts (numbers) and misleads the investors, creditors and general public.
27

11. Prevention of CA

1. 2. 3. 4. 5.

Those companies most at risk for fraudulent financial reporting tend to be those that have one or more of the following attributes:Weak Internal Control No Audit Committee A Family Relationship Among directors and/or Officers Low assets and Revenue (less than $100 Mn.) A Board dominated by Individuals with Significant Equity Ownership and Little Experience serving as Directors of Other companies.
28


1.

Steps for Prevention of CA:

Accountants and Managers should divide the duties of an internal control checklist. An independent Audit Committee should always have some one with a strong accounting background and audit experience who deals directly with outside auditors.
29

2.

The End

30