Accounting numbers take part in an importance role of decision making, contracting and stewardship. Besides, accounting numbers are used mainly for decision making. They are also measures used in management compensation contract because of the following reasons: According to Ross et al (2011), in order to motivate managers act in the shareholders’ interests. It is known that a company is owned by its shareholders but the management is separate from the ownership. This means the owners (shareholders) will employ someone else to manage the company and represent their interest.
The management may be concerned about salary ,position ,security of the employment while the owner s are concerned about investment opportunities, growth, risk, profit ,wealth maximization…etc. It is possibility that there is a conflict of interest occurring between the owner and the manager. Therefore in order to avoid this agency problem and to put closely the interest of owners and manager , the managers are compensated basing on the performance of the firm through accounting numbers. They are those numbers such as return on assets, net profit after tax, assets, liabilities, the profits and sales of the firm…etc .
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As Deegan (2010) suggested the ways that managers are compensated such as share of profit of the firm or better performer will get higher salaries and are promoted. Also, managers are rewarded when share price in the market increasing because managers are compensated with the option to buy share of the company at fixed price that usually below the market price so higher share price, higher compensations they earn. Moreover, company use accounting numbers to compensate managements because of attracting and retaining caliber and valued managers to produce value for shareholders and wealth for the company.
However, also according to Deegan, this incentive method causes negative effects on accounting numbers that managers have a tendency either to manipulate those number , for example falsifying the revenue and expense accounts to increase their own personal wealth or using accounting techniques to focus increasing income in the short term instead of the long term. As the result, the company will face costs that are too expensive such as bonding cost (paying bonus on accounting numbers), monitoring cost (Hiring auditor to measure financial statements of the company).
In conclusion, using accounting numbers as a tool to compensate management in the company have huge advantages that management have an effort to perform well to maximize shareholders’ wealth and receive rewards correspondingly . Besides, this approach has some disadvantages as well. In addition, all the existing accounting standards can not cover all type of transactions and events in producing the financial statements . Therefore, as owners (shareholders) of the company have to keep an eye, closely monitor the management and replace them where inappropriate behaviors occurring.
Part B As is stated by Sivabalan at al (2011), one of companies that uses accounting numbers in their management compensation contracts is JB Hi-Fi Limited. For example, at JB Hi-Fi, remuneration of senior executives are compensated based on specified performance targets such as if Sales revenues increasing up to 17. 4% in 2010 or the Earnings before interest and tax (EBIT) grow 23% to $175. 1 million (2010) they will get additional bonuses and a portion percentage of those increasing in their salaries. Part C
According to Janda on ABC transcript report on 28th of May 2012, senior management in Hasties company took part in amending accounting results to make them look better. In particularly, they hided the loss of $20 million in its financial year 2008/2009. The managers are attracted in producing good earning results to enhance company performance in order to receive huge remuneration, bonus and increase their own personal wealth because their reward based on the strength of company’s financial performance . In addition to this ,the company’s share price rise will attract more investors investing in the company to develop its growth.
This lead some managers to make fraud and unethical accounting decisions. For example, the number of accounting scandals at Enron, World Com ,HIH and other companies…showing that falsify true performance of the company such as at WorldCom, mangers made fraud of 11 billion as the result of inflating profits and hiding expenses or at Enron managers were corrupted of 4 billion when hiding debt (Sivabalan et al, 2011). Consequently, it is unlikely that the management of Hasties pay back the 20 million to the company because of they are greedy and have great incentives to spend on that money.
On the other hand, fraud is a criminal offence which managers of Hasties may be sentenced to jail. Whatever accounting errors occurs, managers still are responsible for the duty of care and they are facing of convicted of serious offence. Hence, under the law they may be required to return those money even though they want to do or not. Therefore, the senior management of Harties will return those money on the ground that the law force them to pay back and also in order to reduce following serious consequences that will apply to them.
Deegan, C.(2010), Australian Financial Accounting, Australia, McGraw –Hill Janda, Michael (2012), Hastie collapse engineered by hiden losses, viewed 18 August 2012, <http://www.abc.net.au/pm/content/2012/s3512834.htm > Ross, Trayler, Bird, Westerfield & Jordan, S.R.R.R.B. (2011), Essential of Corporate Finance, Australia, McGraw -Hill Sivabalan, Tyler, Wakefield & Thiagarajah, P.J.J.T. (2011), Accounting for Business Decisions, Custom, McGraw-Hill