Analyze the case and respond to the following questions: a) Discuss the earnings management techniques employed by the management of Satyam. Earning management or creative accounting is referred to the manipulation or misrepresentation of the company’s financial earnings in order to achieve stable and positive financial position. This was achieve through directly or indirectly use of the accounting methods. Even though the manipulation may follow all the accounting standards and laws, they may go opposite of what the standards and laws were originally trying to establish.
Therefore, earning management is often considered materially misleading and referred to a fraudulent activity. Satyam Computer Services is a leading Indian outsourcing company which provides a wide range of information technology services. However, this company was involved in earning management where in 7 January 2009 it was publicly announced that the Chairman, Ramalinga Raju confessed that Satyam’s accounts had been falsified. By referring to the Satyam case, one of the earning management technique used by the management of Satyam is off-balance sheet financing which an asset or debt was not disclose in the company’s balance sheet.
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This can hide the company’s true financial state. In Satyam case, Ramalinga Raju had understated the company’s liability of US$ 261. 99 million on account of funds and he had also overstated the debtor’s position of US$ 104. 37 million as against US$ 564. 66 million. The amount was so significant that the financial statement was not showing the true position of the company. The other technique employed by Satyam is through income recognition where Raju had adjusted the profit figures from one year to another year resulting into inflated profits.
As in the Raju’s letter, he had confessed that he was manipulating the reported revenue for September quarter of Rs 2,700 crore as against the actual revenues of Rs 2,112 crore. Raju manipulated this revenue figures in order to increase the company’s profit figures and show a better financial performance. However the gap between actual operating profit and the one reflected in the books of account continued to grow over the years and Raju finally failed to eliminate this gap. Satyam had also created the fictitious revenue in order to manipulate his profit figures so that he can meet the shareholders expectation.
This earning management technique was applied by creating a non-existent accrued interest of US$ 80. 09 million to the books of account of Satyam. When this amount created, the revenue of the company will increase and finally boost up the company’s operating profit and shows a good company performance to the users of their financial statement. Satyam also created a fictitious asset in his earning management. The cash and bank figures amounted to US$ 1. 07 billion had been created to inflate their financial statement.
The other earning management technique used is by using corporate takeover where in this case, Satyam wanted to acquire Maytas Properties and Maytas Infrastructure to cover up Satyam’s inflated cash. Raju, the Chairman of Satyam was siphoning the money from Satyam to Maytas for the past 6 years. Unfortunately, his last attempt to fill the fictitious assets with the real ones failed. b) In your opinion, why do the managers of Satyam want to manage their earnings and subsequently be engaged in fraudulent activities?
In my opinion, Satyam want to manage their earnings and subsequently be engaged in fraudulent activities because of the pressure to meet the investor’s expectations. It was started with the company cooking up false numbers so that the profit expectations could be met but slowly and steadily, things had blow out of proportion. It is management’s responsibility to direct the organization’s operations with a goal to achieve targeted result set by the shareholders. This had created a pressure to Raju because he needs to meet financial target to avoid decrease of share price and short of capital.
Because of the pressure situation, he finally decided to come into decision to manipulate the company’s earnings and engaged in fraudulent activities. The other factor that motivated Satyam to manage their earnings is due to the need to maintain a competitive position within the financial market. Satyam Computer Services is among of the top leading company in Indian IT industry. If Satyam fails to shows that company is operating in profitable manner and he discloses the real loss of the company it will cause the investors and public loss confidence in them.
Therefore, they will not be able to place the company’s name as the leading company of IT services and unable to compete with the other top leading IT companies. Because of this reason, Ramalingam Raju had engaged in fraudulent activities. In addition, factors that may motivate managers of Satyam want to manage their earnings is because of their personal gains such as bonus and they might be belief that the laws and regulations can be easily be bypassed. The managers will be rewarded with bonus if the company shows a high profit.
So in order to get the bonus Satyam was motivated to commit fraud. Since earning management was a complex techniques that are not easily to trace, this make Satyam feel confident that involving in earning management will not be caught. But as the consequences, due to too much gap between the real earnings figures with the reported earnings figures, Satyam was not be able to hide the fraud anymore and Raju finally be caught due to his guilt. c) What were the consequences that befell the company upon the discovery of the fraudulent activities?
Among the consequences that befell the company upon the discovery of the fraudulent activities is the investors will lost their confidence towards the company. Investors are the most important people in the company because they are the person that provides funds to ensure that company can operate. Since the company involved in fraudulent activities, the investors will no longer invest in Satyam and they will also withdrew their funds invested in Satyam because they do not want to bear the risk of loss of investment.
This will cause the company not able to operate because they do not have the sufficient funds. Banks are the other important bodies that can provide funds to the organization. Upon the discovery of the fraudulent activities, the banks will also hesitate to give any loans to Satyam because they are not certain whether Satyam have the ability to pay back its loan. Therefore, Satyam will face difficulties in obtaining funds from the banks and subsequently it will not be able to operate the business due to lack of funds.
It was found that Satyam had a drop by at least 25% in the supply of funds or loans during the two years following the fraud discoveries. Upon discovery of the Satyam fraudulent activities, the employees are among the most affected parties. When the company not be able to operate at his normal level production due to lack of funds, many workers and employees will be unemployed by the company. Therefore, many employees will lost their job and income and subsequently increase the number of unemployment in India.
Other than that, the related parties who involved directly in managing the earnings and commit fraud will be faced with civil and criminal penalties. Ramalingam Raju is the person that had been convicted with the fraud guilt. II. Discuss in what instances is earnings management acceptable and in what instances is it not acceptable? Although earnings management is generally seen as a “bad thing”, the facts that Generally Accepted Accounting Principles (GAAP) allows certain adjustments that directly impact earnings.
So this shows that earnings management is acceptable in the certain situations. For instance, implementation of a decision to improve the entity’s credit and collection activities may legitimately support reducing the estimate of bad debt expenses. These are acceptable earnings management practice whose consequences are accounted for in conformity with GAAP. The other acceptable earnings management practice is the activities that involve legitimate discretionary choices of when to enter into transactions that require accounting recognition.
For instance, advertising expenditures, which generally should be expensed when incurred, may be accelerated in the fourth quarter if the entity is exceeding its earnings target or deferred if it is failing to meet that target. As for the unacceptable earnings management practice is when the managers intentionally manipulate the earnings figures and not complying with the standards such as recording non-existent sales, backdating sales invoices and overvaluing assets. For instance, in Satyam case the company had created the accrued interest account which was non-existent.
Other than that, earnings management will be considered as unacceptable if the effect of the alteration is very material that it will indicate false implication of the company’s financial situation to the users of the financial statement. This is because false impression will cause the users such as the investors to make a wrong decision in making their investment. Other than that, Satyam also had inflated its cash and bank balances figures to increase the revenue of the company. III.
In your opinion, what are the impacts on the accounting profession if it doesn’t take the necessary strategies to curb the abuses in earnings management that subsequently result in fraudulent activities? In my opinion, if the accounting profession doesn’t take the necessary strategies to curb the abuses in earnings management, it will lead to a bad reputation of the professional accountants. In the eyes of public, the accounting profession should provide a reliable accounting framework that can prevent fraudulent activities.
If the abuses in earnings management that resulted in fraudulent activities keep occurring, this will give the impression to the public that accounting profession cannot provide reliable services. The other impact is it will lead to inappropriate perception toward the misuse of earnings management. There will be a possibility that managers will think that misuse of earnings management is rational and will not suffer any penalties because there are many other managers abuses this technique but not suffering any bad effects or be convicted into guilt by the law. So there will be more managers that will involve in the fraudulent activities.