ABC Learning Collapse - Case Study Example

Name : xxxxxx Tutor : xxxxxx Title : ABC Learning Collapse Course : xxxxxx Institution : xxxxxx @ 2010 Introduction History of ABC learning ABC learning centre is the largest provider of early childhood education in the world which is based in Australia. It was founded in Ashgrove a town in Queensland in the year 1988 and by June 2001, the company had expanded to 43 centres for childcare. The vigorous expansion saw ABC learning manage to purchase united states based learning care with 467 centres and the third largest making ABC to have around 70,000 centres from its previous 50,000 by June 2006. ABC company expansion strategy is to increase its centres y four per week and therefore purchasing its competitors companies. For example, it purchased Kid Campus in the year 2006 which increase its centres by 106. The company has experienced a decline in the expected profit by 42% by the end of 2007 second half which led to a drop in the price of the shares of the company. This led to a successive increase in its debts forcing the government to inject some funds amounting to 22 million US dollars to keep the company and its branches open. Business strategy used by ABC learning This company used the strategy of market segmentation. Market segmentation is where a business opens smaller branches or segments for it to ensure efficient services to its customers by being within reach. In this case, ABC operated so many branches and also had a strategy of expanding on a weekly basis. Increased segments means increase children which saw the company enroll over 70,000 children by 2006. Each additional enrollment is accompanied by an increase in the unit cost making the increase in marginal cost to exceed the increase in average cost. Any additional enrollment which was done by ABC learning led to over utilization of the available resources leading to diseconomies of scale bearing in mind that the company was facing an increase in debts. Diseconomies of scale put the ABC Company into a risk of running into debts. The remedy for this situation facing ABC Company is to reduce the enrollment to optimal levels or stop further enrollments so as to ensure that the marginal cost equals the average cost which results to economies of scale. Intangible assets They are mainly the non-monetary assets which cannot be touched or measured. They include patents, copyrights, trademarks and goodwill. Two forms of intangibles exist which are legal and competitive intangibles. Competitive include knowledge activities while legal ones include trade secrets, copyrights and trademarks. In accounting for intangible assets, the assets should amortize through out its useful life. The cost of the asset is systematically allocated through out the assets useful or its legal life. Pitcher partners who audited ABC learning accounts did not give a good opinion concerning the accounts of the company. The balance sheet of ABC Company was made up of unaccredited intangible assets or assets which had not been amortized through out their useful life and this was termed as the failure to use the Generally Accepted Accounting Principles (GAAPS). Failure to amortize intangible assets inflates the balance sheet and makes it fail to balance. Balance sheets as a financial account is used to show the financial position of the company therefore, un amortized assets posed a problem to ABC learning as it acted as a deceit to its financial position. Inflated accounts exhibit errors in them. Change of standards from a bright-line rule to principle-based ac counting standard Bright-line rule is a standard rule which is clearly defined and consists of factors which are objective and does not allow for any change in interpretation. Principle-based accounting gives the auditor to give explicit recommendations regarding the financial statements of the company. Bright-line rule uses strict regulation which does not allow the auditors to reveal some things about the company. It sets rules and regulations to be used in the auditing profession. Most of ABC auditors used the bright-line rule to make recommendations about the company or to make a report. Ernst & Young's Brian and Pitcher Partners who were auditor of ABC learning gave two materially divergent material opinions which were really confusing to the shareholders and stakeholders of the company due to the expectation gap created by the auditors. An expectation gap is the difference between what users of audited reports think of the auditor’s responsibility and what the auditors actually does. This can have adverse effects to the company investors s they will continue to invest while the company is not yielding anything. Besides, companies are different and should be audited independently from each other with different recommendations. Auditors are supposed to give a true opinion of the financial position of the company failure to which an expectation gap is created. Principle based auditing enhances auditors independence which should be a freedom to enjoyed by the auditor. The auditor should have independence of thought, action and the independence to choose the best method for looking for audit evidence together with the best method of analytic review procedures and make his own recommendations without any external influence. Changing to principle based approach to auditing gives the auditor the independence to do an analytical review procedures of the company financials and thus giving an independent report. Reports given by independent auditors are quite reliable the one given by un independent one who is subject to manipulation from the management. Auditing of a company’s financial accounts by two auditors like the case of Ernst & Young's Brian and Pitcher Partners should give almost the same recommendations and opinions even though tolerable errors are accepted depending on the method of collecting evidence used by the auditor. Dangers of removing bright-line rules Bright- line rules are a set of rules that should be followed in auditing and are aimed at ensuring harmonization of the auditing procedures and audit tests. Principle based approach to auditing also has some bright-line rules in it. Removing this rules then it means that auditors might audit financial accounts to their favor or to gain fame or to the favor of the management. Every profession has its guiding rules and principles and therefore removal of this rules auditing to be with no governing rules and principles. Removing of bright-line rules can also make auditing to e meaningless to the managers or to the stakeholders and shareholders. This is because the auditors could be doing auditing only to earn income but not like a profession. Besides, all careers have their guiding principles and rules Effects of debts to lenders ABC learning had a debt of 1.6 billion United States dollars in 2008 and this lead to an agency cost in the side of its lenders. Lenders like credit companies and banks use credit score to assess the possibility of a potential risk which might incur if money is lend to the company with debts and this helps the lending company to be able to mitigate the losses due to the bad debt. The cost involved in evaluating the occurrence of risk is termed as the agency costs of a debt. A debt of $1.6 billion is a great amount of debt and for lenders to be able to lend money to ABC learning, they must evaluate the financials of the company to determine whether it has any assets which can be used as a security. By doing this the company will have undergone a cost which is termed as the agency cost. Mechanisms to reduce agency costs The lenders should use the audited reports of the company. Audited reports give a true and correct view of the company’s financial position. Instead of taking a lot of time to evaluate the company’s financial statements, it could be time saving and cheap to use the auditor’s reports hence reducing agency costs. Auditors report also gives the occurrence of risks found in the books of accounts and this could be essential to lenders. They lenders to ABC Company have been lending it money and from its record of repaying the loans the lenders can be able to determine the paying ability of the company. With these records the lenders are able to evaluate the occurrence of a risk if it lends money to ABC learning and hence reducing much costs of going to the company for the analysis of their records. Reasons why the previous and current auditors had diverging opinions In my opinion it seems like the current and previous auditors were manipulated by the internal management to make an opinion to their favor. They used the bright-line rule of auditing. In this case, auditors are given guidelines to follow in the auditing of the financial statements. The auditors audited the books separately and they are likely to have been manipulated differently by the management depending on the financial statements at hand and this led to breach of care by the auditors. Like for example, Pitcher Partners who were ABC auditors just endorsed the company management’s interpretation. The auditors did not perform a clear scrutiny of the firm’s accounts to determine the presence of errors and frauds. Like for example ABC learning company had had subsidized the loss making centres for normal revenues which should have revoked the auditors to collect enough evidence from the centres and determine the validity of the financial statement. The agency problem reflects a conflict of interest between managers and stockholders. To assure that managers act in the best interest of the stockholders, the managers must be rewarded with appropriate incentives and monitored. Agency costs include these incentives and monitoring costs. Recommendations to promote auditor independence Auditor independence gives the independence of thought, integrity and objective approach. The auditor should be in a position to provide an opinion on the financial statement credibility by providing a true and a fair view of the books of account independently. Independence of auditors enables the auditor to give a true view of the accounts. To promote auditor independence, auditors should use principle based approach to auditing which gives the auditor independence in his auditing procedures. Auditors should not let themselves to be influenced by other parties like the managers. Using this method of approach the auditor is able to choose the best strategy to conduct the audit. Auditor independence gives the auditor the freedom to determine the approach method to the audit work meaning that auditors are the bosses when it comes to auditing and therefore the work should be left in their hands. To promote the independence of the auditors, auditors should have a thorough training in the auditing profession as it is through training that they attain an analytical mind that will enable them carry out the audit work independently and without consultation when it comes to the report writing. Through training, the auditor understands that he should have access to the company’s financial accounts and be able to analyze the best method of analytical review procedures. In conclusion the ABC Company used a good marketing strategy of market segmentation but it used it at the wrong time when it did not have enough resources to sustain this expansion which made it to run into debts. It also contracted auditors who did not give the true view of the accounts of the accounts of the company which can be discouraging and confusing to the shareholders and stakeholders. I would therefore encourage ABC learning company to use the best marketing strategy depending on its resources and also use an independent set of auditors who will work without manipulation to give the financial position of the company if the company wants to survive in the market with lenders and stakeholders. References Jorge A. Chan-Lau 2001. The impact of corporate governance structures on the agency cost of debt, International Monetary Fund Erkki Koskela and Rune Stenbacka 2000. Agency cost of debt and lending market competition: a re-examination Bank of Finland Hand, J., Lev, B. 2003, Intangible Assets: Values, Measures, and Risks, Oxford University Press, Oxford, UK. Heckman, J. 1979. Intangible Assets, Values, Measures and Risks, Oxford Management Readers, Oxford, pg 303-. 331. Larry E. Rittenberg, Karla Johnstone and Audrey A. Gramling 2009. Auditing: A Business Risk Approach. Cengage Learning Jordan Tait. 2004. ABC Learning Centres: a case-study of Australia's largest child care corporation JM Publishing Iain Gray, Stuart Manson 2007.The Audit Process: Principles, Practice and Cases. Cengage Learning EMEA “Lessons to be Leant from ABC Learning Collapse”, Colin Kruger, Sydney Morning Herald, January 2, 2009 Read More