Ethical Issues, Strengths, and Weaknesses of the Financial Reporting of the Companies - Case Study Example

FINANCIAL STATEMENTS Name Course Tutor Date Executive Summary The report is about financial statement and its importance in financial analysis of any given organization. The introduction gives a rough idea of what financial statement is and goes on to give an elaborate explanation of the various types of financial statements that one can expect of a company. The chosen companies for the model are Commonwealth Bank of Australia (CBA) and SATYAM computer services in India. The latter was realized to have committed white collar crimes that violated the integrity of the financial statements as well as the ethics that must be observed. The ethical issues in financial statement explore the various ethical issues that arise from poor preparation of financial statements giving a clear example of the recent case of CBA where the customers made decisions based on falsified information that resulted from omissions. The other eminent ethical issue in financial reporting is misappropriation of assets. The Strengths and weakness section takes the form of a comparison where the strengths of one company’s financial reporting is put alongside another company’s financial reporting that was not a success. For the strength section CBA forms the ideal company based on the idea that it is existent and has a wide investor base and has also not been affected by the ethical issues over a long period of time. The conclusion summarizes what has been discussed in the paper highlighting the key issues at hand pointing where they exist in the paper in a clear and directive manner. Table of Contents Executive Summary 2 Table of Contents 4 Introduction 5 Ethics in Financial Statements 6 Fraud in Financial Statement 6 Strengths and Weaknesses of Financial Statements 8 CBA’s Strengths in Financial Reporting 8 Weaknesses of SATYAM Financial Statement 10 Conclusion 12 Bibliography 14 Introduction Financial statement also called financial report is a formal representation of the fiscal activities of any given entity (Stickney, Brown, & Wahlen, 2007). It gives an outline of the financial strength, liquidity and performance of the company in the market. All the financial effects of a given business undertakings and events of an entity are represented in the financial report. There are four different types of financial statements or reports (Stickney, Brown, & Wahlen, 2007). The first one is statement of the financial position of the business, commonly known as the balance sheet which represents the financial position of an entity at any given date. It majorly comprises of three elements: Assets which are the things the business owns and controls; Liabilities which are the things that the business owes other businesses or people; Equity which are what the business owes its owners (Stickney, Brown, & Wahlen, 2007). The latter is equivalent to the amount of capital that remains in the business after all the assets have been used to pay off liabilities (Stickney, Brown, & Wahlen, 2007). In short, it is the difference between assets and liabilities. The second is an income statement that highlights income of the business and expenses of the business. Third is the cash flow statement that records the movement of cash and bank balances over a given duration. This includes investing, financial and operating activities of the business or firm (Stickney, Brown, & Wahlen, 2007). Lastly, the changes in equity also called the statement of retained earnings, which details the movement in the equities of the owners over a given period of time. This includes share capital repaid or issued over a period of time, dividends payments, gains or losses realized directly in equity, and effects of change in accounting policy or rectification of accounting errors. This paper explores two companies Commonwealth Bank of Australia and SANTYAM computer services companies and analyzes their financial reporting. The paper first investigates the ethical issues in CBAs financial reporting and then later looks into the strengths and weaknesses of the financial reporting of the two companies. Ethics in Financial Statements In reference to financial reporting ethics governs how moral and good choices are made in regard to preparation, presentation and consequent disclosure of financial information (Tinker, Merino, & Neimark, 2010). There have been a number of scandals surrounding many companies in the nineteenth century. Some of the most common issues are fraudulent financial reporting, misappropriation of assets, and disclosure errors (Frecka, 2008). The latter falls under fraud in financial reporting since there might be deliberate omissions (Frecka, 2008). Fraud in Financial Statement CBA has experienced fraudulent financial disclosure of its financial information. This has occurred mostly due to misstatement of the financial statements by the company’s management (Frecka, 2008). Janda (2014) reviews the statement of commonwealth Bank Boss Ian Narev stating that he was sorry for the multimillion dollar financial planning scandal. The financial planners of CBA ended up investing the investors’ money in high-peril investments without the shareholders or customers permission (Janda, 2014). This followed poor advice and misstatements in the financial statement during the period between 2003 to 2012 causing financial distress and losses that highly impacted the customers negatively (Janda, 2014). As is evident this caused the investors to be misled while the company’s share price was maintained. However, as can be seen from the apology, the effect is only short term and the bank has to compensate the affected customers who were beneficiaries of the financial wisdom of CBA in the period between 2003 and 2012 (Janda, 2014). Manipulations, falsifications, or intentional alteration of accounting records as well as other supporting materials from which financial statements are based is regarded as fraud (Holtzman & Financial Executives Research Foundation, 2008). Additionally, fraud may be hidden through falsification of documents but when identified appropriate penalties must be taken (Frecka, 2008). The other way fraud may be concealed is through collusion with the management, third parties as well as employees in the organization (Law, 2010). This could be through the falsification that control measures have been taken to prevent such frauds in financial statements (Frecka, 2008). Another good example of accompany that has had scandals or ethical issues is WorldCom that made accounting errors that were very inappropriate even in the eyes of a rookie accountant (Janda, 2014). Enron on the other hand inflated artificially the prices of its income and used mark to mark model to deliberately expand their value of financial assets thus falsifying the financial statements (Holtzman & Financial Executives Research Foundation, 2008). Misappropriation of Assets The assets that are under the name of the company may end up not being used for purposes of the company but instead of the executives (Frecka, 2008). As a result the company will be buying or investing in assets that benefit it less (Frecka, 2008). A good example is when the chairs of the company end up in the homes of the executive instead of being in the offices (Law, 2010). Another good example is buying shares in companies where the owners show conflict of interest with the management of the company maybe through family ties or part of the stake (Frecka, 2008). Strengths and Weaknesses of Financial Statements CBA’s Strengths in Financial Reporting The financial statements of CBA are understandable and reliable since people from different backgrounds are able to read and understand the financial statements (CBA, 2013; CBA, 2014). The financial reports have a summary at the end of each statement explaining the policies and terms that were followed when developing it. The summary additionally gives an overview of what is expected from the fiscal statements (Ellis, 2015). It is possible to trace the figures in the summary to the figures in the statement being that they both correlate. Additionally, the deviations are accounted for (CBA, 2013; CBA, 2014). Secondly, the financial statements are relevant and material in the context of the company (Ellis, 2015). The prior expectations represented in the company’s financial statement correlates well with the information and have been used to predict future trends (CBA, 2013; CBA, 2014). For instance, every financial statement has a summary of the five year period financial statements that are outlined. All the components of the financial statements are traceable (Ellis, 2015). The only scandal that appeared concerned the financial intelligence dissemination and was not in any way intentional (CBA, 2013; CBA, 2014). In the financial statements all the costs incurred, expenses, assets and liabilities are well stated as well as the equity. Different categories of the same are reflected in the summary of the financial statement explaining every term so that even someone who is relatively new in the field of accounting can understand the statement. The reports are also released at the end of every financial year the latest being the one for financial year 2014 (CBA, 2013; CBA, 2014). This ensures that the information is timely so that the investors and shareholders can be able to make decisions. The report clearly elucidates the income statement, balance sheets, statements on changes in equity, and statements on cash flows. There is also a slot for independent Auditors report which further ascertains the authenticity of the report based on the generally accepted accounting principles (Ellis, 2015; CBA, 2013; CBA, 2014). The auditor gives their opinion with regard to report and appends their signature. The financial statements are also comparable and verifiable (Ellis, 2015). These are parts of the tenets that form the qualitative characteristics of a financial statement Miller & Bahnson, 2002). Comparability enables the beneficiaries (users) of the reports to understand the difference between items as well as their similarities (Ellis, 2015). It entails the comparison of two items (CBA, 2013; CBA, 2014). CBAs financial report has the power and ability of easy comparability based on the consistency of the items and the representation order (Miller & Bahnson, 2002). It is therefore very easy to obtain similarity or difference between the items of interest (Ellis, 2015). As aforementioned at the end of every financial report that is given in the annual report, an independent auditor has to have their opinion drafted and their signature appended after careful evaluation and thus ascertaining the truthful and representation of the statement. The reports also explain the assumptions made (CBA, 2013; CBA, 2014). Weaknesses of SATYAM Financial Statement SATYAM Computer Services is one of the scandalous companies after Enron and WorldCom (Govindaraj & Sampath, 2009; Bhasin, 2013). The fraud that resulted from white collar crime fringed the integrity of the financial report of the company (Bhasin, 2013). This in effect contributed to loss of investors, economic losses and decreased investors’ confidence on the reliability of the financial reports. The fraud dates back to 2009 and is dabbed creative accounting (Bhasin, 2013). Mr. Ramalinga Raju, who is the chairman of the company, admitted to have been manipulating the company’s accounting records for a number of years (Bhasin, 2013). The assets were overstated by him in SATYAM’s balance sheet accruing to a discrepancy of almost $1.5 billion (Bhasin, 2013). This meant that all the bank loans and cash flow the company claimed to have at hand, were all a fuss. There was also under reporting of liabilities on the balance sheet meaning that in itself the financial report was immaterial and irrelevant (Bhasin, 2013). Additionally, the income was also overstated in almost every quarter for a spread for several years so as to meet the analyst’s demands and expectations (Jesswein, 2011). The chairman did all these in his computer by creating numerous bank statements to further propagate the fraud (Bhasin, 2013). Additionally, he also created fake salary accounts that counts for the expenses incurred by the company and even went to an extent of appropriating money after the company had deposited it in all the 6000 fake accounts over the previous years prior to being identified (Govindaraj & Sampath, 2009; Bhasin, 2013)). There was collusion between the chairman and the global manager of the internal audit who created fake customer identities and ended up generating bogus invoices alongside their names so as to raise the revenue (Stuart & Stuart, 2004). There should have been an independent external auditor to ascertain the authenticity of the records after careful analysis of the financial statement this was lacking in the case of SATYAM computer services (Govindaraj & Sampath, 2009; Bhasin, 2013). It did not end at this but the same global head of the internal audit counterfeited board resolutions and illegally manipulated loans from the company (Govindaraj & Sampath, 2009). Not all the income was recorded on the balance sheet. As evident in this case all the ethical concerns in accounting and financial reporting both for the process and for the preparers was not adhered to (Stuart & Stuart, 2004). The sum total of all the above financial inadequacies is breach of ethical standards in accounting (Frecka, 2008). Apart from fraud, misappropriation of assets was also eminent in the company. Despite the skewed financials the company also had earnings of $350 million and a net return of almost twenty million dollars. Raju had a share of 35% in a real estate investment company called Maytas Properties (Govindaraj & Sampath, 2009). The revenues of SATYAM increased to over one billion dollars in just one year 2006. In 2008, the board agreed to buy a stake at Maytas Properties that was mostly owned by Raju’s relatives and family members (Bhasin, 2013). Consequently Raju himself owned a total of $1.7 billion (Bhasin, 2013). The management made the decision without the approval of the management (Govindaraj & Sampath, 2009). Due to the unorthodox transaction legal battles were existent and World Bank eventually banned SATYAM for eight years. In 2009 the company was discovered t have a lot of financial irregularities (Bhasin, 2013). The result of the poor financial reporting or disclosure was a ruined reputation not only for the corporation but also for the industry at large. This in turn keeps off future foreign investments (Hong Kong Institute of CPA, 2010). Companies can learn a lot form this scenario. One when there is discrepancy in the financial statements and the real figures on the entity it is good to investigate (Hong Kong Institute of CPA, 2010; Bhasin, 2013). Two, there is a need for a good corporate governance so that the top management is not dominant in making decisions that in the long run can harm the organization (Govindaraj & Sampath, 2009). The executives have a huge role to play in setting pace for the company (Bhasin, 2013). There is also need to involve an external auditor and split the role. Above all, there is importance in remain ethical and transparent in every undertaking in the name of the company (Govindaraj & Sampath, 2009). Conclusion Financial reporting is very crucial for any given organization that is aspiring to expand and has a wide customer base as well as investors. This is because most of the forecasts are made by customers based on the information gotten from the financial statements. There are ethical parameters that must be observed or met by the preparers and the financial statement itself failure to which the statement will be rendered invalid and thus irrelevant. The ethical issues mostly seen in financial statements include fraudulent financial reporting where deliberate manipulations are made for the gain of the company, and misappropriation of assets that happens when the assets of the organization or company are acquired by the relatives or individuals in the top management positions as well as when the company assets are used for other purposes other than the company. A good case of a strong financial statement is that of CBA for reasons discussed above. On the contrary, poor practices of SANTYAN computer services lead to the weaknesses in its financial reporting. As evident on the case of SANTYAN computer services, there are consequences and lessons that can be learnt from such weaknesses in financial statements. Bibliography Bhasin, M.L. 2013, Corporate Accounting Fraud: A Case Study of Satyam Computers Limited, Open Journal of Accounting, 2013, 2, 26-39. CBA 2014, August 12, Commonwealth Private | Tailored financial advice and services – CommBank, Retrieved from https://www.commbank.com.au/.../annual-reports/2014 CBA 2013, August 19, Commonwealth Private | Tailored financial advice and services – CommBank, Retrieved from https://www.commbank.com.au/.../annual-reports/2013 Ellis, D 2015, February 11, CBA : Commonwealth Bank of Australia Analyst Report | Analyst Report, Retrieved from http://analysisreport.morningstar.com/stock/research?t=CBA®ion=AUS&culture=en-US&productcode=MLE Frecka, T. J 2008, Ethical Issues in Financial Reporting: Is Intentional Structuring of Lease Contracts to Avoid Capitalization Unethical? Journal of Business Ethics. doi:10.1007/s10551-007-9436-y Govindaraj, S & Sampath, V 2009, May 21, Learning from Satyam: How to Detect Fraud – Businessweek, Retrieved from http://www.businessweek.com/globalbiz/content/may2009/gb20090521_309883.htm Holtzman, M. P & Financial Executives Research Foundation. 2008, What's new in financial reporting: Financial statement notes from annual reports, Florham Park, NJ: Financial Executives Research Foundation. Hong Kong Institute of CPA 2010, Conceptual Framework for Financial Reporting 2010, Retrieved from http://app1.hkicpa.org.hk/ebook/copyright-notice.pdf Janda, M 2014, July 4, Commonwealth Bank boss Ian Narev says sorry for multi-million-dollar financial planning scandal - ABC News (Australian Broadcasting Corporation), Retrieved from http://www.abc.net.au/news/2014-07-03/commonwealth-bank-responds-to-financial-planning-inquiry/5568504 Jesswein, K 2011, Analyzing financial statements with potentially misreported cost of goods sold figures, Journal of Finance and Accountancy, 2(1), 1-10. Law, P 2010, A theory of reasoned action model of accounting students' career choice in public accounting practices in the post-Enron, Journal of Applied Accounting Research. doi:10.1108/09675421011050036 Miller, P. B., & Bahnson, P. R 2002, Quality financial reporting, New York, McGraw-Hill. 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