Lecture 2 (BECG).1

8/3/2019 Lecture 2 (BECG).1

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Issues in Management of a Public Limited Company

(BECG)

Prof Sriram RajannFaculty ± IBS, Hyderabad



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Contents

1. Corporate Objectives/Goals2. Ownership Pattern3. Revisiting Corporate Goals4. Ethics in Managing

5. Creative Accounting (CA)6. Ways of committing Frauds in Financial Statements7. Characteristics of Management Prone to Fraud8. Classification of CA Practices9. Expected Rewards for Resorting to CA methods10. Problems relating to CA11. Prevention of CA



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Culture consists of shared values,

beliefs, and norms of theorganization, which grow over time, based upon the assumptions

of what it takes to be successful.

«. this can lead to corporate failure



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1. Corporate Objectives/Goals

Objectives/Goals are end points towards whichactivities are aimed. Objectives are the results tobe 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 howmuch they can delegate. In any case, managersshould know the relative importance of each of their goals.



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Management by Objectives (MBO)

MBO is a system of managing. MBO is a processconsisting of setting goals at the highest level of the organization, clarifying the specific roles of those responsible for achieving the goals, andsetting and modifying objectives for subordinates. Goals can be set for line as wellas staff managers or personnel. Goals can bequalitative as well as quantitative.

MBO results in better managing, often forces

managers to clarify the structure of their organizations, encourages people to committhemselves to their goals, and helps developeffective controls.



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Examples of Corporate Objectives

Shareholders¶ wealth maximization

Total Computerization

Profit maximization Developing better managers

Productivity Improvement

Globalization Sales maximization



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erarc y o ec ves:A. Top-Down Approach:

Socio-economic purposeMissionOverall objectives of Organization (Longrange and Strategic)

More Specific Objectives (Key ResultAreas - KRAs)Division ObjectivesDepartment and Unit objectives

Individual Objectives (Performance andPersonal Development)

B. Bottom-up Approach (Reverse of TDA)



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Objectives of a University

Attracting highly qualified students

Offering basic training in professionalfields

Granting Ph.D. degrees to qualifiedcandidates

Attracting highly regarded faculty

Discovering and organizing newknowledge through research

Operating a school thru gifts of alumni.



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2. Ownership Pattern

A. Forms of Business organizations in India: Sole Proprietorship (Ownership and control are

united in this one individual, who is identified asthe µentrepreneur¶).

Partnership (Two are more persons associate ineconomic activity by pooling their resources or efforts together).

Corporate Sector (Pvt. & Public Ltd Cos.)

Pvt. Ltd. Co. means limited members (50) and cannot go public. Founders retain control. Public Ltd.

Co. is large, no limit for members and can gopublic to raise resources to finance big projects.



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2. Ownership Pattern (Contd.)

Multinational Companies ( As wholly ownedsubsidiaries or joint ventures or as licensees. MNCs¶HQ is located in Home country and other branches/offices are located in various Hostcountries)

Co-operatives (Producers ± association of workers,Consumers ± association of consumers to buycollectively and share the profits, Credit &Thrift Co-operatives ± members save and grant loans tomembers at low interest rates)

Public Enterprises (Departmental undertakings arecontrolled by Govt. Departments; in Govt. Cos.±Govt ownes 51% of share capital or more; and PublicCorporations are statutory bodies)

Joint sector Companies (Largely public resourcesand pvt. promoters managerial skills)



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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 Companywhere 51% or more shareholdings are owned by Central/StateGovernments and Public Corporations like Statutory Bodiesviz. MMTC, FCI etc. which are autonomous but accountable toParliament)

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)



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3. Revisiting Corporate Goals

At the planning stage, a corporation sets itsgoals. The goals are consistent with thecorporate objectives, which are based onbusiness priorities, deliverables, enablers and

satisfiers. Deliverables focus on achieving excellence;

enablers are the infrastructure and the peopleworking for the organization and their skills; andthe satisfiers include those enhancing the

customer service and providing information tothe public policy making decisions. Additionally,there is an overall corporate strategic objectivefor Financial Management.



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3. Revisiting Corporate Goals (Contd.)

The principal objective of a private sector firm is to make a profit. But the objectivesof public sector enterprises are often

conflicting in nature ± they have to strikea balance between making a profit andproviding public services. Nowadays,even large private sector companies are

much concerned about the effect of their operations on the life and welfare of thecommunity, by revisiting their goals.



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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 withwhat is good and bad and with moral duty and obligation.´Thus personal ethics has been referred to as the ³rules bywhich an individual lives his/her personal life´.

Accounting ethics pertains to ³the code that guides theprofessional conduct of accountants´.

Business ethics is concerned with truth and justice and has avariety of aspects such as expectations of society , fair

competition, advertising, public relations, socialresponsibilities, consumer autonomy and corporate behavior .



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5. Creative Accounting (CA)

Creative accounting (CA) refers toaccounting practices that may or may notfollow the letter of the rules of standard

accounting practices but certainly deviatefrom the spirit of those rules. They arecharacterized by excessive complicationand the use of novel ways of

characterizing income, assets or liabilities. The terms "innovative" or "aggressive" are also sometimes used.



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5. Creative Accounting (CA) (Contd.)

CA refers to systematic misrepresentation of thetrue income and assets of corporations. CA is atthe root of a number of accounting scandals,and many proposals for accounting reforms

usually center on an updated analysis of capitaland factors of production that would correctlyreflect how value is added.

Newspaper and television journalists havehypothesized that the stock market downturn of

2002 was precipitated by reports of accountingirregularities at the Enron, Worldcom, and other business entities in the United States.



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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 over-reporting of corporate income which came to light in 2002

was the granting of stock options as part of executivecompensation packages. Since stock prices reflect earningreports, stock options could be most profitably exercisedwhen income is exaggerated, and the stock can be sold atan inflated profit.

Enron scandal led to the Sarbanes-Oxley Act to curb suchactivities.



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5. Creative Accounting (contd.)

Earnings management usually involvesthe artificial increase (or decrease) of

revenues, profits, or earnings per sharefigures through aggressive accountingtactics. Aggressive earnings managementis a form of fraud and differs from

reporting error.



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6. Ways of committing Frauds inFinancial Statements

Fictitious Revenues (These are shown in books, butnot earned. This is done by booking non-existentrevenues by creating journal entries by debitingaccounts receivable and crediting sales. Sometimesfalse sales are shown to existing customers. Smartaccountants select transactions with a few major customers like large organizations and governmentagencies that they will be difficult to confirm.Sometimes major vendors are willing to confirm

false confirmations to the auditors. But theseaccounts can be detected by verifying unusual journal entries and other supporting documents.)



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6. Ways of committing Frauds inFinancial Statements (Contd.)

Improper or Fraudulent Disclosures or Omissions (GAAP requires adequatedisclosures and fraudulent disclosures or

omissions materially mislead the investors. Anymaterial facts not covered in the financialstatements should be disclosed in the footnotes)

Creative Accounting (This is done creatively

valuing or manipulating the stock and the work-in-progress. Cash can be manipulated byvarying the timing of payments and receipts.)



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Fraudulent Timing Differences ( Assets andincome can be overstated by taking undueadvantage of accounting cut-off period to either boost sales and/or reduce liabilities and

expenses. Such differences can be eliminated byearly revenue recognition and delayed recordingof expenses.)

Concealed Liabilities & Expenses (These are notshown in the f inancial statements. These occur

when companies do not record certain liabilitiesor understate contingencies, warranty costs /liabilities and report only revenues when cash isreceived.)



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Fraudulent Asset Valuation (This usuallytakes place in estimating inventory byfalsely stating its value or changing themethods of valuation from FIFO to LIFOand so on).



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7. Characteristics of ManagementProne to Fraud

Unduly aggressive financial targets

Domination by person or group withoutcontrols

Major performance-related compensation

Pressure to reduce tax liabilities

Aggressive accounting policies to keep

stock prices high Inadequate monitoring of significant

controls



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8. Classification of CA Practices

Recognizing Pre-mature or FictitiousRevenue

Aggressive Capitalization & ExtendedAmortization Policies

Misreported Assets & Liabilities

Getting Creative with the IncomeStatement

Problems with Cash Flow Reporting (Source: Financial Numbers Game: Detecting Creative

Accounting Practices. Authors: Charles W Mulford & Eugene MComiskey)



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9. Expected Rewards for Resorting toCA 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



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How to Detect CA?

Ask the following questions:

1. How the company makes money?

2. How is it accounting for money?



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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 andgeneral public.



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11. Prevention of CA

Those companies most at risk for fraudulentfinancial reporting tend to be those that haveone or more of the following attributes:-

1. Weak Internal Control

2. No Audit Committee3. A Family Relationship Among directors and/or

Officers4. Low assets and Revenue (less than $100 Mn.)5. A Board dominated by Individuals with

Significant Equity Ownership and LittleExperience serving as Directors of Other companies.



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Steps for Prevention of CA:

1. Accountants and Managers shoulddivide the duties of an internal controlchecklist.

2. An independent Audit Committee shouldalways have some one with a strong

accounting background and auditexperience who deals directly withoutside auditors.



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Lecture 2 (BECG).1