Joshua, an employee working in the accounts office of a medium-sized company listed on the Australian Securities Exchange, was working late one evening during the week. He realised he had left his pen in the boardroom at an earlier meeting and, given its value, went upstairs to look for it. As he walked past a room, he heard the following conversation between the Chief Executive Officer, Paul and one of the non-executive director, Alan who is also a cousin of Paul:
Paul: I am deeply concerned that if this fall in profit figures is disclosed in the next annual report, there will be all sorts of problems with the shareholders. We may even lose a number of big investors.
Alan: Well, I suppose we could always find a way of making them look better.
Paul: How? I can't see it at all.
Alan: Well, we could make them just slightly higher than last year's figures by including the proceeds of the sales of our toothbrush division.
Paul: But the sale doesn't go through until October.
Alan: No, but it will … and it doesn't make much difference, we need the money on the books now.
Alan: Not really … I don't see why … it's just a manipulation of timing rather than numbers.
Paul: OK. That sounds good to me. Let?s sort it out now.”
Joshua left and spent the evening worrying about what he should do, if anything. He decided he would anonymously ask the accountant how he could deal with this situation, and bring the issue out into the open.
As the accountant, you receive a report from the employee (Joshua) about the conversation. Write a brief summary for board members of the corporate governance problems raised by this employee, and the weaknesses in the company’s corporate governance which are evident from the conversation which was overheard.
Nature of a Corporate Entity
A corporate entity is a legal entity which is separated from its owners. Unlike sole proprietorships and partnerships, corporations are designed differently such that owners would not directly carry debt burdens in case of liquidation. In law, corporations are recognized as legal persons while humans are regarded as natural persons. Managers and board of directors are appointed to oversee the running of business as agents of shareholders who are the actual owners. The concept of corporate governance aims to bring in legal and ethical principles to define the roles of managers, directors, shareholders, and other stakeholders with the objective of minimizing conflict of interest (Du Plessis, Hargovan & Harris, 2018). The end result of successful corporate governance is the maximization of shareholder wealth and long term continuity of the entity. This report discusses corporate governance with due regard to its challenges, ethical principles, and their impact on company productivity.
The main feature of a corporation is that it has distinct rights and liabilities separate from those of its owners. The shareholder’s liability is limited to the amount of money invested in the enterprise (McLaughlin, 2018). However, the shareholder has the freedom to transfer his shares to other investors unless otherwise stated by the organizational charter. A corporation might be owned by many shareholders owning varying amount of shares. Therefore, shareholders appoint a board of directors whose duty is to appoint managers to run the daily operations of the entity. The board of directors also provide strategic direction to the corporation through ensuring that managers work towards the mission. The Australian corporation act is the primary legislation that regulates legal entities in the country (Bednall, 2018). The act provided for the formation of the Australian securities and investments commission (ASIC), an independent regulatory agency. The commission registers corporations, and shares information about the companies available to the public. Additionally, ASIC investigates breaches to the act and enforces its compliance.
Statutory requirements affecting accounting and reporting of corporate entities are state made laws that affect the preparation, disclosure, and reporting of financial information. The Australian corporation law governs formation, management, and liquidation of corporate entities. Company law review Act was later enacted to improve corporate regulation through streamlining provisions of the corporation’s law. The Australian corporation law provides that government has jurisdiction over all companies incorporated under Australian Law (Garcia- Sanchez & Martinez- Ferrero, 2017). The law requires that the board of directors is responsible for ensuring that functional audit and finance are established. The aim of this provision is to have financial reports and audit opinions that are reliable. The Australian Securities Exchange commission outlines that corporate entities should have separate CEO and chairperson. The international financial reporting standards and the International financial accounting standards are other authoritative provisions that guide financial accounting and reporting in Australia.
Goodwill is an intangible asset that occurs when an existing business is acquired. It is basically the value attached to an existing business by virtue of its location and existing customers (Annisette, Vesty & Amslem, 2017). The issue of goodwill remains a controversial issue since there is no universally accepted treatment despite the existence of generally accepted accounting standards. Depreciation techniques are methods of accessing the decline in value of a commodity over time. Common depreciation techniques are reducing balance method and the straight line method. Accountants are yet to devise a single depreciation technique that is applicable in every industry.
Statutory Requirements of accounting and reporting in the Australian regulatory environment
Accounting professional bodies should convene meetings to discuss controversial issues in accounting so as to arrive at an agreement on how they should be accounted for. A uniform agreement on treatment of accounting issues promotes the achievement of uniformity and comparability in accounting. A global perspective is the agreement of a common measure or method of treatment of a transaction or activity. Globally accepted standards are supported by ethical perspectives imposed by professional bodies and the law. Regulatory solutions involve the use of laws and statutes to enhance compliance.
The implementation of stricter corporate governance provides confidence to investors and company stakeholders who fear the abuse of powers by corporate leaders and allows transparency in the corporation. Corporate governance helps with the regulations and policies that controls corporates from any misconduct (Su & Sauerwald, 2018). The Organization of Economic Cooperation and Development (OECD) defines principles of good corporate governance as – the rights to shareholders, equitable treatment of shareholders, role of stakeholders in corporate governance, disclosure and transparency and the responsibilities of the board. This protects the rights of shareholders and stakeholders, resolve internal conflicts and differences that may arise. Also, it would contribute to economic growth on a larger scale and give confidence to foreign and domestic investors to invest in the company.
Shareholders are the owners of the corporation. They can either be corporate shareholders or individual shareholders. Corporate shareholders are companies that have interests in form of shares in the corporation (Schwartz, 2017). Individual shareholders on the other hand are people investors who also hold stocks. Shareholders have voting rights which they exercise during annual general meetings. Voting power is dependent on the by-laws of the organization such that in others, the one man one vote rule applies. However, the voting rights of shareholders in other organizations is dependent on the number of shares they own.
There are several theories that explain corporate governance. The agency theory defines corporate governance as a relationship between an agent and a principal. The agent and the principal are the managers and the shareholders respectively. The agent is employed to carry pursue the interests of the principal. A company for instance might have many shareholders which makes it impossible for them to run the company. They authorize few individuals to run the operations of the company on their behalf. The agency theory argues that good corporate governance is achieved when agents strictly serve the interests of their principal without any form of conflict of interest.
Stewardship theory originates from psychology and sociology. The Stewards are the managers, directors, and employees. The steward’s role under this theory is to protect and maximize owner’s wealth (Naranjo, Saavedra & Verdi, 2017). This theory majors on the roles of managers as stewards of the business and not as agents of the principal. The stewards integrate their goals with the firm’s goals such that the success of the organization is perceived as their success as well. Stewards are not self- interested and thus their satisfaction is higher when organizational goals are attained. Good corporate governance under the stewardship theory is the development of structures simultaneously promotes the interests of both the company and the steward. The independence of the steward is viewed as a motivating factor that enhances performance.
Contemporary accounting controversies
The stakeholder theory of corporate governance is based on the argument that managers serve a network of parties such as suppliers, employees, and owners. The maintenance of a good and productive relationship between the manager and these other parties, promotes the achievement of shareholder’s wealth (Jones, Wicks & Freeman, 2017). The role of the managers under this theory is to ensure that stakeholders obtain fair returns from their stake in the firm. This theory proposes some kind of corporate social responsibility principles that emphasizes on ethical practice (Schaltegger & Burritt, 2017).
Adoption of corporate governance best practices contributes immensely to the achievement of the firms objectives. The goals of corporate governance best practices is to propose actions that private and public corporations should adopt in their management structure to promote accountability ( Bowie, 2017). Shareholders, managers, board of directors, and independent auditors are the main stakeholders addressed. Shareholders who are keen to enhance performance and improve access to capital should insist that best practices be adopted. As a company, we should enhance our corporate governance principles to serve the interests of the shareholders. It is worth noting that shareholders are interested in wealth maximization and sustainability of production.
Shareholders as owners of the company expect transparency from the side of the management. The chief executive officer and his team should make relevant information relating to the firm easily accessible by shareholders, board of directors, and auditors. The shareholders have the right to disclosure of information that would enable them to oversight the managers. These information include general company activities, future plans, and risks attached to the business strategy. Stakeholders especially shareholders and potential investors are able to make rational decisions when they have access to all relevant information ( Johnson & Petacchi, 2017). Financial regulators, professional bodies, and governments recognize the benefits of transparency in making truth available to relevant stakeholders. Financial reporting standards require that company managers should timely disclose financial information.
Accountability requires board of directors, management, and independent auditors who are agents of corporate governance to be answerable to their principal. The accountability principle states that agents have the obligation and responsibility make explanation for their actions and conduct (Rossouw & Van Vuuren, 2017). Shareholders expect the management and directors to carry out their duties and responsibilities with due diligence. Also, shareholders require the board to account for the company’s risk management strategies, create appropriate stakeholder communication channels, and present periodic reports of the company’s performance.
Fairness is an important corporate governance principle that requires managers, shareholders, and board members to be treated fairly. Shareholders of companies hold varied amount of shares. Majority shareholders and minority shareholders should be given equal treatment irrespective of the size of their shareholding. The one man one vote rule supports this principles since all shareholders hold equal influence on the firms. In cases where the one man one vote rule does not hold, shareholder agreement policies might exist to facilitate the protection of minorities. Employees, public officials, and the community in general should also be treated fairly. Corporate social responsibility activities is one of the ways by which companies compensate local communities for use if their resources (Aguilera & Crespi- Cladera, 2016).
Solutions for routine accounting problems
The board is tasked with the authority to act on the corporation’s behalf. They should take full responsibility for authority bestowed upon them by shareholders. The board of directors oversee management of the enterprise, appoint the CEO, and oversight company performance (Johnston & Petacchi, 2017). While undertaking these duties, the interests of the organization should come first. Directors and managers should not pursue high risk investments to increase chances of securing high bonuses. Investment decisions should be made after due assessment of risk and return is conducted. The risk-return trade off theory states that, the higher the risk, the higher the expected return. However, when expected returns are not realized, there is a chance of huge loss.
Weaknesses of firm’s corporate governance
Corporate governance determines how a company is directed and controlled. Effective corporate governance leads to effective, entrepreneurial and rational management which can support long-term success of the organization. Loop holes in corporate governance compromises the company’s progress placing it at risk of not fulfilling its objectives (Epstein, 2018). Our company is experiencing weaknesses in corporate governance. Identifying these issues is a first step towards solving them.
Earnings management is a key accounting controversy. It involves the use of accounting techniques to alter financial statements and reports. Common earnings management strategies aim at overstating profits and understating losses. Managers pursue these unethical undertakings especially when their earnings are linked to the performance of the firm. Companies that offer bonuses to managers when higher profits are recorded are major victims of this practice ( Narrajo, Saavedra & Vedri, 2017). Organizations should employ manager performance appraisal techniques that are promote sustainability of performance. Appraisal techniques based on short term performance breeds unethical practices such as alteration of profits.
The Chief Executive Officer is unethical. Ethics is a virtue that defines the moral conduct of an individual. The chief executive officer as the senior most manager in an organization. His role is to manage the day to day operations of the company. Also, the overall success of the organization is a responsibility of the CEO. Shareholders expect the CEO to make rational decisions that would propel the company towards achievement of its goals (Mayer, 2017). Corporate governance principles prescribe that officers should carry out their duties ethically. The shareholders have the right to truthful information regarding the performance of the organization. The C.E.O or any other officer should therefore not engage in fraudulent misreporting aimed at providing false information to shareholders. Decline in profits in a year compared to that of a previous year should be reported. Manipulation of financial information to hide facts leads to poor decision making among shareholders and investors.
Non- Executive directors are not part of the management. In corporate governance, their role is to provide strategic leadership. Since they are not part of the executive, they should aid in the development of strategy by providing independent expert input (Garcis- Sanchez & Martinez- Ferrero, 2017). They also scrutinize the management and monitor performance reporting. Additionally, these directors ensure the integrity of financial reporting. In our organization, some non- executive officers lack the independence to carry out their duties without the influence of the management. The non- executive director in some instances have been noted colluding with the chief executive officer to fraudulently hide a decline in yearly profits. This is a clear breach of duty and corporate governance in general.
Benefits of corporate governance
An effective internal controls system reduces the occurrence of fraud in the organization by implementing procedures that might lead to identification and frustration of fraud plans (Darby, 2018). Our organization has a weak internal controls system. Few individuals such as the CEO and a non – executive director can interfere with financial information without being discovered. The board of directors lapsed in their duty since they failed to implement a strong internal controls system. Shareholders expect the board of directors to devise and implement efficient risk management systems. Transparency is an essential corporate governance principle. Our company should disclose truthful financial information to shareholder, investors, and other stakeholders. The management should not hide facts from the users of these accounting information.
A corporate entity is an organization whose owners are separated from its owners. Corporate governance is a critical aspect that defines the way a company is controlled. Corporate governance principles include accountability, responsibility, fairness, and transparency. The goal of these principles is to minimize conflict of interest and ensure that managers pursue the maximization of shareholder’s wealth. Unethical practices such as window dressing financial information, collusion between managers and non- executive members, and inadequate internal controls are among the critical corporate governance weaknesses witnessed in the organization.
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