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Financial Reporting And Transparency In Corporate

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Question:

Discuss about the Financial Reporting and Transparency in Corporate.

 

 

Answer:

Introduction

Corporate governance and transparency are the major issues in the present market. Several incidences such as the collapse of Dick Smith have made the investors wary of the public offering and investment in public entities. Dick Smith Holdings Limited was a publically listed organization; therefore, it should have been more secure for the retail investment due to increased corporate governance and transparency. Public listing of the companies force them to improve their corporate governance practices by introducing changes in several ways such as board composition, compensation and participation of investors.

The guidelines for the publically listed companies suggest that they should have an independent board, a nominating committee, and an audit committee. Along with it, these companies should have an independent chairperson. The compensation is designed such that the managers of the organization are paid with equity or share options. It aligns their interest with that of other investors. In publically trading companies, the investors are active; they scrutinize the changes in the internal and the external environment of a country and lobby for different changes in the country. The interest of the investors can force business organizations to reform, improve performance, and increase the corporate value of the organization. Listed companies also have a high credibility in front of investors and increase the transparency of the organization (The Bull, 2017). However, in spite of these characteristics, several companies such as Dick Smith failed to follow ideal corporate governance practices, which led to heavy losses for the investors. The present report will identify the issues, which led to the failure of the organization and present recommendations to address the situation.

 

Issues in the financial Accounting and Corporate Governance of the Organization

The collapse of electronics retailer began in 2013, which can be identified by the prospectus issued to the investors in 2013. The 2013 float raised about $520 million for the private equity organization, and created enormous liquidity for the organization. It could be noted that the organization has been brought for $94 million from Woolworths a year earlier. There were some discrepancies in the balance sheet of the organization. The company’s account showed that the inventory was worth $370 million and the next day it was written down to $312 million, which gave anchorage benefit of $58 million.

Anchorage acquired the company later. It can be critiqued that the inventory write-down should be mentioned in the prospectus of the company, as it is a material information. The write-down was not mentioned in the report in spite of it being a material information. The companies fulfilled its obligation, the auditors fulfilled their obligation; however, transparency is not maintained in the report. According to the Australian Corporations Act, a disclosure test is developed to analyze different prospectuses (Lee, 2007).

The prospectus should encompass all the information pertaining to investors, professional advice, which is essential in making an informed assessment about the prospect and intent of the issuer. The timing of the release of the historic information is also essential is also crucial in the investment decision. The prospectus is relatively selective of the information about the historic trading performance and analyzing the changes in the balance sheets. Dick Smith was founded in 1968; however, the prospectus revealed that the company was incorporated in 2013, which stated that there were changes in ownership and structure of the organization. It was cited as a valid reason for being unable to provide information required by the retail investors. There was very less available data related to extent of changes in the inventory.

It can be critiqued that the reason for the demise of the building is considered as inventory changes and the role of private equity; however, the Senate enquiry should broaden its scope and must encompass the disclosure regime (Montgomery, 2016).

 

Practice of Manipulating Sales figures, Stock Inventories, and Accounting Policies thereof

In the demise of Dick Smith, dubious accounting methods were considered as the major issue. In these practices, the company manipulated the sales figure and the stock inventories and these figures made the company buy excessive amount of inventory, which resulted in rapid expansion of stores and bank rebate from suppliers. The problem began with the transition of Dick Smith from the subsidiary of Woolworths to a listed organization in Australian Stock Exchange. The private equity owner of the company, Anchorage obtained a very high value when the company was listed. It can be critiqued that the private equity firms make investment to increase the value of the firm by a large amount.

There are several methods such as selling non-core assets, ceasing the operations of unprofitable business segments, and increasing the efficiency of the business. After selling the remaining parts of the business, the company owner sells the remaining part of the business as a growing business. The retail investors were attracted to the IPO of Dick Smith, as it was considered as growing business. The company’s directors increased the pressure and the demand on the staff so that they purchase the inventory in bulk. These strategies are considered as “earning management” and in this case, it is considered as “real activities management” (Parker, 2016).

The Real Activities Management refers to the divergence of the managers and other employees from the standard operational behavior, which can structure the transaction, alter the balance sheet, and mislead the potential investors.

The managers get involved in different activities such as research and development expenditure, selling the fixed assets, price discount, and overproduction. It generates inventory in excess, which reduces the cost of the products sold. These activities are difficult to identify as they are easily disguised in the everyday activities of the organization. These methods reduce the overall value of the firm in a long duration. The managers intensify these activities in financial distress (Keasey, Thompson & Wright, 2005).

The companies attain different benefits to manipulate the accounting policies. It increases the temporary income and protect against the default on debt. Other than that, it also reduces the additional monitoring on the shareholders.

The business of Dick Smith is extremely competitive, it has low profit margins, and the inventory has a short life span. The inventory of the company was in abundance. The auditor of the company, Deloitte questioned these rebates and the company wrote down the net inventory worth by 60 million AUD, as there was a lot of traditional stock (Lanis, Govendir, & Wells, 2016).

 

Poor Corporate Governance Arrangements and Low Transparency in Financial Reporting

The above discussion highlights the poor corporate governance practices and low transparency in the financial reporting in the case of Dick Smith. The failure of Dick Smith created a huge impact on the different stakeholders of the company. The stakeholders are the entities, which are influenced by the success of business and are influenced by the company’s takeover or demise. It includes creditors, employees, customers and the business community. The interest of the entire stakeholder’s was breached due to poor corporate governance and low transparency of the organization.

However, in several cases such as that of Dick Smith, the disclosure is inadequate which prevents the company’s in forming an accurate view of the value of the company. When the transparency in the audit is low, there is high risk of inaccurate valuation of the company’s assets. The liquidity in such environment will be less, volatility will be higher, and market shocks and surprises will be higher. Several investors and banks were unable to reacquire their investment as due to the failure of the company.

It should be realized that increased disclosure would not result in increased transparency. It means that the company should make provision for the periodic release of information so that the investors are well aware of their decisions. Transparent audit requires that the company discloses accurate financial statements but also discloses the major corporate objectives, organization practices, and standards. It is an essential aspect of transparency for the business organizations. Other than that, the companies should not only disclose accurate and timely information on the operating and the financial results, but also on the information related to the commercial objectives and ownership structures. The companies should also release information regarding the policies developed for different stakeholders and corporate social responsibility.

In order to operate the business efficiently, the companies should follow the corporate governance framework developed by the government. Along with providing transparency, the companies should specify the rights of the shareholders and provide support to the stakeholders to exercise these rights. There should be elaboration of the duties, roles, and responsibilities of the key participants of the organization, such as board of directors and CEO (Witherell, 2003).  

The corporate governance structure serves several functional areas. It ensures that the minority stakeholders of the organization receive reliable information about the firm’s value and they are not cheated regarding the value of their investment. It regulates the managers to maximize the value of the firm and instead of focusing on their individual goals. There are several institutions, which regulate or govern the firms such as investment banks and audit firms.

It can be critiqued that financial accounting information is the combination of corporate accounting and external reporting system. It measures and discloses the audited data; analyze the financial information and the performance of the publically listed organizations. However, developing and maintaining this financial information is expensive. It is important to devote substantial financial resources to produce and regulate the financial information. The resources not only include the financial information, but also include the deployment cost of highly skilled human capital.

The government should also develop a conceptual framework for characterizing and measuring the corporate transparency in the company. The corporate transparency can be defined as the availability of the relevant and reliable information about the performance, financial position, investment opportunities, governance, value, and risk associated with the business organizations. There are several measures of the corporate transparency which includes measures for analyzing the quality of corporate reporting, examining the intensity, timeliness and credibility of the financial disclosures of the company. It also includes the measures of examining intensity of private information, their acquisition, investment schemes, and insider trading activities. There are also several measures, which measure the quality of information dissemination (Bushman, & Smith, 2003).

Corporate governance encompasses the firm’s formal and informal business contracts and help aligning the interest of the managers with that of shareholders. Generally, corporate governance focuses on agency problems, which arises from the conflict of interest, which arise between the managers and the shareholders. The design of the board of directors is dependent on the information provided by the corporate boards. The board of directors has an important role in monitoring the management of the organization. The board of directors serves two major functions, advising the senior management regarding the firm specific knowledge and monitoring the senior management of the organization. Bringing outside directors can increase the independence of the decisions, and they can increase the objectivity of the decision and scrutinize the behavior of the management (Armstrong, Guay, Mehran, & Weber, 2016).

 

Conclusion

Conclusively, it can be stated that the corporate governance and the financial accounting are integral in maintaining the success of the business. When the companies indulge in fraud and intentionally prevent some information from leaking, it misled its shareholders. In the present case of Dick Smith, the company showed that the organization is a growing organization and invited funds from different investment banks. It also got listed on the stock exchange and released IPOs. The company increased the value of inventory and showed itself as a growing organization. However, it misled the investors and they invested in the company. The company was made insolvent in a few months and resulted on heavy losses for the investors and other stakeholders. The auditors also turned a blind eye on the discrepancy in the financial records of the company.

In regard to the case of Dick Smith, the disclosure of the financial information was inadequate which prevented the company’s stakeholders in forming an accurate view of the value of the company. They invested in the IPOs of the company and failed to get any interest on the investment. The auditor, Deloitte also turned a blind eye on the malpractices of the company. Although, the company as well as the investor and auditor did not breach the law, their intentions were not in the favor of the public. When the transparency in the audit is low, there is high risk of inaccurate valuation of the company’s assets. It resulted in the failure of the company. The present situation also reduced the liquidity in the company, increased volatility, and market shocks will be higher. Several investors and banks were unable to reacquire their investment as due to the failure of the company, which should have been prevented by the regulators.  

It is recommended to maintain financial transparency in the corporate governance of the companies. The price risk and the financial markets are essential functions of financial markets, which can enable the investors to forecast the investment worth in the future. In this process, the disclosure of the current operations and the financial results and business operations is important. It is an important pricing information for the customers. The credibility of information is essential so that reliable information can be generated. The audits and accounting procedure plays an important role in maintaining the integrity of data (Islam, 2015).

 

References

Armstrong, C.S., Guay, W.R., Mehran, H., & Weber, J.P. (2016). The Role of Financial Reporting and Transparency in Corporate Governance. FRBNY, pp. 107-128.

Bushman, R.M., & Smith, A.J. (2003). Transparency, Financial Accounting Information, and Corporate Governance. FRBNY Economic Policy Review, pp. 65-87.

Islam, S.N.S. (2015). Corporate Governance and Financial Management: Computational Optimisation Modelling and Accounting Perspectives. Springer.

Keasey, K., Thompson, S., & Wright, M. (2005). Corporate Governance: Accountability, Enterprise and International Comparisons. John Wiley & Sons.

Lanis, R., Govendir, B., & Wells, P. (2016). Some answers, more questions over Dick Smith failure. The Conversation. Cuffelinks. Retrieved 9 January 2017 from https://theconversation.com/some-answers-more-questions-over-dick-smith-failure-62485

Lee, T.A. (2007). Financial Reporting and Corporate Governance. John Wiley & Sons.

Montgomery, R. (2016). Dick Smith prospectus failed to disclose. Cuffelinks. Retrieved 9 January 2017 from https://cuffelinks.com.au/dick-smith-prospectus-failed-disclose/

Parker, J. (2016). Dick Smith hearings reveal questionable accounting of rebates. ABC News. Retrieved 10 January 2017 from https://www.abc.net.au/news/2016-09-28/dick-smith-hearings-reveal-questionable-accounting-of-rebates/7885480

The Bull. (2017). Five reasons investors shouldn't swear off IPOs. Retrieved 9 January 2017 from https://www.thebull.com.au/premium/a/67435-five-reasons-investors-shouldn%27t-swear-off-ipos.html

Witherell, VB. (2003). The Roles of Market Discipline and Transparency in Corporate Governance Policy. Retrieved 10 January 2017 from https://www.oecd.org/corporate/ca/corporategovernanceprinciples/2717763.pdf

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