I. Analyze the case and respond to the following questions:
(a) Discuss the earnings management techniques employed by the management of Satyam.
In this case of Satyam, I can conclude that the obvious technique employed by the said management are:
1. “Big Bet on The Future”.
When an acquisition occurs, the company acquiring the other is said to have made a big bet on the future. As refer to this case, Ramalingam Raju the Chairman of Satyam Computer Services Ltd. believes the acquisition of Maytas Infra and Maytas Properties will benefit Satyam and boost its earnings in the future.
The first instance is when he knows both Maytas companies are highly growth company in developmental infrastructure. So, after the acquisition, he may claim the earnings of the recently acquired corporation providing an automatic earning boost.
Apart from that, other justification brought up by Raju regarding this buyout deal are the acquisitions may de-risk Satyam’s core IT business by adding a new business vertical in infrastructure. From this statement, we can see that Satyam is slowly planning to diversify its business into infrastructure sector. By acquiring Maytas, he already write-off the continuing R&D costs from Maytas. This means that when the costs are actually incurred in the future, they will not have to be reported and thus future earnings will receive a boost.
(b) In your opinion, why do the managers of Satyam want to manage their earnings and subsequently be engaged in fraudulent activities?
In today’s material world, many companies give an extra focus on how they could achieve high profit from their business. This profit will determine the number of earning they make. Lenders and investors almost always look at the quality of this figure to assess the “health” of a company. For instance, an investor would attract to invest in a company that has high liquid ratio because they have the ability to meet its debt obligation in time compared to a company with low liquidity ratio. Thus, it’s important for an organization to have these attractive factors in order for them to raise additional funds from the investors to run their operations.
However, it is nearly impossible for a company to consistently report periodical earnings over a long period of time due to changes of economic cycles, seasonal changes, new legislation, and other extraordinary events. In order to “normalize” the continuous succession of flows in financial result, most company managers will resort to a practice known as earning management. “Earnings Management” occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of a company or influence contractual outcomes that depend on reported accounting numbers. In simple words, earning numbers are deliberately manipulated by management for the purpose of meeting company’s objectives whatever they might be.
Pressure from the management.
(b) What were the consequences that befell the company upon the discovery of the fraudulent activities?
ii: Discuss in what instances is earnings management acceptable and in what instances is it not acceptable.
Before defining what earnings management is, it is important to understand the meaning of earnings first. Earnings are the profits of a company. Investors and analysts look to earnings to determine the attractiveness of a particular share. Companies with poor earnings prospects will typically have lower share prices than those with good prospects. It is very crucial for a company to generate high profit since it will determine the share price in the future. Earnings management may be defined as reasonable and legal management decision making and reporting intended to achieve stable and predictable financial results. Earnings management is the choice by a manager of accounting...