Accounting Scandals: ABC Learning and Parmalat Cases - Case Study Example

ACCOUNTING SCANDALS: ABC LEARNING & PARMALAT CASES By Student’s Name Code + Course Name Professor’s Name University Cite, State Date Table of Contents A. Facts Related to the Case Scandals…………………………………….3 B. Stakeholders Involved in the Scandals…………………………………6 C. Ethical, Legal, Accounting And /Or Corporate Governance..................8 D. Similarities & Differences: Enron, ABC Learning and Parmalat………8 E. Suggestion on Improvements and Changes……………………………10 References List…………………………………………………………11 A. Facts Related to the Case Scandals ABC Learning: ABC Learning was established in 1988 as a child care center by a couple: Edmund Groves and his now alienated wife Le Neve Groves in Brisbane, Queensland. In the period for which the facility was established, childcare centers were mostly of non-profit organizations or were being supported by the government of the time (Mak, 2012). By the year 1996, this firm has already established a total of about 18 childcare centers and also, it was deemed as the most popular facility that provided nascent private childcare services in the whole of Australia. Come the early 1997, the Australian government embarked on a policy that transferred the subsidy offered to the sector and instead make direct payments to families. This had an objective of developing a potential for growth within the entire sector as a whole (Mak, 2012). As a result of this development, ABC Learning embarked on expanding mission where it acquired numerous properties in prime base locations as well as purchasing single daycare facilities as well as notable smaller childcare groups so that by the end of 1999, the facility had accumulated a total of 30 centers (Mak, 2012). In 2001, the firm listed on the Australian Stock Exchange where it was able to access additional capital for further expansion strategies. It is noted that after the listing, the firm’s level of growth doubled up at a faster rate with the operations doubling each and every year of operations (Mak, 2012). By the end of the financial year ending 2005, the firm’s had already secured at least 660 centers in Australia and coming into the following year, it explored the opportunity of venturing into overseas market. Two years later, it managed to acquire and operate at least 2,238 childcare centers in such regions as Australia, the United States of America, the United Kingdom as well as New Zealand (Mak, 2012). It is fundamental to mention that when the firm first listed in the stock exchange market, it had a total of A$25 million in market capitalisation, which increased tremendously to A$2.5billion in 2007. Within the same year, it managed to report profits totaling to A$143.1million and a revenue base of about A$1.7 billion (Mak, 2012). Then suddenly, the firm was overwhelmed with enormous level of debt repayments and thus, it was forced to sell about 60% of its US based subsidiary as well as the whole of UK subsidiary. Its trading price dropped to A$0.54, which was below its peak of A$ 8.60. As a result of this miss-happening, it was delisted from the ASX and immediately put under receivership (Mak, 2012). The fundamental accounting issues that lead to the collapse are attributed to its massive acquisitions that led to recognition of the licenses of operating the facility as well as enormous recognition of goodwill amounts, which are intangible assets in nature (Mak, 2012). The level of goodwill and childcare license had rose to a substantial value within a period of two years hence overstating the balance sheet. Profits of the company continued to increase through the aforementioned acquisitions despite the fact that its asset base constituted of 70 per cent of intangible assets that were not realizable in future. Subsequently, the firm’s total liabilities in the period between June and December of 2007 remained at a constant figure but in the end of December within the same year, A$1.1 billion of borrowings were reclassified from current to non-current liabilities due to the underlying refinancing of the company (Mak, 2012). Consequently, the firm could not raise enough operating cash flows to pay off such short commitments like interests, salaries and suppliers (Mak, 2012). It later emerged that the couple; Edmund and Le Neve and some other directors of the firm had embarked on pledging their shares to borrow cash. As the share prices of the firm continued to deteriorate, they engaged in the selling of 5.6% of the total shares of the firm in order to counter the margin calls. This led to a flood of the company’s shares in the stock market hence devaluing the share prices even further (Mak, 2012). Parmalat’s Case Facts: The company was formed in 1961 by Calisto Tanzi. It innovated a newer way of preserving milk without the use of refrigeration equipment. In the period between 1990 and 2003, the company embarked on enormous borrowing sprees that were mostly funded by large international banks as well as brokerage firms to engage in massive acquisition of businesses and assets in international markets (Strategic Competency, 2014). Some of the most notable banks that helped the firm raise a minimum of $600 million debt funds include; J.P. Morgan, Bank of America and Citigroup. Subsequently, the firm also accessed additional $6 billion from foreign and Italian based banks through aspect of direct lending as well as use of complex derivative transactions. In the course of 2003, it was noticed that the bank had started to experience challenges in making interest payments on its underlying enormous level of borrowings (Strategic Competency, 2014). Despite the fact that the firm’s financial statement depicting a stronger cash flow position of about $5.2 in addition to its borrowings, it was not clear why it was not able to pa-off a $190 million bond issue that had come due. This triggered a panic in the stock market. The inquiry led to the exposure of accounting fraud where the firm had initially lied that it had a $.49 billion of cash account with Bank of America (Strategic Competency, 2014). Subsequent, it was noted that the company through its CFO had misappropriated in excess of $11 billion of assets. All in all, the debt funds borrowed from the banks were used for purposes of executing massive and unrealistic acquisitions pay the interest rate on the ever growing debt of the firm as well as in hiding ever growing losses of companies owned by Tanzi across globe (Strategic Competency, 2014). Similarities of the Case: Both of these firms engaged in massive borrowings for purposes of engaging in enormous acquisitions sprees of assets and smaller businesses in overseas markets. Significantly, additional borrowings from all of these firms were accessed through complex transactions. For instance, while ABC Learning founders and directors used their shares to pledge for more borrowings, Parmalat used complex derivative based transactions to secure loans from financial institutions. It is also noted that both of these firms had misstated their total liabilities, which led to restructuring of these liabilities. In both cases, auditing firms that were appointed to evaluate and give opinions on the nature of these firm’s annual reports failed to execute their task effectively. Such auditing firms like KPMG, Deloitte and Grant Thornton failed to see the falsifying of accounts of both firms hence leading to a massive fraud. B. Stakeholders Involved in the Scandals ABC Learning: Edmund Groves and Le Neve Groves: these are the co-founders of the company and they played a major role in executing the scandal. Together with some of the company’s directors, they were able to pledge their shares for borrowing money. However, as the shares of the firm plummeted, they were forced to sale at least 5.6 per cent of the total value of the company for purposes of satisfying the margin calls. This resulted to the flooding of the stock market with shares of the company; an aspect that later led to the delisting of the firm from AUX altogether. The two are said to have later separated as result of this occurrence (Mak, 2012). Auditing Partners: in regards to auditing firms, ABC Learning had, for a long time, been audited by Pitcher Partners and always gave unqualified opinion from the time they were appointed to evaluate the viability and presentation of the firm’s annual report. However, come the late of 2007, they decided to resign from auditing it. Ernst & Young was later appointed as the auditing firm and was able to postulate a different opinion about the profits of the firm (Mak, 2012). This prompted the appointment of yet another giant auditing firm; KPMG, to aid with reconciling the discrepancies in the annual reports. KPMG’s faulty auditing services did not manage to locate the discrepancies. The failure of the giant auditing firm to expose the fraudulent reporting of profits and cash flow led to collapse of the firm and a negative reputation of the auditor. Banking Institutions: ABC Learning received massive borrowings from local banks for purposes of acquisition and expansion strategies in excess of A$1.2 billion (Mak, 2012). As a result of the fraud, these banks refused to engage in further loan agreement with these banks but the turnaround was rejected altogether. Interest expenses that were due could not be repaid to the banks involved. Employees: junior employees that had worked for the company for a number of years were left jobless and also, they were not paid salaries for a substantial period of time due to the inability of the firm to generate substantial cash flows. Parmalat: Tanzi: he was the founder of the business premises. He helped to falsify the accounts and siphoned-off at least $600 million to counter losses in other family businesses. He was later arrested by the government of the day (Strategic Competency, 2014). Fausto Tonna: he was the firm’s CFO and was responsible for the precise architect of continuous funding to the firm by way of misrepresenting accounts. He was later arrested together with the CEO for falsifying accounts (Strategic Competency, 2014). Global Banks: the funding of the firm came from such notable banks as Citigroup and Bank of America. They engaged in massive personal borrowings of money by way of complex derivative transactions. They were affected by the scandal in the sense that most of them were forced to write down enormous amounts of money on their respective Parmalat bond holdings. Employees: the firm’s immediate employees are also some of the stakeholders that were caught unaware by the scandal. They were affected by the fact that despite the government promising to save the firm from collapse through provision of emergency rescue package, they later lost their jobs. Italian Government: The government is yet another stakeholder involved in this scandal. It made efforts to secure the collapse of the firm in vain. It lost massive cash through emergency rescue packages. Auditing Firms: the firm had been audited by such notable auditing firms like Grant Thornton and Deloitte Touche Tohmatsu, which failed to note the misrepresentation of liabilities and cash flow generations of the firm. As a result, these firms are affected in the sense that they face a probable prosecution from the Italian government for their failure to exposure discrepancy in the annual reports for substantial number of years (Strategic Competency, 2014). C. Ethical, Legal, Accounting And /Or Corporate Governance For ABC Learning, the ethical issues involve the use of company’s shares to pledge for personal loans from banks at the expense of other stakeholders. The legal issue is manifested when the firm fails to adhere to the AASB legal framework associated with the concept of faithful representation of reports. The firm goes ahead to reclassify its current liabilities into noncurrent liabilities without following proper legal accounting frameworks. The accounting and corporate governance issues arise from the case when the firm’s management and executive fail to commit to taking into consideration of stakeholders interests. These occur when about 5.6 per cent of the firm is sold in terms of shares without the consent of other shareholders. This raises the questions on whether the management performance and compensation package are tied to the performance of the company in regards to profitability and appreciation of its share prices. For Parmalat, the major ethical concern rests with the CEO and CFO engaging in misrepresentation of accounts as well as assets and liabilities. The two siphoned money from the firm without the consent of other shareholders and as a way of covering for the lost money engaged in a continuous borrowing exercise. A legal issue arises when the accounts are not prepared in accordance with the stipulations of AASB, which calls for fairness and materiality of accounts. For instance, Parmalat has misstated its liabilities at $16 billion as opposed to $2 billion earlier reported. Issues attributed to corporate governance are perceived when the two managers engage in unfair and unrealistic mission to fraud resources and also, engage in illegal market activities like the use of complex derivative transactions to access for additional funds from both foreign and Italian based banks. In both of these scandals, the management team is involved in siphoning monies from the company’s accounts despite the fact that they are entitled to practicing fair corporate governance practices. D. Similarities & Differences: Enron, ABC Learning and Parmalat Just like the cases of both ABC Learning and Parmalat, Enron engaged in great expansion strategies of investments into the overseas market. With the appointment of Jeffery Skilling as the new CEO of Enron in 1997 came about new changes especially in the accounting system. The accounting system of the company was changed from the normal straightforward way of accounting under which the firm listed actual sales revenues as well as costs incurred in the course of supplying and selling of gas to a market-to-market form of accounting system. This approach required that estimation of future revenues from long-term contracts to be reflected in the annual reports. This was allowed despite the fact that the money was not yet received hence, leading to a misleading of accounting information to investors and other stakeholders. Despite the firm getting approval from SEC, the method backfired given that it had corrupted the company’s books of accounts; it was noticeable that the firm had only paper revenues (He, 2008). Enron, just like ABC Learning and Parmalat, engaged in the fabrication of losses and company’s earnings. The only difference is that Enron used multiple special purpose entities (SPEs) (Li, 2010). Subsequently, the company also like its counterparts engaged in misstating of its total liabilities section especially by way of hiding the debt levels of its capital structure. As a result, it lead to a panic in the stock market for which the stock prices began to fall and numerous SPEs began to collapse as well due to the drop in the share price (He, 2008). In all of these scandals, the CEO and CFO are deemed responsible for the collapse of the companies as a result of bankruptcy filling. For instance, in Enron’s case, the CEO; Jeffery Skilling was responsible for market-to market accounting system that proved ineffective and lead to loss of capital related costs (Li, 2010). The CFO; Andrew Fastow embarked in the formulation and implementation of SPEs, which was a way to hide losses and debt of the firm. Significantly, just like Tanzi of Parmalat, Enron’s former CEO and chairman; Kenneth Lay allowed his family to misuse the firm’s assets given that they used the firm’s jets for personal travels. He was also involved in the conspiracy to fraud the company of cash resources (Li, 2010). Just like the other two scandals, Enron’s aftermath is seen to have affected numerous stakeholders. For instance, employees lost their jobs and a steady supply of income. Both Andy Fastow and his wife Lea pleaded guilty of the offence and were jailed (Pavel & Encontro, 2012). E. Suggestion on Improvements and Changes Utilitarianism theory stipulates that a suitable course of action is one that should be able to maximize utility and reduce or eliminate the level of suffering attributed to it (Bentham, 2009). On that note, it is significant that formulation of legal frameworks be put in place to aid with the supervision of corporate governance. For instance, all public companies should have majority of independent directors and compensation committees. Subsequently, audit committees should be composed of members that are financially enlightened and one of them should have prior experience in the field. It is of great benefit if careful selection of accounting practices is adopted and financial structures used as well. Deontology is a normative theory that assumes a position that is able to review the morality of individual actions based on a set of rules or regulations (Waller, 2005). For this reason, such scandals can be avoided in the future in case effective rules and regulations are put forth to outlay the possible prosecution of stakeholders involved in any manner of fraudulent activities. For instance, participants of the fraud regardless of their position should be made accountable of the entire scandal. Auditing firms like Grant Thornton and Deloitte, involved in provided misleading opinion on the financial statements of Parmalat should be also be held responsible for their misjudgments. A good remedy is to dissolve their operations in the event that they are found responsible for providing misleading opinions voluntarily (Xu, Peng and Li, 2005). References List Bentham, J .2009. An Introduction to the Principles of Morals and Legislation (Dover Philosophical Classics). Dover Publications Inc. He X 2008. The Responsibility of False Accounting and Governance. Journal of Central South University of Forestry & Technology (Social Sciences), vol.2, no.4:pp. 69-72 Li, Y. 2010. The Case analysis of the scandal of Enron, International Journal of Business and Management, vol.5, no.10:pp. 37-40 Mak, Y, T.2012. The ABC of a corporate collapse. The Business Times, p.17. Retrieved from http://newshub.nus.edu.sg/news/1212/PDF/ABC-bt-28dec-p17.pdf Pavel, T & Encontro, M. 2012. The Enron scandal. Retrieved from http://www.math.chalmers.se/~rootzen/finrisk/GR7_TobiasPavel_MyleneEncontro_ENRON.pdf Strategic Competency. 2014. Global Perspective: The Fall of Parmalat. Retrieved from http://www.cengage.com/resource_uploads/static_resources/0324226217/8477/SC_c11_parmalat.pdf Waller, B, N. 2005. Consider Ethics: Theory, Readings, and Contemporary Issues. New York: Pearson Longman Xu H, Peng L and Li P 2005. Analysis of the strategies of avoiding the accounting fabrication. Journal of Xi’an University of Engineering Science and Technology, vol.19, no.4:pp. 469-473. Read More