Financial Accounting & Reporting

Assignment 1

1. What Mr. Ramlingam Raju and his associates were doing to “Cook the Books of Satyam
Computers? What is your personal take away from this case?

Ramalingam Raju along with his associated were convicted of Rs 7,000-crore corporate scandal in
which chairman Ramalinga Raju confessed that the company’s accounts had been falsified by
sending an email to SEBI on Jan 7, 2009. Considered to be one of the biggest scandals the country
witnessed, it is very important to notice how the Board was able to cook the books without
intervention or suspicion.

It all began when Hyderabad was declared as the one of the fast-developing city in India and as a
result of which, the real estate and properties’ prices around Hyderabad shoot up. Raju saw this as
an opportunity and started buying or investing lands with the money from Satyam Computers.
However, with the incorporation of Maytas Infra (Raju’s family being 100% shareholders), Raju used
it as a way to siphon his money.

In order to achieve and strengthen the position of company, they started “window dressing” their
financial statements by inflating the asset figures along with deflating the liabilities. They sewed up
deals with fictious clients, had teams work on these “non-existent” projects along with introducing
around thousands of fake invoices to record sales that did not exist. Moreover, they showed a good
sum of money under the creditors tab so as to give the misconception of money being held in
market. Raju also managed to set up around 325 companies (owned by his relatives) as a way to
purchase lands. All these skyrocketed the share prices and gave Raju the opportunity to share his
and his immediate relatives shares as well as deposited shares as collateral for money from banks.
Apart from these, the company was able to show around 10,000 fake no. of employees, thereby the
money incurred was directed towards the real estate. The auditors (external) and as well as other
involved in the accounting were paid well enough i.e. PwC the external auditor was paid twice the
amount than it received from a company of same stature as Satyam.

My personal take is that it is if it wasn’t for the recession of 2008 and also due to the distress from
the shareholders against the acquisition of Maytas, I believe it wouldn’t have uncovered sooner. As a
last resort of reviving the company, if acquisition indeed had happened, then it would have become
a totally different story. It also brings to the conclusion for more transparent accounting and also
more scrutinization from the Government and SEBI.

2. What is the professional and personal cost of Mr. Srinivas Talluri, and Mr. Subramani
Gopalakrishnan, the PWC auditors associated with Satyam Computers.

PwC was the external auditors for the Satyam Computers when the news of scam broke out and it
was of the utmost importance of why an auditing firm couldn’t realise fraudulency before. These
questions pinpointed the involvement of PwC and the auditors in the scam. After 9 years of
investigation, SEBI found PwC guilty of charges and was handed over a ban of 2 years from auditing
any listed company. Both Mr. Srinivas Talluri, and Mr. Subramani Gopalakrishnan (then PwC
employees) were asked to repay a sum of Rs. 13,09,01,664 with the interest of 12% p.a. calculated
from 7th Jan, 2009 along barring them from issuing audit certificated to listed companies for three
years. They were also given a 7 year sentences along with lifelong ban by ICAI.

3. From your understanding of the Satyam Computers, what is the cost to PWC as an organization
and what it needs to do/ would have done to mitigate the risk?

PwC’s credibility as an auditing agency came under lens. This also led to the involvement and
scrutinization of PwC’s previous and existing audit works. 2-year ban to PwC from auditing any listed
companies, along with the proof of involvement in the scandal and other monetary penalty
hampered the status of PwC.

Peer review of audits so as to ensure transparency in work. Risk assessment before taking up any
company as client. PwC should have collected adequate internal financial records and its operating
effectiveness. Better corporate governance (Clause 49) at the time would also have mitigated the
risk.

4. What are principal agent conflict – give at least examples from Indian Companies.

Principal agent conflict are the problems or conflicts in priorities between a person or group and the
representative or agent to act on their behalf maybe due to asymmetric information.

Examples:

 Satyam Computers.
 NSEL Case: NSEL crisis is a case of “principal-agent problem", where the agent (Sinha) acted
against the interests of the principal (NSEL/FTIL) owing to self-interest;
 ICICI – Videocon Case: Due to personal interest, Chandra Kochhar sanctioned 3250 crore
loan from ICICI bank to Videocon and later upon default of payment, declared it as NPA.

5. Many-a-times there have been cases “principal-principal” conflict? Give an example from Indian
companies (hint: Minority vs. Majority shareholders)

Conflict between controlling and minority shareholders in a company. This happens when large
share uses their voting rights for their personal interest while minority has to bear the
consequences.

Satyam Computer is a typical example on how promoters diverted firm resources for their personal
benefit.

6. What is the meaning of “Ltd. or Limited” as mentioned in names of companies?

Limited in the names of companies indicates the shareholder’s liability is limited to what they have
guaranteed or invested originally. If such a company goes bankrupt, the shareholder’s personal
assets remain secured.
7. What are the difference between “Moral Hazard” and “Adverse Selection”? Which kind of
companies experience these and why?

Moral Hazard occurs when there is change in behaviour of one of the parties or when one provides
misleading information to the other because the consequences/cost of the action will be dealt by
the other. In the commercial banking sector, the belief of government absorbing the loss incurred by
creditors have led to the feeling of moral hazard prompting banks to take on more risky clients than
optimal

Adverse Selection occurs due to asymmetric information i.e. one part having more information than
the other and thereby can distort the choices. The person with less information is at disadvantage. In
insurance companies, when the applicant can dishonestly provide the proof of him belonging to a
low risk category, can avail the insurance benefits at a lower premium than a normal high risk
person.

8. Do you ever have come across these two concepts in your life? Elaborate from your personal
experience.

I believe I have experienced both Moral Hazards and Adverse Selection during my life.

Moral Hazard that I had experienced would be the time when my phone was initially uninsured, I
used to take care and made sure that not a single scratch occurred to it but the moment it was
insured, more careless I became of the safety of the smartphone. Basically, I became more careless
with my owned items.

In case of adverse selection, I was at the receiving end as I was unaware about a invisible defect in
the laptop when I bought from second hand seller at a reasonably good price and later due to my
information indifference, I had to regret later.