FINANCIAL A CCOUNTING & R EPORTING –

A SSIGNMENT 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? (15 marks)

Answer:

Mr. Raju and his associates formed the company Satyam in 1986. Being a fast-paced IT company, investors’ confidence
was easily captured leading to the rise in stock prices. Contrary, the shady platform which had been hidden from most
people apart from the promoters and Mr. Raju’s family. Mr. Raju did the following to make Satyam seem profitable-

• Spoofing the profits – Mr. Raju started showing more profits to build customer and investor confidence, causing
increase in the share prices. The shares were sold off and kept as collateral to the bank. They waited for infrastructure
to boom which would help them later to balance the books.
• Spoofing cash invoices- Bills were forged to show cash transactions to back up their profit claims. Bills were faked by
him alone which over-stated the company’s revenues by Rs 4,783 crore over a period of 5 -6 years.
• Fictitious debtors- Huge amount of debt was mounted as a ghost debt of around Rs 500 crore. The debtor number
were being inflate already and accompanied by forged bank account statement to show a pile of non-existent cash.
• Money laundering- Mr. Raju and his associates wanted to pile up money to buy infrastructure. They believed that it to
a sector of a certain boom. They started investing all the money that they gained from selling off shares and gaining
loans in infrastructure. They somehow came to know about the Hyderabad metro line thus strategically buying these
lands which when sky rocketed in price would be sold off to them. When all of these failed and Mr. Raju surrendered
along with his associates it was worth noting the roles of an auditor in this play, in this case PWC. Turns out the external
auditors were paid three to four times the market standard. Internal auditors were also misguided by Satyam higher
professionals. Even though multiple red flags were raised by some auditors in the internal probes, Satyam was always
able to turn the matter in such a way that the books would be balanced in near future.

This gullible nature and ignorance of the auditors were heavily capitalized upo n and Satyam in FY 2008-09 inflated their
sales by Rs 1100 crore and profit by 21%. But at the end when the scam came out Satyam investors had to deal with
heavy losses in hundreds of crores. This went on to show the vitality of the role of an auditor. PWC was barred from any
further certification given to company for two years. Senior partners along with Satyam scammers were jailed thus
putting into perspective the level of corporate governance at that point of time. One of the key take away from this scam
was that an auditor has a solemn role to uphold to all standards that are prevalent in the market, barring which huge
amount of losses might be encountered by investors and the general public.

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

Asnwer:

Mr. Srinivas Talluri and Mr. Subramani Gopalakrishnan were the two senior partners from PWC who failed to bring
Satyam’s illegal financial statement to the lime light. They were accused of intentionally overlooking the accounting
books. They were charged with accepting huge fees in lieu of turning a blind eye to Satyam’s books and hence were
made to pay a huge fine of Rs 5 lakh. Their jail statement made them lose their livelihood, freedom and their licenses.
To add to it, their licenses were revoked by Institute of Chartered Accountants of India such that they won’t be able to
practice. The loss of investor confidence and revoking of PWC’s license can also be said to be the aftermath and thus
included in their professional cost.
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?

Answer:

The Satyam scam saw huge uproar against its external auditing team associated with PWC. It was claimed by CBI that
the auditor “intentionally” failed to meet the auditing standards, thus giving them the opportunity to exploit the
incompetency. Further, CBI also found transaction worth Rs 4crore in FY 2007- 08, which was twice the market standard
at that moment. In the year 2018, PwC was found guilty in front of SEBI and they were instructed to disgorge Rs 13crores
at 12% interest from 2007. PWC was also banned to issue certificate or audit any other Indian company for next two
years. However, this decision was later turned over in 2019 by the Securities Appellate Tribunal (SAT).

Year 2008 saw huge backlash against the standard of auditing that was being followed in and arou nd the world. As a
result, the Indian Accounting Standard was established. It was like the International Financial Reporting Standards but
based on the Indian markets. Had it been present at the time of Satyam scam, then PwC could have been able to
mitigate the risk against bad books. Risk analysis could have been performed way before taking up Satyam as a client.
Frequent cross checking of checklists and books would have also caught any negligence on part of the tied -up auditors.
PwC being one of the big four in the world can’t afford to get its name tainted again and should adhere to the
government standards thus ensuring no foul play happens on their side.

4. What are “principal-agent” conflict – give at least 2 examples from Indian Companies clearly identifying the “Principal”
& Agents”

Answer:

Principal-agent conflict occurs consequently to irregular information that is generally prevalent in the market. The term
arises when there is a trade-off between two parties having different interests. One person, the principal, generally hires
another person, the agent, to act on their behalf to obtain new skills or characteristics. This kind of conflict has generally
been the cause of many scams happening over the years. Some examples of Indian companies have gone through this
state and came out as scams-
• Satyam scam- The Satyam scam saw investors and shareholders lose around Rs 13600 crore of their money. LIC, a
major institutional investor in Satyam, saw a drastic loss of approx. Rs 950 crores. In this case, the investors were the
“principals” as they invested in Satyam hoping for high profits seeing the sudden rise of stocks’ price shown by the
company, which was all false. On the other hand, the “agents” turned out to be Mr. Raju and his associates who duped
people of their money to launder them for their own investment plans.
• Sarada Chit Fund- The chit fund affecting around 15 lakh people turned out to be a Ponzi scheme in 2012, duping
people off Rs 40000 crores. The Sarada group promised high returns to small time investor in lieu of their money as
investment. In this case the investors turned out to be “Principals” and Sarada group “Agents”.

5. Many-a-times there have been cases “principal-principal” conflict? Give at least 2 examples from Indian companies (hint:
Minority vs. Majority shareholders)

Answer:

Principal-principal conflict happens when two stakeholders of any case don’t share the same alignment and one turns
out hogging more than the other one. The minor shareholder receives dividends, but the amount is so less that it
adversely impacts the company’s growth. Some Indian companies have faced this conflict, making them an example on
this case -
• Kingfisher case- The Kingfisher airline was founded as a no-frills aircraft line. However, after few years into the business
despite the heavy protests from smaller stockholders, Vijay Mallya went ahead and tried to be in the heavily competed
international luxury flight market. Bad decisions like buying Air Deccan and a series of bad loans saw the final loan
amount on Kingfisher mount to Rs 7000 crore. This resulted in prompting the company to not pay salaries to its
 employees. Many people lost their jobs and the majority shareholder company was closed in spite of hogging most of
the revenue.
• Maharashtra Scholarship Fraud- In 2017, the funding given for scholarships to backward classes’ students had been
mismanaged. The fraud came into focus because of a probe by the Nagpur commissioner of police. Around 1300
institutes who were given the flag for using the fund had embezzled about Rs 2000 crores from year 2010 to 2017. This
hogging of scholarship money created a major setback for the minority in term of quality education.

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

Answer:

A limited company is defined as a legal separate entity from its owners. The owners of a limited company usually have
limited liability which is mainly the capital invested by them. The assets and liabilities of a limited company is different
from a shareholder. In case of a financial distress, the shareholder assets will not be at risk. The taxation is also separately
filed for the holder and the company. The limited companies also enjoy corporate tax benefit but due to the elaborate
steps of forming a ltd smaller company tend to avoid this. This structure of a limited provides a wall between the finances
of the company and the owners. The ownership can be transferred by selling off their shares to next bidder. There are
mainly two types of limited companies-
• Private limited- This type of company is not listed on the stock market and thereby can’t sell their shares to a third
party. This prevents them from giving up ownership of their company. Also, the minimum number of people required to
start a private limited is two.
• Public limited- This type of company is listed on the stock exchange and owners can sell of their shares as they deem
fit. The public limited companies should have minimum seven shareholders to be accepted in the market.

7. What are the differences between “Moral Hazard” and “Adverse Selection”? Which kind of companies experience these
and why?

Asymmetric information is passed when two parties involved in an exchange of cash, property or as simple as talks, have
an inequal amount of information about what they are talking about. There are two types of asymmetric information-
• Moral Hazard - This type of asymmetry information is received when a person is willing to take a risk knowing that
they won’t be charged for its fallout. This type comes into effect when one party had the capability to assume additional
risks but doesn’t mention it to the other party as they question the benefit, not the morality of the situation. ExIn 2008
the housing and infrastructure industry collapsed due to the subprime loans issued to homeowners. The agents of the
banks already knew most would not be able to pay back the mortgage, but investors’ money would come in seeing all
the borrowed quantity.
• Adverse selection - This describes the point in an asymmetric transaction or exchange where one party knows less
about the other before the actual agreement. This insufficiency in information leads to variation of efficiency of prices
for good deals. Ex- Lemon car industry is mixed with the already vast 2nd hand car industry. Due to this mixture of choices
a buyer of the car doesn’t want to pay more money for the Orange category instead ends up paying for a Lemon category
as the price is low. But he doesn’t realize his mistake as he had less information than the seller.

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

Answer:

Personal experience of Moral Hazard- The college students often eat the street foods as their evening snacks. Some
regular customers started keeping “books” in the shopkeeper’s shop. The debt used to be paid off monthly with pocket
money. Some people took advantage of those regular customers and claimed they were from those regular ones’ friends
and made entries into those books. They did this for the monetary benefit.

Personal experience of Adverse Selection- This incident has happened to many people who move to new cities including
one of my relatives. After joining his workplace, he thought of buying a 2nd hand bike from a local market. Not knowing
the details of this local market proved a backlash as he bought a bike which looked and felt okay on the first ride but had
multiple electrical issues and was worth Rs 20000 less than the amount paid by him. Also, it did not have a valid
registration and insurance. He was forced to sell it at a much lesser price and incurred huge a loss.