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A Presentation on

Agency Relationship
W &
E Creative Accounting Practices
L
C
O
M
E
Learning Objectives
Agency Relationship
Why agency Relationship
Sources of conflicts
Ways to minimize this conflict

Scope of Creative Accounting

Techniques of Creative Accounting


Why Agency Relationship Appears
Self-dependent
A Primitive Society
G
E
N Little
C Communities
Y

R Surplus
E
L
A Sole
T Proprietorship
I
O
N Partnership
S
H
I
Corporation
P
Structurer of Agency Relationship

a)Structure of Agency Relationship:

Shareholders Agents
Structure of Agency Relationship

a)Structure of Agency Relationship:


>Information Asymmetry
(Rotten Lemon Theory)
Annual Report

Agent Shareholder
Why Agency Relationship Appears
A
G
E Dependency
N
C
Y

R Specialization
E
L
A
T
I
Decentralization
O
N
S
H
I
P
Sources of Conflicts
A
G
E
N Information Asymmetry
C
Y

R Self Interest
E
L
A
T
I
O The Rotten-Lemon Theory
N
S
H
I
P
In Business Context…
A
G
E
N Whenever a manager owns less than 100% of the
C
Y firm’s equity, a potential agency problem exists.
R
E
L
A Where there is dependency, there is Agency
T
I problem. We can see agency relationship
O
N everywhere in our society. (say, between us and
S
H the hair dresser).
I
P
In Business Context…
A In theory, managers would agree with shareholders’
G
E wealth maximization.
N
C
Y

R However, managers are also concerned with their.


E
L personal wealth, job security, fringe benefits, and
A
T
lifestyle.
I
O
N
S
H
This would cause managers to act in ways that do
I not always benefit the firm shareholders.
P
Minimization of this conflict
A Two ways:
G
E a) Stick (Monitoring, Market Forces),
N
C b)Carrot(Incentives)
Y
Stock Options or
R
E Golden Handcuffs
L
A Performance Plans
T
I
O
N
S
H
I
P
C Creative Accounting
R
E Creativity is a positive word, but in accounting
A
T world this word is severely feared.
I
V
E
This word is being attached with the unethical
practice of manipulating or engineering financial
A
C statements into something that suffice the
C
O interest of the managers, rather than the interest
U
N
of the Shareholders.
T
I That interest is being flown from the agency
N
G
relationship dilemma.
C Scope of Creative Accounting
R
E 1. Regulatory Flexibility (in Accounting Methods,
A
T LIFO-FIFO-WAV),
I
V
E

A 2. Dearth of Regulation (Stock Options & Pension


C
C Liabilities)
O
U
N
T
I 3. Management Scope for Discretion in estimation
N
G
in Bad debts (Timing, amount)
C Scope of Creative Accounting
R
E
A
T
I 4. Timing of Transaction (Selling Financial assets
V
E
like Shares, Bonds, Options in the period when
it servers the purpose),
A
C
C
O
U
N
5. Artificial Transaction (Assets selling & Leasing
T back the same asset & smoothing through
I
N increasing and decreasing the rental payment)
G
C Scope of Creative Accounting
R
E
A
T 6. Reclassification (Liability) & Representation
I
V (Cognitive Reference) of Financial Numbers.
E

A Current-Mid-Long terms
C
C
O
U
99 Million Vs 101 Million
N
T
I
N
G
C Techniques of Creative Accounting
R
E 1. Income Smoothing
A
T
I
V a)Extraordinary Gain in the IS & Loss in
E SOCIOE,
A
C
C b)Transferring Product Expense from one year to
O
U
another, (Absorption Costing)
N
T
I c)Shifting / aligning Period Cost as per the
N
G
smoothing Agenda (Advertising, R&D Cost)
C Techniques of Creative Accounting
R
E
A
T 2. Big-Bath (if Loss occurs let it occur severely, so
I
V that next years profit have less possibility to go
E down)
A
C
C
O
U
N 3. Report Fabrication (Fabrication of some certain
T
I financial items like liability items for
N
G
management )