Examining the Satyam Financial Reporting Scandal

Corporate accounting fraud has been one of the most significant challenges that the world of accounting has had to grapple with. High profile examples of companies resorting to financial and accounting fraud include Enron and WorldCom. The latest to join this group is Satyam, one of India’s leading IT firms. This article shall seek to explore the financial reporting scandal in Satyam and how it came about, and the role of International Financial Reporting Standards (IFRS) in preventing such incidents from recurring in the future, were it to be adopted by India. For students who are seeking business dissertation help, evaluating cases such as Satyam's can provide insights into corporate governance, ethics, and practices related to financial reporting.

Satyam Computer Services Limited was founded in 1987 by Mr Ramalinga Raju, and quickly became one of the fastest growing companies in India. It also won several awards for its innovation and corporate accountability, culminating in 2008, where the World Council for Corporate Governance awarded Satyam with the ‘Global Peacock Award’ for global excellence in corporate accountability (Economic Times, 2021). Shortly after, on January 7th 2009 the markets received the resignation by Mr. Raju and along with it a confession that he had manipulated accounts of Rs. 7000 crores (Bhasin, 2013). The corporation claimed to own about $1.04 billion in bank loans and cash, but none of it actually existed. Satyam's liabilities were similarly understated on its balance sheet. Over the course of several years, Satyam inflated income nearly every quarter in order to match market expectations. Investigations later revealed the extent of the misreporting, wherein on certain occasions, quarterly revenues were overstated by 75 % and profits were overstated by almost 97 %.This fraud was achieved by a number of means. Mr Raju advanced the fraud by creating many bank statements on his personal computer. He also fabricated bank accounts in order to inflate the balance sheet with fictitious balances. By claiming interest income from the fictitious bank accounts, he inflated his income statement. In addition to all of the above, he also created approximately 6000 fake salary accounts of owners who did not actually exist and the money which the company deposited to these accounts were siphoned off by Mr Raju himself. To exaggerate revenue, the company's worldwide head of internal audit created phoney customer identities and made fake invoices in their names (Bhasin, 2013). In addition, the company's worldwide head of internal audit faked board resolutions and received illegal loans. The money was allegedly used to invest in buying large amounts of real estate in Andhra Pradesh in an attempt to take advantage of the erstwhile boom in the real estate sector in Andhra Pradesh for individual gain. In addition to all of the above, a network of of 356 investment companies was created in order to divert funds away from Satyam. These companies had several financial transactions in various forms, for example inter-corporate investments and they also had multiple instances of advances and loans within and among them. For illustration, one of the aforementioned companies with a paid up capital of Rs 5 lakh, had made an incredible investment of Rs 90.25 crore and received unsecured loans worth upwards of Rs 600 crore. The trigger which led to the dramatic confession was a last ditch failed attempt to buy real assets when it was becoming increasingly harder to keep up the deception. In late 2008, the Satyam board, including its five independent directors had approved the founder’s proposal to buy the stake in Maytas Infrastructure, which was also partially owned by Mr Raju. The hope was that the acquisition of the company would help justify the missing revenue and extra costs. Although they did not have the required shareholder approval, the directors decided to proceed with the management’s decision. That decision was soon forced to be taken back barely twelve hours after because furious investors sold Satyam’s stock and threatened to take legal action against the management. This soon led to the filing of numerous lawsuits filed in the US contesting the Maytas deal. The World Bank responded by banning Satyam from conducting business for 8 years due to inappropriate payments to staff and inability to provide information sought on invoices. This turn of events led to Mr Raju ultimately deciding to turn himself into the authorities as he realised that the scam would shortly be uncovered (Bhasin, 2013).

The Satyam fraud served to undermined investors' faith in the country's corporate governance. The effect was all the more glaring because on the outside, the company seemed to have a pristine reputation. Factors contributing to this image of being clean included being audited by PricewaterhouseCoopers, one of the biggest accounting firms and Satyam was also one off the first Indian companies to adopt International Financial Reporting Standards (IFRS). It is pertinent to examine whether India having adopted the IFRS would have changed anything, and whether it is an effective tool in preventing future similar episodes.

Studies have demonstrated that it is very difficult to irrespective of the financial reporting system which is used, there will always be room for opportunistic behaviour with regards to financial reporting and accountability, especially in a climate like India, where the government agencies lack the necessary resources in terms of infrastructure and human resources to enforce the regulations strictly (Polinsky and Shavel, 2000). This casts a doubt whether India adopting the IFRS would have significantly changed the course of the scandal, especially since Satyam was one of the few companies to adopt the IFRS. Having said that, scholars are unanimous in stating that sound financial reporting is meant to protect the investing public and provide confidence in the securities markets, and further, investors who have or intend to invest in the company and lenders have the right to access reliable and transparent financial information when making investing decisions about an entity (Armstrong, 2010). Bolkestein (2002) posits that since the IFRS is principle based, it was superior to its other equivalents such as the GAAP system used in the USA. This reflects a larger trend in international geopolitics especially in the world of finance, as increasingly the IFRS is becoming the de-facto global standard in financial reporting, and countries such as Japan have adopted the IFRS in an attempt to prevent similar instances of financial fraud (Tsunogaya, 2016). Hail et.al., (2018) points out that it is not just the reporting system and the regulations that are important, but the enforcement capabilities of the local government authorities that are the biggest determinant of such financial scandals, demonstrated by the fact that over the last two decades financial scandals have often succeeded changes in financial regulations also. In the context of India, India adopting the IFRS would not have changed the ability of local law enforcement to detect, investigate and prosecute the matter. The Indian government however did institute policy changes after the scandal. The government and the Securities and Exchange Board of India (SEBI) have strengthened corporate governance regulations. The Companies Act, 2013, has a well-defined code of conduct for independent directors. According to the new act, companies and organisations must necessarily change their external auditor every five years for the individual auditor and every 10 years for an audit firm. The external auditor must report irregularities found or any fraud directly to the government. Punitive changes include new rules whereby shareholders can sue directors and auditors in class action lawsuits for damages.

The central idea behind why IFRS will prevent such financial scandals in the future is that the IFRS is more principle based than rule based. A theoretical shift from ‘rules-based’ to a more principle based accounting standard will in theory discourage any aggressive financial reporting, such as overstating financial performance on the part of the organisations (Agoglia, et.al., 2011). The authors explain the theoretical reason behind it is that less guidance forces organisations to take a ‘step back' before adopting an accounting standard, increasing the requirement for decision makers to use professional judgement consistent with the standards' intent, resulting in more relevant and informative financial statements, in contrast to a rules-based standards allow the individual to structure the transaction to ‘get around’ the rule so that it still technically meets the requirements (Agoglia, et.al., 2011).

Thus in conclusion, India should adopt the IFRS as it would allow more seamless and faster interpretation across international firms, especially in the context of India trying to attract global foreign investment for Indian firms. On the subject of prevention of such frauds, while it is not wholly dependent on just the financial reporting model, but instead also on enforceability of the laws, the general academic consensus is that it would help decrease the financial scandals.

References

Agoglia, C.P., Doupnik, T.S. and Tsakumis, G.T., 2011. Principles-based versus rules-based accounting standards: The influence of standard precision and audit committee strength on financial reporting decisions. The accounting review, 86(3), pp.747-767.

Armstrong, C.S., Guay, W.R. and Weber, J.P., 2010. The role of information and financial reporting in corporate governance and debt contracting. Journal of accounting and economics, 50(2-3), pp.179-234.

Bhasin, M., 2013. Corporate accounting scandal at Satyam: A case study of India’s enron. European Journal of Business and Social Sciences, 1(12), pp.25-47.

Bolkestein, F., 2002. The financial services action plan. Speech, 3 June 2002, SPEECH/02/49, Available from: https://europa.eu.rapid.

Hail, L., Tahoun, A. and Wang, C., 2018. Corporate scandals and regulation. Journal of Accounting Research, 56(2), pp.617-671.

Tsunogaya, N., 2016. Issues affecting decisions on mandatory adoption of International Financial Reporting Standards (IFRS) in Japan. Accounting, Auditing & Accountability Journal.

Polinsky, A.M. and Shavell, S., 2000. The economic theory of public enforcement of law. Journal of economic literature, 38(1), pp.45-76.

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