Answer

Accounting Theory

1. Do you think that remuneration incentives are working in the way intended under agency theory for AMP limited? Why or why not?

The payment of high remuneration packages by AMP executive management opens up the principal-agent problem. In this case, the management of AMP as appointed by the board acts as agents allowing them to make crucial decisions on behalf of its shareholders or the principal. Due to their relationship, conflict of interest or moral hazard may occur. Acting this way, AMP management have broken their fiduciary duty to maximize shareholders wealth by offering themselves high compensation packages. As a result, AMP shareholders and proxy advisers voted against the remuneration report for disproportionately large incentives to the executives. In aa virtual annual general meeting held in March 2020, 67% of the shareholder proxies voted against the report. The shareholders and proxies argued that the remuneration package was over way generous and performance hurdles as presented by the executive were not rigorous enough to demand such compensation. Announced by the board chair, Mr. Murray, AMP generous package was meant to attract and retain an executive team capable of implementing the company’s transformation strategy. The CEO, Mr. De Ferrari’s in a statement, communicated that the company was facing hurdles that would only be overcome by higher rewards to the executive team. Based on these scenarios, the remuneration incentives are not working as intended under the agency theory (Tyge & Oleg, 2019). As a result of the conflicts of interest, the board, management, and shareholders should find ways to solve the conflicting decisions.

The agency theory in financial management works to explain and resolve the relationship between the shareholders (principal) and the management (agents). Incorporate setting, shareholders delegate decision making authority to management. The management has the optimum authority in making financing, investment, and dividend decisions for the benefit of the organization. Because of the decision-making authority, differences in opinions, priorities, and interests arise. The latter is the root of the principal agency problem at AMP. While AMP executive team has been allocated resources through equity to maximize shareholders’ wealth, their decisions and interests are against shareholders’ will to maximize their wealth. The agency theory is supposed to find a solution or dispute resolution mechanism rather than the management team’s expulsion, which could further deteriorate the performance of the AMP (Tyge & Oleg, 2019). On the shareholders’ thinking, it is wrong to reward higher compensation benefits while the firm faced losses amounting to $2.5 billion in 2019.  The executive team is viewed as serving their interests rather than that of shareholders considering they would not be receiving dividends or capital gains due to investor confidence loss. In these circumstances, the executive team has faced the first strike on the remuneration report, and a repeat in the coming year could see a board spill (Tyge & Oleg, 2019). Therefore, the agency theory should provide solutions to the differences between the shareholders and the management rather than escalations, which may worsen the firm’s performance.

The agency theory plays an essential role in the corporate governance structure. In the AMP case, a principal-agent problem has arisen due to conflicts of interest. The board is the negotiating body that should play its corporate governance role in ensuring a cohesive relationship between the management and shareholders. Corporate governance ensures that the AMP management work towards the achievement of shareholders’ wealth rather than high remuneration packages that consume more of its resources. Though the agents must be offered with proper incentives to facilitate their work arrangements, they must be in line with the firm’s goals and objectives. The agency theory was developed to ensure that such incentives are appropriate and serve the organization’s interests. Incentives encouraging the executive team’s greed must be removed, and rules that discourage moral hazard must be installed at AMP. The board as the negotiating agent must apply the agency loss principle that explains the difference between the shareholders’ optimal results from the actions or behavior of the AMP executive team. In this case, an evaluation must be done on the remuneration package at the expense of shareholders’ wealth mainly on the earning per share value since the costs will lead to more losses at the firm. Hence unless there is an improvement in the current loss of $2.5 billion, the executive team should not receive any incentives. Therefore, agency loss would drop if the shareholders and management have similar interests in achieving the desired income level. Secondly, AMP shareholders must be conversant with the firm’s goals and objectives to avoid conflict of interest that would lead to a second strike resulting in a board spill in the coming year. Overall, the agency theory has not played its role in resolving the high remuneration package to AMP’s executive team and its shareholders.

1. How might earning management be relevant remuneration incentives?

The agency theory is used in financial management in describing earnings management behavior. In many business scenarios, when the principal and agent are a utility of financial resources maximizers, they will not always act in the best interest of the shareholders (principal).  The management has an undue advantage to the shareholders based on asymmetric information as they control the day to day activities or operations of the business. The management may, therefore, in some cases withhold information resulting in conflict between themselves and stakeholders of the business. Increasing levels of information asymmetry result in earnings management through cases of accounting manipulation to influence investor decisions. In many cases, shareholders lack proper incentives, resources to ensure effective monitoring of management decisions, and actions (Prena, Fazeena, & Priyashni, 2013). Therefore, the agency theory acts as a basis point in understanding earnings management since agents are driven by economic incentives to manipulate financial results.

In the case of AMP, conflict of interest between the management and its shareholder’s earnings management might be relevant to remuneration incentives. From the chairman of the board statement, the 2019 remuneration designed to reflect the scale, complexity, and challenges involved in transforming AMP business. During the year, part of the management goals was to separate the life insurance business, address regulatory and legal matters facing its operations, and complete client remediation. The chief executive reflected that for the executive team to face the hurdles, a high compensation award was recommendable, which was opposed by the shareholders and proxies at the virtual annual general meeting. With these circumstances, earnings management can arise in different ways, including window dressing, internal targets, income smoothing, and external expectations. On window dressing, the AMP management team could redress the hurdles or challenges facing the company to lure the shareholders for high compensation perks (Xuerong & Li, 2017). For example, the management might lure the shareholders in believing that with higher remuneration to the executive team, the firm will achieve higher profits in the future, which would be fraudulent, with the company still facing financial losses. Achievement of internal targets is also an earnings management technique. The chief executive officer alludes that with higher awards, the business will transform its strategy in achieving higher financial results. The company will also address its legal and regulatory challenges to turn its business around. The management also alludes to achieve a higher share value to attract more investors to its portfolio. The income smoothing strategy may result in a spike in its share price but drop further in the future. Furthermore, management has high external expectations that AMP will achieve better results (Al, 2019). Based on the following evidence, earnings management may be relevant to remuneration incentives to the executive team. The management might lure the shareholders in believing that the AMP business performance will turn around in the future for them to receive higher perks.

1. What theory or theories from ACC30008 do you think can explain why Australia’s two-strike rule was introduced?

Based on AMP’s management’s conflict of interest, a two-strike rule might result in a board spill if more than 25% of the shareholders vote against the executive team’s in the following year. The two-strike rule is a law designed in Australia to hold directors accountable for the management or executive salaries and bonuses (Georgia, 2012). If there are conflicts of interest on disagreements on the award of salaries and bonuses, the board can face re-election. The two-strike rule is an amendment of the Corporations Act that came into effect in 2011. Under this rule, the first strike occurs when a remuneration report is released outlining executive management salaries and bonuses. It receives a no vote of more than 25% of the shareholders of proxies’ votes. In this case, the remuneration report received a no vote of 67%, which confirms that the first strike occurred at AMP. The second strike occurs when a subsequent remuneration report receives a 25% or more no vote (Georgia, 2012). Hence, the AMP board of directors faces a risk of the two-strike rule resulting in a board spill or re-election in the coming year.

 Several theories can explain Australia’s two-strike rule, including the agency theory and stakeholder theory. The agency theory concentrates on the interests of shareholders and looks for ways to find solutions between the management and shareholders as the principal parties of the organization. Incorporate governance, the agency theory underlines the separation of powers between the board, management, and shareholders of the organization. (Reza & Chew, 2013) In principle, the board is the decision-making organ of the organization elected by the shareholders to act on their behalf within a period based on corporations and guidelines. The Board of directors is, therefore, supposed to act on behalf of the shareholders in protecting their interests, mainly in maximization of their wealth. Since shareholders cannot run the company’s operations, management is appointed or recruited by the board acting as agents. With AMP having received the first strike on the remuneration report with a 67% no vote, which is way above the recommended 25%, it means that shareholders are losing confidence from the board members. The latter, therefore, faces re-election if a subsequent no vote is received from the shareholders. The two-strike rule relates to the agency theory since the board is responsible for executive salaries and bonuses. In circumstances where shareholders’ interest is not looked at, then the rule takes effect. (Reza & Chew, 2013) Hence, in this case, the worsening principal-agent relationship and failure of the board to act for the interest of shareholders led to the first strike at AMP.

            The second theory explaining the two-strike rule is the stakeholder theory. The stakeholder theory in corporate governance explains the relationship between a business and its stakeholders, including suppliers, customers, investors, communities, and employees. The theory argues that an organization should create value for the shareholders and all stakeholders (Reza & Chew, 2013). In this case, the board of directors at AMP have a responsibility to review all the organization’s interests. As part of employees of AMP, the management has a right to fair remuneration. Thus, despite the conflict of interests, which may arise from high remuneration, the board should consider whether their issues are genuine and formidable to the company’s transformation. In his statement, Mr. Murray is defensive on the high remuneration package to the executive team, which led to the first strike rule indicating a loss of confidence from the board members. Overall, the agency and stakeholder theory oversee that corporate governance structures are enhanced to avoid conflict of interests and moral hazard issues. The board, management, and shareholders of AMP should look for alternative strategies to solve the internal and external disputes that avoid the two-strike rule that might derail the company’s strategic goals.

Question Two

1. From the content above, explain fully what theories from ACC30008 can be used to explain:
2. Rio’s response to the prospect of a price on carbon

The most suitable theory in this case is the theory of Sustainable operations. According to Maczulak, (2010), this is a theory which states that even as producers strategize to maximize their returns, there is need to cater for the environmental effect on production level. According to sustainable operations theory, operations should ensure that the environment from which it extracts all its factors of production, is properly kept, so that it can be used by the current and future generations.  Rio has taken an initiative which is geared towards ensuring the emissions of carbon into the environment is drastically reduced. Consequently, the company modelled the effects of this, and the cost implications which will be associated with it. With reduction in the level of carbon emission, Rio will be able to protect its customers from   health hazard exposure of carbonated air and rain water and also reduce global warming effects. As such, the company will be able to use the current resources optimally, and   save the environment for the future generation. By operating sustainably, Rio Limited is able to cater for its best interest, while also taking care of the interest of its stakeholders.  Sustainable operations though could be costly, it is a good way of winning the trust of the various stakeholders, and building a good business image.

The response from Rio’s institutional investors?

The theory which best explains this the agency theory. Pouryousefi and Frooman (2017), defines an agent is one who is contracted by another person known as the principle, to manage a particular thing on his or her behalf. The decisions of an agent on behalf of the principle, are binding in nature both to the agent and to the principle. However, such decisions must be ratified by the principle, who the agent is working on behalf. The manager of Rio Limited and the company’s shareholder are in an agency relationship. In this case, the shareholders are the principles, while managers are agents. Opposition of the managers’ proposal is a classic example of agency conflict. The conflict usually arises when the principle and the agents fail to read from the same manuscript. Typically, shareholders are risk averse. Decision to implement carbon emission reduction by Rio will obviously affect its revenue, will in consequence reduce the earnings of the company and the shareholders thereof. This is the reason as to why the proposal has met such an opposition.

1. What is the meaning of the term ‘underlying earnings’ used by Rio Tinto Ltd in explaining the impact on its iron ore division of putting a price on carbon?

Underlying refers to an analysis which is done internally by a company, to show case the most realistic amount of money it is able to generate in form of revenue from its trade (Yang & Abeysekera, 2018).  In arriving at the underlying earnings, the frequent or else regular charges or one-time charges. Instead, the accounting cycle is fully relied on, to arrive at the final figure which is reported as an underlying earning.  The underlying earnings is different from the normal earnings reported in the income statement, and other statutory statements and documents which accompany the financial statements of a company.  Owing to the exclusion of certain factors when calculating the underlying earnings, the actual figure is likely to be exaggerated. However, the underlying earnings is suitable for modelling as in the case at hand. Relying on accounts will only give a historical information, which cannot be used to accurately predict future activities and state. This is due to the fact that the financial statements are usually made on accrual basis, while relying heavily on historical information.

Question Three

1. You work as an accountant in a small manufacturing firm and the Chief Executive Officer has asked you not to impair goodwill this year despite indications that it is carried at an amount above its recoverable amount. What should you do?

       Ethics refers to codes of conduct which are acceptable within a particular professional cycle. Accounting just like any other profession has a defined code of conducts of ethics which must be strictly observed by any practicing accountant.  However, there are a number of cases when the practicing accountants are exposed to ethical dilemmas as in the case above.  In this case, I will advise the Chief Executive Officer that it will be to be the best interest of the organization to have the good will impaired.  I will explain further that failure to report the impairing value of the good will in the financial statements would make me to compromise the following codes of conduct, or ethics in accounting.

Integrity

               Failure to report the impairing effect of the goodwill, will make the company to have an exaggerated statement of financial position, statement of cash flows, and even the statement of changes in equity (Nowak, 2018). This is due to the fact that net book value of the assets will be overreported, the profits will be overreported, hence the reported retained earnings will not be a true and fair one. Besides, the cash flow statement will also   not be accurate because the inflationary effect will not be accurately captured. Presenting false financial statement, or else falsifying the financial statements, is not allowed by ethical requirements in accounting. This is due to the fact that the financial statements are used both by the internal and external stakeholders in making decisions regarding investments. I would advise the CEO that failing to reported the impairment could even attract suits in future, if the stakeholders come to realize the financial statements were misleading.

         In the event that a suit is filed by any of the stakeholders, be it internal or external, then the CEO and myself will be the first respondents, on behalf of the company. With suits, the company is likely to taint its image, and even incur further losses due to increased expenses on image redemption and hiring of legal experts to help it exonerate itself.

Independence

               According to Nowak (2018), it is an ethical requirement that accountants be able to prepare the financial statements independently, without colluding with any other officer presenting a misleading financial information.  The fact that the CEO wants me the impairment value excluded, is a collusion which is geared towards ensuring the shareholders are impressed by reporting a higher profit. In most organizations, the Chief Operating Officers (CEO) are usually rewarded if a significant percentage profit is reported.   This collusion is therefore compromising this ethical requirement, and the cost of the shareholders’ interest. I would therefore, advise the CEO to kindly allow me work independently without any misleading collusion with him, which could expose the company to numerous risks.

Honesty

               The accounting information presented at the end of the year should present a true and fair view of the company. For this to be achieved, honesty must be practiced, in that no material information such as good will impairment should be intentionally omitted (Jeffrey,2013).  I will therefore tell the Chief Executive Officer that by failing to report the impairment value, I will be dishonest, which is could make me lose by professional trust and even credentials. Besides, dishonesty of the company accountant will be equal to dishonesty of the company, and the government is likely to execute fines, in the evet that the error or omission is detected by the independent auditor.

Responsibility 

It is an ethical requirement that accountant be responsible enough and put the interests and the users of financial statements first before theirs (Jeffrey, 2013). Finally, I will tell the CEO that omitting the impair value, will make to prioritize his and my interests, while ideally the interests at the cost of other stakeholders’   interest. In this case, I will have acted irresponsibly