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Earning management is the strategy that is used by the management of any entity for manipulating the earnings of the entity deliberately. It is done with the objective of matching the figures with the pre-determined target and smoothing the income. Hence, instead of having years of exceptionally bad or good earnings, entities try to maintain the figures at stable level through making addition and subtraction of cash from the reserve account (Riwayati & Siladjaja, 2016). Although number of methods are used by the managers for smoothing the earnings those are confusing by nature, important thing to note is that driving force behind managing the earnings is meeting pre-determined target (Knaus, Evershed & Karp, 2019). The report will highlight the earning management approaches used by the ASX listed company Commonwealth Bank through considering its annual report for past 2 years.
Commonwealth bank of CBA is the primary provider for integrated financial service including premium, retail, business, fund management, superannuation, institutional and business banking, investment, insurance, share-broking services as well as products. Recently it has admitted that it is the worst entity in Australia as it charges fees for the financial advices those were never received by the customers. Counsel, Mark Costello who is assisting Royal commission is question to Wealth management arm of CBA regarding this (ABC News, 2019). Financial business planning of CBA was systematically charging ongoing services fees amounting to $31,500 million during July 2007 to June 2015 and it could not provide them with the annual review. Further, the bank was unable to give any confirmation to the ASIC that it provided any service to the customers actually against the fees charged from them. Among various failures, regulator told that CFP (Commonwealth financial planner) breached the financial services license as it could not do all the necessary things for assuring that financial services have been provided honestly, fairly and efficiently in accordance with the requirement of Corporation Act (ABC News, 2019). Senior management were aware of the fact that comparatively insignificant number of CFP ongoing services customers who were not allocated to active advisor might not have not received annual review, as said by ASIC. It was also stated by the regulator that broader potential risk was there on account of fees for providing no service issue but it was not notified by ASIC till 2014 July that is after 7 years of breach. As an outcome of investigation both the parties entered into the enforceable undertaking. Originally CFP was allowed time till December 2018 to implement the satisfactory remediation program for overcharging customers however the same deadline further extended till 31st January 2019 (ABC News, 2019). The bank already paid $119 million to the customers who were charged the fees without providing any actual services. However, as CFP was not able satisfying ASIC that fees for providing no services conduct will not be repeated, regulator applied unusual step for banning the bank from earning any fees for the work. Rational provided by ASIC was that it wanted to reduce further risk to the client significantly (ABC News, 2019).
Apart from that looking into the financial report of the entity for the year ended 2017 and 2018 it is found that there is some issues regarding treatment of provision for lending assets impairment owing to the judgments provide by the management while deciding when to recognize the impairment provisions against the lending assets and approximating size of this provisions. Management individually assesses impairment provisions that exceed the particular threshold limit (Commbank.com.au, 2019). These provisions are set up on the basis of future expected cash repayment as well as projected proceeds from value of collateral held by the bank on account of those loans. If the loan assessed individually is not impaired, it is added in the group of loans with the alike characteristics of loan in addition to loans below specific threshold. Adjustments or the overlays related to provisions are made through taking into account for emerging trends and where the models may fail in fully capturing all the risks under portfolio (Commbank.com.au, 2019).
It was further found that the bank holds the financial instruments that represent 17% of total assets and 5% of total liabilities of the bank. These financial instruments include Derivative assets and liabilities, Life investment contracts, Available for sale securities, Bills discounted and other assets and liabilities designated at fair value. Major part of the financial instruments are accounted for as non-complex in the nature as the fair value is based on the rates and prices that can be observed easily in relevant markets (Commbank.com.au, 2019). Based on this major part of the financial instruments are segregated as Level 1 or Level 2 under Australian Accounting Standards. These classifications have been considered as crucial matter owing to their financial significance. Further, it has been considered as crucial on account of their completeness as well as accuracy of the data inputs that include sourcing the data inputs from independent market and methodology for determining fair value adjustments. Major issue in this regard was found that management used their own model for measuring fair value (Commbank.com.au, 2019).
In the above mentioned all the situation management may have used earning management approach to enhance their remuneration or bonus. As the STVR portion of remuneration are measured based on overall performance and individual performance assessment, increasing overall earning of the bank through earning management approach will provide the managements with higher amount of remuneration (Dibia & Onwuchekwa, 2014). Various other reasons behind using the earning management approaches are as follows –
From above discussion regarding earning management issues and applying same by Commonwealth bank it can be concluded that it is a tool that is used for fulfilling self interests of the managers and executives. However, it can further be used for welfare of the stakeholders if used ethically. Hence for getting maximum benefit from earning management steps shall be taken for improving the corporate governance and accounting standards shall be revised and set in such ways that there remain no loopholes to manipulate the earnings. In addition the auditors shall be more careful while detecting the earning manipulation along with assuring their independence. Finally, morality as well as consciousness of stakeholders may turn the malpractices into good one if motivations for earning management are free from the evil intentions.
ABC News. 2019. CBA to stop charging 'fees for no service' for most customers. [online] Available at: https://www.abc.net.au/news/2019-02-04/asic-orders-commonwealth-bank-to-stop-charging-financial-fees/10776870 [Accessed 7 Dec. 2019].
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