The report is intended to provide a brief account of the earnings management techniques that have been applied by Syrah Resources Limited in its Annual reports for the year 2017 and 2018. The report provides an introduction of the company, meaning of the term earnings management, commonly used techniques used for earnings management. The report describes the ways in which the company has done earnings management, the impact of these ways on financial reports and also discusses about the possible motivation to the company for resorting in earnings management. The report provides a conclusion and recommendation section at the end.
Syrah Resources Limited is an Australia based company which also carries on its operations in some other countries of the world. The company in involved in exploration of graphite and other minerals. The main project of this company is the Balama Graphite Project which is located in Mozambique. The company started operations at its Balama site in the year 2018. The company owns some of the very important graphite mines in the world. The company intends to make the Balama project achieve 70 percent of its capacity towards the end of year 2019. The company aims to become the biggest provider of high quality graphite in the world. However, despite its vast size and big plans for expansion, the financial performance of this company has been going down and it is on the decline since last two-three years. It is quite a common phenomenon that whenever a company faces financial difficulties, it tries to present its rosy state of affairs and statement of profitability by managing their earnings. Earnings management refers to those techniques which are used by the management of companies to make their accounts look better by manipulating the accounts of the company in relation to the earnings. This report will provide a brief study of the earnings management ways and techniques which have been adopted by the management of Syrah Resources Limited in order to manipulate the accounts of the company.
The term earnings management is used to describe that process which is followed by management of the company so as to manipulate the accounting records of the organization so that these records present what they want them to show instead of the actual state of affairs and the financial performance of the company. These are a lot of reasons owing to which the management of a company may resort to earnings management. These reasons can be internal as well as external (Cengage.com. n.d.) However, most of the times these factors are related to external pressure that is faced by the management of a company. The factors that motivate the management to involve in earnings management are briefly described below.
Pressure to meet the internal targets
Expectations of PUBLIC
The accounting bodies and the regulators have from time to time tried to reduce the “loopholes” in accounting rules that give way to companies to indulge in earnings management. However, since accounting by its very nature is not completely objective and is based on assumptions and estimates which give rise to subjectivity in accounting which is misutilized by the management of companies to indulge in practices that form part of earnings management. Some of the most commonly used practices which are used by companies to manipulate their accounts by adjusting their earnings have been described below:
The big bath – This is also known as income smoothing. In this earnings management technique, a company tries to accelerate its expenses into that year which already has low profits so that future years show a better financial performance. This basically involves shifting expenses of one period to another period (Merritt 2018).
Creative acquisition accounting- In this technique of earnings management, a company tries to recognize undue profits from accounting for goodwill/capital reserves in case of acquisition.
Cookie jar reserves- In this technique of earnings management, a company tries to shift its profits from year to a future year (Merritt 2018).
Recording of one-time expenses – In this technique of earnings management, a company tries to avoid the recognition of a huge one time expenditure in its profit and loss statement by recognizing that item as a capital asset in its balance sheet (Merritt 2018).
Inconsistent accounting methods – in this technique of earnings management, a company tries to manipulate its earnings by switching between different accounting policies for each year depending upon the fact that whether they want to inflate or deflate their earnings for that year (Merritt 2018).
This report discusses on the ways and measures employed by Syrah Resources Limited so as to manipulate its financial performance and state of affairs as is evident from the annual reports of the company for the year 2017 and 2018. In order to identify the ways in which company has done its earnings management, a critical evaluation of the financial reports, notes to accounts and the auditor’s report was performed. The ways are described below in detail:
The company recognized millions of amounts as development costs for its Balama Graphite Project. In 2017, the company capitalized development costs of $108 million and in year 2018 it again capitalized costs of $58 million towards cost of development of Balama site (Syrah Resources Limited. n.d. a :Syrah Resources Limited. n.d.b ). The company has done this so as to be able to present a better picture of its profitability to its investors and to present a strong balance sheet. The earnings management technique of “recording of one-time expenses”, has been followed by the company in this case.
All the costs incurred by the company during the commissioning stage of its mining projects have been adjusted against revenues from the project (which are very low at present). The costs that remain after adjusting them from revenues have been reported in the balance sheet (Syrah Resources Limited. n.d. a).
Capitalization of huge amounts as development costs
The company has recognized huge amounts as development costs of Balama Project in its balance sheet. However, it was mentioned by the auditors of the company in their audit report that there were a lot of financial reporting risks that were involved in the recording of above costs by the company (Syrah Resources Limited. n.d. a). It was indicated by the auditors that company had capital those costs which do meet the definition of “development cost”. There were instances of recognition of operating costs as development costs. All these incorrect accounting treatments enabled the company to report to earnings management by being able to reduce the amount of its net operating losses and present its mining assets at inflated values in its balance sheet.
Non-recognition of expenses related to commissioning stage of Balama project
This treatment is not according to the accounting treatment that has been provided in the Australian Accounting Standard 115 related to Construction Contracts. This case falls in the category of earnings management technique of “inconsistent accounting methods”.
In case of Syrah Resources Limited, the motivation for earnings management may due to internal pressure as well as external pressure. The company has been incurring high operating losses since last two years. The deteriorating financial results of the company may have put internal pressure on the company for earnings management as the top executives could be pressurizing the managers for achieving improvement in current financial position of the company. At the same time, the company could be facing external pressures from the public and investors who would be viewing the high operating losses of the company as a red signal for selling of the shares of the company. A lot of media reports have recently stated that the shares of Syrah Resources Limited are overvalued and investment in those shares is not as promising as is claimed by the company (Neil 2017). When a company faces significant negative publicity, it would have a tendency to resort to earnings management so as to meet external expectations of investors and the general public. This appears to be the case with Syrah Resources Limited for which the possible external factors for earnings management would have been external expectations.
The above discussions clearly indicate that Syrah Resources Limited has indulged in serious earnings management mainly by recording unqualified expenditure as its mining development cost. It is recommended to the management of Syrah Resources Limited that those expenses which do not qualify as mining expenditures are reversed. It should revise the amount at which its mining assets are presented in the balance sheet. The company should also make a disclosure in its Annual report regarding non compliance of accounting standard AAS 115 related to accounting for construction contracts. Earnings management is an unethical act, and if company makes an attempt to window dress its balance sheet and profit and loss statement, the real state of affairs would ultimately be revealed before its investors and the public. Therefore, it is better to correct its Financial reports at the right time so as to avoid the investors from loosing confidence in the company in future.
Cengage.com. n.d. Earnings Management. [Online]. Available at https://www.cengage.com/resource_uploads/downloads/032459237X_174365.pdf
Merritt C. 2018. Techniques in Earnings Management. [Online]. Available at https://yourbusiness.azcentral.com/techniques-earnings-management-11857.html
Neil S.2017. Should you sell Syrah Resources Ltd?. Retrieved from https://www.fool.com.au/2017/05/25/should-you-sell-syrah-resources-ltd/
Syrah Resources Limited. n.d.a The Future of Graphite – Annual Report 2007. Retrieved from http://www.annualreports.com/HostedData/AnnualReports/PDF/ASX_SYR_2017.pdf
Syrah Resources Limited. n.d. b The Future of Graphite – Annual Report 2007. [Online]. Available at http://www.syrahresources.com.au/application/third_party/ckfinder/userfiles/files/20190329%20Annual%20Report%20secured.pdf
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