Creative Accounting, Corporate Governance Watch dog Institutions and
Systems - The Case of Cadbury(Nig.)Plc.
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Introduction
The receipt of a copy of Cadbury‘s Annual Reports and Accounts for 2005
in June 2006 by The Securities and Exchange Commission was the starting
point for the discovery of a monumental overstatement of the company‘s
profit to the tune of approximately #13billion within the period 2003
and 30th September,2006. Upon review of the report, SEC wrote to the
company on 22nd September, 2006 expressing concerns on certain areas of
the report. The areas included declining profitability, worsening
leverage ratio, deteriorating cash flow, inadequate disclosure, non
compliance with corporate Governance code and obtaining loans for the
payment of dividends to shareholders contrary to SEC regulations. The
Chairman of Cadbury (Nig) Plc then wrote to the commission on 16th
November,2006 intimating it of the decision of the company to engage an
independent firm of PriceWaterhouseCoopers(PWC), to investigate the
allegation of overstatement in the company‘s Financial Statements for
the period 2003 to 30th September, 2006.At this juncture, SEC empanelled
its own in-house Committee which carried out a thorough investigation
on the matter and confirmed the report of misstatements in the account
of Cadbury to the tune of approximately #13billion. In line with its
mandate, SEC convened its administrative Proceedings Committee (APC)
and invited some directors of the company, some of its management
staff, its external auditor, Akintola Williams Delloite (AWD) and its
registrars, Union Registrars Limited, to explain their various roles in
the scandal. The findings of the committee, made at its march 27and 28
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2009 sittings, were very revealing and have dire consequences for good
corporate governance in Nigeria.
The concept of Corporate Governance
Corporate governance is concerned with the ways suppliers of finance
assure themselves of getting a return on their investment suppliers of
finance are interested in ensuring that managers return some of their
profits to them. Managers, for example, may steal the capital they
supply or invest in bad projects(SHLEIFER & .VISHNY 1997). The advent
of the modern corporation with its divorce of ownership from management
gave rise to what is popularly known as the agency problem. Corporate
governance can also be looked upon as the set of processes, customs,
policies, laws and institutions affecting the way an institution is
directed, administered or controlled. It deals with the manner in which
rights and responsibilities are shared among the various stake holders
of a given institution(Awoyemi 2009)Corporate governance is concerned
with the reconciliations of conflicts among various corporate
stakeholders(Becht et al. 2005)
Corporate Governance Watch Dog Institutions in Nigeria.
A watch dog, among other things, probe issues to ensure that what is
being presented can stand the test of truth. In so doing, watch dogs
lower co-ordination costs by designing and enforcing disclosure
requirements and by policing managerial behaviour(Kane 2004).
Corporate watch dog institutions in Nigeria can be divided into
internal and external. External watch dogs for Public Limited Companies
in Nigeria include the Securities and Exchange Commission (SEC),
External auditors and the Nigerian Financial Reporting Council.
Internal watch dog institutions include Board of Directors, Audit
Committees, internal audit.
The company and allied matters act of 1990(CAMA) provided for the
establishment of audit committees in Nigerian public companies( Section
359(6)(a-e). Strong audit committees acting as surrogate for investor
interests provide a key check and balance in the governance system.
CAMA also provided for the appointment, remuneration duties and
disqualification of auditors of PLCs in Nigeria(Section 357). The
Nigerian Financial Reporting Council( Formerly Nigerian Accounting
Standards Board)has its origin to the promulgation of the NASB Act of
2003.The major function of this body was to strengthen compliance with
accounting standards and thus enhance their reliance. The Nigerian
Securities and exchange commission is the apex regulatory organ of the
Nigerian capital market. In 2005, it issued a code of corporate
governance to guard public limited companies.
Some of the principles and practices that promote good corporate
governance include:
-Installation of a committed and focused board of Directors which will
exercise its oversight functions with a high degree of integrity and
responsibility
- Appointment of able and committed management team who should be
knowledgeable in business and financial matters and also possess the
requisite experience.
- Entrenchment of the culture of compliance with rules and regulations.
- Appointment of external and internal auditors with high integrity,
independence and competence
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-Effective internal monitoring and enforcement of well articulated code
of conduct/ ethics for Directors, management and staff
- Timely and accurate disclosure of information and transparency on all
matters material to company performance, ownership and governance, and
the responsibilities of the board to act in good faith with due
diligence and the best interest of the company and the public.
Creative accounting
There does not seem to be a consensus, at least at the international
level, of what is creative accounting or what it represents. Neither
are its basic principles of universal appeal (Balaciu et al. 2009)
Accounting processes and choice of policies resulting from many
judgments at the same time are capable of manipulations, which have
resulted in creative accounting. Many Preparers of accounting
information often succumb to the temptation of massaging numbers. The
Enron saga in 2001 was a classic case of fraudulent financial reporting
in recent times. It concealed about $600 million net losses for over a
period of three years 1997- 2000. Back home in Nigeria, a debt of #10.6
billion was concealed in the wake of the privatization of African
petroleum Plc despite due diligence search by consultants to the
privatization exercise. Many reasons have been adduced as the
motivation for the increasing spate of manipulation of accounting
numbers. These include:
- To enhance earning status
- To improve company‘s Debt- Equity ratio
- To improve company share valuation and pricing
Some of the methods used in manipulating accounting figures include:
-Careful modification of depreciation methods to ensure that
expenditure which could have been written of in one year is treated
and amortized over a number of years.
-Manipulation of foreign exchange reporting
- Creation of prepayments
- Inconsistency in stock valuation methods
-Manipulation of goodwill figures
In the case of Cadbury (Nig) Plc, stock buy backs, cost deferrals,
trade loading and false suppliers stock certificates were used to
manipulate its financial reports that were issued to the public.
The Cadbury Accounting Scandal as a Failure of Regulation
At the heart of capital market regulation is investor protection.
Investors need to be protected from misleading or fraudulent
practices which include, creative accounting, insider dealing and
misuse of client money. The core objectives of Capital market
regulation comprise:
- The protection of investors;
- Ensuring that markets are fair, efficient and transparent.
- The reduction of systemic risk.
Capital market regulation in Nigeria is a multi- institutional affair.
The investment and Securities Act (ISA) No. 29 of 2007(as amended)
recognises two main levels of the regulation of the Capital market.
Apex regulation is represented by SEC while self regulation is
represented by institutions like the Nigerian Stock Exchange, Institute
of Capital market Registrars and Chartered Institute of Stock Brokers.
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Two major approaches to Capital market regulation are discernible. The
first approach places responsibility for implementing, monitoring and
enforcing standards on market participants within a broad legal
framework. The second approach, dubbed the self-regulatory approach,
places responsibility for implementing, monitoring and enforcing
standards on market participants within rules and agreed upon by
members. Nigeria is known to operate the two systems. Strategies for
investor protection include:
- Ensuring disclosure requirements;
- Ensuring accounting and auditing standards;
- Ensuring fit and proper persons are registered to operate in the
market;
- Ensuring adequate capital requirement;
- Setting minimum standards for market participants;
- Ensuring just and equitable treatment of investors by market
intermediaries;
- Enthroning a comprehensive system of inspection, surveillance and
compliance program.
SEC wrote the management of Cadbury in September 2006 expressing
reservations about certain aspects of its operations as revealed by the
company‘s financial statement for 2005.In December 2006, the board of
Cadbury (Nig.) PLC announced a discovery of a significant and
deliberate overstatement of its results, which had existed over a
number of years and relieved its Chief executive officer and finance
director of their respective positions. SEC‘s response to this
development was to commission its own in-house investigation into the
matter. The rest is now history. Here, regulation failed in at least
two fronts. Fit and proper persons and institutions were not registered
in the first instance to operate in the capital market as exemplified
by the role of Union Registrars. The financial misstatement at Cadbury
(Nig)Plc took 5 years before it was confirmed by SEC. Table 1 below
shows a sharp dip in the company’s profit as a return on capital
employed in 2002( a red flag). Capital employed, in this case, is the
sum of share capital, capital reserve and reserve for bonus issue,
general reserve and minority interest.
Table 1
Profit as a Percentage of Capital Employed
2005
35.45%
2004
40.69%
2003
46%
2002
47.48%
2001
72.71%
Source: Computed from the financial statements of the company by the
researchers.
SEC as a regulator had come across a privileged information that the
company was paying dividends from bank borrowings but only warned the
company to desist from such a practice. It did not follow the available
lead (another red flag) to thoroughly investigate the liquidity crisis
of the company which may have led to an early discovery of the
financial scandal in the company. The umbrella body for registrars of
companies also failed to detect that Union registrars ceded its
statutory obligation to pay dividends to the shareholders of the
company to the management of the company while contenting itself with
merely preparing the warrants for the payment of the dividends.
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The Inspectorate unit of NASB also failed to discover the financial
misstatements.
Board Failure.
It is clear that the board and top management of Cadbury (Nig) Plc
allowed self interest and sheer greed to come between them and their
prime duty of shareholder value creation. It is on record, for example,
that the company maintained and operated an undocumented and
undisclosed off-shore account from which the erstwhile managing
director of the company, its former Finance director and other
erstwhile executive directors were paid offshore remunerations. This
was done without the approval of the committee responsible for fixing
remunerations of Executive Directors and was not recorded, either, in
the company‘s financial report and accounts. Thus the board embarked on
what, with the benefit of hind sight, can be described as the
destruction of shareholder value. Table 2 is an extract of some key
performance indicators for Cadbury (Nig) PLC for the period 2001- 2008.
Table 2
Extracts of some key Performance Indicators of Cadbury PLC
for the period 2001-2008.
Year
Amount
2008
#B
2007
#B
2006
#B
2005
#B
2004
#B
Turnover
24.3
19.9
19.2
29.5
22.2
(loss)/profit on
(2.8)
(4.2)
(5.8)
3.9
3.8
ordinary activities
before taxation
Shareholders‘ fund
(3.0)
0.3
2.2
10.9
9.5
Market Price per
#65.52
#60.2
share at year end
Basic(loss)/earning (244k) (66K)
(428K)
270K
281K
per share
Dividend per share
130K
160K
Source: Compiled by the Researcher from various annual financial
statements of Cadbury (Nig) PLC
2003
#B
2002
#B
2001
#B
20.6
3.8
16.0
3.3
13.2
2.4
8.2
#63.2
6.9
#31.7
3.3
#31.5
357K
300K
206K
175K
150K
120K
As at October23 2009, the rights issue price of Cadbury (Nig) PLC was
#8.65. Compared to the share price of #65.52 at 31st December 2005,
share price had declined by about #56.87 per share. Such was the
enormity of shareholder value destruction. Although, the directors of
the company had some shares in the company, it did not motivate them to
work in the best interest of the company. Apparently, the directors‛
shareholdings were insignificant. From the table, it can also be seen
that the shareholders funds had been completely wiped out by the end of
2007. By the end of 2008, the shareholders funds had become a negative
figure of over #3 billion.
Cadbury Scandal and Internal Control
In accordance with the provisions of the Companies and Allied matters
Act 1990, the Directors are responsible for the preparation of annual
financial statements, which give a true and fair view of the state of
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affairs of the Company and of the profit or loss for the financial
year. The discharge of these responsibilities includes ensuring that:
-
Appropriate internal controls are established both to safeguard
the assets of the company and to prevent and detect fraud and
other irregularities;
- The company keeps accounting records which disclose with
reasonable accuracy the financial position of the company and
which ensure that the financial statements comply with the
requirements of the Companies and Allied Matters Act of 1990;
- The company has used suitable accounting policies, consistently
applied and supported by reasonable and prudent judgments and
estimates, and that all applicable accounting standards have been
followed; and
- It is appropriate for the financial statements to be prepared on
a going concern basis.
A good starting point for a good internal control is the ethical
environment set up by the directors of a company. A good ethical
environment admits a culture of integrity across the entire gamut of
the organization. The board of such an organization must lead by
example and must emphasis merit and competence in the recruitment
and reward of staff. In such an organization, duties are segregated
in such a way that no one department or individual carries out a
duty from the beginning to the end. In the case of Cadbury(Nig}PLC
ethical failure occurred right at the board level with the managing
director, the finance director and some other board members
conspiring to falsify the company‘s records. Other members of staff
like the internal auditor and head of accounts had no difficulty in
joining the effort to falsify the company‘s records. Personality
trait has been adjured a fraud risk factor(Cohen et al. 2010)
The Cadbury Scandal as a Case of Audit Failure.
Audit failure or performance gap occurs when public expectations are
reasonable but the auditor‘s performance does not fulfill them. This
means that there is a shortfall in the auditor‘s performance. Many
factors have been adduced as responsible for the increasing spate of
audit failures in Nigeria. These include:
- Ethical Failure
- Negligence in carrying out the audit process
- Environmental and cultural influences and
- The limitations of the modern audit process(Chukwunedu 2009)
The external auditors of the company, Akintola Williams Deliotte
(AWD) had been the external auditors of the company for over 40
years. The APC of SEC found that:
- #13.255 billion was the accumulated overstatement for the years
2002 to September 30, 2006 and that AWD audited the published
accounts for those years as well as carried out an interim audit
for the period ended September 30, 2006:
- A balance of #7.7 billion was credited to the company‘s account
in 2005 without confirmation of the bank balances from any of the
banks. AWD did not make any note in the 2005 audited account that
it did not receive confirmations from any of the banks for the
balances recorded against such banks. The materiality of the
amount is significant enough to have put AWD on enquiry:
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-
-
-
-
-
AWD sent management letters on the company‘s 2001-2005 accounts,
yet they failed or refused to note the lapses in the accounts
when no satisfactory response was given by the company‘s
management:
In carrying out its job as Reporting Accountants in the Rights
issue of #5 billion irredeemable loan stock ,AWD reviewed the
accounts and forecasts following which it filed with the
commission a memorandum of profit forecast that was unrealistic:
Though auditors normally rely on documents presented to them by
clients to do their work however they are required to probe
further when put on enquiry as shown by the stock certificate of
#700 million allegedly issued by JOF Limited but disclaimed in
writing by the alleged issuer which was large enough to make AWD
seek further confirmation but it did not.
Professional skepticism generally requires that an auditor should
not believe documents presented by a client till it sees evidence
that they are genuine. In the company‘s case, AWD did not probe
further or doubt documents presented by the company in spite of
the internal control lapses detected and revealed in its
management letters:
AWD and in particular the partners that handled the company‘s
account did not carry out their assignment with high level of
professionalism and diligence expected of a reputable accounting
firm of its caliber.
The role of the Audit committee of the Company
The role of the audit committee in the Cadbury Saga was most
intriguing. SEC found members of the audit committee culpable in that:
- they failed and neglected to discharge their statutory
responsibilities as specified under section 359(4) and (6) of the
Companies and Allied Matters Act( CAMA )by:
(a)Failing or neglecting to examine the auditor‘s report and making
proper recommendations thereon at the Annual General Meeting.
(b)Failing or neglecting to review and make proper findings on
management matters in connection with the External Auditors and
departmental responses thereon.
(c)Failing or neglecting to keep under review the effectiveness of
the company‘s accounting and internal control system and ensuring
that appropriate investigations are carried out by internal auditors
into some aspects of the company‘s activities which ought to be of
interest or concern to the committee.
- that the audit committee members in conjunction with the head of
the internal audit of the company and its External Auditors failed
to follow available leads which ought to put them on enquiry in
respect of the company‘s accounts.
- that the audit committee members in conjunction with the
management of the company authorized the issue of a rights circular
in 2005 which contained untrue statements.
Early Warning Signs
The Cadbury financial statement misclassifications started in 2002
and only came to light in 2006 when a lot of damage had already
been made to the company‘s fortunes. The chairman‘s statements
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for the period in question and directors reports continued to pay
glowing tributes for performances that outstripped those of the
previous years on a year on year on basis. Similarly, the
auditor‘s reports throughout the period were unqualified. In
2006, the auditor PricewaterHouseCooper qualified its report and
also drew attention to emphasis of matter concerning the going
concern situation of the company. The external auditor‘s report
in this instance also failed to act as an early warning model for
corporate distress. Many auditors have argued that where to look
for warning signs is not really in the audit report proper but in
the management letter which is routinely sent to the client
management on completion of an audit. The problem is that such a
letter is not at the moment statutorily required to be disclosed
and will require a change in existing company legislation to make
it legal to do so. It will be advisable for SEC to initiate the
change in legislation because of the overriding need to have an
early warning model. Creative accounting usually makes it more
difficult for early warning signs to be readily discernible from
financial statements. For example by 2006 the share capital of
the company had already being wiped out. To hide this fact the
directors quickly revalued the assets of the company and the
revaluation surplus was able to mask the fact of the negative
shareholders funds.
Table 3 is an extract of the cash flow statements of Cadbury (Nig)
PLC for the periods 2000 to 2008.
Year
Amount
Net
cash
flow
2008
#B
-.710
2007
#B
-.635
2006
#B
15.845
2005
#B
1.635*
2004
#B
2.051
2003
#B
.780
2002
#B
.211
2001
#B
5.023*
2000
#B
.479
Source: Extracted from various financial statements of Cadbury by
the researcher
Table 4 is an extract of the bank overdraft/short term borrowings of
Cadbury (Nig) PLC for various years
Extract of bank Overdraft/Short term borrowings of Cadbury (Nig)PLC
for various Years
Year
2008
2007
2006
2005 2004 2003 2002 2001 2000
Amount
#B
#B
#B
#B
#B
#B
#B
#B
#B
Bank
15.150 15.077 16.571 5.46 2.03 0.62 0.26 0.68 1.7
OD/Short
term
borrowings
Table 5 is an extract of interest expense of Cadbury Nig PLC for
various Years
Extract of various interest paid by Cadbury for various Years
Year
2008
2007
2006
2005
2004
2003
2002
2001
Amount
#B
#B
#B
#B
#B
#B
#B
#B
.44
Interest 2.1
1.82
1.81
1.09
.68
.38
.28
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2000
#B
.6
Paid
The information shown by table 3 is revealing. From the extract of
the statement of cash flow, net cash inflow into the company
progressively declined from 2002 to date prompting the company to go
to the market in 2009 with a rights issue expecting to rake in a net
issue proceeds of #b21.69. Out of which #b15.55 will be spent on
retirement of bank borrowings. In 2001 the company had earlier
issued #b2.5 irredeemable convertible loan stock to shore up its
finances. This was again repeated in 2005 with the issue of #b5
irredeemable convertible loan stock. It is clear that the company
was permanently in liquidity crisis during the years involved in the
scandal. The resort to intermittent issue of convertible loan stock
in 2001 and again in 2005 were not of such a magnitude to make the
desired impact on the company‘s cash flow. The resort to heavy bank
borrowings mainly as overdraft had the negative consequence of
impacting on the amount of interest paid during the various years in
question. With interest paid exceeding the #2billion mark in 2008,
the company was simply working for the banks. Why would a cash
strapped organization continue to borrow to pay dividends as alleged
by SEC in this case? One Possible explanation is that the erstwhile
management of the company wanted to keep the shareholders happy and
thus shield the company‘s financial woes from the prying eyes of
disgruntled shareholders. One other possible explanation was that
sooner than latter the company will be in the market to shop for
the more benign equity funding to free the company from suffocating
interest payments to banks. Such a scenario would demand that the
shareholders be kept happy by way of dividends if they must be
called upon in the near future to provide additional fund for the
company.
Conclusion
It is now almost 5years since the Cadbur(Nig) Plc accounting
scandal came to the fore. The 2009 financials of the company show a net
loss of over 4.6 billion Naira. A new management and Board has since
been empanelled to turn the fortunes of food and beverages giant which
is now a subsidiary of Kraft Plc. Many studies have tried to establish
a relationship between corporate governance factors and fraudulent
financial reporting. Identified factors include presence of independent
boards, purchase of non-audit services from the auditor, frequency of
election of directors and audit committee effectiveness. The results
have been varied. While some governance factors have been associated
with being capable of restraining earnings management, the same thing
cannot be said of other governance factors(Visvanathan 2008;
Abdolmohammadi et al. 2010). Many commentaries on the Cadbury Saga have
emphasized different aspects of the problem. While some see it as lack
of value based leadership especially at the board level, others point
out the lack of transparency of the actors involved. Yet other comments
emphasise lack of nuture of corporate governance system in Nigeria(IwuEgwuonwu 2011; Olumide- Fusika 2009; Inyang 2009; Abduiiahi et al.
2010). A welter of suggestions have been made to remedy the perceived
problems. These include enthronement of value based leadership,
strengthening of internal control systems, encouragement of whistle
blowing culture and shareholder activisim. There has also been a call
to reposition the regulatory institutions for greater effect. Perhaps,
the greatest lesson from Cadbury(Nig) Plc episode is that in governance
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issues, it is the effectiveness of the watch dog institutions and
systems that is paramount. Cadbury(Nig) Plc paraded a galaxy of
eminently qualified corporate board with a good mixture of independent
and executive Directors. Its governance system is world class given its
association with the food giant, Cadbury Swechpes of United Kingdom.
When the chips were down, however, the entire watch dog institutions
where compromised. The external auditors, the corporate Board, the
Internal audit, the audit committee, the accounting function, the
registrar, the Stock Exchange, SEC and even the then Nigerian
Accounting Standards Board were all smeared. It is instructive to note
that the financial misstatements at Cadbury( Nig ) Plc was only
unearthed when the parent company did a due diligence search when it
wanted to increase its stake in the company from 46 to 50 percent. As
the world moves steadily to one global uniform standard of reporting,
the IFRS, one challenge that must be addressed is the issue of
accounting infrastructural and regulatory weaknesses in various
jurisdictions especially in emerging markets otherwise the much touted
benefits of global uniform financial reporting standards may well
remain a mirage.
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