Earnings Management of Patisserie Valerie Case Study 2022

Running head: EARNINGS MANAGEMENT OF PATISSERIE VALERIE
EARNINGS MANAGEMENT OF PATISSERIE VALERIE
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Executive summary
The primary purpose of the study is to observe the earnings management of Patisserie
Valerie. Patisserie Valerie is a chain of cafés that are being operated from the United
Kingdom. The business was going well until the black hole in their accounts has been
discovered. From the observation, it has been found that the managers of Patisserie Valerie
were overstating their revenue by providing unethical financial statements. The accounting
blackhole ceased most of their trades. As per the agency theory and signal theory, the primary
purpose of the statement is to boost the revenue of the firm by lowering the expenses and
removing sales entries from the ledgers as they were going through the financial downtime.
The managers habituated this practice to increase their incentives and job security. Based on
the study, it has been perceived that there are several issues of earnings management which
includes financial statement manipulation and overstatement of revenue. It has been found
that managers engages themselves in earnings management to improve their job security and
incentives. UK corporate governance structure can assist the organization to eliminate the
unethical earnings management. It can be stated that the board should identify and self
evaluate their performance to strengthen their corporate governance structure.

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Table of Contents
Introduction................................................................................................................................3
Earnings management................................................................................................................3
Factors driving managers towards earning management...........................................................4
Incentive bonus and job security............................................................................................4
Lowering the earnings............................................................................................................5
Issues of earning management of Patisserie Valerie..................................................................5
Financial statement manipulation..........................................................................................5
Overstated revenue.................................................................................................................5
Role of UK corporate governance..........................................................................................6
Conclusion..................................................................................................................................7
References..................................................................................................................................8

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Introduction
Patisserie Valerie is a chain of cafés that are being operated from the United
Kingdom. They supply cakes, continental breakfast to their customers. The business was
going well until the black hole in their accounts has been discovered. That resulted in
Patisserie Valerie to almost cease their trades. In the year 2018, it has been found that
Patisserie Valerie has been overstating its earnings for an extended period of time. This
resulted in gaining a huge revenue boost for their firm illegally (Bhaskar and Flower 2019).
Later on, they stated that there were thousands of false entries in the ledger of the company
related to earnings. After the scandal in 2018, the accounting black hole swelled
approximately £ 94 million in their account, which is almost double than the previous
estimate according to report by its administrator. In the month of January, the café chain
overstated their cash position by £ 30 million and failed to disclose their bank overdraft nearly
of£ 10 million. The company had been claimed approximately £ 54 million in cash according
to the report from KPMG (Breslin, and Reczek 2019).
Earnings management
Earnings management is one of the most critical tools, which manipulates the
financial record of a company. This tool is being used by the management of the company
over a long period of time to artificially boost the financial results of an organization (Lo,
Ramos, and Rogo 2017). It is an accounting technique to produce a financial statement that
presents an overly positive view of the organization. The primary purpose of earning
management is to create a financial statement, which will provide a smooth earning of the
organization. In addition, unethical earnings management alter financial reports of a
company showing the excellent position of the firm to its investors (Fang, Huang, and
Karpoff 2016). Earnings management is a legal approach but can also be used as an illegal

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weapon. It influences the financial report to obtain some private gain. Earnings management
misleads the shareholders about the underlying financial performance of the firm. The
credibility of the financial report gets weaken by unethical earnings management. It can be
used to increase the market value of the firm by providing misleading information to the
outsiders (Barghathi, Collison and Crawford 2017).
The signal theory discusses about the earnings management considering that the
information is not shared by all economic agents. The managers are the informed party on the
future prospects of the company as the have some important informations related to the
organization (Ilmi, Kustono and Sayekti 2017). The managers can take advantages of this
these informations therefore they can use earnings management. Managers can misuse these
informations to improve the condition of the firm unethically. The main purpose of these is to
increase the incentives and job security. Along with this, the moral and ethical issue is also a
concerning factor of earnings management (Gras-Gil, Manzano, and Fernández 2016).
As per the agency theory, the managers and leaders seeks to maximize their personal
utility from the organization therefore they intentionally overstate the earnings, unethically
ensuring that the organization reach its goals (Hussain, Rigoni and Orij 2018).
The managers generally uses four types of unethical earnings management, which
include unsuitable revenue recognition and inappropriate estimates of liabilities, excessive
provisions, and intentional minor holes of financial reporting to influence the financial
figures of the report (Sajjad et.al 2019).
Factors driving managers towards earning management
Primarily, there are certain factors, which drive the manager towards earning
management. Patisserie Valerie was also affected by these factors as they were going through
financial downtimes in recent years (Singh, Aggarwal, and Anand 2017).

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Incentive bonus and job security
Performance-based bonuses were made in 1993, ever since the managers of every
firm tries to hit a certain performance level by which they can get the right amount of
incentives. During the downtime of the organization, the managers and the higher authorities
use illegal alteration of financial reports, which aids them to show the perfect position of the
firm (Chhabra 2016). Occasionally, the managers miss their incentives if they miss out on
target revenue; thereby, they always try to meet their target. As observed in the signal theory,
the managers make changes in the revenue, alters reserves, and shows greater sales in the
financial reports to get bonuses and increase their job security. The managers are always at
the pressure of being fired from the organization if they cannot perform to a certain extent,
thereby they approach methods like unethical earnings management illegally to present fake
financial reports of their organization.
Lowering the earnings
All of the managers try to lower their earning intentionally, misleading the outsiders
and their CEOs.They mislead the outsiders and CEO by providing false information in the
financial reports. Managers reduce earning by inflating the reserves of the company. One-
third of the company provides false information related to their earnings to the CEO’s and
investors (Amelia and Wardhani 2018).
Issues of earning management of Patisserie Valerie
The scandal happened as Patisserie Valerie had several issues in earnings
management. The issues of earnings management are described below, which will help
understand the impact of unethical earnings management in Patisserie Valerie. Fraudulent
financial reporting in Patisserie happened as the managers were forced to boost the
performance of their company. Their company was going through financial downtime.

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Financial statement manipulation
The executives of Patisserie Valerie manipulated their financial statements to show
the performance of their company by which they can get an incentive bonus for their
company. They primarily followed two approaches to manipulate the financial statement.
They exaggerated the current earnings on the income statement of the company by inflating
the revenue and gains artificially (Izzat and Rashid 2017). Along with this, they deflated the
expenses of the current period of the company. By this approach, they forecasted their
revenue to the investors, misleading them intentionally.
Overstated revenue
As per the agency theory, the managers of Patisserie Valerie overstated their net
incomes to the investors by overstating their revenue in their financial statements. The
primary reason for this was to improve the financial position of the company unethically. To
improve their incentives, the managers overstated the earnings of Pattisserie Valerie during
2018, resulting in the audit scandal. They created fictitious revenue by recording sales from
customers who do not even exist. Overstated revenue affected the investors of the
organization (Muktiyanto 2017). The management of Patisserie Valerie made thousands of
false entries related to sales in the ledger of the company. They also recorded revenue of the
products, which they have not purchased. The sales returns of the company were also
understated, increasing net sales illegally. They also recorded the revenue without the GAAP
compliances.
Role of UK corporate governance
The resilient structure of corporate governance in the UK plays a notable role in earnings
management. Over the years, the structure of UK corporate governance is changing and
evolving (Nakpodia and Adegbite 2018). The role and elements of UK corporate governance

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in constraining earnings management is given below, which will aid us in understanding the
position of strong corporate governance.
 Corporate governance of the UK assisted the board of directors in managing the firm
efficiently. UK corporate governance is better than other countries in achieving high
standards of corporate governance at low cost (Katmon and Al Farooque 2017). As
per the agency theory, smaller board can provide better control than large board that
has manager’s domination and creates conflicts across the employees.
 The Cadbury report of UK corporate governance stated that to improve the earnings
management of firms, they should establish an audit committee with three non-
executive directors. UK corporate governance improves the trustworthiness of
financial reporting through the implementation of corporate governance to the
management structure (Price et.al 2018).
 Agency theory also considers that the functions separation reduces the agency cost
and improves firm,s performance. UK corporate governance follows agency theory to
mitigate the constraints of earnings management.
 Corporate governance helps the management to identify working capital discrepancy.
Identification of working capital discrepancy is vital to detect problems of earning
management in an organization (Abbas et.al 2019).
 UK corporate governance ensures efficient risk management mitigation in the
organization. Corporate governance provides a transparent and accountable system by
which makes the board of the company aware of the risk of earning management in
their organization (Klumpes et.al 2017). This facilitates monitoring related issues
regarding earnings management of the organization.
 UK corporate governance provides necessary and essential information about the
issues of the organization securing the investments of the shareholders.UK corporate

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governance protects the shareholders' rights by providing them voting rights along
with the right to information (Ferguson et.al 2017).
 UK corporate governance assists the directors to eliminate the negative earnings
management. UK corporate governance structure provides accurate disclosures and
transparency to the organization (Beekes et.al 2016).
Conclusion
This study signifies the role of UK corporate governance in constraining earnings
management. From this study, it has been observed that Patisserie Valerie, which was going
through financial downtime, overstated their earnings. The main intention of the managers
was to secure the job and earn incentives from the organization. The managers lowered the
earnings of their organization to provide false information about their organization to the
outsiders. On a concluding note, it can also be stated that earning management of an
organization can be used both positively and negatively; therefore, UK corporate governance
can aid the firm to solve their earning management problems. It is recommended that the
corporate governance structure should be strengthened to overcome such earning
management problems in the future. To strengthen the structure, corporate governance must
ensure that the directors of an organization have all of the information they need to observe
and monitor the discrepancy of the organization.
References
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Amelia, D. and Wardhani, R., 2018. THE EFFECT OF PERSONAL TENURE ON
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