Financial Accounting: Corporate Governance, Ethics, and Financial Theories

This article discusses the role of ethics in corporate governance, agency problem, and shareholders wealth maximization. It also covers relevant financial theories such as Modigliani-Miller theory and pecking order theory. The case of AMP Company is used as an example to illustrate the importance of efficient corporate governance and ethical guidelines in a company.

Running head: FINANCIAL ACCOUNTING
Financial Accounting
Name of the Student:
Name of the University:
Author’s Note:

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Table of Contents
Part A:..............................................................................................................................................2
Answer to Question 1:.................................................................................................................2
Requirement a:.........................................................................................................................2
Requirement b:.........................................................................................................................2
Requirement c:.........................................................................................................................2
Answer to Question 2:.................................................................................................................2
Answer to Question 2:.................................................................................................................3
Answer to Question 4:.................................................................................................................4
Answer to Question 5:.................................................................................................................5
Part B:..............................................................................................................................................5
Introduction..................................................................................................................................5
Role of Ethics in Corporate Governance.....................................................................................6
Agency Problem and Shareholders Wealth Maximization..........................................................7
Financial Theories.......................................................................................................................7
Conclusion...................................................................................................................................8
References........................................................................................................................................9

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Part A:
Answer to Question 1:
Requirement a:
Particulars Amount
Earnings per share $0.02
P/E Ratio 7.66
Stock Price as on 30th June 2018 $0.15
Requirement b:
Particulars Amount
Earnings before Interest & Tax $13,05,000
Interest Expense -$12,47,000
Tax Expenses -$17,000
Net Earnings after Tax $41,000
Earnings per share $0.02
Nos. of Shares Outstanding 20,50,000
Market Price per share $0.15
Market Capitalization $3,14,060.00
Requirement c:
The average P/E ratio of the retail industry in Australia is 96.81, which is very higher
than the current P/E ratio of ABC Ltd (Pages.stern.nyu.edu, 2018). It means that the overall
Australian retail industry pays comparatively lower earnings than ABC Ltd. The difference
between the P/E ratios of ABC Ltd and overall retail industry has been caused as the other
companies in the industry have not generated sufficient earnings in comparison to their market
share prices.

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Answer to Question 2:
The current ratio and quick ratio of ABC Ltd are shown in the following table:
Particulars 2016 2017 2018
in $'000 in $'000 in $'000
Cash $342 $344 $281
Accounts Receivable $4,346 $4,892 $5,239
Inventory $6,483 $7,196 $8,013
Current Assets $11,171 $12,432 $13,533
Bank Overdraft $14 $0 $65
Accounts Payable $6,224 $4,167 $3,982
Current Liabilities $6,238 $4,167 $4,047
Current Ratio 1.79 2.98 3.34
Quick Ratio 0.75 1.26 1.39
From the above table, it can be stated that the current ratio of the company has remained
above 1 for last year and the quick ratio has become more than 1 over the period. It indicates that
the company has maintained sufficient current assets, as well as, highly liquid assets to pay off
its current liabilities. Moreover, as the ratios have increased over the years, it also implies that
the liquidity position of the company has been improving with the due course of time.
Answer to Question 2:
As the current ratio and quick ratio have been satisfactory for the last three years, it can
be stated that the company has retained adequate working capital to operate its business.
Moreover, the receivables turnover ratio, shown below, has decreased over the period, which
denotes that the company has become slower in collecting dues from its debtors. The payable
turnover ratio has increased, which implies that it is paying its creditors more quickly than

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previous periods. For this reason, the company may face issues in maintaining sufficient cash
funds.
Particulars 2016 2017 2018
in $'000 in $'000 in $'000
Accounts Receivable $4,346 $4,892 $5,239
Accounts Payable 6224 4167 3982
Sales 38222 39258 40592
Earnings before interest & tax $1,208 $1,281 $1,305
Total Operating Expenses $37,014 $37,977 $39,287
Receivables Turnover Ratio 8.79 8.02 7.75
Payables Turnover Ratio 5.95 9.11 9.87
Answer to Question 4:
The profitability ratios of ABC Ltd are shown in the following table:
Trend Analysis
Particulars 2016 2017 2018 2016 2017 2018
in $'000 in $'000 in $'000
Sales $38,222 $39,258 $40,592
Earnings before interest & tax $1,208 $1,281 $1,305
Interest Expense -$1,077 -$1,215 -$1,247
Tax Expenses -$39 -$20 -$17
Net Earnings after tax $92 $46 $41
Current Assets $11,171 $12,432 $13,533
Property, Plant & Equipment $16,546 $16,456 $18,746
Accumulated Depreciation -$8,273 -$11,582 -$14,983
Total Assets $19,444 $17,306 $17,296
Total Equity $2,456 $2,479 $2,499
Operating Profit Margin 3.16% 3.26% 3.21% 100.00% 103.24% 101.72%
Net Profit Margin 0.24% 0.12% 0.10% 100.00% 48.68% 41.96%
Return on Assets 0.47% 0.27% 0.24% 100.00% 56.18% 50.10%
Return on Equity 3.75% 1.86% 1.64% 100.00% 49.54% 43.80%

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Though, the operating profit margins were higher in 2017 and 2018 in comparison to
2016, the net profit margin of the company has fallen drastically in last two years. For this
reason, the rates of return, generated by the company, over its assets and return, provided to its
shareholders, have fallen very significantly.
Answer to Question 5:
For lending loan to any company, it is necessary to evaluate the solvency ratios of the
firm. The solvency ratios of ABC Ltd is given below:
Particulars 2016 2017 2018
in $'000 in $'000 in $'000
Total Assets $19,444 $17,306 $17,296
Total Equity $2,456 $2,479 $2,499
Total Liabilities $16,988 $14,827 $14,797
Debt Ratio 0.874 0.857 0.856
Equity Ratio 0.126 0.143 0.144
Debt-to-Equity Ratio 6.917 5.981 5.921
The debt ratios of the company for the last year have remained quite higher than the
equity ratio and the debt-to-equity ratio has been more than 1 also. It indicates that the company
has relied more on the debt capital for its operation than the equity capital. Hence, ABC Ltd
should not be provided any further loan, which would increase its debt.
Part B:
Introduction
Corporate Governance and Ethics the widely used term in the policies and procedures of
the corporate world, which governs the working of the organization. The guiding principles of
the corporate governance directs the workings and ways in managing the work of the company.

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Ethics is a concern for the morale of an individual whether the work done is done in the right or
wrong manner. The key personnel and the management of the company can influence culture of
the company by making decisions and actions by the company. The for pillars of efficient
corporate governance in the modern organization is based on fairness of opinion, accountability,
transparency in the information provided, assurance, stakeholders or investors relationship
management. The main purpose of the efficient corporate governance in the organization is to
ensure that the entrepreneurial management can deliver robust long-term growth and prosperity
to the organization (Kraakman and Hansmann 2017).
Role of Ethics in Corporate Governance
Corporate Governance is intended to ensure that the accountability of the company is
well taken by the management of the company. The recent news of AMP Company involved in
charges from the corporate regulators is solid reason for the need of effective corporate
governance in the company. The aim of the corporate governance was not properly met by the
board of directors of the company hampering the long-term growth and prospects of the
company. Corporate Governance of the company should be integrating in nature, which will act
as a process that will be economically and socially benefit the company at the same time. The
AMP financial services company operating in the Australia and New Zealand regions caters
investment and financial products to the investors. The AMP Company charged with the
allegations of charging its customer’s with services and the respective charges where the
investors or the customers of the company was not acknowledged to it. The royal banking
commission formed for inspection of all irregularities observed in the financial markets. The
Australian Securities and commission has charged the company for providing misleading
statements. The financial advisory business of the company has mislead and involved in

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fraudulent cases by charging the customers, which boosted the company’s revenue from services
(Tricker and Tricker 2015).
Agency Problem and Shareholders Wealth Maximization.
The agency problem is also referred to as the conflict of interest between the management
of the company and the stakeholders of the company. It is necessary for the companies to have a
common group, goals and interest in the long term to achieve growth and prosperity. Agency
problem arises because of the diverging principal and guidelines set up by the company. The
long-term viability and performance of the company along with its sustainability should deliver
and create value and wealth for the shareholders of the company (Lin, Chen and Long 2017).
The motive of the management for the company is shareholders’ value creation and wealth
maximization, the same needs to be done in a proper way and an accountable way, which is
guided by the corporate governance of the company. Shareholders wealth maximization and
value creation should be done with the primary and principal activities of the company, which
the AMP Company should have done. The corporate governance in a company influences the
economic and social landscape aspects. Shareholders tend to loose trust and faith in the
organization with poor corporate governance and ethical guidelines set up by the company. The
poor corporate governance leads to loss in valuation of company. Corporate Accountability and
management could be one of the best way for management disciplines in the company
(McCahery, Sautner and Starks 2016).
Financial Theories
The relevant financial theories are important in the modern corporate organization, which
acts as the building block. The Modigliani-Miller theory represents and explains the market
value of the company, which is determined from the earnings potential and the underlying risk of

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the assets is independent of the way it uses in procuring its investments and distributions of
dividends (Brusov et al. 2015). The pecking order theory is another relevant theory in the
modern corporate governance, which explains the rising costs with asymmetrical information.
Company’s use of fund in the different methods and priority is explained in the theory
(Serrasqueiro and Caetano 2015). The internal sources or the reserves and retained earnings of
the company is first used as the internal source of fund which is the best cheap and fast of
internal financing for the company. The second order is the use of debt or borrowing from
creditors and banks. The order can be affected for companies like AMP where the business risk
of the company has increased due to false and incorrect financial representation and positions.
Generally companies, which are claimed for poor corporate governance and inefficient ethical
guideline’s suffers and pay costs in terms of extra risk premium borne by the lender. The third
order is the use of equity as a source of fund, which is the expensive source of funding for the
company. The clientele effect explains about the effect and volatility in stock price and the
changes observed from the same due to demands, goals and reactions of the investors in response
to any news or policy change. The AMP company share price and valuation was affected when
the company affected the investors and stakeholders of the company due to misrepresentations of
financials report.
Conclusion
The above events observed by the company occurred due to financial and accountability
irregularities observed in the company. The company could be further advised and the situation
for the company could be further explained with the bird in theory approach, which says that the
investors of the company should be given the returns achieved by the company. The companies
should not invest in a robust way, which can distorts shareholder’s wealth. The corporate

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governance in a company should be such, which should give accounting responsibility and
guidelines for the same (Sturge-Apple et al. 2017).

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References
Brusov, P., Filatova, T., Orekhova, N. and Eskindarov, M., 2015. Inflation in Brusov–Filatova–
Orekhova theory and in its perpetuity limit—Modigliani–Miller theory. In Modern Corporate
Finance, Investments and Taxation (pp. 135-153). Springer, Cham.
Kraakman, R. and Hansmann, H., 2017. The end of history for corporate law. In Corporate
Governance (pp. 49-78). Gower.
Lin, H.C., Chen, R.R. and Long, M.S., 2017. THE MULTI-PERIOD AGENCY PROBLEM
AND RESULTING DISAPPEARANCE OF SINKING FUNDS. Advances in Financial
Planning and Forecasting, (8), pp.189-219.
McCahery, J.A., Sautner, Z. and Starks, L.T., 2016. Behind the scenes: The corporate
governance preferences of institutional investors. The Journal of Finance, 71(6), pp.2905-2932.
Pages.stern.nyu.edu. (2018). Price Earnings Ratios. [online] Available at:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/pedata.html [Accessed 13 Sep.
2018].
Serrasqueiro, Z. and Caetano, A., 2015. Trade-Off Theory versus Pecking Order Theory: capital
structure decisions in a peripheral region of Portugal. Journal of Business Economics and
Management, 16(2), pp.445-466.
Sturge-Apple, M.L., Davies, P.T., Cicchetti, D., Hentges, R.F. and Coe, J.L., 2017. Family
instability and children's effortful control in the context of poverty: Sometimes a bird in the hand
is worth two in the bush. Development and psychopathology, 29(3), pp.685-696.

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Tricker, R.B. and Tricker, R.I., 2015. Corporate governance: Principles, policies, and practices.
Oxford University Press, USA.