1) The following article is taken from my assignment in Financial Statement & Reporting Analysis subject. I acknowledge the outstanding contributions of Arif Birowo, Catur Budi Wibowo and Irwan Hardiyono on this "high marked" paper. Well done guys!
2) For complete version of this paper which includes the company background, good governance issues, internal and external auditors issues as well as the impact on financial analyst/analysis, please send email to me via markv_bommel@yahoo.co.uk
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The Underlying Issues
According to AASB (Australian Accounting Standar Board) 101 paragraph 13: “A financial report shall present fairly the financial position, financial performance and cash flows of an entity. Fair presentation requires the faithful representation of the effect of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in framework”. So, it is clear that company has to present its economic transactions on a fair and faithful practice. However, in Parmalat that was not the case. Melis and Melis (2005) indicates that Parmalat falsified the accounts of their financial reporting both asset and liability side to manage their financial positions and performance. In other words the nature of the issue on Parmalat case is about the fraudulent accounting practices which have violated both fair and faithful presentation of financial reports.
One of the fraudulent practices was regarded with forged depository accounts. Hamilton (2005) describes that Bank of America (BoA), New York branch informed Grand Thornton, auditors of Parmalat’s subsidiary in the Caymand Island, that it did not have an account in the name of Bonlat on 17 December 2003 and denied authenticity of a document dated 6 March 2003 that certified the existence of securities and liquidity amounting EU 3.95 billion. On the other hand, Delloitte & Touche, chief external auditor of Parmalat, was relying heavily on Grant Thornton report which accepted a verification letter, seemingly from Bank of America, confirming that Bonlat held EU 3.95 billion in cash and investment in an account at the bank. Later, Tonna Fausto, former CFO, confessed that he had faked BoA documents.
In liabilities accounts, US Security Exchange and Commission (2004) believed that Parmalat Finanziaria (Parmalat’s holding company) had understated its reported debt of €14.3 billion as opposed to €6.4 billion reported as of 30 September 2003. it seems that Parmalat Finanziaria applied various strategies to understate its debt, including: (a) removing approximately €3.3 billion of debt held by one of its nominee entities; (b) recording approximately €1 billion of debt as equity through fictitious loan participation agreements; (c) improperly eliminating approximately €300 million of debt associated with a Brazilian subsidiary during the sale of the subsidiary; (d) mischaracterizing approximately €300 million of bank debt as inter-company debt, thereby inappropriately eliminating it in consolidation; (e) eliminating approximately €200 million of Parmalat S.p.A. payables as though they had been paid when, in fact, they had not; and (f) not recording a liability of approximately €400 million associated with a put option and (g) creating revenues through fictitious sales to its subsidiaries.
In liabilities accounts, US Security Exchange and Commission (2004) believed that Parmalat Finanziaria (Parmalat’s holding company) had understated its reported debt of €14.3 billion as opposed to €6.4 billion reported as of 30 September 2003. it seems that Parmalat Finanziaria applied various strategies to understate its debt, including: (a) removing approximately €3.3 billion of debt held by one of its nominee entities; (b) recording approximately €1 billion of debt as equity through fictitious loan participation agreements; (c) improperly eliminating approximately €300 million of debt associated with a Brazilian subsidiary during the sale of the subsidiary; (d) mischaracterizing approximately €300 million of bank debt as inter-company debt, thereby inappropriately eliminating it in consolidation; (e) eliminating approximately €200 million of Parmalat S.p.A. payables as though they had been paid when, in fact, they had not; and (f) not recording a liability of approximately €400 million associated with a put option and (g) creating revenues through fictitious sales to its subsidiaries.
Such fraudulences were stimulated by lack of good corporate governance practices as well as external auditor independence. Concerning lack of governance practices, the major shareholders in Parmalat represented in Board of Director would cause conflict of interest between shareholder and management. As a result Parmalat’s board of directors did not safeguard minority shareholders since they are dominated by the Tanzi family. Moreover, Parmalat’s board of statutory auditors was composed by three members dominated by Tanzi family, which leads to a conflict of interest situation.
The other factor which greatly affect to fraudulent accounting practices in Parmalat is the independency of external auditor. Melis (2005) points out that Parmalat was audited by 3 auditors in the last two decades before collapsed which are Hodgson Lamndau Brands (1980-1989), Grant Thorthon (1990-1998) and Deloitte and Touche (1999-2002). However, the president and partner of Grant Thornton that dealt with Parmalat had worked for Hodgson Landau Brands until 1989. Even though Grant Thornton had been replaced by Deloitte and Touche as chief auditor, and Grant Thornton continued to audit Parmalat’s off-shore subsidiaries after 1998 including Bonlat Financing Corporation where the forged depositary account revealed.
Issue Impacted on the Company’s Profitability, Financial Stability and Share Price
The other factor which greatly affect to fraudulent accounting practices in Parmalat is the independency of external auditor. Melis (2005) points out that Parmalat was audited by 3 auditors in the last two decades before collapsed which are Hodgson Lamndau Brands (1980-1989), Grant Thorthon (1990-1998) and Deloitte and Touche (1999-2002). However, the president and partner of Grant Thornton that dealt with Parmalat had worked for Hodgson Landau Brands until 1989. Even though Grant Thornton had been replaced by Deloitte and Touche as chief auditor, and Grant Thornton continued to audit Parmalat’s off-shore subsidiaries after 1998 including Bonlat Financing Corporation where the forged depositary account revealed.
Issue Impacted on the Company’s Profitability, Financial Stability and Share Price
Parmalat and its misleading financial information were trying to cover up their real condition, but in fact the company faced bankruptcy and insolvency. The picture of the scale of Parmalat’s misreporting based on the PwC investigation (Hamilton, 2005) as follows:
- 2002 revenues had been overstated by €1.5bn (€6.2bn vs €7.7bn reported). It had been marked up by 24%.
- 2002 EBITDA had been overstated by €0.6bn (€0.3bn vs €0.9bn reported). It had been marked up by 200%.
- 2002 revenues had been overstated by €1.5bn (€6.2bn vs €7.7bn reported). It had been marked up by 24%.
- 2002 EBITDA had been overstated by €0.6bn (€0.3bn vs €0.9bn reported). It had been marked up by 200%.
Those overstated revenues wereas caused at least by creating fictitious onal revenue through sales toby its subsidiaries. Moreover those sales would be transferred or sold to nominee entities moreover in order to avoid unwanted scrutiny due to aging of the receivables. those sales would be transferred or sold to nominee entities.
From those figures we can infer that the revenues and EBITDA are not as high as stated in the financial reporting. As a result, the company’s profitability was highly impacted by the issues.
Furthermore, concerning the financial stability, these fraudulent accounting practices had direct impact to the company’s ability to meet their short term and long term obligations that led to insolvent declaration by the court of Parma on 27 December 2003.
Regarding the company’s share price, we can see the major impact of the scandal in the following graph, which shows a substantial decrease to the lowest price before it was suspended by CONSOB.
Final Outcome Resulting From the Issue
As a result of being recovered by the Italian Government due to the vast company’s role in economics and social environment, the extraordinary administrators of new Parmalat intends to restructure the group of Parmalat in order to make them survive. The restructuring plan was started with the negotiation process with the creditors and Italian government and then followed by a series of restructuring actions that will be done in a period of 4 years since 2004 to 2007, comprising industrial aspect, financial aspect and company’s control structure. As stated in the Restructuring Plan (June, 2004), the related action plans can be described briefly as follows:
1. Industrial aspect
The outline Plan aims to position Parmalat as one of the world’s leading players in the high added value foods sector, and to concentrate its activity on beverages (milk and fruit juice) and milk related products..
2. Financial aspect (Debt Restructuring)
The method that is currently used for the debt restructuring is a “debt for equity swap” method, with creditors receiving shares that would be tradable on a regulated exchange.
3. Company’s control structure
The plan will lead to the creation of strong and efficient corporate control structures, the strengthening of the Group’s management and the introduction of international best practice corporate governance standards.
By doing the continuous restructuring actions, Parmalat Group can survive and avoided from being bankrupt. Currently, after being re-listed in October 2005, just almost 2 years after its shares were suspended by Milan Stock exchange, the company is struggling to earn its going concern.
As a result of being recovered by the Italian Government due to the vast company’s role in economics and social environment, the extraordinary administrators of new Parmalat intends to restructure the group of Parmalat in order to make them survive. The restructuring plan was started with the negotiation process with the creditors and Italian government and then followed by a series of restructuring actions that will be done in a period of 4 years since 2004 to 2007, comprising industrial aspect, financial aspect and company’s control structure. As stated in the Restructuring Plan (June, 2004), the related action plans can be described briefly as follows:
1. Industrial aspect
The outline Plan aims to position Parmalat as one of the world’s leading players in the high added value foods sector, and to concentrate its activity on beverages (milk and fruit juice) and milk related products..
2. Financial aspect (Debt Restructuring)
The method that is currently used for the debt restructuring is a “debt for equity swap” method, with creditors receiving shares that would be tradable on a regulated exchange.
3. Company’s control structure
The plan will lead to the creation of strong and efficient corporate control structures, the strengthening of the Group’s management and the introduction of international best practice corporate governance standards.
By doing the continuous restructuring actions, Parmalat Group can survive and avoided from being bankrupt. Currently, after being re-listed in October 2005, just almost 2 years after its shares were suspended by Milan Stock exchange, the company is struggling to earn its going concern.
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