7.16 A friend cannot understand why executives and directors of companies are often paid bonuses and not simply paid a set salary.

(a) Using principles from positive accounting theory, explain the reasons for, and nature of, bonus plans offered to directors and executives.

(b) Why are shares or share options often incorporated as part of a manager's remuneration package?

7.2 CASE STUDY

ABC LEARNING 'RELIANT' ON DEBT TO COVER CASH SHORTFALLS

Stakeholders were told that ABC Learning almost certainly became insolvent in the first half of 2008. What is interesting is that it was about six months later before the directors appointed administrators to take control of the company. According to financial statements prepared by the administrators Ferrier Hodgson, the company went from a positive cash flow of $207 million from its operating activities in its 2007 accounts to a deficit of almost $20 million in the first half of 2008. Their cash flow had grown significantly over eight years of operation. ABC first emerged as a significant player in the childcare industry in 2004. They were running 327 child care centres by June 2004. The company experienced significant growth and expansion since it had listed on the ASX in 2001 with only 43 centres. Ferrier noted in its report to creditors that its analysis showed a 'significant deterioration' in the net cash flow from its operations in the last few months of its corporate life. Ferrier moved into ABC Learning in November 2008, days after its board concluded the company had insufficient cash to pay its debts. Its banks, who were owed nearly $1 billion, called in receivers immediately. The administrators believed ABC's failure was due to a combination of factors including: 'inadequate focus' on daytoday practices and procedures inadequate attention and monitoring of results of operations lack of strategy to integrate businesses it bought over seven years a dependency on compensation payments, liquidated damages and fee guarantees from developers to provide revenue too high a reliance on debt to fund acquisitions and to support a shortfall of cash from operations. The administrator said the company's business model became 'unsustainable'. It is difficult to ascertain which factors played a more significant role and what exactly tipped the business over the edge and caused it to fail. Further investigation, including an examination of former directors and management is needed to help determine the detailed causes of the company's failure.

QUESTIONS

1 Outline the importance of cash flow to ensuring the ongoing operation of a company.

2 Discuss the corporate governance and board mechanisms that could have served to limit the chances of corporate failure in the case of ABC Learning.

8.28 The listed investor, Djerriwarrh, had a solid year in 2016, but not according to IAS rules. Its net operating profit rose by 21.1% despite holding nearly 29% of its portfolio in bank shares. Because of AASB139/IAS39 Financial Instruments: Recognition and Measurement, it had to report a pretax 'impairment' charge of $70.9 million and a net charge of $49.7million, pushing its results to a loss of $14.1 million. Shares in the Djerriwarrh portfolio qualified for the charge, shares that were not even remotely close to going broke but were affected by the global financial crisis. The problem is that as share prices recover, impairment charges already taken against earnings cannot be reversed.

(a) Does the accounting impairment rule, as it stood in 2016, make sense?

(b) What changes were made to AASB139/IAS39 Financial Instruments: Recognition and Measurement as a result of the unforeseen consequences such as that suffered by Djerriwarrh?

(c) As a result of the changes, will investment companies that book impairment losses to the balance sheet be able to report dividend income as income?