Auditing - Crumbling Art Form?

Audit conundrum?

What is the event that triggers the doomsday scenario for auditing profession?

The US housing crisis before 2009. It sparked off a series of bank collapses or near collapses leading to forced government bailouts for some banks and loss of billions of dollars for many depositors, investors and homeless homeowners.

In October 2010, the European Commission issued "Green Paper Audit Policy - Lessons from the Crisis" to open a debate on two key matters:-

• the expectation gap between auditors and the users of financial statements; and 
• the issue of independence, size and governance of audit firms.

Singapore contributed to the debate through a series of panel discussions organised by ICPAS, ICAEW and SID.

Here are some key comments and observations of the debates and my humble responses to the respective comment:-

1. "Many of the speakers cast audit and auditors as a misunderstood lot - it is just unfortunate that investors and users of financial statements do not fully appreciate the value and the limitations of an audit." - Willie Cheng.

Edgar - Audit profession is said to have responded by attempting to EDUCATE the "misinformed" public about what an audit is and what is not. So far in my "baseless" opinion, the "misinformed" public (who are both, your clients and users) has yet to be fully informed/convinced and consequently be fully appreciative of auditor's work. Why?

I guess the "misinformed" public have read and some have been personally hurt when business entities that have been subjected to the vigorous regime of audit procedures, have actually gone bankrupt or going bankrupt, succumbed to frauds etc etc.

In most of these debacles, the auditors have been seen to have been able to walk away from the rubbles unscathed on defences that "an audit is FIRSTLY to just express an opinion on the true and fair view of the financial statement and SECONDLY, not to report on the financial health of the company". Auditors want to be paid for their services but to the "misinformed" public, they do not seem to carry appropriate level of responsibilities and liabilities.

Let me cite a situation from Jonathan Weil's article entitled "Why have auditors at all?", which is unfolding before our very eyes. PwC said MF Global and its units "maintained, in ALL Material respects, effective internal control over financial reporting as of March 31, 2011". MF Global filed for bankruptcy about 6 months later on Oct 31, 2011 with USD1.2 billion of customer's money MISSING!!!. A lot of people who have relied on that audit opinion lost a lot of money.

2. Willie Cheng opined that the key root of auditor/"misinformed" public expectation gap lies in the issue of auditor independence.

What is the problem?
As the "person writing the cheque calls the shots" or "He who pays the piper calls the tune", it is very difficult for the auditors to stand up against the Board of Directors/managements to preserve shareholders' and stakeholders' interests when your rice bowls are at stake.

Counter measures that have been encouraged over the last few years are:-

• ensure auditor rotation
• limits on fees from non-audit services and;
• increasing the role and powers of the audit committees.

Edgar - Are these measures sufficient?
In my "baseless" humble opinion, no. Two further key areas are being addressed. Firstly, we need to tackle the bunch of people who are writing the cheques to the auditors. Secondly, the European Commission want to address the structure of providers of audit services.

What do I mean by the "bunch of people who are writing the cheques to the auditors"? I am referring to the individuals who are appointed directors/senior managers of business entities. Essentially all the current debates on corporate governance, term of directorship, number of directorships, independence/executive/non-executive status focus on strengthening the quality and ethical compass of our limited pool of directors in this small ecosystem of directors and auditors in Singapore.

European Commission is also encouraging an open debate on reforming the audit providers industry. Please consider the possibility of KPMG, Deloitte, Ernst & Young and PwC being required to put their audit and other consultancy services in separate legal entities with "unrelated" branding.

Or perhaps increase the number of "authorised" and "acceptable" audit providers for public-listed entities. The "misinformed" public, like me, seems to have the impression that the Big 4 are auditors of most public listed companies in Singapore. Take for example - When a PLC, currently being audited by Ernst &Young, got into some sort of trouble, one of the other 3 firms would be appointed to conduct the SPECIAL audit. There isn't many alternatives.

Concluding remark - Questions like "Do we need auditors?", "Why have auditors at all?", "What are the roles and responsibilities of auditors?" will continue to be raised with answers leading to the destruction of existing structures and birth of a better structure (I hope) as part of a necessary evil of natural human thirst to do things better.

References
Willie Cheng, "Change is in the air for auditors", Business Times, Sep 22, 2011.
Jonathan Weil, "Why have auditors at all", Straits Times, Nov 28, 2011.


Acknowledge credit on graphic used
http://www.123rf.com/stock-photo/audit.html

Can bankrupts hold directorships?

Apparently yes as almost anyone can sign up to be directors of companies.

There is no independent check by ACRA. At least this is the situation when Justice Steven Chong, a High Court judged criticised ACRA in a case reported in Straits Times, Dec 9, 2010 page B10.

It is thus apparent that there is no database linkage between ACRA and IPTO (Insolvency and Public Trustee's Office.

The implication is that an undischarged bankrupt may continue to operate companies for years.

Not sure whether the gap between ACRA and IPTO has since been rectified. Anyone any info on this front?

In similar vein, should there a database linkage between ACRA, IRAS, CPF, Ministry of Manpower and Immigration and Checkpoints Authority?

Monetary Authority of Singapore (MAS) posted a record net loss of $10.9 billion for the year ended March 31, 2011

I am naturally curious to read on for the cause of the massive loss and that being the 2nd loss in the last 40 years. Here are the info that I reaped STRICTLY from the articles from Business Times and Straits Times on Friday last.

Numbers as published:-

• Total loss - $10.9 billions
• Investment gains before adjusting for exchange rate revaluation - $12.3 billions.
• SGD up against USD by 10% for year ended March 31, 2011.
• SGD up against Euro by 5%.
• Given the stronger SGD, domestic oil prices up by only 10% as compared to 20% on a global basis.
• MAS manages $299.8 billions in assets as at year ended March 31, 2011 with foreign financial assets representing $287.7 billions ie. 96%!!!!

Here are the various key points discussed:-

1. Headline in BT attributed the massive loss to strong SGD. (Edgar - Thus exchange rate is said to be responsible for $23.2 billions reversal upon valuation of various balance sheet items.)
2. 'With recovery in asset markets over the past two years, MAS' portfolio, excluding exchange rate effects, has more than recovered from effects of the global financial crisis,' Mr Menon said. The loss is hence the result of 'a reporting convention' as per Mr Menon. If MAS reported its financial results in foreign currencies such as the US dollar or SDRs, as some central banks do, it would reflect a 'healthy profit', he noted. (Edgar - I presume he is trying to assure us that the loss is mainly due to a valuation exercise as there is no actual cashflow involved. Are you also telling us that if our reference currency is based on any other weaker currency other than SGD, we would be happy with our performance?) 
3. But is it not a fact that Singapore's purchasing power has declined by $10.9 billions? Mr Menon said no as the INTERNATIONAL purchasing power of our reserves is unaffected by the strength of Singapore dollars. I guess he is trying to say the $287 billions worth of foreign currencies would still buy Singapore the same amount of goods and services.
4. So what have the stronger SGD and $10.9 billions loss bought for Singapore? MAS has essentially shielded the domestic economy from even higher inflationary pressures as the stronger SGD effectively halved the impact of higher oil and food prices.

New Corporate Governance PROPOSED (Part B)

Dear friends,

My focus for this posting is the composition of the Board and other specified criteria for directors.

Proposal - Board Composition
Half the board to be made up of independent directors under the following circumstances where:-
a) the chairman and CEO is the same person;
b) the chairman and CEO are immediate family members;
c) the chairman and CEO are both part of the management team;
d) the chairman is not an independent director.

Mak Yuen Teen said the whole long-winded recommendation "can be simplified to just recommending that there should be at least half the directors independent if the chairman is not an independent director" (full stop).

Based on data from the 2010 Governance and Transparency Index, it is estimated that only 14 per cent of SGX-listed companies have an independent chairman and with more than 50 per cent of all SGX-listed companies currently have less than half the board independent. The Council views that a director be deemed non-independent if he has served on the board for more than nine years. The average tenure for all independent directors is 6 years.

Given the statistics presented in paragraph above, I wish to raise again the issue of whether the Council's proposals can be effectively carried out given our limited pool of qualified and experienced directors.


Proposal - Director with multiple directorships
The Council has decided (ie. chicken out, don't know or just being flexible?) not to spell out an 'ideal' number of directorships any one director should have. (Hong Kong has suggested a limit.) But Council has chosen to delegate that responsibility to the nominating committee "to decide if a director can carry out his duties, bearing in mind his commitments".

In my opinion, Mak Yuen Teen opines that this proposal would be inconsequential as board with directors. with many directorships. would have its nominating committee setting higher limit, vice versa. Anyway by the time we do the next review, the next Council would be able to harvest the experience of last few years in determining the ideal limit.


Proposal - Appointment of alternate director
The Council suggests that directors should avoid appointing alternate directors - except for limited periods in exceptional cases. Why? Alternate directors may not be as well-prepared nor able to perform as well as full-time directors.

This suggestion could be attributed to Mak Yuen Teen's vigorous exchanges with Christopher Chong in Sep 2010 on Xpress Holdings' the nominating committee endorsing the appointment of an alternate director for one of its independent directors.

Reference

Michelle Quah, "Cracking the code of Corporate Governance", Business Times, June 15, 2011.

Michelle Quah, "Will bold proposals survive the fate of 2005?", Business Times, June 16, 2011.

Mak Yuen Teen, "Now let's see the practical impact", Business Times, June 16, 2011.

Mak Yuen Teen, "Unticking the box", Business Times, September 6, 2010.

New Corporate Governance Guidelines PROPOSED (Part A)

Dear friends,

My intention here is to bring together key ideas and comments I can gather so far on each of the proposal.

Background
Singapore's Corporate Governance Council (CGC) was appointed by the Monetary Authority of Singapore (MAS) in February 2010 to review the 2005's version of corporate governance guidelines accepted by Ministry of Finance (MOF). On June 14, 2011, CGC has proposed bold changes to existing corporate best practice guides for MAS acceptance by end 2011.

Proposal - Independence of independent directors
Stricter definition of independence for independent directors (to now include independence from substantial shareholders)

The Council seeks to define "independence" by defining when a director is not independent. How?

• The council suggests that a director be deemed non-independent if he is or has been directly associated with a substantial shareholder of the company in the current or any of the past three financial years.
• The CGC also suggests that a director be deemed non-independent if he has served on the board for more than nine years (the first time a tenure for an independent director has been mentioned.)

The CGC intends to put the respective board, on the spot, by recommending that they should identify, in the company's annual report, each director it considers to be independent.

Comments
Michelle Quah of BT reminded us that the definition of an 'independent' director (to include independence from substantial shareholders) was proposed and rejected by MOF in the last review of the Code in 2005 on the basis that firstly, there was insufficient ground to assume association with substantial shareholders could impair independence as compared to principal-agent relationship for executive directors. Secondly, MOF further assume that there would be an alignment of interest between the substantial shareholders and the REST of shareholders. (I strongly beg to differ. CH Offshore - substantial shareholders sold but the remaining shareholders get nothing. May I also cite the case with Pacific Century.) Michelle recognised that as possible 'expropriation of minority investors' interests by large investors'.

MOF could not take that more stringent definition of independence then possibly due to the fact Singapore's pool of qualified and quality directors is very limited and that possibly almost every one of them, in one way or another, has or had dealings with one another.

But HK and Malaysia have adopted (but is it enforced?) the more stringent definition by making it mandatory ie. as part of listing rules, instead of Singapore's more flexible approach as "guidelines".

Mak Yuen Teen said you can come out with the guidelines and talk about independence but he suggested the following approaches to ensure "independence".

• We allow minority shareholders greater say in the election or re-election of independent directors.
• We must extend the range of sanctions against independent directors who fail to properly discharge their duties and to be more active in taking action against such directors. 

But he concedes that these approaches are beyond the scope of current discussion.


Proposal - Greater disclosure of board and executive remuneration
The CGC suggests that companies disclose the exact remuneration earned by each individual director and the CEO on a named basis, instead of within bands of $250,000 in the current Code.

Michelle again reminded us that the same was proposed and rejected in 2005. The main reason offered by MOF then was to prevent poaching of good directors and consequent escalation of directors' fees. Huh.. are we still living in stone age? Whether a talent would stay on course would depend on many factors beside money. Furthermore, some of the largest listed companies in Singapore have actually been disclosing the exact remuneration of directors and senior management.

For minority shareholders like myself, we need the information to determine value for money paid. I always find it disturbing to see the substantial shareholders, acting as directors and senior managers, paying themselves more than the profit the company made in a financial year. Another example of expropriation of minority investors by large investors?

Reference
Michelle Quah, "Cracking the code of Corporate Governance", Business Times, June 15, 2011.
Michelle Quah, "Will bold proposals survive the fate of 2005?", Business Times, June 16, 2011.
Mak Yuen Teen, "Now let's see the practical impact", Business Times, June 16, 2011.
Mak Yuen Teen, "Unticking the box", Business Times, September 6, 2010.

Forecasting and budgeting

Question - Are government officials in the budgeting department poor in forecasting?

The following are Hong Kong government's experiences:-

1. In 2009-10 budget, Financial Secretary John Tsang Chun-wah predicted a HK$39.9 billion deficit. But strong growth in income from stamp duty on property and stock transactions, the government may end up with a surplus of more than HK$10 billion.
   
2. In 2006, then finance chief Henry Tang Ying-yen predicted a surplus of HK$5.6 billion for the 2006-07 financial year but recorded a HK$58.6 billion surplus.
   
3. In 2001-02 budget, the then financial secretary Donald Tsang Yam-kuen predicted a HK$3 billion deficit. The government eventually recorded a HK$63.3 billion deficit.
   
4. The best forecast was made by Donald Tsang in 2000. He predicted a HK$6.2 billion deficit for the 2000-01 financial year. The administration ended up with a deficit of HK$7.8 billion.
   

With another forecast of a budget deficit set to be proved wrong, a senior accountant has suggested the government carry out more frequent reviews of its financial position.

Capitaland and Singapore's new revenue recognition standard

where was i?

Effective on 1 Jan 2011, Singapore’s Accounting Standards Council requires that revenue be recognised when control of a property has passed on to the owner. Thus previous year's figures have to be restated to allow for fair comparison. (Yes, this is additional work for everyone involved in the preparation of financial reporting.)

The purpose of this article is an attempt to understand the possible impact of the standard change to a company in the business of property development and management such as CapitaLand.

Quantify the change
Here are the figures reported by ST April 27, 2011 on CapitaLand's performance for quarter ended March,

Sales revenue
2010 - $440m ($687.3m before restating)
2011 - $611.5m

Profit
2010 - $29.8m ($115.4m before restating)
2011 - $101.5m

Edgar's observations and analysis
Both sales revenue and profit for Q1 of 2010 declined significantly by 36% and 74% respectively after the change in standard. Thus when you compare current quarter's performance with that of previous year's quarter, the management is able to report significant positive change in both sales revenue and profit.

The question is how much of the sales revenue and profit reported for current quarter could be due to revenue and profit "deferred" from previous quarters which we now captured due to the change in accounting standard.

The share price has hardly moved on the reporting. Edgar would like to speculate on possible reasons.

Efficient market hypothesis that we learned in class stated we assume the market is semi-strong in terms of efficiency in the share price reflecting all past, currently and publicly available information. Has the market been able to quantify the possible impact on CapitaLand's bottomline since the announcement of its new standard adoption last year?

The lack of reaction to the strong figures could be due to other news, prevailing in the market, that are distracting the investors. Since the completion of the Election, property sector has been deemed to have been earmarked for radical changes deemed not conducive for investors.

Taking the more pessimistic stand, we should question whether investors understand the impact of the change in accounting standard. This was highlighted to me by an industry veteran who was very wary of earnings volatility due to the change in standard. The uncles and aunties type of investors may sell their shares unnecessary when a property firm is reporting losses in the current year due to "deferred" recognition of sales revenue and profit.

We await for more clarity.

How to prevent auditors from assessing your financial records?

Dear Friends,

I was just catching up on my reading of some old newspapers after a hectic couple of months when I come across this interesting article.

Sino Techfibre firstly announced that there were some issues pending from its year-end audit. While the management was in the process of arranging with E&Y for an expanded audit review of its operations in China (as informed in newspaper), Sino Techfibre reported that there was an early morning fire at its office premises in Shandong office which destroyed books and financial records. While the office premises were said to be damaged, the remaining production facility in Shandong province remained intact. Of course, the fire is being investigated by local police but the records have been destroyed forever.

Another interesting way to prevent auditor from reviewing financial records was to get the lorry carrying those records STOLEN while the driver was having lunch. This actually happened in 2009 with PwC having issues with verfying cash balances of China Sun Bio-Chem.

Source - Straits Times, April 25, 2011 page B13


China Gaoxian has also appointed PwC to verify cash and bank balances, the underlying sales and purchases and capital expenditures for its two subsidiaries in Zhejiang and Fujian provinces for quarter ended March 31. Luckily, the factory operations in the two respective provinces are still operating for now.

Other S-chips with similar accounting irregularities are Hong Wei Technologies and China Hong-xing.

Source - Business Times, April 22, 2011 page 6