Unaudited and Audited Accounts: UnReal or Real?

Posted on 30th April 2008, And what about Pentamaster? .

The issue about Pentamaster was the massive variation in between audited and unaudited account. It was not pleasant reading.

Yesterday, the Edge carried the following article, 12 report accounts deviations in a day. Yes, Pentamaster was not the only one!

• KUALA LUMPUR: As many as 12 companies, the majority of which are listed on the Second Board, reported deviations between their unaudited and audited accounts for the financial year ended Dec 31, 2007 on Wednesday.
  
  Topping the list by variance size was Main Board-listed Englotechs Holding Bhd, which reported a 720% deviation between its unaudited and audited FY07 profit after tax figures.
  
  Englotechs reported unaudited net profits amounting to RM3.14 million versus the audited RM19.5 million audited net losses reported for the year.
  
  In a filing to Bursa Malaysia, it said the variances were due to a RM14 million provision of doubtful debts and net unrealised foreign exchange losses.
  
  “The cost of research and development has been expensed off due to failure to fulfil the criteria of Approved Accounting Standards. Taxation decrease was due to deferred taxation overprovided,” the company added.
  
  Second Board firm MESB Bhd announced a deviation of 624.3% with its audited accounts showing a net loss of RM561 million against the unaudited RM107 million net profits for the period.
  
  The company attributed the sizeable variance to the change of accounting policy in relation to the recognition of project costs incurred on construction of telecommunication towers.
  
  The project costs, MESB said, had previously been recognised as contract expenses. The company had since changed its policy to discontinue this recognition, the company said.
  
  Eden Inc Bhd, which was in the news early this month for aborting its planned RM120 million Sukuk Ijarah programme, reported a 77% deviation amounting to RM1.23 million and RM281,000 respectively.
  
  It had made a provision of RM233,000 for gain on dilution of interest in a foreign subsidiary, RM1.07 million on preliminary expenses of a foreign subsidiary inadvertently capitalised, RM100,000 in under provision of depreciation and RM10,000 for other provisions.
  
  Another firm announcing significant variance was Thong Guan Industries Bhd, which reported a 42.4% or RM8.84 million difference.
  
  The company reported higher unaudited net profits amounting to RM12 million. It explained that the deviation resulted from a combination of correction of accounting errors (due to a foreign currency translation error), under provision of taxation, overstatement of inventory and other provisions.
  
  Second Board-listed industrial products player PJ Bumi Bhd reported a 41% variance, with its audited net loss widening to RM18.11 million from the unaudited figure of RM12.84 million.
  
  PJ Bumi listed the provision for doubtful debts, renovation and written off office equipment, provision of income tax and tax penalty, and other provisions as reasons for the deviation.
  
  The remaining seven companies, however, reported considerably smaller percentages of deviations in net profits/losses ranging from between 3% and 20%. They are Limahsoon Bhd, Ta Win Holdings Bhd, Rex Industry Bhd, APP Industries Bhd and Fitters Diversified Bhd, CNLT (Far East) Bhd and Frontken Corporation Bhd.

Today's Star Bizweek, there was one brilliant set of commentary made by Erral Oh, Audit-related issues – a yearly affair

Here are some of the major points made.

• So, it seems that there will always be a small percentage of listed companies whose profits need to be adjusted a lot after the auditors have gone through their books. We can say that such cases are the exception, not the rule, but that doesn't quite address the issue.
  
  The excuse we often hear is that the financial statements in the quarterly reports are management accounts and because they have yet to be audited, they should not be taken as final. Also, it's a standard complaint among the companies' management that in this post-Enron era, the auditors are more likely to err on the side of caution in interpreting financial reporting standards (FRS) and they often press for audit adjustments that will slash revenue and profit figures.
  
  But these are weak arguments. To begin with, the management of every listed company knows that their quarterly results are for public consumption. That calls for great care in preparing the management accounts. It's important to get these accounts right from the get-go. (Yeah, responsibility!)
  
  That means grey areas and disputes regarding accounting treatment should be resolved well before the audits commence. These companies have accountants (or chief financial officers, as we call them these days), whose jobs should include keeping abreast with developments in FRS and liasing with the external auditors.
  
  Let's not forget that the FRS are backed by law and apply to all, and there's little room for subjectivity. The auditors have the final say. Hence, when a CEO grumbles about the auditors insisting on provisions, impairments or write-offs, he's pointlessly swimming against the tide.
  
  Of course, companies have been known to switch auditors after battles over accounting treatment, but that too is a corporate governance concern.
  
  Furthermore, a CEO who rejects the opinions of the accounting experts risks being regarded as either optimistic to the point of ignoring the need for prudence in accounting, or as being reluctant to allow the financial statements to reflect the true state of his business.
  
  Besides, how do you explain the fact that the management accounts of the rest of the listed companies – as at last Wednesday, there are 988 companies whose shares are traded on Bursa Malaysia – are pretty much similar to their audited accounts?
  
  And what does it say when a company has had to explain variances between its audited and unaudited profits more than once in recent years? Among the 20 companies in this year's batch, the repeat cases include KBES Bhd, Liqua Health Corp Bhd, Dolomite Corp Bhd, Pasdec Holdings Bhd, Eden Inc Bhd, Limahsoon Bhd and MESB Bhd.
  
  Bursa Malaysia has made a stand on variances that could not be justified. For example, in April 2005, it publicly reprimanded and imposed fines on Goh Ban Huat Bhd and Supercomal Technologies Bhd after their audited 2004 profits varied significantly from the figures announced in their fourth-quarter reports.
  
  The basis for these actions was that when these companies released their unaudited accounts, they made announcements that did not meet the criteria of the listing requirements.
  
  The problem is, it's unclear how the exchange determines whether a variance is tolerable or not. If Bursa Malaysia doesn't penalise a company for a variance, should we conclude that the company has done all it could to ensure that its management accounts reflected a true and fair view of its financial position? ( Seriously, this is one good suggestion! Punish these buggers! )
  
  And how can we tell that the company has taken steps to ensure that it will not have variances in the future? A little more transparency surely won't hurt.
  
  And what about those companies that fail to meet the deadlines for the submission of audited accounts?
  
  We know about the accounting-related woes at Liqua Health Corp Bhd, Ho Hup Construction Co Bhd, Satang Holdings Bhd, Welli Multi Corp Bhd, Golden Plus Holdings Bhd and Mems Technology Bhd. So, when they say their audited accounts will be late, we just take it as the latest in a cascade of bad news. ( How true!!!!!!!!!!)
  
  
  However, what was unexpected was that other companies too had trouble finalising the audit of their financial statements. Those in the latter group include Nakamichi Corp Bhd, Haisan Resources Bhd, Advance Synergy Bhd, LFE Corp Bhd and Kosmo Technology Industrial Bhd. Bursa Malaysia has consistently acted against the late filing of audited accounts. And rightly so, because these are major failings and are often red flags of bigger problems. Perhaps, it’s time to think of variances as the same things.

One of the key issue in investing is that investing is all about trusting the company, the management and the owner of the stock that we trust in.

If there is no trust, it's so pointless and so brain dead to talk about investment based on yardsticks such as PE, NTA, ROE, ROCE, INTRINSIC VALUE and so on.

How do you value a company that you cannot trust?

Could you ever, ever get a fair value from your investment?

Is there even any value?

And since there is no trust, one may never know when they might be screwed by these rather un-trustworthy people!

Trust is such an important word which many fails to understand. Some would blissfully choose to ignore!

Last but not least, Bursa Malaysia has to do something about this. It's simply not right to see companies announcing such massive deviations in their audited accounts. Bursa simply needs to be more stict in their enforcement of its rules. As it is, it's so clear to see that our local market already lacks investors and if nothing is done to punish all the wrong doer, the end result could see innocent investors losing massive savings in such stock(s), which ultimately leads to more and more destruction of the already shrinking market capital.

Which investor wants to invest in our market when the issue of trust is not there, given the massive deviation in audited and unaudited earnings?

And when there is no trust, sooner rather than later, the investing public would simply lose faith and trust in the exchange!

Needless to say, in the long run, Bursa Malaysia would hurt big time!