EPPA4716 INTEGRATED CASE STUDY Semester 2 2015/2016
CASE STUDY: TRANSMILE GROUP BERHAD
PREPARED FOR: DATIN DR. ZAINI BINTI EMBONG
PREPARED BY: TAN BEE KUN
A140209
LAU KAR LING
A139789
WAH JUN YEW
A142341
NUR HALIZA AMIRAH BT HALEMI
A140099
NUR SHABIRAH BT SALIMAN
A136723
KOO YUH JYE
A139477
Content Description
1.0 Introduction
Page 2
2.0 Board of Directors
3-6
3.0 Audit Committee 3.1 Role of Audit Committee 3.2 Issue about the Integrity of Audit Committee 3.3 The issue of Effectiveness and Independence 3.4 Issue of Competency
7-10
4.0 Internal Auditor
11-12
5.0 External Auditor 5.1 Issue on Low Audit Fee 5.2 Issue the Long Long Term Relationship between Deloitte& Touch and Transmile Group 5.3 Issue of Deloitte Judgement towards Transmile Due to Their Long Relationship 5.4 Issue of late report fraud to BOD within 2 and half months months 5.5 Audit Procedure and Practices
13-29
6.0 Research Analysts
30-32
7.0 Conclusion
33
1
Content Description
1.0 Introduction
Page 2
2.0 Board of Directors
3-6
3.0 Audit Committee 3.1 Role of Audit Committee 3.2 Issue about the Integrity of Audit Committee 3.3 The issue of Effectiveness and Independence 3.4 Issue of Competency
7-10
4.0 Internal Auditor
11-12
5.0 External Auditor 5.1 Issue on Low Audit Fee 5.2 Issue the Long Long Term Relationship between Deloitte& Touch and Transmile Group 5.3 Issue of Deloitte Judgement towards Transmile Due to Their Long Relationship 5.4 Issue of late report fraud to BOD within 2 and half months months 5.5 Audit Procedure and Practices
13-29
6.0 Research Analysts
30-32
7.0 Conclusion
33
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1.0
Introduction The case study is about a company, Transmile Group Berhad who encounter
with accounting scandal where it causes the company to face suspension and delisting on Bursa Malaysia Securities Berhad. The overstated of revenue and profits had resulted in negative consequences to both the company and its shareholders due to the issue of corporate governance and business ethics. Transmile Group Berhad is an investment holding company who involved in the provision of air freight, aircraft engineering and maintenance services.The company was founded by Gan Boon Aun in November 1993 and was later listed on the Bursa Malaysia Securities Berhad on 27 June 1997. Operationally, Transmile had maintained regular flights between Peninsular Malaysia and East Malaysia as well as some major cities in the Asia Pacific. With a wide range network of operations, Transmile reported increasing revenues and profits since 1998 until 2006. The strong showing in revenue and profit were tracked by its share price which had risen substantially. However, in 2007, the external auditor of the company, Deloitte &Touche declined to approve the annual accounts for lacking of certain supporting documents. These has caused the company failed to adhere the deadline in submitting its audited annual accounts for the financial year ended 31 December 2006 to Bursa Malaysia for public release. Thus, the company faces suspension and de-listing. de-listing. The culprits to the accounting scandal may include the audit committee, the board of director, the internal auditor, the external auditor and the research analysts. However, in our opinion, we strongly believe that the external auditor is the main culprits who cause the accounting scandal in the company due to few issues against the regulations and accounting standards caused by the external auditor during their audit works.
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2.0 The Board of Directors (BOD) The Board of Directors is a body of elected or appointed member by shareholder who will be responsible for monitoring the running company on behalf of the shareholder for the benefit of the shareholder. Based on the corporate governance principles, the responsibilities of the board of directors is monitoring managerial performance and achieving an adequate return for shareholders, while preventing conflicts of interest and balancing competing demand on the corporation.
The Board of Directors must able to exercise objective and independent judgement to effectively complete their responsibilities. The board of directors also responsible to oversee the risk management system and systems designed to ensure that the corporation obeys applicable laws, including tax, competition, labour, environmental, equal opportunity, health and safety laws. The board is not only accountable to the company and its shareholders but also has a duty to act in their best interests.
As stated in the Corporate Governance Principles and also the Transmile Group Berhas’s annual report that the responsibilities of the BOD included overseeing and monitoring of the performance of management and the business of the Group, setting strategic and succession plan, developing and implementing shareholder communication policy, managing risks and putting in place adequate internal control and reporting procedures. The BOD are allowed to delegated some of the responsibilities to several agents but they still need to held fully responsible on the overall monitoring and overseeing the performance of the company.
However, in practice the board of directors of Transmile Group Berhad have left all their responsibilities to the agents where they believe that it would conduct the business with proper corporate governance and keep all directors informed. This was against the principles of the corporate governance and also the policy of the company that stated in the annual report.
It shows that the BOD never fulfill their responsibilities to the company and shareholders. As BOD of a listed company, the BOD have no obey to the Corporate
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Governance Principles where they need to held fully responsible on the overall monitoring and overseeing the performance of the company. The BOD had break the trust of the shareholders and the principles of the corporate governance. The BOD pass all the responsibilities to the agents and just with an assuming that the business with be conducted properly according to the corporate governance. BOD also against the principles of corporate governance where disclosure of information which is not true and fair. As stated in annual report BOD have the fully responsibilities in overseeing the company but in real the BOD did not practice it.
The corporate governance principles stated that, the board members should be able to commit themselves effectively to their responsibilities and the boards should regularly carry out evaluations to appraise their performance and assess whether they possess the right mix of background and competences. Training and evaluation are suggested to make sure for the competency of the boards. However, this two principle are also not being practicing by Transmile.
Refer to corporate governance, the boards should consider setting up specialized committee to support the full board in performing its functions, particularly in respect to audit and depending upon the company’s size and risk profile, also in respect to risk management and remuneration. When committees of the board are established, their mandate, composition and working procedures should be well defined and disclosed bythe board. Besides, in order to fulfill the responsibilities given, the boards should have access to accurate, relevant and timely information. In the case of the Transmile, the boards had formed the Audit Committee to assist them in term of the statutory duties and responsibilities relating to accounting and reporting practice of the company and subsidiaries.
The committee also play a role in serving as a bridge in the communication network between internal and external auditors and the boards. However, the committee had fail to fulfil their responsibilities where they the committee have been informed about the serious accounting issues found in the company’s unaudited 4 th quarter of 2006 report on 14 th and 15th February of 2007 and they hide this from the boards. The boards only know the issues on 4 th May 2007 via a letter from external auditor. This end up that the boards had fail to fulfil their responsibilities in 4
overseeing the performance of the company and the company had breached the Listing Requirement of the Exchange. The reputation of the company also affected as the public was believe that the boards with the assistance of Audit committee will ensure for the quality of reporting. However, it was not as what the public expected.
The boards have the responsibilities to oversee the risk management system to ensure the internal control of the company. The boards of Transmile had passed the responsibilities to the Audit committee to determine the adequacy of the company’s internal control system. Since year 2014, Transmile had outsource the internal control function however the sales and finance division was not under the service of the internal control. It was happened since year 2014, the boards of Transmile had fail to fulfil their responsible in risk management.
The sales and finance division are vital division related to revenue. The boards should have to make sure adequate internal control on the divisions and also the whole company. The fraud was happened since year 2014 where the sales is overstated from year 2014 to years 2016. Inadequate of internal control in sales and finance division should be one of the reason that letting a chance for the fraud to be conduct. The boards fail their responsibilities in risk management in the company and fail to appoint a committee which are competence in carry out the responsibilities given.
In conclusion, the boards of director have the responsibilities on the fraud that occurred. The boards play an important role in overseeing the management and performance of the company. They have to ensure and implement adequate internal control for the company to prevent any fraud. “Prevention is better than cure”, even though the BOD have formed a special audit to investigate the issues found after informed by the external auditor. However, it have been late for them to notice.
We are recommend that the BOD should practice the principles of corporate governance. The boards should carry out their responsibilities at their own instead of pass all the responsibilities to the agents. The boards should have the self-awareness in carry out their duty and be more proactive in communication with the audit committee, internal and external auditors. The boards have to make sure the 5
information reached is relevant and in a right timing. The boards have to make sure the audit committee and auditors being appoint are competence in carry out the responsibilities given. Evaluation of the boards should be implemented too to ensure for the quality of monitoring of the management of the company.
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3.0
Audit Committee
The members of audit committee in Transmile Group Berhadare:
Mr. Chin KeemFeung, the head of the audit committee
Mr.Shukri bin Sheikh Abdul Tawab, independence non- executive of Transmile Group Mr.Khiudin bin Mohd@ Bidin, former executive director ofTransmile Group
Under Section 320.5 Companies Act an audit committee is required for all companies listed on the Bursa Malaysia Securities. Under the Bursa Malaysia requirements, the audit committee should comprise at least three directors, and all members must not be executive directors of the company or any related corporation.
Section 94 of the Companies Act determines that the audit committee must
consist of at least three members who must be directors of the company and not:
be involved in the day to day management of the company for the past financial year;
be a full-time employee for the company for the past 3 financial years;
be a material supplier or customer of the company such that a reasonable and informed third party would conclude in the circumstances that the integrity, impartiality or objectivity of that director is compromised by that relationship; and
be related to anybody who falls within the above criteria.
The audit committee can consist of as many members as the company wishes to appoint (but at least three), but each member must meet the criteria and must be a director of the company. The audit committee may utilise advisors and obtain assistance from other persons inside and outside of the company. The audit committee may also invite knowledgeable persons to attend its meetings. However, the formally appointed members of the audit committee entitled to vote and fulfil the functions of the audit committee will have to meet the criteria (non-executive independent directors) in accordance with the prescribed requirements.
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3.1 Role of Audit Committee Audit committee is a selected number of members of a company’s board of directors whose responsibilities include helping auditors remain independent of management. Audit Committee in Transmile play a lot of roles rather than only carrying their statutory duties and responsibilities relating to accounting and reporting practices of the company and its subsidiaries. Based on the Annual Report in 2005, audit committee also evaluates and monitors the financial process. They also provides assurance that financial information provided by management is relevant, reliable and timely. Besides, audit committee also determine the adequacy of the c ompany’s internal control system.
3.2 Issues about the Integrity of Audit Committee Integrity is one of pre-require in auditing. It is essential that auditor act, and are seen to act, with integrity, it is only need an honesty, it needs a broad range of related qualities such as fairness, candour, courage, intellectual honesty and confidentiality.
Integrity needs an auditor not affected, and not seen to be affected by conflict or interest. Conflict may arise from personal, financial, business, employment and other relationships which the audit engagement team, the audit firm or its partners or staff have with the audited entity and its connected parties.
Integrity is very important since the director and management are rely on auditor information obtained during the auditing since it is confidential. Without integrity, there is danger that director and management will fail to disclose such information to the director and the effectiveness of the audit will thereby be impaired.
In Transmile case, one of the audit committee is the former executive director of the company. This is against the Act of Companies, which will have conflict interest that will affected the independent of the member. The audit committee were alerted several times by external auditor which is Deloitte & Touch about the accounting issue found in the company’s unaudited 4th quarter of 2006 report. Even though the audit committee knowing the external auditor’s concern, they are still
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ignore the concern and went to seek board of director consideration to release unaudited annual report. What making the situation more worst is, audit committee and top executives did not inform the BOD about the unaudited report. Here, we can see that the audit committee have no integrity, they have failed in perform their fiduciary duties to alert the board.
3.3The issue of Effectiveness and Independence Independence in auditing means taking an unbiased viewpoint in the performance of audit tests, the evaluation of the results and issuance of audit reports. For example if an auditor is an advocate for the client, a banker or anyone else, he or she cannot be considered independent.
They are two type of independence in fact and independence in appearance (Section 290.6, MIA Law ). Independence in fact existed when the auditor is actually able to maintain an unbiased attitude throughout the audit, whereas independence in appearance is the result of other’s interpretation of this independence. The value of auditing depends heavily on the public perception of the independence.Theauditors not only must be independence in fact, but they must also be independence in appearance. If auditors are independence in fact but users believe them to be advocates for the client, most of the value of the audit function will be lost.
In this case, public believe with the present of the independence director in audit committee, the quality of monitoring would be increased but what happen is opposite, that is the independence auditor had knowingly permitted the making of misleading statements to Bursa Malaysia which breached the Listing Requirement of the Exchange when the unaudited report on fourth quarter of financial year ended has been released.
3.4 Issue of Competency Competence is closely related to due care in the performance of professional duties. Competence requirement means that a member should have formal education in accounting, adequate practical experience for the work being performed, and continuing professional education. While due care means that member is a
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professional responsible for fulfilling his or her duties diligently and carefully. Due care includes consideration of the completeness of the working papers, the sufficient of audit evidence, and the appropriateness of the audit report. As a professional, the auditor must avoid negligence and bad faith, but the auditor is not expected to make perfect judgments in every instance. Under MIA law Section 410, the law implies an accountant to observe the professional’s technical and ethical standards, strive continually to improve competence and the quality of service through Continuing Professional Education (CPE) and discharge professional responsibility to the best of his or her ability.
The audit committee have been assign to determine the adequacy of the internal control of the Transmile. Prior to year 2004, audit committee was helping the Internal Audit Department in overseeing the internal control system. Beginning from the middle of year 2004, the internal audit function of Transmile have been outsource. The internal service that been outsource was not cover the sales and finance division and also reviewing of the financial statement. As the audit committee of a listed company, the member should be have the competency in overseeing the internal control. The audit committee should have the ability and knowledge in determine the adequacy of internal control in the company. However, the audit committee had failed to meet the competency. They should know the lack of internal control in the sales and finance division. They have failed the responsibilities being given.
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4.0 Internal Auditor In middle of 2004, Transmile had outsourced its internal audit function to Moores Rowland Risk Management Sdn Bhd, which is an independent professional firm. Prior to 2004, the Audit Committee was assisted by the Internal Audit Department in overseeing the internal control system of the company.
The role internal audit is to provide independent assurance that includes detecting and preventing fraud, testing internal control, and monitoring compliance with company policy and government regulation. Internal auditor reports to the board and senior management who are within the organizations governance structure. A small business might not be able to afford to have an own internal auditor but for Transmile, it came to question why a large capitalized company to outsource its internal audit works to a third party, Moores Rowkland Risk Management Sdn Bhd against norm of having it done internally. Accordance to International Standard for Professional Practice of Internal Auditing (IPPF), engagements must be performed with proficiency and due professional care (IPPF 1200).
From IPPF 1220 – Due Professional Care
Internal auditors must apply the care and skill expected of a reasonably prudent and competent internal auditor. Due professional care does not imply infalli bility.
IPPF 1220. A1 - Internal auditors must exercise due professional care by considering
the:
Extent of work needed to achieve the engagement objectives
Relative complexity, materiality, or significance of matters to which assurance procedures are applied
Adequacy and effectiveness of governance, risk management and control processes
Probability of significant errors, fraud, or noncompliance, and
Cost of assurance in relation to potential benefits.
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Generally, internal auditors help organisations to succeed. The assurance part of internal auditor’s work involves telling managers and governors how well the systems and processes designed to keep the organisation on track are working. Then, internal auditor offer consulting help to improve those systems and processes where necessary. Internal auditors should deal with issues that are core important to the survival and success of any organisation. Unlike external auditors, they look beyond financial risks and statements to consider wider issues such as the organisation's reputation, growth, its impact on the environment and the way the company treats its employees.
When it comes to activities that relate to internal control, the internal audit function had to evaluate the internal control by reviewing controls, evaluating their operation and recommending improvements thereto. In doing so, the internal audit function provides assurance on the control.For example if a line manager is concerned about a particular area of responsibility, working with the internal auditor could help to pinpoint improvements or perhaps a major new project is being undertaken, the internal auditor can help to ensure that project risks are clearly identified and approached with action taken to administer them.
However, Audit Committee had limited the scope of auditing of Moores only on several specific areas and not expanded to some critical areas such as the sales and finance divisions of the company. Hence, it did not cover the review of financial statement. Therefore, the inter nal auditor’s work did not cover the review of financial statement.
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5.0 External Auditor 5.1Issue on Low Audit Fees The Malaysian Institute of Accountants (“MIA”), had in 2010, issued a Recommended Practice Guide 7 (Revised) on the charging of audit fees. This is a
replacement to the earlier practice guide issue in 2007. All auditors in Malaysia are required to abide by this practice guide. The purposes of issuing this Practice Guide are because of the following reasons: i.
Increased in compliance burden due to higher auditing standards requirements
ii.
Increased in operating costs, mainly salaries
iii.
To ensure auditors professionalism are not affected due to “price wars” among auditors
As a response to stakeholder concerns about downward pressure on fees being a factor potentially adversely impacting audit quality, there are important considerations in the Code of Ethics for Professional Accountants (the Code) for auditors in relation to the setting of audit fees. This Code will be relevant to auditors when considering tendering for a new audit engagement, or when proposing or agreeing fees for recurring audit engagements. It may also be of interest to those charged with governance, preparers, regulators and audit oversight bodies, investors, and others with an interest or role in auditors’ work and their independence.
In this case, Deloitte & Touche have quoted its client an audit fee, which was comparatively low. This could be Deloitte & Touche’s strategy to continue secure auditing assignments from Transmile. Yet, from another point, it could be seen as fear of losing the client, especially with the intense competition from the other audit firms. According to the accountants, evidence of low audit fees by Deloitte & Touche could be found in the case of Transmile where in 2006 and 2005, the fees were RM150,000 and RM73,000 when revenue were RM655.8 million and RM356.4 million respectively. However, when the audit was taken over by KPMG in 2007, the fees shot up to RM280,000 while the revenue dropped to RM616.2 million. The practice of setting the fees so low could compromise the principle of competence and due care as auditors might be in difficulty to perform their duties satisfactory.
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In my opinion, Deloitte & Touche should not quoted Transmile a low audit fee just because of fear of losing Transmile or to continue secure auditing assignments from Transmile. Although Deloitte & Touche have a long-term relationship with Transmile for a number of years, based on the Code of Ethics for Professional Accountants, auditors should set an audit fee which is reasonable and acceptable without affected by other factors such as the relationship between auditors and clients. Besides, the low audit fees might give the wrong impression to other people that the quality of the audited report is bad and it might affect the reliability of users on the audited report. Based on the Recommended Practice Guide 7 (Revised), it gives a guidelines to auditors on the charging of audit fees in order to increase in compliance burden due to higher auditing standards requirements , increase in operating costs, mainly salariesand to ensure auditors professionalism are not affected due to “price wars” among auditors. Therefore, Deloitte & Touche should consider this guideline in order to set a reasonable audit fee to clients as reduced audit fees can present problems in terms of quality and it might raise auditor independence issues or may be ineffective.
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5.2 Issue the Long Term Relationship between Deloitte& Touch and Transmile Group Other than competence and due care, another things to concern was the integrity and theindependence of external auditor. As referred to the case Deloitte& Touch and Transmile Group have a very long relationship that is more than a decade. This can be proven or supported by the statement given by ChalyMah Chee Kheong, Chief Executive Officer (CEO) for Asia- Pacific of Deloitte& Touch said “We have been serving them for a number of years, even before their initial public offering”.
What bothers in this case is the relationship between Deloitte and Transmile Group. This relationship could to a certain extent, pose familiarity threat. Familiarity could negatively affect the auditor’s independence of mind and therefore their auditing quality. Chief Consultant at Alliance IFA (M) Sdn. Bhd explained, “When the auditor go for a job, there is a presumption in their mind that everything is in good faith”. The value of auditing depends heavily on the public perception of th e independence of auditor. In auditing process there are two types of independence that are independence in fact and independence in appearance.
Independence in fact exist when the auditors be able to maintain unbiased attitude throughout the audit, whereas independence in appearance is the result of others’ interpretation of this independence. Deloitte might look independence in fact, but independence in appearing they were not. This is due they already served with Transmile Group for number of years before Transmile was listed in KLSE. The long relationship definitely could effects auditor independence and the quality of audit report. This can be supported when Deloitte& Touch seemed to be relying on the auditing fees of the Transmile Group, especially with the intense of competition in the market, and it could be the reason why they have been hesitating to report the overstatement to the authority.
The concept of independence is abstract and easily be misinterpreted or manipulated. Relationship with clients, direct or indirect, financial or otherwise can be perceived to impair both form of independence.
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While integrity means adherence to moral and ethical principles, soundness of
moral, character or simply honesty. Every professional job need to integrity. For example, a medical doctor is expected to have high integrity, objectivity to observe professional standard and have to act in public interest. However, one difference between auditors and others professional s need not be concerned about is the remaining and independent. Independence must certainly be most critical characteristic.
In my opinion, the action replace Deloitte with KPMG is a correct and appropriate action since Transmile was eroded by the irregularities. Yes, it’s true that Deloitte might be the firm which discovered the problem but it’s still not justifiable to continue its service as the problem was tracked back to 2005 and the quantum was huge.
This is not a small issue such as student who didn’t do his homework, but a catastrophe which turned shareholders’ investment into red overnight. Even a student who didn’t do his assigned homework would probably be punished, so Deloitte should consider itself lucky to be able to continue its business without a single cent poorer.
Transmile first notified in Bursa Malaysia that its auditors had trouble verifying its account for the year ended 31 December 2006 on May 7, due to the absence of some documents. Mah (executive of Asia-pacific) said in the course of an audit, the external auditors rely only on the company’s management and board of directors, who are tasked with the governance and overall responsibility of the company.
Regardless whether the accounting irregularities was discovered because of a sudden stringent audit process by Deloitte or because the worms were too huge to be kept inside the can, the fact remains that Deloitte has failed in his duty to protect the shareholders.
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5.3 Issue of Deloitte Judgement towards Transmile Due to Their Long Relationship Deloitte already served the Transmile Group for over than 10 years. During their tenure to Transmile, of course the management will know the in and out of auditing procedures done by the external auditor, Deloitte, so the issue here is there might be the high possibility of management of Transmile manipulate the information given by their company to Deloitte
They can hire their accounting department to create fictitious invoice and dummy sale and so on, in other words, Transmile can abuse Deloitte as they know how auditor works since they know very well how Deloitte works. In year 2004 and 2005, the report is released but the fraud cannot be detected. This might be due the company might change their full set cycle of supporting document. The change of full set cycle of supporting document can affect the materiality How the materiality affected?
Let say the materiality is 1% of the revenue which is equal to RM12 million ( for the example) and auditors needed 60 samples of transaction that material and in the year 2004 or 2005 and only find 25 samples material, so the remaining 35 samples will take randomly on any the sales. Transmile might make the fictitious sale that below their benchmark that is RM120 000. Therefore it will fall under “non-key item” for sale. The sample is a lot but auditors can only choose a few.
Even auditors choose the samples without supporting document in 2004 and 2005, Deloitte might change the selected sample due to their long term relationship. Any selected sample which are “non-key item”, the external auditor may just change the sample if they found that the sample are lack of some supporting document. Because of their long term relationship, the external auditor are believe that there will be a possibility accept any explanation from management about the lack of document, and they will just change the sample as they tend to bias towards materiality. If Deloitte maintain use 1% materiality for more than ten years, no wonder the report in 2005 and 2004 can be released even they do not have enough supporting documents.
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As the management can be easy to manipulate and the judgement of external auditor will be affected due to the long term relationship and trust towards the company.
5.4 Issue of late report fraud to BOD within 2 and half months According to its 2005 Annual Report, the role played by Deloitte and Touche was to “evaluate the overall financial statements presentation and ensure that they are prepared in accordance with statutory requirements”. One of the roles of external auditors in corporate governance is protecting the interests of shareholders. This is possible because external audition reports are conducted independent of the company’s influence. External auditors report the state of a company's finance and attest to the validity of financial reports that may have been released. They ensure that the board receives accurate and reliable information.
In this case, Deloitte &Touche had held regular discussions with the management and the audit committee to address the accounting issues when they were first discovered, but was to no avail. Finally, on 4 May 2007, via a letter, Deloitte &Touche informed the BOD that they declined to approve the annual accounts as they had not been able to obtain “relevant supporting documentation from the management on certain transactions relating to trade receivables and related sales and additions to property, plant and equipment so as to enable them to satisfy themselves on fairness or validity of those transactions”. In response, on 7 May 2007, the BOD appointed Moores Rowland Risk Management to conduct a special audit on issues raised by Deloitte &Touche. An unaudited annual account was released in 2006 to Bursa Malaysia was made but the report was released without the auditor’s concern over the accounting issue had breached the Listing Requirements of the Exchanges and what was more unfortunate is about how Deloitte react or responded to the matters. Deloitte had failed in fiduciary duties to alert the board on the warning raised sooner after the release of the unaudited results on 15 February 2007.
One of the roles of external auditors in corporate governance is protecting the interests of shareholders. They ensure that the board receives accurate and reliable information. In this matter Deloitte should informed BOD sooner in order to protecting the interests of shareholders. If an external auditor detects fraud, it is his
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responsibility to bring it to the management's attention and consider withdrawing from the engagement if management does not take appropriate actions. Normally, external auditors review the entity's information technology control procedures when assessing its overall internal controls. They must also investigate any material issues raised by inquiries from professional or regulatory authorities, such as the local taxing authority. As we can see after Deloitte informed BOD, BOD immediately appointed special audit. So if Deloitte had informed earlier, maybe Transmile may be listed company by now with released the audited financial report
Furthermore, Deloitte also should inform the security commission about this matter. According to the Section 99E of Security Industry Act stated that “if an auditor is of the professional opinion that there has been a breach of security laws or rules of the exchange or any matter which may adversely affect the financial position of the listed company, the auditor must immediately submit a written report on the matter to the security commission”. The Securities Commission Malaysia (SC) is a statutory body entrusted with the responsibility of regulating and systematically developing the Malaysia’s capital markets. It has direct responsibility in supervising and monitoring the activities of market institutions and regulating all persons licensed under the Capital M ar kets and Ser vices Act 2007 . Therefore, before releasing the unaudited report, SC had been informed and the action of charging audit committee can be done earlier. However, Deloitte had failed to inform them.
The question that arises is whether there is a possibility conspiracy between Deloitte and the audit committee of Transmile. There could be a tremendous pressure on the auditor not to report to the security commission as per requirement of the Section 99E since the audit committee played a role in selecting auditors, determining their remuneration, dismissal or retention could be implicated if found guilty. The conspiracy issue reinforced when the external auditors informed of the rejection of the latest report is two months and 20 days late compared to the date of unaudited report was release that is on 15 February 2007. Deloitte supposed told directly to the BOD regardless after being ignored many time by the audit committee and top management about unaudited reports.
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In conclusion, Deloitte had failed to fulfil their role as external auditor of listed company and protecting the interests of shareholders. Being late for 2 months after releasing the unaudited report to Bursa Malaysia to Board of Directors and also Security Commissions is unacceptable. Deloitte could have done earlier and save the company for being delisting by 2011.
5.5
Audit Procedures and Practices
Integrity and Independance
Issue on the Materiality when audit work is performed ISA 320 Para 9 : Materiality Level for the Financial Statement as a Whole
When establishing the overall audit strategy, the auditor shall determine a materiality level for the financial statements as a whole for purposes of: (a) Determining the nature, timing and extent of risk assessment procedures (b) Identifying and assessing the risks of material misstatement (c) Determining the nature, timing and extent of further audit procedures.
ISA 320 Para 10: Materiality Levels for Particular Classes of Transactions, Account Balances or Disclosures
When establishing the overall strategy for the audit, the auditor shall also consider whether, inthe specific circumstances of the entity, there are particular classes of transactions, accountbalances or disclosures for which misstatements of lesser amounts than the materiality level forthe financial statements as a whole could reasonably be expected to influence the economicdecisions of users taken on the basis of the financial statements. In such circumstances, theauditor shall determine the materiality levels to be applied to those particular classes oftransactions, account balances or disclosures.
ISA 320 Para 11: Amounts Lower than the Materiality Level or Levels for Purposes of Assessing Risks and Designing Further Audit Procedures
The auditor shall determine an amount or amounts lower than the materiality level for the financial statements as a whole (and an amount or amounts lower than the materiality level for particular classes of transactions, account balances or disclosures,
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if applicable) for purposes of assessing the risks of material misstatement and designing further audit procedures to respond to assessed risks.
Based on the case Transmile, Deloitte have been serving Transmile for more than a decade and there was this concern about Deloitte independence due to the long – term relationship. This long-standing relationship could however to a certain extent pose the familiarity threats. Familiarity, could negatively affect auditors’ independence of mind and therefore their auditing quality.
If the auditor remain unchanged their method in determining materiality for Transmile for over the decade, this could lead to management of Transmile abusing. For example if Deloitte using 1% of revenue as the materiality level for the financial statement as a whole and management of Transmile decided to “cook the book”, culprits could create fictitious invoice under the materiality level once they has forecast their revenue for the particular year.
During sampling test, it is divided into 2 parts which is key-value item and non key value item. Key-value item consists of item above the material level and non key-value item consist of item below the material level of the company. For every single key-value item, auditors have to do vouching the entire cycle supporting documents. Where else for non key-value item, this group of item consists of numerous amounts of transactions and audit will only pick samples by sampling method. Therefore if Deloitte does not change method of determine materiality, there is opening opportunity for the management to abuse and create fictitious invoice for dummy sales under the materiality level.
Besides, the familiarity with Transmile can cause auditor to change samples of non-key value item when they did are unable to vouch full set of supporting documents for the samples selected and hence this affect the integrity of auditor. Using the same method and style to determine materiality over the decade could lead to fraud among management level of clients. Therefore, determining the materiality of a company during the planning of audit is very important.
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Issue on the Sample Selection ISA 530 Para. 6, 7, 8:
i. When designing an audit sample, the auditor shall consider the purpose of the audit procedure and the characteristics of the population from which the sample will be drawn. ii. The auditor shall determine a sample size sufficient to reduce sampling risk to an acceptably low level. iii. The auditor shall select items for the sample in such a way that each sampling unit in the population has a chance of selection.
ISA 530 Para. A4:
Audit sampling enables the auditor to obtain and evaluate audit evidence about some characteristic of the items selected in order to form or assist in forming a conclusion concerning the population from which the sample is drawn. Audit sampling can be applied using either non-statistical or statistical sampling approaches.
Generally, every audit firms have created their own template for calculation of samples during sampling test. Within this template, an auditor will key in account balance of the item in financial statement, materiality, risk of material misstatement, and multiplier of samples. Automatically, template will calculate the numbers of samples selected for testing.
In the case, Deloitte have been auditing Transmile for over a decade and have been a long-standing relationship. Usually when auditors have good faith in their clients due to long term relationship, they will tend to reduce the multiplier and risk of material misstatement. If the risk of material misstatement (RMM) and multiplier of samples being reduce to relatively low, number of samples selected to be tested will be little too. If this were to happen, the chances of selecting the samples which is fictitious invoice in case of Transmile will be low especially when the item is fall inside non-key value item. For example, selecting 60 samples from 10,000 samples will have less chance selecting the fictitious invoice and selecting 250 samples from 10,000 will have more chance an auditor came to detect the ficti tious invoice.
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Issue on why Auditor did not Report to SecuritiesCommission Security Industry Act Para. 99E: Duties of Auditor of Listed Companies
(1) If an auditor, in the course of the performance of his duties as an auditor of a listed corporation, is of the professional opinion that there has been a breach or non performance of any requirement or provision of the securiti es laws, a breach of any of the rules of the stock exchange or any matter which may adversely affect to a material extent the financial position of the listed corporation, the auditor shall immediately submit a written report on the matter: i. in the case of a breach or non-performance of any requirement or provision of the securities laws, to the Commission ii. in the case of a breach or non-performance of any of the rules of a stock exchange, to the relevant stock exchange and the Commission iii. in any other case which adversely affects to a material extent the financial position of the listed corporation, to the relevant stock exchange and the Commission.
Deloitte have found out serious accounting issues in the unaudited 4 th Quarter 2006 report of Transmile 14th February 2007. Yet, Deloitte did not report the serious accounting issues that might be adversely affects to a material extent the financial position of Transmile to Securities Commission. The question here is whether it is because the tremendous pressure on auditor not to report to Securities Commission as per requirement of the Section 99E since audit committees which played a role in selecting auditors, determining their remuneration, dismissal or retention could be implicated if found guilty.
Although, auditor are appointed to audit Transmile by Audit Committee but it is the responsibility of auditor to uphold integrity and independence as they responsible not to audit committee but to the every shareholders of Transmile. Therefore, whenever a serious accounting issue is found out by auditor, a management letter must be send to board of directors to get clarification at very first place and not by after two over months, 4 th May 2007. If the board of directors were to ignore, auditors still have to be responsible to other minority shareholders that does not hold any position in the company by reporting it Securities Commissions.
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Issue on the Level of Reliable of the External Auditor towards the Internal Control The International Standard on Auditing ISA 530 Audit Sampling is guidance for auditor when they decided to use audit sampling in audit procedure. It consists of statistical and non-statistical sampling method where auditor can use to design and select the audit sample, performing test of control, test of detail and evaluating the results from the sample. The sample size determine by auditor have to reduce the sampling risk to a low level which are acceptable. The auditor shall select items for the sample in a way that each sampling unit inside the population have the chance to be choose.
The higher the sampling risk willing accepted by auditor the lower the sample size will be selected. Sampling risk is normally related to the internal control, the test of control and the test of detail that will conducted by the auditor. For tests of controls normally auditor will makes an assessment of the expected rate of deviation based on the auditor’s understanding of the relevant controls or on the examination of a small number of items from a population.
The purpose of assessment is to design audit sample and to determine sample size. If the expected rate of deviation is unacceptably high, the auditor will normally decide not to perform tests of controls. Similarly, for tests of details, the auditor makes an assessment of the expected misstatement in the population. If the expected misstatement is high, 100% examination or use of a large sample size may be appropriate when performing tests of details.
From the ISA 530, we are clear that the auditor in selecting the sample size for testing is always depend on sample risk that willing to accept and always related to the effectiveness of the internal control of a company. Normally, the more assurance the auditor intends to obtain from the operating effectiveness of controls, the lower the auditor’s assessment of the risk of material misstatement will be, and the larger the sample size will need to be. When the auditor’s assessment of the risk of material
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misstatement at the assertion level includes an expectation of the operating effectiveness of controls, the auditor is required to perform tests of controls.
In the case of Transmile, since year 2004, the internal controlof the company have been outsourced to Moores Rowland Risk Management Sdn Bhd. However, the sales and finance division of the company are not under the area of service for the internal audit. It means that the internal control for the sale and finance division is less as compared to other division in the company. We always clear that sales is always directly affected to the revenue of a business. Transmile have been overstated its revenue in a total of RM530 million since year 2004 till year 2006. This amount had turn the Transmile financial position from a gain to a loss. So, we are questioning on the quality audit work that been done by the external auditor, Deloitte.
The external auditor should be noted that the sales and finance division are not included in the outsource service of internal audit since year 2014. It means that the audit work especially the audit procedure, test of control, test of detail and the level of accepted sample risk will be different as compared to before year 2004 due to the change of the effectiveness control of the divisions. We will questioning are the external auditor doing differently since year 2004 in order to obtain more assurance. However, from the explanation of the ChalyMah Chee Kheong (CEO Deloitte), we believe that external audit still performing inadequate of audit work in this case.
Mah explain that their audit work tend to bias towards large items which are material, and he further explain that the responsibilities of ensuring proper internal control system and accurate accounting record lies with the directors and management of a company. From the explanation of Mah, it can be seen that audit work done by the external auditor was tend to rely or highly rely on the internal control of the company. We can believe that this trust of Deloitte towards management of Transmile might due to their long term relationship. We believe that Deloitte designing the audit procedure tend to referring to the prior year (before year 2004) working style. That will be the possible reason why Deloitte unable to discover the overstatement in year 2004 and year 2005. Referring to the ISA 530, the effectiveness of the internal control will affected the level of sample risk of the audit procedure. Since year 2004, the
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structure of the internal control of Transmile have been changed. The audit procedure designed should be different.
Therefore, we are believe that external auditor have the big responsibilities on this matter which their inadequate audit work since 2004 have make them fail to discover or prevent the fraud.As an auditor conducting an audit in accordance with ISA is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error.In accordance with ISA 330, the auditor shall design and perform further audit procedures whose nature, timing and extent are responsive to the assessed risks of material misstatement due to fraud at the assertion level.
Issue on Communicate to the Board of Directors Referring to the ISA 240, the external auditor has the obligation to communicate to the management level and with those charged with corporate governance when they have identify the possibility of fraud during conducting of the audit work. If the auditor has identified a fraud or has obtained information that indicates that a fraud may exist, the auditor need to communicate these matters on a timely basis to the appropriate level of management in order to inform those with primary responsibility for the prevention and detection of fraud of matters relevant to their responsibilities.
If the auditor suspects fraud involving management, the auditor shall communicate these suspicions to those charged with governance and discuss with them the nature, timing and extent of audit procedures necessary to complete the audit. The auditor shall communicate with those charged with governance any other matters related to fraud that are, in the auditor’s judgment, relevant to their responsibilities.
As stated in the ISA 240, we noted that the timely basis is a vital element when the external auditor informed the management level or those charged with corporate governance there are possibility of fraud. Based on the Transmile case, the external auditor have fail to meet the timely basis when they communicate to the Board of Directors. On 14 th and 15th February 2007 external auditor have informed the Audit Committee of the Transmile relate to the serious accounting issue found in
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the fourth quarter 2006 unaudited report. The issue was not immediately highlighted to the BOD. After two and half months, on 4 th May 2007 external auditor only communicate to the BOD about the accounting issue found.
The timely basis was not follow by the external auditor. They do not have any further action during the two and the half months. The decision of audit committee failed in fiduciary duties to alert the board on the warning raised had given to a suspicion that something sinister was going on. The external auditor should able to identify the suspicion that something sinister was going on among the audit committee. The external auditor should inform the board in a timely basis. The external auditor should have further action within the two month. Therefore, the external auditor had fail their responsibilities to inform the board on timely basis.
Issue on Communication to Securities Commission Referring to the ISA 240, external auditor can communicate to Regulatory and Enforcement Authorities when if they found that the fraud in a company which is involving the managementand also those charged with corporate governance. If the auditor has identified or suspects a fraud, the auditor shall determine whether there is a responsibility to report the occurrence or suspicion to a party outside the entity.
Although the auditor’s professional duty to maintain the confidentiality of client information may preclude such reporting, the auditor’s legal responsibilities may override the duty of confidentiality in some circumstances. In the exceptional circumstances where the auditor has doubts about the integrity or honesty of management or those charged with governance, the auditor may consider it appropriate to obtain legal advice to assist in determining the appropriate course of action.
Based on the case Transmile, with the explanation from Mah, “I don’t believe we have done a bad job as far as Transmile is concerned. At the end of the day, it was our stringent audit processes that led us to discover the accounting irregularities. If our quality of work were really that bad, we probably would not have discovered them.” It shows that external audit was able to identify the overstatement or the fraud.
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Based on the Section 99E of the Securities Industry Act , “if an auditor is of the professional opinion that there has been a breach of securities laws or rules of the exchange or any matter which may adversely affect the financial position of the listed company, the auditors must immediately submit a written report on the matter to the Securities Commission.” With the explanation of Mah, the external auditor had failed to follow the ISA 240 and also the Section 99E. We will questioning why there are no have further action from the external auditor during the two and the half months period. The external auditor are able to identify the overstatement which will adversely affect the financial position of Transmile, however a written report was not submitted to the Securities Commission. Therefore, the auditor have failed their responsibilities in this audit work done procedure.
Issue On Audfit Rotation Referring to the By-Laws (On Professional Ethics, Conduct and Practice) of the Malaysian Institute of Accountants Section 290 : Independence – Audit and Review
Engagement, stated that in respect of an audit of a public interest entity, an individual shall not be a key audit partner for more than five years. After such time, the individual shall not be a member of the engagement team or be a key audit partner for the client for two years.
During that period, the individual shall not participate in the audit of the entity, provide quality control for the engagement, consult with the engagement team or the client regarding technical or industry-specific issues, transactions or events or otherwise directly influence the outcome of the engagement.Key audit partners whose continuity is especially important to audit quality may, in rare cases due to unforeseen circumstances outside the firm’s control, be permitted an additional year on the audi t team as long as the threat to independence can be eliminated or reduced to an acceptable level by applying safeguards.
Based on the case Transmile, the external auditor, Deloitte have served Transmile for more than 10 years. Referring to the Section 290, there should be rotation of the partner and also the audit team in Deloitte to serve the Transmile Group Berhad. Rotation of the key audit partner and audit team beside to maintain the
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independence and integrity, it is also for the purpose of maintaining the quality of audit work done. With the explanation of Mah, Deloitte have high familiarly with the operation of the Transmile. The audit team from Deloitte will be tend to more relies and tend to more confident to the management of the Transmile. It is the nature of human, things will be easier when we have high familiarly. Deloitte failed to discover the overstatement in year 2004 and year 2005 we can believe that the trust and familiarly towards Transmile had affected their professionalskepticism and judgment throughout the audit process.
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6.0The Research Analysts Transmile had always been one of the favorite companies for investors and analysts alike. Its share price had risen by 428.3% since 2003 and the role of analysts had always maintained bullish views on Transmile.
The role of analyst is to prepare investigative reports on equity securities. The research carried out by the research analyst is in an effort to investigate, examine, discover or revise facts, principles and theories. The analyst prepares the report could contain an analysis of equity securities of companies or industries. Accordance to the rule 3400 Research Restriction and Disclosure Requirements, it establishes requirements that analysts must follow when issuing research reports or making suggestions. These requirements defined that the minimum procedure requirements that Dealer Members must be fulfil to minimize potential conflicts of interest. Therefore, disclosure requirements under Rule 3400 must be clear and comprehensive.
In this case, the research analysts did not do their study or research completely and had caused few mistakes or errors that had led the investors to think that the analysts’ reports are reliable. These mistakes have influenced the investors’ decision making in making investments and have caused the unconscious herd instinct. The following are the mistakes done by the analysts.
i.
Indicatorsthat could have material effect on the investors’ decisions in
making investment were missing from analysts’ reports
While many analysts were focused on the earnings and company’s prospects, there were other indicators that could have a material effect on the investors’ decisions to invest in the company but were largely missing from many analysts’ reports. The analysts should be alert on the unusual growth and the amount showed in the financial statement as these might be the indicator that could have a material effect on the investors’ decisions to invest in the company. In addition, the analysts should perform additional works and research to ensure if there are possible indicators that is material to the investors’ decision making. Analysts should also go in deep to study
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and investigate the company before compiling their report. They should go to the company for site visit, meet up with the staffs, and contact the CEO of the company in order to find out the possible indicators. The analysts play an important role in stock market, most of the investors will make their decision whether to invest in that particular company based on their report. Thus, all the reports that they prepare need to be complete and obtain as many information as possible including the indicators that could have material effect on the investors’ decisions in making investment.
ii.
Lack of prudential and alert on Transmile’s trade receivables
Despite being a strong growth company, Transmile had not really been able to turn its sales into cash. Transmile’s trade receivable had been building over the years with trade receivables for 2006 were reported at RM381.2 million, which was a 243% jump or RM270.1 million more than the previous year, while growth in 2005 was 5% and 2004, 46.1%. With revenue recorded increase of 80% or RM439.1 million during the same year 2006, receivables accounted for much more of the company’s revenue growth. Since trade receivables could have influence on the profitability reported, it would be prudent for analyst to be on the alert as these trade receivables could easily be reclassified as doubtful debts.
Based on the article from Business Times by Kang Siew Li, it stated that “An analyst who declined to be named said it appears that there was a deliberate attempt to manipulate the account with a plan to deceive the board or shareholders .” Analysts should be alert on these issue earlier and alert on Transmile’s trade receivables since there are unusual growth rates or increments in Transmile’s financial statement. But, the analysts have failed to do so in assessing the performance of Transmile. In addition, Transmile said that following the final report, the assets of the company will be adjusted downwards with the adjustments primarily in property, plant and equipment, investment in associated company and trade receivables. Hence,it is prudent for analyst to be on the alert as these trade receivables could easily be reclassified as doubtful debts.
iii.
The unconscious herd instinct caused by the assessments by the analysts
With such favorable assessments by the analysts, the influence on the share price went without saying, as “when research houses are upbeat on a stock, most 31
others tend to follow suit. And when investors are buying into a counter, others too think it must be a good idea. It is called the unconscious herd instinct,” says a seasoned investor. The analysts should take the responsibility and think one step ahead of the effects that will cause if they publish their report. The analysts are like a guidance for the investors because many investors will make the decision based on the assessment made by the analysts. Besides, investors should not blame analysts if they are losing money as the analysts are just giving their professional opinion based on their study and research. Hence, the investor should know the risks when they invest in this particular company based on the analysts’ report only.
iv.
High reliability on the publicly available information without verification
Analysts too relied on the publicly available information obtained from sources believed to be reliable but had not been independently verified by them, thus no guarantee as to its accuracy, completeness or correctness. Meanwhile, investors were supposed to seek financial advice regarding the appropriateness of investing in the share assessed by the research house in its report. The assessments were actually intended for information purposes only and not to be construed as an invitation to buy or sell the shares referred.
Based on the articles from Asia Times, it indicated that “analysts wonder whether it was merely a case of poor accounting standards or if management was trying to hide something in the accounts. If it was merely bad bookkeeping, which could be easily rectified, auditors most likely would not have held back on signing the accounts,” they say. In my opinion, the analysts should have not rely on the audited report only but perform some other procedures to obtain other reliable information to verify and make an accurate assessment on the performance of Transmile as the investors rely on these assessments made by the analysts.
In conclusion, research analysts can contribute to the reason of delisting because analysts play a vital role in providing clear and reliable report to the potential investor in order to help investor do their decision making based on the performance of Transmile. It is important that research analysts possess professional skepticism whereanalyst should question all things that happened towards the company. This helps analyst to make sure that all review that they make is reliable. 32
7.0 Conclusion There are many issues against the laws caused by the culprits. These culprits should take their responsibilities in order to help and assist the company to handle the problem faced by the company which is suspension and de-listing. The potential factors should be solved as soon as possible so that the interest of the shareholders of the company can be protected. The potential factors may consists of the engagement of Transmilein the illegal actionwhich is to cover up somefacts by reporting a higher profit than the actual one. Whereas,the opportunistic action taken by the analysts and investorsis investing in a growth potential business where they should actually be alert of overly strong growth in companies, weakness in the internal control systems as well as operational systems. The analysts and investors should not only rely on the publicly available information but to do more studies and researches before making any decisions.
In conclusion, it’s the responsibility of a listed company and its directors and chief executive to prepare and present financial statements in accordance with approved accounting standards issued or adopted by the Malaysian Accounting Standards Board (MASB). Failure to fulfill this obligation is an offence. Furthermore, the culprits should carry out their responsibilities and comply with regulations and accounting standards in order to protect the innocent parties such as shareholders and investors.
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References
1. Kang Siew Li. “Transmile Audit Shows Losses in 2005, 2006.” Business Times 19 June 2007. http://www.malaysianbar.org.my/business_news/transmile_audit_shows_losse s_in_2005_2006.html 2. Anil Netto. “Cooking the Books in Mala ysia.” Asia Times 30 May 2007. Asia Times Online. 30 May 2007. http://www.atimes.com/atimes/Southeast_Asia/IE30Ae01.html 3. Corporate Governance http://www.kantakji.com/media/3100/v148.pdf 4. Corporate Governance http://www.bursamalaysia.com/misc/listed_companies_corporate_governance _CG_Guide_bm.pdf 5. International Standard on Auditing 530 Audit Sampling, December, 2009 http://www.ifac.org/system/files/downloads/a027-2010-iaasb-handbook-isa530.pdf 6. International Standard On Auditing 240, 15 December, 2010 https://www.frc.org.uk/Our-Work/Publications/APB/ISA-240-The-auditor-sresponsibilities-relating-to.pdf 7. MIA Handbook, Section 290 http://www.mia.org.my/handbook/bylaws/pIB290-150.html 8. International Auditing and Assurance Standards Board, ISA 320 & ISA 450, 15 Febraury 2007 www.paab.co.za/index.php/component/docman/doc.../255-ed-015-02 9. MIA Tchnical Staff, “Materiality in Planing & Performing Audit”, April,2012 http://www.mia.org.my/new/downloads/professional/audit/staff/2012/MI A_Staff_Alert_No2_2012_Materiality_in_Planning_and_Performing_the _Audit.pdf 10. International Auditing & Assurance Standards Board, “ISA 530, Audit Sampling”, 31 October 2007 https://www.icaew.com/~/media/corporate/files/technical/audit%20and%20ass urance/consultations%20and%20representations/consultations/proposed%20re drafted%20isa%20530.ashx
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