In the wake of corporate scandals in recent years, auditor's ethical judgment and corporate governance have become important topics in the economic transition. This study examines the causal factors on corporate scandals. To begin, the study will review the accounting scandals which occurred in Malaysia and in other countries. In reviewing the scandals which occurred in Malaysia, we will document the company's financial statement before the discovery of the malpractice is found and investigate the possible causes for such scandals. Also, this study will discuss the possible ways to help investors and other stakeholders to be alerted to the accounting malpractice.
Examining causal factors on corporate scandals is important to the accounting profession for a number of reasons. Firstly, corporate scandals blazed across worldwide media at the speed of light and lead to the continued scrutiny of the existing Professional Code of Conduct which will surely lead to further changes. Hence, an understanding of the factors that could contribute to accounting scandals could help a person to handle the circumstances encountered in one's professional career without exclusive reliance on the Professional Code of Conduct.
Besides, the knowledge of these factors may help the accounting professional organizations and accounting firms to set out more effective and efficient rules which may help in enhancing current quality control measures so as to promote professional due-care in the performance of accounting and auditing services. The knowledge of these factors may also lend a hand to the investors and other stakeholders in determining the credibility of the company's financial statements.
LITERATURE REVIEW
According to Rezaee (2002), corporate structure, condition and choice can explain frauds accomplishment. These three variables can help to explain motivations and opportunities of accounting/ financial fraud.
Rezaee (2002) define the accounting and financial fraud as deliberate misstatement or omission of amounts or disclosures in financial statements to deceive financial statement users, particularly investors and creditors. According to Riccardo Tiscini et al. (2006), frauds can be divided in two categories, i.e. management frauds and employee frauds. Due to collusion, management fraud will be more difficult to be detected. An effective corporate governance mechanism (such as internal control structure and audit committees) will be the best deterrent for fraud. It is because the existence of an effective corporate governance mechanism would discourage managers from committing frauds due to a larger probability of detection.
Besides, an effective and objective audit is an essential part of corporate governance (Low, 2002). However, in the wake of accounting scandals, the role of the accounting profession has been questioned by legislators, regulators and the public. Most of the accounting scandals prove that the auditors have failed to carry out their duties and obligations properly. The auditors are usually blamed for conducting an inferior audit when the audited company was to fail within certain months after being audited (Dopuch, 1988). Hence, much emphasis is placed on auditors in the context of corporate governance in a company.
The condition such as pressures will be one of the most relevant factors in the process of fraud committing (Rezaee, 2002). Economic and financial pressures, such as the pressures to meet the earnings target for the purpose of securing bonuses, complying with bond covenants, or meeting stakeholders' expectation, may result the managers to involve in unethical business strategies, especially when the firm is unable to sustain in reporting a stable growth of income. Also, managers have their own characteristics in terms of aggressiveness and lack of moral principles so that fraud is also a matter of choice despite of environmental pressure or corporate structure (Riccardo Tiscini et al., 2006).
RESEARCH DESIGN
Data Collection and Sample Selection
The sample is a non-financial public listed company- Transmile Group Bhd- whose annual reports are available in December 2004 to 2008. We choose Transmile Group Bhd as our sample testing is due to the scandal involving Transmile Group Berhad was likened to the accounting fiasco of Enron and WorldCom. This firm was once an adorable firm in the local stock market- Bursa Malaysia. From its annual reports, we were able to obtain both the financial and corporate data of this firm. These annual reports are available and downloadable from the website of the exchange (http://announcements.bursamalaysia.com).
DATA ANALYSIS
Question 1
Choose one company in Malaysia that was noted to have some problems with its accounting malpractice or suspected malpractice.
Lately, the Malaysia's stock market has been spurred chaos by corporate scandals. Prominent companies such as Megan Media Berhad, NasionCom Berhad, United U-Li Corporation Berhad, Transmile Group Berhad, and OCI Berhad were involved in the corporate failures in Malaysia. In this paper, our group had decided to choose Transmile Group Bhd as our sample testing.
Transmile Group Bhd is a cargo airline based in Malaysia whose providing the principal activities such as the provision of air transportation and related services and leases of aircrafts. Other activities include dealings in aircrafts, aircraft parts and equipment, provision of management, aircraft engineering, line and base maintenance, aircraft ground handling and investment holding services. The Group operates principally in Malaysia with a company slogan of 'Asia serving the world' that indicates their involvement in the international services such as DHL Worldwide Express, United Parcel Service, Air Macau and CEN Worldwide instead of having a courier transportation services between Peninsular Malaysia and East Malaysia.
Transmile Group was listed on the Bursa Malaysia Securities Berhad (formerly known as Kuala Lumpur Stock Exchange) on 27 June 1997. It was once an adorable firm in the local stock market. The company founder, Gan Boon Aun succeeds to list Transmile in the Main Board in 2002 after he fail in 2000 when the application was rejected by the Securities Commision. He has contributed lots in Transmile until bringing the Group to the great heights. However, he has voluntarily resigned as a CEO but remained as a company Director on June 2007 with immediate effect after the accounting scandal in the Groups have revealed.
Question 2
Document its financial statement before the discovery of malpractice is found and trace its share and key performance indicators before the malpractice discovery and after the discovery of the malpractice.
Share price
The revelations of accounting scandal in Transmile Group has skyrocketed them on the world map as the Enron of Malaysia. Within four months after the accounting scandal exploded, Billions of ringgit was wiped out from the market capitalization when Transmile's share price plunge from as high as RM15.00 per share to as low as RM3.50 per share.
Before the discovery of the accounting malpractice in Transmile, A comparison of the performance of Transmile's stock with the composite index reveals that the former has pretty much outperformed the market's key barometer throughout 2000 (except for 2001) to 2006. The enthusiasm was palpable as it reached its peak of RM15.20. Many research houses; local and foreign, continued to set soaring price targets of up to RM18.40 given its exposure to the burgeoning air cargo industry overseas.
However, the share price is trade as low as RM5.50 when a special audit by Moores Rowland Risk Management founds the loss attributable to financial years 2005 and 2006. Investors have been bracing for bad news from Transmile when it told Bursa Malaysia on May 7, 2006 that its audit could not be finalized due to the absence of relevant supporting documentation from the management on certain transactions. The analysts cut their price target on the stock to as low as RM3.33 because the recognize losses in 2006 had shrink the book value for 37.5% to RM3.33. However, the initial audit findings were worse than they had expected.
When the former Chief Executive Officer resigns, the stock has fallen some 60% in 2007. It dropped to its lowest intra-day level of RM5.45 before closing 13% or 85 cent lower at RM5.75. Analysts expect the share price to continue falling to as low as RM2.80, following the accounting adjustments as well as the uncertainty that continues to pile on the stock. What had happened recently to Transmile was indeed an in vain. Therefore, the Malaysian authorities should put in a better framework to prevent it from happening again to make sure the interest of investors, shareholders and public always protected.
Source: Stocktube BlogSpot
Key Performance Indicator (KPI)
Airline Industry has always been a growth oriented and highly challenging sector. In recent times the airline industry has undergone tremendous and radical changes due to multiple factors like airline bankruptcy, increased competition, operating costs, etc. Therefore, evaluating the performance of companies in this sector under such circumstances is a complex task. So, it is complex to evaluate an airline based company such as Transmile Group which is involve in highly profile of accounting malpractice recently. Therefore, Key Performance Indicators (KPIs) can play a major in devising an objective procedure for evaluating the performance of the airline industry like Transmile Group Bhd.
Every company has its own key performance indicator to measure their performance in order to make sure their objectives or goals are achieved. Same for Transmile Group Bhd, it has its own key performance indicator to measure its performance in the airline services field. The KPI of the company usually changed according to the many factors for example global economic uncertainties. However, Transmile's KPI remain unchanged without matters the conflicts happen in the company and the discovery of malpractice in Transmile. Transmile's KPI is 95% on time, with less than 5% late or cancelled flights for uncontrollable reason such as weather conditions.
Question 3
Discuss the malpractice discovered and the extent of any accounting abuse encountered.
Transmile Corporation, a global aviation group that has come under fire for overstating its profits by a fine work of "creative accounting" was charged by Malaysia's Securities Commission to court, on charges of providing misleading company accounts. In this case, Gan Boon Aun, founder and chief executive of the firm until he resigned on June 19, 2007, Lo Chok Ping and Khiudin Mohamad have been charged with helping Transmile make the misleading statements in 2006 financial accounts. According to the charge, the misleading information was contained in Transmile Group's quarterly report on unaudited consolidated results for the financial year ending 2006.
A special audit carried out by Moores Rowland Risk Management later found that it had severely overstated revenue and assets going back to 2004 through dubious invoicing.
They has discovered that its revenue for 2005 and 2006 may have been overstated by over than RM500 million. The report showed that Transmile made pre-tax losses of RM126 million and RM77 million for 2006 and 2005, respectively, instead of pre-tax profits of RM207 million and RM120 million as originally reported which is a total of RM530 million in overstatement. The special audit report revealed that revenues generated from invoices purportedly issued to some 20 companies were recorded as trade receivables. Subsequently, the trade receivables were reduced primarily with payments for "purported purchase of property, plant and equipment" and purported cash receipts. The report said there were no documents to support payments of RM341 million made for the purchase of property, plant and equipment.
As an external auditor of Transmile group, DELOITTE & Touche is responsible on the company's management and board of directors, who are tasked with the governance and overall responsibility of the company. They also rely on the segregation of duties which is they believe that it is almost impossible for auditors to check on every single transaction so they rather only check based on samples randomly picked because they are so many transaction to check on. In this case, many think that they had failed to detect and report Transmile's accounting irregularities. From DELOITTE & Touche points of view, the primary responsibility of external auditors is only on ensuring proper internal control systems and accurate accounting records lies with the directors and management of a company but they think in Malaysia, external auditors are depends on a lot. Therefore, auditors have the right to stand up against the pressures of wrongful financial reporting. They have to continue to function as the ultimate guardian of investor interests and corporate accountability.
Since the scandal has been revealed, Transmile has lost more than half its market value. Transmile shares have lost 80 percent of their value since the accounting irregularities surfaced on May 2006, resulting in the company restating its results to show pretax losses, not profits, for its previous two fiscal years. The investors, shareholders and the management itself are deeply hurt by the Transmile fiasco. So, the ways on how the government protects the innocent investors from the Enron-type of corporate accounting fraud in Transmile was critically review in order to safeguard their interest in the company and the lessons learnt from the Transmile scandal are becoming the examples or guidelines to avoid such cases happen again. For instance, following the Transmile fiasco, the Securities Commission (SC) released a revised Malaysian Code of Corporate Governance 2007 on 1st October 2007. The key amendments aimed to strengthen and improve the quality of board of public-listed companies, audit committees and the internal audit function of public-listed companies in enhancing the quality of the financial reporting.
Question 4
In your view, what are the possible causes that lead to the malpractice?
Based on the situation that was happened in Transmile, we can deem that the company was lacked of proper corporate governance and the audit committee of Transmile was lacked of independence. The ex-Chairman of Audit Committee of Transmile, Mr Khiudin had 25,000 shares in the Transmile. It is shocking but not uncommon. As we know, a member is prohibited from accepting appointment as auditor if he or she has any interest in shares of the company, directly or indirectly. Besides, according to MIA By-Laws- Professional Independence, Section 290, a member in public practice should be, and be seen to be, free in each professional assignment he undertakes, of any interest which might distract from objectivity. The phrase "should be, and be seen to be", means that an auditor not only has to maintain an independent attitude in fulfilling their responsibilities, but it is also essential that the financial statement users have confidence in that confidence. As the audit committee Chairman, Mr Khiudin should have been more independent because he is supposed and has the fiducially to report to the Board of Directors if there is any misstatement in the financial reports. However, it seems like Mr Khiudin failed to do so.
Besides, it is possible that managers involve in unethical earnings management or income smoothing activities. With the intention of meeting the earnings target for the purpose of securing bonuses, meeting stakeholders' expectation, stock price motivations, or complying with bond covenants, managers may not perceive unethical earnings management or income smoothing activities are unethical as long as the business reports earnings. For example, managers who want to portray a good picture of a stable trend of reported income to outsiders may involve in unethical earnings management strategies or income smoothing activities such as falsified accounting transactions and adjusted the timing and the rate of recognizing certain items according to the objective of the management. Consequently, it leads to accounting failures which found in Transmile.
Lastly, we suspect that the external auditor (Delloitte & Touche) of Transmile didn't carry their responsibilities properly. With more stringent auditing and accounting standards, it is just too much work to do, too little time and too much pressure for the auditors. Hence, it is possible that some things do get overlooked, and so the auditor unable to take immediate action to overcome the financial misstatement.
Question 5
Can you draw a parallel between the experience of this Malaysian company and that of the International companies mentioned above? Any similarities and differences?
The scandal involving Transmile Group Berhad was likened to the accounting fiasco of Enron. Both companies announce a remarkable improvement in the net profit in one day, and are being investigated for accounting irregularities on the next day.
Besides, both companies have the problem of lack of corporate governance and falsified in reporting in order to duped investors in believing their companies were growing at a sustainable rate. For example, in the case of Transmile, according to a special audit carried out by Moores Rowland Risk Management Sdn. Bhd in 2007, Transmile made pre-tax losses of RM126 million and RM77 million for FY 2006 and FY 2005 respectively, instead of pre-tax profits of RM207 million and RM120 million as originally reported. This means that there were false statement of revenue and purchase. Also, in the Enron case, the company used sketchy accounting mechanisms to hide its massive debts which result in overstating the profitability.
Besides, from our point of view, we think that the managements of both companies are experiencing the pressure to portray a good picture of a stable trend of reported income to outsiders. Hence, the managers may involve in unethical earnings management or income smoothing activities in order to meet stakeholders' expectation when the companies unable to sustain in reporting a stable growth.
Question 6
Suggest some of the early warnings that could help investors and other stakeholders to be alerted to the accounting malpractice?
In order to get rid of corporate scandals, it is essential to get the "tone at the top"- board structure right. According to Coles et. al (2001), the Board of Directors (BOD) is designated for the purpose of making sure that the top managers are behaving in a way that will provide the optimal value for shareholders. BOD has the responsibilities to ensure that the alignment of the firm activities and its specified objectives. Though Haniffa and Cooke (2000) states that CEO-Chairman duality, where a single person assumes the position of Chairman and CEO simultaneously could enhance the efficiency in monitoring management since less contracting is needed and information asymmetry is reduced; there are empirical studies claimed that the CEO duality will cause the CEO has a concentrated power base that will allow the CEO to make decisions in their own-self interest at the expense of shareholders. Hence, it is advisable to use separate leadership structure where the titles are separated into two positions held by two separate individuals. This is expected that the board able to perform its fiduciary duties more completely.
Jensen (1993) claims that board size is negatively related to the board's ability to advise and engage in long-term strategic plans due to difficulties in organizing and coordinating large groups of directors. This means that the size of the BOD significantly affects the likelihood of financial statement frauds. According to Beasley (1996), board size is directly proportional to financial fraud; as board size increases, the likelihood of financial statement fraud also increases. Hence, smaller board is needed to enable the directors to monitor and control managers more effectively.
An independent audit committee must be in place to oversight the financial reporting process of the company. MIA By-Laws- Professional Independence, Section 290, requires an auditor should be, and be seen to be, free in each professional assignment he undertakes, of any interest which might distract from objectivity. Hence the auditor not only has to maintain an independent attitude in fulfilling their responsibilities, but it is also essential that the financial statement users have confidence in that confidence. This is to strengthen internal controls and to ensure that an independent audit committee could better able to oversight the financial reporting process and to protect the reliability of the accounting process. For the external auditor, more experience and expert auditor should be assigned to the company with more complex financial structure.
Lastly, ownership structure and financial transparency are important in determining the strength of the company's corporate governance. Mitton (2002) states that large shareholders always referred as block shareholders who can benefit the minority shareholders due to their power and incentive to prevent expropriation. According to Hay (2008), due to the lack of control over other internal decisions, major outside shareholder may require to increase external auditing to reduce the information asymmetry. Also, minority shareholders will demand increased external assurance as a balance against the power of the major shareholder. These would consequently enhance the disclosure quality of a firm. Higher disclosure quality would provide depositors, creditors and shareholders with reliable assurances that they will refrain from fraudulent activities.
CONCLUSION
Recently, the newspaper headlines have been dominated by the business scandals and corruptions. CPA firms, investors, lenders, and innocent bystanders are deeply affected by the discovery, nature, and extent of corporate malfeasance. Undeniably, it is not easy to detect fraud, especially management fraud where the management will make their fraud looks as realistic and legal as possible. As the Malay saying goes, "Sepandai-pandai tupai melompat, akhirnya jatuh ke tanah juga". Hence, no matter how fancy a fraud is, it is leap to be found; the larger the number you are hiding, the more you bound to get caught.
From our analysis, we found that economic/financial pressure was the most relevant factors in the process of fraud committing. In order to protect the investors and other stakeholders, companies should strictly comply with the rules and regulations that set by government and professional bodies. Also, penalty will be imposed to the company that did not comply with the existing laws and regulations.
The principal limit of the analysis is sample size (i.e. the number of the cases). In this paper, we only select two companies, i.e. Transmile Group Bhd and Enron as our sample testing. The number could be increased if wish to obtain more thorough understanding of the trend of accounting scandals. Then, the behavior of controlling bodies (independent directors, audit committees, external auditors, gatekeepers and others) should also be studied to infer the relationship between accounting fraud, corporate governance systems and the prevention and detection of accounting frauds. Besides, since we are limited to publicly available data, our suspected causes of the scandal may be incorrect and our suggested control may not be effective. Future research in this section is needed to examine the exact factors of the scandal.
