When the numbers don't add up

[Musicwhiz]

Apr 11, 2011
When the numbers don't add up
Auditors have raised issues over some firms recently, but numbers have plunged since financial crisis
By Jonathan Kwok

A NUMBER of firms listed in Singapore have recently had the skeletons in their closets paraded for all to see, as external auditors scour their books to finalise their accounts.

The high-profile cases of the China-based trio of China Hongxing Sports, Hongwei Technologies and China Gaoxian come to mind, though there have also been others.

With the annual report season under way, the audited financial statements of Ossia International, for instance, reflected differences with the unaudited version. And the auditors of CarrierNet Global and NEL Group included disclaimers of opinion in their reports.

For their part, the independent auditors of China Powerplus and Asia Environment emphasised some matters to the investing public.

Several companies with Dec 31 financial year-ends are now issuing their annual reports, ahead of their annual general meetings in the coming weeks.

Unlike numbers released during the year, financial statements in annual reports need to be audited by external professionals to be given clean bills of health. Auditors' reports also need to be included.

Various scenarios are possible when an external auditor goes through the books with a fine-tooth comb. Mostly, they will give an 'unqualified opinion' on the numbers, meaning the report is true and fair, and the auditors have no issue at all.

When they raise an 'emphasis of matter', it means the numbers are true and fair, but the auditors need to flag certain issues, such as challenges the companies may face as going concerns.

In these instances, investors should be careful over the uncertainties about which the auditors have expressed concerns, said Dr Ernest Kan, president of the Institute of Certified Public Accountants of Singapore and a partner at Deloitte.

Investors also need to take note when auditors issue a 'qualified opinion' or a disclaimer on an opinion, he added. This means the auditors cannot form an opinion on a part of the financial statements, or the whole of them.

Dr Kan said this can occur when the auditors cannot verify certain information, or disagree with the management on accounting standards or listing rules.

Another possible scenario that should concern investors is when auditors give an 'adverse opinion', something they do when they feel the accounts do not give a true and fair view of the company.

The red flags raised recently may rattle investors, but the number has already dropped sharply since the financial crisis.

'In 2009, we had a lot more cases of auditors raising issues,' said Mr Shariq Barmaky, an audit partner at Deloitte Singapore and South-east Asia. 'This time round to date, there have been a few, but not as many as two years ago. But right now, a lot of companies are finalising their annual reports, so it is possible that there may be some more companies with issues that may come to light.'

At about this time in 2009, more than 40 companies had been flagged by auditors with 'emphasis of matter' notes. Accounting scandals erupted at companies such as China Sun Bio-Chem, Oriental Century and Fibrechem Technologies.

Mr Barmaky said: 'The auditors are required to be professionally sceptical, in accordance with professional standards requirements.'

Mr Adrian Chan, an independent director of several companies, said that as the financial crisis hit, companies saw asset values coming down and impairments becoming greater.

'So, of course, there may be more cases where the management disagreed with the auditors, on valuation methodology, for example.'

He added: 'Coming out of the crisis, the accounts should be getting healthier, so we should be seeing fewer of these disagreements generally.'

In the latest round of issues, auditors for China Gaoxian, China Hongxing Sports and Hongwei Technologies - from Ernst & Young in all three cases - highlighted discrepancies in their accounts.

In China Powerplus' case, RSM Chio Lim emphasised that the firm could need to make further write-downs in an investment, depending on its associate's ability to raise funds and be profitable in future.

At Asia Environment, KPMG has raised some uncertainties that could cast doubt on the company's ability to continue as a going concern.

jonkwok@sph.com.sg

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What auditors mean when they say...

Unqualified opinion

The report is true and fair, and the auditors have no issue at all.

Emphasis of matter

The numbers are true and fair, but the auditors need to flag certain issues, such as challenges the companies may face as going concerns.

Qualified opinion

The auditors cannot form an opinion on a part of the financial statements, or the whole of them.

Adverse opinion

The auditors feel the accounts do not give a true and fair view of the company.

[lonewolf]

Apart from the companies mentioned in the report, I think it will be useful to highlight other companies, whose auditors has make an emphasis of matter, qualified opinion or adverse opinion.

I know of 3 other S-chips companies. Feel free to add on any which you come across.

1) ChinaKangda

We draw attention to note 3(b) to the financial statements concerning the adoption of the going concern basis on which the financial statements have been prepared. The Group’s current liabilities exceeded its current assets by approximately RMB100.8 million as at 31 December 2010. This condition, along with other matters as set forth in note 3(b), indicate the existence of a material uncertainty which may cast significant doubt about the Group’s ability to continue as a going concern. Our opinion is not qualified in respect of this matter

Source

2) JIUTIAN CHEMICAL GROUP LIMITED

Without qualifying our opinion, we draw attention to Note 1 to the financial statements which indicates that the Group incurred a loss for the year ended December 31, 2010 of RMB157,150,000 and its current liabilities exceeded its current assets by RMB211,814,000 as at December 31, 2010. These conditions, along with other matters as set forth in Note 1, indicate
the existence of a material uncertainty which may cast significant doubt about the Group’s ability to continue as a going concern.

Source

3) CHINA FASHION HOLDINGS LIMITED

Summary: Incurred net loss of RMB 4,297,000 and company's and group's current liabilities excess its current assets by RMB31,024,000 and RMB39,333,000 respectively. Deficits in shareholder's funds of RMB4,621,000 (company) and RMB4,990,000 (Group)

Source

============== Add on Companies ==================

4) CNA Group Ltd

We draw attention to notes 5 and 9 to the financial statements. The Group’s jointly controlled operations in Dubai (which are held by a 50% subsidiary of the Company) are engaged in contracts where the contract works have been completed during the year ended 31 December 2010. The consolidated financial statements of the Group include its proportionate share of the assets, liabilities, income and expenses of its jointly controlled operations in Dubai. The Company expects the trade receivables, consisting of amounts billed and to be billed and certified in future, to be recovered although there will be delays in payments.

The recovery of the Group’s trade receivables in Dubai of approximately AED124.2 million (S$43.4 million), and the Company’s investment in subsidiary of AED20.0 million ($8.4 million) and advances to the subsidiary of AED24.2 million ($8.5 million) are dependent upon the agreement of the final contract value and the terms of payment with the contract employer, a limited liability company wholly owned by the Dubai Government.

Source

5) ADVANCED SYSTEMS AUTOMATION

Without qualifying our opinion, we draw attention to Note 1 to the consolidated financial statements. As at 31 December 2010, the Group and the Company were in net shareholders’ deficit positions of $14.9 million and $11.6 million respectively and their current liabilities exceeded current assets by $20 million and $25.8 million respectively. These factors indicate the existence of a material uncertainty which may cast significant doubt about the Group and Company’s ability to continue as going concerns.
As disclosed more fully in Note 1, the ability of the Group and the Company to continue as going concerns depends on the undertaking of the Group’s substantial shareholder, ASTI Holdings Limited, to provide continuing financial support and the Group’s ability to generate sufficient cash flow from its operations.

Source

6) ASTI Holdings

Without qualifying our opinion, we draw attention to Note 3©(ii)(6) to the financial statements. As at 31 December 2010, the Company and the Group have loans and advances owing by an associate, Advanced Systems Automation Limited (“ASA”) of S$27.5 million. As disclosed more fully in the note, the Board has assessed that there is no impairment to the carrying value of these loans and advances on the basis that these loans and advances would be substantially reduced upon the completion of a proposed rights issue of shares to be undertaken by ASA (the “Proposed Rights Issue”) and the continuing improvement of ASA’s business to generate positive cash flow from its operations. The recoverability of the carrying value of the loans and advances owing by ASA as at 31 December 2010 is dependent on the successful completion of the Proposed Rights Issue and ASA’s ability to generate positive cash flow from its operations.

Source

[port]

i'm vested in ams transport whose curr liab r much greater than curr assets.

http://www.amspt.com/db_img/1011ie

[d.o.g.]

Apart from the companies mentioned in the report, I think it will be useful to highlight other companies, whose auditors has make an emphasis of matter, qualified opinion or adverse opinion.

It may be even more useful to highlight companies where common sense would raise a red flag, but the auditors have chosen to remain silent and collect their fees.

For example:

Ezra
==
1. Subsea Operations

This segment recorded $96m in revenue over 2008-2010 but collected just $8m in cash, with $88m in receivables still uncollected. The receivables are supposedly collateralized by a drilling permit, but if this permit is worth so much, why isn't it being seized and sold off? Obviously if it COULD be sold for cash it should have been. The logical conclusion is that it probably can't be sold for cash which is to say it's not worth anywhere near what Ezra claims. Therefore the trade receivables are probably impaired and should be provided for.

2. EOC

EOC is carried as an associate despite Ezra being the single largest shareholder (47%) and having KS Lee and Lionel Lee (Chairman and MD of Ezra respectively) as Chairman and Vice-Chairman respectively of the board of EOC. Ezra has also guaranteed some of EOC's debt i.e. it can decide the fate of EOC. Apparently Ezra and its audtors Ernst & Young take the investing public for fools in claiming that Ezra doesn't control EOC.

Raffles Education
==
1. Trade Receivables

This company runs schools. In a normal school, students pay IN ADVANCE before starting classes. It is rare to give more than 1-2 weeks' grace before non-paying students are evicted. Yet, in the past 9 years, the trade receivables at each year end (30 Jun) ranged from 23 days to 67 days of sales.

What kind of school allows its students to pay, on average, 3 weeks AFTER school has started, let alone 2 months after starting classes? Only the kind of school enrolling the worst type of students - those who can't pay. The last time Raffles Education looked like a normal school was in 2001, when the trade receivables were 3 days of sales.

How do we know the students can't pay? Following the acquisition of OUC in 2008, the bad debts provided for or written off increased, reaching 1.5%, 3% and 5% of revenues respectively in 2008-2010. Again, what kind of school enrolls students where 5% of them are deadbeats?

2. Bad Debt

Bad debts, as a percentage of the previous year's trade receivables, were 14%, 25% and 61% respectively in 2008-2010. Shouldn't the auditors be questioning whether the trade receivables can even be recognized as such, given that such a high percentage of them are going bad?

Furthermore, the company's bad debt recognition seems to be seasonal - bad debts spike in the 4th quarter (30 Jun) each year. Is it mere coincidence that 30 Jun is also when the auditors show up to look at the accounts? Take a look at bad debt provisions/write offs versus revenues for Q1-Q4 in FY08-FY10:

FY08: 1.2%, 0.5%, 1.6%, 2.2%
FY09: 1.8%, 2.0%, 2.9%, 5.8%
FY10: 1.9%, 5.1%, 3.5%, 10.5%

The pattern is clear: every time the 4th quarter rolls around bad debts mysteriously spike. Do the students somehow agree to skip payments, or is the company reluctantly complying with accounting requirements to write down bad debt? And isn't something seriously wrong in Q4 FY10 when 10.5% of that quarter's revenues go bad?

Are the auditors BDO allowed to apply any common sense at all in looking at the accounts? Going strictly by accounting rules perhaps there is nothing wrong. But anyone who has any understanding at all of how commercial schools operate should be extremely alarmed by the numbers being reported by Raffles Education.

[valuestalker]

Hi D.O.G,
Thanks for the insightful info on Raffles Edu.

[donmihaihai]

The number add up which is why there are so many Emphasis of matter reports regarding net liabilities position whether on net current or capital deficit position.

It used to be the case where there was hardly any report with emphasis of matter. Recent crisis throw local auditor guts and common sense out. Technically they are right but what about common sense?

For Ezra receivables, the amount is certainly material, the period is questionable long. Auditor will question management/director but what they do after questioning require at least common sense if not knowledge.