Mockingjay and IFRS 10/FRS 110 in Asia 2014: Changing Balance Sheet and The Rebellion Year for Accounting Frauds?

The following article is extracted from the Bamboo Innovator Insight weekly column blog related to the context and thought leadership behind the stock idea generation process of Asian wide-moat businesses that are featured in the monthly entitled The Moat Report Asia. Fellow value investors get to go behind the scene to learn thought-provoking timely insights on key macro and industry trends in Asia, as well as benefit from the occasional discussion of potential red flags, misgovernance or fraud-detection trails ahead of time to enhance the critical-thinking skill about the myriad pitfalls of investing in Asia at the microstructure- and firm-level.

The weekly Bamboo Innovator Insight series brings to you:

  • Mockingjay and IFRS 10/FRS 110 in Asia 2014: Changing Balance Sheet and The Rebellion Year for Accounting Frauds? Nov 25, 2013 (Moat Report Asia, BeyondProxy)

Rebellion

Dear Friends and All,

Mockingjay and IFRS 10/FRS 110 in Asia 2014: Changing Balance Sheet and The Rebellion Year for Accounting Frauds? 

“Fire is catching! And if we burn, you burn with us!” 
― Katniss Everdeen in Mockingjay, series #3 of The Hunger Games

When you’re in the arena … you just remember who the enemy is.”

– Haymitch in Catching Fire, series #2 of The Hunger Games

Audit firms that show up year after year to express their “true and fair” opinion on the financial statements to be free of material misstatements run the risk of getting complacent and, worse still, in cahoots with their clients in their chemical dependence on the comfortable audit fees, like the victors of previous Hunger Games who show up annually at the event and spend the rest of their time in the relative comfort of the Victor’s Village in each district. Last week on Nov 19, an arrow struck into the client-auditor nexus that perpetuates frauds in Asia: The Seoul Central District Court ordered Samil-PwC, the largest auditor in Korea, to pay a $13 million fine to a group of 137 shareholders for failing to conduct its audit in Kosdaq-delisted software firm Forhuman with due care. The shareholders filed the lawsuit to claim compensation for their losses after the company was delisted from the Kosdaq exchange over embezzlement and accounting fraud scandals. Lee Yong-hee, the company’s CEO, was ordered to pay more than $23 million on charges of embezzling $9.4 million. Forhuman was listed on the Kosdaq market in 2002. From 2008 to 2010 it recorded $15.5 million of net losses. However, the software developer forged its accounting records, recording $39 million of net profit instead. During that period, Samil-PwC consistently gave Forhuman high evaluation scores.

This is the first time that a court has ruled to hold big accounting firms such as Samil-PwC responsible for poor auditing, whether in Korea or in Asia. And this ruling came despite the financial regulator defending Samil-PwC, arguing that it would be wrong if an auditor should assume responsibility for what was perpetrated by a client company. Both retail and institutional investors in Asia have frequently fallen prey to the negligence of auditors in terms of their duties or collusion with companies, as has been seen in the savings banks and Tongyang Group scandals which prompted the unprecedented ruling in Korea. Over the last three years in Korea, accounting firms had to pay a total of only $3.2 million for partial responsibility and settlements in accounting scandal cases. Incorporated accounting companies also came up with clever ways to escape responsibility over charged of negligence. The ruling against Samil PricewaterhouseCoopers was the second decision made by the same court in the same month that an accounting firm is responsible for negligence. The Seoul Central District Court ruled on Nov 9 that BDO-Daejoo is partially responsible for compensating investors of the failed Samhwa Mutual Savings Bank.

Accounting fraud has long been a prevalent and deep-seated problem. There had been various measures to tackle it, but fraudulent practices continue. In Hunger Games, the mockingjay bird becomes a symbol of rebellion in the second series Catching Fire. Hopefully, the Forhuman is the “mockingjay” symbol that can spread throughout Asia to unravel more accounting frauds with the various colluders from auditors to financial advisors/dealmakers with the company’s insiders. The S-chip (or Singapore-listed Chinese companies) scandals have also cases of auditor partners directly or indirectly involved, such as Ziwo in which the Deloitte Singapore audit partner was advertised to have invested in the company as one of the largest shareholders. As explained in our series on Detecting Accounting Frauds (Part 1 and Part 2), Ziwo is a typical case in employing the capex inflation (“Grand Capex”) and consolidation trick in accounting by using balance-sheet items in the “Subsidiary”, “Amount Due from Subsidiary” and “Prepayment/Advances” accounts (“Roll-Away Loans or Advances”) to generate artificial sales and mask possible acts of tunneling and expropriation of cash and assets. Since the media blitz which includes the audit partner’s investment, the all-expense-paid IR trip and bullish sell-side research piece, share price of Ziwo is down nearly 90% from S$0.42 to S$0.05.

Like Ziwo, the fraudulent accounts of Korea’s Forhuman are detected via their affiliate overseas business partners in Japan. These are all part of the related-party transactions atypical of Asian firms. Noteworthy for Forhuman, Ziwo and Prince Frog is that if their hidden “related-party” entities (subsidiaries, associates, SPEs/VIEs (special purpose entities/ variable interest entities), JVs, pool arrangements, financial assets/instruments) are consolidated into the balance sheet as they ought to be, a far clearer picture on the financial health, particularly the hidden liabilities and debt, of the group (of companies) can be analyzed and evaluated. Value investors would be able to observe the explosion in the hidden debt and liabilities for Korea’s Forhuman at the group level once the Japanese affiliated entities are consolidated into their balance sheet and not be misled by the nice quant numbers of just the listed vehicle at the company level.

IFRS10

What are the implications of the new IFRS 10 Consolidated Financial Statements (the outgoing IAS 27), effective for annual periods beginning on or after Jan 1, 2013 but delayed in Singapore to allow more time for implementation. In Singapore, the FRS 110 will be effective for annual periods beginning on or after Jan 1, 2014. The power of control is one of the most difficult questions to answer in accounting since it involves subjective judgment, leading to diversity in practice related to consolidation. What is the impact on family business groups such as Jindal, Jaypee/Jaiprakash, Essar, Adani, JSW, GMR, Lanco, Videocon, and GVK? Or the chaebols in Korea such as Doosan, Dongbu, Hanjin and Kolon? Or to the REIT/real estate/construction industry and shipping industry? Yet, all these accounting standard changes are not impactful if the auditors are not held accountable for any material misstatements and fraud revelation. Hence the importance of the mockingjay symbolized by the court ruling case for delisted Kosdaq tech firm Forhuman last week. The auditors are now in the fire. What are the 4 key Bamboo Innovator takeaways?

It’s complicated: Management thinkers disagree on how to manage complexity

It’s complicated: Management thinkers disagree on how to manage complexity

Nov 23rd 2013 |From the print edition

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THERE can be few better places to talk about complexity than Vienna. This was the capital of the most complicated political organisation yet seen: the Austro-Hungarian Empire. It was also the centre of some of the most convoluted cold-war spy games. On November 14th and 15th hundreds of management enthusiasts converged on the Austrian capital to debate the subject. They had little interest in the complexities of the Habsburgs or the cold war. They were preoccupied instead by two points: that business is more complicated than ever before; and that managing complexity is at the top of businesspeople’s agenda. Read more of this post

‘Overworked people become hopelessly inefficient’

November 24, 2013 1:58 pm

Unfair demands on your free time

By Rhymer Rigby

We all know that the line between work and personal time has become blurred. But how do you cope with a boss or organisation that makes constant demands on time that is clearly yours?

Where do I begin? 
First, you need to be on solid ground. “If you’re doing an outstanding job, you’ll be able to say ‘I’m going home on time because I’m hitting all my targets,’” says Fergus O’Connell, author of The Power of Doing Less. Jane Barrett, founder of the Career Farm coaching consultancy, adds: “Do a bit of due diligence – are these hours the norm in your industry?” Read more of this post

The leader as a driver in the great race for good results; Gone is the time-wasting focus on why something happened and finding who is responsible. When something isn’t going well, a “high-octane leader” will probably completely skip the “why” and root cause analysis, and instead ask and get answers to a series of questions that keep the race car (team) moving forward and adjusting their approach as the car continues. Everything is about what can and will be done

The leader as a driver in the great race for good results

James Engel
senior executive director and director
 
The Centre of Excellence at The APMGroup.
November 25, 2013 1:00 am

Let’s have a race – a race for business results. The winner gets increased profits, market-share and growth in the Asean Economic Community (AEC) marketplace; the loser, a lot less. You, as a leader, are the driver. Your team is the car. The racetrack is your strategy. The finishing line is achieving your key performance indicators (KPIs). Now imagine that the “fuel” is supplied by your mouth and ears. Remember, you can have the best race car in the world, but without fuel, you’re going nowhere.  Read more of this post

Blood, sweat and tears; How the Napoleonic wars made Britain

Blood, sweat and tears; How the Napoleonic wars made Britain

Nov 23rd 2013 |From the print edition

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Britain against Napoleon: The Organisation of Victory, 1793-1815. By Roger Knight. Allen Lane; 678 pages; £30. Buy from Amazon.co.uk

THE role of Britain in the world was transformed by the Napoleonic conflict. By the time France declared war in 1793 the British empire was in decline; it had lost its North American colonies a decade earlier. But after Napoleon’s defeat at the Battle of Waterloo in 1815 Britain emerged as the world’s pre-eminent superpower. How did it overcome its previous setbacks to inflict a crushing defeat on Napoleon’s France? Historians have tended to explain this in terms of military and naval strategy. But “Britain against Napoleon”, a new book by Roger Knight of the University of Greenwich, argues that Britain was just far better at organising its war effort. Read more of this post

Clarity of purpose, values vital for leaders

Updated: Monday November 25, 2013 MYT 7:14:58 AM

Clarity of purpose, values vital for leaders

BY WONG WEI-SHEN

PETALING JAYA: The Iclif Leadership and Governance Centre aims to help individuals find their purpose in life and values, among others, at the upcoming Leadership Energy Summit Asia 2013 (LESA). “I strongly believe that genuine leadership transformation is only possible when there is clarity of purpose and values together with a deeper understanding of human consciousness,” said Iclif chief executive officer Rajeev Peshawaria in an e-mail interview with StarBiz. Read more of this post

From Tickle Me Elmo to Big Hugs Elmo: nearly two decades of Christmas toy dominance

From Tickle Me Elmo to Big Hugs Elmo: nearly two decades of Christmas toy dominance

By Roberto A. Ferdman @robferdman

November 22, 2013

Christmas time is Elmo time. The lovable red monster from Sesame Street has been one of the most popular gifts in the US nearly every year since 1996. And his dominance reveals a lot about the state of the American toy industry. Each year’s Elmo is a different interactive incarnation. The latest, Big Hugs Elmo, has been declared one of this year’s hottest toys on every list known to US moms: Toys R Us’sTarget’s, etc. It follows in the steps of, to name just a few, Rock ‘n Roll Elmo, Chicken Dance Elmo, Hokey Pokey Elmo, TMX Elmo, Let’s Rock Elmo, and the bestselling Elmo of all time, Tickle Me Elmo. Read more of this post

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