QUESTION 1

It is important to seek public confidence in the accounting profession where its role is to

maintain the integrity of corporate reporting. Discuss the possible effects of Flat Cargo

Berhads (FCB) fraud in this matter.

Through the audit working paper of FCB in 2005, there are some inconsistencies

found which lead to a fraud. Among of them is the auditors were unable to verify the aircrafts

claimed to have been purchased by FCB in 2005. The audit team found around RM231

million of non-functional rundown aircraft in hangar. This situation leads to potential fraud

because those old aircrafts had high price tag. As a result, it will increase the holding cost or

storage cost of the assets. Due to this situation, the auditor should conduct the common test

procedure which includes the examination of vendors’ invoices and receiving reports. Besides

that, the auditor had to perform the physical examination of those assets in order to verify the

existence of the assets with the records. It is a must for every purchase to have invoice or

grant to verify the purchase. Besides that, for the purchase involving high value of asset, it

must have approval from top level of company which is Board of Director. In case the aircraft

is non-functional rundown, it must be disposed in order to eliminate the unnecessary expenses

for the company.

Another issue found was related to several debtors. There are increasing in debtors’

confirmation letters were returned. This is because; those debtors had changed their mailing

addresses. Perhaps the company had a phantom client. Thus as an auditor, Mr. Chuah need to

confirm the account receivable whether the address is updated or real address. Besides that,

the company should be using positive confirmation letters. Apart from that, the service

agreement should be reviewed and obtain the explanation from FCB. For control procedure,

the auditor needs to review periodically the account receivable trial balance especially for

large and unusual receivable. Another procedure need to be implemented is adoption of

allowance for doubtful debts.

The third issue is regarding a non-existence supporting documents involving a large

sum of sale transactions which involved small clients. This is considered as potential fraud

which will lead to overstatement of sale. Due to that, the company may not be able to collect

all those revenues which will indirectly recognize as fictitious revenue. Supporting documents

are important for every transaction. Thus, the auditor needs to trace all sales journal entries to

supporting documents. It is including duplicate sales invoice, bill of lading, sales order as well

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as customer order. The auditor should also conduct the control procedure which involves the

pre-numbered invoices and also regular reconciliation of the invoices and journal entries.

Next issue involves a loan from a Hong Kong based company was found to be

incorrectly recorded in the debtors’ account. This situation is recognized as an error of

principle. This is considered as a misconduct of FCB in concealing loan from its stakeholders.

The loan received was recognized as a debtor instead of creditor account. The loan

recognition is to show the increase in cash flow without any claim against the company’s

assets. As an auditor, Mr. Chuah should trace the incorrect entry into debtor and creditor

ledgers due to the imbalance control account. In addition, the accounting in FCB should be

more transparent and ethical manner.

Last issues discovered in FCB are several abnormal transactions involving the increase

in purchasing of aircrafts by FCB and offsetting the debtors’ accounts. By offsetting the

debtors’ accounts with the purchased of aircrafts, it results in low cash in the debtors accounts

and high cash in bank accounts. The duty of the auditor is to review the purchases invoices as

well as the account receivables. In addition, to record the revenue and expenses, it should be

derived from the rules for owner equity which is the total assets should be equal to total

liabilities and owner equities.

Another issue in FCB is non-compliance of governance structure in FCB with MCCG.

In FCB, Chairman and CEO were held by two different individual, Dato Ibrahim Samad and

Mr. Lim Loon Sim. According to MCCG, the entire board should be a balance between the

executive and non-executive directors. However in FCB, there were only three executive

directors out of nine directors sitting in the board. It means that, FCB has not complied with

the MCCG’s requirement. The imbalance of the BOD structure will lead the decision made

may not be effective. Besides that, the decision made may be lack of independency in

discharging the duties of the board to deal with several issues including strategy, performance

and standard of conducts.

Another non-compliance issue is regarding the audit committee in FCB. Due to

MCCG, all members of audit committee should be non-executive directors. This code is not

being followed by FCB where there is one executive directors being the member of the

committee; Encik Ali bin Ahmad. As a result, the audit committee of FCB may not be able to

discharge their responsibilities effectively and independently. This is due to the involvement

of executive directors in the audit committee.

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QUESTION 2

By the end of 2006, it was reported that FCB had been involved in accounting fraud that

inflated its earnings for 2004 to 2006. In your opinion, should the auditors be held

responsible for not detecting the misstatement earlier?

Yes. The auditor should not be responsible for detecting the misstatement earlier. The

governance of the entity and management are the primary responsible for the prevention and

detection of the frauds, not the auditor responsibility. In addition, external auditor can rely on

the internal auditor work, which the internal auditors carry out their work throughout the year.

It will be more comprehensive to the work of external auditor since all the works had been

carried out by internal auditor. Moreover, the presence of internal auditor also will reduce

control risk. Otherwise, the external auditor can refer and understanding their roles as a

guidelines in performing the investigation.

Material misstatement could be reduced if the Flat Cargo Berhad has good corporate

governance. The basis for good corporate governance is Internal Auditor helps an

organization accomplish its objectives by bringing a systematic, disciplined approach to

evaluate and improve the effectiveness of risk management, control, and governance

processes. Whether the company is large or small, good corporate governance can be critical

in establishing a positive organization culture. Good corporate governance is evident by

responsibility, accountability, consistency, fairness and transparency.

The financial statements are management's responsibility. Management is responsible

for adopting sound accounting policies and for establishing and maintaining internal control

that will, among other things, initiate, record, process, and report transactions. The entity's

transactions and the related assets, liabilities, and equity are within the direct knowledge and

control of management. The auditor's knowledge of these matters and internal control is

limited to that acquired through the audit. The auditor's responsibility is to express an opinion

on the financial statements. The auditor has no responsibility to plan and perform the audit to

obtain reasonable assurance those misstatements, whether caused by errors or fraud, that are

not material to the financial statements are detected.

According to the ISA 200 about Professional Skepticism, the auditors should maintain

professional skepticism throughout the audit, recognizing the possibility that a material

misstatement due to fraud could exist, notwithstanding the auditors past experience of the

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honesty and integrity of the entity management and those charge with governance. Following

ISA 240: Communications to management and with those charged with governance: If the

auditor has identified a fraud or has obtained information that indicates that a fraud may exist,

the auditor shall 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. Such in the Flat Cargo Berhad

case, the auditor Mr Chuah need to communicate with the relevant parties in order to find the

information through the company to assess the possibility of fraud. If the auditors 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

professional duty to maintain the confidentiality of client information may preclude such

reporting, the auditor legal responsibilities may override the duty of confidentiality in some

circumstances.

Auditors in dilemma whether to continue servicing FCB or else they will be unable to

continue the engagement. If misstatement resulting from fraud or suspected fraud, the auditor

encounter exceptional circumstances that bring into question the auditors ability to continue

performing the audit, the auditor shall determine the professional and legal responsibilities

applicable in the circumstances, including whether there is a requirement for the auditor to

report to the person who made the audit appointment or in some cases, to regulatory

authorities. Otherwise, the auditor needs to consider whether it is appropriate to withdraw

from the engagement, under applicable law or regulation.

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QUESTION 3

Using the Fraud Triangle Model, which has the three elements of pressure, opportunity

and rationalization, analyze the situation in FCB.

The first factor in the Fraud Triangle Model is pressure. Pressure can become the

motivation for individuals or companies to be involved in fraud. In FCB, situation which

created a pressure in the company can be identified in the financial aspect of the company.

The analysts’ expectation on increase of revenue and the consistency in payment of dividend

even though the profit margin is low due to highly competitive market and the increase in oil

prices that significantly affect the business might had become FCB’s trigger factor to smooth

its earnings by using any means available even though it might be oppose the laws and

regulations.

The second factor in the model is opportunity. Fraud occurs due to the opportunity

factor is commonly due to weak internal control of a company. Good corporate governance is

one of the elements in a strong internal control. By having good corporate governance, any

door for committing fraud can be tightly closed and there will no opening for individuals or

companies to perform any misconduct. The corporate governance structure in FCB did not

follow the Malaysian Code on Corporate Governance where it requires all members of the

audit committee to be non-executive directors. However, that was not the case in FCB as one

of the audit committees in this company which was Ali Bin Ahmad was non-independent

executive director which violated the Code of Corporate Governance. The violation of the

code by having an executive director will affect the independence of the Audit Committee.

The function of audit committee to oversee the internal control of the company might be

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OpportunityRationalization

Pressure

Fraud Triangle Model

jeopardized due to the absence of independence in carrying the duties. Besides that, despite

FCB having a good composition between executive and non-executive directors, the

composition between independent and non-independent directors were not in balance as

required by the Code to ensure that there will be no individuals can dominate the board’s

decision making. Hence, the objective to maintain independence could not be achieved.

The third factor of the model is rationalization. Rationalization can be defined as the

mindset of fraudsters in justifying themselves that the action they have taken is legal and there

is nothing wrong with it. They might think their action is valid and everyone also takes the

same measure. The individuals that committed a fraud by manipulating the accounting records

or known as “cooking the books” in FCB might justified themselves by giving a reverse

reasoning where their responsibilities to maintain the company’s reputation and meeting the

analysts’ as well as other stakeholders’ expectation are far more important and any means to

achieve these are acceptable and valid.

In summary, the three factors of the Fraud Triangle Model existed long before they

had been discovered, thus result in late detection on the possibility of fraud committed in

FCB.

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