A newspaper article reported that company has been found to have

opportunistically window dressed its financial statements.

The executive chairman of a listed company said he was stunned when senior

finance managers approached him after the departure of the firm's most senior

executive officer. It was reported that there were irregularities in the

company's financial accounts which had left its 35 stores across the country

on the brink of collapse.

The executive chairman immediately called in its external auditors to conduct

an investigation. It was later confirmed the worst: the company's assets had

been overstated and its liabilities understated for up to six years, leaving it in

the dire position where it was unable to pay its debts.

The executive chairman and its board of directors then reported to the Security

Exchange and one week later, the senior executive officer's resignation was

then reported to the Exchange. One day later, the chief operating officer

informed the board that he was on medical leave. In view of the situation, the

executive chairman and the other directors resolved to call in accountants from

another international company who told the board to take steps to ensure no

further liabilities were incurred. They also advised the board not to pay any

debts until the situation could be stabilised.

The international accounting firm told the executive chairman that he had to

immediately notify the company's biggest secured creditor, the EMI Bank. A

meeting with the bank's credit evaluation centre was scheduled for the

following day, where the executive chairman said that if urgent funds were not

made available within 36 hours, the listed company would have to stop trading

and appoint administrators.

Many meetings were held between the company and the bank with a view to

salvage the financial position of the company, and to avoid receivership. After

one week, the bank lost it patient aa it found out that it is exposed to potential

losses of RM50 million. As such, the bank appointed an insolvency specialist

as receiver, who announced the company would be sold to recover its debts.

The sale came as no surprise to the listed company's 1,000 unsecured trade

creditors, many of whom had been experiencing difficulties for several years

with getting payments. Some had been forced to use debt collectors to ensure

bills were paid. One of the creditors, said the company was experiencing a

difficult trading year because of the tax, interest rates, increasing petrol prices

and the post-COVID spending slump. In the market, there are rumours that

creditors exercised caution when supplying stock to its stores in different

locations.

According to figures provided by the company, its assets of RM200 million

were 'predominantly funded through debts' of RM120 million. Observing this

situation 'indicates a cause for concern' as the company was in 'a poor short

position, meaning short-term debt is not covered by short-term asset position'.

This situation was confirmed during a creditors' and the company's cash flow

projections 'revealed that the liabilities of the company had been understated

and the assets overstated'. This 'systematic overstatement of profit has been

funded by increased debt both to the bank and to creditors'.

Further investigations were continuing into how these irregularities had

occurred. Company records had been seized and copies sent to the Securities

Commission. The employees of Commission worked closely with the finance

personal of the Company in a bid to unravel what happened inside the

Company and how misleading financial accounts were allegedly maintained

for up to six years.

The executive chairman who was an internal audit committee with another two

board members charged with ensuring the accuracy of the company's financial

records, has said senior management did not inform directors of the problems.

This situation will be closely examined as it is the legal responsibility of

directors to ensure they fully inform themselves about the financial positions

of companies they represent.

The Commission also will investigate statements by the directors that they

relied on the accuracy of reports prepared by Company's auditors over the past

seven years. Both the current and outgoing audit firms lodged formal

declarations that the accounts had been subjected to full audits 'conducted in

accordance with country Auditing Standards'. This included statements to the

Commission which said 'our procedures included examination, on a test basis,

of evidence supporting the amounts and other disclosures in the financial

report, and the evaluation of accounting policies and significant accounting

estimates'.

Required:

Read the above newspaper article:

(a) Identify the "dire" condition of the company. (3 marks)

(b) Explain how debt hypotheses under the Positive Accounting Theory can

be employed, under the efficiency and opportunistic perspective, to

explain and predict the action of the senior executive officer which

created the "dire" condition of the company. (12 marks)

(c) The Company typically have a contractual arrangement with the bank

with many covenants written to incorporate accounting numbers.

Explain why the Company agrees to enter into such agreement with the

bank and do the bank gain from the existence of such agreements?

(15 marks)

[Total 30 marks]