MUCH ADO ABOUT FAIR VALUE Mohd Noor Abu Bakar Ahmed Razman Abdul Latiff Susela Devi PROLOGUE Alex Chong slumped on his chair in his office and reflected on the lunch time conversation he had with his old friend, Ben Smith. He recalled the event that occurred during the board of directors meeting which has been concluded in the morning. It was supposed to be a simple presentation of the companys draft financial statements, to be endorsed by the board before its formal submission to Bursa Malaysia. However, when Kassim Selamat, the CEO, presented the report, Alex Chong was surprised to see the figures reported because they were completely different than what was presented during the audit committee meeting held 10 days before. Apparently there has been an upward valuation of the Sekinchan Project Development Agreement impairment loss on the intangible assets of the company. The revision was done through an engagement of another valuation agent, something that Alex Chong was not aware of until that fateful board meeting. He still remembered what Kassim Selamat said to the board, I strongly suggest that we endorse this report because if we use the first valuation report, the company will be risking its profitability and suffers a real threat of becoming a PN17 status company. He pondered, How should I resolve these issues? BACKGROUND OF THE COMPANY Likubend Development Sdn Bhd (LDSB) is a subsidiary of Likubend Holdings Bhd (LHB), a property developer listed on the Main Board of Bursa Malaysia. The company has landed property through various joint ventures with other entities. Their financial year end is 31st December. Datuk Shamsul, 62 years old, is the chairman of LHB. He used to work as an engineer in various engineering firms during the early days and eventually started to set up his own engineering company in the late 1980s. The company later diversified its activities including property development. Alex Chong, 60 years old, is the chairman of audit committee of LDSB. He is a chartered accountant and holds various professional memberships. His early training was in the UK and he also used to work in the Auditor General Office. LDSB AUDIT COMMITTEE MEETING (15 st April) 2 The meeting was about to begin when Alex Chong realized that Kassim Selamat, the CEO of LDSB was not around. Alex Chong turned to his secretary, Pn. Julia and asked, Do you know whether Kassim Selamat is going to attend our meeting or not? Puan Julia replied, I have just been told that he is unable to make it because he is meeting a minister over some land issue. Alex Chong said, Well I guess Mr. Tan, our CFO, can present the report on his behalf. Mr. Tan presented the draft financial statements and Alex Chong looked at the figures and remarked, Can you explain why there is a huge impairment loss in the accounts? Mr. Tan replied, The impairment is due to the valuation report from Right Price Valuations on the Sekinchan project, for which we have entered into a development agreement and paid RM50 millions for it. Henry Goh, a member of the audit committee team who is also a valuer, turned to Richard, the external auditor, and asked, Are you happy with this valuation and this impairment loss? Richard, from Richard & Lingam, replied, We have reviewed the valuation and we think it is reasonable estimate of the fair value of the project under present circumstances. Another member of the committee, Saloma, observed, So, this valuation results has an impact on the profit? I see the profit will reduced by RM10 millions. What are the implications when we announce this result to the Bursa Malaysia? Mr. Tan answered, Of course, we have a dilemma. The holding company will have a variation of more than 10% from its announced quarterly report results. Worst case scenario is that the holding will be a PN17 company, but this will depend on the consolidated financial statements. Can we highlight to the meeting here that we are not the auditors of LHB and the consolidation will be done by their own external auditors. Therefore the holding company should be informed on these possible implications, Richard interjected. OK, if there is no objection from members of the committee, we will approve the accounts as drafted, said Alex Chong. IMMEDIATELY AFTER THE AUDIT COMMITTEE MEETING 3 Kassim Selamat : Mr Tan, how did the audit committee go? Mr. Tan : They approved the draft accounts although there is a huge impairment loss on the Sekinchan project. Kassim Selamat : What loss? Which valuation report did you use? Mr. Tan : Of course the Right Price Valuations. There is only one, isnt it? Kassim Selamat : No! I have got another report from Betoi Appraisals. Remember in our earlier meeting we agreed to consider disposing this Sekinchan project. I then commissioned a valuation from Betoi Appraisals which I think will give us more favourable valuation. Mr. Tan : I did not know about this. So what should we do? Kassim Selamat : Go back and redraft the accounts and use the Betoi Appraisals valuation. Mr. Tan : What about the auditors and the audit committee? Kassim Selamat : Dont worry, I will take care of this. LDSB BOARD OF DIRECTORS MEETING (25 th April, Morning) Kassim Selamat, the CEO presented the draft financial statements to the board of directors. Suddenly, Alex Chong exclaimed, Hey, this set of financial statements is not what was tabled at the audit committee meeting recently. The previous set of accounts showed an impairment loss but this one does not. Can you explain? Kassim Selamat replied, We use another valuation report which shows a much higher valuation and therefore there is no impairment loss. Datin Sherliza, an independent and non-executive director, asked, Why is this valuation higher than the previous one? Are you saying that previous valuation is wrong? Did the internal auditors review the valuation? Saloma intervened, And this valuation needs to be approved by the audit committee and the external auditors. Kassim Selamat answered, But we dont have time! Only few days left before we are due to announce the results to Bursa. Or else we face severe consequences Datuk Shamsul looked at Alex Chong and said, Alex, I dont understand why it is so difficult for you accountants to come with an exact value for an asset. As for me, the price of an asset is the 4 price which a buyer is willing to pay for it! Let the users of our financial information crack their head in figuring out what is the worth of our assets. You are wasting the company resources for all this valuation business. Please sort this out with the auditors and report back to me by tomorrow morning. EPILOGUE Right after the board of directors meeting, Alex Chong had a lunch with his old friend, Ben Smith, who is a senior partner of an audit firm. They used to train together during their early days of practicing in the UK so Alex Chong did not hesitated to relate the whole dilemma he is currently facing to Ben Smith. Ben Smith asked, May I know what this Sekinchan project is all about? Alex Chong said, The project involved was right in the middle of paddy field, and the company entered into a development agreement about two years ago. The initial intention was to build a medium cost high rise apartment. However there is some indication that the project was overpriced and there is need for impairment losses on this project. I also heard that the project was acquired from one of the LDSB directors brother-in-law. Ben Smith then said, So what is the problem here? Just approve the revised accounts. Alex Chong, But its easier said than done because I dont think Richard, our external auditors, will accept the second valuation by Betoi Appraisals. Ben Smith said, Alex, I really sympathize with you because you are definitely in the real fix at the moment, and I think you need all the professional help you can get. Why dont you appoint me as the consultant and I will solve your problem? Read thoroughly the given case (Much Ado About Fair Value). Assume that you are Ben Smith and the company decided to appoint you as the consultant.

Prepare a written report that will answer these questions:

1) What are the critical issues in this case?

2) What are the possible solutions for the company?

3) What should be the best recommendation to the Board of Directors?

4) How do we address the ethical and internal control issues of this company?