Intended audience: Professional Accountants in Business

Scenario

Over a number of years, X Pte Ltd, of which you are now Finance Director, has adopted an aggressive growth strategy via targeted acquisitions together with an organic growth plan. This has significantly enhanced earnings per share through fully integrating the businesses, creating economies of scale and paying close attention to cost control.

X Pte Ltd and its numerous subsidiaries are fully owned by Y Ltd, a listed company, and as such your half-year and year-end reporting are governed by the listing rules and the timetable laid down by your parent.

The opportunity recently arose for X Pte Ltd to make an acquisition which would transform your business in regard to geographic exposure, revenues and profits and move you into the position of being a top five player. The target company was ABC Ltd and its various subsidiaries. When the proposed acquisition was presented to your parent company, it received a very warm response and your parent agreed to provide the necessary financial support to make the acquisition happen.

During the negotiation process, issues arose surrounding management structure, value and due diligence. While you had concerns, there was nothing tangible that you could point to (partially through lack of due diligence data and lack of access to management).

While your concerns were noted by the board and minuted, your parent and other board members were keen to proceed with the acquisition. A deal was concluded with adequate warranties and indemnities but the new board and management is heavily weighted towards the acquired business – a cost your parent was willing to pay for the prize of concluding what, on the face of it, looked a very attractive acquisition.

Post completion, the problems started to emerge and the lack of data provided in due diligence reflected the fact that it either didn’t exist or was at best incomplete.

The timing of the acquisition meant that the preparation of the year-end group accounts for X Pte Ltd included the last few weeks of your new acquisition. It became clear that you would need to disclose your findings to your auditors, as for some of the acquired companies, there were incomplete accounting records and incorrect exchange rates had been used historically for converting foreign exchange transactions and year-end balances.

In short, the preparation of audited, unqualified year end accounts was a significant challenge. You and your team achieved this through recreation of complete financial records, full reconciliations and seven day working for a period of some four months. To summarise: your auditors’ sign off, the audit committee is satisfied and your parent is grateful for your efforts.

Your parent’s results are due to be approved in 3 days time and all is well, until you discover a branch of an overseas subsidiary, Z Pte Ltd, which hasn’t been disclosed in due diligence, and for which no accounting records exist. You investigate the limited available information on this branch and tentatively conclude that it is not material.

What do you do on the basis that disclosure of this to your auditors may delay your parent company’s results announcement to the market?

What do you do now?

Analysis of Scenario: What are the readily-identifiable ethical issues for your decision?

I. For you personally

The need to consider whether disclosure of your findings has to be made known immediately to your fellow directors, the board of the parent company and the auditors.

What is the likely impact on your company’s (X Pte Ltd) accounts which have already been finalised?

II. For the company and group

Is there a supportive environment for open discussion of practical dilemmas without a recriminatory, or ‘blame’, culture? Is there someone within the group with whom you can discuss this dilemma?

Does your company have a Code of Conduct that provides guidance on such matters?

Was sufficient due diligence undertaken on this acquisition and will this issue impact on potential future acquisitions?

III. Who are the key parties who can influence, or will be affected by, your decision?

‘You’; your fellow directors in X Pte Ltd; the directors of Y Ltd; the directors of ABC Ltd; the directors or equivalent of Z Pte Ltd; the shareholders of Y Ltd; the auditors of Y Ltd (assumed same auditors as X Ltd and ABC Ltd); financial analysts; local tax authorities; and possibly foreign tax authorities.

IV. What fundamental ethical principles for accountants are most applicable and is there an apparent conflict between them?

-          Integrity: Can you retain your integrity by doing anything other than immediately informing your fellow board members and the Board of your parent company? Or, as your initial brief review indicates that the recently uncovered branch’s results are likely to be immaterial to the overall group, can you possibly delay releasing the information until after the auditors have signed off on your parent company’s accounts? Does the possibility exist that there are other components of the acquired subsidiary which have not yet been discovered?

-          Objectivity: The likely adverse consequences of delaying your parent company’s results announcement should not interfere with the decision which you have to make.

-          Professional behaviour: The need to ensure that the board of the parent company and then subsequently the auditors have all of the information required to allow them to perform their respective duties in relation to the group’s annual financial statements. The directors of the parent company are responsible for ensuring the truth and fairness of the group’s financial statements and the auditors are responsible for issuing an opinion on this. You also have to consider the consequences of this discovery on X Pte Ltd’s accounts which have already been finalised.

V. Is there any further information (including legal obligations) or discussion that might be relevant?

More detailed information on the newly discovered branch would be required to allow a proper assessment, both in qualitative and quantitative terms of its materiality. Does the possibility exist that there are further components of the group that have not yet been discovered?

VI. Is there a conflict between the ‘Guardian’ and ‘Commercial’ strands of an accountant’s responsibilities?

In this case, in the short-term there is the potential for conflict. If the parent fails to meet its reporting deadline this is likely to have a negative impact on its short-term share price. However, how would the market react if the parent company reported as planned and then concluded that it had to disclose a newly discovered branch at a later date?

This case study was published by the Technical Policy Board of The Institute of Chartered Accountants of Scotland (ICAS), and adapted by the Institute of Singapore Chartered Accountants (ISCA) with the permission of ICAS