Potential Accounting Tunneling Fraud at China Environment?

Part 2https://asianextractor.com/2015/02/17/potential-accounting-tunneling-fraud-at-china-environment-part-2/

Part 3https://asianextractor.com/2015/02/23/potential-accounting-tunneling-fraud-at-china-environment-part-3/ 


17 thoughts on “Potential Accounting Tunneling Fraud at China Environment?

  1. Thanks for raising this article @terence and shan rui. Just adding some more comments after looking at the company’s financials and AR.

    Went to dig out historical financials up to 2010, if one were to look at accounts receivable/ other receivables, Firstly, trade receivables have fluctuated greatly from 358m in 2010 to 479m in 2011, 347m in 2012, 490m in 2013. Receivables not growing in line with revenue is generally a red flag, in this case – a potential explanation could be the lumpy nature of projects accounting for the wide swings in receivables.

    However, the next red flag is that in 2012, PPE increased from 18.4m to 274m out of which construction in progress (capex figure – suddenly increased from 9.5m to 265m which was attributed to construction of the office building, steel fabrication plant, electronic control assembly plant and warehouse on the land of 16,536 square meters in Fujian Province (Note11) and prepayments for land use rights of 193,493 square meters in Anhui Province (Note 12).

    Why is there a lumpy increase in construction in progress all in one year and lumping all as CIP – while if the increase was due to a one off purchase in land, I would believe it to be more possible, however it attributes it to construction of office building, steel fabrication plant, electronic control assembly plant and warehouse in Fujian of 16,536sqm is visibly smaller than its current production facility of 46,572sqm. So there is no reason to see such a sharp increase in PPE. And in the case of prepayment for land use rights in Anhui (193,493 sqm) – base on the FY2013 annual report (Dec 2013 YE), the project should have been completed by Aug 2013, which also means the much larger project should have been completed and no longer accounted for under CIP. Once again raising questions about the capex spending that the company has adopted.

    Liked by 1 person

  2. This is an interesting piece of work especially since this company has been on most investors’ attention over the past few months. However there are some points that I have a different insight to.
    1) Regarding investment in subsidiaries, I followed you to pg93 of their 2013AR, I can’t seem to find RMB121.5m that you were mentioning. In addition, I think that the increase in subsidiaries is be a natural subset of the increase in retained earnings held by those subsidiaries. (I’m not accounting-trained, I could be wrong?)
    2) Looking at trade receivables on pg95 of 2013AR, China Env had an increase of RMB150m. However when you look at their cash flow statement on pg67 2013AR when you net out FY12 decrease in receivables of 177m and FY13 increase in receivables of 183m, net-net increase in receivables is minimal. I direct your attention to Q3’14 results, they actually show RMB204m increase in receivables. This is significantly huge as compared to Q3’13 amount of RMB79m. Despite the red flags the increase in receivables have caused, I feel it would be fair to observe the receivables’ number for a few more quarters. In pg15 of their Q3’14 results, they stated that “Based on the trade receivables as at 30 September 2014, approximately 50% of our customers are state-owned enterprises or government-linked enterprises and approximately 25% of our customers are public listed companies.” Since they do business with SOEs, I would be less concerned about the fluctuating trade receivables number.
    3) Focusing on your point 6 whereby you state “operating expenses paid on behalf by directors” (NOT paid on behalf of directors), it seems to me that directors paid these these amounts with their own cash (RMB36.9m in FY13, RMB13.8m in FY12) and they were reimbursed exactly the same amount under “repayments to directors”.


  3. I agree with Ronald regarding the build-up of their PPE.

    In pg12 of 2012AR, the company disclosed the land cost and construction cost in Anhui to be RMB295m. A filing with SGX shows that land costs RMB49m. that would imply construction cost of RMB246m. The construction cost relative to land cost is high and I am highly doubtful of the high construction cost.

    (link for Anhui land filing: http://infopub.sgx.com/Apps?A=COW_CorpAnnouncement_Content&B=AnnouncementLast3rdYearSecurity&F=68CF159FD6051E1C482579D400209245&H=d38e5489e312125ad6da9a23a002b8db84ff2131c5e0ffafc7fdb4fbbcbf9dbf#.VNrrXnacxEw)

    Liked by 1 person

  4. Thanks for the additional insights Ronald and Roy. Admittedly this report is limited by the latest annual report we can get our hands on to do some quick back of the envelope calculations on the company given that they have gained quite a sizable of attention with their staggering rise in the last few months as Roy rightly pointed out.

    On to Roy’s question about the increase in investments in subsidiaries; I direct you to page 93 of the AR2013; you’ll find the above mentioned increase by subtracting 2013 unquoted shares at cost with AR2012’s numbers; as I highlighted in my report, in reaching this, I have ignored the effects of currency alignment in my calculations. It is the view of the author’s that given that the shares are unquoted, more information should be given to investors and proper accountability of what the money is to be used for.

    To Roy’s third point, we raise the question of why the operating expenses were paid for by the directors.

    Liked by 1 person

  5. With regards to Terence’s question on increase in investment in subsidiaries, China Env has filed its disclosure with SGX on 7 Nov 2013 with regards to the increase in paid-up capital of its subsidiaries and the purpose of increasing the paid-in capital. It has been accounted for with their filing through SGX.

    The pertinent question that investors have to find out as what Ronald has mentioned is the accounting of PPE on their balance sheet. Clearly their Anhui factory has been completed in Aug 2013 and it should not be classified under CIP on their balance sheet. Their corporate presentation on 7 Oct 2013 supports the claim that their Anhui’s factory has been completed.

    (Link for increase in paid-up capital: http://infopub.sgx.com/Apps?A=COW_CorpAnnouncement_Content&B=AnnouncementLast2ndYearSecurity&F=8A04BAFDACF7514648257C1C00305945&H=2ff9cfdb7f0f59be62ccf6cd861ffdc5814c303b1617d1c2162210170dc52efa#.VNw6_nacxEw)

    (Link for corporate presentation: http://infopub.sgx.com/Apps?A=COW_CorpAnnouncement_Content&B=AnnouncementLast2ndYearSecurity&F=FE087F6B9AC9F0FA48257BFD0047BD38&H=92d01aa68230fc5c382ea4cf2e8f3a0c0ecc2ec44d14c719cffe532526d98203#.VNw7tXacxEw)


  6. My problem with your point is that it only addresses where the RMB48,090,000 went. (S$10,500 x 1 SGD/4.58 CNY*), that means only about 40% of the amount is accounted for. What about the rest of the 60%?

    The RMB48,090,000 is used to invest in their subsidiary “China Dongyuan Environment Pte Ltd (“CDY”)” who in turn invested RMB50,000,000 in Fujian Dongyuan Environmental Protection Co.

    The purpose of the investment was according to their announcements, to The rationales for the increase in investment in FJDY through CDY are to:

    “(a) support the growth of the Group’s business and operations in the PRC, including funding
    of strategic investments, joint ventures, acquisitions and/or strategic alliances as and
    when such opportunities arise and are deemed appropriate by the Board;
    (b) acquire fixed assets for production purpose; and
    (c) be used as general working capital for the purposes of (i) purchase of raw materials for
    production purpose and (ii) settling general overheads of the Group.”

    How much is exactly to be set aside for each item? Why is there a need to transfer the sum in this manner?

    Even ignoring the above transactions, on page 54 of the annual report 2013,

    The Company has on 13 October 2013 (the “Effective Date”) entered into a loan agreement with the Executive Chairman of the Company, Mr Huang Min (the “Lender”), for obtaining S$12 million interest-free loan from the Lender. The loan tenure is one year from the Effective Date or the date notified by Lender in writing. The loan is provided by the Lender without any collaterals or charges from the Company. The loan proceed will be transferred to the Company’s
    wholly-owned subsidiary, Fujian Dongyuan Environmental Protection Co., Ltd. to meet its working capital requirement.

    I direct you to the last line, this means that a total of RMB103,500,000 (based on my back of the envelope calculations) has been transferred to Fujian Dongyuan Environmental Protection Co., does the above disclosure from the announcement mean that the initial transfer is insufficient to cope with their operating needs?

    The total sum of RMB103,500,000 represents about 90% of their increase in revenue in 2013.

    *Rate taken as of today 12th Feb 2015, actual amount might vary slightly.

    Liked by 1 person

  7. Thank you Terence for your detailed response. As per pg93 of 2013AR, the group stated that they have 3 main subsidiaries; China Dongyuan Env, Gates Engineering, Infinitron Asia. The former should be the main operating subsidiary of China Env and has paid-in capital of ~RMB175m. With regards to Gates Engineering and Infinitron Asia, perhaps Terence, you could assist me in finding out the paid-in capital for the other 2 subsidiaries. In additional, it would be great if you could share with us the technical aspects of how a company consolidates the subsidiaries in general. (ps I’m not accounting-trained)

    With regards to the point of the capital being transferred in this manner, we have to understand the structure of the Group as per pg93 of 2013AR. The capital is transferred from China Env Group to China Dongyuan (CDY) . As Fujian Dongyuan (FJDY) is a subsidiary of China Dongyuan, hence capital was transferred from CDY to FJDY.

    With regards to the allocation of proceeds, I believe it to be similar to the allocation of its proceeds from its 65m share offering. This is so as the money for the paid-in capital came from the 65m share offering.

    In addition, I feel we could invest more time into breaking down the PPE number instead.


    • Thanks CK. We have discussed several actual – and potential – Asian fraud cases using an analytical and critical thinking framework about how expropriation or tunneling of wealth can be carried out for instance through related party transactions (RPTs), JVs and corporate investments, and how there are some eerily similar accounting transgression thumbprint patterns left behind in a proprietary framework. Controlling owners and managers have more discretion in setting transfer prices for “intellectual property” or “intangible-intensive” goods which are harder to value than tangible assets.

      For example, a firm could set up a separate legal entity with minimal real operations; transfer an intangible assets such as a patent, copyright, or trademark to the entity; and then use a royalty or similar arrangement to shift income to the entity which the owners subsequently expropriate for his or her own personal gains.

      In addition, the use of JVs under the accounting treatment of equity method avoid balance sheet recognition of the assets and liabilities of investees; the income statement also lacks detail on investee revenue and expenses. They become an important tool for fraud perpetrators to hide debt in the JVs since they need not be consolidated – and they are usually unaudited. In short, they become a fertile ground to shift and hide expenses and debt, as well as shift income back to the controlling parties where economic control is definitely not neatly defined by percentage shareholdings. Economic substance should prevail over ‘legal’ form.

      We will be sharing in the course the relationship between accounting fraud and securities fraud (stock manipulation and pump-and-dump schemes using action-based, information-based and trade-based manipulation methods). For instance, as part of the scheme, shares are transferred to stock-promoter-controlled nominee accounts which are used to execute a series of “wash-sale” trades (buying and selling of shares amongst their own accounts) to create artificial price run-ups which attract huge trading interest by naive investors, at which point the “insiders”, syndicates, stock promoters and pool-operators take their profits.

      Essentially, screening for high net cash or high net current asset as a percentage of market cap, and low price-to-book valuation ratio, might be the first step for many Graham-style net-net “value investors”, so that the “liquidation value” acts as the floor to protect downside risk against further price declines, thus providing call-option-like returns as mean-reversion works its magic to realize returns over time for the patient value investor. This is highly misleading. We share in detail both actual and potential fraud Asian cases the four key accounting mechanisms in how artificially high net cash and net current asset stocks are ironically more prone to frauds in Asia due to the prevalence of money-go-round tunnelling opportunities via related-party transactions to generate artificial sales and they unravel in accounting scandal.

      Some basic info on this topic in our course:

      Related links to our course:

      Week 1: Survival in the Asian Capital Jungle: Who Knows What When – Remembering Accounting Superhero Abraham Briloff (Link) (108 slides)

      Week 2: Western Tools To Catch An Asian Snake? (Link) (111 slides)

      Week 3: The Incentivized Asian “Wedge” Snake to Tunnel Corporate Wealth (Link) (86 slides)

      Week 4: Shedding of the Asian Snake’s Skin: The Opportunistic Tunneling of Corporate Wealth (Link) (157 slides)

      Week 5: Descend into the Asian Snake’s Lair, Occult Offshore Centers, Tax-Tunneling, and Consolidation Craftiness (Link) (89 slides)

      Lifelong learners might also find the below resource link of articles to be interesting:

      Alternatively, one may go to Google search and type in “Accounting Fraud in Asia” or “Detecting Accounting Fraud in Asia” and some of our articles are found in the first page.

      Warm regards,

      Liked by 1 person

      • In the words of the late economic architect Dr. Goh Keng Swee, we desire to “explain, inform and educate” our abhorrence of stock manipulation schemes and potential accounting frauds in the Asian capital jungle.

        We hope that the regulatory authorities in Asia will take a more serious and proactive (as opposed to reactive) approach to tackling stock manipulation and potential accounting frauds and restore trust in the capital markets. The large transfer of wealth from outsiders to insider manipulation significantly discourage how much and how many outside investors choose to invest in the market. The presence of manipulators impose large participation costs for genuine participants trying to either invest or raise capital in equity markets and explain why market reforms are hard to implement and emerging equity markets remain a fertile playground for the professional manipulators and insiders who have the incentive and power to manipulate prices, volumes, information and to inject “action” to lure investors and then offloading in a pump-and-dump scheme via related-party and accounting money-go-round transactions.

        We need to make right the capital market phenomenon that the sagacious Peter Bernstein aptly described: “The ‘gulls amongst the public to feed the maws of professionals’ seem to replenish itself with remarkable regularity regardless of how many gulls drop out along the way.”

        Liked by 1 person

      • Brief notes for the general reader to understand more about accounting fraud via tunneling using intercorporate loans, other receivables, and short-term financing schemes (one of the four commonly-used methods used by actual insiders and syndicates to expropriate cash and assets out of the firm):

        Step 1: Listco engages in “intercorporate loans”
        DR “Other Receivables” (or prepayments, advances, cash equivalents, etc)
        CR Cash (raised from IPO, SEO, bank etc)

        Step 2: Generates artificial or fraudulent sales via undisclosed related-party transaction disguised as fictitious “customers” (this is not observable in the financial statement, but will show up in Step 3)
        DR “Cash” (“cash” or short-term financing loans re-enters the listco)
        CR Sales (artificial or fraudulent sales)

        Step 3: Check for artificial or fraudulent sales
        DR “Other Receivables” (or prepayments, advances, cash equivalents, etc)
        CR Cash (raised from IPO, SEO, bank etc) – strikethrough
        DR “Cash” (“cash” or short-term financing loans re-enters the listco) – strikethrough
        CR Sales (artificial or fraudulent sales)

        The accounting transgression thumbprint left behind:
        DR “Other Receivables” (or prepayments, advances, cash equivalents, etc)
        CR Sales (artificial or fraudulent sales)

        Changes in “Other Receivables”, cash equivalents, prepayment, advances etc, or accounts that are short-term financing schemes should not lead to revenue generated. Only the sale of products or performance of service obligation leads to revenue transactions. If there is a “matching” debit or increase in other receivables and a credit in sales, Step 2 shows up, that is, sales was generated using fictitious customers disguised as undisclosed related party transactions. Th

        When the insider decides not to maintain the scheme, as in the case of the “missing cash” syndrome in the S-Chips and HK-listed P-Chips, the transactions unwind and a plunge in sales correspond to a plunge in these “Other Receivables”, cash equivalents, prepayment, advances and short-term financing accounts.

        Thus, traders and investors using aggregate financial accounting numbers to derive superficial financial ratios (e.g. profit margin, return-on-equity) and valuation metrics (e.g. low price-to-earnings, low price-to-book) without understanding the underlying business model, the related-party transactions artificially inflating the aggregate financial numbers and the data generation process in the financial footnotes can be misled.

        We have observed this accounting transgression pattern in a comprehensive list of Asian companies that unravel in actual accounting fraud. We are happy to share our findings with the regulators, including the White Collar Crime Investigation unit of CAD (Commercial Affairs Department).

        KB Kee

        Liked by 1 person

  8. For anyone still following the case on China Environment, these are the latest updates on the Company.

    3rd June 2016 – Resignation of China Environment’s Auditors Baker Tilly
    The reasons cited for this is the “…difficult relationship between component auditor (i.e. Baker Tilly China) with the Company’s management team in China (“management team”).”
    You can see the link for yourself here – http://infopub.sgx.com/FileOpen/Change%20Auditors.ashx?App=Announcement&FileID=407867

    Following the above announcement, both of their Executive Directors Andrew Bek, 49 and Wu Jida, 46 resigned on the 23rd of June 2016. According to the SGX announcement, Andrew Bek has resigned to pursue further interest and career, whilst Wu Jida resigned due to health reasons.
    You can see the link for yourself here – http://infopub.sgx.com/Apps?A=COW_CorpAnnouncement_Content&B=AnnouncementLast3MonthsSecurity&F=PUROZCCKILDOXAZS&H=998bd7ca7cff3f921e92a14c5827cd9c0f75fe54fe0d2dfff0d13f075fa23149


    China Environment has therefore, effective on 24th of June this year requested for suspension of their shares – http://infopub.sgx.com/Apps?A=COW_CorpAnnouncement_Content&B=AnnouncementLast3MonthsSecurity&F=8YDTO6TUNLVDCIHT&H=ac41fe9c6e9e18b028c88dbbaff2b36a1541626ec14e5b9b1ff116140ed5a671

    According to the Board, the suspension was due to recent developments of the Company: 1) ACRA’s requirement to restate and refile the financial statements for FY2013 and FY2014 and 2) the resignation of the two executive directors on the 23rd of June 2016.

    They have also filed on the 12th of August 2016 the Application for and Further grant of extension of time to hold their Annual General Meeting.

    Their shares remain suspended.


  9. The Board of Directors of China Environment has lodged a report against former Executive Chairman Huang Min and former CFO Chiar Choon Teck. See below. You can also see the link here; http://infopub.sgx.com/FileOpen/CEL-CAD.ashx?App=Announcement&FileID=433681 filed with SGX.

    The Board of Directors of China Environment Ltd (the “Company” and, together with its
    subsidiaries, the “Group”) wishes to announce that the Company has lodged a report to the
    Commercial Affairs Department of the Singapore Police Force against its former Executive
    Chairman Huang Min and its former Chief Financial Officer Chiar Choon Teck in respect of
    the non-existent receivables, as announced on 21 September 2016.

    The Company will keep the shareholders informed on material developments.

    China Environment Ltd.
    Norman Winata
    Executive Chairman
    21 December 2016


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