3 thoughts on “Potential Accounting Tunneling Fraud at China Environment? (Part 2)”
As an add on to the Related Party Transaction: from 2012 to 2013; when one considers the change in the cost of goods sold for the company. The discrepancy becomes more stark, (395,448/317,795)-1 * 100 = 24.2%. Why did the Group’s operating expense paid for by the directors (emphasis) rise by such a disproportionate 166%?
Hi Terence and John, just commenting on both points. John was raising his comments for further debate and evaluation and some of the points raised were good questions for further debate.
Just to further address the concerns that John raised and further elaborate on Terence’s elaboration. While “reverting back to the mean” is something that happens quite often in terms of revenue, it is always important to question why sudden large decline occurs. Note I mean this from a normal’s investor’s POV and not with respect to fraud. (28% drop is huge). Also the group’s construction contracts are mostly 1 year in nature (refer to completion of projects vs. projects ongoing at end of year), which means large fluctuations in revenue could occur if contract procurement in that year does not occur. Thus highly fluctuating revenue in this case may not be an issue.
For the increase in investment in subsidiaries, refer to note 13 of the financial statements subsidiaries. Unquoted equity shares, at cost has increased from 577,950 to 699,460 or ~20% or 120m RMB. At the same time, if one were to compare details of the subsidiaries from the previous year to this year, there were no new subsidiaries. Which means the subsidiary has raised capital from the parent level. While my accounting is not fantastic and I would readily admit I might have got this wrong, I would like to ask why the increase considering that operating assets and cash are held at the subsidiary level. (From 2010-2012, unquoted equity shares, at cost have not changed). Just note that after you include the loan to subsidiaries, cash from Holding Co level to subsidiary has increased by RMB190m.
I think Terence has already argued his point regarding receivable turnovers versus industry, however do let me add another angle to the argument.
Firstly, lets establish trade receivable terms. ” Generally, the customers are required to pay immediately once the progress of the projects meets the payment terms stated in the sale contracts. However, customers generally retain 5% to 10% of the project sum as retention monies which are held for a warranty period of up to 12 months.” Next, considering the company completes a project within one year, and generally I would assume at least two payments if not three for a construction project. (Upfront, partial completion and end of construction). For more details, refer to slide 11 of http://www.chinaenv.net/attachment/2014030710221917_en.pdf
Thus, first lets use 10% of revenue to allocate as retention monies, that gives ~50m RMB. If I then assume thrice collection in a year, I should have days receivable outstanding at about 120 days. If i convert the 50m into DRO and even making it aggressive at 60 days. I should have DRO of 180 days, or collection twice a year which would mean trade receivables should be about half revenue. Much lesser than the current trade receivables of the company.
For point 3, what John argued for is right, companies do not necessarily give full disclosure and there could be various explanations which we would not know.
Point 4 – I would look at any borrowing from directors with suspicion. would you as a director lend 50m rmb to a company you were running? Why risk your own money and not borrow from a bank? Banks do provide working capital loans afterall. Also various funding options such as pledging receivables to banks to obtain loans are available, why borrow from their own director?
During the initial research phase on China Environment, I remember coming across the following announcements below. Readers of the second report would have noticed the same announcement on page 2 of the report (See report above).
“The contracts were entered into on commercial terms. None of the directors has any interests, direct or indirect, in the contract. As far as the directors are aware, none of the controlling shareholders of the Company has any interest, direct or indirect, in the contract.”
“SGX-ST’s Query:-
The statement “As far as the directors are aware” is not acceptable. Please rephrase the
sentence and confirm whether the Company is in compliance with Chapter 9 of the Listing
Manual of the SGX-ST. ”
Only then did they change and say they were compliant just two days after the initial announcement.
“Company’s responses to SGX-ST’s Query:-
The Board of Directors of the Company confirms that the Company is in compliance with
Chapter 9 of the Listing Manual of the SGX-ST.
The sentence is rephrased as follows:-
“The contracts were entered into on commercial terms. None of the directors and controlling
shareholders has any interests, direct or indirect, in the contracts”.”
I didn’t think this was an issue then because I gave them the benefit of the doubt, that it could be just a phrasing issue. But after the lesson on textual analysis by the Professor and also the presentations done by my classmates on how textual analysis can be a useful tool to analyse potential cases of accounting fraud, we can see how sometimes it is useful to scrutinise the statements made by companies, as they can sometimes reveal slips in intentions on the company’s part. In this case, which SGX also picked up on, their statement ” as far as the directors are aware” shows that China Environment has a questionable attitude towards accountability, as it indicates that they feel that there is no real need to really ascertain that there has been no conflict of interest, and feel that this excuse is enough to justify their lack of doing the necessary and proper checks on their contracts. While this alone doesn’t prove accounting fraud, it definitely shows a lack of responsibility on the company’s part. Their reply to SGX’s query is very unsatisfactory also, as they did not back up their statement with evidence, which also points to the possibility that they are merely being patronising with SGX’s compliance requirements.
AsianExtractor: Unearthing Accounting Fraud in Asia 
As an add on to the Related Party Transaction: from 2012 to 2013; when one considers the change in the cost of goods sold for the company. The discrepancy becomes more stark, (395,448/317,795)-1 * 100 = 24.2%. Why did the Group’s operating expense paid for by the directors (emphasis) rise by such a disproportionate 166%?
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Hi Terence and John, just commenting on both points. John was raising his comments for further debate and evaluation and some of the points raised were good questions for further debate.
Just to further address the concerns that John raised and further elaborate on Terence’s elaboration. While “reverting back to the mean” is something that happens quite often in terms of revenue, it is always important to question why sudden large decline occurs. Note I mean this from a normal’s investor’s POV and not with respect to fraud. (28% drop is huge). Also the group’s construction contracts are mostly 1 year in nature (refer to completion of projects vs. projects ongoing at end of year), which means large fluctuations in revenue could occur if contract procurement in that year does not occur. Thus highly fluctuating revenue in this case may not be an issue.
For the increase in investment in subsidiaries, refer to note 13 of the financial statements subsidiaries. Unquoted equity shares, at cost has increased from 577,950 to 699,460 or ~20% or 120m RMB. At the same time, if one were to compare details of the subsidiaries from the previous year to this year, there were no new subsidiaries. Which means the subsidiary has raised capital from the parent level. While my accounting is not fantastic and I would readily admit I might have got this wrong, I would like to ask why the increase considering that operating assets and cash are held at the subsidiary level. (From 2010-2012, unquoted equity shares, at cost have not changed). Just note that after you include the loan to subsidiaries, cash from Holding Co level to subsidiary has increased by RMB190m.
I think Terence has already argued his point regarding receivable turnovers versus industry, however do let me add another angle to the argument.
Firstly, lets establish trade receivable terms. ” Generally, the customers are required to pay immediately once the progress of the projects meets the payment terms stated in the sale contracts. However, customers generally retain 5% to 10% of the project sum as retention monies which are held for a warranty period of up to 12 months.” Next, considering the company completes a project within one year, and generally I would assume at least two payments if not three for a construction project. (Upfront, partial completion and end of construction). For more details, refer to slide 11 of http://www.chinaenv.net/attachment/2014030710221917_en.pdf
Thus, first lets use 10% of revenue to allocate as retention monies, that gives ~50m RMB. If I then assume thrice collection in a year, I should have days receivable outstanding at about 120 days. If i convert the 50m into DRO and even making it aggressive at 60 days. I should have DRO of 180 days, or collection twice a year which would mean trade receivables should be about half revenue. Much lesser than the current trade receivables of the company.
For point 3, what John argued for is right, companies do not necessarily give full disclosure and there could be various explanations which we would not know.
Point 4 – I would look at any borrowing from directors with suspicion. would you as a director lend 50m rmb to a company you were running? Why risk your own money and not borrow from a bank? Banks do provide working capital loans afterall. Also various funding options such as pledging receivables to banks to obtain loans are available, why borrow from their own director?
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During the initial research phase on China Environment, I remember coming across the following announcements below. Readers of the second report would have noticed the same announcement on page 2 of the report (See report above).
In their September 2013 announcement, see below, the directors made such a claim;
http://infopub.sgx.com/FileOpen/CEL_Major_Contract_Sept2013.ashx?App=Announcement&FileID=38148
“The contracts were entered into on commercial terms. None of the directors has any interests, direct or indirect, in the contract. As far as the directors are aware, none of the controlling shareholders of the Company has any interest, direct or indirect, in the contract.”
I remember picking up the above statement, and wondering whether the claim that “as far as the directors are aware..” was robust enough for assuring investors that there was really no conflict of interest. SGX also picked up on the statement, and pointed out that this was not good enough.
http://infopub.sgx.com/FileOpen/SGX_Query_Major_ContractAnnouncement.ashx?App=Announcement&FileID=38459
“SGX-ST’s Query:-
The statement “As far as the directors are aware” is not acceptable. Please rephrase the
sentence and confirm whether the Company is in compliance with Chapter 9 of the Listing
Manual of the SGX-ST. ”
Only then did they change and say they were compliant just two days after the initial announcement.
“Company’s responses to SGX-ST’s Query:-
The Board of Directors of the Company confirms that the Company is in compliance with
Chapter 9 of the Listing Manual of the SGX-ST.
The sentence is rephrased as follows:-
“The contracts were entered into on commercial terms. None of the directors and controlling
shareholders has any interests, direct or indirect, in the contracts”.”
I didn’t think this was an issue then because I gave them the benefit of the doubt, that it could be just a phrasing issue. But after the lesson on textual analysis by the Professor and also the presentations done by my classmates on how textual analysis can be a useful tool to analyse potential cases of accounting fraud, we can see how sometimes it is useful to scrutinise the statements made by companies, as they can sometimes reveal slips in intentions on the company’s part. In this case, which SGX also picked up on, their statement ” as far as the directors are aware” shows that China Environment has a questionable attitude towards accountability, as it indicates that they feel that there is no real need to really ascertain that there has been no conflict of interest, and feel that this excuse is enough to justify their lack of doing the necessary and proper checks on their contracts. While this alone doesn’t prove accounting fraud, it definitely shows a lack of responsibility on the company’s part. Their reply to SGX’s query is very unsatisfactory also, as they did not back up their statement with evidence, which also points to the possibility that they are merely being patronising with SGX’s compliance requirements.
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