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Restoring trust in financial reporting 

First published in The Business Times on 21 May 2013
Accounting profession should stand up for the rules it promulgates, and defend firms that comply with those rules

NOT long ago, Olam came under intense scrutiny. Allegations were made about its financial statements not clearly revealing the state of its financial health. Olam put in a robust defence. Its shareholders and the investor community paused to think hard about what was at stake.

With Olam's share recovering to the levels prevailing before the allegations started, I thought it was a good time to respond to a question that was raised: How can the accountants allow this to happen?

It is a valid question, highly relevant to our capital markets in Singapore which are built on trust. Trust that companies follow the rules, trust that auditors are independent and alert, and trust that enforcement agencies do their job.

When there is widespread fear that financial reports are unreliable, capital markets cease to function. An attack on a Singapore company that suggests it is not playing by the rules strikes at that trust.

This erosion of trust was clear, when in the midst of the storm a press commentary suggested that Olam should engage an independent international consultant based in New York, London, or Hong Kong to audit its books.

While I should state my interest as a Singapore-based accountant, I am happy that this was not the route that Olam chose.

I genuinely believe that our auditing profession in Singapore is entirely on a level footing with these globally respected centres. However, the nature of trust is elusive, and I understand why it is tempting to restore the trust that has been taken away by looking for it elsewhere.

This article focuses on that trust, which requires that all of us affected by the Olam saga understand the issues, beyond the interests and the emotions.

There were three key allegations relating to the accounts.

Firstly, it was that Olam's gearing was too high to be sustainable, and that it would shortly face bankruptcy.

Secondly, it was that Olam accounted for its plantation assets in a misleading way that inflates profits, by including as its income unrealised gains from the increase in value of crops not yet ready for harvest.

The third allegation similarly related to inflated profits and it was that Olam's income included "negative goodwill".

Let me take the first question first. An accountant's task here is to ensure that Olam's financial statements set out the facts relevant to its gearing: its borrowings, its interest burden, its cash flows.

The accounting for these items is not contentious. It is then for an investor to understand the financial information presented and interpret it, in this case as to whether the company's gearing is unsustainable.

There has been no suggestion that any of these facts were presented wrongly. As an accountant, on behalf of my profession, I feel acquitted of the charge.

The second and third questions are not as straightforward.

The ferocity and self-assuredness of the allegations by itself suggested that the numbers were wrong, and accounting methods suspect. This strikes at the heart of our capital markets, which depend on accurate financial information to function.

Accurate financial information has three key supports: consistent application of accounting standards, competent audits by independent auditors and supportive enforcement of the agreed rules.

In a world of investors having multiple investment choices, and having to choose between investing in Olam and investing in some other company, the only right way for Olam to account for its plantation assets is to follow internationally agreed accounting standards like everyone else.

Olam accounts for unrealised profits on its plantation assets, which gain in value as they get closer to harvesting.

Some investors do not like such treatment of revaluation profit, saying it takes up profit years before the crops are harvested and sold for cash. Other investors think that the gain in value needs to be recognised immediately in order to accurately judge the performance of the company in the current period.

Unrealised profits are also recognised when Olam buys businesses at a bargain price, a situation often referred to using the jargon "negative goodwill". The "saving" in the purchase price that Olam pays, when compared against the market value of the business purchased, is reported as income.

Some investors dislike this treatment for the same reason, that this is also a form of revaluation profit. Other investors think that such a gain made from an astute purchase should be recognised immediately, it being a legitimate measure of how well the company did.

In this particular debate, it does not work for Olam to poll which method investors prefer. This is why we have accounting standards, so that everyone can use the same language.

In choosing a standard from a range of choices, standards bodies carry out extensive consultation. The chosen standard is the one that has strong measure of support, but in practice this will never be unanimous.

With agreed accounting standards in place, what remains to be asked is whether Olam followed the accounting standards.

Its financial statements state that Olam complies with Singapore Financial Reporting Standards. Its auditors issued their independent report confirming that the financial statements comply with those standards. Neither party has found it appropriate to withdraw its report and reissue revised financial statements.

There will always remain room to disagree with an accounting standard on theoretical grounds.

Better ways

My point is simply that we do not shoot the messenger. We should not pick on a single company to hold it responsible for what we do not like about an accounting standard that everyone else uses. In fact, we expect all our companies to follow the same rules as everyone else and not make their own rules.

It is for the accounting profession to stand up for the rules that it promulgates, and defend the companies that comply with those rules. If in time to come we find better ways to account for these assets, we certainly should not hesitate to improve the standard.

In fact, with the International Accounting Standard 41 - Agriculture, changes are currently being contemplated for certain types of agricultural assets to be accounted at cost instead of regular revaluations.

It is clear that the various allegations took their toll on trust in financial reporting in Singapore. That Olam is recovering far better than the other companies (outside Singapore) that were subject to similar allegations of financial ill-health shows that this trust, although eroded, has a strong core.

The trust is not a God-given right but does require that each of us continue to do our part - that companies comply with accounting standards, that independent auditors carry out competent audits, and that supportive enforcement agencies reinforce the trust.

This article is contributed by Tham Sai Choy, who is the Managing Partner at KPMG in Singaore. He is also the chairman of the Financial Reporting Committee, Institute of Certified Public Accountants of Singapore.